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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy CPI day!  We cover the data below, but the quick read is that prices rose less than expected, lifting equity futures, which were leaning higher before the report.  Tropical Storm Nicholas has hit the Texas coast, dumping prodigious amounts of rain.  The storm track is taking it toward Louisiana.  Our coverage begins with the New York Fed’s inflation survey, followed by an update on the uranium market and Facebook (FB, USD, 376.51).  Our regular coverage begins with China news.  Bond market jitters continue.  The international roundup is next; the center-left wins in Norway.  We close with pandemic coverage.

NY Fed and Inflation:  The New York FRB conducts a survey of consumer behavior and outlooks, and its recent polling on inflation expectations is sobering.  The overall inflation expectation for one year out is 5.2%; the three-year rate is 4.0%.  Older Americans (over 60) are most concerned, forecasting a 6.0% rate over the next 12 months.  But even the under 40 bracket is looking for 4.5%.  Check out the above link for the breakdown by education, age, and region.  The bottom line for the Fed is that inflation expectations are rising, and the central bank’s only real tool to address it is to weaken aggregate demand, which we doubt it will do.

Uranium on a tear:  We have been friendly to uranium on the idea that, eventually, it will become obvious that you can’t achieve a carbon-free energy sector without nuclear power.  That doesn’t mean nuclear power isn’t without its externalities, but so does every other power source.  The uranium market isn’t huge.  Much of the production and consumption is tied to long-term contracts, meaning the spot market is even smaller than it looks.  In such situations, a small amount of buying can lead to price spikes.  Investor interest appears to be high, and that has sent prices up sharply.  We don’t know how long it will last, but over the long run, we suspect prices will remain higher than seen in recent years.

Facebook (FB, USD, 376.51):  In the spirit of Animal Farm, it turns out that all animals are equal, but some are more equal than others.  A WSJ report reveals that the social media company does not screen all Facebook users the same.

 China:  Evergrande (EGRNF, USD, 0.46) remains in the news.

• The steady drip of bad news from the property developer Evergrande is now starting to become a broader problem. Until around 2015, China essentially prevented defaults.  Investors tended to assume they wouldn’t occur and, thus, take excessive risk.  But the Xi regime has changed the rules of the market, and the Evergrande situation could prove to be a serious test.  We are seeing evidence of protests against the company, with investors demanding their money back, employees demanding their pay, and homeowners demanding their homes get built.  The company is cautiously starting to outline a restructuring plan.  It is offering investors some mix of cash, payables, and property.  The CPC has shown limited tolerance for protests and civil unrest.  Beijing will likely press for some sort of resolution, but it looks like there are not enough assets to make all creditors and shareholders whole.  In one sense, allowing bankruptcy and restructuring will inject an element of hazard to investors, which isn’t a bad thing.  However, the fallout could be difficult to manage.
• Blackstone (BX, USD, 129.21) dropped its plans to purchase Soho China (410, HKD, 2.20) due to concerns over a lengthy regulatory review. It may be a polite way of saying China was never going to approve the transaction.  The owners of Soho China are under scrutiny regarding concerns they are dumping their properties in China to flee the country.  In the current political environment in China, this is a problem.  Shares in Soho China plunged on the news.
• The former head of the PBOC, Zhou Xiaochuan, criticized the venture capital industry for creating a “winner take all” environment in the digital economy. These comments dovetail with Beijing’s recent criticism of the “disorderly expansion of capital.”  Zhou is an establishment figure in China, and his position is further evidence that the investment practice of funding firms with strong network effects may be under pressure in China.  He also suggested that curbing tech monopolies would “ensure growth,”
  • In related news, regulators have warned against tech giants blocking links to rival companies.
• Alibaba (BABA, USD, 165.41) has offered details on how it will spend its CNY 100 billion (USD 16 billion) “common prosperity fund.”
• Although it is being dubbed an “anti-fraud” app, a new app also appears to be designed to track Chinese users’ access to foreign financial news sites. If so, it would suggest that China continues to use the “great firewall” to control the news narrative.
• The SEC’s Gensler indicates Chinese firms listed in the U.S. will need to be audited. We suspect that won’t happen under General Secretary Xi.

International roundup:  Labor wins in Norway, the Peronists don’t win in Argentina, and Lebanon gets aid.

• Norway’s Labor party and its allies look poised to take control of the government. Labor itself won 48 seats out of 169, over half needed to gain control of the legislature.  The Center and the Socialist Left won 28 and 13 seats, respectively, giving it a majority of 89 seats.  Most important for Norway’s oil and gas industry, the current coalition does not need the Greens to form a government.  The Greens wanted to end exploration which, would have led to eventual declines in production.
• Meanwhile, the opposition won handily in primary elections in Argentina. Given recent polling, this outcome was not unexpected.
• Lebanon, which is near economic collapse, has received $1.135 billion in SDRs from the IMF. Although this won’t fix the country’s problems, it will likely buy the new government some time.
• Although the Nord Stream 2 pipeline is complete, it will be several weeks before gas will flow. The line still needs some final work, testing, and regulatory approval.
• Spain, dealing with rapidly rising electricity prices, has implemented a windfall profits tax.
• The leaders of the Quad—the U.S., Australia, Japan, and India—will meet in Washington on September 24^th. This meeting will be the first one in person for this group.  China views this arrangement as an alliance to contain China.  We agree with Beijing on this one.

COVID-19:  The number of reported cases is 225,359,152, with 4,641,746 fatalities.  In the U.S., there are 41,223,105 confirmed cases with 662,252 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 456,755,755 doses of the vaccine have been distributed, with 380,831,725 doses injected.  The number receiving at least one dose is 209,701,005, while the number receiving second doses, which would grant the highest level of immunity, is 178,982,950.  For the population older than 18, 65.0% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

• The debate of booster shots is heating up. The Lancet’s most recent research suggests boosters are not needed at this time.  However, the White House is pushing for boosters after promising them and is accusing the FDA and CDC of withholding data.  To us, this looks like a classic case of a collision between politics and science.  Science is a form of inquiry, and “settled science” means that the preponderance of opinion supports a certain point.  Since science is inductive, the truths it unearths are always tentative.  Politics, on the other hand, is about making decisions with available data.  Conflicts are inevitable.
• There are inquiries about data procedures at the National Institutes of Health after genetic samples of COVID-19 were destroyed at the request of Chinese researchers. Even if this event is innocent, the action does not look good.
• There are new outbreaks of COVID-19 cases in China.

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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!  A lot is going on in the world today as we turn toward autumn.  After a soft week, equities are lifting this morning.  We begin with comments on what is shaping up to be a turbulent month.  There is an abundance of election news around the world, and we take a look at several races.  Crypto news comes next, followed by our coverage of China.  Next up is economic and policy news and our international roundup.  We conclude with a pandemic update.

We used to like September:  School resumes, the NFL returns, the baseball season winds down with at least a couple of races for the playoffs.  Summer weather gradually cools, and temperatures become less oppressive.  The hint of autumn comes with the equinox (September 22 for those keeping score).  However, this September could be volatile.  The nuts and bolts of the budget are being introduced in Congress.  As we noted in the latest WEU, energy companies are trying to prevent, or at least modify, taxes directed at them on carbon and methane.  Capital gains taxes are almost certain to rise, but that’s not all being considered.  Increases to corporate taxes are also on the agenda, and maybe special taxes on stock buybacks.  It is clear that capital is being targeted.  Equity markets usually don’t discount these sorts of events very well.  The market didn’t anticipate the Trump tax cuts, for example.  Thus, we probably won’t see the market take the taxes into account until they are passed.  This position makes sense; tax law is very complicated.  It’s better not to move until you know exactly what the final outcome is, but the budget will hang over the market for the next several weeks.  We will continue to monitor this situation as it unfolds.

But wait…there’s more!  The debt ceiling issue is coming at the same time we are dealing with the budget.  In reality, the debt ceiling is a formality.  The spending and borrowing have already occurred, but minority parties or the party out of the White House can use the debt ceiling as leverage.  This time around, the Democrats who control Congress could simply put the increase into the reconciliation bill and pass it on a party-line vote.  However, that creates a campaign issue for the midterms, and it already appears that a change in control is probable.  So, the Speaker wants to force a vote on the idea that the GOP leadership won’t vote to shut down the government.  Both sides look dug in, which likely means a crisis is in the offing.  In the autumn of 2013, when we had similar circumstances, we saw a short-term spike in T-bill rates.

