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

[Posted: 9:30 AM EST] | PDF

Good morning! Today’s report begins with a discussion about Starbucks (SBUX, USD,115.35). We then turn to U.S. economic and policy news, followed by China-related stories. International news is next, and we end with our pandemic coverage.

Baristas in a Starbucks store in Buffalo voted to form a union on Thursday. The vote reflects how a tight labor market can give workers the confidence to push for concessions from their employers. Since the pandemic began, restaurant workers, who are grouped as Leisure and Hospitality by the BLS, have seen their wages accelerate faster than inflation.

In fact, there is some evidence suggesting the pickup in wages may have leaked into the inflation data.

The chart above shows that in October, the rise in service inflation for Food and Accommodation and Recreation Services were only exceeded by Transportation Services. Hence, the PCE Price Index, the Federal Reserve’s preferred inflation gauge, may already show signs that the labor tightness is pushing up prices. It is worth noting that the jump in inflation for Food and Accommodation can also be attributed to an increase in food and drink prices. Meanwhile, price increases for Recreational Services were likely boosted by a surge in demand due to the lifting of pandemic restrictions and will eventually fade away. That being said, if more workers start to unionize, especially in low-skill and critical industries like food processing, we could see sustained inflationary pressure, margin contractions, or possibly both in the upcoming year. In this event, we think the Fed may decide to respond by enacting more hawkish policy that could slow GDP growth. It could be beneficial for industries with relatively low overhead and stable revenue (i.e., tech).

Economics and policy:

• The Senate passed a measure that would make it easier for Democrats to raise the debt limit without Republican support. The move would allow the debt ceiling to be raised with a simple majority as opposed to 60 votes.
• The U.S. military has ended its combat mission with ISIS in Iraq and will now focus on advising and assisting the local government.
• The Biden administration is looking to develop an economic framework with Asian countries hoping to resolve supply chain issues, export controls, and standards for artificial intelligence. Because the administration doesn’t feel confident it can push a trade deal through Congress, the administration is looking to secure a deal that falls just short of the definition of a trade agreement.
• News about supply chain relief may have been exaggerated. Recently, the reduction in the number of container ships waiting to dock at the ports of Los Angeles has been attributed to ships floating out of range from which the vessels were being counted. Additionally, the resurgence of the Omicron variant has led to increased concerns that the new supply-chain disruptions are on the horizon.
• The labor crunch could affect your commute to work this winter. States are finding it difficult to find snowplow drivers due to the lack of qualified applicants.

China:

• At the behest of Beijing, Nicaragua cut off diplomatic ties with Taiwan. The move comes after Nicaragua faces international scrutiny over its handling of the country’s presidential election last month. By ending its relationship with Taiwan, Nicaragua appears to be positioning itself to build closer ties with China.
• Fitch Ratings declared that property development companies Evergrande (EGRNF, USD, 0.23) and Kaisa (1638 HK, HKD, 0.92) were in default because both companies missed U.S. dollar-denominated payments earlier this week. Chairman of the Evergrande Group, Hui Ka Yan was forced to sell shares following the news of his company’s default. In light of the slowdown of its property market, China has imposed additional measures designed to prevent further contagion. China has forced banks to hold on to more foreign currency to prevent an appreciation of the yuan due to speculation. The PBOC Governor Yi Gang has stated that there will be no bailout of Evergrande.

International news: 

• President Biden held a meeting with NATO leaders of Eastern Europe on Thursday. The discussion focused on whether Washington was willing to compromise with Moscow’s request to draw down NATO deployment in Eastern European states along Russia’s border and to end its recruitment of Ukraine to join NATO. Eastern European countries fear accepting terms laid out by Moscow could set a dangerous precedent that could lead to more confrontation with Russia in the future. During the meeting, President Biden reaffirmed the U.S.’s allegiance to NATO and stated that it was fully committed to ensuring Ukraine’s sovereignty. The growing angst about a possible Russian invasion of Ukraine has made Eastern European countries wary of the U.S.’s willingness to protect fellow NATO members from a Russian attack. At this time, it is unclear what concession Biden plans, but we suspect that at a minimum, it will include a reassurance that Ukraine does not join NATO.
  • Discussion over a new cease-fire agreement between Ukraine and Russia broke down on Thursday after Kyiv accused Moscow of not taking the negotiations seriously.
• Turkish President Recep Erdogan is struggling to maintain his popularity as the country’s economy continues to struggle. President Erdogan’s refusal to listen to experts and advisors has led many people to question his leadership. With elections 18 months away, President Erdogan has a lot of ground to make up if he wants to win re-election.

COVID-19:  The number of reported cases is 268,663,978, with 5,290,569 fatalities.  In the U.S., there are 49,664,506 confirmed cases with 794,648 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 588,422,575 doses of the vaccine have been distributed with 477,433,765 doses injected.  The number receiving at least one dose is 237,468,725, the number of second doses is 200,717,387, and the number of the third dose, the highest level of immunity, is 49,900,089. The FT has a page on global vaccine distribution.

• The Omicron variant is four times more transmissible than the Delta variant, according to a recent study. There is still no evidence that suggests the Omicron variant is more dangerous than the Delta variant.
• The pandemic led to the biggest rise in the payout of death benefits since the 1918 Spanish Flu.
• New restrictions to curb the spread of COVID-19 went into effect in the U.K. on Friday.
• South Korea is in the midst of its worst wave of COVID-19 infections since the start of the pandemic.

