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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Friday!  U.S. equity futures are marking time this morning.  The dollar is a bit lower, while gold, crypto, and oil are higher, and Treasury yields are easing.  Our coverage begins with economics and policy.  The Fed announced new restrictions on trading activity for FOMC members and other officials.  China news is next, with some reflections on the hypersonic missile tests.  The international roundup follows; EU and NATO talks continue in Europe.  We close with crypto news and the pandemic update.

Economics and policy:  The Fed announces new rules for FOMC members.

• The Fed announced new rules for members of the FOMC regarding their personal accounts. Going forward, governors and regional presidents can only purchase diversified investment vehicles (no individual shares or bonds) and are barred from derivative transactions.  To make a transaction, a member must give notice 45 days in advance, and no trades can occur under periods of financial stress[1].  We are somewhat surprised such rules were not already in place, but this new structure should reduce future controversies.  It remains to be seen if Powell can be renominated, although we are reaching a point in the calendar where an announcement must be made soon if a change is forthcoming.
  • There remains an underlying issue on this topic. If a member of the FOMC is wealthy, it puts that person in a quandary; what if the policy action taken has a negative impact on his wealth?  Nothing short of complete liquidation of financial assets would avoid this concern, and these rules don’t address that potential conflict of interests.
• Negotiations on the budget continue. There are reports that discussions between Sen. Manchin (D-WV) and Sen. Sanders (I-VT) became quite heated recently, with Manchin threatening to not support any funding increases.
  • On yesterday’s report that Manchin is considering leaving the Democrats, there is something to it. However, he isn’t thinking about joining the GOP but instead becoming an independent.
• How big a deal is the backup in container ships in California? It is estimated that $22 billion of goods is floating in the harbors of the Golden State.  Conditions are not getting better as the wait time to unload a vessel is up to 13 days.
  • The White House is considering activating the National Guard to help ease bottlenecks. We are not sure how much this would matter.
  • As goods pile up in the supply chain, warehouse space is becoming scarce.
  • Around the world, supply chain issues are crimping economic growth and lifting prices.
  • Whirlpool (WHR, USD, 207.90) says it expects the appliance shortage to persist.
• Due to labor shortages, Southwest Airlines (LUV, USD, 48.66) announced it would reduce its flight schedule.
• The CFPB is investigating how tech firms use financial data.
• Russia says it could increase natural gas supplies by 10% if Nord Stream 2 is approved.

China news:  We look at the recent missile tests, and the U.S. returns to the U.N. to thwart Beijing’s ambitions.

• We have been reporting on China’s recent hypersonic missile tests. There are usually two questions that come from such tests—why? And why now?  The likely answer to the first one is proof of concept; can China do this or not?  The second may be more important.  When my youngest took an AP history course in high school[2], he studied the Soviet test of a hydrogen bomb.  The thesis he developed was that nuclear weapons became the guarantee against unconditional surrender.  If two nuclear powers went to war, they could not completely vanquish each other conventionally because the party losing could decide to “go nuclear.”  If China is considering military action against Taiwan, it may want to preclude the U.S. from threatening to use nuclear weapons against China if it didn’t withdraw.  We have no proof of this theory.  But we remain puzzled as to why China would test this weapon now and try to frame the narrative, as this test had nothing to do with weapons.  The U.S. clearly didn’t see it that way.  Beijing may view this test as a signal to Washington that we shouldn’t think about using a nuclear threat in a Taiwan conflict because China can use these hypersonic missiles at will.  If we are correct in this assessment, it could be argued that China may be close to taking military action against Taiwan.
  • We noted that at yesterday’s town hall meeting, President Biden specifically indicated the U.S. would defend Taiwan from attack. Although the White House has suggested nothing has changed, this looks to us like a change in strategic ambiguity.  China appears to see it that way.
• Even though the U.S. was instrumental in creating the U.N., over the years, Washington has become frustrated with the latter and has tended to not cooperate with it. The position is defensible, but the U.S. has inadvertently created an opportunity for China to expand its influence at the U.N.  Beijing has taken advantage of that opening, filling leadership roles in many committees at the U.N., often with persons that the U.S. should oppose.  The Biden administration appears to be working to reverse this situation.
• The NBA is in hot water with China again. Enes Kanter, a center with the Boston Celtics, made posts supporting Tibetan independence.  The NBA has been trying to expand its popularity in China but keeps running up against players and others affiliated with management who speak out against China’s human rights violations.  China is refusing to air Celtics games for now.
• For years, when China would implement austerity or crack down on important sectors of the economy, there was a tendency to restore support at any hint of weaker growth. So far, that isn’t happening, and comments from the PBOC suggest that support for the real estate sector isn’t on the horizon.
• Surprisingly, Evergrande (EGRFN, USD, 0.34) has made a payment on some of its bonds, staving off default. Next Friday, another payment is due.
• We may see a “buy China” movement, as a key social media influencer is touting Chinese products.

International roundup:  EU/NATO talks continue.

