by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today focuses on international news, including a U.S. victory in its dairy trade dispute with Canada and the latest OPEC+ decision on oil supplies.  We also cover several developments related to China’s real estate and technology sectors and a new treaty between Japan and Australia to enhance their defense against potential Chinese aggression.  We wrap up with the latest news on the coronavirus pandemic.

United States-Canada:  In the first-ever use of a new dispute resolution panel established by the U.S.-Mexico-Canada Agreement of 2020, the Canadian government will be forced to end tariffs on U.S. dairy products worth hundreds of millions of dollars.  If Canada doesn’t come into compliance by the deadline of February 3, the U.S. could begin the process of initiating tariffs or other countermeasures.

OPEC+:  After a meeting yesterday in Vienna, the Organization of the Petroleum Exporting Countries and its Russian-led allies (OPEC+) said they will continue with their plan to boost global oil sales by 400,000 per day.  The group is betting the surge of coronavirus infections from the Omicron mutation will have only a limited impact on rebounding energy demand.

• Oil prices surged in response to the sign of confidence in demand, after initially shrugging off the news.
• In London, Brent crude jumped almost 2.0% to approximately $80.50 a barrel, while U.S. crude surpassed $77.50, almost a six-week closing high.

Kazakhstan:  President Kassym-Jomart Tokayev accepted the resignation of his prime minister and the rest of his government after protestors took to the streets in major cities demanding action against rising prices for energy and other basic commodities.

• As we have warned, periods of rising commodity prices often lead to political unrest in less developed countries.
• The unrest in Kazakhstan is notable because the Central Asian country has been tightly controlled by its government since it was a member of the Soviet Union.  Reports indicate mass protests are continuing even after the government’s resignation.
• In response to the situation, the country’s bond values have declined significantly so far today, illustrating what could be in store for other emerging markets that might face similar inflation-inspired unrest.

China Real Estate Sector:  Heavily indebted real estate developer Evergrande (EGRNY, USD, 4.97) said it would meet January 7-10 with holders of one of its onshore bonds to negotiate payment delays.  The meeting may provide additional clues about how the government will manage the firm’s massive debt default.

• The government’s clampdown on heavily indebted developers remains a major threat to China’s economic growth in 2022, especially with some big players already defaulted and facing difficulties completing current projects.  Home sales have also been falling.
• Reflecting the likelihood of a slowing economy, new data shows banks trying to meet their annual lending quotas in late December focused much more on buying bankers’ acceptances than putting their money at greater risk by issuing loans.

China Technology Sector:  Internet giant Tencent (TCEHY, USD, 57.37)  has cut its stake in a highly valued Southeast Asian internet company, shedding an ownership position worth about $3 billion.  Coming on the heels of other such divestments by Chinese technology firms, the move has sparked concerns that the Chinese government is pressuring them to shrink.  In response, Chinese tech stocks trading in Hong Kong have fallen sharply today, with Tencent itself down approximately 4.3%.  As with the real estate sector, Beijing’s tightening regulatory noose continues to present growing risks for investors.

Japan-Australia:  Japanese Prime Minister Kishida and Australian Prime Minister Morrison will hold a virtual summit tomorrow to sign a historic defense and security treaty.  The reciprocal access agreement will provide a framework for enhanced interoperability and cooperation between the two countries’ militaries.

• The agreement will be only the second such treaty for Japan, after the longstanding agreement that governs its hosting of U.S. troops and cooperation with the U.S. military.
• More broadly, it illustrates the growing defense cooperation among many key U.S. allies in the Indo-Pacific region as they face China’s growing geopolitical assertiveness.

North Korea:  According to Japanese and South Korean officials, North Korea fired a suspected ballistic missile into waters off its east coast early today, continuing a series of tests it has conducted while rebuffing Biden administration offers to reopen arms control talks.

Italy:  Parliament has formally launched its process for electing the country’s next president, with voting set to begin on January 24.  Prime Minister Draghi, the former ECB chief, has announced that he would be willing to serve as president, but that would raise the prospect of renewed Italian political instability by ending the current unity government and forcing new elections.

Autonomous Vehicles:  Deere & Co. (DE, USD, 371.29) announced that it has developed a fully autonomous tractor designed for large-scale farming.  The tractor, a version of the company’s 410-horsepower 8R machine, will be available for sale later this year.

COVID-19:  Official data show confirmed cases have risen to 295,242,378 worldwide, with 5,455,889 deaths.  In the U.S., confirmed cases rose to 57,041,530, with 828,436 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who have received at least their first shot totals 244,947,293.  The data show that 73.8% of the U.S. population has now received at least one dose of a vaccine, and 62.2% of the population is fully vaccinated.

• The CDC issued updated quarantine guidance.  Now, if an infected person has access to testing and wants to get tested, the best method would be to use an antigen test (also known as a rapid test) toward the end of their five-day isolation period. The person should continue to isolate until day 10 if the test is positive but can end isolation after five days if the result is negative, as long as the individual wears a well-fitting mask around others.
• A panel of outside experts advising the CDC today will consider whether the vaccine from Pfizer (PFE, USD, 54.53) and BioNTech (BNTX, USD, 224.09) should be authorized as a booster for adolescents aged 12 to 15.
• Walmart (WMT, USD, 142.00) and Kroger (KR, USD, 46.17) said they are raising their prices for BinaxNOW at-home, rapid COVID-19 tests, after the December 31 expiration of a deal with the White House to sell the test kits at cost, $14.  Walmart is increasing the price to $19.98 a box, and Kroger now sells them for $23.99.
• In France, President Macron is being criticized for saying in an interview that he is deliberately trying to “p*** off” the unvaccinated by depriving them of restaurants, cinemas, and social activities as a way to pressure them to get inoculated.  Ahead of the elections coming up in a few months, the king (oops! I mean president) is being criticized by his political opponents not only for his vulgar language but also for his lack of empathy toward those who are afraid or can’t get vaccinated.
• In Hong Kong, the arrival of the city’s first Omicron cases has prompted the government to impose a two-week ban on incoming flights from eight countries, including the U.S.  The government is also banning nighttime dining and closing bars for the period.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

We open today’s Comment with a couple of U.S.-related developments, including news that a Russian recently extradited from Switzerland on insider-trading charges may actually have information on the Russian government’s interference in the 2016 U.S. presidential election.  We next review a range of other global and international developments, and we close with the latest news on the coronavirus pandemic.