In 2013, the combination of a government shutdown and a new Fed Chair led to a spike in short-dated Treasuries.  Although the Fed’s lending facilities in place today would likely prevent significant fallout, there is a risk of short-term volatility in the money markets. The bottom line is that the next eight weeks could be rocky.  We don’t think this situation will necessarily require defensive action in portfolios, but we are monitoring the situation closely.

Elections!  We have been keeping close tabs on the German elections, but that isn’t the only ones underway.  There are others of note.

• Norway is holding elections today, and it appears a center-left party will take control. Although the leadership of the Labor party isn’t calling for an immediate end to oil exploration, the Greens and the Socialist Left, the latter a likely member of the emerging coalition, have made calls for this outcome.  In addition, it is possible Labor will need the support of the Greens to form a government.  We don’t anticipate an immediate end to Norway’s oil production, but once exploration ends, output levels will decline.  What is happening in Norway is consistent with our position that oil prices will tend to be stronger, due to supply fears.  Oil companies will likely not perform as well as the commodity.
• Argentina held primary votes yesterday to determine who contests national elections on November 14. Polling suggests the Peronists will lose some of their dominance of the legislature.
• California holds its governor recall election tomorrow.
• Germany held another debate before its upcoming elections. By all accounts, the SDP’s Scholz won the event, increasing the odds of a change in government this month.  For the most part, Scholz is the best-looking candidate in a weak field.  The CDU’s Laschet appears poised to lose an election he should not have lost.  At the same time, it is not unusual that a strong leader prevents the rise of rivals, and when she steps down, there are no adequate replacements.

Crypto:  The BIS wants CBDC, and regulators are pushing against cryptocurrencies.

• Late last week, Benoît Cœuré, currently with the BIS but previously an official with the ECB, said that central banks must move “quickly” to develop digital currencies to offset the threat from decentralized finance and stablecoins. Cœuré is leading the BIS research effort on CBDC.  He sees stablecoins as a competitor to sovereign currencies.  It may also be a source of financial instability that the central banks could be impotent to respond to a funding crisis in this area.
• Regulators are becoming increasingly concerned about decentralized finance lending activities tied to cryptocurrencies. One problem is that if there is a run on these assets, it isn’t clear how central banks could intervene.  If this lending has infiltrated the traditional banking system, the potential for a financial crisis becomes elevated.
• A couple of years ago, Facebook (FB, USD, 378.69) tried to roll out a cryptocurrency dubbed “libra.” The program really didn’t get off the ground, but that didn’t kill the project.  The new coin is called “diem.”  Facebook and the other collaborators on the project wanted to release the coin last year, but not much has occurred yet.  The coin is a permissioned blockchain, meaning there is a centralized control regarding who can use the system.  Bitcoin, in comparison, is permissionless, meaning anyone can use it.  Regulators are pushing back on the release of this currency.
• South Korea has been a hotbed of crypto activity. As we are seeing elsewhere, regulators are cracking down in Seoul, too.  By September 24, the government will require all foreign and local exchanges to register as trading platforms.  Approximately two-thirds of the local operators appear unable to meet the regulatory standard.  If they close, about 42 local “kimchi coins,” the South Korean won-related crypto coins, could be eliminated.  These are said to represent 90% of trading in crypto in South Korea.  Investors (or more properly, punters) are finding they can’t cash out these altcoins.  If they can’t, it is estimated that $2.6 billion may be lost.

China:  We are still trying to determine what common prosperity means, and new tariffs on China may be in the works.

• A recent commentary in China over the regulatory crackdown continues to paint a less-than-clear picture about the direction of policy in China. Li Guangman, the author of a recent editorial calling for a wholesale rejection of Western values and the curtailment of capitalist activities, is on one side of the debate.  We note that his essay on this topic remains available online in China, which would suggest it hasn’t been rejected by the leadership of the CPC.  Other voices have called for moderation, fearing a wholesale rejection of markets will cripple China’s economy.  Our take is that General Secretary Xi is determined to bring every part of Chinese society under the control of the CPC, including the market economy.  Much of the crackdown is on leaders in industry and culture.  Still, there is a degree of uncertainty that will only become clear with time; no one knows how far Xi intends to take this program.  For those involved in China, this uncertainty is difficult to manage and has led some to reduce their exposure.  Reducing exposure is manageable for financial investment; for direct investment, the options are less attractive.
  • Chinese regulators have indicated they want to separate Alipay, the loan app of Jack Ma’s Ant Group (BABA, USD, 168.10), from the rest of the company. Alipay is a prodigious source of data on consumers.  It is likely the reason regulators want to pull it away from Ant so Beijing can access Alipay’s data.
• The Biden administration is investigating Beijing’s industrial subsidies to determine whether government support gives these firms an unfair advantage. If the analysis finds it does, countervailing tariffs might be implemented.  The White House has kept most of the Trump-era tariffs in place, and now it appears that more may be added.
• We have documented the travails of Evergrande Group (UGRNF, USD, 0.45) in recent weeks. It appears that some degree of contagion is developing, as the bonds of other property developers are plunging.  Dollar bonds of Fantasia Holdings (1777, HKD, 0.65) and Guangzhou R&F Properties (2777, HKD, 6.33) have slipped under 60 cents per dollar, pushing yields to around 40%.  For years, Beijing didn’t allow companies to default.  Banks were encouraged to perpetually extended credit.  With the potential of default looming, it remains to be seen if regulators will simply allow these firms to fail and bear the consequences.
• The Biden administration is moving toward allowing a name change in Taiwan’s representative office in Washington. It is currently referred to as the “Taipei Economic and Cultural Representative Office.”  The proposal is to change the name to the “Taiwan Representative Office.”  This change gives the impression that Taiwan is a separate sovereign.  Lithuania recently did something similar, which Beijing didn’t take well.  China opposes the move.  Coming so soon after the Biden/Xi call, this action suggests a deliberate escalation of tensions.

Economics and policy:  Tax proposals are out, a couple of regional FRB presidents are in hot water, and manufactured homes are becoming popular.

• As noted above, we are starting to see tax proposals from the $3.5 trillion budget. Several of the measures proposed are controversial, and we doubt all will be passed.  Some missing elements are notable.  There are no changes to the estate tax in the linked proposal, for example.  Passing this budget will still be tenuous; moderate Democrats remain opposed, and given the slim majorities in Congress, it will be hard to make it all work.  We continue to expect something to get done, but probably less than what is currently on paper.
• Dallas FRB President Kaplan and Boston FRB President Rosengren are apparently active traders in their own accounts. This revelation has led to concerns that they may be using information from their role on the FOMC for their benefit.  Although neither appears to have violated regulations, the conduct raises questions.  Both have indicated they will sell their individual holdings and invest in broad indexes going forward to avoid the appearance of impropriety.  This news may turn out to be nothing. However, progressives have eyed the role of the regional bank presidents with concern for a while.  Regional bank presidents are appointed by their regional bank boards, which are usually populated with local business leaders.  None are vetted by Congress.  Voting patterns show a clear skew towards hawkishness.  Don’t be surprised if Congressional progressives use this event to gain influence on the selection of a president, potentially removing hawks from the FOMC.
• Although LIBOR isn’t dead quite yet, regulators continue to press for its demise. In advance of the expected conclusion of the rate by year’s end, CLO managers are rushing to do deals while the rate is still available.  This seems a bit silly to us.  If LIBOR goes away, some other rate must be used.  We note that some loan language says that if LIBOR becomes unavailable, the rate is fixed at the last known rate.
• The EPA is moving to block the development of the Pebble Mine project in Alaska. Although there are understandable environmental objections, it is also true that the move away from fossil fuels is essentially a change from oil and gas to metals.  Making areas unavailable for development simply drives the prices of metals higher.
• As the courts have ended the eviction moratorium, evictions are starting to occur. This is despite the fact that billions of dollars of rental assistance are available.  In the end, the program was a massive failure and shows that money alone won’t facilitate a government program.  Planning and bureaucracy are also necessary.
• As home prices soar, manufactured homes, perhaps the lowest end of owned housing, are starting to perk up.

