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

[Posted: 9:30 AM EDT] | PDF

Good morning, happy Monday, and welcome to November!  It’s going to be a busy week.  The ISM manufacturing data is out this morning.  The FOMC meets this week and will likely announce its tapering plans.  We may also get a vote on the budget and infrastructure package this week.  COP26 kicks off today.  Our coverage begins with the international roundup, which previews the COP26 and recaps the G-20 weekend meeting.  Economics and policy are up next, with inflation and central banks leading the headlines.  China news follows, and we close with the pandemic update.

International roundup:  The G-20 met over the weekend, and COP26 starts today.

• The G-20 meeting over the weekend was a mixed bag. As we noted last week, the U.S. and EU avoided a tariff spat over steel.  However, any hopes of a climate agreement among the world’s largest nations were mostly dashed.  All the nations agreed that climate change was a problem, but there was no notable consensus on what to do about it.  The U.S. was pushing to end coal usage; all that emerged was an agreement to stop funding international coal-fired electricity  Coal producers and consumers opposed the plan to end the burning of coal.  President Biden blamed China and Russia for the lack of progress.  International environmental goals suffer from the free-rider problem.  Simply put, all are better off by adjusting, but a single participant does best by doing nothing and “riding” on the actions of others.  If all act in that fashion, nothing gets done.
  • There was an agreement on a minimum corporate tax rate of 15%. The agreement also distributes taxes based on revenue generated in individual nations.  The goal is to undermine the incentive to “jurisdiction shop” to avoid taxes.  The U.S. was successful in getting nations to back away from proposed digital services taxes, which would have fallen heavily on U.S. tech.  It should be noted that the tax distribution clause is considered a treaty and thus requires a 2/3 majority in the Senate.  There is little chance of that happening.  Without the distribution approval, the digital taxes will likely go forward.  Thus, GOP senators will be lobbied hard by the tech industry.
  • President Biden and President Macron of France met to smooth over tensions triggered by the nuclear sub deal with Australia. It appears the two leaders made up, but the underlying issues remain, specifically, the U.S. is shifting focus to Asia, and the EU is going to be less important to American interests.
• For the next two weeks, the 26^th meeting of the Conference of the Parties (COP26) will be held in Glasgow, Scotland. It is an annual climate meeting that was postponed last year.  The official business is to monitor the progress of the Paris Agreement on climate goals.  As noted in the above discussion of the G-20, there is an almost insurmountable free-rider problem.  Every nation wants something done on climate but paid for by someone else.
• The LDP held its majority in legislative elections over the weekend, confirming that Fumio Kishida will remain in power. We will analyze the new PM in an upcoming WGR.
• The fishing wars between France and the U.K. are showing no signs of abating. Paris is trying to drum up EU action against the U.K. on this issue.
• The Persian Gulf Arab states pulled their ambassadors from Lebanon. The current government in Lebanon is seen as supporting Iran, and recent criticism from Lebanon over the Yemen war prompted the withdrawal.
• There has been a coup in Sudan. Large protests against the new government developed over the weekend.
• South Africa is holding local elections today. The ANC has become increasingly unpopular, and this vote will be seen as a test of future support.

Economics and policy:  The budget and central banks lead the news.

• There is rising optimism that a vote might come soon on the budget and the infrastructure package. Negotiations have continued to include drug cost containment.
• Financial markets around the world are pricing in central bank tightening. We are also seeing the yield curve flatten, suggesting markets expect the central banks to step in and raise rates; this action will slow economic growth.  The latest jump in rates was seen in Australia, where the central bank decided not to defend its previous yield curve control measures, leading to a rapid rise in interest rates.  The 3-year Australian sovereign has moved from 20 bps to 100 bps in the past month.  The Bank of Canada recently surprised the markets by abruptly ending its QE.
  • The consensus appears to be that the markets will force the central banks to raise rates, and policy tightening will increase the risk of recession. This is seen by the tumult in short-term parts of the yield curve and the lack of reaction on the long end.  We are still not convinced that the Fed will bow to market pressure.  Powell still wants to get reappointed to Chair, and raising rates won’t help with that goal.  But, for now, that is the market’s position.
• A key element to the market’s position is the persistence of inflation. Wage pressures are unrelenting.  Much of the low inflation of the past 40 years was based on wage suppression through offshoring, automation, and flexible scheduling (gig work).  The ride-sharing companies are forced to lift pay to attract workers.  Since these companies are not profitable anyway, the business case for these firms looks rather shaky.  The loss of baby boomers to retirement appears to be a key factor in tightening labor markets.
  • The strike at John Deere (DE, USD, 342.31) may be nearing an end. The union leadership and the company have come to a deal, but it still needs to be ratified by the rank-and-file.  The vote will be held tomorrow.
  • The port problems continue. Logistical snarls simply are not improving.  The supply chain rested on a large number of low-paid workers, and the lack of available labor is forcing the entire chain to scramble for workers.  Higher pay looks like an inevitability.
  • American Airlines (AAL, USD, 19.20) canceled over 600 flights yesterday due to the lack of staffing.
  • Inflation has come to breakfast foods. Prices for common items consumed at this meal are at 10-year highs.  Meanwhile, DOE Secretary Granholm is blaming OPEC for high gasoline prices.
  • As semiconductor chip shortages led to slower production of autos and appliances, firms that supply low-tech materials are seeing their demand decline.
• One of the more interesting op-eds from the weekend comes from the junior senator from Missouri, Josh Hawley (R-MO). His premise is that global supply chains are broken, and something akin to industrial policy will be required to fix them.  This means reshoring production and using domestic content rules to ensure that most things are produced in the U.S.  The industrial policy used to come from Democrats.  We also note that recent comments from Sen. Rubio (R-FL) suggest the GOP should abandon “big business” and focus on the working class.  Such proposals have been circulating for some time, but the fact such ideas are coming from GOP senators shows party constituents are in flux.
• Last week, natural gas prices in Europe fell on reports Russia was going to boost production. However, we note that Russia reversed the flow of a natural gas pipeline to Europe, which led to a withdrawal of gas from the EU.

