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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with multiple U.S. developments that have the potential to affect the financial markets today, including the latest on the federal government’s debt limit, signs of growing worker clout in the labor market, and new regulatory risks for the technology sector.  We next turn to a range of international news, including several developments related to Chinese risks.  We wrap up with the latest news on the coronavirus pandemic.

U.S. Fiscal Policy:  Senate Majority Leader Schumer scheduled a vote Wednesday on a House-passed bill to increase the federal government’s borrowing ceiling until December 2022.  However, Republicans have already telegraphed that they would block the bill, prompting President Biden to accuse them of recklessness by putting the dollar’s status as a reserve currency at risk.  Schumer offered no plan on how the Democrats could overcome their lack of the 60 votes needed to pass the measure.  The continued uncertainty and risk of a federal default will likely continue to weigh on financial markets in the coming days.

U.S. Labor Market:  The International Alliance of Theatrical Stage Employees (IATSE), a union representing over 150,000 behind-the-scenes workers in entertainment, voted yesterday to authorize a strike if there is a breakdown in the ongoing negotiations with film studios and streaming services over working conditions and pay.  Fully 98% of IATSE’s members voted in favor of the strike.

• A strike would cripple Hollywood as it is emerging from the pandemic slowdown and bring production to a near-standstill, throwing studio plans for future movies and shows into turmoil and immediately costing millions of dollars.
• More broadly, we are keeping an eye out for any sign of a broader, longer-lasting increase in labor power arising from the pandemic.  There are still very powerful political, economic, and social forces favoring capital versus labor.  If that changes and workers gain the ability to demand higher wages and more favorable working conditions, it will bolster the case for higher inflation and reduced profit margins going forward.

Facebook:  In the latest revelation from whistleblower Frances Haugen, Facebook (FB, $326.23) is accused of misleading investors about the size of its audience and concealing a years-long decline in younger U. S. users.  Haugen, a former Facebook product manager, pointed to internal company projections that a drop in engagement from American teens could drive an overall decline in its U.S. daily users by as much as 45% between 2021 and 2023.  Given Facebook’s large market capitalization, the accumulating downward pressures on the company’s stock will alone help hold down U.S. market indexes, on top of other recent challenges such as concerns about inflation and rising bond yields.

United States-China:  As we previewed in our Comment yesterday, U.S. Trade Representative Tai said in a speech that President Biden will maintain the Trump administration’s trade tariffs against China in an effort to make it comply with the “Phase One” agreement signed by the U.S. and China in early 2020.  At the same time, she said, the U.S. would reopen a process for U.S. companies to seek exemptions from the tariffs.  For now, she said the U.S. would also refrain from launching the Phase One deal’s dispute mechanism or any broader investigation into China’s unfair trade practices.  It will, however, press the Chinese government for a new round of trade talks to address U.S. concerns.

• Tai’s policy statement suggests the Biden administration wants to slow down its approach to China, opening up room for the Chinese to compromise while buying time to further strengthen U.S. alliances against Beijing.  The downside is that Republicans in Congress will probably tag the administration’s policy as “soft on China.”  Meanwhile, reopening the process for tariff exemptions will likely only benefit a limited number of U.S. firms.
• If the new policy approach succeeds in cooling U.S.-China tensions without ceding too much to Beijing, it could help calm global financial markets.  All the same, the broader trend toward greater U.S.-China friction will probably remain, along with its risks to investors that we’ve continually been discussing.
• Separately, in an example of how trade policies can distort global markets, cotton prices have surged approximately 18% over the last ten trading sessions amid growing Chinese demand.
  • The surge in Chinese demand reflects U.S. restrictions on importing goods made from Xinjiang cotton.
  • To get around the ban, Chinese manufacturers are importing more U.S. cotton, using it to make clothing and other goods, and then exporting those products back to the U.S.

Chinese Debt Defaults:  As major real estate developer Evergrande (EGRNF, $0.41) continues to hurtle toward an unsettling default, luxury apartment developer Fantasia admitted it didn’t make a $206 million payment on its international bonds that was due yesterday.  Even worse, in recent weeks and days, the company told investors it would make the payment.

• Hours before Fantasia’s disclosure, Fitch Ratings cut its rating on Fantasia by four notches to CCC-, reflecting an extremely high risk of default. The global rating firm said the developer reportedly recently missed another payment on a private bond—which Fitch was previously unaware of—and said the incident “casts doubt on the transparency of the company’s financial disclosures.”
• Not only are Fantasia’s bonds now trading at the same distressed levels as Evergrande’s, but the new disclosure has the potential to further scare investors about other Chinese property developers and China’s broader problem with excess debt.

China-Taiwan:  At a recent meeting of China’s top-level Central Military Commission, President Xi reportedly ordered the country’s armed forces to increase their military pressure on southwestern Taiwan.  The order was likely behind the recent surge in Chinese aircraft incursions into Taiwan’s air defense identification zone, which we described in yesterday’s Comment.  As U.S.-China geopolitical tensions continue to intensify in the region, perhaps the key risk is that aggressive Chinese actions will lead to an accidental conflict.  Xi’s order, therefore, should be seen as another important risk for global markets.

China-Australia:  Reflecting the severity of China’s current energy shortage, the government has quietly started allowing some Australian coal shipments to be unloaded in the country, despite an official ban imposed last year in retaliation for Australia’s demand that China is investigated for its role in the coronavirus pandemic.

European Energy Crisis:  Amid skyrocketing electricity prices and fears of natural gas shortages during the upcoming winter, the governments of France and Spain have joined forces to demand sweeping changes to the EU’s energy market rules.  One key demand is to reform the linkage between natural gas and electricity prices.  Still, that alone would not address issues like the loss of nuclear and fossil fuel supplies due to their political unpopularity.

Global Oil Market:  OPEC and its Russia-led allies decided at their latest review of global oil markets to keep boosting their collective crude production by a modest 400,000 barrels per day, despite the current high prices.

• The decision gave a further boost to global oil prices, pushing up the key WTI and Brent benchmarks by 2.3% or more to the highest levels in more than three years.
• Against the backdrop of global demand still recovering from the coronavirus pandemic while petroleum exploration, output, and inventories all remain constrained, the OPEC+ decision is likely to keep supporting oil prices in the near term.  Naturally, continued high energy prices will help keep alive investors’ fears about inflation.

Japan:  Newly appointed Prime Minister Kishida has spooked financial markets with comments suggesting he may seek an increase in the country’s capital gains tax.  On top of that, a poll by Kyodo News shows public support for Kishida’s new cabinet stands at just 55.7% compared with the initial support of 66.4% for predecessor Yoshihide Suga’s cabinet last year.

• The benchmark TOPIX index fell as much as 3% during the morning session, before recovering slightly, to avoid narrowly the 2% drop that would bring in the Bank of Japan to support the market by buying exchange-traded funds.
• Until last week, the central bank had only intervened in the stock market three times since April, prompting speculation that it was engaged in a stealth tapering of an ETF-buying program that has run for over a decade.

COVID-19:  Official data show confirmed cases have risen to 235,511,364 worldwide, with 4,811,527 deaths.  In the United States, confirmed cases rose to 43,853,214, with 703,402 deaths.  Vaccine doses delivered in the U.S. now total 478,392,765, while the number of people who have received at least their first shot totals 215,502,382.  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, 64.9% of the U.S. population has now received at least one dose of a vaccine, and 56.0% of the population is fully vaccinated.
• Now that three new coronaviruses have wreaked havoc around the world in the last 18 years, scientists have redoubled their efforts to develop a vaccine that would work against a broad range of viruses.
• AstraZeneca (AZN, $60.54) said it requested emergency-use authorization for an antibody drug that earlier this year showed strong efficacy in preventing symptomatic COVID-19, offering a potential alternative in evading the disease.
  • The company said in August that it would deliver the antibody combination as a shot aimed at preventing COVID-19 symptoms, like a vaccine.
  • The primary use, AstraZeneca said, would be for a minority of people with chronic diseases and other conditions that could render vaccines less effective.