At the peak of the housing crisis, shipments and starts reached 2.0 million units.  As housing crashed, that number collapsed too, falling to 400,000.  When home prices began to recover, so did manufacturing and shipments, although levels remain below earlier levels.  The above chart shows prices moving up rapidly, and manufacturing and shipments are rising, although below levels one would expect given price levels.  It is likely that supply chain problems are affecting this industry as well.  Part of the problem is that local governments have used zoning to prevent the establishment of manufactured home parks.  At the same time, these homes are significantly cheaper than on-site homes and could solve the housing deficit.

• One surprise in this recovery is the robust rise in earnings. Earnings usually rise in recoveries, but current S&P earnings as a percent of GDP are 7.8%, well above the previous highs of 6.5%.  A large part of that strength has been the ability of firms to pass higher costs on to consumers.  However, at some point, societal pressure will start to affect the ability of firms to move higher costs to consumers, which will adversely affect margins.  We are seeing the first industry reaction on this front.  The world’s third largest shipper, CMA CGM announced it is capping shipping rates for the next five months.  The top six container ship operators control 75% of all ship space, giving them remarkable pricing power.
  • On a related note, the White House has a new council on competition; it held its first meeting last week. The narrative being built is that inflation is caused by industry concentration.  So, antitrust becomes an anti-inflation policy.
  • UPS (UPS, USD, 193.26) says the pandemic will permanently change logistics, reducing globalization and leading to increased regionalization.
• At the same time, BMW (BMWYY, USD, 31.10) and Daimler (DMLRY, USD, 20.26) announced over the weekend that they intend to keep prices high. Ford (F, USD, 12.68) has indicated similar sentiments.  Both will likely do so by holding less inventory.  The pandemic’s disruption of supply chains has proven to automakers that they really don’t need dealer lots loaded with cars.  A casual drive-by of car lots shows a lot of asphalt and little stock.  This may become the future, one of the permanent changes from the pandemic.  Car buyers are becoming more comfortable with buying online and seem to be less concerned about immediate delivery.  Car dealers are rapidly consolidating in front of this trend.  For years, dealers were protected by a web of state laws that prevented the auto companies from selling direct to consumers.  The dealers themselves began to see their business as providing service after the sale, and thus, the walls of direct-to-consumer sales, or the need for inventory, are rapidly weakening.  The days of haggling over a car may be coming to a close.  That isn’t necessarily good news for consumers.

International roundup:  Will the Eurobond become a permanent feature, and PM Johnson hikes taxes.

• A report issued last week is attempting to frame the relationship between the Russian government hackers operating from that nation. Although the Kremlin has ties to these groups, the relationship is distant enough to give Moscow plausible deniability.
• North Korea has tested a new long-range cruise missile.
• Russia and Belarus are planning joint military exercises. This decision raises fears in the West as the two nations have moved steadily to unify.
• Ireland, which is something of a tax haven for big tech, is apparently failing to enforce EU laws on tech firms.

COVID-19:  The number of reported cases is 224,712,819, with 4,632,043 fatalities.  In the U.S., there are 40,956,417 confirmed cases with 659,975 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 456,755,755 doses of the vaccine have been distributed, with 380,241,903 doses injected.  The number receiving at least one dose is 209,437,152, while the number receiving second doses, which would grant the highest level of immunity, is 178,692,875.  For the population older than 18, 64.9% of the population has been vaccinated.  The FT has a page on global vaccine distribution.

• The administration is steadily moving toward vaccine mandates. Opposition to this action is elevated; it should be remembered that opposition to mandated vaccination is nothing new.  Yet, it should be recognized that the courts usually favor the implementation of mandates.
• Restaurants are closing dining rooms again as infections rise.
• Brazil is the latest country to move away from China’s vaccines. This is despite Beijing’s attempt to distribute its vaccines in the emerging and frontier worlds.
• The U.S. currently ranks sixth among the G-7 nations for vaccine distribution; with Japan ramping up its program, the U.S. will likely fall to seventh.
• Recent studies indicate that those infected with the Delta variant are 11 times more likely to die from the disease if unvaccinated. The highly infectious Delta variant is adversely affecting working-age populations.
• Eventually, through vaccination and natural post-infection immunity, COVID-19 will probably become a seasonal infection.

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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 a discussion of the call between Presidents Joe Biden and Xi Jinping. International news is up next followed by U.S. economics and policy news, including details about Treasury Secretary Yellen’s warning that the debt ceiling could pose a threat to financial stability.  China news follows, and we end the report with our pandemic coverage.

They Finally Speak: Last night, President Biden called Chinese President Xi Jinping in order to de-escalate tension between the two countries. This was the first call between the two leaders since they spoke on President Biden’s inauguration. Biden made the call after discussions among aides were unfruitful, believing that they would be able to make more progress if they spoke directly. Although details have not been released, the call is believed to have set “guardrails” for future policymaking.

In our view, Xi has been trying to make it appear that China is in the driver’s seat in negotiations with the U.S. as opposed to the other way around. This was made evident by China’s deliberate efforts to set up meetings between U.S. aides and Chinese officials in more junior roles. Now that Biden has made this call to Xi, we suspect these games may finally end. So far, the market has responded positively as it seems the call has mediated concerns over an imminent split between the two countries. After Xi reportedly said that China-U.S. ties should get back on the right track, the yuan strengthened and Chinese equities rallied.

International news: 

• Brazilian President Jair Bolsonaro has banned social media companies from removing certain content from their platforms. The new rules prevent companies from removing certain content without receiving a court order. The decision to limit social media companies’ ability to remove content appears to be rooted in Bolsonaro’s attempts to delegitimize the result of the upcoming presidential election. If polls are correct, Bolsonaro will be voted out of office. In that event, we believe that Bolsonaro could stage a military takeover of the government.

This is the first time a national government has established rules to limit social media firms’ ability to remove content from their own platforms. However, we suspect it will not be the last. Countries around the world have become more hostile toward social media companies as they believe these platforms could stir civil unrest and hinder their ability to communicate with constituents. As a result, social media companies will likely come under more regulatory scrutiny in the coming years.

• In a joint news conference, Russian President Vladimir Putin and Belarusian President Aleksandr Lukashenko pledged to build closer ties. The announcement comes as Belarus struggles to deal with the blowback after it forced a plane to land prematurely in order for authorities to arrest an activist journalist. The agreement has led to speculation that the growing integration between the two countries will lead to an eventual merger.
• On Thursday, the first international commercial flight took off from Afghanistan following U.S. troop withdrawal.
• European debt has made its way back into the spotlight in German politics. On Thursday, the Christian Democratic Union (CDU) party accused Olaf Scholz, the frontrunner to succeed Angela Merkel, of trying to force German taxpayers to pay for the debt of other European countries. Disputes over Germany’s role as lender of last resort in the currency bloc caused major headaches for Merkel during the European Sovereign Debt Crisis. It appears that disagreements over paying for pandemic debt could emerge as another thorny issue for her successor and could have implications for the euro.
• Calls continue to mount for regulation of cryptocurrencies. A senior official at the Bank for International Settlement, an international financial institution owned by central banks, has sounded the alarm over the growing threat these digital assets pose to banks. He urged policymakers to hasten their response to the cryptocurrency threat and develop a digital asset backed by national policymakers. The warning comes amidst growing fear that crypto has made its way into the global financial system and could lead to another financial crisis.

 Economics and policy:

• The presidents of the Federal Reserve Banks of Boston and Dallas, Eric Rosengren and Robert Kaplan, respectively, pledged to liquidate their individual stock holdings by September 30. The move comes as recent financial disclosures showed that the two Fed officials had traded at the same time that the central bank implemented extensive monetary easing. They have vowed to not trade stocks throughout the remainder of their tenure at the Fed. Although the Fed officials were allowed to purchase stocks at this time, the optics of doing so has exposed the central bank to additional scrutiny and could provide fodder for those looking to limit its influence.
• Treasury Secretary Janet Yellen continued to push Congress to raise the debt ceiling on Thursday. Yellen warned that failure to do so could have implications on financial stability. In the past, a lack of risk-free assets has led financial institutions to invest in riskier assets. Although the scarcity of risk-free assets could curtail lending, the standing reverse repo facilities at the Fed should be enough of a backstop to prevent a financial crisis.
• Several major airlines have attributed the decline in bookings to a surge in COVID-19 cases.
• Walmart (WMT, $146.42) has decided to end its quarterly bonus in order to fund higher wages. The move shows how some companies may be looking to fund higher wages without having to increase prices.