• The EU and NATO meeting continued today. So far, there have been discussions, but there is only modest evidence that the dispute between Poland and the EU over the role of the courts has been resolved.  This situation has Merkel’s mark on it; she tended to support talks over decisions with difficult issues.  Her goal was to prevent disruption at all costs.  NATO talks did lay out a plan to counteract Russian aggression.
• The Pentagon and intelligence agencies have issued reports indicating that climate change challenges global security. The concern still includes how changes in climate affect military preparedness but now also includes analysis of how extreme weather can weaken regimes and create failed states.
• South Korea successfully launched its first rocket but failed to put a satellite in orbit.
• The ransomware group that hacked the Colonial pipeline has brazenly set up a fake firm to recruit hackers.

Crypto:  The immaturity of the crypto market is creating arbitrage opportunities.

• A contango calendar structure in a futures market creates an opportunity for an arbitrager to buy spot and sell the deferred contracts.  With stability, the higher-priced deferred futures contract will converge on the spot, earning the trader a profit.  Reports suggest that the new ETF may create opportunities to expand this trade.  The good news for ETF holders is that if this practice becomes widespread, the deferred contract spread to spot will narrow, reducing the cost of the roll yield.
• Worldcoin, a new crypto, has scanned the eyeballs of 100,000 people; in return, those scanned receive the new coin.

COVID-19:  The number of reported cases is 242,605,732, with 4,931,905 fatalities.  In the U.S., there are 45,302,004 confirmed cases with 733,226 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 498,702,405 doses of the vaccine have been distributed, with 411,010,650 doses injected.  The number receiving at least one dose is 219,624,445, while the number receiving second doses, which would grant the highest level of immunity, is 189,924,447.  For the population older than 18, 68.7% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

• S. medical authorities have approved boosters for the current vaccines in use and will allow “mixing and matching” of the types.
• The U.K. is seeing a spike in cases related to a new mutation of the Delta variant. Westminster is adamant it won’t order new lockdowns.
• Belgium is reporting a “fourth wave” of infections.
• There is a growing shortage of rapid COVID-19 testing materials. The U.S. vaccine mandate is coming into effect on November 22 and will require testing in some circumstances.  If there is a shortage of tests, it isn’t clear how this situation will be accommodated.

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[1] Thus far undefined.

[2] This is Bill talking.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  Risk markets are a bit weaker this morning but are mostly marking time after a strong week thus far.  Our coverage starts with the Beige Book and moves on to confirm that Q3 was a soft quarter.  Economics and policy come next with a focus on the budget process.  Bitcoin is making new highs.  We discuss that and other items in the crypto section.  China news follows; the heavy hand of government presses harder, and the real estate sector remains shaky.  We then look at international news as the EU meetings begin, and we close with a pandemic update.

On a lighter note:  Yesterday, there was a Bloomberg interview where a young child photobombed the video.  We have the link—check it out! It’s a hoot.

Beige Book:  Yesterday, the Fed released its Beige Book, a survey of the economy performed by the regional district banks.  The report offers information about the U.S. economy on a regional basis.  The report confirms what the next section is signaling—for a variety of reasons, the economy has slowed recently.  Supply problems are plaguing the economy, and until these kinks are resolved, the economy will continue to struggle.

• There are a couple of notes on the supply chain issues. First, there is growing evidence of double ordering; this activity is to be expected.  First, during the 1970s, it was common practice to overorder, hoping that at least some of what you ordered would arrive.  Just-in-time inventory methods are rapidly turning into just-in-case, which will tend to lift prices further.  Second, persistent problems with orders are undermining the case for globalization.  If globalization unwinds, it will result in higher prices.
• On the topic of the Fed, yesterday we noted that Fed Governor Waller suggested rate hikes might become necessary sooner than currently expected. Governor Quarles joined him in that sentiment.

Q3 is looking weak:  The Atlanta FRB’s GDPNow nowcasting model is projecting Q3 GDP growth of 0.5%.  Weak industrial production and soft housing starts were the latest data to lead to a lower forecast.

This summer, when the bank began forecasting for Q3, it was projecting 6.1% growth, with inventories adding 3.7% points and consumption 1.5%.  Consumption is now expected to add a small 31 bps to GDP.  What is surprising to us is that when consumption falls, net exports usually become a smaller drag on growth.  That isn’t the case in this model.  Inventories will have a smaller contribution as well.  Overall, the expectation is that Q3 will be an anomaly caused by supply chain problems.  That idea is likely correct, but nearly flat GDP in Q3 is disappointing; the worry is that supply chain issues won’t get resolved until well into next year.

• A caveat to the above—high-frequency data is hinting that the worst may be over and that hiring is picking up. This data is noisy, but if current trends continue, Q3 may just be a hiccup.
• One factor that may be reducing available workers has been the continued expansion of business startups. We know that much of the pandemic relief was saved.  Former workers may have decided to use those funds to start their own businesses, thus depriving current businesses workers.  Surveys suggest that many of these startups are in the leisure and hospitality area, which has struggled to find workers.

Economics and policy:  Talks on the budget continue.