 Economic and Financial Market Impacts

• Amid the post-pandemic rebound in demand and supply shortages in areas such as container shipping and trucking, retailers are starting to worry that they won’t have sufficient inventory to meet demand during the all-important holiday season.

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

[Posted: 9:30 AM EDT] | PDF

Good morning on the first Monday of October.  Risk markets are generally lower this morning as uncertainty in Washington and worries about valuations weigh on sentiment.  USTR Tai will discuss the trade relationship with China today.  We discuss what we expect below, but the short answer is that tariffs will remain in place.  Our coverage begins with the state of the budget and infrastructure legislation.  Next, we look at the situation at Facebook (FB, USD, 343.01) and the Pandora report, followed by the Fed.  Continued tensions in the South Caucasus are discussed as well.  Our regular coverage begins with China news.  Economics and policy follow, with the international roundup next, and we close with pandemic coverage.

Legislative drama continues:  President Biden went to Capitol Hill and apparently sided with the progressives.  Moderates were promised a vote on the bipartisan infrastructure package and then didn’t get one.  Progressives now say they are willing to scale back the $3.5 trillion budget.  The new “deadline” is now Halloween.  It appears the progressives won on this round, but the battle isn’t over yet.  Is anything going to get done?  Probably, but it isn’t going to be easy to watch.  There will likely be an abundance of budget adjustments; programs will be shortened in duration to reduce their spending impact, for example.  Our take is that the markets don’t like the uncertainty.  Although a major increase in tax rates would be a negative, clarity in either direction—the measures fail or something passes—will likely improve market sentiment.

We note a couple of observations.  First, the president appeared to side with progressives.  Since Biden was a moderate for most of his career, we view his position as a political calculus.  Moderates fear that an expansive fiscal package will be a problem for their reelection in 2022.  It looks like Biden has concluded that Congress is likely to flip to the GOP anyway, so he has decided to support the progressives to ensure that as much gets passed as possible.  Second, the interparty negotiations have deeply undermined party unity.  That development isn’t a surprise.  Unity comes in acquiring power. Maintaining it while in power is always hard.  But the trust deficit that has developed will reduce the party’s ability to pass much next year.

Facebook:  Anytime your company is the focus of a 60 Minutes interview, the leadership of the firm has to be nervous.  Frances Haugen, a former product manager for the firm, gave a lengthy interview that aired last night, where she put the firm in a harsh light.  Haugen was apparently the source for a recent group of articles that were published in the Wall Street Journal.  For anyone following the company, or for that matter, social media in general, nothing revealed here should be a surprise.  So far, the revelations haven’t affected equity performance significantly.  However, if the information results in new regulations, we could see the tech sector affected.

Pandora:  No, it is not the streaming service or those charm bracelets but something more akin to the box of Greek mythology.  The International Consortium of Investigative Journalists published their third, and arguably their most, comprehensive data regarding how the wealthy and politically connected use a web of offshore accounts and trusts to avoid taxes and shelter assets from scrutiny.  Vladimir Putin, King Abdullah of Jordan, and former U.K. PM Tony Blair figure prominently, although there are many others caught in the database.  Some observations—political leaders are prominent in the disclosures.  Five continents are represented.  Surprisingly, South Dakota trusts are also quite popular.  Mostly, offshore accounts are used to hide assets and, for some leaders, provide an “exit strategy” if they need to leave the country.  Another interesting sidelight is how aggressively Chinese firms used offshore tax havens to create variable interest entities (VIE) to allow for listing on U.S. exchanges and facilitate capital flight.  Even state-owned firms had VIE’s for various purposes.  The papers also show that U.S. sanctions have forced Russian oligarchs to take aggressive actions to protect their assets.

What is the impact of these disclosures?  We seriously doubt if they will lead to significant prosecution.  Those involved are too powerful for that outcome.  The biggest issue may be that this revelation will deepen the mistrust of political elites.  Trust among the ruled is already low, as evidenced by populist movements across the West.  The evidence shows that the powerful create legal means to avoid scrutiny.  It’s hard to argue for shared sacrifice when the data suggests the sacrifice isn’t shared or likely to be shared at any time.

The Fed:  In a similar vein, the Fed has been rocked by trading scandals among the regional bank presidents.  It came out over the weekend that Vice-Chair Clarida made large trades just before Chair Powell announced pandemic measures.  Although the trades were pre-arranged and cleared by the Fed’s ethics official, the optics are terrible.  Clairda’s term ends on Jan. 31, 2022.  This news likely precludes any chance of him being renominated.

War in the South Caucasus?  Last week, we noted rising tensions between Kosovo and Serbia.  It looks like tensions between Armenia and Azerbaijan are escalating again.  This conflict is over the troubled Nagorno-Karabakh region, which is claimed by both sides.  Last year, Azerbaijan won territory from Armenia; it appears that the conflict didn’t settle the matter.  There are two complications from this escalating conflict.  First, it will involve outside powers.  Russia supports Armenia while Turkey aids Azerbaijan.  Second, oil from the Caspian Sea region flows through this territory, meaning that if a hot war develops, it might reduce oil supplies when prices are already elevated.  And, if that’s not enough (no wait, there’s more!), Azerbaijan has arrested Iranian truck drivers delivering exports to Armenia.  There are unconfirmed reports that Iran is massing military assets on the Azerbaijan frontier.

China news:  Trade and real estate dominate the news.

• There was a surge of Chinese military air incursions over Taiwan’s airspace over the weekend. Reports indicate that over 93 sorties were conducted by Chinse military aircraft, prompting a warning from Washington.
• As noted above, USTR Tai will give a speech today on China’s trade policy. All indications suggest the Biden administration will maintain the Trump era trade deal, meaning tariffs will remain in place.  Essentially, it looks like Tai is going to argue that China isn’t complying with the Phase One part of the Trump trade agreement.
• The Evergrande (EGRNF, USD, 0.355) saga continues. The company has missed several scheduled interest payments, and it is unlikely many of them will be made.  It appears failure of the company is a foregone conclusion; this issue now is how will the fallout be managed.  Parts of the company are being prepared for sale.  It looks like the goal is to ring-fence the firm, not to save it.  Residential real estate is a very large part of the Chinese economy.  Bringing the sector under control (along with its associated debt) is probably only possible with a notable decline in China’s economic growth.
• We are seeing a global energy crisis. It’s a combination of several factors.  Oil and gas investments have declined due to the pandemic and environmental restrictions, and  ESG concerns have played a role in limiting investment funds.  Meanwhile, the recovery from the pandemic has led to a surge in demand, which is hitting constrained supply.  We have been discussing these issues for weeks in our Weekly Energy Update.  China isn’t immune to these issues, but the rolling energy crisis in China has some unique characteristics as well.  Pollution in China has been a problem for years, one that General Secretary Xi has promised to address.  Reducing coal consumption is part of this goal.  At the same time, frayed relations with Australia have led to a sharp curtailment in coal imports.  To bring emissions down and deal with constrained coal stocks, China is cutting factory output and electricity, which is affecting production.  These cuts are beginning to affect global goods supplies.  One interesting sidelight is that the drop in Chinese factory output is leading to a sharp fall in shipping rates.
• The three-year countdown for the delisting of Chinese stocks failing to meet U.S. accounting standards has started.
• A report in The Lancet suggests that China’s population could fall by 50% by 2100. We noted last week that the CPC has moved 180^o on population policy, going from using harsh measures to limit births to a new policy that may be just as draconian in the opposite direction.  Perhaps it was this study that prompted the more aggressive change.