China news:  PMIs were soft, and real estate remains a worry.

• Manufacturing PMI data for October show continued slow economic activity. The data are not signaling a recession, but growth is barely at trend.  Power problems and the ongoing issues in real estate are plaguing the manufacturing sector.
• Evergrande (EGRNF, USD, 0.31) made another bond payment, staving off default yet again. However, there is no indication that this process can continue.  Local and provincial governments have funded themselves with land sales. As that source is cut off, bonds issued by these entities will likely come under strain.
• The U.S. is moving forward on delisting Chinese stocks from U.S. exchanges.
• China is reportedly rationing fuel supplies at gas stations. If the U.S. experience is any guide, expect unruly crowds and shortages.
• China’s EV sales in Europe are rising.

COVID-19:  The number of reported cases is 246,815,047, with 5,001,932 fatalities.  In the U.S., there are 45,971,267 confirmed cases with 745,836 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 518,696,735 doses of the vaccine have been distributed, with 422,070,099 doses injected.  The number receiving at least one dose is 221,520,153, while the number receiving second doses, which would grant the highest level of immunity, is 192,453,500.  For the population older than 18, 69.6% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

• Declassified U.S. intelligence reports build a circumstantial case that poor security could have led to the creation and distribution of COVID-19.
• We are seeing accumulating evidence that lockdowns caused significant mental health problems.
• The FDA is investigating the Moderna (MNRA, USD, 345.21) vaccine to determine whether it causes myocarditis in children 12-17 years old. Although the side effect appears to be rare and reversible, the investigation will likely delay its distribution among children.

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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 lower open this morning. Today’s report begins with international news, followed by U.S. economics and policy coverage.  China news is next, and we conclude with our pandemic coverage.

International news: 

• The European Union is expected to accept a quota on its exports to the U.S. of steel and aluminum. The deal would end a three-year standoff over metal tariffs. In 2018, then-President Trump imposed tariffs on steel and aluminum because of national security. The new agreement allows for the removal of tariffs on European metals as long as shipments to the U.S. don’t exceed a predetermined number. A similar arrangement was made under President Trump but was dismissed by European diplomats as being petty. The arrangement is further evidence that the relationship between the two sides is slowly starting to unravel.
• The tension between the U.K. and the EU over fishery licenses escalated on Thursday after France seized a British boat in French waters. The dispute between the sides started when French fishermen received only half of the licenses needed to fish in British waters. In their defense, the British claimed to have given licenses to vessels that met requirements. The French have threatened to impose sanctions if these licenses aren’t given to the fishermen by November 2. The back and forth is another example of post-Brexit tension. If left unchecked, this could possibly lead to a hard Brexit. In the past, the U.S. has intervened to mediate tensions between European countries.  However, lately, it has shifted its focus to the Pacific. As a result, it isn’t clear how this dispute will resolve itself.
• On Thursday, Taiwanese President Tsai Ing-wen confirmed a Wall Street Journal story claiming there were U.S. troops deployed on the island. In an interview with CNN, she acknowledged that U.S. military presence on the island is part of Taipei’s broader cooperation with Washington. The revelation comes after allegations that Taiwan’s military isn’t prepared to defend itself from a possible invasion from China, something Chinese officials have indicated as being inevitable. The deployment of troops in Taiwan highlights the level of seriousness that both Taiwan and the U.S. have taken against China’s growingly assertive posture toward the region. China has since asked the U.S. to withdraw troops from the island, but it is unlikely this would happen.
• The global chip shortage appears to be getting worse as firms are complaining of even longer wait times.
• Natural gas and power prices fell in Europe after Russian President Vladimir Putin reassured the continent that it would send extra gas. The move is likely another example of the amount of sway Moscow has in its ability to influence energy markets in Europe. Over the last few weeks, Putin has been accused of intentionally withholding gas to pressure Europe into approving the Nord Stream 2 pipeline, a pipeline linking Germany with Russia.
• Global authorities have started to pressure operators of blockchain-based decentralized finance services to comply with anti-money laundering rules.
• Moldova’s prime minister, Natalia Gavrilita, has asked for help from the EU as the country tries to stave off pressure from Moscow. Recently, Moldova was forced to declare a state of emergency after Gazprom (OGZPY, $10.03), a majority state-owned energy company, reduced gas deliveries by a third and threatened to cut off the country completely if it didn’t agree to a more expensive contract. In talks, Moldova was told it could receive a better contract if it agreed to adjust its free-trade deal with the EU and delay energy market reforms. This bullying from Russia is further evidence that it has weaponized its energy resources.
• France is pressuring Brussels to delay trade talks until after the French elections take place in April.