• The budget saga continues, and since the fiscal budget is inherently a political process, politics matters. The recent uproar includes reports that Sen. Manchin (D-WV) is considering leaving the Democratic Party and becoming an independent.  The senator has denied the story.  We suspect this report reflects a couple of possibilities.  First, Manchin is using the threat of going independent as a way to boost his bargaining leverage.  With an equally split Senate, even if Manchin caucused with the Democrats, the GOP leadership would try to at least split the committee chairs.  So, Manchin does have some power here.  Second, Manchin may simply have been expressing frustration at the process.
  • There has been a tendency to link Manchin with Arizona Senator Sinema, but they have differences on various issues, which are complicating negotiations. The latter has pushed back against the majority of the budget’s funding by opposing tax hikes that would mostly reverse the Trump tax cuts.  Manchin has been more open to higher taxes on higher-income households.
  • Budget negotiators are considering alternatives to rolling back the Trump tax cuts due to Sinema’s opposition. Ideas like taxing stock buybacks and a form of the wealth tax are being floated.
  • At the same time, establishment Democrats want to return the SALT deductions, and this group won’t approve a budget without ending the restrictions on state and local government tax write-offs. However, restricting these deductions has increased tax revenue, and the optics are awful, given that most of the benefit goes to the wealthiest taxpayers.
  • President Biden is increasing his intervention to push through his budget. Although his participation may be helpful, in reality, the problem is that with such narrow majorities, it is nearly impossible to make everyone in the party happy.  So, the odds of something getting done are falling.
• A San Francisco FRB study suggests that the fiscal support package may be creating conditions that foster a normal Phillips Curve relationship. In other words, the job vacancies to unemployment ratio has become sensitive to inflation for the first time since the early 1980s.
• Amazon (AMZN, USD, 3415.06) is facing a unionization drive at its Staten Island facility. Amazon has, so far, fended off such movements, but New York is a more fertile ground for such actions.  If the vote is successful, it will be worth watching to see if the efforts spread.  On a different note, the company is becoming a very large player in parcel delivery.
• The Commerce Department is formulating rules that would limit the sale of hacking tools to foreigners (read: Russia and China).
• Sen Warren (D-MA) wants to give powers to bankruptcy creditors to go after private equity. Often, in a merger, private equity will burden a target with debt to extract value from the company.  The company sometimes can’t service the debt and goes bankrupt.  Warren’s bill would allow creditors to go after the private equity firms to claw back the equity withdrawal.

Crypto:  The bitcoin ETF spurs buying.

• Bitcoin has hit a new high, moving past $66,000 on buying momentum from the newly issued ETF (BITO, USD, 43.28). The ETF is now over a billion in market cap.  As we have noted in the past, crypto is becoming the debasement asset of choice, steadily unseating gold.
• Crypto miners are facing increasing scrutiny over their electricity consumption and resulting carbon emissions.
• Crypto is regularly used for nefarious purposes. Ransomware payments and money laundering are common uses of bitcoin.  It is also used to circumvent capital controls, allowing citizens to protect their purchasing power in countries facing hyperinflation.  The Treasury Department is also starting to realize that crypto could be used to undermine U.S. sanctions.  The department is reviewing the sanctions policy in light of this development.

China news:  Beijing continues to weigh on society, and real estate problems widen.

• Since General Secretary Xi began his rule of China in 2012, we have watched his steady accumulation of power. It hasn’t always been obvious what he would do with all that influence.  At times, it looked as if it was simply for its own sake.  Recently, though, it looks like Xi has changed his mind.  He is almost certainly going to get a third term, something unprecedented in the Deng Era.  The recent move to bring debt under control signals another element of control.  In an interesting development, Xi now is moving to take control of China’s historical narrative.  In 1945, Mao issued a resolution on the history of the party and China.  Deng did something similar in 1981.  Both resolutions were designed to consolidate authority and quash dissent.  Although these actions, in part, are likely to prepare the ground for a third term, some of this is also to bolster his position as he tackles China’s debt problems.
  • We note that as part of the narrative control, Beijing has excluded Caixin from its approved internet news list. The publication is one of the more trusted reporters on business in China, but it is sometimes critical of the government.
• Speaking of debt, real estate firms beyond Evergrande (EGRNF, USD, 0.36) are missing debt payments, often a precursor to default. Sinic Holdings (2103, HKD, 0.50) has reportedly defaulted on offshore bonds.  And sadly, it doesn’t appear that conditions will improve anytime soon as the housing market in China remains weak.  We note that new home prices have had their first month-to-month decline in six years.  Local governments, fearing unrest, are trying to shore up home prices, but this effort may make conditions worse.  The better outcome would be to allow prices to fall to where the market would clear, but the loss of wealth would bring lasting economic damage.
  • Evergrande’s attempt to sell its property services unit has failed, making it increasingly likely it won’t avoid default and potentially bankruptcy. Officials are trying to contain a steadily spreading problem.
• The WTO is conducting its review of China’s trade practices. The U.S. and others are pushing to censure China, while Beijing is looking for approval.
• One area of potential conflict in the U.S. is that the political class has mostly decided that relations with China are probably not possible. On the other hand, business leaders loath to give up the opportunities to continue to do business with China.  What will be interesting to watch is how the regulatory state handles this conflict.  It is a well-known fact that there is a “revolving door” between business and government regulators.  When working in the private sector, a middle-level executive may be trying to do business in China; when she cycles into government, she may be doing just the opposite.  The problem is that such conditions create divided loyalties.  How the elected political class will try to control this problem is still unclear.
  • Here is an example. Sinopec (SNP, USD, 51.17) has signed a massive agreement to purchase U.S. LNG, a deal that will more than double current sales.  Not only will this sale potentially reduce supply available to other nations (read: Europe), but it will make energy producers less open to sanctioning Beijing.
• China is taking aggressive measures to contain coal prices. Although prices dropped on the news, it isn’t obvious how prices can be regulated lower without further curtailing supplies.  One way China is trying to boost supplies is by reopening mines.
• On the geopolitical front:
  • China apparently conducted two hypersonic missile tests this summer.
  • The EU is concerned about the Chinese threat to Taiwan (hint: it’s all about semiconductors). At the same time, Taiwan’s military leaders are worried they may not be able to mount an effective defense against a Chinese invasion.