Economics and policy:  Inflation and trade remain key worries.

• A report from the Washington Post details the ongoing global logistical problems. The Economist notes that job postings for truck drivers are up across Europe; it’s not just a U.K. problem.
• The Fed is launching a review of a central bank digital currency. We would not expect a digital dollar to emerge soon but do expect one to be released by the end of the decade.  Meanwhile, there is a growing push to regulate stablecoin issuers as banks.
• Global trade fell 0.9% last month.
• Like pasta? It looks like prices will be rising because of poor crop yields for durum wheat, the primary ingredient in pasta.
• As firms across the West struggle to source labor, companies are turning to automation.
• State and local governments have been slow to distribute funds to help renters avoid eviction. A recent podcast is worth a listen on this topic.  One interesting development is that landlords tend to prefer eviction rather than the payment of back rent because rents are rising.

International roundup: Rising energy and food prices remain a problem.

• It isn’t just China facing an energy crisis, so is India, as coal supplies dwindle. India has been discouraging imports but may be forced to buy from abroad to avoid outages.
• Georgia (nation, not state) held elections over the weekend.  The governing party did well, although there were allegations of election irregularities. We also note that former president Saakashvili returned home and was arrested.
• There were large demonstrations against Brazilian President Bolsonaro over the weekend. Overall discontent is high, in part due to the pandemic but also due to rising inflation.
• Venezuela unveiled yet another new currency, dubbed the “digital bolivar,” although it is still paper money. The new currency lopped off six zeros.  Such maneuvers are common in South American history.
• As noted above, the USTR will be discussing China’s trade policy today. In related remarks, President Biden and Commerce Secretary Raimondo spoke in favor of steel tariffs in discussions with the EU.
• German political parties continue to negotiate to form a government.
• Comments from French President Macron led Algeria to ban French military aircraft from its airspace.
• Britain is careening toward a winter of discontent. Shortages of all kinds, coupled with rising prices, are increasing impatience with the Johnson government.

COVID-19:  The number of reported cases is 234,356,026, with 4,803,322 fatalities.  In the U.S., there are 43,683,392 confirmed cases with 701,178 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 478,410,525 doses of the vaccine have been distributed with 395,934,825 doses injected.  The number receiving at least one dose is 215,233,625, while the number receiving second doses, which would grant the highest level of immunity, is 185,492,579.  For the population older than 18, 67.2% have been vaccinated.  The FT has a page on global vaccine distribution.

• Last week, Merck (MRK, USD, 81.40) announced it developed what appears to be a remarkably potent antiviral in pill form. If this works as initial studies suggest, this could lead to a long way to end the pandemic.  Opposition to vaccination is probably going to prevent reaching a level enough to end the spread of the disease.  Most estimates suggest that to stop the Delta variant, a level of 80% to 85% is necessary.  That level is probably impossible.  However, if an easy-to-take antiviral therapy is available to keeps patients out of the hospital, the disease becomes a seasonal nuisance.
  • Meanwhile, the demand for antibodies for COVID-19 has been increasing.
• In Alaska, where cases are rising, physicians are forced to allocate scarce care.
• Israel, which has been actively using vaccine passports, is considering pulling them from those who don’t receive booster shots.

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

[Posted: 9:30 AM EDT] | PDF

Good morning! U.S. equity futures are signaling a higher open this morning. Today’s report begins with an international news roundup followed by U.S. economics and policy coverage. China news is next, and we end the report with our pandemic coverage.

International news: 

• The European Union is advocating for the continent to start mining its own rare earth minerals. The plan, published by the European Raw Materials Alliance, asks governments and firms to support mining and processing through subsidies and sales quotas. The move is designed to reduce the EU’s reliance on China for its rare earths. Last week, China announced that it will consolidate all of its rare earth companies into two firms to gain better pricing power in markets. The demand for rare earths has increased as countries look to produce more electric vehicles. Last year, the EU overtook China in electric car sales. However, the push by Europe to mine its own rare earths does have a downside. The mining of rare earths is extremely pollutant, so the proposal could face some backlash from environmentalists.
• The leader of the World Trade Organization, Ngozi Okonjo-Iweala, is rumored to be considering resigning from her position, citing inertia. Since taking office, she has been unable to make any headway in achieving her policy agenda. She is believed to be seeking a resolution to fishery subsidies, reducing trade-distorting agricultural policies, and developing a framework to expand global trade in vaccines. Her frustrations were shared by her predecessor, Roberto Azevedo, who resigned for similar reasons. The WTO has struggled to get anything meaningful approved as China and the U.S. struggle for influence over the multinational organization. If Okonjo-Iweala steps down from her role in the WTO, it would likely add further chaos within the organization and make it harder for countries to resolve trade disputes.
• North Korea launched an anti-aircraft missile on Thursday in response to stalled nuclear talks with the U.S. After a failed summit with President Trump in 2019, the two sides have not met to discuss the removal of sanctions.
• Turkey, a NATO ally, announced that it could deepen defense ties with Russia. The proposal by Turkish President Recep Tayyip Erdogan includes developing war planes, jet engines, and space technology. The announcement will likely anger members of NATO who view Russia as a strategic threat to their interests. Erdogan’s decision to build closer ties with Russia has been attributed to his inability to get a meeting with President Biden. The U.S. has had a dicey relationship with Erdogan following his decision to purchase an anti-defense missile from Russia. Thus, his recent overture to Russia will likely further anger the U.S.
• The EU postponed trade talks with Australia as the fallout from the AUKUS deal continues. In September, Australia canceled a deal to secure submarines from France in favor of a deal with the U.S. and U.K. The EU, and particularly France, are still angry over the cancelled deal.
• Ethiopia expelled seven U.N. officials after the agency criticized the country’s treatment of the people of Tigray. The expulsion comes two days after the U.N. aid chief warned that the government’s blockade of aid likely led to a famine in the northern region of Tigray, an accusation Ethiopia has denied.

 Economics and policy:

• House Speaker Nancy Pelosi delayed a vote on the infrastructure bill on Thursday likely due to a lack of support. She is expected to push for a vote on Friday. The holdup appears to be coming from progressives who are threatening to sink the infrastructure bill if the Senate does not vote on the $3.5 trillion spending bill. The delay of the vote underscores the growing friction between moderates and progressives within the Democratic Party. Moderates would like to reduce the price tag of the spending bill or increase the bill’s funding, meanwhile progressives believe that they have compromised enough after coming down from their original $6 trillion proposal to $3.5 trillion. The standoff between the two sides has escalated the chances that neither bill passes. That being said, moderates clearly have the advantage in negotiations as the infrastructure bill has a better chance of receiving bipartisan support having already passed the Senate with the help of Republicans. If Pelosi could corral votes from moderate Republicans in the House, she could offset the loss of support from progressives and make the passage of the infrastructure bill much more likely to happen. However, the same is not true for the spending bill, which will need every Democrat vote in the Senate in order to secure its passage.
  • On Thursday, Senator Joe Manchin (D-WV) announced that he would like the spending bill to be cut to $1.5 trillion in addition to including natural gas in the clean energy program. Democrats have so far scoffed at the proposal but still appear willing to work with Manchin.
• A map developed by Axios shows that the Biden administration has prioritized trips to Asia and Europe. The map provides further evidence that U.S. foreign policy is becoming more focused on countering China’s influence in the Indo-Pacific region.
• On Thursday, President Biden signed a temporary stop-gap government funding bill that will avoid another shutdown for nine weeks.
  • During her testimony before the House Financial Services Committee, Janet Yellen stated that she would like the power to raise the debt limit taken away from Congress.
• LinkedIn, which is owned by Microsoft (MSFT, $281.92), has received scrutiny for blocking the profiles of U.S. journalists in China. LinkedIn cited prohibited content as its reason for blocking the profiles. The move has led to backlash from U.S. policymakers. Senator Rick Scott (R-FL) sent a letter to Microsoft seeking answers.
• New rent data from Zillow suggests that average rents have increased more than 10% from the prior year. The increase in rent prices could further add to inflation woes. Most of the rise appears to be coming from areas that were forced to lower rent prices at the start of the pandemic, thus the sharp rise could be an indicator of things returning to normal. However, there is a possibility that rent prices could continue to increase as firms look to recoup earnings that they may have foregone during the pandemic.

