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

[Posted: 9:30 AM EDT] | PDF

Good morning on this August Friday.  Equity markets remain under pressure this morning as worries about the economy and monetary policy weigh on sentiment.  Our coverage begins with China, where regulatory conditions are changing fast and Taiwan is also in the headlines.  Up next is our update on Afghanistan.  Economics and policy are next as the FTC returns to tech and the rules for banks regarding gold are changing.  Our international roundup follows, and we close with pandemic coverage.

China:  The crackdown on tech and big business expands, and credit issues dominate.  Taiwan is also in the news.

• We continue to closely monitor activities in the Chinese financial markets, especially focusing on the government’s continued interventions on tech companies and markets. Here are some recent developments:
  • Evergrande Group (EGRNF, USD, 0.70) leadership has been scrambling to sell assets and shore up its balance sheet. Representatives from the PBOC and financial regulatory bodies summoned company leadership and told them to resolve its debt issues without destabilizing property and financial markets (how helpful!).  About the only way the company can do that is by issuing equity or selling off more assets.
  • Meanwhile, Huarong (2799, HKD, 1.02), the “bad bank” that housed defaulted loans from the restructuring that occurred earlier in the century, is getting bailed out by other state-owned enterprises. Huarong is majority owned by the government.  Although the company is getting better treatment than Evergrande, the same can’t be said about its former chairman, Lai Xiaomin.  He was executed.
  • Beijing is issuing new rules for tech companies. First, competition rules are being tightened to prevent market power.  Second, today China passed a new data privacy law that looks to us to be designed to reduce the ability of tech firms to access and use data for advertising.  These laws dovetail into recent new cybersecurity rules.  The privacy rules weaken the business model of tech firms.  After all, it’s the promise of targeted advertising that makes these firms attractive.
  • Baidu (BIDU, USD, 137.25) has come under scrutiny but that didn’t prevent investors from snapping up new bonds.
  • However, equity values of Baidu and Alibaba Group (BABA, USD, 98.78) remain under pressure on fears of increased regulation.
  • Chinese regulators are looking to regulate online games, especially those that may not conform to the CPC’s version of history.
  • The FBI is warning that China and Russia are turning tech employees into sources of information.
• U.S. firms want auditing on some Chinese goods to prove they were not made with incarcerated labor. The U.S. auditor, Verite, has a Chinese partner; that partner was shut down by Beijing.  This means firms will have a more difficult time determining the veracity of claims on Chinese goods.
• Meng Wanzhou’s extradition hearings have finally concluded. A decision will likely occur in October.
• Taiwan continues to be a flashpoint.
  • In responding to questions about America’s resolve, President Biden responded with this comment:

STEPHANOPOULOS: You talked about our adversaries, China and Russia. You already see China telling Taiwan, “See? You can’t count on the Americans.” (LAUGH)

BIDEN: Sh– why wouldn’t China say that? Look, George, the idea that w– there’s a fundamental difference between– between Taiwan, South Korea, NATO. We are in a situation where they are in– entities we’ve made agreements with based on not a civil war they’re having on that island or in South Korea, but on an agreement where they have a unity government that, in fact, is trying to keep bad guys from doin’ bad things to them.

We have made– kept every commitment. We made a sacred commitment to Article Five that if in fact anyone were to invade or take action against our NATO allies, we would respond. Same with Japan, same with South Korea, same with– Taiwan. It’s not even comparable to talk about that.

• • We bolded the word “Taiwan” because it appears Biden was giving a direct security guarantee to Taiwan, which would be a major policy shift. The State Department walked back the comment later, but it does look to us that he probably is now including Taiwan in that security umbrella.  If true, that is a big deal and will signal to China that the “one China” policy is over.  This issue bears watching; it may blow over as a simple mistake, but the fact that he said it twice makes us think that isn’t the case.
  • Deputy SoS Sherman defended Lithuania’s decision to upgrade its ties to Taiwan. Beijing has been critical of the decision.
  • SoS Blinken has invited Taiwan to a U.S. democracy summit that will be held in December. This invitation was not taken well in Beijing.
  • Japan’s concern about aggression against Taiwan has led Tokyo to accelerate its five-year military spending plans.
• Although Afghanistan is a crisis and a failure, it’s important to note that it isn’t fatal because the country was never vital to U.S. interests. We note that the focus has already shifted toward China.  Getting out of Afghanistan, in particular, and the Middle East, in general, is part of shifting the focus of policy on Great Power competition with China.
• We continue to closely monitor the policy shift we are seeing toward “common prosperity,” which looks to us to be the Chinese version of an equality cycle.

Afghanistan:  Here is what we are following:

• The Taliban’s rapid expansion of control initially stunned the country and the world. However, we are starting to see some resistance.  We reported earlier this week that protests against the Taliban led to members of the group firing on protestors.  However, a more potent adversary exists in the north.  The old Northern Alliance, which was dominated by Tajiks, may be forming to oppose the Taliban.  Ahmad Massoud, the son of Ahmad Shah Massoud, has reportedly been in talks with former Afghan VP Amrullah Saleh.  Although the Tajiks could receive some degree of autonomy in return for allegiance to the Taliban, maintaining control of this group could be a challenge.  We are also monitoring groups aligned with the Taliban that operate in the southern part of the nation.  It is possible the Taliban has become more sophisticated in managing the tribal structure of Afghanistan, or that patina of sophistication may simply be a cover crafted on social media.
  • Yesterday was the anniversary of Afghanistan’s independence from Britain in 1919. The flag from this government was prominently displayed during protests against the Taliban.
• The Taliban is reportedly searching for Afghans who worked with NATO forces in the region. Women are said to be going into hiding.  The Taliban has been accused of killing the relative of a journalist.
• The Taliban has captured a treasure trove of military assets, although it isn’t clear if they can use them all. That in itself may present a problem.  As we noted yesterday, the West is moving rapidly to deny funding to the Taliban government.  One way it can generate liquidity is by selling arms.  The Taliban, as we noted yesterday, has several sources of funding.  A new report suggests that much of their resources come from taxing fuel sales in the regions they control.  In effect, the Taliban has been acting like a shadow government for some time.
• Meanwhile, at the Kabul airport, there is still little evidence of order. Part of the problem is the lack of preparedness on the part of U.S. officials for the crush of Afghans wanting to flee the country.
• There are two underlying questions to the collapse in Afghanistan. The first is why the administration didn’t see this coming.  Over the past couple of days we have seen a steady stream of reports from intelligence agencies and analysts within departments warning of just this outcome.  Here is the problem with such reports—a decision maker never knows for sure if these reports are accurate assessments or an attempt to shape behavior.  Since Bush, U.S. presidents have been trying to figure out how to exit Afghanistan.  It was clear that the costs of “winning” this war exceeded the benefits.  But it is likely that the State Department and the Pentagon didn’t want to leave.  Obama did authorize a surge but with a deadline, suggesting he wanted to limit the commitment.  Trump wanted out, too.  The key unknown is whether these departments limited their preparation, assuming that Biden wouldn’t really stick to his guns.  Second, whenever the U.S. leaves a war, it raises concerns among allies about U.S. support for their interests.  Although the credibility argument is common among the foreign policy elite, the reality is that the best way to gauge America’s commitment is to frame an area or issue in terms of U.S. interests.  Based on this idea, the Far East should not doubt U.S. commitment.  If anything, leaving Afghanistan enhances that effort because it frees up resources to focus on containing China.  On the other hand, Europe should be worried.