China:

• China has announced that it will release some of its oil reserves in order to alleviate the price pressures in commodities.
• Fitch Ratings angered Taiwan and confused traders when it referred to the island as “Taiwan, China” in a report. Initially, traders believed the report was referring to both Taiwan and China but later realized that it was referring solely to Taiwan.
• A typhoon in China threatens two of the country’s main shipping ports. So far, the ports remain open, although they have asked ships to adjust their navigation plans to the storm. Complications at ports in Asia have been a major source of bottlenecks for supply chains, thus port closings could contribute to a slowdown in the production of goods.

COVID-19:  The number of reported cases is 223,204,222 with 4,606,035 fatalities.  In the U.S., there are 40,602,892 confirmed cases with 654,598 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 452,781,195 doses of the vaccine have been distributed with 377,622,065 doses injected.  The number receiving at least one dose is 208,305,270, while the number of second doses, which would grant the highest level of immunity, is 177,433,044.  The FT has a page on global vaccine distribution.

• President Biden ordered all executive branch employees, federal contractors, and millions of healthcare workers to get vaccinated. He also announced that he will issue rules requiring firms that have over 100 employees to mandate vaccinations or testing.
• A. schools are requiring students 12 years and older to be fully vaccinated by January 10.
• The United Kingdom is expected to be the first government to allow the mixing of different vaccines. The move will likely make it easier for patients to receive the third booster shot as efficacy of the previous two vaccines have shown signs of waning.
• Singapore is considering new restrictions following a surge in COVID-19 cases.

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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 under pressure again this morning as equity markets grapple with the ongoing pandemic, the uncertainty around the budget process, and the potential for a debt ceiling standoff.  The ECB and the Fed kick off our coverage.  Today’s ECB meeting showed no rate changes, but there is a modest slowing of asset purchases.  The Fed Beige Book was released; we comment on the report and other Fed issues.  Remarks on distributed finance follow. Our regular coverage begins with China news, as investors and analysts try to determine how much policy will change.  Economics and policy follow, with a look at the budget talks and the debt limit.  The international roundup is next, and we close with pandemic coverage.

ECB:  For the most part, the ECB stays accommodative.  There were no changes in policy rates, as expected, but there will be a slowing of the Pandemic Emergency Purchase Program (PEPP) bond-buying.  It may not be an actual taper.  We could see the reduced buying in PEPP shifted to the overall buying program.  This change was mostly signaled, so market action has been modest.  By the way, the ECB also describes the rise in inflation as “transitory,” keeping in line with the Fed.  In the press conference, the tone was generally more dovish than the statement, leading to a weakening EUR and stronger European equities.

Beige Book:  The keyword is “moderation” in the Beige Book.  This report, which is compiled by the regional FRBs, gives an insight into regional conditions.  In most districts, the common theme was that growth has slowed but remains positive; the weakness is driven by the ongoing pandemic and supply-side shortages, including both materials and labor.  These shortages are leading to inflation concerns.

• Jim Bullard, president of the St. Louis FRB, is pressing forward with calls for tapering, despite last week’s lackluster labor market report. He is arguing that the high level of labor demand will allow the Fed to start withdrawing stimulus.

This chart shows the job openings from yesterday’s JOLTS report regarding the level of the unemployed.  In the 2001-07 expansion, this level was never achieved.  In the 2009-20 cycle, this level wasn’t achieved until February 2018.  We crossed the lines in May, showing a rapid recovery.[1]

• Democrats remain split over Chair Powell’s reappointment (the topic of tomorrow’s Asset Allocation Weekly)

Crypto:  The SEC is investigating Coinbase Global (COIN, USD, 258.20) over its lending program using crypto assets as collateral.  This prompted the CEO of the company to criticize regulators in a series of tweets.  The SEC is arguing that this proposed lending activity is potentially violating securities laws.  The government is also investigating Uniswap.  Much of what these firms are doing in decentralized finance is consistent with lending and trading in the regulated world, but these crypto firms want to do it in an unregulated environment (who wouldn’t?).  History shows that, eventually, leverage leads to bad debt and the potential of a crisis.  The fact that the firm was advertising 4% deposit rates is a clear warning.  The SEC and others are trying to prevent this.  We note that over the weekend, the NYT reported on the “boom” in crypto lending that has caught the attention of regulators.

• The mainstream media have discovered that central bank digital currencies are programmable, meaning negative nominal interest rates could become operable.

China:  China’s financial markets remain a concern, and the confusion surrounding what exactly Xi means by common prosperity is beginning to look like a mess.

• Evergrande (EGRNF, USD, 0.50) continues to be a concern. Moody’s (MCO, USD, 382.37), along with Fitch, has downgraded the company again, leading to the suspended trading of the company’s bonds.  There are reports that suppliers are being paid in undeveloped property, a sign of illiquidity.
  • One way for parents to improve their children’s education is to buy apartments in good districts, allowing them to claim residency. It has led to soaring prices in these select districts.  But recently, Beijing is fostering policies to break the link between home ownership and schools, leading to a decline in prices for apartments in these districts.
  • In the past, Beijing regulators have moved to constrain the real estate market but would tend to back off on worries over triggering a financial crisis due to the concentration of debt in this sector. There are concerns that regulators may be serious this time about following through on addressing this sector.
• We have been watching with great interest a growing tension between what appears to be a conservative social trend of reining in capitalism along with other activities against those who suggest that the core regulation isn’t changing. Our view is that the conservative shift is likely the trend in place, but the fact that Xi is allowing this editorial battle to occur suggests the policy might not be fully developed.
• Tencent (TCEHY, USD, 65.23) is calling out a “gray” industry that has emerged to give gamers more playing time. The government recently moved to limit gaming to three hours a week.  New services are appearing that create profiles for players who either don’t exist or for people who don’t play, allowing a gamer to purchase more time.  If Beijing is serious about limiting time, it will need to implement some sort of identification, such as facial recognition.
  • Regulators called in gaming companies for yet another meeting, described as an “ear-bashing.” However, it is notable that China has not moved to what some would suggest is the nuclear option, which would be to ban ads on gaming sites.  The fact that regulators haven’t taken that step, which would hurt the gaming companies, suggests they don’t want to crush these companies, at least not yet.
  • The growing esports industry in China is under threat from new rules on gaming.
• The increased regulation on technology appears to be a building block of data accumulation, with the goal of controlling the population and the economy. General Secretary Xi has discussed data as bringing the “fifth factor of production.”  If anything, we expect Beijing to continue to expand its control over data, including taking it from China’s tech firms.
• Blackrock (BLK, USD, 924.93) has raised $1.0 billion for the first Chinese mutual fund to be run by a foreign firm. This expansion of participation in China is running against geopolitical trends and has been criticized in some circles.
• China’s PPI rose sharply in August to a 13-year high. In response, China announced it would release oil from its strategic reserve.
• In criminal law, there is often a decision about who bears the responsibility for the wrongdoing. For example, drug dealers often face harsher penalties compared to consumers.  China has tended to severely punish bribe takers, who are usually government officials; there has been less focus on those making bribes.  It appears that new regulations consider upping the punishments on the bribers.
• Brazil has suspended beef exports to China after finding two cases of bovine spongiform encephalopathy, commonly known as “mad cow disease.” Brazil is the largest supplier of beef to China.  If the suspension persists, it will lead to reduced supplies in China.  However, it is unknown whether Chinese consumers will balk at buying beef due to the risk of the disease.
  • China is increasing funding for agriculture in what appears to be a move toward self-sufficiency. The country has a water problem.  It has been said that grain imports are effectively water imports, allowing China to use its scarce water for industry (which tends to have a higher value added) than agriculture.  However, in a world of economic warfare, the inability to feed oneself becomes a vulnerability.  It appears China is moving to address that problem.  However, it isn’t clear whether Beijing is willing to accept the lower economic value of diverting water to agriculture.
• China continues to crack down on the private tutor industry, now banning online classes.
• In Hong Kong, Tiananmen Square anniversary protestors were arrested.
• China is using fake social media accounts to spur protests abroad.

Economics and policy:  Budget negotiations accelerate, and debt limit concerns are higher.

• As serious budget negotiations begin, lobbyists are preparing to attempt to shape taxes and spending for their clients. Industries targeted for tax increases are pushing back hard to avoid this outcome[2].  The White House has been moving at a fast pace to push through these changes.  However, the past few weeks have drained the president’s political capital, putting the budget goals at risk.  Currently, the most potent hurdle is the centrist Democrat senators.  Senator Manchin signaled he would only support less than a third of the current proposals.  Polling suggests Americans are siding with the West Virginian.