China:

• High energy prices have started to impact China’s manufacturing sector. On Thursday, China’s PMI revealed that its manufacturing sector fell into contraction territory in September. The dip was due to an increase in input costs resulting from the growing shortage of commodities. The shortage has led China to push firms to secure energy resources at all costs as it prepares for the winter.
• The Biden administration has warned China that it is willing to impose Trump-era tariffs on its imports if Beijing does not honor its agreement outlined in the Phase One trade deal. So far, China has lagged in its commitment to purchase $200 billion worth of U.S. trade goods. However, implementing tariffs would be harmful for U.S. firms that are struggling to deal with the high input costs. As a result, we suspect the administration will not likely be quick to implement these tariffs any time soon.

COVID-19: The number of reported cases is 233,799,148 with 4,784,202 fatalities.  In the U.S., there are 43,459,971 confirmed cases with 697,849 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 474,245,945 doses of the vaccine have been distributed with 392,909,995 doses injected.  The number receiving at least one dose is 214,332,261, while the number receiving second doses, which would grant the highest level of immunity, is 184,601,450.  The FT has a page on global vaccine distribution.

• Vaccination mandates for healthcare workers have boosted rates to 90% or higher for most major healthcare employers.
• Merck & Co., Inc. (MRK, $75.11) announced that it has developed an antiviral pill, molnupiravir, that can reduce the risk of hospitalization or death by 50%. The discovery could make it easier for COVID-19 patients to receive at-home treatment. The company has stated that it will seek an emergency-use authorization from the U.S. Food and Drug Administration.
• More countries are beginning to turn down COVID-19 vaccines developed by China in favor of those developed by the U.S. or Europe. The shift comes as the Chinese vaccine, Sinovac, has proven to be less effective against the delta variant.

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

[Posted: 9:30 AM EDT] | PDF

Good morning as we bid farewell to Q3.  Although there is plenty to worry about, equities continue to move up on that wall of worry.  Our coverage begins with a recap of legislation and other concerns in Washington; today could be quite active.  We follow that with a report on tensions between Serbia and Kosovo.  Our regular coverage begins with China news.  Economics and policy are up next, and we close with the international roundup and pandemic news.

Washington update:  A series of converging deadlines are occurring as we head into October.  Let’s recap to see where we are:

• Bipartisan infrastructure package—Speaker Pelosi has set a vote for today on the bill. The current reading is that it is not at all clear that the Speaker has the votes.  Sometimes, a Congressional leader will bring a bill to a vote knowing full well it will fail.  The failure can be used as a tool to bring the measure later, but the risk is that it may never get another chance.  Democratic moderates have pressed the leadership for a vote, even without tying it to the broader $3.5 trillion reconciliation package.  Until this week, the leadership indicated both had to occur at the same time.  Pelosi’s reputation is that she doesn’t bring bills to the floor if she doesn’t have the votes.  However, if she delays a vote, it increases the likelihood that the moderates won’t support the reconciliation package.  At the same time, Democratic progressives fear that if they support the infrastructure package, the moderates will then kill the reconciliation bill, leaving them with little of their legislative goals.  Thus, they are threatening to vote down the measure.  Complicating the issue is that this bill does have some support from the GOP, and that party might provide enough votes to offset the progressives.  Overall, if the vote is held today, it very well may not pass.
• Reconciliation bill—it has become something of a foregone conclusion that the $3.5 trillion spending number is too high, but two key senators, Manchin (D-WV) and Sinema (D-AZ), have refused to indicate the number they will accept. In fact, the former released a statement suggesting that he won’t support most of the bill.
• Debt ceiling—this issue remains unresolved. Although the Democrats can lift the ceiling unilaterally, doing so becomes a campaign issue in what is looking increasingly like a midterm meltdown for Democrats.  A measure has passed the House to extend the suspension of the ceiling into 2022, but the Senate won’t approve that measure.  We expect the Democrats in the Senate to blink on this one, but it could go to the 11^th
• Government funding—although a government shutdown remains a possibility, we expect a short-term funding extension to pass today.
• The Fed—as we noted yesterday, Senator Warren (D-MA) publicly indicated she won’t support Chair Powell’s renomination. We still think odds favor his reappointment, but the decision markets are signaling a rising degree of uncertainty.  The betting odds dipped to 60% from 85% this week, although they have recovered to 75% this morning.  We believe Powell will remain, but progressives will push to put doves (and regulatory hawks) in the remaining open governor positions and will push Quarles out as well.

All this turmoil has consumed the president’s political capital.  He is facing criticism for his management of the process and is accused of not being as aggressive in building support as he needed to be.  The Congressional leadership has also become frayed in the process.  But, ultimately, this may be more about trying to push through expansive legislation with a razor-thin majority.  Everything had to go well; there was no margin for error.  We suspect history will argue that the distraction of Afghanistan severely weakened the odds of getting all this done.

 Serbia and Kosovo:  Tensions between Kosovo and Serbia are heating up again after a few years of relative quiet.  As background, Kosovo became independent of Serbia in 2008 but has never been recognized by the Serbian government.  The quarrel is ostensibly regarding rules in Kosovo requiring vehicles with Serbian license plates to swap them for Kosovo ones.  This is similar to rules for Kosovo drivers who travel to Serbia, but Serbia is angry about the rule.  There is a large Serb minority in Kosovo, and there have been incidents of civil unrest.  NATO is monitoring the situation, and the EU is calling for calm.  There are reports that Serbian tanks have moved toward the border.  There have also been air incursions.  Additional reports indicate  Serbia is moving troops to the border as well.

We will continue to monitor the situation.  If an armed conflict develops, it isn’t clear to us whether the U.S. would intervene.  And, if Washington doesn’t act, we doubt the Europeans will come to the aid of Kosovo.  Russia is a longtime ally of Serbia and would likely use a potential conflict to support its interest.

China news:  PMI’s dip and population policy swings.

• China’s official manufacturing PMI data fell to 49.1 for September, dipping under the 50-expansion line, suggesting that the sector is in contraction. The private Caixin survey reversed that signal, moving from 49.2 in August to 50.0 in September.  It is notable that both surveys were taken before the recent power interruptions, which would suggest that October could signal a full-blown pullback.  In the official survey, export orders fell to a 15-month low.
• The Chinese firm SenseTime, a privately held AI firm, has apparently been able to avoid U.S. sanctions. The company was accused of participating in the suppression of Uighurs.
• Evergrande (EGRNF, USD, 0.44) was able to sell an ownership interest to a state-owned enterprise for $1.5 billion in a bid to improve its cash position. We think this might be the ultimate resolution of this saga.  SOEs will pick up the distressed assets of the company, and this is how the debt will be socialized.  The company has missed another offshore bond payment.
• Estimates are suggesting that China’s local government debt may be up to 50% of GDP.
• LinkedIn is blocking U.S. journalist profiles in China.
• China’s population policy is undergoing rapid changes. After years of squelching births, General Secretary Xi is rapidly moving to increase birth rates, clearly spooked by a rapidly aging nation with a falling population.  It is worth noting that since the Communists took power, population policy, especially regarding reproductive policy, has taken massive swings.  Mao supported larger families in the early 1960s, only to reverse the policy soon after as the population surged.  Over time, the policy became even stricter, limiting families to one child.  Policymakers engaged in draconian measures to restrict births, forcing abortions on mothers.  Now, the Xi regime is flipping the other direction in short order, allowing up to three children per family.  Authorities are now restricting abortion and are trying to prevent divorce.  This rapid policy shift is leading to unintended consequences.  For example, employers used to be fairly certain that if they hired a mother, there was a low likelihood that she would be out on a future maternity leave.  That is no longer the case, and women are facing employment discrimination.  These sorts of social policies are extremely sensitive; the dissension in the U.S. over reproductive issues is an example.  China’s heavy-handed approach to this issue will complicate its recent turmoil.