 Economics and policy:  The FTC returns, and Basel III hits gold.

• The FTC has refiled its antitrust lawsuit against Facebook (FB, USD, 355.39), arguing its “buy or bury” strategy is designed to eliminate competition. This suit has already been rejected in Federal Court.  The FTC has added details in the new suit.
• Here is one we missed earlier. International banking rules are conducted in Basel; they establish how much capital a bank must allocate to various assets it holds.  The most recent rules, Basel III, change how banks must allocate capital to their gold holdings.  Physical gold—bullion, coins, bars—now get a zero risk rating, meaning that if a bank holds that asset, it no longer needs to allocate capital to it; gold becomes like government bonds or cash.  This type of gold is called “allocated.”  Unallocated gold, which is gold represented “on paper” such as swaps, futures, ETFs, and forwards, now needs to have capital allocated to it.  For most investors, this probably won’t make an immediate difference, but it could, over time, prompt banks to buy more allocated gold and may widen the spread between bullion and unallocated products.  It will also make the market less efficient.  Now, banks will have to move actual bars instead of swapping paper promises.  The rules come into effect in January 2022.
• The SEC looks open to approving bitcoin ETF products that are based on futures as opposed to actual bitcoin. There is a race by financial product firms to build these products.  A warning to investors—these products, common in commodity markets, have a number of issues.  First, there is the “roll yield” problem.  If the spread between contract months goes into contango, the investor can be disadvantaged.  Second, unless the product is sourced in the Caribbean, it will generate a K-1.  Third, firms often use exchange-traded notes for these sorts of products because it is easier to keep the spread between the underlying and the cash market narrower and you avoid the K-1 problem.  But, you accept credit risk and these products often have out clauses in the fine print that can lead to automatic product liquidation at the most inopportune time.

 International roundup:  North Korea and Cuba are in focus today.

• North Korea threatened to retaliate against U.S./South Korea military exercises. Although it appears that nothing occurred, as the war games have come and gone, a small earthquake was reported in Rajin.  It is possible that the DPRK tried to conduct missile tests but may have misfired.  It has also been noted that Kim Jong Un has taken another holiday as the war games started.
• Cuba, the subject of a recent WGR, has issued new decrees to take more control over the internet and social media. Social media dissent is now a criminal activity.  We note that the Biden administration has maintained a hardline policy against Havana.

COVID-19: The number of reported cases is 210,108,036 with 4,405,174 fatalities.  In the U.S., there are 37,297,023 confirmed cases with 625,183 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 422,175,735 doses of the vaccine have been distributed with 359,623,380 doses injected.  The number receiving at least one dose is 199,887,548, while the number receiving second doses, which would grant the highest level of immunity, is 169,592,873.  For the population older than 18, 62% of this population has been vaccinated.  The FT has a page on global vaccine distribution.

• AstraZeneca (AZN, USD, 59.19) is seeking approval for an antibody treatment that reduces the symptoms of COVID-19. This is a non-vaccine treatment; clinical trials suggest it gives protection for at least a year from the virus.[1]
• Although the majority of people who contract COVID-19 survive, the disease has inflicted long-lasting symptoms on some survivors. The medical establishment is starting to work on cures for “long-COVID.”
• The WHO has established a new group to examine the origins of COVID-19. The origin story has become politicized and we have doubts that a new group will get access to Chinese data, which will be critical in determining the actual origins.
• Three senators, all vaccinated, have tested positive for COVID-19.
• Fake COVID-19 vaccination documents are readily available; interestingly enough, Customs and Border Protection report many of them are coming from China.
• On the international front, Australia, which has followed a “zero tolerance” policy on COVID-19 similar to China’s, is locking down again and is pushing faster vaccine distribution. A single case of the virus has led to the shutdown of the Ningbo-Zhoushan Port in China.  The shutdown is snarling shipping yet again.

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[1] In an interesting twist, no participants in the trial who received the drug died; two receiving the placebo did.  This event shows that care must always be exercised when examining the results of treatments.

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

[Posted: 9:30 AM EDT] | PDF

Good morning on the 30-year anniversary of the Soviet coup.  Risk markets continue to slump this morning.  Equities and commodities are lower, and Treasuries prices are higher.  The combination of tighter policy signaling and rising pandemic concerns are weighing on risk markets.  Our coverage begins with the Fed minutes; reducing QE appears to be coming.  There is an update on the situation in Afghanistan.  A brief comment on La Niña follows.  Next, we cover economics and policy, China news, and our international roundup.  We close with pandemic news.

Fed minutes:  It appears the FOMC will begin slowing its asset purchase program by early next year.  That doesn’t mean that rate hikes will follow, but it is reasonable to expect that rate hikes will be the next step toward policy normalization.  Equity markets didn’t take the news well; we saw over a 1% decline in the S&P 500 yesterday.

Asset purchases remain controversial.  We still don’t know for sure how they work.  The argument for using them was that it lowers long-term interest rates.  However, that effect is ambiguous.

There are episodes where expanding the balance sheet clearly led to falling yields; in other times, expanding the balance sheet had the opposite effect.  With equities, it appears the presence of QE is bullish, but the absence isn’t necessarily bearish.

This behavior has raised the idea that the apparent positive correlation is spurious.  We are not sure that’s the case.  The rise in equities in 2016, despite a flat then declining balance sheet, may have been due to the anticipation of corporate tax cuts.  However, since March 2020, the relationship between the balance sheet and the index is pretty clear.  So, concerns about slowing the expansion of the balance sheet are causing obvious concern about future equity values.

Is the Fed making a mistake by reducing accommodation?  We suspect the answer depends on what constitutes a mistake.  If tapering raises unemployment, then it’s probably a mistake.  It could reduce asset values.  Some members of the FOMC don’t think this is a problem.  Several have consistently expressed concerns, especially about housing prices.  Reducing the expansion of the balance sheet is potentially a negative factor for equities; thus, yesterday’s reaction bears watching.

On a couple of related notes, the market isn’t projecting anything of substance from the annual Jackson Hole meeting.  Although we agree with this sentiment, it creates conditions for a surprise.  The Roosevelt Institute, a left-leaning think tank, has issued a very favorable paper on Chair Powell’s policies.  There have been rumblings from left-wing populists in Congress opposing Powell, but this paper may quell some of these concerns.