International roundup:  The Europeans hold meetings; Poland is the main topic.

• The European Council meetings begin this week, and the big topic is the Polish rejection of EU courts. Poland’s government was trying to bring its domestic courts under its control but ran afoul of EU courts and is now facing the threat of a cutoff of EU funds.  In the past, Chancellor Merkel tended to protect states like Poland and Hungary, mostly to protect German investments there (Germany offshores production in central Europe), but with her power waning, the EU might move against Warsaw.
  • The other big issue is immigration (which was, interestingly enough, a big issue in Merkel’s first council meeting in 2005). Poland is facing waves of Middle East immigration being fostered by Belarus as a way to dilute sanctions against Minsk.  In an offer fraught with symbolism, Germany has offered to patrol the Poland/Belarus frontier jointly.
  • NATO is also meeting this week; Germany is warning against growing sentiment for a Europe-only defense. We would, too; history suggests a Europe-only defense would devolve into the inter-Europe tensions that led to two world wars in the last century.
• As we noted yesterday, the resignation of Bundesbank President Weidmann is creating a political situation for Germany’s coalition negotiations. The SPD, FDP, and Greens are allocating power, and we suspect all three would like to put one of their own in this position.  An FDP member would maintain the hawkish tradition of the Bundesbank; either other party would suggest an easier stance.  Although the Bundesbank has not been able to prevent an expansion of monetary easing in recent years, a dovish German would likely open the door for even more policy easing.
  • The ECB wants European banks to begin pulling activity to the continent and out of London.
• Brazilian President Bolsonaro is facing criminal charges for his handling of the pandemic.
• Although Pakistan generally welcomed the Taliban taking power in Afghanistan, it is facing an increase in Islamic insurgency activity as a result. It will be interesting to see if these insurgents target Chinese nationals who work in Pakistan.

COVID-19:  The number of reported cases is 242,163,439, with 4,924,605 fatalities.  In the U.S., there are 45,220,057 confirmed cases with 731,2712 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 496,915,265 doses of the vaccine have been distributed with 410,189,737 doses injected.  The number receiving at least one dose is 219,381,466, while the number receiving second doses, which would grant the highest level of immunity, is 189,709,710.  For the population older than 18, 68.6% of the population has been vaccinated.  The FT has a page on global vaccine distribution.  The Axios weekly map shows cases rising as temperatures cool across the northern tier of states.  Meanwhile, the south is showing continued declines as cooler weather there allows outdoor gatherings.

• Booster shots for the three major vaccines have been approved by the FDA; patients can “mix or match” the vaccines. In related news, the CDC says it’s acceptable to get the COVID-19 vaccine and the annual flu shot on the same day. Boosters are showing a strong immune response.
• Russia has ordered a seven-day shutdown to curtail rising infection rates.
• On the other hand, the U.K. is resisting closures, even as cases rise.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  Comments will be brief today due to a mix-up on coverage (blame Bill—senior moment!).  Risk markets are mostly marking time this morning.

China and property taxes:  As we have been reporting at length recently, the real estate sector has been under pressure due to regulatory changes designed to limit leverage.  However, to date, Beijing has avoided the most aggressive action to curb real estate, which would be the implementation of a property tax.  Apparently, President Xi is considering taking this step.  He is facing stiff resistance from within the CPC.  A property tax would almost immediately lead to a decline in property prices which would directly affect household debt.  To some extent, this is the clearest test of just how serious China is regarding dealing with its overvalued and overleveraged property sector.  Although it looks like the government is backing down, for now, this idea is worth watching.  It isn’t out of the ordinary for a government to run “trial balloons” to see reactions to policy.  There is one positive factor to a property tax; it could fund local governments that would become less dependent on property sales and thus less interested in rising property prices.

Bitcoin trading:  The bitcoin ETF started trading yesterday.  ProShares launched its product (BITO, USD, 42.14), and we expect others to follow.  The U.S. products are based on futures contracts, and with the calendar structure in contango, the ETF will face a negative roll yield, which will adversely affect performance.