Economics and policy:  Supply chain woes continue.

• Central bankers around the world are lamenting supply chain problems and now admit that “transitory” means “long time.”  The problem is that there is little evidence that supply chain issues are improving.  Border controls, part of the pandemic response, and logistical snarls are exacerbating the problem.  We are hearing increasing calls that holiday shopping could be very difficult…and inflationary.
• We are watching with great interest as companies try to ramp up hiring. The mystery remains, “where are the workers?”  We view this issue as having multiple causal factors. One factor may be that for the past four decades, workers across the West bore the cost of adjustment to globalization and deregulation.  Working conditions continually deteriorated, especially for lower skilled, lower educated workers.  Now they are rebelling.  Flush with pandemic cash and with older workers opting for retirement, firms are facing a shortage of labor and must decide how to attract workers.  In the end, it appears to us that higher wages are unavoidable.
• Dollar Tree (DTLR, USD, 100.51) is raising price points above a dollar.
• The U.S. and EU are working together to alleviate the semiconductor shortage.
• Senator Lummis (R-WY) says stablecoins should be fully back with cash and equivalents.
• Plant meat substitutes may become more expensive as the price for a key ingredient—peas—soars.
• In Mexico, builders are experimenting with 3-D printing for affordable housing.
• Although regional FRB boards select presidents, the Boston Fed, who will need to replace the resigning Eric Rosengren, says it is “open” to calls for diversity.

International roundup:  Washington and the EU talk trade.

• U.K. polls suggest Brexit isn’t going well; we note the GBP fell hard yesterday. The French government is threatening retaliation after the U.K. rejected most French fishing permits.
• North Korea claims it has tested a hypersonic missile.

COVID-19:  The number of reported cases is 233,356,026, with 4,776,055 fatalities.  In the U.S., there are 43,350,990 confirmed cases with 695,123 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 473,954,085 doses of the vaccine have been distributed with 391,992,662 doses injected.  The number receiving at least one dose is 214,043,376, while the number receiving second doses, which would grant the highest level of immunity, is 184,335,263.  For the population older than 18, 66.8% have been vaccinated.  The FT has a page on global vaccine distribution.  The new Axios map shows rising cases in the northern parts of the U.S., falling cases in the south.

• The president’s trust in COVID-19 polling has taken a dive recently. Pollsters suggest that the lack of a timeline for the end of pandemic measures has undermined trust.  The slide isn’t partisan; declines were reported among Democrats, Republicans, and independents.  This polling may reflect that Americans are experiencing pandemic fatigue.
• Company mandates for vaccines are running headlong into tight labor markets. United Airlines (UAL, USD, 48.71) is starting to fire unvaccinated workers.  It is unclear how it will fill these openings.  Meanwhile, oil firms facing mandates are worried they will be losing workers.  It is possible the mandates may become unenforceable or may exacerbate worker shortages.
• Supply chains in Asia are being adversely affected by the lack of vaccines.

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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 the latest brinksmanship in Congress over the federal government’s debt limit and budget, along with a note on Federal Reserve Chair Powell’s prospects of being reappointed to a second term later this year.  We next turn to international news, including the selection of a new leader in Japan and the latest on Evergrande’s debt issues in China.  We close with an update on the coronavirus pandemic.

U.S. Fiscal Policy:  Political maneuvers in Congress continue to stymie efforts to raise the federal debt limit and provide stopgap funding for the government.  Just a day after Senate Republicans blocked a House-passed bill that would have raised the borrowing limit and provided stopgap funding until early December, Senate Majority Leader Schumer yesterday sought unanimous consent to move straight to a final vote on a simple debt-limit increase.  That maneuver would have allowed Democrats to raise the ceiling on their own with just a majority vote.  However, Senate Minority Leader McConnell objected, blocking the effort.

• In testimony before the Senate Banking Committee, Treasury Secretary Yellen warned that the government would be unable to pay its bills beginning October 18 if the debt limit is not increased.
• The U.S. faces an estimated $20 billion in Social Security payments on October 20, along with around $6 billion in individual tax refunds, according to forecasts by the Bipartisan Policy Center. It faces another $49 billion in payments through October 29 and then an additional $80 billion in payments on November 1, including $14 billion in interest on the federal debt.
• Democrats are actively exploring several alternatives to hike the debt limit on their own, most likely by attaching the increase to their budget resolution.  However, plenty of political wrangling and brinksmanship is probably still in store, which has the potential to unsettle markets over the coming weeks.

U.S. Monetary Policy:  For the first time, progressive firebrand Sen. Elizabeth Warren explicitly said she would oppose a second term for Fed Chair Powell if President Biden nominates the central bank leader.  The statement highlights the Democrats’ intraparty divide over his candidacy.  The most progressive legislators want Biden to nominate someone who would support progressive policies much more strongly than Powell has.  If the progressives eventually appear to be getting the upper hand in the debate, it will likely spark concerns about excessively loose monetary policy and unsettle the financial markets.

Japan:  Former Foreign Minister Fumio Kishida won the ruling Liberal Democratic Party’s leadership election.  It makes him the presumptive successor to Yoshihide Suga as Japan’s prime minister and ensures he will represent the LDP in the general elections slated to be held by November.  With no candidates obtaining a majority in the first round, the runoff in the LDP election was a head-to-head race between first-place Kishida and second-place Taro Kono, the vaccine czar and top choice for prime minister in public opinion polls.

• An extraordinary Diet session will be convened on Monday, at which Kishida will officially be nominated to take over the Prime Minister’s Office. The LDP has a majority in the Lower House, essentially guaranteeing that he will become prime minister.  After his nomination, he will immediately form a Cabinet and appoint ministers.
• Kishida has already vowed to continue strengthening Japan’s coronavirus response and to compile an economic stimulus package worth trillions of yen.  Indeed, he has vowed in the past to moderate the country’s neoliberal policies and reduce its wealth gap.  He has also supported raising the country’s low birth rates.  Although he comes from a traditionally dovish wing of the LDP, he has also recently expressed a need to ensure a free and open Indo-Pacific region.
• We’ll provide a biography and assessment of Kishida in a Weekly Geopolitical Report soon.  For now, however, we suspect Kishida won’t stray too dramatically from the Abe and Suga policies of the recent past, so financial markets are unlikely to react badly.

China Evergrande (EGRNF, $0.40):  Heavily indebted real estate developer Evergrande said it sold part of its stake in Shengjing Bank for approximately $1.5 billion.  However, those funds won’t necessarily be available to settle the firm’s wider obligations because the bank is demanding the net proceeds from the sale be used to settle liabilities Evergrande owes to it.

• The Evergrande saga, and China’s broader problem with excess debt, will likely remain a key risk for global financial markets in the near term.