Economics and policy:

• During the pandemic, there was a record jump in the number of business formations. According to the Census Bureau, new filings for employer identification numbers surged 57% in 2020 and are on track to make a similar jump this year. The increase in business formation may be another reason employers are struggling to find workers. An increase in stimulus and leisure time due to the lockdown may have inspired workers to start ventures of their own, thus, leading to a decrease in the number of available workers and an increase in labor demand. If true, this could mean the labor shortage could be a longer-term problem.
• Speaker of the House of Representatives, Nancy Pelosi, was forced to delay the vote on the Bipartisan Infrastructure bill after progressives threatened to vote it down. Progressives have signaled they would not support the infrastructure bill without reassurances that the social spending bill has the support from moderate Senators Kyrsten Sinema (D-AZ) and Joe Manchin (D-WV). The setback has placed more uncertainty as to whether President Biden will be able to get the bills pushed through Congress. So far, Manchin has signaled support of a social spending bill that cost $1.75 trillion. However, it is still unclear where Sinema stands. President Biden has stated that the success of his presidency rests on the passage of these two bills. Failure to pass either bill could lead to weaker growth prospects in the future.
• Analysis by the St. Louis Fed shows the pandemic has forced many baby boomers into retirement.

China:

• Speculation that the Chinese government could take steps to boost raw material prices led to a rebound in aluminum and coal prices on Thursday. China is the world’s largest producer of aluminum and coal, so a sharp drop could negatively impact its economy.
• Chinese real estate company Evergrande was able to avoid default by making an overdue payment on dollar-denominated bonds before the end of a 30-day grace period. It is the second payment the company has made in two weeks as it tries to bide time to negotiate with creditors and avoid a default on its debt.
• India has deployed weapons to bolster its defenses along the border it shares with China.
• Tajikistan will allow China to build a police outpost on the Afghan border. Although no Chinese personnel will be housed there, the move is the latest indication of Beijing’s growing security concerns.

COVID-19:  The number of reported cases is 245,655,515, with 4,983,764 fatalities.  In the U.S., there are 45,826,252 confirmed cases with 743,362 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 510,735,525 doses of the vaccine have been distributed, with 417,795,537 doses injected.  The number receiving at least one dose is 221,348,530, the number of second doses is 188,281,747, and the number of the third dose, the highest level of immunity, is 15,417,340. The FT has a page on global vaccine distribution.

• A significant percentage of unvaccinated workers said they would quit their jobs if required to get vaccinated or get tested weekly. According to a study conducted by the Kaiser Family Foundation, over 70% of unvaccinated workers would quit over a strict vaccine mandate, and nearly 40% said they would quit if there was an additional possibility of being tested weekly.

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

[Posted: 9:30 AM EDT] | PDF

Good morning!  It’s a big day today.  Q3 GDP is out (quick take—the data was weaker than expected, with very weak investment and a larger drag from net exports); we cover it in detail below.  The ECB meeting is also today.  As expected, there was no change in policy, but the European bank is getting out of step with the rest of the world.  For example, the Bank of Canada surprised everyone by (a) abruptly ending its QE program and (b) signaling rate hikes as early as Q2 2022.  Oil execs are on Capitol Hill today.  Meanwhile, markets are mixed.  U.S. equity futures are trending higher, while oil prices are in retreat.  Our coverage begins with the ECB.  Economics and policy are next.  China and international news will follow.  We close with Crypto and pandemic news.

The ECB:  Policy, as expected, didn’t change, but the leadership of the bank is facing increasing pressure to tighten credit.  It is, like the Fed, arguing that the inflation rise is temporary.  Market reaction has been muted, suggesting there were no surprises in the news.

Economics and policy:  The budget and the Fed lead the news.

• The White House presented a “framework” to move the budget and infrastructure plan through Congress. We will be watching to see if it is enough.  Major progressive goals are falling out of the bill; paid leave is the latest proposal to be excluded.  Progressive anger is rising, and we are still skeptical that a deal is in the offing.  The odds are that we are still talking about this in November.
• Although Chair Powell has implemented new trading guidelines for the FOMC members, Congress is considering a law that would enforce a financial penalty if the rules are violated.
• President Biden has seen his approval ratings falling since summer. Confidence in his ability to engineer a strong economic recovery is declining.
• One standard answer to low pay is that workers should get training to make themselves more valuable. It seems that workers are taking that message to heart, with interesting consequences.  There is a surge in job interest in IT, media, civil engineering, and software.  On the other hand, nobody wants to work in childcare, restaurants, warehousing, and home health areas.  We appear to have forgotten the wisdom of Judge Smails.  If this trend continues, those undesirable jobs will either need automating or generate higher wages.

China news:  More on the reaction to the hypersonic missile test, the real estate situation, and shortages.