Afghanistan:  Here is what we are following:

• The Taliban takeover is likely to create a refugee problem. Iran has responded by closing its border with Afghanistan. Meanwhile, the EU is sending mixed signals about its willingness to accept Afghans.  Some nations in the bloc are still keen to deport Afghans living in Europe.  Greece’s migration minister, Notis Mitarachi, remarked that it was okay for Greece to deport Afghans to Turkey.  Needless to say, Ankara didn’t agree.  The EU Commission is meeting on the issue and is trying to plan in advance regarding what will certainly be a wave of asylum seekers.  However, the EU always faces the collective action problem.  It’s better for an individual nation to avoid taking refugees if others do instead.  With elections looming in Germany, another refugee crisis has EU leaders concerned.
• The West is rapidly moving to deny funds to the new Taliban government in a bid to gain some leverage over the group. The U.S. has frozen accounts and pressed the IMF to stop disbursements, essentially shutting down the central bank.  In the short run, these actions will create serious problems for the new government.  Around 80% of the ousted government’s budget came from foreign aid, representing about 43% of GDP.  At first blush, these numbers suggest the economy will collapse.  However, this situation is more like a cash crunch rather than a serious threat to the economy.  The Taliban will likely rely on two sources of income.  The first is opium.  Poppy field cultivation has increased since the U.S. incursion and will remain a potent source of funds.  The second source is minerals, including valuable rare earths.  We note China has made overtures to the Taliban, and we would not be surprised to see Beijing move to exploit rare earths.  After all, China is the world’s largest processor of these metals.  In addition to these two sources, the Taliban has been a moneymaking operation for some time, engaging in extortion and other similar activities.  It is estimated the group has earned around $400 million per year since 2011 but has been making much more money recently as its grip on the country widened.  Our take is that denying official funds will hurt in the short run, but the leverage value is limited.
• The Taliban has apparently fired on protestors. We were a bit surprised to see protests emerge, but it is clear the Taliban isn’t interested in allowing them.  There were at least three killed in the protests.
• The ousted president of Afghanistan, Ashraf Ghani, has ended up in the UAE. And, members of the Afghan military apparently used U.S. supplied aircraft to flee to Uzbekistan.
• Meanwhile, the handling of the U.S. military exit is seriously undermining the creditability of the U.S. and likely marks the end of the Biden administration’s policy momentum. Reports of stranded Afghans who allied with the U.S. efforts and are now exposed to the tender mercies of the new government in Afghanistan are unsettling.  The lack of planning for a mass evacuation is stunning.  It appears U.S.  troops will remain in Afghanistan after the end of August.
  • China is moving quickly to take advantage of the debacle, calling the collapse a failure not just for the U.S. but for Western civilization as a whole. Beijing noted Taiwan should take notice of the reliability of U.S. security support.  At the same time, however, Beijing knows Afghanistan represents a security threat, and at some point, the Taliban will no longer be a drain on U.S. resources that can be redirected against China.  Both China and Russia will try to fill the vacuum created by the U.S. exit, but it won’t be easy.

La Niña:  NOAA is projecting that La Niña conditions could develop soon and likely last into winter, although it will likely be a weak event.  La Niña events can have an adverse effect on crop yields and could lead to higher grain prices.  As if the area needed it, La Niña events can lead to dry winters for the Southwest.  The Northwest, on the other hand, may receive much-needed rain.  The upper Midwest tends to be colder and snowier than normal.

Economics and policy:  Firms continue to order aggressively to secure supplies, and the government crackdown on crypto expands.

• As continued reports of tight shipping conditions persist, we are seeing firms aggressively order goods. In the ISM Manufacturing Index, only 3.3% of purchasing managers are placing fewer orders, the lowest in history.

Meanwhile, 56.3% of purchasing managers see their customer inventories as “too low,” also the highest in history.  This combination of characteristics could lead firms to aggressively overorder for fears of supply shortages.  At some point, we could see a major inventory imbalance.

• The crypto industry is still reeling from the adverse policy ideas that emerged from the Senate in the budget and infrastructure bill. Although the industry is attempting to respond, it looks to us that, at best, they are merely managing greater regulatory action.  The SEC appears to be leading the charge to regulate the industry.
  • In response to regulatory threats, Coinbase (COIN, USD, 244.39) claims it has built up a $4.0 billion cash hoard.
  • A crypto firm called Helix, which provides “mixer” services (a way to hide transactions) has pled guilty to conspiring to launder money and will pay $200 million in bitcoin, and its principal may go to prison.
• As we watch the economy adapt to the post-pandemic world, the service industry is reviewing the services it provides and how they are provided. For example, hotels are moving to à la carte pricing, meaning that if there are services you don’t use, you can get a price break or some other service.  For example, for a two-day stay, you might forgo another round of sheets on the second day for a free drink at the bar.
• A judge has blocked Alaska oil permits on grounds of inadequate environmental impact studies.
• Toyota (TM, USD, 175.73) announced it would cut global auto production by 40% due to supply chain problems.
• China is reducing its crude steel output to cut emissions and is pressing the industry to make more steel from scrap. This action is detrimental to iron ore prices.

China:  Beijing continues to move against inequality.

• General Secretary Xi spoke at the 10^th meeting of the Central Committee for Financial and Economic Affairs. He continues to press on addressing inequality and is specifically targeting the wealthy.  The turn of phrase is “common prosperity.”  China became quite unequal during its development.  Although the official data suggests inequality has declined, the data are suspect.  In any case, Xi is calling for direct wealth redistribution.
• We noted yesterday that Beijing is taking direct investment in large companies, acquiring a “golden share” that gives the government a large say in the governance of the firm. Interestingly enough, this idea has been around at least since 2017.  The investment is giving fodder to U.S. policymakers looking to further restrict U.S. investment in Chinese equities.  We also note that the government is taking steps to direct the wage policies of some firms.
• The closure of the Chinese tutoring industry has tutors (often Americans) and families scrambling to make informal contacts.
• As noted above, China is insinuating to Taiwan that the U.S. is unreliable; after making these comments, the PLA held aggressive exercises around the island.

International roundup:  The German conservatives are in trouble, and Lithuania is securing its border.

• Chancellor Merkel is on her way to Moscow to discuss Afghanistan and Ukraine with President Putin. Meanwhile, the selected successor, Armin Laschet, continues his party’s lackluster poll performance.  In fact, the previously moribund SDP has now risen to the second-best party in recent polls.  Green Party leader Baerbock is working to prepare for a push into the elections.  There is a chance the next government will exclude the CDU/CSU.  Odds still favor the conservative bloc, but the risks are rising.
• Lithuania, facing a surge of refugees being funneled from Belarus, has put up a temporary border wall.
• Brexit has reduced the number of immigrants in the U.K. That has apparently also reduced workers in chicken processing plants, leading to a shortage of chicken meat.

COVID-19:  The number of reported cases is 209,489,010, with 4,396,744 fatalities.  In the U.S., there are 37,158,863 confirmed cases with 624,260 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 419,612,925 doses of the vaccine have been distributed, with 358,599,835 doses injected.  The number receiving at least one dose is 199,325,940, while the number receiving second doses, which would grant the highest level of immunity, is 169,186,268.  The FT has a page on global vaccine distribution.  Here is the latest Axios state infection map.

• The U.S. is planning on offering booster shots to some groups beginning in autumn. The federal government will require nursing home staff to get vaccinated as a funding requirement.
• Steadily, governments around the world are preparing to live with COVID-19. This means that instead of dealing with a pandemic, it will be more like addressing periodic epidemics.  In other words, the virus will ebb and flow over time.
• China’s “zero tolerance” policy of locking down areas with infections is exacerbating shipping bottlenecks.
• Beijing is aggressively ramping up its propaganda apparatus to deflect attention from the Wuhan lab leak theory. The attention is suggesting the U.S. was the source of the virus.
• We are watching a resurgence of infections in Israel. The country has a high vaccination rate, but the increase may suggest the immunity is not lasting very long.  At the same time, Pfizer (PFE, USD, 49.31) suggests booster shots improve immunity.