• Reflecting those concerns, Japan’s Government Pension Investment Fund has decided to shun renminbi-denominated Chinese sovereign bonds from its $1.73 trillion portfolio, citing liquidity concerns and other risks related to Chinese government debt.

China Belt and Road Initiative:  New data shows China’s “Belt and Road Initiative,” which has provided billions of dollars in infrastructure development aid worldwide, has left scores of lower- and middle-income countries saddled with “hidden debts” totaling $385 billion.  According to AidData, an international development lab at the College of William & Mary in Virginia, more than 40 of those countries now have debt exposure to China higher than 10% of their national gross domestic product.

COVID-19:  Official data show confirmed cases have risen to 232,888,917 worldwide, with 4,767,825 deaths.  In the United States, confirmed cases rose to 43,233,019, with 693,069 deaths.  Vaccine doses delivered in the U.S. now total 472,646,105, while the number of people who have received at least their first shot totals 213,752,856.  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, 64.4% of the U.S. population has now received at least one dose of a vaccine, and 55.8% of the population is fully vaccinated.
• Now that the FDA and CDC have said people over 65 and those at heightened risk from COVID-19 can get booster shots of the vaccine from Pfizer (PFE, $43.04), many doctors and pharmacies are providing the boosters with little or no verification that the recipients are really eligible.
• United Airlines (UAL, $48.68) announced that it is moving ahead with plans to terminate close to 600 employees who didn’t meet its vaccination deadline.  In August, United said it would require all of its 67,000 U.S. employees to be vaccinated, making it the first major U.S. airline and one of the first large U.S. companies to do so.
  • In a Gartner survey of legal, compliance, and human resources executives at companies across the country, 46% of organizations now plan to institute a vaccine mandate where legally permissible.
  • Still, only 15% of companies said they’d fire workers who refuse the shot.
• Harvard Business School has moved most of its M.B.A. classes online following a spate of breakthrough infections among its students.  The move to remote instruction for all first-year courses and some second-year courses will run until at least October 3 and comes about a month after the start of classes. It is one of the first instances of a major university halting some in-person instruction this fall.
• As the latest Delta wave of infections sweeps across the U.S. and tens of thousands of frontline workers face dismissal for refusing to be vaccinated, healthcare employers and unions have called on the federal government to tackle crippling staff shortages by addressing issues such as low pay and insufficient nursing training.

 Economic and Financial Market Impacts

• Both traditional and new, high-frequency data series ranging from shopping trips to movie theater attendance suggest the European economy continues to recover at a good pace.  The data suggest European consumers feel emboldened by high vaccination rates, despite a slew of worrying economic news, including higher energy bills, supply chain disruptions, and worries about the impact of an economic slowdown in China.

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with a range of recent developments regarding U.S. fiscal and monetary policy.  Next, we review international news that could have an impact on the financial markets today or in the near future.  We wrap things up with the latest developments related to the coronavirus pandemic.

U.S. Fiscal Policy:  As expected, Republicans in the Senate blocked a House-passed bill that would have raised the federal borrowing limit and provided stopgap funding for the government until early December.  The main thrust of the Republican opposition to the measure was to force the Democrats to take responsibility alone for raising the debt limit.  Both parties support the stopgap spending measure.

• The failure of the procedural vote could prompt Democrats to decouple the short-term spending measure and the debt-limit vote.  House Speaker Pelosi suggested last week that Democrats would do so, saying Congress would pass a stopgap spending measure before the end of the month to keep the government funded.
• Despite the likelihood that the measures will be decoupled and passed separately, the brinksmanship over the coming days has the potential to unsettle markets.  Underlining that risk, New York FRB President Williams yesterday warned that the Federal Reserve would be unable to mitigate the “extreme kind of reaction in markets” that would result from a potential default on the government’s debt.
• Indeed, bond market dynamics are already affected by the risk of a potential default.  Short-term Treasury bills most at risk of delayed payment are being sold off, driving up their yield, while investors are snapping up the dwindling supply of longer-term obligations, driving their yields down.
• Meanwhile, at a closed-door meeting last night, it appears that House Democrats started to coalesce around a deal to pass President Biden’s $1 trillion “hard” infrastructure package, with progressive opposition weakening in response to arguments about the political realities in the Senate.  If enough progressives move, it will open a path to the immediate passage of spending for roads and bridges, with a promise of future work on climate change and other progressive priorities.

U.S. Monetary Policy:  The Federal Reserve banks of Boston and Dallas said their presidents were resigning, following reports of the two leaders’ investment trading that prompted calls for their departures and a central-bank review of its ethics rules.

• The two banks gave different reasons for the exits.
  • Dallas Fed President Kaplan, who is resigning on October 8, acknowledged in a statement that his stock trading distracted from the Federal Reserve’s work.
  • Boston Fed President Rosengren, who will retire on Thursday, about nine months early, cited health reasons. He said in a statement that he was leaving as he had qualified for a kidney transplant to deal with a long-running condition.
• The Fed is under intense criticism for the trading by Kaplan and Rosengren, but one important implication of the resignations is that Chair Powell may have more control over the organization than might have been expected, given that some policymakers have been far out in front of Powell’s view regarding inflation risks.  Influence over administrative personnel issues is separate from monetary policymaking.  Powell’s apparent success in pushing out Kaplan and Rosengren suggests he may still be able to keep policy accommodative, despite some policymakers’ preference to tighten policy in the near term to guard against inflationary risks.

China Evergrande:  Heavily indebted real estate developer Evergrande (EGRNG, $0.34) remains in limbo for the next few weeks during the grace period after its missed international interest payment.  The sector as a whole, however, got a boost today when the People’s Bank of China said it would support liquidity in the sector.  Rival Sunac (SCCCF, $1.72), which had been under heavy selling pressure recently as investors feared it could be the next to default, is rebounding particularly strongly today.

• Despite the central bank action today, Chinese debt risks remain high.
• The risk of a messy default will also complicate Beijing’s effort to rein in the country’s property sector.

Germany:  Following up on the weekend parliamentary elections, the mid-sized leftist Green Party and the libertarian Free Democratic Party have emerged as the likely kingmakers, since both the main parties would likely need to ally with these two parties to form a governing coalition.  To fully leverage their position, the parties are, therefore, launching talks to determine how to bridge their policy differences and wield the greatest possible influence, regardless of which government they join.  All the same, it still looks like the process of forming a government could take until the end of the year.

France:  The center-right Les Républicains (LR) party has delayed choosing its candidate for next year’s presidential election until it can hold a primary election in December.  Party leaders hope that the divided movement will be able to coalesce behind a champion who can take on President Macron and far-right leader Marine Le Pen in the April vote.

European Union-Russia:  Hungary signed a new 15-year natural-gas supply deal with Russia’s state-controlled energy giant Gazprom.  At least in part, the move reflects Russia’s use of energy as a political weapon.  At one level, the deal means Ukraine will lose tens of millions of euros in gas transit fees.  Against the backdrop of Europe’s current energy shortage, it may also exacerbate tensions between Brussels and Hungary.

North Korea:  The North Korean military has launched at least one more short-range missile, marking their third test this month and pointing to a possible renewal of tensions on the Korean peninsula.

COVID-19:  Official data show confirmed cases have risen to 232,428,536 worldwide, with 4,758,529 deaths.  In the United States, confirmed cases rose to 43,117,906, with 690,556 deaths.  Vaccine doses delivered in the U.S. now total 471,818,715, while the number of people who have received at least their first shot totals 213,657,193.  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, 64.4% of the U.S. population has now received at least one dose of a vaccine, and 55.4% of the population is fully vaccinated.
• In an effort to “lead from the front,” President Biden yesterday received a booster shot of the vaccine from Pfizer (PFE, $43.57).  He received the booster more than eight months after getting his second shot of the vaccine on January 11.
• Russia has recorded 852 fatalities over the past 24 hours, marking its highest daily coronavirus death toll since the start of the pandemic.