U.S. Telecom System:  AT&T (T, USD, 25.43) and Verizon (VZ, USD, 52.44) have agreed to postpone the rollout of their new 5G service until January 19   The nation’s airlines will address potential interference issues with cockpit communications systems.  The decision came after initially refusing a request by the Transportation Department and FAA over the weekend.

• The reversal came as the FAA was preparing to issue flight restrictions that the airlines worried would significantly disrupt air travel and cargo shipments around the country.  In response, the airline industry association was reportedly preparing to file a lawsuit demanding postponement of the rollout.
• The quick turn of events may reflect intense pressure on the telecommunications firms to avoid worsening the supply shortages and operational disruptions that contribute to today’s high inflation.

United States-Russia:  Court filings indicate that Vladislav Klyushin, the Russian technology tycoon extradited to the U.S. from Switzerland on insider trading charges in mid-December, is close to high-level Russian officials and may have inside knowledge of their efforts to interfere in the U.S. presidential election in 2016.

• According to people in Moscow who are close to the Kremlin and security services, Russian intelligence has concluded that Klyushin has access to documents relating to a Russian campaign to hack Democratic Party servers during the 2016 U.S. election.
• These documents, they say, show the hacking was led by a team in Russia’s GRU military intelligence that U.S. cybersecurity companies have dubbed “Fancy Bear” or APT28.
• Such a cache would provide the U.S. for the first time with detailed documentary evidence of the alleged Russian efforts to influence the election, according to these people.
• If Klyushin cooperates and provides more information on the Russians’ election interference or broader cyberattacks, U.S.-Russian relations are likely to worsen even further.

Cryptocurrencies:  New reporting says about 10% of the notoriously conservative customers at German savings banks have held cryptocurrency assets.  The data comes as multiple mainstream banks outside the U.S. are starting to experiment with offering cryptocurrency wallets and other services to their clients.

Indonesia:  The energy ministry has proposed banning Indonesian coal exports for the month of January in the face of looming shortages for the nation’s electricity generating plants.

• Officials will meet tomorrow to refine their plans, but coal prices in China have already jumped, threatening a new energy crisis like the one in October that shut down factories and caused electricity prices to soar.  A ban would also likely drive coal and electricity prices up in India, another major importer of Indonesian coal.
• On the other hand, the proposed ban benefits major coal producers in Australia, who have seen higher prices.

Sudan:  Prime Minister Abdalla Hamdok has resigned, leaving the military-led government with no civilian members.  The move will put more pressure on the generals to move toward elections, as they have promised since taking over in an April 2019 coup, but protests and demonstrations are likely to increase in the meantime.

COVID-19:  Official data show confirmed cases have risen to 292,169,523 worldwide, with 5,446,606 deaths.  In the U.S., confirmed cases increased to 56,155,350, with 827,341 deaths.  For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.  Meanwhile, in data on the U.S. vaccination program, the number of people who have received at least their first shot totals 243,527,564.  The data show that 73.3% of the U.S. population has now received at least one dose of a vaccine, and 62.0% of the population is fully vaccinated.

Virology

• Driven by the highly transmissible Omicron mutation and catch-up reporting after the holidays, new U.S. infections rose to a pandemic record of 1.08 million yesterday.  The seven-day average of new cases rose to 480,375, also a pandemic record.  The surge prompted several Wall Street banks, which have been among the biggest champions of returning to the office, to backtrack on those plans and encourage those who could work from home to do so.  Hospitalizations for confirmed or suspected COVID-19 reached a seven-day average of 97,855, up 41% in the past two weeks.  However, that was still comfortably below the pandemic peak of 137,510 last January 10.
• Starbucks (SBUX, USD, 116.68) yesterday said that workers in its U.S. cafes, offices, and manufacturing plants must be vaccinated by February 9 or get tested weekly. Workers who choose to test must have a pharmacist or doctor administer it rather than taking one at home; workers themselves will need to obtain and cover any costs for the tests.
• In a sign that Omicron could prompt wider cancellations of entertainment events, organizers of the Grammy Awards are considering postponing this year’s event, as they did last year.  The event is currently scheduled for January 31 in Los Angeles.
• In Japan, Okinawa Prefecture today reported 225 new cases, marking the highest figure since mid-September last year.  In response, the prefectural government is now considering asking the central government to issue a quasi-state of emergency.

 Economic and Financial Market Impacts

• Senior living facilities may have been some of the hardest-hit casualties of the pandemic, with many pushed into bankruptcy and approximately 8% of the sector’s municipal bonds now in default.  Nonetheless, investors are piling into those obligations in search of yield.

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

[Posted: 9:30 AM EST] | PDF

In today’s Comment, we open with a major new U.S. regulatory initiative and further indications the U.S. and its NATO allies are trying to scare off Russia from any invasion of Ukraine.  We next turn to a range of other international developments that have the potential to affect the financial markets today.  We wrap up with the latest news on the coronavirus pandemic.

U.S. Regulatory Policy:  President Biden today is launching a crackdown on the country’s largest meat producers, including a push for tighter “Made in America” labeling rules that could fuel tensions with U.S. trading partners.

• The Biden administration has singled out excessive market concentration in the meat industry as a key source of vulnerability in the country’s food supply chain and as one cause of high inflation.
• The White House says just four companies controlled 85% of the beef market, 70% of the pork market, and 54% of the poultry market.