Fiscal packages:  It appears serious negotiations are occurring, and a scaled-back budget with means testing of programs looks like where the legislation is heading.  The president is talking about $2.0 trillion, which is probably about right.

Monetary Policy:  Bundesbank head Weidmann has resigned.  Although he has cited personal reasons, he may have concluded that the new coalition is going to force the German central bank to accept easier monetary policy, and rather than fighting, he decided to leave.  Fed Governor Waller has indicated the Fed may need to accelerate rate hikes in the face of persistent inflation.

COVID-19:  The number of reported cases is 241,718,224, with 4,916,060 fatalities.  In the U.S., there are 45,140,220 confirmed cases with 728,313 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 495,844,635 doses of the vaccine have been distributed with 409,438,987 doses injected.  The number receiving at least one dose is 219,161,368, while the number receiving second doses, which would grant the highest level of immunity, is 189,487,793.  For the population older than 18, 68.6% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

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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 several global issues, ranging from magnesium supply shortages that could further crimp automobile output to a new pilot project on central bank digital currencies in France.  We next review the latest real estate developer default in China before turning to a range of other international news that could affect the financial markets today.  We wrap up with a couple of U.S. developments and the latest on the coronavirus pandemic.

Global Supply Shortages:  Just when you thought the global supply chain issues couldn’t get any worse, new reporting suggests Chinese production curbs have started to show shortages of magnesium.  Since magnesium is needed to produce aluminum alloys like those used in automotive products, any shortage of this metal could worsen the global shortage of new automobiles.

Global Digital Currencies:  France has used digital assets and blockchain technology in a series of bond transactions, marking one of the most significant trials to date of cryptocurrencies in a leading established market.  In the pilot project, a consortium of France’s biggest financial market participants used a digital currency issued by Banque de France as part of the 10-month experiment in the country’s debt market.  The experiment underlines how seriously some major central banks are looking at the possibility of issuing and utilizing their own digital currencies, potentially outlawing private digital currencies at the same time.

Chinese Debt Crisis:  Yet another Chinese real estate developer has defaulted on its debt.  This time, Sinic Holdings (2103.HK, HKD, 0.50) missed repaying $246 million in bonds that matured Monday.  That adds to a growing list of heavily indebted developers who have defaulted recently.

• Major developer Evergrande (EGRNY, USD, 9.41) reportedly made a scheduled interest payment today of a domestic bond issue, reflecting the government’s prioritization to protect homebuyers and domestic investors first.
• However, Evergrande this weekend faces the end of its grace period to pay millions of dollars of interest on its international dollar bonds, and that payment remains highly in doubt.
• Markets have now largely priced in the financial problems with Chinese developers, and there is little apparent market impact from today’s Sinic default.  However, markets could still react negatively if the wave of defaults worsens or there is any indication of contagion affecting other parts of the economy.

NATO – China:  In an interview with the Financial Times, NATO Secretary General Stoltenberg said the alliance’s new military doctrine for the coming decade would address how it will defend against China’s cyberwarfare capabilities, new technologies, and long-range missiles.  At one level, the statement reflects how the Biden administration has been working to build coalitions to counter China’s growing geopolitical aggressiveness.  At another level, however, the statement probably reflects European concerns that the U.S. will focus less on them unless they pony up to help with U.S. efforts against China.

NATO – Russia:  In response to NATO’s expulsion of eight members of Russia’s mission to the alliance earlier this month, the Russian government said it would suspend the mission entirely as of November 1 and close the NATO military mission in Moscow the same day as well.  According to Russian Foreign Minister Lavrov, Russia will now deal with NATO through its ambassador in Brussels.

European Union – Rule of Law:  In a speech today, EU Commission President Ursula von der Leyen vowed to punish Poland for its continued challenges to the supremacy of EU law over member countries.  In particular, von der Leyen said the EU could try to bring Poland in line using legal processes, a formal sanction that could withhold tens of billions of euros in EU funds, or a political process that could strip the country of bloc membership rights.

• Some EU officials prefer a less confrontational approach to Poland and other Eastern European governments that have taken action when at odds with the bloc’s laws and cultural values.
• However, von der Leyen is coming under increased pressure from EU parliament members and other officials who worry about the potential for the disintegration of the EU if member countries don’t follow EU law or adhere to common bloc principles.

European Union – Economic Policy:  EU Competition Commissioner Vestager said the bloc may extend its pandemic-related relaxation of rules on state aid to industry “one last time,” but arrangements for certain industries would remain even after the special exemptions are phased out.

• The relaxed rules, which made it easier for European governments to offer financial assistance to their companies in the midst of the coronavirus crisis, are currently due to expire at the end of the year.
• If the relaxation is extended or made permanent for some industries, it would mark significant backtracking from some of the EU’s stringent rules on competition and state-funded assistance to business.

Italy:  In another sign of at least partial recovery for Europe’s traditional centrist parties, the center-left Democratic Party won municipal elections and has taken control of both Rome and Turin.  In each city, the Democrats beat populist right-wing parties and the struggling Five Star Movement.