 Economic and Financial Market Impacts

• The federal government’s extra pandemic unemployment benefits were long considered a reason firms are having trouble finding workers.  Evidence is now accumulating in both the U.S. and Europe that shows removing those programs isn’t necessarily prompting potential employees to come off the sidelines.
• As the pandemic eases and the economy continues to recover, landlords in New York are once again boosting rents.

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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 one for September 2021 (time flies!).  U.S. equity futures are mostly flat this morning, while crude oil is near a three-year high.  Our coverage leads off with the German elections, which were something of a draw.  The Meng Wanzhou saga is up next, followed by an Evergrande (EGRNF, USD, 0.32) update and crypto news.  The British supply crisis is next in line.  We then take a look at the current state of the budget, the infrastructure bill, and the debt ceiling.  We close our special coverage with an update on the SEC’s action regarding corporate bonds.  Our regular coverage includes China news, international news, economics and policy, and our pandemic coverage.

BREAKING:  Boston FRB President Rosengren announced his retirement.  He, along with Dallas FRB President Kaplan, were aggressively trading their own accounts during the 2020 financial crisis and have come under harsh criticism for the appearance of trading on privileged information.  His term didn’t end until 2026.  We will be watching for news from Dallas.  It should be noted that he has renal failure and is awaiting a kidney transplant, so his retirement may not be tied to the trading situation.  If Kaplan resigns as well, Powell will have removed a source of complaint against the Fed and may preserve regional bank control of the president selection.

German Elections:  The SDP won a plurality, ending 16 years of CDU/CSU dominance, but the vote was close.  The SDP won 25.7% of the vote compared to 24.1 for the CDU/CSU.  The Greens took 14.8% of the vote, while the FDP won 11.5%.  Die Linke won 4.9%.  All other parties fell below the 5% threshold, meaning they won’t get seats in the Bundestag.  Although both the SDP and CDU/CSU have claimed they won the right to form a government, the Greens and the FDP will most likely be the basis of the new government.  These two parties are already in coalition talks, and once they fix their agenda (like who gets what ministries), they will engage the two larger parties.  However, talks between the Greens and the FDP won’t be easy.  The Greens stand for environmental policies and are pro-EU.  The FDP leans libertarian and opposes higher taxes and the Eurobond.   Christian Linder, the FDP’s leader, will probably demand the finance ministry.  If the Greens and FDP fail to build a bloc, the next government could take months to form.  At this point, the German government is something of a “jump ball.”  We expect the FDP and the Greens to try hard to form an alliance, considering the power it will give them; what happens after is anyone’s guess.

Coalitions are becoming more common as the two leading parties become less popular.

(Source:  Adam Tooze)

Although the exit of Merkel creates a power vacuum of sorts, we don’t see any other EU power that will be able to replace Germany.

Meng goes home:  Huawei (002502, CNY, 6.64) CFO Meng Wanzhou was detained in Canada in 2019 on charges she and her company sold telecom equipment to Iran in violation of U.S. sanctions.  She was held under house arrest until this weekend when she flew home to China.  Under terms of the plea deal, she admitted to assisting her company’s attempt to conceal the sales to Iran.  The other element of this affair was that Beijing arrested two Canadians and held them in conditions far harsher than Meng’s palatial estate in British Colombia.  Meng’s plea deal was also a prisoner swap; China freed the two detained Canadians.  It appears the arrest of the Canadians was with the intent to swap for Meng.  We suspect this sort of thing will become more common in China and should be taken as a warning to ex-pats living there.

Evergrande:  The slow-motion collapse of Evergrande continued over the weekend.  Last week, the company failed to make debt payments, and it is now in the 30-day grace period before there is an official default.  Cities are starting to take the lead in managing the breakup of the company.  City governments have reportedly seized presales to prevent the company from using the funds which should be escrowed.  Although this move makes sense, it will deprive the company of funds.  The electric vehicle unit is warning that it is running out of cash.  Meanwhile, Beijing continues to manage the default by a strong security presence and control of social media.

Although there have been obvious analogs to LTCM and Lehman, a better analog may be Japan in the early 1990s.  When Japanese regulators allowed banks to fail, it ended the expectation that default wasn’t possible.  China fears repeating Japan’s experience of the 1990s with good reason; excessive debt led to years to near-zero economic growth.

Cryptocurrencies:  On Friday, China announced a complete ban on the use of cryptocurrencies.  We suspect there are two reasons behind the ban.  First, China is speedily moving to issue its own CBDC and likely doesn’t want alternative crypto as competition.  Second, and likely the reason Beijing acted now, bitcoin and other cryptocurrencies can facilitate capital flight.  The Evergrande situation will almost certainly lead to arrests, perhaps of corrupt officials, and Beijing likely wants to prevent anyone under threat from moving their assets out of China so those assets can be seized.  The next step will probably be attempting to corral offshore exchanges.

In the U.S., stablecoins are the focus of regulators.  The fear is that these funds are runnable, and given that crypto has infiltrated into other financial assets, a crisis emanating from stablecoins could spread.  The Treasury and SEC are moving rapidly to regulate this space, but so far, we haven’t seen a move to follow China.

And finally, a couple of other notes—bitcoin, which uses lots of electricity in its clearing process, has come under criticism from environmentalists.  There are reports that miners are teaming up with nuclear power operators with excess capacity.  There are emerging market economies with primitive financial systems that are adopting bitcoin as a national currency.  In some respects, this is not unlike a foreign nation setting up a currency board and using a foreign currency as the basis of its monetary system.  The drawback with using bitcoin is that it is naturally deflationary and may make managing the economy a challenge.

U.K. supply crisis:  A combination of Brexit restrictions on trade and the movement of labor, coupled with supply chain disruptions triggered by the pandemic, have left the U.K. looking like the 1970s, with lines at gasoline stations and empty supermarket shelves.  The transportation minister, Grant Shapps, has exacerbated the obvious political fallout from this evolving crisis, blaming trucking firms for creating the situation.  However, the real problem is a lack of truck drivers who returned to Europe after Brexit and have not been replaced by locals.  PM Johnson will issue short-term visas to try to attract those drivers back.  Albeit, after leaving, that might not be enough.  As gas lines form, Johnson is also planning to use the military to haul fuel to gas stations.  Panic buying (something we saw in the U.S. in the 1970s and recently during the Colonial Pipeline crisis) is exacerbating the problem.  Although Johnson remains secure, these types of events can consume political capital, undermining the government’s ability to do other policies.

Budget, infrastructure, and the debt ceiling—oh my!  First, the infrastructure bill is expected to come to the House floor by Thursday before the budget bill.  This action crosses a red line for progressives, who said they won’t vote for it before the budget, fearing that if the infrastructure bill passes, moderates will pare back the budget.  This is a legitimate concern, but it may not matter.  As all this drama occurs, the Treasury is facing a debt ceiling crisis and is considering several emergency measures, including a government shutdown and various actions to swap debt.  So far, financial markets are taking the news rather well.  Perhaps they view the situation as one described by the 1980s group Adam Ant.  In the end, the Democrats will likely have to put the debt ceiling in the reconciliation process and give the GOP election talking points.  Although we expect this “crisis” will be over by Halloween, with the infrastructure bill passed, a much smaller budget ($2.0 trillion), and a new debt ceiling, the uncertainty could trigger some market volatility.

About bonds:  Last week, we reported the SEC was considering changing the disclosure rules for corporate debt, which may have led brokers to stop placing bids/offers.  Mercifully, the SEC has postponed the action and may end it altogether.