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

[Posted: 9:30 AM EST] | PDF

Good morning!  After several days of risk-on, today is shaping up as a risk-off session.  Our coverage begins with economics and policy, where we discuss yesterday’s JOLTS data and inflation.  Tomorrow we get CPI, and there are worries we will see a yearly rate in excess of 7%.  International news is next.  The Summit for Democracy begins today, and the situation in Ukraine continues to evolve.  China news follows; the real estate sector situation is moving toward restructuring. We close with pandemic coverage.

Economics and policy:  Job openings continue to exceed the level of unemployment, and inflation data comes out tomorrow.

• The JOLTS report shows that job openings continue to exceed the level of the unemployed.

The JOLTS series only has about 23 years of data.  To get a feel for the longer-term pattern, we used a model to graft the JOLTS data to the older help wanted/unemployed ratio.  That data suggests the current labor market is as tight as it was in the late 1990s.

As this chart shows, the recovery has been remarkably strong and may prompt the Fed to conclude that the labor market has mostly recovered (see below).

• One typical market pattern is the first time an outlier event occurs, it tends to have a major impact on financial markets. Each successive event of a similar nature usually has less impact.  That appears to be the emerging pattern on various COVID-19 infection cycles.
• Polls show that inflation has become the most important concern among Americans. Such polls may account for the recent shift in emphasis by the Federal Reserve.  The current inflation appears to have both supply and demand characteristics; unfortunately, monetary policy usually only works, in the short run, on demand, meaning that reducing inflation requires weakening the economy.  Although we haven’t discussed the idea of a “soft landing” for years (maybe since the mid-1990s) this is what the Fed will be trying to engineer.
  • Anecdotal reports suggest rents are rising rapidly. That will typically boost core inflation.
• Starbucks (SBUX, USD, 116.25) is facing its first unionization drive in Buffalo.
• The large fiscal support packages led to a massive increase in household savings. Recent data suggest lower-income households may be near exhausting their saving, which may prompt faster job acceptance.
• The U.S. is taking steps to prevent money laundering in the real estate sector. Increased corporate transparency in terms of ownership is also underway.
• Congress is moving on some key legislation as the end of the year approaches. It appears the debt ceiling issue will be addressed, at least in the short run.  However, the marijuana industry was disappointed when measures to give the industry access to banking were excluded from the legislation.
• Due to the lack of support, Saule Omarova, the administration’s nominee for Comptroller of the Currency, has withdrawn from consideration. Her positions on government involvement in banking were considered outside the mainstream.
• Over 200 newspapers are suing the tech industry over monopolizing ad revenue. Amazon (AMZN, USD, 3523.16) has been fined $1.3 billion by Italian regulators.
• The CIA is working on several cryptocurrency projects. We suspect that some of the efforts are going to breaking down the pseudo-anonymous features of many cryptocurrencies.
• The Northwest has been hit by a swarm of earthquakes.

International roundup:  The Summit for Democracy kicks off today, and negotiations around Ukraine continue.

• In the face of evidence suggesting democracy around the world is weakening, the U.S. will hold a Democracy Summit today and tomorrow. A list of 110 nations is included, although we note that the list is somewhat inconsistent, where countries generally not considered democracies have been invited, while others with democratic characteristics failed to get a slot.  To a great extent, this summit appears to be more about coalition building to isolate China and Russia and less about fostering democracy.
  • Because Hungary wasn’t invited, it vetoed EU participation, meaning that European nations can only take part as individual countries, but the EU cannot.
  • China has been making loud statements that the CPC is a democracy, too, even though there are no elections of consequence held outside the party. China’s narrative shows the power of democracy as a concept.  China is also upset that an activist from Hong Kong will speak at the summit.
• We are carefully watching U.S. actions on Ukraine. In the wake of a call with Putin, Biden is calling for meetings with NATO partners to address Russia’s concerns.  This may be a serious concession to Moscow.  As we have noted in the past, Russia’s primary defense is maintaining influence in its “near abroad” to force invaders to move greater distances to attack the Russian core.  If Ukraine is unfriendly, Russia is insecure.  Thus, for Russia, controlling Ukraine is seen as existential.  It is true that the U.S. could seriously threaten Russia by dominating Ukraine and accepting it into NATO, but the cost would be significant.  The U.S. is clearly signaling there are limits to American involvement.  Simply put, the U.S. isn’t putting troops on the ground.  That doesn’t mean the U.S. doesn’t have tools at its disposal.  For example, SoS Blinken warned the U.S. could deploy “high-impact economic measures.”  Germany’s new Chancellor Scholz has warned that an invasion of Ukraine by Russia would put Nord Stream 2 at risk.  It is looking increasingly like the U.S. will end up endorsing the “Finlandization” of Ukraine to ease tensions.  Eastern European nations will be horrified at this prospect because Russia will probably use this playbook for other nations in the region.
• Both Blinken and Chief of Staff General Milley have warned that China is attempting to revise the global rules. Beijing sees parts of the U.S.-directed international order as detrimental to its goals.
• As we noted earlier this week, the EU is putting together a new trade tool that would give it significant trade power independent of the individual nations in the EU. If the European Parliament approves the measure, it would be an important vehicle for EU power.
• India’s military chief, Bipin Rawat, died in a helicopter crash yesterday; so far, it appears the event was an accident.
• Latin America has been facing a series of unsettling events. Chile is dealing with a constitutional convention, and presidential elections and Peru’s new government is already getting impeachment calls (which it managed to avoid…so far).  Brazil has presidential elections next year in the face of rapidly rising inflation.  In Mexico, AMLO has decided to not nominate the former finance minister Arturo Herrera to the head of the central bank, instead choosing a loyalist.  Although the political risk is nothing new in the region, it is unusually elevated.
• Turkey is skating dangerously close to conditions conducive to hyperinflation.
• As we noted yesterday, Germany has a new Chancellor. Thus far, he is taking a tough stance on Russia but looks conciliatory toward China.
• The U.K., upset that it was unable to remove steel tariffs applied by Washington, is threatening retaliation.
• Falling investment flows are hurting the emerging markets.