(Source: No Labels)

• Revenue increases are part of this package, and we note a report yesterday suggesting that the highest-income households have “evaded” $163 billion in taxes. The article didn’t make it completely clear this was all evasion or avoidance.  The former is illegal; the latter is not.
• The White House wants to allow the government to negotiate Medicare drug prices; the pharma industry clearly opposes.
• Yesterday, Treasury Secretary Yellen warned that the U.S. would hit its debt ceiling next month and urged Congress to approve a higher borrowing limit. This issue is currently at an impasse.  The Congressional GOP wants the Democrats to make the debt ceiling part of the budget process, which would allow the increase to pass with a simple majority.  The Democrats don’t want to do that, knowing the GOP will use the issue as an election talking point.  It doesn’t appear to us that there are 10 GOP Senate votes to increase the ceiling without changes to the budget.  We expect some sort of deal to be made, but only at the brink of default.  However, the curtailment of the T-bill supply is already affecting money market funds, reducing the supply of short-term paper these funds use.
• The FTC is deciding on a merger of Amazon (AMZN, USD, 3525.50) and MGM (MGM, USD, 42.44). In general, progressives, increasingly dominating the FTC, look askance at all mergers.  Arguably this merger won’t lead Amazon to dominate the streaming industry.  If anything, if Amazon doesn’t buy MGM, someone else might.  So, the decision on this merger could signal just how aggressive the FTC will be regarding future mergers.
• In the 1980s, there was a time when the land under the Imperial Palace in Tokyo was worth more than all the land in California. Now, five U.S. tech stocks are worth more than the entire TOPIX stock index.
• Artificial intelligence is one of the potentially groundbreaking technologies that would allow greater machine independence from human oversight. We are observing that the race to develop this technology isn’t distributed widely on a geographic basis, which could lead to some cities gaining major advantages.

International roundup:  Will the Eurobond become a permanent feature, and PM Johnson hikes taxes.

• The issuance of a Eurobond earlier this year was a significant change, allowing the EUR to have a full faith and credit bond tied to it, which should improve its attractiveness to foreign reserve management. Although this issuance was said to be a “one-off” when it occurred, as we expected, there is growing pressure to make Eurobonds a permanent fixture.
• PM Johnson passed a significant tax hike to fund social and health legislation.
• North Korea holds a modest military parade; Kim Jong-un was described as “looking fit.”

COVID-19:  The number of reported cases is 222,650,255, with 4,598,278 fatalities.  In the U.S., there are 40,266,505 confirmed cases with 652,930 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 450,584,465 doses of the vaccine have been distributed, with 376,955,132 doses injected.  The number receiving at least one dose is 208,024,209, while the number receiving second doses, which would grant the highest level of immunity, is 177,104,652.  For the population older than 18, 64.4% of the population has been vaccinated.  The FT has a page on global vaccine distribution.  For the most part, cases are stabilizing, although a few central U.S. states are showing a noticeable rise.

• There are new details emerging on coronavirus research being done in Chinese labs. The new reporting suggests the funding from the U.S. facilitated research into creating novel coronavirus strains.  Although this new evidence doesn’t prove the lab leak hypothesis, it raises serious concerns that this research, which reports describe as “risky,” could have facilitated the spread of disease if it left the lab.
• As COVID-19 continues to circulate, we are moving into flu season, and there are rising concerns that the medical system, already under strain, could buckle if this year’s influenza year is a bad one. There are worries that this year’s flu strains will be more virulent than last year.
• As the Delta strain of COVID-19 circulates, researchers are watching the newest strain, dubbed “mu.” It has caused about 40% of cases in Colombia.
• Breakthrough cases of COVID-19, infections that occur in a vaccinated person, do happen, but rarely do they lead to a severe case. Current data suggest there is a 1/13,000 chance of a fully vaccinated person becoming seriously ill.  Of those breakthrough cases triggering hospitalization, about 70% occur in adults over age 65.
• The WHO-sponsored global vaccine program has cut its delivery forecasts by 25% due to manufacturing and approval delays. The total doses to be delivered this year will be 1.4 billion.

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[1] One interesting sidelight is that companies have become increasingly reliant on algorithms to screen job applicants.  Large companies often receive thousands of applications, and using human resource professionals to review and screen would be cost-prohibitive.  However, these algorithms are mostly designed to eliminate, not find, candidates.  It might be the case where these screening tools may be eliminating candidates who could meet the job requirements.  It may be a function of the programs being written in a time of looser labor markets.  Simply put, firms may have lots of openings but lack the ability to find workers.  A recent Harvard Business Review article examines this problem.

[2] In tomorrow’s Weekly Energy Update we will comment on the energy industry’s opposition to methane taxes.

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

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with a wide range of developments regarding U.S. monetary, fiscal, and regulatory policy.  We then move to global technology company regulation and other key foreign developments that could drive the financial markets today.  We conclude with the latest news related to the coronavirus pandemic.

U.S. Monetary Policy:  St. Louis FRB President Bullard yesterday said the Fed should soon dial back its asset purchase program despite the big slowdown in payroll growth reported last week.  According to Bullard, “There is plenty of demand for workers, and there are more job openings than there are unemployed workers . . . The big picture is that the taper will get going this year and will end sometime by the first half of next year.”

• Bullard’s statement illustrates how Chair Powell is coming under increasing pressure to pull back the Fed’s massive pandemic stimulus policies as the economy continues to recover.
• In fact, our analysis increasingly convinces us that the current economic recovery is more like the strong pre-1990 recoveries than the long, slow, drawn-out recoveries after 1990.  If so, monetary policy probably should be normalized more quickly than Powell intends.  By deftly separating the issue of near-term tapering from rate hikes in the future, Powell’s Jackson Hole speech may give him the leeway to thread the needle by launching a tapering program somewhat earlier than he originally planned but still pushing rate hikes farther out into the future.

U.S. Fiscal Policy:  President Biden has asked Congress for $30 billion in extra funding to tackle the impact of the hurricanes, floods, and wildfires that hit the U.S. over the past 18 months. About $10 billion would cover the cost of the government’s response to Hurricane Ida, while $14 billion would cover the costs of earlier extreme weather events.  In addition to the disaster relief, the White House added it would also need $6.4 billion in funding to aid Afghan refugees.  The request will likely further complicate the passage of Biden’s proposed programs related to infrastructure, poverty, and climate change.

U.S. Cryptocurrency Regulation:  Coinbase (COIN, $266.81) said the SEC has threatened to sue the company if it launches its proposed digital asset lending product called Lend.  The cryptocurrency trading platform also said the SEC has issued subpoenas requiring it to provide more information on the product, which it considers a security.  At the same time, Coinbase and other companies have complained that the SEC isn’t explaining exactly why it sees their products as securities subject to regulation.  In any case, the situation highlights the growing regulatory scrutiny of cryptocurrencies and the bureaucratic struggle to be their primary regulator.

Global Technology Industry:  At a parliamentary forum this week, South Korean lawmakers warned large technology companies that they should be careful not to abuse their market dominance in the pursuit of profits.  Not only did the warning spark a sharp drop in the shares of South Korea’s top social media companies, but it also suggests that other countries may follow Beijing’s lead in cracking down on the power of big tech firms.  As we have mentioned before, we see a significant rise in antimonopoly and other regulatory risks targeting technology companies worldwide.

United States-China:  The U.S. Navy today conducted a freedom-of-navigation operation by sailing a warship, the guided-missile destroyer USS Benfold, near a Chinese-controlled island in the disputed South China Sea.  It was the first such operation since Beijing began implementing a law that requires foreign vessels to give notice before entering waters it claims.  As might be expected, China’s military lambasted the operation as the latest proof of the United States’ “militarization of the South China Sea,” adding that it had tracked the vessel and warned it off.

Mexico:  A powerful earthquake registering 7.1 on the Richter scale struck southeast of Acapulco last night, causing at least one death and some property damage.  However, reports so far suggest the temblor has caused no major damage.

Brazil:  More than 100,000 Brazilians staged street rallies yesterday in a mass show of support for right-wing President Bolsonaro, ahead of elections next year where he will face a surging leftist challenger.  Despite Bolsonaro’s continued drop in preference polls as Brazil battles the coronavirus pandemic and the president fends off corruption charges, his supporters gathered in the streets of São Paulo and more than 100 other cities to disparage Bolsonaro’s political opponents, communists, Congress, and the courts.