United States-Russia-Ukraine:  In a phone call yesterday, President Biden assured Ukrainian President Zelensky that the U.S. and NATO would “respond decisively” if Russia invades Ukraine as feared.  Tensions over the possible invasion remain high, despite a pre-Christmas agreement for a series of de-escalation talks beginning January 10 between Russia and the U.S., NATO, and the Organization for Security and Cooperation in Europe.  Separately, in a year-end address, Zelensky struck a defiant tone toward Moscow, saying, “No army on the other side of the border frightens us . . . because a great army on our side of the border protects us.”

• In a sign of how Russia’s threatening stance on Ukraine affects politics in Europe, Finland’s president, Sauli Niinistö, and prime minister, Sanna Marin, used New Year addresses to underscore that the country reserved the option of seeking NATO membership at any time.
• Russia’s foreign ministry said last week that Finland and Sweden joining NATO “would have serious military and political consequences that would require an adequate response from the Russian side.”

European Green Policies:  The European Commission has recommended that nuclear energy and natural gas be considered “green” for investment purposes.  The controversial Commission push is part of the so-called “taxonomy” list, which will be crucial to channeling billions of euros in investments toward technologies needed to build clean power plants and decarbonize the bloc’s economy.  Some EU governments, including Germany’s, have already criticized the move, but reports indicate they will not be able to block it.  The move should therefore be positive for nuclear and gas producers in the EU.

China:  The Hong Kong stock exchange today suspended trading in defaulted real estate developer Evergrande (3333 HK, HKD, 1.59) following reports that the government instructed the firm to demolish 39 buildings in the southern province of Hainan because its planning permit was obtained illegally and had been revoked.

• Such legal problems would add to the company’s inability to borrow following the government’s crackdown on real estate debt.  These legal problems might also signal the crackdown on the real estate sector may go beyond just debt issues.
• In any case, the news raises further questions about investing in Chinese assets amid President Xi’s regulatory drive, although it’s important to remember that the regulatory issues have had much less impact on domestically-traded shares than on shares traded outside of China.

Turkey:  As President Erdogan continues pressuring the central bank to cut interest rates and the currency plunges, the country’s December consumer price index was up a whopping 36.1% from the same month one year earlier.  That marks Turkey’s highest inflation rate since Erdogan came to power almost two decades ago.  Nevertheless, Erdogan shows no sign of any major reversal of his low-interest-rate policy.  The lira looks set to remain weak, and economic instability remains a serious risk in Turkey.  The chart below shows how Turkey’s annual inflation rate has fluctuated since 2000.

International Trade:  On Saturday, the Asia-Pacific region’s new free-trade grouping, known as the Regional Comprehensive Economic Partnership (RCEP), officially began operating.  The RECP will eventually eliminate more than 90% of tariffs on commerce among its 15 member countries in what economists say will be a boon to trade in the region.  It could also give China a more prominent role in setting trade rules in the region at the expense of the U.S., which has declined to join.

COVID-19:  Official data show confirmed cases have risen to 290,319,169 worldwide, with 5,445,346 deaths.  In the U.S., confirmed cases increased to 55,114,128, with 826,065 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who have received at least their first shot totals 243,527,564.  The data show that 73.3% of the U.S. population has now received at least one dose of a vaccine, and 62.0% of the population is fully vaccinated.

Virology

• Reflecting the high transmissibility of the newly dominant Omicron mutation, as well as seasonal factors, new U.S. infections continue to soar and set new daily records.  The seven-day rolling average of new cases neared 400,000 on Saturday, its highest daily tally since the start of the pandemic and more than double the average registered on Christmas Day.  According to the Pentagon, the recent new cases include Defense Secretary Austin, although he reportedly only has mild symptoms.
  • Compared with earlier variations of the coronavirus, a smaller percentage of Omicron patients get seriously sick and need hospitalization.  However, if total cases expand enough, even that smaller share of hospitalizations would put added stress on the healthcare system.
  • In addition, even less serious cases can keep people out of work and contribute to staffing disruptions, as discussed below.
• Only a week after the CDC sparked controversy by saying that people who are infected but asymptomatic may leave isolation after five days, provided they wear masks around others for five more days, chief administration pandemic officer Dr. Anthony Fauci yesterday said that could change this week to require a negative test after five days of isolation.  Several countries facing unprecedented levels of new infections due to the Omicron mutation are also cutting back on isolation requirements in order to limit mass staffing shortages.
• In Britain, a senior government official said recent data suggests the country’s latest wave of infections, driven by Omicron, is starting to plateau.  If so, the official said, the government may be able to avoid imposing further social distancing measures.

 Economic and Financial Market Impacts

• Surging Omicron infections, coupled with a major winter storm, prompted thousands of airline flight cancellations in the U.S. over the New Year weekend.  The infections kept thousands of airport and airline employees from working, just as they have for many other types of workers.  The staffing challenges could have some impact on economic growth in the fourth quarter of 2021 and the first quarter of 2022, but it isn’t yet clear just how significant the impact will be.
• Meanwhile, the lapsing of the monthly child tax credit payment at the end of the year means approximately 30 million households will no longer receive the benefit of up to $300 per child beginning this month.  The loss of that income is one example of the fiscal tightening we expect to weigh increasingly on the economy this year.

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

[Posted: 9:30 AM EST] | PDF

Note to readers: The Daily Comment will go on holiday after Friday’s comment and return on January 3, 2022. From all of us at Confluence Investment Management, have a Merry Christmas and Happy New Year!

Good morning! U.S. equity futures are signaling a lower open. Today’s report begins with U.S. economic and policy news, followed by China-related stories. International news is next, and we end with our pandemic coverage.