China news:  The IMF head is in trouble.

• An investigation at the World Bank found that the current IMF head, Kristalina Georgieva, pressured the body to boost China’s ranking in the Doing Business Report. She has denied the reports but is coming under scrutiny for the World Bank’s findings. China has been trying to increase its presence in international organizations and may have used Georgieva for this purpose.
• CNOOC (883, HKD, 8.48) is preparing for U.S. delisting by a large domestic stock issuance.
• Commerce Dept head Raimondo called for strengthening U.S./China business ties. Although this is a clear exposition of the establishment’s view of China, we see it as out of step.

International roundup:  Washington and the EU talk trade.

• The U.S. and EU trade negotiators are meeting in Pittsburgh this week.
• Germany wasn’t the only election over the weekend. Iceland held them as well, and the ruling coalition won.

Economics and policy:  Supply chain woes continue.

• A cascade of problems, from the lack of workers, too many empty shipping containers, and logistical snarls, are all leading to continued supply chain problems. The longer this goes on, the longer inflation remains elevated.  We are seeing firms aggressively bid for labor.
• High crop prices are boosting the farm economy.

COVID-19:  The number of reported cases is 231,913,317, with 4,749,880 fatalities.  In the U.S., there are 42,932,211 confirmed cases with 688,041 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 471,814,235 doses of the vaccine have been distributed with 390,114,328 doses injected.  The number receiving at least one dose is 213,456,787, while the number receiving second doses, which would grant the highest level of immunity, is 183,670,870.  For the population older than 18, 66.6% have been vaccinated.  The FT has a page on global vaccine distribution.

• Although we will probably never know for certain the origin of COVID-19, the continued drip of reports from bio labs raises fears about the nature of the research being conducted.
• Vaccine distribution continues to lag in the developing world.
• Given that none of the vaccines give sterilizing immunity (that means, once vaccinated or infected, you don’t get the disease again), treatments for COVID-19 remain critical. There are reports of great progress on anti-virals, which will be critical in managing the ongoing endemic.
• On the social side of the pandemic, life expectancy took a dip last year, unusual outside of war. Women especially are reporting career adjustments in the post-pandemic world.

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

[Posted: 9:30 AM EDT] | PDF

Good morning, all! U.S. equity futures are signaling a lower open this morning. Today’s report begins with an Evergrande (EGRNF, USD, 0.3550) update and international news roundup. Next, we cover U.S. economics and policy developments. China news follows, and we end with our pandemic coverage.

Evergrande update: U.S. markets closed higher yesterday as investors shrugged off concerns of an imminent Evergrande collapse. On Thursday, Evergrande failed to make an interest payment of $83.5 million on a $2 billion offshore bond and didn’t provide clarity as to when it was going to make a payment or whether it planned to do so. It has been speculated that the market’s reaction may have been related to a debt covenant that gave the company an additional 30-day grace period. Hence, the company likely has more time to make the payment than investors may have originally realized. Although this could be good news for markets now, Evergrande may not be out of the woods yet. It still has a $47.5 million interest payment due next week and it is unclear whether it will be able to make that payment.  That being said, we suspect the possibility of an international market contagion may be less severe than reports suggest. At $20 billion, its international debt burden is relatively small and thus may not be enough to collapse international markets. However, its $300 billion in total liabilities due largely to creditors and businesses in mainland China could be dangerous for the country. As a result, we suspect that if Evergrande and other similar firms collapse, it could be the beginning of the end of investment-led growth in China.

International news: 

• North Korea rejected South Korea’s request to formally end the Korean War. The two sides never agreed to a peace treaty after signing a ceasefire in 1953. Pyongyang insisted that the U.S. must end its hostility toward the country before it can agree to formally ending the war.
• The upcoming German elections have wealthy individuals on edge as it is widely believed that the next administration will be left-leaning. A new left-leaning parliament could result in the reintroduction of a wealth and inheritance tax. As a result, wealthy individuals have decided to move their assets into Switzerland.

Economics and policy:

• House Speaker Nancy Pelosi announced that Congress will not allow government funding to expire next week. The statement came hours after the Biden administration announced that it was preparing contingency plans in case of a partial government shutdown. Her remarks have been viewed as a signal that Democrats could decouple the government spending bill from the debt ceiling. A vote on the debt ceiling is expected to take place on Monday and Republicans are expected to vote against it. At this time, we are confident that the debt ceiling will be raised before the deadline because Democrats, who hold the majority in both houses, would have the most to lose in the event that it does not get lifted. However, we expect the debt ceiling to be lifted at the very last minute as the two sides continue to haggle.
  • Additionally, Nancy Pelosi and Senate Majority Leader Chuck Schumer announced an agreement for “a framework” of options to pay for the social spending ambitions in the $3.5 trillion government spending bill. The revelation has led to confusion among Democrats who claimed to have not been briefed on the framework. Although last minute changes to controversial bills are not unusual, the lack of transparency may make it harder for Democrats to rally around the bill.
• Treasury yields rose sharply due to a sell-off in bonds on Thursday. The increase in yields appears to be in response to tightening credit conditions. This week, the Federal Reserve and the Bank of England signaled that they could tighten monetary policy.
  • Fed reverse repo usage rose considerably over the last week after the Fed increased the limit for counter parties. The change allowed financial institutions another place to park their excess cash.
• U.S. household net worth rose to an all-time high in the second quarter bolstered by high equity prices and increases in home values.
• The White House is mulling over whether to invoke a cold-war era national security law that forces companies to provide information on the inventory and sale of semiconductors. This is the latest attempt by the Biden administration to address the semiconductor shortage.
• Higher oil prices have made it easier for private and small companies to enter the market. It is expected that these companies will account for more than half of total output growth next year.

China:

• The People’s Bank of China announced that all forms of cryptocurrency transactions are illegal and must be banned. Although sudden, the move was likely inevitable as the country prepares its own digital currency. Nevertheless, there are concerns that the ban may be related to the ongoing Evergrande crisis.
• Beijing escalated tensions with Taipei on Thursday by sending 24 fighter jets over Taiwan’s air defense identification zone. The move comes in response to Taipei’s bid to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP).
• China is planning to consolidate all its rare earth mining and processing firms into two large firms. By having the two largest rare earth firms, Beijing believes it will have the ability to better control prices. Rare earth minerals are crucial in the production of clean energy, electric vehicles, consumer electronics, and some national defense technologies.
• On Friday, Commerce Secretary Gina Raimondo suggested that despite the friction between the U.S. and China, the two countries will still look to strengthen business ties. This is a huge shift in tone from the Biden administration. In July, the administration warned companies about the risks of investing in Hong Kong following the passage of the national security law. Although it is possible that the change in tone could be related to Xi and Biden’s most recent call, we suspect that it may be due to a divide within the administration on how to best deal with China.

COVID-19:  The number of reported cases is 230,663,767 with 4,729,308 fatalities.  In the U.S., there are 42,672,241 confirmed cases with 684,349 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 462,561,625 doses of the vaccine have been distributed with 387,821,704 doses injected.  The number receiving at least one dose is 212,564,346, while the number receiving second doses, which would grant the highest level of immunity, is 182,587,334.  The FT has a page on global vaccine distribution.

• An advisory panel for the Centers for Disease Control and Prevention have recommended that the Pfizer vaccine be limited to seniors, nursing home residents, and certain adults with underlying conditions. The recommendation for such a small group of people will likely hinder efforts from the Biden administration as it attempts to halt the spread of the delta variant through vaccinations.
  • The CDC chief overruled the panel decision and recommended that workers at high risk of COVID-19 infection should receive the booster.

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