• General Milley, chair of the Joint Chiefs of Staff, publicly compared China’s recent hypersonic test to a near-“Sputnik” moment. The Chinese test continues to reverberate, with the U.S. intelligence community being caught off guard by the scope of the Chinese test.  Calling the test a Sputnik moment will trigger memories of the U.S.S.R.’s satellite launch in 1956 that also caught the U.S. by surprise and launched a scramble by the U.S. to catch up on science and missile technology.  If this characterization holds, look for defense budgets to be expanded in the coming years.
• We are starting to hear rumbles about debt restructuring for China’s troubled real estate industry. This outcome is to be expected.  There are assets available but not enough income to service the debt.  Lowering the debt service is a time-honored way to address the problem if it is a liquidity issue.  If the problem is solvency, restructuring is futile.  Caixin published an editorial calling on the government to maintain its crackdown on the sector.
• Inflation is a key factor in Chinese history. The Nationalist government failed, in part, due to runaway inflation.  Tiananmen Square coincided with a spike in price levels.  The Xi government, acutely aware of history, likely understands this issue.  We are watching a number of developments on the price front.  One-way authoritarian regimes deal with higher prices is to prevent them from being published.  That appears to be occurring in the coal industry.  However, the lack of price transparency will likely lead to a cession of trading, not lower prices.  When households face higher prices, they often “trade down” in their purchases; beef gives way to pork.  One way that is often used is to reduce protein consumption and eat more vegetables.  However, prices on these items are soaring as well.  The risk of unrest is rising.  The other sensitive commodity is gasoline. Reports of shortages are emerging, which will exacerbate the tensions.
• The EU has been reluctant to press against China. Much of this hesitancy is due to Germany’s massive investments in China.  However, there is some evidence that German industry is becoming jaded with China, too.  If so, this development could pave the way for a tougher EU stance on China.
  • A recent trip from a Taiwanese official to Brussels has angered Beijing.
• One issue we constantly monitor is the disconnect between the U.S. business sector and the political class in China. The former tends to want to maintain open and friendly relations; the latter has moved to an adversarial position.  Although it’s not a foregone conclusion who will win out, the odds favor a decoupling.  However, that isn’t stopping China from trying to use the differences as a wedge to improve its position.  A recent meeting to woo U.S. chip firms to build capacity in China is an audacious example of this situation.
• The FBI raided the U.S. offices of PAX Technology (PXGYF, USD, 1.00), a Chinese firm that manufactures point-of-sale devices. The investigation appears to be examining data transfers of purchasing information.
• China’s foreign direct investment is often criticized by foreign host nations because Beijing usually imports Chinese workers to build the project instead of using local labor. Apparently, it’s no bed of roses for the Chinese workers either.

International roundup:  Poland and the EU lead today’s news.

• The European Court of Justice is accessing a €1.0 million per day fine on Poland until it complies with a court ruling, which will change how Warsaw oversees its judiciary. The EU will be able to collect the payments by reducing transfers to Poland.  Evidently, Chancellor Merkel’s policy of avoiding confrontation didn’t hold.
• France and the U.K. are having yet another spat concerning fishing rights. Both sides are making threats.
• Portugal’s minority government has failed. Elections will be coming soon.
• The recent flare-up over diplomats in Turkey is having longer-term effects. Erdogan remains mercurial.  He still wants U.S. warplanes but feels he doesn’t need to cooperate with Washington.
• U.S. intelligence agencies warn that the U.S. could face terrorist events emanating from Afghanistan.

Crypto:  The SEC spikes leveraged bitcoin ETFs for now.

• Although the current bitcoin ETF has been very popular, the SEC is, for now, delaying the approval of leveraged products.
• The CFTC looks to increase its policing of the crypto products.
• In related news, global regulators are backing tougher money laundering rules related to crypto transactions. Crypto has become the currency of choice for nefarious activities.

COVID-19:  The number of reported cases is 245,179,357, with 4,975,680 fatalities.  In the U.S., there are 45,705,087 confirmed cases with 741,242 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 507,637,305 doses of the vaccine have been distributed, with 416,154,424 doses injected.  The number receiving at least one dose is 220,936,118, while the number receiving second doses, which would grant the highest level of immunity, is 190,990,750.  For the population older than 18, 69.1% of the population has been vaccinated.  The FT has a page on global vaccine distribution.  The Axios map shows that infection rates are falling across most of the U.S.

• Although vaccines have gotten most of the media’s attention, anti-viral treatments are also critically important. It is abundantly clear that vaccines won’t prevent infections.  There is strong evidence they reduce hospitalization, but people are still getting sick.  Having treatments to reduce the impact of infection will move us further along in the process of leaving the pandemic and entering the endemic phase.
  • The antidepressant fluvoxamine has shown promise in reducing hospitalizations. The drug is inexpensive and could be attractive to the developing world.
  • Merck (MRK, USD, 81.54) has indicated it will grant licenses for molnupiravil at no cost to developing nations.
• China has maintained a “zero tolerance” policy on COVID-19, which has led to rolling shutdowns across the economy. We expect the policy to be maintained through the Winter Olympics, which are 100 days away.
• Germany is likely to end its national emergency related to the pandemic at the end of November.
• New studies indicate that meatpackers were much harder hit by the pandemic.
• We continue to monitor the externalities of the lockdowns. The most recent insight is that lockdowns increased smoking.

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

[Posted: 9:30 AM EDT] | PDF

We open today’s Comment with U.S. news related to fiscal policy and potential new regulatory risks for the technology sector.  Next is a discussion regarding the Chinese debt crisis and a range of other foreign news that could affect the financial markets today.  We conclude with the latest developments related to the coronavirus pandemic.

U.S. Fiscal Policy:  Key Democratic Senators yesterday proposed a minimum corporate income tax of 15% to help pay for President Biden’s planned social-spending and climate-change program.  Although details were not provided, the sponsors said the plan would apply to about 200 large companies and raise hundreds of billions of dollars without raising the corporate income tax rate above the current 21%.