Economics and policy:

• President Biden announced on Thursday that a vote on the $1.75 trillion Build Back Better bill will be delayed for several weeks. The pushback was likely due to resistance from West Virginia Senator Joe Manchin, who has expressed concern that the bill could contribute to inflationary pressures.
• The market has downplayed the possibility that the Fed could raise rates three times in 2022. On Thursday, trading in futures markets showed investors expect the U.S. central bank overnight rate to be 1.27% in 2023, down 11 bps from the previous day. The decrease in expectations is related to investors’ concern that the economy has still not fully recovered from the pandemic and that too many rate hikes could hurt growth.
• Driven primarily by India and China, coal power generation is expected to hit a record high by the end of 2021. The steep rise in coal power production shows how difficult it will be for the world to move away from fossil fuels as it tries to reduce carbon emissions. A faster than expected recovery this year has made cleaner sources of fuel scarce, thus leaving countries with no other choice but to use more coal. The lack of alternatives, especially during times of crisis, suggests that countries will likely be hesitant to reduce the production of these resources in the future.

China:

• The U.S. placed China’s Academy of Military Medical Sciences as well as 12 affiliated research institutions on its blacklist. The institute has been accused of helping the Chinese government to develop brain-control technology. By being placed on the black-list, U.S. companies will be banned from selling these institutions’ technology.
• Chinese real estate developing company Evergrande (EGRNF, USD, 0.20) was labeled a defaulter by S&P Global Ratings. The rating agency had downgraded Evergrande’s credit rating from SD to CC but withdrew the rating at the company’s request. The designation comes a week after Fitch Ratings had declared the company a defaulter.
• The U.S. is considering imposing more sanctions on China’s largest chipmaker, Semiconductor Manufacturing International Corp ( 981 HK, HKD,18.68), in order to limit China’s access to technology that could be used for military purposes.

International news: 

• A new wave of COVID cases weighed on business sentiment in Germany, according to the IFO institute. The main business confidence indicator fell from 96.5 to 94.7 in December, its lowest level since February of this year. It is the sixth consecutive month the indicator has fallen and has led to concerns that Germany could be heading for recession next year.
• The chip shortage has impacted car sales in Europe. Car registrations in the EU fell for the fifth consecutive month in November, as automakers continue to struggle to find the chips needed to make new vehicles. Germany and Italy, which rank 1 and 3 respectively in EU car exports, saw the steepest declines in registrations. The weakening in car sales suggests that the EU could possibly see sluggish growth going into the next year.
• Russia’s central bank has decided to raise its key interest rate by 100 bps to help tackle rising inflation. It is the seventh time Russia has raised its key interest rate this year, and it has not ruled out another rate hike in February.
• The Bank of Japan signaled it does not expect to raise rates in 2022. While other countries have seen multi-decade highs in inflation, Japan has only had a modest rise in inflation.
• The British government has softened its stance concerning the North Ireland issue. The U.K. would like to establish an interim agreement on the most critical issues of the arrangement. It would deal with reducing the number of custom checks as well as decreasing the bureaucratic burden faced by traders. Talks between the U.K. and EU are expected to continue in 2022.

COVID-19:  The number of reported cases is 273,058,583, with 5,340,088 fatalities.  In the U.S., there are 50,513,437 confirmed cases with 803,652 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 CDC reports that 602,523,315 doses of the vaccine have been distributed, with 490,030,849 doses injected.  The number receiving at least one dose is 240,321,022, the number of second doses is 203,159,327, and the number of the third dose, the highest level of immunity, is 57,101,568. The FT has a page on global vaccine distribution.

• France will block the entry of U.K. tourists in order to contain the spread of COVID-19.
• A study showed that vaccines made by Sinopharm (1099 HK, HKD, 16.56), Johnson & Johnson (JNJ, USD, 173.01), and Sputnik produce little or no antibodies against the Omicron variant.
  • Russian President Vladimir Putin has since responded to the report by stating that the Sputnik V vaccine is effective against the Omicron
• The CDC has recommended that adults get the Pfizer (PFE, USD, 61.25) or Moderna MRNA, USD, 282.02) vaccine instead of the J&J. The advisory change is in response to growing evidence that the J&J vaccine can cause blood clots in rare cases.
• States across the U.S. are starting to see a pickup in COVID-19 cases.
• On the positive side, Omicron cases in South Africa have shown signs of easing. In addition, hospital admissions remain below previous waves, suggesting that waves in other countries will likely be short.

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

[Posted: 9:30 AM EST] | PDF

Note to readers: The Daily Comment will go on holiday after Friday’s comment and return on January 3, 2022. From all of us at Confluence Investment Management, have a Merry Christmas and Happy New Year!

Good morning!  So far this morning, financial markets are in risk-on mode.  However, we warn there is a torrent of news this morning that could change sentiment.  We start with a quick run of headlines before we dive into the FOMC’s decision yesterday.

• The BOE surprised the market this morning, becoming the first G-7 nation to raise policy rates; the bank lifted rates by 25 bps.  Market expectations called for no change in rates.  Gilt yields rose, and the GBP rallied.
• The ECB announced it has started to taper…slowly. Rates were left unchanged.  The EUR rallied on the news.
• Taking a familiar opposite tack, the central bank of Turkey cut rates by 100 bps to 14%, and the government announced a 50% increase in the minimum wage. The TRY has plunged to a new record low.  As we have noted before, Turkey appears to be heading toward hyperinflation.

Our coverage begins with a recap of the FOMC decision.  Our regular reporting starts with China news.  The update on economics and policy comes next; it looks like Build Back Better won’t be passed this year.  The international roundup follows, and we close with pandemic news.

The FOMC:  The Fed issued a hawkish statement yesterday, doubling the pace of its taper and signaling, through the dots plot, rate hikes next year.  Here is a snapshot of the dots.

First, yesterday’s meeting:

(Source:  Bloomberg)

And, the September meeting.

(Source:  Bloomberg)

The difference is that at the September meeting, there was one rate hike projected by a small majority.  Most of the tightening was projected for 2023.  That has clearly changed.  The majority is projecting a 0.875% fed funds target by year’s end, which is three rate hikes.  Fifteen of 18 members project two to three rate hikes, and no member signaled no change in rates.  Even the most dovish (Kashkari, Minneapolis FRB most likely) has moved to one rate hike.  The expansion of the balance sheet is set to end by March.