U.S. Technology Industry:  Congressional efforts to reign in the U.S. technology sector have started to gel, with new legislation now introduced to clamp down on anticompetitive practices and control online content.  As we’ve warned many times before, the tech industry worldwide is facing increasing regulatory threats that could have a negative impact on its operations and stock returns.

California Drought:  The California Department of Water Resources said the year ended on September 30 was the driest since 1924, measured in terms of precipitation and runoff.  Dry weather, warmer temperatures, reduced snowmelt, and population growth have all contributed to drought conditions, which have put added strains on water resources.  Potential economic consequences range from mandatory water rationing that reduces agricultural production to decreased reservoir levels that could impede hydroelectric production.

COVID-19:  Official data show confirmed cases have risen to 241,261,660 worldwide, with 4,908,382 deaths.  In the United States, confirmed cases rose to 45,051,922, with 726,267 deaths.  Vaccine doses delivered in the U.S. now total 494,655,075, while the number of people who have received at least their first shot totals 218,973,123.  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, 66.0% of the U.S. population has now received at least one dose of a vaccine, and 57.0% of the population is fully vaccinated.
• Following on its decisions to authorize booster shots in some cases, the FDA is reportedly preparing to allow people to receive booster shots that are different from their first vaccine doses.
• Washington State University yesterday fired football coach Nick Rolovich for failing to comply with their state’s vaccination mandate, making him the first major college football coach to face professional and financial consequences for his refusal to get the shot.  The university also fired four assistant coaches for not getting vaccinated.
• Singapore has eased one of the world’s most stringent pandemic regimes, launching quarantine-free travel arrangements with ten countries after nearly 21 months of closed borders.  Vaccinated people now will be able to travel freely to eight countries, including the U.K., the US, France, Italy, the Netherlands, and Canada.

 Economic and Financial Market Impacts

• The UN Conference on Trade and Development said international corporate investment in the first six months of 2021 totaled some $852 billion, more than doubling from the $373 billion recorded in the first half of 2020.  However, the rebound from the early days of the pandemic was wildly uneven.
  • According to the report, international investment in the developed countries more than doubled, reflecting their economic stimulus measures and relatively good prospects, while investment in the poorest countries contracted.
  • Most of the growth in investment also reflected mergers and acquisitions, while investment in new industrial production facilities weakened, despite the recent dearth of supply and high prices.

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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!  Risk markets are lower this morning as Treasury yields rise.  Our coverage begins with China news this morning, including comments on weak Q3 GDP.  Economics and policy are next, where we look at the progress on the budget and the situation in the labor markets.  Crypto follows; a bitcoin ETF has been approved but with caveats.  We close with the international roundup and pandemic news.

China news:  China’s GDP plummets, and a hypersonic missile surprises military analysts.

• China’s Q3 GDP fell to 4.9% from last year (down from 7.9% in Q2) and up 1.6% on a Q/Q% annualized basis. Power shortages and supply chain snarls adversely affected the data.  The longer-term outlook isn’t all that positive either.  Beijing’s decision to rein in residential real estate will tend to weaken China’s growth going forward.  It has been well known for some time that China has used investment, mostly with leverage, to maintain greater than 6% GDP growth.  A more realistic growth rate is probably closer to 3%.  At that rate, China can likely slow its debt growth.  However, cutting growth to that level creates a bevy of new risks.  Commodity consumption is at risk, and it isn’t obvious whether General Secretary Xi has been able to substitute some other factor for CPC legitimacy.  In other words, the CPC has argued that it gains legitimacy by fast growth.  Xi is trying to substitute nationalism or national pride (“Chinese Dream”), but it isn’t clear whether the people buy in.  So, there is much to watch in the coming months and years.
• In August, China tested a nuclear-capable hypersonic missile that circled the globe before landing near its target. Military analysts were caught by surprise by Beijing’s rapid development in this space.  Hypersonic missiles are mostly gliding vehicles that travel at five times the speed of sound.  Although slower than a ballistic missile, they don’t follow a fixed path and are thus harder to track.  Current anti-missile systems would not be of much use, and warning systems are less effective as well against these vehicles.  This test suggests China is a much more formidable nuclear adversary than analysts thought and will likely trigger a response in U.S. defense spending.
• NATO leaders say they are focusing on the security threat from China. This announcement is important because NATO has traditionally paid attention to Russia.  We find it interesting that NATO made this announcement as Chancellor Merkel is preparing to exit Germany’s leadership.  Germany has tended to push back against confronting China.
• Brazilian ranchers are worried about the ongoing ban on beef exports to China. A couple of cases of mad cow disease in September triggered the initial ban, but Brazil thought the restrictions would be lifted by now.

Economics and policy:  The House is back as Congress tries to pare back the budget.