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

[Posted: 9:30 AM EDT] | PDF

Today’s Comment begins with news showing China’s crackdown on big, fast-growing tech companies is perhaps even worse than we’ve been describing.  On top of that, President Xi has signaled a broader prioritization of income redistribution that could also be a significant threat to Chinese companies.  We next review a range of U.S. and international news, including the latest on Afghanistan.  We wrap up with the latest developments related to the coronavirus pandemic.

China:  We’ve written a lot about Beijing’s regulatory clampdown on big, fast-growing technology firms, but new reports show the government is going even further to make sure those companies act in accordance with the Chinese Communist Party’s goals.  According to corporate filings and people familiar with the matter, the government is taking a more direct hand in managing its internet-content companies by acquiring stakes, filling board seats, and sending dedicated regulators to police content at firms more frequently.

• The moves build on guidelines first proposed in 2016 but only enacted vigorously over the past year.  Under the rules, state-owned entities have purchased small “special management stakes” of 1% or so in publicly traded companies like ByteDance and Weibo (WB, $46.35).  The stakes grant the right to a seat on the companies’ boards of directors, and in at least one instance, the stake also includes veto rights over certain matters related to content and specific future financings.
• The corporate stakes are the latest move in a multiyear campaign by Beijing to establish a foothold inside influential social-media and news platforms and, more broadly, to tighten control over public opinion on China’s internet.  More broadly, the stakes suggest the government won’t be content with merely regulating Chinese internet firms and other technology companies.  The government is seeking much more control over those companies, which almost certainly won’t support their long-run profitability.
• In addition, President Xi reportedly told a high-level Communist Party committee yesterday that China needs to “regulate excessively high incomes and encourage high-income groups and enterprises to return more to society.”  The committee added that while the party had allowed some people and regions to “get rich first” in the early decades of China’s reform period, it would now prioritize “common prosperity for all.”
• Note to investors:  China really is run by a bunch of Communists!  The government’s “special management shares” may not be outright nationalization, but it’s important to remember that there can be a fine line between regulation and ownership.  After all, even in the U.S., heavy government regulation can trigger lawsuits over the “takings” clause of the constitution.  Beijing’s small stakes basically amount to “golden shares” that provide the government with much more control than is compatible with a wholly profit-seeking company.  Coupled with the government’s apparent turn to income control and redistribution, this is bad news for investors in Chinese companies.

Afghanistan:  To keep hundreds of millions of dollars from the Taliban, the administration last week canceled bulk shipments of dollars to Afghanistan and imposed a block on Taliban access to government accounts managed by the Federal Reserve and other U.S. banks.

• The administration is also working to prevent the group’s access to nearly half-billion dollars’ worth of reserves at the International Monetary Fund.  As the de facto government of Afghanistan, the Taliban could seek to tap those funds, but the U.S., as the IMF’s main shareholder, would be in a powerful position to block it.
  • If the Taliban gets access to the IMF account, it will require another country to exchange the IMF unit of lending into usable currency.
  • China and Russia both have made political and economic overtures to the Taliban in recent years, so either one might perform that function, which would likely go far toward cementing their relationship with the group.
• The moves may give the administration a small amount of leverage over the Taliban.

U.S. Fiscal Policy:  Top Democrats in the House said they would move forward with a vote on a budget blueprint funding the progressive wing’s $3.5 trillion antipoverty and climate change plan, despite moderates’ demand to move the Senate-passed $1 trillion “hard” infrastructure plan first.  The decision by the House Democratic leadership probably reflects the fact that dozens of party progressives have threatened to scuttle the infrastructure plan if the antipoverty bill isn’t passed first, versus just nine moderates who have insisted the infrastructure plan be prioritized.

United States-Germany-Russia:  At least two U.S. officials stationed in Germany sought medical treatment after developing symptoms of the mysterious health complaint known as Havana Syndrome, which includes symptoms like nausea, severe headaches, ear pain, fatigue, insomnia, and sluggishness.  Moreover, U.S. officials said other intelligence and diplomatic personnel in other NATO countries have also been affected, leaving some unable to work.

• The Syndrome, first identified among U.S. diplomats stationed in Cuba, is suspected of being initiated by foreign intelligence services.
• Some victims in NATO countries were intelligence officers or diplomats working on Russia-related issues, such as gas exports, cybersecurity, and political interference.

Japan-Taiwan-China:  Reflecting Japanese leaders’ increasing realization that a Chinese takeover of Taiwan would threaten Japan’s security, the Liberal Democratic Party is planning to launch online talks on security issues with Taiwan’s ruling Democratic Progressive Party as early as this month.  The moves follow a decision by the LDP in February to establish a project team under its Foreign Affairs Division to discuss Japan-Taiwan relations.

Peru:  The country’s new president, former schoolteacher Pedro Castillo, has had significant problems getting his cabinet in place.  Yesterday, his foreign minister, Héctor Béjar, resigned amid an uproar over his accusations that the Maoist Shining Path rebels who terrorized Peru during the 1970s and 1980s were actually linked to the country’s navy and the CIA.  Castillo has also generated controversy over his appointment of a hardline leftist, Guido Bellido, as his prime minister.  The moves have been weighing heavily on Peruvian currency.

Global Commodity Markets:  After enduring the worst drought in nearly a century followed by a bout of cold temperatures, areas within Brazil’s farming belt are braced for further adversity as the La Niña weather phenomenon threatens to bring more dry conditions later this year.  If conditions worsen as expected, prices for key Brazilian exports such as coffee and sugar would likely rise further than they already have.

COVID-19:  Official data show confirmed cases have risen to 208,757,350 worldwide, with 4,385,726 deaths.  In the United States, confirmed cases rose to 37,020,723, with 623,329 deaths.  Vaccine doses delivered in the U.S. now total 417,477,975, while the number of people who have received at least their first shot totals 198,929,642.  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, 59.9% of the U.S. population has now received at least one dose of a vaccine, and 50.9% of the population is fully vaccinated.
• Yesterday in Texas, Governor Abbott tested positive for COVID-19, but his office noted that he was fully vaccinated and was not symptomatic.  If he avoids becoming seriously ill, his experience could encourage more people in Texas to be vaccinated, regardless of the state’s relatively low uptake to date.
• In Japan, Prime Minister Suga asked the country’s largest business lobby to help reduce the number of commuters through telework, as the increasingly rampant Delta mutation puts a strain on the country’s medical system.
• Health officials in Sydney, Australia, are rushing to vaccinate thousands of high school students ahead of in-person end-of-school exams they fear could accelerate the spread of the virus in a country that, until recently, had avoided the worst of the pandemic.
• After months in which antibody treatments were heavily underutilized, doctors are increasingly turning to them in a bid to keep hospitals from being overwhelmed by the latest surge in cases.
  • Primary provider Regeneron Pharmaceuticals (REGN, $647.44) delivered 135,023 doses of its drug to U.S. healthcare providers last week, marking a ninefold increase from a month earlier.
  • Regeneron estimates that as recently as June, fewer than 5% of high-risk patients were receiving treatment, before increasing recently to as much as 30%.