In the economic projections, members are expecting inflation to fall; the core PCE forecast is for 2.7%, up from 2.3% in September.  GDP is also expected to rise to 4.0% from 3.8% in September.  In Powell’s comments, he suggests we are near full employment.  There is evidence that confirms that position, although other evidence suggests otherwise.  In a sense, the decision suggests the Fed has concluded that the pandemic has changed the labor markets, and using the pre-pandemic levels as a benchmark is no longer appropriate.  This means the Fed can declare victory on the labor front and move to confront inflation directly.

Here are our thoughts:

• Every Fed chair puts his stamp on the FOMC. Some dominate, like Volcker or Greenspan.  Others sway by the strength of the intellect, like Bernanke or Yellen.  Powell is probably best characterized by the term “pivot.”  He is not an economist and seems to bear no allegiance to a particular school of thought within economics.  Because he lacks a core position, he tends to sway with the situation.  Thus, in 2018, he seemed on a path to tightening regardless of the outcome…until, of course, equities cratered, and he rapidly reversed course.  He aggressively moved to support the economy as the pandemic hit, engaging in novel measures to directly backstop various markets usually not supported by the Fed.  Now, after assuring markets that tightening is far off, he suggests it’s coming soon.  To some extent, Chair Powell seems to adhere to the ideas of one of the 21^st century’s great thinkers, Groucho Marx, who famously noted, “I have my principals…if you don’t like them, I have others.”
• Financial markets are used to Fed chairs with ideological leanings. When a course of policy is decided upon, there is a tendency for that policy to be held until some goal is met.  That isn’t the case with Powell.  A course of action decided today may not last if conditions change.  In some respects, this stance isn’t necessarily a problem.  It can allow a chair to move quickly and boldly without the restraints of ideology.  For market participants, it’s a bit like batting against Ebby LaLoosh.  At any point, the bull could be hit.  The financial markets have already built in expectations of rate hikes.  The Fed essentially confirmed that today.  Just be careful “digging in.”  If inflation falls by midyear and there is any cooling of the economy, these expectations could vaporize rapidly.
• The other thing to remember is that two voters will be gone by the end of January. The president could select doves for three open governor positions and change the stance of the FOMC.  On the other hand, the roster of regional bank presidents voting next year is hawkish.  For now, the path of tightening will be generally supported by the committee.  However, by midyear, it could become less clear.  Of course, as we have noted, the White House has become increasingly deliberative over time, so it may be a while before governor replacements are nominated.
• Clearly, so far, financial markets are pleased with the tightening decision. There were growing worries that the Fed would ignore signs of inflation.  In the end, the Fed has pivoted yet again to now fight inflation.  It’s only bullish for risk assets if the Fed engineers a soft landing.  Although such outcomes are rare, if any chair can pull one-off, it’s probably this one because he is so flexible.

China news:  The U.S. continues to restrict trade with China.

• Washington continues to tighten regulations on China trade. The House has passed a bill that bans all imports from the Xinjiang region due to worries over the use of forced labor.  In addition, the U.S. has expanded its blacklist of Chinese firms in the technology surveillance area.  Beijing’s actions to limit U.S. listings are worrying U.S. financial firms.
• On the real estate front, the government is getting deeper into managing the Evergrande (EGRNF, USD, 0.19) restructuring. Regulators have conducted an audit and indicated there would not be a rapid liquidation of assets.  As regulators deal with Evergrande, stress is spreading to other firms, as well.  At the same time, vulture investors are showing interest in buying distressed assets of these companies.
  • The government is starting to encourage the construction of affordable housing.
• The U.S. formula for hegemony has had two components. The first has been to provide security in conflict zones (Japan/China, Europe, Middle East) to “freeze” these potential conflicts.  The second is to act as the global importer of last resort, freely running current account deficits to provide necessary dollar funding to the world.  The reason we believe U.S. hegemony will come to an end is that there is no domestic political consensus to maintain these policies.  Americans are done with security wars[1] or operations.  In addition, the distortions triggered by trade on jobs and the economy have become intolerable.  Consequently, SoS Blinken’s trip to the Far East, cut short by COVID-19, was likely doomed to disappointment.  What these nations want is access to the U.S. market through free trade deals.  Those are now politically untenable in the U.S.  Thus, Washington can no longer provide the trade support these countries desire, opening the door for China to deepen economic relations.
• Russia and China are not natural allies. In fact, the “Nixon to China” event was mostly due to the fact that China and the Soviet Union were close to war.  Hostility toward the U.S. has created conditions of mutual benefit for China and Russia.  This benefit was seen by a recent set of video conferences between the two leaders.  Although both characterized the meetings as warm, we note the two nations have not made a formal alliance.  Russia worries that its steadily falling population will encourage China to encroach on its Siberian regions, which are rich in natural resources.
• China’s economy is slowing; recent data has shown weaker spending and investment. In the past, such data would trigger fiscal and monetary stimulus.  However, in Xi’s bid to bring debt under control, policymakers may not come to the rescue this time.
• Lithuania has recalled its diplomats from China. The Baltic state is in a quarrel with Beijing over relations with Taiwan.

Economics and policy:  Build Back Better won’t get passed this year, and new money market regulations may be coming.