Afghanistan:  The Taliban finally revealed a new government in a hastily called nighttime press conference.  The Taliban’s supreme leader, Hibatullah Akhundzada, retains overall oversight of state affairs; the new prime minister will be Mullah Hassan Akhund, who served as foreign minister in the previous Islamic Emirate until the U.S. invasion in 2001.

• In an appointment that would complicate any recognition of the new government by Western nations, Sirajuddin Haqqani, designated a global terrorist by the U.S. because of close links between al Qaeda and the Haqqani network that he heads, was named minister of interior, with oversight of Afghanistan’s police and internal security.
• The new government includes no women or members of the Shiite minority, despite the Taliban’s repeated assurances to foreign governments and fellow Afghans that they would establish an inclusive government that represents all parts of the Afghan society.

COVID-19:  Official data show confirmed cases have risen to 222,042,024 worldwide, with 4,588,950 deaths.  In the United States, confirmed cases rose to 40,282,910, with 650,691 deaths.  Vaccine doses delivered in the U.S. now total 450,122,155, while the number of people who have received at least their first shot totals 207,589,611.  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, 62.5% of the U.S. population has now received at least one dose of a vaccine, and 53.2% of the population is fully vaccinated.
• Hundreds of civil society groups are demanding the postponement of a UN climate change conference scheduled for November in Scotland because the U.K. government has been too slow in providing vaccines to delegates.  The COP26 meeting has already been delayed a year by the pandemic.
• In Japan, the government plans to relax COVID-19 curbs on travel, large-scale events, and the serving of alcohol only around November and subject to people being mostly vaccinated by then.  The timeline illustrates how long the new Delta wave of infections could delay the budding economic recovery in some countries.

 Economic and Financial Market Impacts

• In a sign that the Delta variant of COVID-19 is curtailing previously strong demand for restaurant, salon, and other in-person service positions, postings on job-search site Indeed.com began to plateau in August.
  • According to the company, postings were up about 39% at the end of August from February 2020, ahead of the pandemic.  However, that was only a modest gain from the comparable week of July, when postings were up 37% from February 2020.
  • The August gain was largely driven by increased demand for jobs that can be done from home, such as software development. Postings for childcare fell, and openings in construction and at restaurants rose only slightly.
• Despite the apparent plateau in U.S. hiring in late summer, the overall economic recovery continues.  Commodity markets are nevertheless showing a wide disparity in performance due to unusual factors like policy changes in China and global supply disruptions.

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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 international developments ranging from a worsening outlook for Chinese corporate debt to a budding political fight in the United Kingdom over higher taxes for the National Health System.  We also cover the latest developments in Afghanistan and the coup in Guinea, which has pushed up aluminum prices today.  We close with the latest news on the coronavirus pandemic.

U.S. Pension System:  As state and local governments continue to struggle with underfunded pension systems, they are increasingly borrowing to meet their pension obligations.  According to an analysis by Municipal Market Analytics, state and local governments have borrowed about $10 billion for pension funding through the end of August this year, more than in any of the previous 15 full calendar years. The number of individual municipalities borrowing for pensions soared to 72 from a 15-year average of 25.

• With borrowing rates extraordinarily low, municipalities are betting they can make more on their existing pension investments than they will have to pay in interest.
• The practice amounts to a leveraged bet that the pension systems can keep making good returns in the financial markets.  Of course, a key test would come in a significant market downturn and/or a steep rise in borrowing rates.

China:  As we’ve said many times, one notable economic vulnerability facing China is its high level of debt.  Throughout 2021, that problem has been especially evident among the country’s major real estate developers, especially the largest, Evergrande Group (EGRNY, $13.49).  Chinese trading in the company’s bonds has now been suspended for the second time in as many days after it admitted last week that it might default, and Moody’s twice downgraded the issues.

• Evergrande’s bonds fell approximately 20% in Shenzhen today, after a similar sharp decline last Friday.
• More ominously, concerns about Evergrande appear to be weighing on other Chinese developers’ bonds and stocks, raising the specter of broader market contagion.

Russia-Germany:  The German government has accused Russia of launching a series of cyberattacks against national and regional politicians as part of an effort to interfere with Germany’s national elections later this month.  The warning comes ahead of what appears to be the most open election in recent German history, with polls pointing to an inconclusive outcome that could usher in months of uncertainty in Europe’s most powerful country.

• Not only is Russia losing a relative friend and ally in Chancellor Merkel, who is retiring, but Merkel’s center-right Christian Democratic Union (CDU) has been losing support faster than most observers expected.
• In contrast, the center-left Social Democratic Party (SPD) has been surging.  Perhaps even more concerning for Russia is that the Greens may be able to garner enough votes to enter the next government.  They have become some of the most vocal proponents of pushing back against Russia and China for their economic, environmental, and human rights policies.

Source: POLITICO research

European Union-Poland:  The European Commission has asked the European Court of Justice to fine Poland for ignoring court rulings over the country’s controversial judicial reform, in a significant escalation of a stand-off between Brussels and Warsaw over the supremacy of EU law over national rules.

United Kingdom:  Prime Minister Johnson appears to be throwing himself into a political crisis.  He plans this week to introduce tax hikes and benefit cuts to shore up the national health insurance program, despite promising explicitly not to take those actions in the Conservative Party’s 2019 manifesto.  Importantly, he faces widespread opposition to the plan, including his own cabinet, even though the expectation of a personnel reshuffle later this week is causing members reluctant to take a public stand.  In any case, the proposal will face widespread opposition from both Conservatives and the opposition Labor Party in parliament.

• The coronavirus pandemic appears to be a key driver behind the proposal.  For one thing, the pandemic has boosted the National Health Service’s backlog of cases, which Johnson had promised to whittle down.
• In addition, the Conservatives manifesto had promised to boost state pensions each year by the greatest of average earnings growth, price inflation, or 2.5%.  Because of labor market distortions brought on by the pandemic, the earnings growth bogey would have boosted pensions by approximately 8% starting next April.

Afghanistan:  Taliban sources yesterday said they had eliminated the last vestiges of armed resistance to them in the province of Panjshir.  If true, it would mean that they now control all of Afghanistan.  Perhaps more significantly, it would also mean that the Taliban have even more control over the country than they did when they last ruled in the 1990s.

• The State Department confirmed that it had facilitated the evacuation of four U.S. citizens from Afghanistan on Monday via an undisclosed overland route.  It is believed to be the first confirmed exit since the U.S. finished evacuating troops and civilians last month via the Kabul airport.  According to the State Department, the Taliban were aware of the evacuation and didn’t attempt to impede it.
• In a press conference today, Secretary of State Blinken said the U.S. is negotiating with the Taliban on resolving issues preventing other American citizens and vulnerable Afghans from leaving Afghanistan through charter flights.  Other countries are working to open the airport in Kabul for international flights within days.
• The Russia-led Collective Security Treaty Organization (CSTO) has started three days of military exercises in Kyrgyzstan that it says are needed in response to the ongoing situation in Afghanistan.  The exercises involve military units from Russia, Kazakhstan, and Kyrgyzstan.  Tajik troops were also scheduled to take part but withdrew at the last moment for unspecified reasons.

Guinea:  On Sunday, officers from an elite special forces unit said they have detained President Alpha Condé and suspended the West African country’s constitution.  A power struggle appeared to be underway in the capital of Conakry as night fell; the Defense Ministry claimed in a contradictory statement that the coup had been foiled. Western security officials said the situation was “fluid,” but the putschists, who controlled state television, “held the cards.”

• Once celebrated as Guinea’s first democratically elected president when he swept to victory in 2010, Condé has since centralized power around his personal authority and cracked down on opposition. Last year he deployed the military to push through controversial constitutional amendments that would have enabled him to stay in power until 2032—when he would be 94 years old.
• The country, which has bountiful deposits of bauxite, iron ore, gold, and diamonds, has logged robust economic growth over much of the past decade, but few of its citizens have seen the benefits. Facing a pandemic-related collapse in revenue, the government has significantly raised taxes in recent weeks.  The price of fuel has increased by 20%, aggravating the sense of discontent among many Guineans.
  • On fears that the political instability could snarl global supplies, aluminum prices on Monday jumped to as much as $2,768 per metric ton, their highest level since 2011.
  • Shares of major global aluminum firms have also jumped on the news.