• There has been rising speculation for weeks that the budget’s spending target would be cut. The general expectation is that spending around $2.0 trillion would be a reasonable target.  Within that lower target, lawmakers are now working on spending priorities.  Manchin (D-WV) is a key swing voter and is starting to dictate terms.  He is officially opposing most of the environmental proposals in the budget, forcing negotiators to either give up on these goals or to use some other tool to achieve them.  Although progressives are pushing a discussion of the costs of not spending on various goals, ultimately, politics is about power, and, with a narrow majority, power is given to those with swing votes.
• As the labor force fails to expand, labor is suddenly finding itself with power. Last week, we noted a rising number of labor actions.  Hollywood has avoided a strike by reaching an agreement with producers.  It’s also worth noting that this isn’t just a U.S. problem; Europe is facing similar worker shortages.  We expect firms will use a variety of tactics to cope; higher wages and better working conditions, higher prices, and investment in new technology are all in the mix.  So far, profit margins have been high, but we worry they are almost certain to narrow in the coming quarters.
  • Supply shortages also affect workers. Anyone who has bought a car recently can attest to nearly non-existent inventories and the lack of haggling with dealers.  The lack of supply is changing the role of car sales personnel and will probably lead to fewer workers who are much better paid.
• A WSJ article points out the problem of public sector pension fund managers. They have high return hurdles in a world of very low-interest rates.  The situation has led managers to have no other choice than to take more risk in portfolios.  This outcome is, of course, of concern and raises the stakes over policy tightening.  The pension system may not be able to cope with a bout of Fed tightening.
• The ECB may expand its buying of Eurobonds.
• Facebook (FB, USD, 324.76) plans to expand its use of AI to manage its platform. Results so far have underwhelmed.  If AI doesn’t do the trick, the company may be forced to hire many more content moderators.
• Oats used to be one of the quieter areas of the grain markets. That might not be the case this year, as drought has reduced this year’s crop.  Oats aren’t just for breakfast porridge anymore; they’re also a “milk,” which has boosted demand.

Crypto:  An ETF is coming, and stablecoins are in the news.

• The SEC has approved a bitcoin ETF, but it won’t be a grantor trust but instead is based on U.S. futures. We suspect regulators are uncomfortable with backing the product with bitcoin itself on concerns about supply and the use of the product for money laundering.  There is a downside to using futures, two in fact.  First, the product will likely have a K-1 for tax reporting, which usually discourages retail participation.  Second, bitcoin futures trade in contango, which means the deferred contracts trade at a premium to the spot.  Futures ETF like this “roll” the contracts at expiration, so when they roll to the next contract month, they will pay a higher price than the one they liquidated, all else held equal.  In other words, there will be a negative “roll yield” that will tend to depress the price of the ETF relative to spot bitcoin.
• The stablecoin Tether was hit with a $41 million fine for misrepresenting its reserves.

International roundup:  Germany begins to form a government, and Lebanon spirals into civil war.

• It’s official; the “stoplight”[1] coalition of the SDP, FDP, and the Greens has started the process of forming a government. If they can form a government, Olaf Scholz will be the next German chancellor.  Although this configuration is no surprise, it will be the first of its kind in Germany.  It remains to be seen how stable it will be.  The policy differences between the groups are vast (the FDP is a libertarian party, while the SPD and Greens are pro-government).
• Lebanon is rapidly descending into chaos. The political situation in the country has been tenuous for years, but recent crises, such as the port explosion, have revealed underlying divisions that may not be manageable.  The country was wracked by civil war in the 1970s and seems to be on a path to repeating the process.  The most recent problem is that Hezbollah appears to be stifling the investigation into the port explosion, most likely because the evidence will reveal it was caused by its negligence.
• The EU Parliament is pushing national European governments to take a harder line on Chinese imports from Xinjiang.
• Criminal groups in Haiti kidnapped U.S. missionaries.
• The U.S. arrested a Colombian businessman linked to corruption in Venezuela. The Maduro government has pulled out of talks over the arrest.

COVID-19:  The number of reported cases is 240,773,139, with 4,900,537 fatalities.  In the U.S., there are 44,934,688 confirmed cases with 724,632 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 494,698,695 doses of the vaccine have been distributed, with 408,265,959 doses injected.  The number receiving at least one dose is 218,805,579, while the number receiving second doses, which would grant the highest level of immunity, is 189,141,481.  For the population older than 18, 68.4% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

• Colin Powell, the four-star general who was Chief of Staff during the First Gulf War and later Secretary of State during the George W. Bush administration, has died due to complications from COVID-19. He was fully vaccinated.  Powell was 84.  His passing shows that even with vaccination, COVID-19 remains a threat to older people.
• The U.S. will ease travel restrictions for fully vaccinated foreign nationals on November 8.
• The Kremlin is attempting to silence analysts who are challenging the government’s official statistics on the impact of the pandemic.

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[1] Referring to the colors of the parties.

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

[Posted: 9:30 AM EDT] | PDF

Good morning! U.S. equity futures are pointing higher this morning. Today’s report begins with our thoughts on EU and U.K. trade relations. Afterward, we review international news followed by U.S. economics and policy coverage. China news is next, and we end the report with our pandemic coverage.

U.K.- EU: The ongoing row between the U.K. and the EU over the Northern Ireland issue appears to be heading to a point of no return. On Thursday, EU leaders urged Maros Sefcovic, Brexit negotiator for the EU, to draw up retaliatory measures if the U.K. decides to trigger Article 16 of the Northern Ireland Protocol. The protocol allows goods to move freely between the EU and Northern Ireland and from Northern Ireland to Great Britain. However, goods from the U.K. into Northern Ireland must go through customs. Invoking Article 16 would allow the U.K. or EU to suspend this arrangement if either side believes that the arrangement is causing “economic, societal, or environmental difficulties.” Earlier this year, the EU threatened to invoke Article 16 to deal with its vaccine shortage but backtracked days later.