• The Build Back Better program is in trouble, as the White House and Congressional leadership can’t seem to sway Senator Manchin (D-WV) to support the measure. It now looks like the bill will not be passed this year, and while we expect something to pass, it will be smaller than the current proposal.
• Flexport has developed a set of shipping indicators that measures the average time for cargo to move from the exporter shipping dock to when it is ready to go on the water to its destination. Two key areas, the Far East Westbound and the Transpacific Eastbound, show this process takes over 100 days; pre-pandemic, this trip averaged between 50 to 60 days.  These indicators suggest there has been little improvement in supply chains.
• The SEC is proposing new rules for money market funds (MMK) that are designed to reduce the likelihood of runs. The proposals have not been taken well by the industry.  One proposal would allow for “swing pricing,” which would give MMK the ability to price their NAV by a calculation of the value of the entire portfolio.  Under current rules, MMK will meet redemptions by selling the most liquid elements of their portfolios first; it tends to give an advantage to customers who liquidate the quickest.  The swing price is designed to take away this advantage.  Another proposal would require that at least 25% of the portfolio be either cash or assets that are one day from maturity.  The current rule allowing MMK to suspend redemptions would be rescinded.  We would not expect MMK firms to support these measures, but MMK remains a worry because they typically become unstable during periods of financial stress.
• Natural gas prices continue to soar in Europe. The weather is turning colder, and tensions with Ukraine are the culprits.  One fallout from the rise in natural gas prices is soaring fertilizer prices, which some farms use as a feedstock.  We will be watching to see if higher fertilizer costs reduce planting or skew the crop away from corn (which needs fertilizer) to soybeans.
• California is seeing a net migration out of the state; high living costs and taxes are likely leading people to leave.
• Thinking about being a trucker? The White House wants to help.
• The EU has been taking the lead on tech policy. Europe’s tech industry is smaller than in the U.S., so the industry has been less effective in lobbying in Brussels.  The rules in Europe are guiding U.S. policy.

International roundup:  Iran installs cameras and Germany expels Russian diplomats.

• Iran has agreed to re-install video cameras on some nuclear facilities. Although this represents progress, we remain doubtful that a deal will be reached to restore the 2015 nuclear deal.
• Germany has expelled two Russian diplomats in retaliation for a court decision that sentenced Vadim Krasikov to life in prison for executing Zelimkhan Khangoshvili, a Georgian citizen of Chechen ethnicity who lived as a refugee in Germany. We would expect Russia to retaliate in kind.
• Brazil will hold presidential elections next year in October. Polls suggest Lula, the former president, holds a comfortable lead.

COVID-19:  The number of reported cases is 272,336,362, with 5,332,813 fatalities.  In the U.S., there are 50,374,554 confirmed cases with 802,511 deaths.  Data show that infection rates are rising rapidly, but so far, fatalities have not, raising hope that the highly infectious Omicron variant may not be as deadly as the earlier version.  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 CDC reports that 599,876,215 doses of the vaccine have been distributed with 488,296,089 doses injected.  The number receiving at least one dose is 239,975,167, while the number receiving second doses, which would grant the highest level of immunity, is 202,845,886.  For the population older than 18, 72.2% of the population has been fully vaccinated, with 61.1% of the entire population fully vaccinated.  The FT has a page on global vaccine distribution.  The Axios map shows increasing cases across most of the East and Midwest.  The mountain states and high plains are seeing falling cases.

• The Omicron variant is triggering a wave of infections. The U.K. hit a new record for daily infections yesterday.  Although cases are rising in the U.S., the outlook is likely for a surge of cases in the coming weeks.
  • Even though we don’t expect widespread lockdowns to occur, we are seeing restrictions and other measures emerge. Several colleges in the U.S., well into finals week, are telling students to go remote into the semester’s end.  Broadway is starting to cancel shows.  Italy is requiring EU visitors to have a negative COVID-19 test before entering.
  • China, which continues to use aggressive isolation measures when outbreaks occur, is starting to see these measures adversely affect its economy.
• Given how rapidly the Omicron variant is spreading, even if it is less virulent, the increased number of infections will likely lead to more deaths and hospitalizations, even if the per capita data remains steady. This is because there will probably be more infections.  The good news is that each infection survived (to quote Nietzsche, “what doesn’t kill me makes me stronger”) increases immunity and moves us along the path of making COVID-19 a seasonal scourge like influenza.
• A recent state-by-state study confirms what one would expect; states that had stricter shutdowns suffered fewer fatalities but had weaker economic growth. States with looser guidelines had a better economy but more deaths.

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[1] Small wars or operations to stabilize areas, such as Vietnam, Iraq, Afghanistan, or the heavy commitment to NATO.

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

[Posted: 9:30 AM EST] | PDF

Note to readers: The Daily Comment will go on holiday after Friday’s comment and return on January 3, 2022. From all of us at Confluence Investment Management, have a Merry Christmas and Happy New Year!

We open today’s Comment with a range of U.S.-focused items, touching on monetary policy, fiscal policy, the labor market, and relations with China.  Next, we shift to several international and global issues, including an important new cybersecurity threat that stems from a flaw in some widely used computer server software.  We close with a number of important developments related to the coronavirus pandemic.

U.S. Monetary Policy:  The Fed today wraps up its latest two-day policy meeting.  When the new policy statement is released, the officials are expected to say they will accelerate the tapering of their bond-buying to end the program by March.  It would position them to start hiking the benchmark fed funds interest rate in the first half of the year if they so choose.  However, Chair Powell’s abrupt mutation into an inflation hawk has some investors nervous about what the policymakers will actually do at the meeting.

U.S. Fiscal Policy:  Last night, Congress passed a measure raising the government’s borrowing limit by $2.5 trillion, sending to President Biden’s desk legislation that is expected to push the next debt-ceiling standoff past the midterm elections.  The Senate voted 50-49 to approve the legislation in the afternoon, and the House later passed it 221-209.

U.S. Labor Market:  Reflecting workers’ bargaining power amid the nation’s massive shortage of relatively lower-skilled workers, employees at two stores of Starbucks (SBUX, USD, 114.71) in the Boston area have petitioned to unionize.  Although successful unionization efforts across industries are still limited, the trend is for increased organization, potentially increasing workers’ pay and crimp corporate margins going forward.

United States-China:  The U.S. government announced it would bar investments in eight more “Chinese military-industrial complex” companies based on their involvement in the surveillance and repression of China’s Uyghur Muslim minority.  The firms added to the investment blacklist include privately held DJI, the world’s largest commercial drone maker, as well as companies primarily involved in facial recognition, cybersecurity, supercomputing, and cloud services.