 Economic and Financial Market Impacts

• Against the backdrop of the super-loose monetary policy launched by the Fed in response to the pandemic, analysts at both S&P and Moody’s have warned that the frenzy for higher-yielding, speculative-grade bonds is setting the market up for a wave of future defaults.  According to S&P, sales of low-rated, speculative-grade debt have already reached $650 billion this year, putting them on track to surpass all-time borrowing records with more than four months left in 2021. Companies of all types had already borrowed record amounts of cash in 2020 in an effort to ride out the coronavirus downturn.
• Now that many big businesses are postponing bringing their workforces back to the office, many small downtown businesses that are dependent on them face new uncertainty and economic difficulties.

Foreign Policy Responses

• In New Zealand, the government’s decision this week to impose a new lockdown on the country after discovering a small number of new cases has prompted the central bank to put off an interest-rate hike.  Instead, the Reserve Bank of New Zealand decided to keep its benchmark short-term interest rate steady at 0.25%.

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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 the latest on the situation in Afghanistan, with an interesting satellite view of the chaos at Kabul’s airport yesterday.  We then turn to U.S. news, including the latest warning sign that the Federal Reserve is coming under increasing pressure to tighten monetary policy earlier rather than later.  Next, we cover a range of international developments, and we close with the latest news on the coronavirus pandemic.

Afghanistan:  In a statement yesterday, President Biden said he stands “squarely behind” his decision to withdraw U.S. troops from the country despite the bipartisan criticism he’s taking over the resulting chaos, collapse of the country’s government, and failure of the country’s armed forces to put up a fight.  In Biden’s judgment, “If anything, the developments in the past week reinforced that ending U.S. military involvement in Afghanistan now was the right decision . . .. American troops cannot and should not be fighting in a war, and dying in a war, that Afghan forces are not willing to fight for themselves.”  Much less reported, former President George W. Bush, who launched the war in 2001, expressed his distress at the fall of Afghanistan but defended his decision to invade the country after 9/11.

• Reports suggest the Taliban so far have refrained from mass detentions or violence in Kabul.  Taliban leaders have also pledged a general amnesty for all in order to encourage government workers to return to their jobs, and some vestiges of normal life have already returned in Kabul.
• However, based on Taliban behavior after taking over other Afghan cities in recent weeks, it would be no surprise if mass detentions and persecutions begin before long.
• Even more important, there have already been stirrings of potential armed resistance to the militants. Amrullah Saleh, former President Ghani’s vice-president, has traveled to the mountainous Panjshir region, a bastion of Taliban opposition, and allied himself with Ahmad Massoud, the son of a charismatic warlord assassinated by al-Qaeda days before the terror attacks of September 11, 2001.  If the situation evolves into a civil war, and some observers expect, many of the worst security and diplomatic implications for regional countries would likely arise.
• In terms of financial market reactions, the threat of refugees, spillover violence, and political instability has already driven down the value of dollar bonds issued by both Pakistan and Uzbekistan.
• Finally, here’s a satellite view of the chaos at Kabul’s airport yesterday.  All those little black dots on the runway?  Those are Afghans storming the tarmac in an effort to get a flight out of the country:

U.S. Monetary Policy:  Boston FRB President Rosengren said his outlook for the U.S. economy improved this year despite the recent COVID-19 outbreaks associated with the Delta variant.  He expects strong hiring to allow the central bank to soon begin reversing the extremely accommodative monetary policy adopted at the height of the pandemic.

• According to Rosengren, the Fed could be in a position to start reducing its $120 billion in monthly asset purchases this fall and, if strong economic growth continues, the Fed might be able to end those purchases toward the middle of 2022.
• Coupled with the extraordinary strength of the post-pandemic economic recovery, Rosengren’s statement adds to the evidence that Fed policymakers may tighten monetary policy sooner than currently anticipated.  If so, the markets could be in for a period of volatility as investors adjust their expectations.

U.S. Fiscal Policy:  After a review of food costs, the Department of Agriculture announced that those eligible for food stamps would see their benefit rise approximately 25% to an average of $169 per month.  The increase would be the biggest ever in the history of the program.

U.S. Water Supply:  For the first time, the Bureau of Reclamation yesterday declared a water shortage in the Colorado River basin.  As a result, several states that depend on the Colorado will see their allocations from the river cut by as much as 18% next year.  For Arizona, which gets approximately 40% of its water from the Colorado, that will mean losing more than 7% of its total water supply—a move that will probably be especially painful for its agriculture sector.

China:  The State Administration for Market Regulation, the government’s antitrust watchdog, released draft rules today banning unfair competition among internet companies.   These rules, which could come into force later this year, would crack down on major platforms using their market dominance to suppress small and medium businesses.

• The draft rules contain a long list of practices that would be banned, many of which are ubiquitous in China.  For example, the measures target practices such as false advertising, fraudulent online reviews, unfair competition, interoperability issues, data protection, and consumer privacy issues.
• In response to this further example of the Chinese government’s effort to bring leading companies to heel, many of China’s top internet-related firms have seen their stock prices drop precipitously again today.  We continue to emphasize that large, fast-growing Chinese technology companies face increasing regulatory risks related to both the Chinese government’s actions and clampdowns by the U.S. related to its geopolitical pushback against China.

COVID-19:  Official data show confirmed cases have risen to 208,044,254 worldwide, with 4,375,086 deaths.  In the United States, confirmed cases rose to 36,891,023, with 622,437 deaths.  Vaccine doses delivered in the U.S. now total 415,958,305, while the number of people who have received at least their first shot totals 198,595,349.  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, 59.8% of the U.S. population has now received at least one dose of a vaccine, and 50.8% of the population is fully vaccinated.
• After their mass vaccination programs lagged through most of the pandemic, many countries in Latin America have finally hit their stride and are now vaccinating people at a faster rate than in many developed countries.  The improved vaccination performance reflects the high demand for the shots and the fact that supply constraints have finally been overcome.
• Seeking approval from the FDA to use their COVID-19 vaccine as a booster shot for the general public, Pfizer (PFE, $48.91) and BioNTech (BNTX, $343.10) submitted data from a small, early-stage study showing a third dose of the vaccine generated higher levels of neutralizing antibodies against the original virus and against the Beta and Delta variants than the standard two-dose regimen.  The preliminary data also suggested the third dose was safe.
• Meanwhile, health officials in the Biden administration are reportedly nearing a decision to recommend that fully vaccinated people get a booster shot eight months after their last injection.  Besides the application for booster authorization from Pfizer and BioNTech, Moderna (MRNA, $373.86) has said it plans to ask regulators next month to authorize its booster shots.  Johnson & Johnson (JNJ, $177.84) expects to release data about the efficacy of two doses of its single-shot vaccine later this month.
• In a new analysis by the Wall Street Journal, the Delta variant appears to be breaking through the protection vaccines provide at a higher rate than previous strains.  However, infections among the fully inoculated remain a tiny fraction of overall cases, and symptoms tend to be milder.
• In New Zealand, Prime Minister Ardern announced a new, three-day national lockdown after an Auckland man became the country’s first resident to test positive for the virus since February.
  • The news came just one day before the Reserve Bank of New Zealand was expected to become the first central bank in the developed world to raise interest rates since the onset of the coronavirus pandemic.
  • In response to the news, the New Zealand dollar fell 1.3% to $0.693, its lowest level in nine months.
• In fact, governments across the Asia-Pacific region are tightening restrictions on daily life and travel as slow vaccination campaigns have failed to halt the spread of infections with the Delta variant.  Concern about the widening restrictions at some point could become a bigger headwind for global financial markets.
• In Japan, what began in late June as a pandemic rebound in Tokyo has escalated within weeks into a nationwide surge, forcing the central government to enact the country’s strictest measures in more than a dozen of its largest prefectures.  The government now plans to expand the country’s state of emergency from six to 13 prefectures and extend it from the end of August until mid-September.  Some analysts believe the expanded measures will keep the economy growing weakly through September.