China news:  More nations join the diplomatic boycott, and the real estate sector glides toward restructuring.

• After the U.S. decided to engage in a diplomatic boycott of the Winter Olympics, Australia, Canada, and the U.K. decided to follow suit. There may be others.  China will not be pleased with these actions, but retaliation will likely wait until the 2024 Summer games.
• The House has passed a bill to ban all imports from Xinjiang unless it can be proven with clear and convincing evidence the products were not made with forced labor. The Senate passed a similar measure in November, but it appears the House bill is more restrictive than the Senate version, meaning a conference committee will create the final version.
  • The U.S. has blacklisted the Chinese AI company SenseTime over Xinjiang connections.
• Although the PBOC has never been as independent as western central banks, the bank has been a given rather wide latitude relative to other financial entities in China. Anticorruption officials are said to be investigating the bank, which is likely a move to increase party control over the bank.  It is possible the Xi government is concerned that regulators were corrupted by the real estate sector and is looking for evidence of such activity.
  • In the past, China has tended to lose its nerve when acting to delever. Authorities know China’s debt levels are dangerously elevated, but when they move to discourage lending, the economy often weakens.  We note that credit growth rose in November for the first time since January.  The PBOC and finance officials want to provide some credit but avoid a rapid recovery.  That will be difficult to manage.
  • In this vein, China has eased restrictions on asset-backed high yield lending often used by property firms, further evidence that regulators are trying to provide some credit support but avoid a rapid expansion. This lending is a form of factoring, where firms supplying products to builders sell their accounts receivables to firms who package the obligations for investors.  Obviously, the payments depend on the builders making payments on these goods received.
  • Although variable interest entities (VIE) have not been completely eliminated, China appears to be cutting off these instruments to tech startups. It appears that China is grandfathering those firms that used VIEs for funding but is denying the use in the future, at least for technology firms.
• China’s economic situation has always been difficult to decipher. For example, it is well known that China’s GDP numbers in the first decade of the century were partly fabricated.  However, as General Secretary Xi increases control over the economy, data is being treated as a state secret, and economic reporting is getting become harder to acquire.
  • China’s CPI rose 2.3% in November, almost entirely due to higher food prices. Core CPI rose 1.2%.  PPI rose 12.9% from last year but was unchanged on a monthly basis.
• Private international primary and secondary schools are facing curbs from the CPC on curriculum. Some schools are closing rather than submitting to oversight.
• Recently we have reported that China may have seen its growth peak already. Reports that marriages have hit a 13-year low would support that idea.
• Evergrande (EGRNF, USD, 0.23) has been sliding toward bankruptcy and will need to restructure its debt. After failing to make debt payments, Fitch has placed the company on “restricted default.”  According to reports, the government has added several officials to the company’s risk committee, perhaps signaling that the Xi administration has decided to intervene directly in the troubled company.  Expect a long, drawn-out process to manage the wind-down of the company.
• The U.S. and Taiwan have announced measures to increase investment in important technology sectors.  As we have previously discussed, Taiwan is a critical bottleneck for semiconductors, and the U.S. has been encouraging Taiwanese firms to build capacity outside of the island.
• China has been cracking down on social media companies. According to reports, some of these companies have started layoffs.
• When the scandal surrounding Peng Shuai erupted, Chinese regulators were able to quickly remove references to her in Chinese social media. However, controlling the narrative abroad was more challenging, requiring bots and fake Twitter (TWTR, USD, 45.72) accounts.
• New Caledonia will vote on Sunday to decide if it will remain a French dependency or declare independence. China is said to be encouraging independence, likely to extend Beijing’s influence in the area.

COVID-19:  The number of reported cases is 268,035,994, with 5,283,305 fatalities.  In the U.S., there are 49,538,960 confirmed cases with 793,228 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 586,471,075 doses of the vaccine have been distributed with 475,728,399 doses injected.  The number receiving at least one dose is 237,087,380, while the number receiving second doses, which would grant the highest level of immunity, is 200,400,533.  For the population older than 18, 71.8% of the population has been fully vaccinated, with 60.4% of the entire population fully vaccinated.  The FT has a page on global vaccine distribution.  The Axios map shows a widespread rise in infections.

• Although COVID-19 continues to dominate the media, infectious disease officials are worried that we could be heading into a difficult influenza season.
• PM Johnson has stumbled into a row over a Christmas party held last year in his residence. His staff apparently denied the event took place, only to be caught discussing the soiree on camera.  News of the gathering is coinciding with unpopular new pandemic restrictions.  Reports of new measures have sent the GBP lower.
• One mystery of the virus is why it seemed to be more lethal in overweight patients. A new study suggests COVID-19 “hides” in fat cells, triggering excessive immune responses.
• Reports suggest boosters offer some degree of protection against the Omicron variant.
• There is clear evidence that the Omicron variant spreads easily, but also some hints it is a milder version. We have been expecting (hoping?) that such a trend would develop, which would be consistent with similar viruses.
• Life insurance payouts reached their highest level since the 1918 flu pandemic.
• The Senate passed legislation blocking vaccine mandates. Although it may not pass the House and will almost certainly be vetoed, the fact it passed the Senate shows increasing opposition to containment measures.
• A serious fallout from last year’s containment measures as a sharp setback in educational progress.