• Manufacturers and technology companies could be among those hit hardest by the plan since the tax breaks they currently benefit from (such as expensing capital investments or stock options) would effectively be limited.
• The proposed levy differs from the 15% global minimum tax the U.S. has been pushing in international negotiations. That plan, which is also likely to be included in the Democrats’ tax-and-spending bill, focuses on U.S. companies’ foreign income, and it would require them to pay at least 15% in each foreign country where they operate. Some companies could be affected by both taxes.
• In any case, the proposed minimum corporate tax and billionaire’s levy show that higher taxes on corporations and wealthy families remain a risk, even though some Democratic Senators have opposed them.  Investors may not be too worried at the moment, as experience has taught that tax proposals can morph dramatically at the last minute, and it doesn’t necessarily pay to react early.  However, if a bill ultimately passes with these types of tax hikes, the markets would be at risk of a quick adjustment.

U.S. Technology Regulation:  As major news outlets continue to publish exposés about operating practices at Facebook (FB, $315.81), Federal Trade Commission staffers have begun looking into disclosures that the company’s internal company research had identified ill effects from its products.

• Specifically, the officials are looking into whether Facebook’s research documents indicate it might have violated a 2019 settlement with the agency over privacy concerns, for which the company paid a record $5 billion penalty.
• The FTC investigation shows how the exposés could lead to new regulatory risks for Facebook and other technology companies, even beyond the alleged abuses they aim to highlight.

Chinese Debt Crisis:  China’s National Development and Reform Commission, the state’s economic planning agency, issued a statement this morning that companies should prepare to pay the principal and interest on their offshore bonds to maintain their reputation and calm the market.  The statement comes days ahead of another big payment deadline for major real estate developer Evergrande (EGRNY, $8.26).  Multiple defaults by smaller real estate firms likely represent the government’s effort to maintain the reputation of Chinese firms and calm international markets as it tries to get control over excess investment and debt in the country’s real estate sector.  As we’ve described many times previously, that effort presents three key risks for investors:

• Even if the government successfully reduces real estate investment and debt levels to more reasonable levels without sparking a financial crisis, the result will be slower economic growth.  Since so many countries around the world depend on China as a major export market, that would likely have some negative impact on global economic activity and take some of the wind out of commodity prices.
• If the government clamps down too hard on new investment projects or new borrowing, it risks touching off a whole series of defaults even beyond what we’ve seen so far.  If that happened, the domestic and international economic impacts discussed above could be more severe, which goes far toward explaining why global investors have been so worried about the travails at Evergrande.
• Of course, based on historical experience, there is also some chance that Chinese officials will get cold feet as they come to appreciate how a clampdown could slow the economy and potentially spark a wave of financial problems.  That’s especially true against the backdrop of President Xi’s crackdown on Chinese technology companies, which could also weigh on economic activity.  The big problem, in this case, is that by kicking the can down the road, the officials could be setting China up for even more bad investment, higher debt levels, and a potentially worse crisis in the future.

Japan Elections:  According to a new Kyodo News poll on voter plans for the general election on Sunday, the ruling Liberal Democratic Party may lose seats in the House of Representatives but should retain a comfortable majority with its coalition partner Komeito.  The LDP and Komeito together could win more than 261 of the 465 seats in the chamber, which would be enough to effectively control all standing committees and push their legislative agenda forward.

Japan Stock Market:  The Tokyo Stock Exchange (TSE) said it plans to extend its trading day by 30 minutes.  With the change, trading in Tokyo will run from 9:00 am to 3:30 pm local time, with a lunch break from 11:30 am to 12:30 pm (in the U.S., the new end time will be equivalent to 2:30 am ET).  The extension of trading is expected to make the Japanese somewhat more competitive with other major Asian markets with longer trading days.

Russia-European Union:  Natural gas storage at European facilities is generally low for the period heading into winter.  Contributing to the EU’s skyrocketing gas prices, new industry analysis indicates that storage at facilities owned or controlled by Russian state-backed gas monopoly Gazprom is especially low.

• The figures will feed concerns that the Russian government is deliberately withholding gas from the EU in order to drive up prices and pressure its leaders to grant final approval for the Nord Stream 2 gas pipeline from Russia to Germany.
• As further evidence that Russia is leveraging its position as Europe’s top gas source for its own geopolitical goals, another report indicates Gazprom offered Moldova lower gas prices if the country amended its tariff-free trade deal with the EU and delayed the implementation of EU rules that require gas markets to be more competitive.

Iran:  An apparent cyberattack that officials ascribed to a “foreign country” has disrupted the sale of fuel across Iran by targeting its electronic card payment system.  The shutdown of the system has forced motorists to form long queues at gas stations nationwide and sparked sharp criticism of the government, which, of course, may have been the intent of the attack.

Afghanistan:  Despite a Taliban pledge that it would not allow Afghanistan to be used as a springboard for jihadi groups, U.S. intelligence officials believe Isis-K would have the capability to conduct external strikes, including on U.S. soil, within six to 12 months. The officials believe it would take al-Qaeda one to two years to reach a similar capability.

COVID-19:  Official data show confirmed cases have risen to 244,662,153 worldwide, with 4,966,122 deaths.  In the United States, confirmed cases rose to 45,616,157, with 738,883 deaths.  Vaccine doses delivered in the U.S. now total 504,584,715, while the number of people who have received at least their first shot totals 220,648,845.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

• According to the latest CDC data, 66.5% of the U.S. population has now received at least one dose of a vaccine, and 57.5% of the population is fully vaccinated.
• Yesterday, an FDA advisory panel of outside experts recommended authorizing the vaccine developed by Pfizer (PFE, $43.56) and BioNTech (BNTX, $292.39) for children aged 5 to 11.
  • The FDA is expected to decide in the coming days or weeks to authorize the shots for young children.  Health officials have said the shots are likely to become available in November.
  • Since the U.S. has approximately 28 million children in that age group, vaccinating a substantial number of them could have a big impact on boosting the country’s overall vaccination rate.
• A new study by the National Bureau of Economic Research indicates that financial incentives, public-health messages, and other tactics used by state and local governments and employers to encourage people to get vaccinated didn’t have a noticeable impact on vaccination rates among those who already were hesitant about getting the shot.
• Merck (MRK, $82.25) has signed a landmark voluntary licensing deal with the UN-backed Medicines Patent Pool to expand access to its COVID-19 antiviral pill throughout the developing world.  By licensing generic manufacturing of the pill, the deal promises to make it available at low cost in poorer countries.
• In Britain, the government is considering imposing a set of new “Plan B” restrictions, including mandatory mask-wearing, but officials are holding out hope that a recent decline in new infections could allow them to avoid the politically unpopular step.