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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.  It’s inflation week—the CPI comes out on Wednesday.  U.S. equity futures are modestly lower this morning, but the real story is in commodities.  Oil and precious metals are tumbling this morning in the face of higher Treasury yields.  Overnight, gold futures fell over $60 per ounce; prices have recovered well off their lows but are still down this morning.  What’s going on?  The solid employment data has lifted expectations of Fed tightening.  But it is also important to remember that market liquidity tends to thin in August as traders take vacations.  Thus, market moves can be exaggerated.  Our coverage this morning begins with economics and policy.  China news is up next, followed by the international roundup.  We close with pandemic news.

About that employment data: Much of the turmoil we are seeing in markets was tied to the employment report.  The data showed clear improvement in the labor markets and raises pressure on the FOMC to react.  Although there is some concern that the survey period did not catch the recent delta variant issues, we suspect that labor markets will continue to recover.  One item worth watching is the participation rate of the 24-54 age bracket.  The 65+ participation rate continues to decline as older workers, more vulnerable to COVID-19, opt for retirement.  Although we are not at a level of complete recovery, we are at a point consistent with a fed funds target of around 1%.

A reading above 82 will increase the likelihood of some form of tightening.

Economics and policy: The infrastructure bill is near the finish line in the Senate.  The IPCC has released its updated climate report.

• It looks like the bipartisan infrastructure bill will pass the Senate this week. The CBO has scored this bill, saying it will add $256 billion to the deficit over a decade.  The crafters of the bill have argued it would be deficit-neutral, but it is not unusual for the CBO to discount some sources of revenue.  Another area of dispute is the idea of “dynamic scoring,” which means that the growth generated by the measures taken will raise revenue.  The CBO rarely accepts such concepts.
• The Intergovernmental Panel on Climate Change (IPCC) released its most recent analysis and, as expected, it shows that global temperatures will likely rise5^o centigrade by 2040. The report makes it clear that even if carbon emissions reach zero now, temperatures will continue to rise.  We expect more spending on mitigation going forward.
  • Wildfires in Greece continue. Neighboring nations are sending firefighters and areas are being evacuated.
• One of the challenges of the current economic situation is figuring out temporary and permanent changes triggered by the pandemic. It has been often said that the pandemic accelerated trends that were already in place.  Although we agree this is at least partially true, other developments probably would not have occurred otherwise.  Work from home is likely to be much more common going forward than it would have been otherwise.  As workers realize they can work from just about anywhere with a reliable internet connection, the allure of smaller cities, with lower costs of living, are elevated.  As workers move to these areas, they affect the local real estate markets and shuffle shopping and entertainment patterns.
• We note the SEC has brought action against a decentralized financial firm for issuing unregistered securities.

 China: Markets continue to grapple with regulatory changes, and nationalism is on the rise.

• From 1979 to mostly the present, China has had its own efficiency cycle, which allowed entrepreneurs to build businesses and become rich. Although Hu Jintao commented on the problem of inequality, Xi is doing something about it.  His anti-corruption campaign weakened the ability of capital owners to affect policy.  Now, Xi is going against out-of-favor industries directly.  The losses are notable.  There is wide debate about the path forward; is Xi merely trying to weaken power rivals, or is this move tied to industrial policy?  Although the answer might be “yes” to both, we suspect the latter is the most important.  If so, investors can probably still do ok in areas that China favors.  At the same time, industry leaders would be advised to keep a low profile.
• One emerging trend we are watching is the generational attitude differences developing in China. The millennials in China have only seen an ascendant China.  They appear no longer content to bide time and wait, and they are intolerant of foreign criticism of China.  This emerging nationalism looks to us to be similar to conditions seen during the Cultural Revolution.
• The crackdown on China’s tutoring industry appears to be an attempt by the CPC to reduce social tensions. However, the drive for tutoring is partly driven by rising youth unemployment.  If good jobs at the entry level are scarce, it makes sense to take whatever steps are necessary to acquire one.
• Despite these trends, some business leaders are calling for new trade talks with China and tariff reductions. Although we think tariffs are a misguided policy (a deliberate policy to appreciate the CNY would be far more effective), it appears to us that business leaders are out of step with the political trends.  If anything, there is a higher likelihood of additional trade and investment restrictions.
• Underlying all these issues is China’s shaky financial system. A recent directive argued that the banking system should stop lending to local government financing vehicles; if this were to occur, widespread defaults would likely follow.  The directive was pulled shortly after its release.  Its disclosure could have been a mistake, or a trial balloon.  But it does show that China has a serious delinquent debt problem that won’t get better by continued funding.  However, cutting off liquidity will only lead to default and the consequences of default could be destabilizing.  Everything we are seeing from the CPC leadership suggests consolidation and centralization.  So, our take is that the central government will use the indebtedness of the local governments as an opportunity to bring them under control.

 International roundup:  The Taliban’s role; Lukashenko remains in power in Belarus a year after the elections.

• The Taliban continues to consolidate gains as the U.S. steadily withdraws. There is no evidence that the U.S. will take steps to counter these gains, meaning that Afghanistan will likely face civil war after the U.S. leaves.  There is also little evidence to suggest Afghan government forces will be effective against the Taliban.
• Germany will be holding elections next month as Chancellor Merkel retires. German voters are unimpressed with their choices; recent polls show 45% would vote for “none of the above.”  Armin Laschet, the CDU candidate, wants to lead Europe, but his recent comments surrounding Poland and his actions during recent flooding suggest he lacks political skills.  Polling indicates the SPD is gaining ground.  Although it’s still a long shot, a Green/SPD/FDP coalition might gain power.
• It’s been a year since the Belarus elections that led to unrest. Lukashenko remains in power but is clearly weakened, becoming increasingly dependent on Putin to stay in control.  The opposition continues to press against Lukashenko.  As we noted last week, the latest tactic being deployed by Belarus is to create a refugee conduit into the EU via the Baltic nations.  Russia will be holding its annual war games in the region soon and Latvia is warning that a border incident is possible.
• Michael Calvey is a longtime proponent of investing in Russia. He has recently received a suspended sentence for various crimes.  His arrest and conviction signal a warning to Westerners about the risks of investing in Russia.

COVID-19: The number of reported cases is 202,872,928 with 4,297,550 fatalities.  In the U.S., there are 35,765,233 confirmed cases with 616,829 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 407,561,705 doses of the vaccine have been distributed with 351,400,930 doses injected.  The number receiving at least one dose is 194,866,738, while the number receiving second doses, which would grant the highest level of immunity, is 166,477,481.  The FT has a page on global vaccine distribution.