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

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with a range of U.S. news, including a detailed readout from President Biden’s call with Russian President Putin yesterday.  We next turn to international news, including an important report on how the Chinese government is planning to regulate future overseas stock listings.  We end with the latest developments relating to the coronavirus pandemic.

United States-Russia-Ukraine:  In a video call yesterday, President Biden apparently issued a tougher-than-anticipated warning to President Putin that if he launches an invasion of Ukraine, as U.S. intelligence believes he may be planning, the NATO allies will respond with severe economic, diplomatic, and military punishments.  For example, National Security Advisor Sullivan suggested Biden threatened to block Russian natural gas shipments to Europe through its newly completed Nord Stream 2 pipeline under the Baltic Sea in the event of an attack on Ukraine.  Biden also warned that the U.S. would respond to an attack on Ukraine by boosting its deployment of troops and military equipment in Eastern Europe.  According to a sober readout from a Kremlin spokesman, Putin complained about strengthening ties between NATO and Ukraine and demanded: “reliable, legally fixed guarantees that rule out eastward NATO expansion and the deployment of offensive strike weapons systems in states adjacent to Russia.”  However, the White House insisted Biden made no commitments or concessions to the Russian demands.

• The threat to shut down Nord Stream 2 illustrates how much the retirement of German Chancellor Merkel has strengthened Biden’s hand in dealing with Putin.  U.S. and German officials have had intense discussions on the issue.  Merkel’s outgoing team and the team of incoming Chancellor Olaf Scholz appear confident that Scholz will take a harder line on Putin than Merkel, who was usually reluctant to put German industrial interests at risk.  (The Scholz coalition will also probably take a tougher line on Chinese President Xi.)
• Analysts have also suggested the U.S. would significantly ratchet up the pain on Russia if it cut off the country from the SWIFT international payments system.  Blocking Russia from trading dollars for rubles would be particularly disruptive for the country since it could leave China as Russia’s only significant oil market.
• We also note that U.S. officials have suggested blocking Russian companies from access to global capital markets.  Given that U.S. officials have started taking such steps against Chinese firms listed on U.S. stock exchanges, that probably shouldn’t be taken as an idle threat.  In the event of an attack on Ukraine, the threat of forced delisting would probably be particularly negative for Russian stocks trading in the U.S.

U.S. Fiscal Policy:  Speaking at a Wall Street Journal conference, Democratic Senator Joe Manchin declined to commit to voting for his party’s roughly $2 trillion social-policy and climate package, citing concerns about inflation and the length of the programs.

• Coupled with continuing resistance from Democratic Senator Kyrsten Sinema, Manchin’s stance shows Democrats are still at risk of not getting the legislation passed or only getting a significantly watered-down version.
• Separately, Congressional leaders have struck a deal that paves the way to raise the federal government’s borrowing limit and avert a looming crisis over the U.S. debt ceiling.  The House passed the legislation yesterday, and the Senate is expected to follow suit on Thursday.

U.S. Monetary Policy:  In a new poll by the Financial Times, more than half of the leading academic economists surveyed said it was “somewhat” or “very” likely the Fed would completely stop its bond purchases by the end of March.  That pace could enable the Fed to raise its benchmark fed funds interest rate as early as the first quarter of next year, a move that 10% of the respondents now expect.

U.S. Labor Market:  One little-noticed factor that may be helping to drive up wage rates is the aggressive pay policies and rapid hiring at Amazon (AMZN, $3,523.29).  As the company establishes ever more warehouse and distribution operations across the nation, often in smaller communities with low wage rates, its relatively high pay is forcing local firms to hike their pay to avoid losing workers.

China:  Several government agencies are reportedly developing a blacklist of startup companies in sensitive economic sectors that will be restricted from using “variable interest entities” to raise foreign capital and list on overseas stock markets.  The targeted sectors would likely include those that are data-intensive or have implications for national security.  The list would exclude big, well-established firms, which have used the VIE structure to list in the U.S. and other foreign markets for decades.

• One Chinese official indicated the blacklist is aimed at ensuring that future national champions critical to the country’s economy would not be dominated by foreign shareholders.
• The official said that while foreign investors may be restricted from investing in Chinese technology companies, they could still invest in traditional firms, which don’t need to use the VIE structure to list overseas.
• News of the limited blacklist is consistent with statements a Chinese official made last weekend, which indicated that the country is not issuing a general ban on VIEs listing overseas or pushing to delist existing VIEs overseas.
• If confirmed, the reliance on a limited blacklist could offer some clarity on the status of existing Chinese listings on the U.S. and other Western exchanges, which could give a boost to those listings.  However, given the worsening U.S.-China geopolitical rivalry, there would still be some risk that Chinese authorities could expand the blacklist over time and/or still put informal pressure on Chinese firms to bring their listings back home to China or Hong Kong.  Besides, as the geopolitical rivalry heats up and U.S. officials increasingly see China as a threat, they are likely to keep pursuing their own restrictions on U.S. investment in China.

