by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning.  It’s GDP day!  After two brutal down days, mostly driven by worsening infection rates and the lack of fiscal support, equity markets are trying to recover.  As expected, GDP had a historic recovery, up 33.1% (q/q% annualized).  This is the largest quarterly gain ever; of course, much of this is due to the “magic” of annualization.  Things were never as bad as Q2 looked or as robust as these numbers appear.  We detail the data below.  Hurricane Zeta has made landfall.

Market comments lead off our coverage.  Pandemic news follows.  China news comes next, including reports on an operation by Chinese operatives to bring back wanted nationals from within the U.S.  Next up are economic observations, including several central bank meetings.  Brexit follows.  We take note of the tech executives’ congressional testimonies.  Reports on Spain and Catalonia follow, and we close with comments on the WTO.  Being Thursday, the Weekly Energy Update is available.  This week, we take a look at the natural gas market.  And, the Q4 2020 Asset Allocation Rebalance Chart Book is also available, where we discuss recent allocation changes and provide the economic background for our decisions.  Lots going on; let’s get to it!

 The markets:  Yesterday was a tough day in the financial markets.  Not only did we see a swoon in equities, but Treasuries, the usual diversifier, also saw prices decline.  Gold prices fell too.  Equities and gold have been following a similar pattern recently, most likely because both have become dependent on policy liquidity.  Thus, the news that there wouldn’t be any fiscal package before the election hurt both.  Former NY FRB President Bill Dudley’s comments that the Fed may be out of tools probably didn’t help.  His comments are patently false; the Fed could engage in negative interest rates (like the ECB) or buy equities (like the BOJ), but it is arguable that these may not be all that effective.  We suspect Dudley’s goal was to highlight the need for fiscal support; however, the timing of his comments was not helpful.

So, what do we think?  The resurgence of the virus is clearly unwelcome.  As we note below, Europe is starting to lock down.  We don’t expect a nationwide lockdown here, but between local actions and a general reluctance of people to risk infection, the service sector is looking at a bleak winter.  Fiscal support would clearly help.  That won’t happen until after the election, and, even then, it may disappoint.  In the long run, immunity, either through widespread infections or a vaccine, is the best answer to growth.  Election jitters are also playing a role.  Although the potential for tail risk is elevated, much of that has been anticipated.  The slope of the VIX curve suggests an elevated level of fear as do high cash levels.  If the outcome of the election isn’t as dire as the worst-case scenario, we would not be surprised to see a relief rally.  We have not finished our 2021 Outlook, because publishing it before the election seemed imprudent.  We are not expecting a strong economy for at least the first half of next year.  That isn’t necessarily negative for equities as slow growth also means less inflation pressure.  At some point, though, we will need to see a new expansion emerge.

 COVID-19:  The number of reported cases is 44,583,829 with 1,175,684 deaths.  In the U.S., there are 8,895,432 confirmed cases with 227,703 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high frequency data on various factors.  The Axios weekly state chart is updated; infections are rising in most states.

Virology: 

• Germany and France announced national lockdowns. Both Chancellor Merkel and President Macron were trying to avoid this measure, but the surge in infections has not been curbed by partial measures.  Macron has warned his country that this winter wave may be worse than what we saw in the spring.  Meanwhile, the U.K. is also trying to avoid national measures, but infection rates are rising quickly, which may force PM Johnson to act.
• In the U.S., hospitalizations are rising rapidly; this will likely cause capacity issues in the coming weeks.
• European researchers have determined that this surge in infections appears to be a new variant of the virus. Mutations are normal.  In fact, sometimes they are favorable.  A virus can change into a form that is less virulent.  This variant of COVID-19 emerged among agricultural workers in northeastern Spain.  The characteristics of this mutation have not been determined.
• China has seen a modest rise in infections.
• A recent study from Tennessee concludes that mask wearing was effective in reducing hospitalization for COVID-19. Masks remain politically controversial, but this study does suggest that masks seem to have a protective effect.
• The U.S. has announced that Medicare and Medicaid will cover the cost of the COVID-19 vaccine. This decision will improve the distribution of the vaccine when it arrives.
• Egypt has become a proving ground for vaccines. The country has the capability to produce vaccines and has a large population.  Russian, Chinese, and Western nations are working on arrangements to test their vaccines on Egyptians.