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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 developments touching on two of the biggest concerns that investors have these days, China’s debt crisis and high prices for commodities and other goods.  We next provide an update to the U.S. fiscal policy negotiations and review a number of news items from overseas that could affect the financial markets today.  We close with the latest developments on the coronavirus pandemic.

Chinese Debt Crisis:  Developer Modern Land (1107.HK, HKD, 0.38) has become the latest Chinese real estate firm to miss an international bond payment.  After a request to delay the maturity of a $250 million bond earlier this month, which it later withdrew, the firm failed to pay principal and interest on the bond yesterday, blaming “unexpected liquidity issues arising from the adverse impact of several factors including the macroeconomic environment, the real estate industry environment, and the COVID-19 pandemic.”

• Despite the fact that major developer Evergrande (EGRNY, USD, 8.63) was barely able to skirt a formal default on its dollar bonds last weekend, the Modern Land default is a reminder that the broad real estate sector in China is at risk as the government clamps down after years of debt-fueled growth.
• China’s real estate sector has been a crucial engine for growth and rising living standards, but it has also become a key reason for the country’s excess growth in private debt.  Now that the government is trying to rein in the sector and get control over its debt growth, Chinese real estate firms face increasing regulatory risks, and some aren’t managing the situation well.
• Along with the risks arising from the U.S.-China geopolitical rivalry and the Chinese government’s broader crackdown on the private sector, the real estate debt crisis is adding to investor caution regarding the outlook for the Chinese economy and the investability of Chinese assets.

South American Drought:  In our recent discussions of surging natural gas prices around the world, we’ve mentioned that one reason is a drought in South America that has reduced hydroelectricity generation and forced a greater reliance on gas.  The Wall Street Journal today has an article that shows the impact of the drought is even broader than that, from reduced river navigation keeping soybeans from the market to lower yields on-farm production.  In any case, the drought will likely add to global price inflation in the coming months.

U.S. Fiscal Policy:  As Democrats in Congress continue negotiating over their social-policy and climate bill, which would complement the $1.0-trillion “hard” infrastructure bill already passed by the Senate, Majority Leader Schumer said that there are now just three to four open issues.

• Lawmakers and aides said major policy areas that remain unresolved include the tax increases to pay for the package, Medicare and Medicaid provisions, and a paid leave program.  The bill is now expected to cost between $1.5 trillion and $2 trillion.
• Top Democrats want to secure an agreement by Friday in order to score a win on climate legislation before President Biden heads to a meeting with a group of 20 leaders in Rome this weekend and a climate summit in Glasgow, Scotland, next week.

Japan:  In the runup to Sunday’s parliamentary elections, Prime Minister Kishida today directed a government economic policy panel to compile “urgent proposals” by early November to flesh out his signature “New Capitalism” vision.  In addition to the hundreds of billions of dollars in new spending that Kishida has promised to help the economy recover from the coronavirus pandemic, his New Capitalism proposals will include expanding the middle-class through wage hikes and improved working conditions for non-regular employees and freelancers, promoting the development of advanced technology for digitalization and decarbonization, and economic security issues including securing semiconductor supplies.

Russia-Europe:  Amos Hochstein, a senior advisor for global energy security at the U.S. State Department, warned Europe against bowing to Russian pressure and waiving the lengthy process needed to approve Nord Stream 2, the controversial Baltic Sea natural gas pipeline from Russia to Germany.  According to Hochstein, if Russia has more gas to ship to Europe to ease the continent’s supply crunch, it should do so through existing export pipeline infrastructure, including the ones that transit Ukraine.

Russia-Afghanistan:  Last week, Russia held another series of joint exercises with its Central Asian neighbors near Tajikistan’s border with Afghanistan.  The military drills highlight its continued concern about social unrest or terrorism spreading across the region as Islamic State challenges the Taliban’s control over Afghanistan.  Involving over 4,000 troops using artillery, tanks, and assault aircraft, the drills sought to signal that any infiltration from Afghan territory into Tajikistan would be met by force, Russian military officials said.

Turkey:  President Erdogan has backed down from his threat to expel ten Western ambassadors over their call for the release of a jailed Turkish philanthropist, which we described in our Comment yesterday.  Although Erdogan viewed the ambassadors’ call as an insult to Turkey, he was reportedly convinced to back down to avoid worsening Turkey’s already-strained relationship with Western countries.  The lira has therefore regained much of the ground it lost at the beginning of the week.

Space Tourism:  In another sign that private space travel is likely to be a growth industry into the future, Blue Origin LLC said it would help build a privately owned and operated space station.  The planned facility will aim to generate revenue from government agencies and private-sector customers, including entertainment companies and manufacturers.