Australia-China:  Just days after the U.S. said it would impose a diplomatic boycott on the upcoming Winter Olympic Games in Beijing, the Australian government announced it would impose its own diplomatic boycott over China’s geopolitical aggression and human rights abuses.  The move seems certain to draw Chinese ire and possibly new economic and diplomatic punishments for Australia.

Germany:  The Bundestag today approved Olaf Scholz as the country’s new prime minister.  Scholz will lead a coalition government consisting of his center-left Social Democratic Party, the leftist Green Party, and the libertarian Free Democratic Party.

• As referenced above, the new government is likely to ally more closely with the U.S. as it tries to counter aggressive geopolitical moves from Russia and China.  In domestic policy, the coalition partners have agreed on a four-year program to overhaul Germany’s economy, fight climate change, digitize public services, and reverse its demographic decline.
• For now, the coalition partners have what appears to be a workable agreement, and investors are likely to appreciate continuing stability in Germany.  The installation of Free Democratic politician Christian Lindner will also probably be taken well by investors.  However, given the wide differences in the coalition partners’ policy aims, Scholz will likely face a tough balancing act to keep the partners together, meaning the current aura of stability and cooperation may not last.

COVID-19:  Official data show confirmed cases have risen to 267,322,517 worldwide, with 5,275,023 deaths.  In the U.S., confirmed cases rose to 49,389,503, with 791,514 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 236,363,835.  The data show that 71.2% of the U.S. population has now received at least one dose of a vaccine, and 60.1% of the population is fully vaccinated. 

• Pfizer (PFE, $51.72) and BioNTech (BNTX, $302.69) said initial lab tests indicate that a third dose of their vaccine offers good protection against the Omicron mutation, even though a two-dose regime is significantly less effective against the new variant.
  • However, the companies said a two-dose regime may still induce protection against severe disease, and they are continuing to monitor the real-world effectiveness against Omicron.
  • The findings by Pfizer and BioNTech are generally consistent with an independent analysis published yesterday by scientists in South Africa.
  • Pfizer also said it was developing a new vaccine specifically targeting Omicron and expected to have it available by March if additional protection is required to combat the variant.
• In the U.K., Prime Minister Johnson is set to announce fresh restrictions to curb the spread of the Omicron variant, including requiring vaccine passports to enter large venues and an order to work from home. The move comes as Omicron spreads rapidly in the U.K., and the government faces a scandal over a Downing Street holiday party last year.  In response, the pound has dropped about 0.5% to approximately $1.3170 today, reaching its lowest level in more than a year.

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with a range of developments touching on the U.S. relationship with other major powers, including China and Russia.  We then move on to other international developments.  We close with the latest news related to the coronavirus pandemic, including some positive assessments of the Omicron variant, which are giving a further boost to global risk markets today.

United States-Russia-Ukraine:  In a video call scheduled for today, President Biden is expected to tell President Putin that the U.S. and its NATO allies will impose steep costs on Russia if it invades Ukraine.  The U.S. intelligence community has been warning that Putin may be preparing for an invasion, although CIA Director Burns emphasizes that it hasn’t definitively concluded that Putin intends to carry it out.  Kremlin spokesman Dmitry Peskov told Russia’s Channel One state television channel that Putin was ready to listen to Biden’s proposals on settling the situation in Ukraine but cautioned against excessive expectations.

• Ukrainian entry into NATO would be a clear red line for Russia and isn’t likely soon.  Nevertheless, the U.S. and other NATO countries have increased their military, diplomatic, and economic support for Kiev in recent years, in what President Putin probably sees as a creeping, informal embrace of Ukraine.  Putin has seemingly decided to put his foot down on the matter and is essentially fomenting a crisis in order to exact U.S. and NATO security guarantees.  It is less likely that Putin actually intends to take over more of Ukraine, although the possibility can’t be entirely discounted.
• All the same, it’s important to remember that anytime two great powers lock horns, there is the risk of miscalculation or accident.  We note that the Biden administration has already warned that a Russian invasion of Ukraine would lead to the U.S. beefing up its troop strength and equipment deployments in Eastern Europe.  At the very least, strident rhetoric or saber-rattling on either side would likely spook the financial markets and drive oil and gas prices higher, especially in Europe.

United States-Saudi Arabia:  U.S. officials are considering an urgent request from Saudi Arabia to replenish its stock of antimissile munitions.

• Saudi Arabia has been facing about a dozen ballistic missile and drone attacks each week from Houthi rebels based in Yemen.
• The Saudi military has successfully fended off most of the barrages with its Patriot surface-to-air missile system, but its arsenal of interceptors—missiles used to shoot down airborne weapons—has fallen dangerously low.
• The Saudi request is likely to be approved, but the U.S. decision is being seen as a test of the Biden administration’s commitment to the Middle East and its allies there.

United States-China:  U.S. Air Force Secretary Frank Kendall said his service is developing a pair of classified combat drones that are designed to operate alongside fighter planes and bombers.  The disclosure is the strongest indication yet that the service is banking on autonomous weapon systems to give it an edge in the increasingly fierce military competition with China.  Other autonomous military equipment being developed worldwide includes drone refueling tankers, drone ships and submarines, and drone resupply transports.

China Debt Crisis:  Major real estate developer Evergrande (EGRNY, $5.97) failed to make an $82.5 million interest payment on some of its international debt by the end of a grace period last night, according to bondholders.  If verified, the missed payment could trigger an official default and lead to a major restructuring.