El Salvador:  The country today becomes the first in the world to make bitcoin one of its legal tenders, along with the U.S. dollar.  Proponents of the plan by populist President Nayib Bukele say it will promote financial inclusion for those without bank accounts, facilitate access to a potentially high-yielding asset, and cut the fees Salvadorans pay to send home remittances, which represent one-quarter of the country’s gross domestic product.  Critics say the rushed plan could cost poorer Salvadorans when the price falls, raise costs for banks and insurers, provide a shield for money launderers, and risk economic stability.

COVID-19:  Official data show confirmed cases have risen to 221,244,447 worldwide, with 4,578,393 deaths.  In the United States, confirmed cases rose to 40,019,441, with 649,168 deaths.  Vaccine doses delivered in the U.S. now total 450,175,825, while the number of people who have received at least their first shot totals 206,908,710.  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, 62.3% of the U.S. population has now received at least one dose of a vaccine, and 53.0% of the population is fully vaccinated.
• As impatience for a children’s vaccine grows, new reporting illustrates that additional safety protocols and other special requirements are slowing the process.  Trial results of the vaccine from Pfizer (PFE, $46.84) for 5- to 12-year-olds could come by the end of this month, which could mean shots aren’t authorized for use until October or November, months after those cleared for adolescents.  Data for younger children could come in October.
• With more countries easing entry restrictions in line with their vaccine rollouts, Japan’s most powerful business lobby is nudging the government to exempt vaccinated travelers from the country’s mandatory 14-day quarantine.
• Also in Japan, government sources say the current state of emergency in Tokyo and other areas could be extended by up to one month beyond its planned September 12 end date to allow the next prime minister to decide when the measures should end.  Prime Minister Suga will give up his post as leader of the Liberal Democratic Party later in September; his successor will have to battle it out in new parliamentary elections by the end of November.

 Economic and Financial Market Impacts

• Travel, tourism, and hospitality businesses that were hoping to see normalizing business conditions this fall are increasingly being disappointed.  The Delta-driven resurgence in infections is prompting more companies to delay calling workers back to the office or renewing business trips.  The more contagious new variant is reportedly affecting the appetite for both business and leisure travel.

U.S. Policy Response

• The federal government’s extra unemployment benefit of up to $300 per week is ending in the roughly half of states still taking part in the program, potentially creating an air pocket in consumer demand but also possibly pushing more people into the labor market.

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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 a discussion about the labor shortage and an update on Hurricane Ida. International news is up next. We cover U.S. economics and policy news, including details about the spending bill.  China news follows, and we end the report with our pandemic coverage.

Labor shortage: Next week, the enhanced unemployment benefits are set to expire nationwide. A massive labor shortage has led many to suspect that ending these benefits could lead to a surge of new entrants into the labor market. However, data released from the Bureau of Labor of Statistics suggests that this expectation may not happen. In June and July, roughly half of the states in the country exited the program that funded the enhanced unemployment benefits. Although the exiting states saw a sharper decline in the number of initial claims filed compared to the states that remained in the program, these states also had a slower increase in the number of workers entering the labor force.

It should be worth noting that the time frame is too short to make any concrete conclusions. However, if the trend holds, it will likely mean that firms may have to increase their wages in order to attract more talent. In fact, there is growing evidence that firms have already begun to do so. Some firms that have been reluctant to raise wages have pressured the government to relax visa requirements to help resolve the worker shortage. Recently, fleet operators have petitioned Washington to allow more foreign operators into the country in order to resolve the shortage of truck drivers. If labor market conditions continue to show evidence of being rigid and tight, it will support the possibility of longer-term inflation. In this event, the Federal Reserve could become more assertive as it attempts to remove policy accommodation.

Hurricane Ida: Hurricane Ida continues to cause damages throughout the country. In the Northeast, there were over 45 deaths due to floods related to the storm.  In response to the mounting damages to property as well as temporary disruptions to businesses, the government has offered some support. The U.S. Energy Department announced that it will release 1.5 billion barrels of crude oil from the Strategic Petroleum Reserve to mediate price pressures. Meanwhile, the Federal Emergency Management Agency (FEMA) is expected to use funds to help local victims of the disaster. As of right now, departments have been able to meet the needs of regions impacted by the storm. However, as the costs of damages become more apparent, Congress will likely fight over additional assistance which could lead to further delays in President Biden’s economic agenda.

International news: 

• Japanese Prime Minister Yoshihide Suga announced that he will not run for reelection as party leader for the Liberal Democratic Party, effectively ending his term a year after he took office. Suga’s popularity took a hit due to his handling of a recent wave of coronavirus cases and the Olympics. Two recent polls showed that support for the prime minister had fallen to historic lows, likely playing a part in his decision to step down. Following his departure, elections will be held sometime before November 28. At this time, his party is expected to maintain its majority. Suga’s expected predecessor is unlikely to drastically alter the country’s foreign policy, such as its relationship with the U.S. That being said, his departure is reminiscent of a period throughout the 1990s and late aught years when prime ministers in Japan changed nearly every year. If this were to happen again, it will likely weaken Japan’s presence on the world stage at the exact time that its chief rival, China, grows in prominence.
• Poland declared a state of emergency along two of its borders following a series of border crossings by Belarusian immigrants. The spike in migration comes as Belarus attempts to use the threat of mass migration as a way to put pressure on the European Union to lift sanctions imposed on Minsk.
• Mexican President Andres Manuel Lopez Obrador is trying to work out a deal with President Biden that will help ease the migrant crisis both countries are experiencing. The deal will involve providing work visas for these immigrants to help with reforestation efforts in the U.S.
• Russian regulators threatened to fine Apple (AAPL, $153.65) and Google (GOOGL, $2,865.74) if the companies do not remove an app that is associated with jailed opposition leader Alexei Navalny. The crackdown represents the growing pushback the tech industry is facing globally as governments seek to reduce tech companies’ influence throughout their respective countries.
• The Scottish National Party has announced that it will not allow the U.K. to keep its nuclear arsenal in Scotland if the country votes to secede. The announcement means the U.K. will have to find a new location for its weapons. Australia, the U.S., and France are all being considered.
• The Pentagon announced on Friday that it is possible the U.S. may work with the Taliban in the fight against ISIS-K. It is also believed to be pressuring Pakistan to support the cause as well.
• Italian Prime Minister Mario Draghi has stated that he is not interested in running for president.

 Economics and policy:

• The Democrats are struggling to come to terms with the $3.5 billion spending bill. Key vote and notable moderate Senator Joe Manchin (D-WV) has pushed for the party to “hit the pause button” on the spending bill as the government deals with inflation and the Afghan evacuation crisis.
• Fifty percent of small business firms have reported that they are having trouble filling open positions, according to the National Federation of Independent Business. Many of these firms have opted to raise wages in order to lure workers.
• Approval of labor unions rose to a nearly sixty-year high, according to the Gallup poll released on Thursday. The poll showed that 68% of Americans approve of unions, the highest recorded since 1965 when 71% of Americans approved of them. The growing popularity of unions highlights the increasing frustration with rising income inequality.

 China:

• Chinese President Xi Jinping announced a proposal for a new stock exchange in Beijing designed to help small businesses. The measure will attempt to reduce the country’s dependence on debt for financing by encouraging firms to rely more on their equity.
• China’s media regulator has announced a boycott of what it referred to as “sissy idols” in favor of celebrities who exhibit more traditional “macho” stereotypes. The change comes as regulators are pushing the country’s entertainment industry to emphasize more traditional Chinese culture.

COVID-19: The number of reported cases is 219,126,141 with 4,542,726 fatalities.  In the U.S. there are 39,550,163 confirmed cases with 643,683 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 445,672,595 doses of the vaccine have been distributed with 372,116,617 doses injected.  The number receiving at least one dose is 205,911,640, while the number of second doses, which would grant the highest level of immunity, is 174,973,937.  The FT has a page on global vaccine distribution.

• The World Health Organization is tracking a new coronavirus strain called Mu. The variant was first discovered in Colombia in January. Preliminary data collected by the WHO suggest the vaccines may not be as strong against the Mu variant.
• The White House’s plan to have the third vaccine shot approved by September 20 has been met with resistance from the Food and Drug Administration and Centers for Disease Control and Prevention. The two departments overseeing the approval process have accused the Biden administration of placing politics over process in its push to have a vaccine ready by its self-imposed deadline.
• Hospitals are struggling to deal with critical patients due to a surge in COVID cases.
• The rise in COVID cases has led to an oxygen shortage. Firms have had to curtail production as a result, including a Texas oil refinery that was forced to restrict operations.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  As the markets wind down before the holiday weekend, U.S. equity futures continue to grind higher.  Hurricane Ida is leaving the U.S. but not before causing flooding in New York City.  Our coverage begins with Afghanistan.  China is up next, followed by economics and policy.  The international roundup precedes our pandemic coverage.