• All eight companies added to the blacklist were already on the Commerce Department’s “entity list,” which restricts exporting technology or products from the U.S. to the Chinese groups without a government license.
• The Commerce Department is also expected to place dozens of additional Chinese companies on its entity list on Thursday, including some involved in biotechnology.  The Thursday action reportedly may include a clampdown on exporting U.S. technology or services to major Chinese computer chip manufacturer Semiconductor Manufacturing International Corp. (981 HK, HKD, 18.72).
• The new announcement demonstrates that one key implication of the U.S.-China geopolitical rivalry is that capital flows between the two countries are gradually getting squeezed because of Chinese and U.S. policies.  As we have been warning all year, that presents significant risks for investors in Chinese companies.

China-Lithuania:  The Lithuanian government has pulled all its remaining diplomats out of China following Beijing’s demand that they hand in their diplomatic IDs to the foreign ministry to have their diplomatic status lowered.  The Chinese move illustrates Beijing’s hardline approach to punishing foreign countries trying to strengthen ties with Taiwan.

Japan:  Prime Minister Kishida admitted that the government’s land ministry had overstated construction orders for years, potentially inflating Japan’s reported gross domestic product.

Global Cybersecurity:  Researchers warn that a newly discovered flaw in some widely used computer server software is one of the most dire cybersecurity threats to emerge in years and could enable devastating attacks, including ransomware, in both the immediate and distant future.  Hackers linked to China and other governments are among a growing assortment of cyberattackers already seeking to exploit the vulnerability.  Widespread, successful attacks could have a negative impact on individual companies, sectors, or potentially even entire economies.

COVID-19:  Official data show confirmed cases have risen to 271,615,381 worldwide, with 5,324,652 deaths.  In the U.S., confirmed cases rose to 50,236,602, with 800,043 deaths.  (For an interactive chart that allows you to compare cases and deaths among countries, scaled by population, click here.)  Meanwhile, in data on the U.S. vaccination program, the number of people who have received at least their first shot totals 239,553,956.  The data show 72.2% of the U.S. population has now received at least one dose of a vaccine, and 61.0% of the population is fully vaccinated.

Virology

• Apple (AAPL, USD, 174.33) said it is once again requiring all customers and employees in its U.S. retail stores to wear masks after making mask-wearing optional at the beginning of November.
• JP Morgan Chase & Co. (JPM, USD, 159.13) said its unvaccinated employees are no longer welcome in its New York offices and would have to start working from home.  The firm said it was unfair that admitting unvaccinated employees requires vaccinated workers to wear a mask at their desks.  It also relaxed mask-wearing requirements for vaccinated employees.
• Despite measures like those, health experts have warned that the U.S. faces an enormous challenge to contain the fast-spreading Omicron variant due to relatively low vaccination rates, inadequate testing, and inconsistent rules about mitigation measures such as mask-wearing.
• New research shows that two doses of the Chinese-made Sinovac vaccine, whose efficacy against the virus was already under question, provide “insufficient” antibodies to be effective against the Omicron mutation.  Beijing-based Sinovac today responded with a statement saying a third shot of its vaccine could improve its ability to neutralize Omicron, citing its own laboratory studies.
  • The Sinovac vaccine has been widely used in China and throughout the poorer countries of the world.
  • Therefore, if it really is ineffective against the fast-spreading Omicron variant, it would suggest much of the global population could be at high risk from the new mutation.
• Adding to the challenge for poorer countries, the World Health Organization has warned that the rollout of aggressive booster-shot campaigns in the developed countries will leave poorer nations with an even greater shortfall of doses than they currently face.
• Yesterday in the U.K., Parliament approved Prime Minister Johnson’s new “Plan B” pandemic measures, including the establishment of a “vaccine passport” allowing access to some venues.  However, Johnson still faced the humiliation of almost 100 of his Conservative Party legislators voting against him.  The vote illustrates the high political risks for politicians trying to reimpose pandemic restrictions, especially once they’ve loosened them and promised not to go back to tight lockdowns.
• In Germany, police carried out raids in the country’s southeast, targeting a network suspected of conspiring to murder local politicians for their role in implementing pandemic restrictions.  Officials are becoming increasingly worried about the radicalization of some anti-vaccine militants as the country edges toward a general vaccine mandate that could come early next year.

 Economic and Financial Market Impacts

• In China, the government’s “zero-COVID” policy and strict new measures against the Omicron mutation are constraining manufacturers and threatening a broader slowdown in the economy.
• As post-pandemic supply disruptions and demand recovery continue to boost inflation worldwide, investors are piling into inflation-linked assets in a bet that consumer prices will continue to soar even as central banks gear up to tighten monetary policy.  Inflation-protected government bonds, commodity funds, and real estate investment trusts are among the products absorbing cash.  The chart below shows the enormous surge in purchases of U.S. Treasury Inflation-Protected Securities (TIPS).

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

[Posted: 9:30 AM EST] | PDF

Note to readers: The Daily Comment will go on holiday after Friday’s comment and return on January 3, 2022. From all of us at Confluence Investment Management, have a Merry Christmas and Happy New Year!

Good morning and happy Monday!  Risk markets are higher this morning as the traditional equity rally into Christmas (the “Santa Claus rally”) appears to be shaping up.  It’s central bank week; coverage of the Fed leads off our coverage this morning.  Economics and policy come next as inflation dominates the news.  We then move on to the international roundup followed by China news, and we close with the pandemic update.

Central banks:  The FOMC meets this week in what is widely expected to be a hawkish meeting.  However, it isn’t the only central bank meeting this week.  The BOE, BOJ, and ECB, along with a plethora of other banks[1] around the world, are gathering amidst rising inflation.  The Fed is being pushed by the markets, pundits, and, surprisingly, the political class as well.  And, among the latter, there are moderate Democrats pressing the FOMC to tighten policy as worries about inflation mount.  We doubt left-wing populists share this desire, but so far, their voices have not risen; their voices will likely rise as tightening begins.