• More important, a default by Evergrande would signal the government’s firm intention to rein in debt and what it sees as excessive real estate investment.
• For the last several months, the government’s moves have sparked sharp volatility in Chinese markets and beyond.  And official default could prompt further volatility, especially if it is handled poorly or if it opens the floodgates to other defaults.  Indeed, cushioning the potential blow to markets is likely one reason Chinese regulators yesterday loosened monetary policy, which is helping support developers’ shares today.
• The clampdown on real estate debt is just one of several headwinds that we see for Chinese markets going forward.  Other headwinds include the government’s hyper-strict “zero-COVID” policies, new energy regulations that have crimped supply, and the rising U.S.-China geopolitical rivalry, which is decoupling the two countries in terms of both information and capital flows.

Peru:  Just four months into his term, radical left-wing President Pedro Castillo faces an impeachment vote in the national legislature today.  Although the vote is not expected to succeed, Castillo is facing rising anger and plummeting approval ratings because of a series of scandals and chaotic leadership.

Ethiopia:  With Tigrayan rebels advancing on the capital, masses of people are reportedly leaving their jobs to join the army, sparking concerns of all-out civil war and all the social and economic disruption that would likely flow from it.

United Arab Emirates:  In an effort to improve the work/life balance (and better synchronize with global financial markets and business activity), the UAE government will shift the country’s official workweek to Monday through noon on Friday, beginning January 1, shifting from the current Sunday through Thursday.

COVID-19:  Official data show confirmed cases have risen to 266,622,610 worldwide, with 5,266,636 deaths.  In the U.S., confirmed cases rose to 49,278,724, with 789,745 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 236,018,871 .  The data show that 71.1% of the U.S. population has now received at least one dose of a vaccine, and 60.0% of the population is fully vaccinated.

Virology

• Physicians and scientists in South Africa have reported early hospital data suggesting the Omicron variant could result in less severe illness than previous waves; they also warned that higher transmission rates could still overwhelm hospitals.  The good news has been a significant reason for the jump in global risk assets since yesterday.  The chart below shows early data from hospitals in the key South African province of Gauteng.

• GlaxoSmithKline (GSK, $41.76) and Vir Biotechnology (VIR, $38.39) said their antibody treatment retained effectiveness against the Omicron variant in laboratory studies.  Early data suggests similar treatments work less well against the strain, but the Glaxo/Vir statement is likely to feed into the newfound optimism regarding Omicron and will likely give further support to risk markets today.
• New data suggest the Chinese vaccines used widely in China and less developed countries are not as effective in stopping the spread of the disease as the advanced mRNA vaccines developed and used mostly in the developed countries of the West.  However, they do appear to be effective in reducing the severity of an infection.
• In Brazil, which was the epicenter of the global pandemic at one point earlier this year, a mass vaccination campaign has brought daily deaths down to less than 200 per day.  On a per-capita basis, that’s now below the U.S., the U.K., and the EU.
• New York Mayor De Blasio yesterday issued a vaccine mandate that all private-sector employees working in person must be vaccinated by December 27, just days before he leaves office.  De Blasio said more details about the rules and how they would be enforced will be released on December 15.
  • At present, it isn’t clear whether incoming Mayor Eric Adams would maintain Mayor De Blasio’s mandate.
  • In any case, the New York City mandate will likely be challenged in court.
• In a major policy speech opening a special session of parliament, Prime Minister Kishida vowed to accelerate the deployment of booster shots.  He also announced the introduction of digital proof of vaccination using Japan’s “My Number” social security system in tandem with taxation identification cards and smartphones starting December 20.

Economic and Financial Market Impacts

• European bond investors are beginning to worry more about an abrupt hawkish shift by the ECB when its policymakers meet next week.  Concern is rising that the officials will be forced to abandon their previous plans to keep monetary policy loose for a prolonged period, based on the Eurozone’s current high inflation, threats from the Omicron mutation, and the Fed’s own recent hawkish shift.

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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  Financial markets remain choppy this morning.  U.S. equity futures are generally higher, as is oil.  Meanwhile, moderate temperatures in the U.S. are sending natural gas prices plunging, with nearest futures off nearly 10%.  Inflation data is out later this week, and a reading over 7% is pos60sible.  The Biden administration is expected to announce a diplomatic boycott of the Winter Olympics this week, which will send a signal to Beijing but allow athletes to compete.

Our coverage begins with the crypto markets, which had a rough weekend.  Economics and policy come next, with an interesting chart on the labor markets.  We also note that Q4 GDP is looking surprisingly strong.  International news follows, with comments on Russia’s troop buildup and Iran/U.S. nuclear talks.  China news is next.  The PBOC cut reserve requirements this morning.  We close with our usual pandemic update; indicators are that the Omicron variant spreads easily but may be less lethal.

Crypto:  Major cryptocurrencies had a tough weekend, with prices falling more than 20% at one point.  It isn’t clear why the selloff occurred, although we note that comments from the Chinese real estate market (see below) coincided with the selling.  That may be a coincidence, but it could be that these real estate firms hold crypto and are selling to boost liquidity.  Crypto is a 24/7/365 market, but that doesn’t necessarily mean that all periods have the same level of liquidity.  Some of the drop may be due to selling into a thin market.  However, the overall reason for the decline appears tied to concerns about policy tightening.  We view crypto as a debasement asset, and a Fed pivoting to tightening isn’t positive for this asset class.

• Researchers warn quantum computers will probably be able to corrupt the blockchain and hack cryptocurrencies.