Afghanistan:  The world begins the next phase of the Afghan situation, which is the political fallout and the Taliban’s attempt at governance.

• With the evacuation essentially over, the aftermath begins. The administration will face months of Congressional scrutiny and may find some of it coming from Democrats.  The withdrawal was viscerally opposed by the foreign policy establishment of both parties.  One area of investigation will be who was left behind and what should be done about it.
• Meanwhile, the Taliban, who has proven adept in taking power, now faces the daunting task of governing. Capital flight and aid restrictions have created a cash shortage; remittances have become increasingly difficult as money transfer firms have stopped moving cash.  The Taliban hasn’t established a governance structure yet, although it says it will soon.  The current supreme leader, Hibatullah Akhundzada, is more of a religious figure and has kept a low profile.  It isn’t clear if he intends to rule or play the role of kingmakers.  Groups from Qatar have been sent to Kabul to help reopen the airport, which will be critical for the economy.
• The withdrawal from Afghanistan is yet another example that the U.S. isn’t all that concerned about Europe. EU leaders, for the most part, welcomed Biden’s election, seeing it as a return to normal relations.  But, as is often the case, the focus is improperly on leaders instead of trends.  The simple fact is that the U.S. isn’t all that interested in Europe anymore, as shown by the decision to leave Afghanistan without consulting the EU.  Europe finds itself terribly dependent on the U.S. for security and now isn’t sure if it can rely on that security anymore.  The obvious response is EU rearmament, but the nation most likely to lead that effort is Germany.  Anyone with any knowledge of history should view that outcome with some degree of concern.

China:  There are worries over an unnecessary military confrontation, credit market worries are rising, and Xi continues to portray himself as a decisive leader.

• China has issued a new rule requiring vessels entering the South China Sea to register with Beijing. The U.S. opposes the rule, calling it a “serious threat” to freedom of navigation.  China has claimed almost all of the South China Sea, which the U.S. opposes.  Former military leaders warn that military-to-military communications are inadequate, which creates conditions for an unwanted confrontation.
• China’s credit markets have been an area of concern for some time. Rapid growth in credit has been shown to be a risk factor.  Since 2009, China’s non-financial corporate debt has increased by an average of 12.9% per year, compared to the U.S., at 4.5%.  The collapse of China Evergrande (EGRNF, USD, 0.53) has warned that construction on some projects has been halted, increasing the odds of default.  Although we haven’t seen a clear indication that the stoppages have occurred due to concerns regarding payment, we suspect that this may be the case.
  • China Evergrande isn’t the only company in trouble. Huarong (2799, HKD, 1.02) has released a report on its $16 billion losses from last year.  The report had been delayed by four months, prompting concerns that the firm was failing.  State-owned companies have been drafted into a bailout plan.
  • Problems at these firms have led investors to avoid Chinese high-yield debt.
• We are hearing a steady undercurrent that General Secretary Xi is bringing a “profound transformation” of China. Xi appears to have aspirations of being the next Mao and Deng.  So far, it isn’t completely clear what this change means, although we are getting signs that it likely means slower economic growth with less inequality.  In addition, he is pressing for the centralization of the party; the individual initiative is getting quashed.  There is a recent case of a student being arrested for researching Chinese labor movements, while at the same time, Didi (DIDI, USD, 9.20) JD.com (JD, USD, 80.78) recently agreed to establish unions.  These examples suggest the CPC doesn’t oppose unionization as long as it is led by the party.  It appears Xi is emulating Mao, not Deng.
• Although it is becoming clear that relations with China are deteriorating, multinational firms with supply chains in China are pushing back against the break with Beijing. They want the Biden administration to remove tariffs and provide “clarity” on the relationship.  We suspect they are facing a lost cause.
• The CPC has shut down the tutoring industry with the goal of reducing stress for households. This move has solved little for most households.  If anything, it has made conditions worse, as parents still worry that their children won’t get ahead and now lack the tools to give their offspring a leg up.
• The African Swine flu, a deadly disease for pigs, ravaged China’s pork industry last year. Indications are that in its wake, the supply disruption has changed consumption patterns, leading to what may be lasting demand destruction.

Economics and policy:  Bitcoin may no longer represent the crypto space and more trouble for tech.

• For a long time, bitcoin was considered a proxy for all cryptocurrencies. That may not be the case much longer.  The expansion of crypto assets is leading to fewer funds flowing to bitcoin.  The lack of price momentum in bitcoin is masking strong price increases in other parts of the space.  We view the entire crypto space as a reaction against currency debasement.  Our expectation is that, over time, governments will snuff out this avenue of debasement protection, similar to the way the Roosevelt administration made it illegal to hold gold.
  • Investors considering this space should note that the area is mostly unregulated. The fraud seen in financial markets in the past, which happened infrequently in regulated markets, is a common occurrence in the crypto space.
• The DOJ is preparing to sue Google (GOOGL, USD, 2904.31) over its dominance in digital advertising. This is the second lawsuit on this issue against the company.
• Major tech firms in the U.S. and China are moving into the chipmaking business, although this effort appears to be more about design than manufacturing. The goal is to make custom chips for their hardware, which will allow them to create better products.
• Modi’s increasing authoritarian tendencies are creating problems for U.S. tech firms

International roundup:  The ECB is considering tapering and the Scots make noise about independence.

• Some ECB members are pushing for tapering. Although the leadership isn’t leaning that direction, we suspect the Europeans will probably, at some point, start following the Fed on this issue.  European bond markets are preparing for the slowdown in buying.
• The new government in Tehran has shown little interest in restarting nuclear talks. However, there are reports that discussions may resume soon.  We still harbor strong doubts the agreement can be revived.
• The Scottish National Party (SNP), which supports independence from the U.K., currently runs a minority government in the region. It recently added two Green party members to the government.  The Greens support independence and this development will be a problem for Boris Johnson.
  • The SNP has indicated it won’t allow nuclear weapons to be stored on its soil if it gains independence. The U.K. may be forced to move its nuclear submarines to the U.S. or France if they can’t remain in Scotland.
  • Brexit-related supply problems are becoming critical; there are reports that beer supplies are running low.
• President Biden met with Ukrainian President Zelensky yesterday. Although Biden attempted to assure the Ukrainian leader of U.S. support, we suspect Zelensky remains concerned.  The U.S. did commit to $60 million of military aid.

COVID-19:  The number of reported cases is 218,516,990, with 4,544,777 fatalities.  In the U.S., there are 39,399,080 confirmed cases with 642,093 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 443,741,705 doses of the vaccine have been distributed, with 371,280,129 doses injected.  The number receiving at least one dose is 205,527,578, while the number receiving second doses, which would grant the highest level of immunity, is 174,600,017.  For the population older than 18, 63.6% of the population has been vaccinated.  The FT has a page on global vaccine distribution.  Although some of the southern states are seeing a decline in cases, the majority of states are reporting increases.

• Recent polling is showing evidence that vaccine hesitancy is weakening. It appears the combination of FDA approval and vaccine mandates by companies are slowly leading to more vaccine acceptance.
  • Studies from Israel support booster shots.
• Each surge in infections tends to be followed by falling cases. There are multiple reasons behind this outcome.  Rising cases lead to increased caution.  As infections rise, the disease can find fewer victims.  Weather plays a role.  As temperatures cool and crowds move outdoors, the virus has less opportunity to circulate.  We could see a decline in cases in the coming weeks in the U.S. resulting from all these factors.
• Vaccination does not grant complete immunity. Those vaccinated are infected, and some suffer symptoms.  However, there is evidence that these “breakthrough” cases are not as severe.  And, it also appears that the vaccinated are less likely to suffer from “long COVID” cases.
• Although children have been less affected by COVID-19, there are cases where kids suffer inflammatory complications, called MIS-C. A U.K. study suggests that for those children who came down with these complications, there were no long-term medical issues.
• Rising cases in Asia are leading to supply disruptions in factories The surge is threatening the manufacturing of parts for key consumer electronics.

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