• The delta variant continues to spread rapidly across the U.S. Community transmission rates remain elevated across the country.  States with high infection rates are scrambling to find hospital bed capacity.  The variant has become dominant due to its high contagion rates.
  • Although we don’t expect widespread lockdowns to return, the spread of infections is still affecting business planning. Companies are reconsidering office reopening plans and some events are being cancelled.
  • Fears that disruptions will affect the economy are leading commodities lower, especially oil prices.
  • In light of the delta variant, we will likely see the need for booster shots.
• Although the mRNA vaccines were the first out of the gate, the technology remains finicky. Handling procedures make them difficult to distribute and the new technology is probably one factor behind vaccine resistance.  Much of their success was due to deft management; the companies involved tested their vaccines when infection rates were elevated, which gave them lots of test subjects, and emerging firms teamed up with established ones to ramp up production.  The Novavax (NVAX, USD, 189.89) vaccine is near the end of its clinical trials and should be available soon.  It has some distinct advantages.  Because it’s based on an existing technology, its handling is less stringent.  The fears surrounding mRNA should not be part of this vaccine.  And, trial data so far suggest it is more effective than the mRNA vaccines.  Reports indicate that side effects are less, which has been a barrier for some low-income groups who fear missing work if they become ill from the injection.

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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. equities appear to be headed for a flat open this morning.  We begin with a discussion about the effect the new variant may have on the recovery.  Our international news coverage includes escalating tensions between Israel and Lebanon and India’s removal of a controversial tax.  U.S. economics and policy news are up next, with details about the infrastructure bill.  China news follows, and we will end with our pandemic coverage.

State Labor Force: As new COVID-19 cases spread throughout the country, there may be a glimmer of hope that the recovery will not be significantly affected.  Although infections are rising throughout the U.S., most of this increase has been concentrated within the Southern region.  Average daily cases per 100,000 in the South are almost double its nearest competitor.  Despite the increase in cases, the political situation in the South makes the likelihood of new restrictions doubtful.  As a result, this region should remain relatively stable regardless of the rise in infections.  Additionally, the fact that southern states have the lowest vaccination rates compared to the rest of the country suggests that hospitalization rates will likely be manageable for other parts of the country.  Hence, the chances of another lockdown are relatively small.

Despite having higher infection rates, the South has seen a faster labor force recovery than its peers.  As of June, the labor force in the Southwest and Southeast regions has returned to their January 2020 levels.  Although there have been new restrictions imposed in certain states, most notably in New York, it should be worth noting that these states are more prepared than they were in December of last year when the country saw a similar uptick in cases. We believe that although the employment data may be relatively weak in the coming months, the impact of the variant on the labor market, as well as the broader economy, may not severely derail the recovery.  That being said, the spread will likely not ease concerns of potential workers who are sitting out of the labor market until the pandemic is better controlled.

International news: 

• Prime Minister Narendra Modi’s government removed a controversial tax that would allow the government to impose taxes retrospectively on foreign investment. The move comes as India struggles to get its economy back on track following pandemic-related setbacks.
• On Wednesday, Israel carried out airstrikes in Lebanon. The attack was in response to a barrage of rockets launched from southern Lebanon into northern Israeli territory. Israel has attributed the attack to Palestinian terrorist groups operating within Lebanon. On Friday, Hezbollah responded with missiles of their own toward military outposts along the border of the two countries.  In its defense, Hezbollah explained that its response was due to Israeli airstrikes within the country that killed two of its operatives.
• An Eyewitness report suggests that Tigrayan forces have taken control of Lalibela. The town is known for its orthodox churches and is regarded as a culturally important site by the United Nations. The report has not been verified.
• Brazilian President Jair Bolsonaro’s request to have printed ballots in case of an electoral challenge was denied by the Brazilian congressional committee. Bolsonaro has argued that electronic voting machines cannot be trusted and warned that he may not accept the result of the elections if he loses. Over the last few months, Bolsonaro has seen a significant drop in popularity due to his handling of the pandemic and the economy. His insistence on printed ballots appears to be a way to delegitimize the election in case he is defeated.

Economics and policy:

• President of the AFL-CIO labor organization, Richard Trumka, died unexpectedly on Thursday. He was an ally of President Biden. The Federation’s secretary-treasurer, Liz Shuler, will take over as president until a successor is elected.
• S. President Joe Biden directed the Department of Homeland Security to offer a “safe haven” for Hong Kong residents who fear returning home.
• The Congressional Budget Office (CBO) announced that the infrastructure bill does not pay for itself, contradicting the claims of the bill’s negotiators. The CBO report claimed the federal budget deficit would expand by $256 billion.
  • In other news, there seems to be more clarification on the provision within the infrastructure bill regarding how cryptocurrency will be reported to the IRS.
• In an effort to reduce carbon emissions, President Biden introduced a plan that will expand upon the tailpipe regulations from the Obama era to help push Americans toward electric vehicles. The plan will look to strengthen auto mileage standards and implement more stringent auto pollution rules for passenger vehicles and heavy-duty trucks. The president is also pushing for 500,000 electric vehicle charge stations.
• A software update in Apple (AAPL, $147.06) will scan the phones for child abuse imagery. Researchers fear the update could lead to an increase in surveillance of phones.

China:

• Antitrust regulators in China are preparing to impose a $1 billion fine on food delivery platform Meitaun (MPGNY, $54.97). Regulators have accused the firm of using its position to disadvantage small companies.  The latest fine represents a larger crackdown by Chinese authorities as a way to reign in tech firms.
• Australia is expected to introduce new powers that will allow it to target individuals who are associated with human rights violations. The proposal is believed to be aimed at Beijing, following its treatment of Uyghurs and dissidents in Hong Kong. Those believed to be affiliated with human rights violations could be subject to sanctions and a travel ban.
• Chinese semiconductor foundry company SMIC (0981, HK$28.15) plans to build two new manufacturing plants in Beijing and Shanghai. The new plants are part of China’s broader goal of being more self-reliant. However, possible U.S. restrictions could prevent it from receiving the production equipment these factories need to operate.

COVID-19:  The number of reported cases is 200,939,775 with 4,267,859 fatalities.  In the U.S., there are 35,440,509 confirmed cases with 615,320 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 403,047,945 doses of the vaccine have been distributed, with 348,966,419 doses injected.  The number receiving at least one dose is 193,199,353, while the number of second doses, which would grant the highest level of immunity, is 165,637,566.  The FT has a page on global vaccine distribution.

• Leading U.S. infectious disease expert Dr. Anthony Fauci announced that the country would start to give additional booster COVID-19 shots to people with compromised immune systems. The booster is still waiting to be authorized for emergency use.
• Moderna (MRNA, $416.26 ) announced that its COVID-19 shot was 93% effective four to six months after the second dose. This is a better outcome than its competitor Pfizer (PFE, $45.06), which had a reported effectiveness rate of 84%.
• China has seen an increase in coronavirus cases in the mainland. In the past, China has dealt with containing the virus through lockdowns. At this point, it is unclear whether such measures will be used this time around while the country tries to maintain growth.
• The Biden administration is considering using regulatory powers and the threat of withholding federal funds from institutions as a way to encourage people to get vaccinated. The proposal will likely impact long-term care facilities, cruise ships, and universities.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  Overall, it’s a rather quiet trading day so far.  U.S. equity futures are edging higher, although recent market action suggests it may not hold.  Our coverage begins with comments from Fed officials who are signaling the end of accommodative monetary policy.  It’s been a year since the fertilizer explosion in Lebanon; conditions have become dreadful.  We start our regular reporting with economics and policy, and China news follows.  International news is next, and we close with our pandemic coverage.