COVID-19:  Official data show confirmed cases have risen to 244,210,069 worldwide, with 4,959,112 deaths.  In the United States, confirmed cases rose to 45,546,609, with 737,371 deaths.  Vaccine doses delivered in the U.S. now total 503,418,475, while the number of people who have received at least their first shot totals 220,519,217.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• According to the latest CDC data, 66.4% of the U.S. population has now received at least one dose of a vaccine, and 57.4% of the population is fully vaccinated.
• An FDA advisory panel composed of outside experts will meet today to consider the effectiveness and risks of injecting children aged 5 to 11 with the vaccine developed by Pfizer (PFE, USD,  43.15) and BioNTech (BNTX, USD, 294.92).  Since the U.S. has approximately 28 million children in that age group, vaccinating a substantial number of them could have a big impact on boosting the country’s overall vaccination rate.
• Meanwhile, Moderna (MRNA, USD, 349.56) said a clinical trial showed its vaccine to be safe and effective in children aged 6 to 11.  The company only released interim results, and the full study hasn’t yet been peer-reviewed.  Nevertheless, Moderna said it expects to submit the results to health regulators in the U.S., Europe, and elsewhere in seeking authorization to widen the use of its shots to include this younger age group.
• Providing more details on its plan to allow foreigners to fly into the U.S. starting November 8, if they have received a WHO-approved vaccine, the Biden administration said the vaccination requirement would not apply to:
  • Children under 18
  • People in certain vaccine clinical trials
  • Individuals with medical contraindications to the vaccines
  • People who are traveling for emergency or humanitarian reasons, and
  • People traveling on non-tourist visas from countries that the Centers for Disease Control and Prevention have determined to have low vaccine availability
• In China, officials have set strict health protocols for the Winter Olympic Games in Beijing next February.  These include a requirement that almost all participants be vaccinated against COVID-19 or face a 21-day quarantine that would effectively shred their competitive hopes.  The requirements are significantly tighter than those imposed by the Tokyo organizers of the delayed Olympic Games held this summer.

 Economic and Financial Market Impacts

• As major banks rolled out their third-quarter earnings reports over the last week, one theme is that they are seeing evidence pointing to renewed credit card borrowing.
  • For example, JPMorgan Chase (JPM, USD, 170.94) said credit card users who were most likely to carry balances before the pandemic are now reducing their deposits, which had been boosted by pandemic stimulus payments and debt forbearance programs, at a faster clip than other customers.
  • The bank believes that as customers spend down their excess deposits, credit card borrowing should start to grow faster, providing a boost to both the banking industry and the overall economy.

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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, the last in October.  Risk markets are trending higher this morning, with WTI moving over $85 per barrel.  Much of the country is being rocked by wild weather.  Anyone watching the late NFL game saw two teams dealing with torrential rain.  California, which has been dealing with drought, is now facing heavy rains that are causing mudslides.  In Missouri and Illinois, the late evening was all about tornadic activity and 20^o temperature swings.  The northeast is preparing for an early season nor’easter.  Our coverage this morning begins with economics and policy.  We update the latest on the budget and discuss the upcoming FOMC meeting.  China news is next.  Real estate and defense are front and center.  The international roundup follows, with Turkey and Poland leading the news.  We then look at crypto; the new ETF and Tether are the focus. We close with our regular pandemic coverage.

Economics and policy:  The budget and the Fed lead the news.

• Budget negotiations continued over the weekend, and the Democratic leadership says they are “close” to a deal. A “billionaire’s tax,” which would include a version of a wealth tax, is apparently being discussed.  The budget is being pared back; the current “talk” is around $2.0 trillion, down from $3.5 trillion earlier.  This report details the current state of the negotiations, including what is still in the mix and what has been pared or cut out completely.
• The FOMC meets on November 3, and it looks increasingly like the central bank will announce tapering. Recent comments from Chair Powell were more hawkish than usual. He admitted this transitory inflation talk no longer reflects the current situation.  Turning hawkish now won’t help him in his renomination efforts, but we are fast approaching the point where the president can nominate a replacement.  If Powell is going to be replaced, the new chair nominee will need to be named in the next three weeks or so.
• In Europe, the energy crisis continues. The latest nation to face problems is Moldova, which has declared a state of emergency due to the lack of supplies.  Russia has been pressuring this country for years and is apparently using Europe’s natural gas crisis as a lever to gain additional influence.
• Inflation is a growing worry; companies increasingly signal that their costs are rising fast and may outstrip their power to pass the increases to consumers. If so, earnings could be adversely affected next year.  So far, though, companies are still passing on price increases.
• Although the level of workers on strike is still low relative to history, the numbers are rising. President Biden has not publicly supported the labor actions.  The most likely reason he has been reticent is that the strikes add to inflation pressures.  Wage pressure is expected to remain elevated.
• The supply chain problems are well known, but we noticed an interesting bit of news. Local regulations limited how high containers could be stacked in California, exacerbating the supply problem.  A recent Twitter blast seems to have led some localities to temporarily relax the rules, adding storage capacity.
• There has been an uptick in hacking activity originating from Russian crime groups. Official Russian cybersurveillance activity has also increased.

China news:  Real estate and defense are in the headlines.