Economics and policy: We comment on the employment report and the economy.

• Here are a couple of notable charts. First, the headline report of weak payroll data overshadowed remarkably strong household survey data.

This difference of 926,000 is rare.  In the 886 months of data, a difference of this level or more has occurred only six times.  We suspect the payroll data will be revised higher, but it is also possible that the household survey is picking up anecdotal reports of a surge in entrepreneurship.  The establishment survey, where the payroll data comes from, won’t pick up workers starting their own businesses.

Second, the Atlanta FRB’s GDPNow report is currently calling for a 9.7% GDP number for Q4.

This level of growth is likely prompting the Fed to shift away from policy accommodation.

• Congress is trying to pass a series of bills before year end, including the debt ceiling.

International roundup:  The Russian troop buildup continues to raise concerns, and talks with Iran are not going well.

• The U.S. is increasingly sounding the alarm over Russia’s troop buildup on the Ukraine frontier. By sharing intelligence with EU nations, Washington has made some headway in convincing even the rather Moscow-leaning European nations that the Russian threat is elevated, arguing that Russia could invade Ukraine in early 2022.  Presidents Biden and Putin are scheduled to have a call tomorrow.  It remains unclear to us just how serious Russia is about an invasion.  Clearly, the buildup of troops would suggest that something is up.  We have little doubt that (a) if Russia is serious, it can successfully invade Ukraine, and (b) the West won’t do much about it other than impose sanctions.  However, sanctions are not a completely idle threat.  If the West denied Russia access to the S.W.I.F.T. network, for example, it may prevent Moscow from selling oil to anyone other than China.  And, if Iran’s experience is any guide, Russia would be forced to sell oil at a deep discount.  Of course, this also would affect natural gas exports, so the EU would likely be cautious about such a step.  It should also be noted that invading is one thing, controlling is another.  Russia currently controls the Russian-leaning areas of Ukraine.  Taking the rest would mean it would govern an anti-Russian majority, meaning that the costs of control would be high.  We expect that Russia’s buildup is a bluff, but the alarm being raised by U.S. intelligence agencies means we are watching this issue closely.
• The negotiations with Iran to return to the JCPOA are not going well at all. Iran’s position is that the U.S. needs to lift sanctions as a precondition to talks, and the Biden administration needs to bind future administrations to whatever agreement is made.  The latter point is impossible, as even treaties can be rescinded.  EU negotiators warn that if Iran holds these positions, talks are doomed.  If the talks fail, the U.S. will likely take steps to add additional sanctions and may need to consider military action to slow Iran’s nuclear weapons development.
• The EU is moving to create a trade retaliation structure that will be controlled by the EU Commission, allowing it to levy trade sanctions without the approval of individual nations. This change would give the EU much greater power in trade, although we struggle to see how the commission would move against the wishes of France and Germany.
• U.K. officials are in the U.S. to encourage America to make a free trade deal. Although, until the row between the EU and Northern Ireland is resolved, we doubt there will be much progress.
• It is now becoming clear that Assad will remain in power in Syria. However, his government is desperate for money to rebuild, is “shaking down” companies for money, and is engaging in drug trafficking.
• In Myanmar, the junta has sentenced Aung San Suu Kyi to four years in prison.
• There was a large volcanic eruption in Indonesia on the island of Java. Volcanic eruptions can spew ash into the upper atmosphere and may reduce temperatures.

China news:  Reserve requirements were cut this morning.

• The PBOC cut reserve requirements by 0.5%; although regulators hope this will spur lending, the move isn’t big enough to boost lending significantly and could be used by banks to expand margins.
• Regulators in the U.S. and China continue to move toward delisting. Didi (DIDI, USD, 6.07) is moving to delist, but without a deal regarding U.S. disclosure requirements, the chances that many Chinese firms will delist is rising.
• Although Russia’s actions in Ukraine (see below) are making headlines, U.S. military leaders warn that Chinese aggression toward Taiwan remains elevated. Meanwhile, U.S. trade with Taiwan is booming, and an escalation in tensions could be an economic disruption.
• Chinese real estate woes continue. Evergrande (EGRNF, USD, 0.28) indicated it intends to include all of its offshore bonds in the expected restructuring.  In addition, Sunshine 100 China Holdings (2608, HKD, 0.34) defaulted on a $170 million bond.
• China is facing some serious long-term issues. First, China has always had water management issues.  From flooding to desertification, leaders have tried to manage water through dams and other actions.  But, one underappreciated fact is that manufacturing uses a lot of water, and as shortages grow, China may struggle to meet production goals.  Second, China’s demographics are deteriorating rapidly, which threatens future growth.
• China is in talks with Equatorial Guinea to build its first Atlantic military base.
• China is merging the assets of several SOEs involved in rare earth mining to create one large “champion.”

COVID-19:  The number of reported cases is 265,990,136, with 5,258,654 fatalities.  In the U.S., there are 49,086,840 confirmed cases with 788,364 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 580,417,105 doses of the vaccine have been distributed, with 470,297,846 doses injected.  The number receiving at least one dose is 235,698,738, while the number receiving second doses, which would grant the highest level of immunity, is 198,962,520.  For the population older than 18, 71.5% of the population has been fully vaccinated, with 59.9% of the entire population fully vaccinated.  The FT has a page on global vaccine distribution.