So far, equity markets are showing little concern about policy tightening.  It is not unusual for markets, at the early stages of tightening, to expect a “soft landing,” a rate hike cycle that doesn’t result in a recession.  This position highlights that equity markets are generally driven by optimists, because the track record shows that soft landings are rare.  The item to watch is the 10-year T-note/fed funds spread.

 

This chart shows the spread along with the policy rate target.  In general, recessions tend to occur when the spread inverts.  In the mid-1990s, Greenspan engineered a soft landing by cutting rates as the spread approached zero.  But, note that in every cycle over the past 30 years, a recession occurred when the spread inverted.

So, what does the spread tell us now?  First, the Fed can take the fed funds target to 1.25% to 1.50%.  For now.  But if 10-year yields fall as the fed funds rate rises, the FOMC may not be able to raise rates that high without inverting this spread.  Second, even with this policy tightening, monetary policy will still be easy; we expect CPI inflation to fall to the 3.0% to 3.5% range next year, and so there is little chance that we will get a positive real fed funds rate.  To achieve that outcome, a recession would be almost a certainty.  For now, financial markets are putting odds that the first rate hike will occur at the meeting on May 4, 2022.

• Although the ECB will likely end its bond-buying program sometime in the next year, Greece still wants the bank to keep buying its bonds.
• Expectations that Turkey will cut interest rates again sent the TRY lower. The bank reportedly intervened to slow the decline.

Economics and policy:  Build Back Better looks like it won’t get passed in 2021 and inflation worries remain elevated.

• Although congressional leaders continue to bravely talk about moving the Build Back Better plan through the legislature before year’s end, it looks increasingly likely that the bill will be on next year’s agenda. The president is talking to Sen. Manchin (D-WV) to sway him to move on the bill, but the senator’s worries about inflation will likely lead him to delay his support.
• Inflation is the dominant concern in the economy. There are growing worries that inflation expectations are rising, which could force the FOMC to take more aggressive policy actions.  We do expect inflation to moderate next year from base effects alone.  However, there is also a rising chance that the inflation that develops will be lasting as real estate inflation begins to filter into the economy.
• Nevertheless, don’t call it stagflation. Economic growth in Q4 still looks robust.
• We continue to monitor the supply chains. So far, the preponderance of the evidence suggests they remain snarled.  Toyota (TM, USD, 182.35) announced it will be closing four plants in Japan due to supply chain disruptions.
• The labor market remains a puzzle. Depending on the metric being used, either the labor market is struggling to recover from the pandemic, or it is so tight that wages will need to rise to balance the market.  One area we have noted is the exit of workers aged 65+ from the labor force.  Although we expect those workers to remain retired, there are anecdotal reports that some may be considering a return to work because the support money has dried up or because the cost of living is rising fast enough that they need the additional cash.  Another area causing tighter labor markets is the decline in immigration; the foreign born population appears to be falling.  Deteriorating health seems to be keeping people out of the labor force as well.
• Climate policy has been a point of political division. Increasingly, financial regulators are changing regulations on financing fossil fuel companies.  However, the area to watch is insurance; the national flood insurance program is looking to lift insurance costs on seaside residential properties.
• Bank overdraft fees are coming under scrutiny.
• One reason crypto volatility is high is due to the lack of liquidity.

International roundup:  The G-7 warns Russia.

• The G-7 has warned Russia that any military action against Ukraine will lead to “massive consequences,” or very heavy sanctions. We do note there is growing skepticism that Russia will be denied access to the S.W.I.F.T. network, but we could see Russia denied access to Western energy technology.
  • Ukraine has accused Germany of blocking military sales to Kiev; Berlin worries that arming Ukraine may provoke Moscow.
• The White House is reviewing military options against Iran if the current nuclear talks fail. We doubt the U.S. will take military action, but other states in the region might act.
  • Iran is deporting refugees from Afghanistan.
• SoS Blinken is making a tour of Southeast Asia. Although the U.S. is trying to woo these nations, American resistance to supporting trade in the region will hamper Washington’s influence.
• South Korea has applied to the CPTPP, the successor to the TPP.

China news:  The diplomatic boycott may be mostly an Anglo-Saxon affair.

• So far, the U.S. diplomatic boycott of the Winter Olympics has not fostered widespread adoption. The EU is considering a boycott, but several European nations have ruled it out (although Lithuania, which has sided with Taiwan, has decided to join the boycott).  For the boycott to be effective, it needs widespread acceptance; if only a few nations participate in the boycott then the action won’t have much impact.
• It isn’t just the West that is struggling to find high-tech workers; so is Beijing.
• In our series on central bank digital currencies, we noted that such currencies would give governments the power to gather data on spending habits. British intelligence agencies warn that China will almost certainly exploit this feature.
• The EU has been working to implement a carbon adjustment tax, which would be a form of tariff that would lift import prices based on their carbon footprint. This development could lead to much higher tariffs on Chinese imports.

COVID-19:  The number of reported cases is 270,252,555, with 5,308,651 fatalities.  In the U.S., there are 49,921,422 confirmed cases, with 797,348 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 CDC reports that 594,475,575 doses of the vaccine have been distributed, with 484,190,896 doses injected.  The number receiving at least one dose is 239,008,166, while the number receiving second doses, which would grant the highest level of immunity, is 201,975,235.  For the population older than 18, 72.1% of the population has been fully vaccinated, with 60.8% of the entire population fully vaccinated.  The FT has a page on global vaccine distribution.

• Cyril Ramaphosa, the president of South Africa, has tested positive for COVID-19. His case is said to be mild.
• There are increasing worries that the low level of booster injections in the 65+ U.S. population could lead to another surge in hospitalizations as the omicron variant expands.  A U.K. study suggests that the booster is up to 75% effective against omicron.
• Omicron may become the dominant variant in Europe by next week.
• Covax, the program to distribute vaccines to the emerging economies, is falling far short of its goals.

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[1] Turkey, Chile, Indonesia, the Philippines, Egypt, Switzerland, Norway, Mexico, Colombia, and Russia