• Last week, we noted one way we know that China was getting serious about bringing their property sector under control would be to implement a property tax. Politically, a property tax would affect nearly anyone from the middle class to the wealthiest, a group that usually has some degree of influence.  It looks like the Xi regime is floating a larger trial balloon on this issue and is something we will be watching carefully in the coming months.
• On the defense front, the fallout from China’s summer test of a hypersonic missile continues to resonate. This system would seriously undermine U.S. antimissile defenses and potentially change the balance of power between the two nations.  According to reports, China is also working on an anti-satellite system that would attach to the satellite’s boosters and could disable it at will.
• General Secretary Xi gave a talk that clarified the “common prosperity” mandate. It appears more about taxing the rich than giving money to the poor.  The “iron rice bowl” policies of the past tended to bring low productivity, something that Xi likely wants to avoid.  On the other hand, he also wants to curb the power of entrepreneurs.
• Evergrande (EGRNF, USD, 0.36) has reportedly resumed working on some projects. It isn’t clear if the firm has found financing to continue or if this is a publicity action taken to reassure investors.
• U.S. intelligence agencies are warning firms in biotech and AI that Chinese intelligence is targeting these industries. China is reportedly seeking to gather information from American firms, while Beijing denies similar access for U.S. firms.
• Tesla (TSLA, USD, 909.68) is reportedly helping Chinese auto battery makers get access to the U.S. EV industry.
• China has passed a new law that will give it expanded powers to police its land borders. This may coincide with the situation in Afghanistan, raising fears of refugee flows.

International roundup:  Turkey and the EU lead today’s news.

• President Erdogan declared 10 western ambassadors “persona non grata” after they released a public letter calling for the release of Osman Kavala, who was acquitted in 2020 on charges he organized protests to overthrow Erdogan’s government.   The ambassadors, who represent Canada, Denmark, Finland, France, Germany, the Netherlands, New Zealand, Norway, Sweden, and the U.S., will likely be forced to leave the country.  The Turkish lira was already under pressure due to Erdogan’s persistent interference with monetary policy.  This latest action will likely increase the pressure further.  Although we have seen nothing official yet, there is growing speculation that some Turkish envoys will be sent home by the EU if Erdogan continues to push for ousting European representatives.
• Poland remains at odds with other members of the EU over the role of the European Court of Justice. Warsaw claims its courts have supreme power within Poland.  The EU claims otherwise.  So far, the “Merkel method” of handling disputes, which is to discuss them endlessly with hopes they go away, remains in place.  Poland has reacted angrily to the threat of subsidy cuts if it maintains its position.  However, unlike the U.K., Poland shows no desire to leave the EU; it just wants to disobey it.
• Colombia’s most wanted illegal drug kingpin, Dairo Antonio Úsuga, known as Otoniel, has been arrested. He could be extradited to the U.S.
• The G-20 meetings on climate change will be held this week; so far, members are divided on the path forward.
• The government in Sudan has been ousted in a coup. The government has been dissolved, and the coup leaders have declared a state of emergency.
• Bosnia has been a frozen conflict area since the mid-1990s. As part of the ceasefire, a Serb enclave within Bosnia was created.  The leader of that enclave, Milorad Dodik, is threatening to separate from Bosnia to join Serbia, which would likely restart the 1995 conflict.
• A deal to recapitalize Monte del Paschi (BMDPF, USD, 1.28), an Italian bank, has failed.
• U.K. exporters are facing an end of a grace period for exports to the EU. There is a risk that exports will decline as firms in Britain struggle to master the new regulations.
• Earlier this year, Chile began the process of creating a new constitution. Left-wing pressures to change the current constitution, which bears the marks of the transition from Pinochet, were strong.  In an interesting twist, recent polls show that a far-right candidate is surging in the presidential polls.  José Antonio Kast is rising in popularity on his anti-immigration stance. The vote occurs on November 21.

Crypto:  Investors should exercise caution with the new ETF, and stablecoins are a cause for concern.

• As we noted last week, the new bitcoin ETF (BITO, USD, 39.51) has seen its market capitalization exceed 1.0 billion, the fastest that an ETF has ever reached this mark. As we also noted last week, the structure of this product, which uses futures instead of actually holding bitcoin, will be a significant drag on performance and create opportunities for futures traders.  Although gold has a similar term structure in the futures markets, most of the ETFs attached to gold are grantor trusts, which actually hold the metal, eliminating the roll yield problem.
• Although “black swans” by definition are unpredictable, we speculate on what could be the next trigger for a financial crisis. Our bet has been stablecoins, which have all the characteristics that would make them runnable (something that has gotten the attention of regulators).  Tether is the one coin facing increasing scrutiny.  A major customer disputes the company’s claims it backs its coin with USD.   Hindenburg, a short-seller, is offering a $1.0 million bounty on information about Tether’s reserves.
• Near the end of the Trump administration, the Comptroller of the Currency eased regulations and allowed banks to trade cryptocurrencies on behalf of their clients. So far, the Biden administration hasn’t reversed the ruling.

COVID-19:  The number of reported cases is 243,780,679, with 4,950,324 fatalities.  In the U.S., there are 45,444,779 confirmed cases with 735,941 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 503,493,015 doses of the vaccine have been distributed, with 413,645,478 doses injected.  The number receiving at least one dose is 220,351,217, while the number receiving second doses, which would grant the highest level of immunity, is 190,578,704.  For the population older than 18, 68.9% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

• As U.S. cases fall, there has been a gradual relaxing of restrictions. Foreign visitors are being allowed into the U.S. if they are vaccinated.
• Germany is seeing a new surge in cases, consistent with climate conditions that encourage indoor activity.
• The pandemic has lifted China’s exports and probably has delayed the transition toward a consumption-based economy.

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