Since coming to terms over the Northern Ireland issue, the two sides have struggled to make the deal work. Rivaling factions within Northern Ireland have made the protocol less tenable as Unionist and Loyalists, who consider themselves British, resented the restrictions placed on U.K. goods. In an attempt to appease critics of the protocol, Prime Minister Boris Johnson has openly pushed to revisit the agreement but Brussels has expressed little appetite for doing so. The unwillingness of Brussels to discuss the matter further has likely put the two sides on a collision course as calls for its removal have become louder.

The rise in tensions between the two sides indicates a growing trend that could lead to a potential hard break between the EU and the U.K. Although we suspect that neither side wants to scrap the Brexit agreement, political constraints may make it difficult for the two sides to coexist. PM Johnson’s credibility and legacy are dependent on not only navigating the U.K. away from the European Union but also selling the public that it was the best decision for the country. Additionally, leaders of countries within the European Union need to convince their constituents that leaving the bloc is a bad idea. As a result, the path of de-escalation is becoming increasingly difficult. Recent polls suggesting the British people have soured on Brexit likely add to PM Johnson’s woes. The fall in sentiment is partially related to the increase in food and energy shortages.

International news: 

• French Finance Minister Bruno Le Maire said that the European Union and the U.S. are not on the same page when it comes to engaging with China. Speaking to Bloomberg News, Le Maire stated that “the U.S. wants to oppose China, Europe wants to engage China.” The differing views on China highlight the growing friction between the U.S. and Europe. Up until recently, Europe has generally followed the U.S. lead when it comes to foreign policy. However, the U.S. appears to be souring on its relationship with Europe. The AUKUS pact between Australia, the U.K., and the U.S. that led to France losing a submarine contract was the latest evidence of this shift.
• Japanese Prime Minister Fumio Kishida dissolved the country’s House of Representatives to pave the way for new elections on October 31. Kishida is seeking a mandate to push his policies through the government. Currently, the country is dealing with a potential resurgence of COVID-19 and a sluggish economy. The move to dissolve the government is rather risky given Kishida’s declining approval ratings since taking office 11 days ago.
  • In a recent interview with the Financial Times, Kishida took a veiled shot at former Japanese PM Shinzo Abe in which he argued that his predecessor’s brand of economics didn’t do enough to support the broad economy.
• Protests over an inquiry into last year’s port explosion turned into armed clashes in Beirut on Thursday. The violence underscores the growing tensions within Lebanon that threaten the newly formed government.

Economics and policy:

• A heightened chance of La Niña could lead to more issues for the global economy. The U.S. Climate Prediction Center stated that conditions favor a La Niña event to take place sometime between December 2021 and February 2022. If accurate, this could mean drier conditions in South America and increased flooding conditions in Indonesia. As a result, agricultural crops would be negatively affected.
• Arizona Senator Kyrsten Sinema (D-AZ) reportedly told Democrats in the House of Representatives that she will not vote for the social spending bill. The Democrats are facing a time crunch to get a bill passed before the debt ceiling expires on December 3, and they are still struggling to cobble together the votes needed to push the bill through Congress.
• Around 10,000 unionized workers at Deere & Company (DE, $329.77) went on strike on Thursday after rejecting a contract proposal settled with the company and the United Automobile Workers union.

 China:

• LinkedIn is removing the social media components of its website in China. The site will be replaced and rebranded as a new job-board service called “InJobs.” Recently, LinkedIn was embroiled in a lot of controversy after blocking the profiles of activists and journalists in China who were critical of Beijing. The decision to remove the social media component highlights the growing scrutiny that social media platforms are receiving from governments around the world. Prior to removing the social media component, Chinese regulators were pressuring LinkedIn to clean up its online content. Given the fact that a large share of new social media users are coming from developing markets, moves like this suggest that these firms may struggle to attract more users to their sites in the future.
• The People’s Bank of China has stated that the fallout from Evergrande (EGRNY, USD, 8.88) is controllable and unlikely to spread. However, the central bank’s decision to loosen restrictions on home loans has stirred speculation that the Evergrande fallout could be worse than China is letting on.

COVID-19: The number of reported cases is 239,642,888 with 4,882,474 fatalities.  In the U.S., there are 44,768,043 confirmed cases with 721,567 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 490,951,045 doses of the vaccine have been distributed with 405,444,558 doses injected.  The number receiving at least one dose is 217,953,275, while the number receiving second doses, which would grant the highest level of immunity, is 188,281,747.  The FT has a page on global vaccine distribution.

• An advisory panel recommended that the Food and Drug Administration should authorize an extra dose of the Moderna (MRNA, $331.88) vaccine to adults 65 years and older as well as those who are younger and at risk. A panel is expected to meet to discuss the booster for Johnson & Johnson (JNJ, $160.11) on Friday.

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