• There is growing evidence that the Omicron variant is highly contagious. It appears this variant has adopted some of the characteristics of a related coronavirus, the common cold, which is helping its spread.  Case reporting shows a rapid rise in cases in Europe.  So far, the rise of cases in the U.S. has been less dramatic but is expected to increase soon.  On the plus side, there is also evidence from South Africa that this variant may be less virulent compared to earlier strains.  If so, the milder strain would be a positive development.
• The U.S. plans to fast-track new vaccines for Omicron, but widespread lockdowns appear unlikely.
• In Europe, there is rising opposition to lockdowns and vaccine mandates.

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

[Posted: 9:30 AM EDT] | PDF

Good morning. U.S. equity futures are signaling a higher open. Today’s report begins with U.S. economic and policy news followed by our roundup of China-related stores. International news is next, and we conclude with our pandemic coverage.

Economics and policy:

• Congressional leaders agreed to a short-term spending bill that would fund government agencies through February 18. The bill passed through both the House and the Senate on Thursday and is expected to be signed by President Biden on Friday.
• Federal Reserve Governor Randy Quarles gave his final speech on Thursday. In it, he warned that the new facilities put in place for the pandemic established a dangerous precedent that could have ramifications for the economy. His comments reflect growing angst among those in the establishment who would like a return to the pre-pandemic norm concerning fiscal and monetary policy.
• The dispute over the Russian troop buildup along the Ukraine border swelled on Thursday. Secretary of State Antony Blinken warned Russia that if it pursued confrontation with Ukraine, there would be “serious consequences.” The vague threat was in response to U.S. concerns that the troop buildup was a prelude to an inevitable Russian invasion of Ukraine. Russian Foreign Affairs Minister Sergei Lavrov responded by stating that continued western military support of Ukraine may lead to retaliation from Moscow. Although Russia has dismissed the chances of an eventual invasion, Ukraine and the U.S. appear to be unconvinced. On Friday, Ukraine Defense Minister Oleksii Reznikov warned that his country was prepared to fight back if Russia were to launch an attack.
• The U.S. plans to lead efforts to limit the export of surveillance technologies to authoritarian governments. The initiative is expected to be launched at the Summit for Democracy event that will take place on December 9.
• Cleveland Federal Reserve President Loretta Mester warned that the Omicron variant could exacerbate inflation. Assuming that this new variant is more dangerous than the delta virus, she claimed there could be more supply chain shortages and higher quit rates. Her warning comes amid growing fears that the variant could slow the global recovery. However, it is worth noting that although there is evidence suggesting the latest variant is more contagious than Delta; it is also believed to have less severe symptoms.

China:

• Chinese ride-hailing app Didi (DIDI, $7.80) has begun the process of delisting from the New York Stock exchange and is expected to pursue a listing in Hong Kong. Recently, Chinese regulators announced a crackdown on companies looking to list overseas. In response to the reports, tech shares listed on the Hong Kong Exchange briefly sank to record lows as investor sentiment dipped in response to increased government scrutiny of Chinese tech firms.
• China is expected to raise prices for long-term coal contracts following a supply scare earlier this year. The increase in coal prices could add to the inflationary pressures faced by manufacturers, who have struggled to secure needed raw materials throughout the year.
• A Chinese think tank claimed that the U.S. military flew a record number of spy planes over the South China Sea. The report comes among rising tensions between Beijing and Washington.
• The People’s Bank of China announced it will decrease the amount of cash that banks need to hold in their reserves. The change is designed to boost bank lending to small businesses.

International news: 

• OPEC plus agreed to proceed with its planned production hike in January. The group will add 400,000 barrels a day to the global market next month but said that it could reverse course at any moment if demand falls due to the Omicron variant.
• Austrian Chancellor Sebastian Kurz resigned on Thursday. He is currently under investigation for suspected corruption. Top officials within the ruling conservative party have picked Karl Nehammer to be the new chancellor.
• The EU slapped several entities in Belarus with sanctions on Thursday due to their involvement in the growing migrant crisis along the country’s border. The EU hit Belarus’s state airline, sovereign debt, and other companies and individuals. It has threatened more sanctions if the country’s president Alexander Lukashenko does not stop the flow of immigrants along its border. The EU has accused Belarus of manufacturing a migrant crisis.
• German Chancellor Olaf Scholz has chosen a new head of the German Bundesbank. The new appointee, Joachim Nagel, had previously worked for the Bank for International Settlements (BIS). Germany is dealing with rising inflation, which hit a thirty-year high of 6.2% in October.  Little is known about his policy leanings, but given the country’s sensitivity to inflation, it is probable that he could push for a more hawkish monetary policy.

COVID-19:  The number of reported cases is 264,304,501 with 5,237,752 fatalities.  In the U.S., there are 48,832,268 confirmed cases with 785,912 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 578,263,565 doses of the vaccine have been distributed, with 464,445,580 doses injected.  The number receiving at least one dose is 234,269,053, the number of second doses is 197,838,728, and the number of the third dose, the highest level of immunity, is 42,973,222. The FT has a page on global vaccine distribution.

• A Pfizer executive stated he believes that the latest booster shot should be able to protect against the Omicron variant. The market responded well to the statement, although the executive mentioned he was merely speculating.
• The German government has imposed lockdowns for those who are unvaccinated.
• There are now five states that have detected Omicron cases. The outbreak may have been related to an anime convention in Manhattan. Cases of the new variant have now been identified in Minnesota, Hawaii, New York, Colorado, and California. At this time, it isn’t clear whether states will reimpose lockdowns.

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