China:  Here is the latest news:

• The DOJ has charged eight people tied to a case where Chinese operatives were engaged in trying to coerce two Chinese nationals living in the U.S. to return to China. Dubbed “operation Fox Hunt,” these eight, a mix of Americans and Chinese, were seen to be harassing this targeted couple.  The DOJ has indicated they were involved in illegal surveillance and making threats.  The U.S. action shows that the government is determined to provide a safe harbor for Chinese citizens who have fallen from favor with Beijing.
• The U.S. is basing Coast Guard cutters in American Samoa and allowing the vessels to counter Chinese activities in the region. This is further evidence of rising tensions in the region.
• SoS Pompeo is on a tour of Southeast Asia; his latest nation to tour is India. The U.S. is actively seeking to engage India to ally against Beijing.
• China remains well behind its targets for imports as part of the Phase I trade deal.
• The U.S. reiterated its commitment to Japan’s security, saying it would defend the Senkaku Islands if necessary. These islands have been a point of contention between China and Japan.
• In search of yield, foreign investors have been snapping up Chinese bank bonds. Purchases for the first eight months of 2020 exceeded those of the past three years combined.  Although China is actively seeking this investment (it has eased regulations to foster it), there is a downside.  It is becoming more difficult for China to manage its financial system and exchange rate.  This problem represents the tradeoff China is facing.  If it wants to internationalize the CNY and make it a competitor for the USD, it will be forced to give up control of its financial system.

Economic news:

• The ECB, as expected, has kept policy steady. As it faces another bout of deflation and pandemic issues, there was some speculation of further easing.  In its comment, the ECB sent a signal that further support is more likely at the December meeting.  We suspect the bank wants to see the impact of EU fiscal actions before adding to stimulus.
• The Bank of Canada left rates unchanged yesterday but also offered forward guidance, suggesting that rates will stay low through 2023.
• The Bank of Japan also left policy unchanged and suggested that the economy is gradually recovering.
• We have been warning for some time that state and local government spending could act as a drag on growth in future quarters. The evidence continues to mount that these governments are facing a severe challenge, and growth will be adversely affected if aid isn’t forthcoming.
• At the onset of the pandemic, there was a rent moratorium. As those measures end, the rental market is facing a crisis.  Renters can’t afford to pay their rent.  Landlords have no choice but to evict but probably face the prospects of lowering the rent to find new tenants.  All this suggests a spiral of problems developing. Again, fiscal support could stave off this problem.
• The Department of Homeland Security is proposing changing the H-1B visa program to have a bias toward filling higher-paid positions rather than a lottery. The idea is that by making this change, lower-paid workers would face less competition from foreign workers.

Brexit:  There does appear to be progress in talks, although fishing remains a sticking point.  The next two weeks are critical to progress.  The EU is taking steps to ensure dual equity listings will function after Brexit.

The curious case of Catalonia:  According to reports, a Russian group offered Catalonian officials 10,000 soldiers to support the province’s separation from Spain.  It appears Catalonian leaders declined the offer, although the existence of it is clearly odd.  Spain has arrested several people who are alleged to have funded the exile of Catalan President Carles Puigdemont.

Technology:  The leaders of several tech firms faced congressional questioning yesterday.  While there is bipartisan disapproval, the issues for the two sides are different.  The right-wing is afraid of social media censoring, and the left fear the growing power of the firms and their spreading of disinformation.

• The healthcare system is being hit with ransomware attacks.

WTO:  The WTO is in the process of selecting a new leader.  The 164 members, less the U.S., approved Ngozi Okonjo-Iweala to the post.  The U.S. opposes her because she has no background in trade.  Other nations criticized the U.S., suggesting Washington’s disapproval had more to do with undermining the organization.  The WTO works on consensus, so the U.S. rejection means, for now, that the WTO continues to operate without a new leader.

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