The Fed:  Vice-Chair Clarida spoke yesterday and indicated that the economy was progressing at a pace that would lead to the removal of stimulus by 2023, with announcements to that effect, such as tapering, starting later this year.  The financial markets didn’t like the message; bond yields rose, equities fell, and commodities slumped.  Clarida is important.  Using the Dudley Rule, the three most important messengers from the Fed are the Chair, the Vice-Chair, and the head of the NY FRB.  According to Dudley, these are the opinion leaders, and as long as they stay unified, the level of dissent doesn’t really matter.  Clarida’s positioning appears to us to be out of sync with Powell and Williams, which could mean evidence of policy dissension later this year.  At the same time, Clarida’s term will end in January, and his messaging will likely prompt Biden to pick a dove to replace him.  Earlier this week, the newest governor also pushed for an accelerated timeline, a similar message spouted by his former boss, St. Louis FRB President Bullard.  Fed tightening will come at some point but preventing a repeat of the “taper tantrum” will be very difficult to prevent.

The unending crisis in Lebanon:  It’s been a year since the massive explosion at the Port of Beirut.  The explosion has accelerated the collapse of the state.  Conditions have become abysmal.  Inflation is rampant, reaching nearly 85% last year; the exchange rate has collapsed, with the Lebanese pound losing 95% of its pre-crisis value.  Electricity generation is unreliable and diesel for private generators is becoming scarce.  Water systems are failing.  This podcast offers valuable background on the crisis.  So far, the crisis has been contained in Lebanon.  Israel occasionally has skirmishes with Hezbollah, which dominates the government.  And although conditions in Lebanon are awful, they are worse in Syria, its neighbor.  The longer-running problem is that another failed state in the region will trigger refugee flows, destabilizing neighboring nations and spreading to Europe.

Economics and policy:  The eviction moratorium may not last, and negative nominal interest rate bonds are expanding again.

• The Biden administration is using the CDC to extend the eviction moratorium. Their legal rationale is shaky, and the courts may overturn the measure, leading to foreclosures and evictions.
• The bond rally seen in the U.S. over the past quarter is sending global yields into negative nominal territory. The stock of negative-yielding debt is up to $16 trillion.  Generally speaking, negative yields tend to support gold prices.

• Many employers struggle to find seasonal help. Tourist or agricultural establishments often rely on foreign seasonal workers who come for the summer and return home in the fall. The U.S., under the H-2B program, offers J-1 visas for such workers.  However, COVID-19 issues have disrupted this process.  As reopening occurs, seasonal firms are scrambling for workers.  Domestic workers usually prefer year-round employment.
• Early indications suggest that the majority leadership in Congress will forego passing the debt ceiling increase in reconciliation and will force GOP members to vote to expand it as well. Although this action might take away the political potency of the measure, it is risky because it may trigger a government shutdown in the fall.
• The crypto industry is reacting against tax proposals, trying to narrow who is considered a “broker” of cryptocurrencies.
• The pandemic has scrambled the global logistics industry.[1] One problem that has emerged is that shipping containers, the backbone of global shipping, are ending up in the wrong places.  Much of this is because the U.S. is importing much more than it is exporting, meaning that containers are piling up here when they are needed elsewhere.

China:  We continue to monitor China’s regulatory policy.

• Investors continue to struggle with the evolving investing environment. We continue to monitor the situation closely.  Although it is still uncertain which firms and industries will avoid problems and which will be targeted, we notice social media and software seem to be catching most of the scrutiny.  Manufacturing—companies that make things—seem to be given a wider berth.  Overall, the CPC seems to be focusing on three areas:
  • Antitrust—the Xi regime appears to view size alone as an area of concern. China has had antitrust rules in place since 2008, but active enforcement didn’t occur until last year.  We note this issue isn’t just one for China; there is an active trend in the U.S. to overturn the Bork Rule, but so far, Beijing has been much more effective in this arena than Washington.
  • Data security—it’s really hard to know what data are critical and what information doesn’t pose a threat. China has noted that the NSA seems to capture data first and ask questions later.  This stance seems to have led Chinese regulators to try to prevent ANY data from falling into foreign hands.  So, firms that collect data are being forced to isolate to China in all matters.
  • Disorder—capitalism is disruptive. Joseph Schumpeter’s description of “creative destruction” details how free enterprise creates conditions of unending stress.  China tends to view disorder and disruption as dangerous.
• So, what is our best guess about what is going on (at least for now)?
  • Much of this is industrial policy. As noted above, Beijing wants to direct resources to industries they consider important.  Every engineer it can move from gaming to chip production is a win.  There are flaws to this thinking; it suggests there are only so many engineers, so they must be marshaled, where, in reality, having gaming might create more engineers.  However, that sentiment isn’t making it in the Politburo.
  • Regulatory turf wars may be part of this too. Regulators get rewarded for regulating, and we may see a fight among regulators to determine who will be the most powerful.
  • Like in the West, there is rising populism in China. The “lying flat” movement and the pushback against “996” are part of the anger against inequality and the difficult labor environment.  Beijing may be trying to get in front of these issues.
• The action of regulators has created conditions of volatility, and it will be difficult to unwind that sentiment. In other words, Chinese equity prices will likely build a discount that will simply reflect regulatory risk.
• China is also cracking down on firms thought to be hoarding critical supplies.
• Equities are not the only market that has faced government action. China has released strategic stockpiles of commodities in a bid to reduce prices.  So far, the actions have reduced the upside momentum of prices but have failed to bring prices down significantly.
• One little thing we noticed is that two Chinese cyclists who won medals at the Olympics wore Mao pins at their awards ceremony. Not only is this against Olympic protocol, but it also suggests a “great leader” worship that Deng tried to end.  Xi has fostered this sort of activity, and this episode suggests it is becoming an acceptable practice.
• Tensions with Taiwan remain elevated. Civil society groups that act to help dissidents leave China are starting to fear that their activities will be next on Beijing’s radar.  Taiwan officials confirm that U.S. advisors were present at Patriot missile tests.  Yesterday, the Biden administration approved arms sales to the island.
• New research offers an insight into how China structures its sovereign loans. Two items are interesting—the bonds do not participate in the Paris Accord, which is a forum for dealing with default.  The other is that China includes language that allows it to call the loan based on certain behaviors, such as increased fiscal spending.  The former means that default must be dealt with bilaterally, giving Beijing leverage.  The latter is common with commercial loans but usually not with sovereign ones because they infringe on the sovereignty of the borrower.  China appears less concerned about this issue.
• Evergrande (EGRNF, USD, 0.65) bonds are being shorted aggressively.

International roundup:  Belarus is honing the migration game, and Mexico is suing U.S. gun manufacturers.

• Monitors are seeing a jump in immigrants moving from Iraq to Belarus. From there, they are heading to the EU.  It appears that Minsk, like Ankara, is using immigration from the Middle East to try to soften sanctions.
• Facing a constant problem with gun violence, Mexico is suing U.S. gun manufacturers.
• So far, attacks on shipping in the region around the Persian Gulf have had little effect on oil prices. If they escalate further, a spike in oil prices is possible.
• Wildfires are affecting Europe and the Middle East. Greece and Turkey are fighting wildfires, which are being fanned by elevated temperatures.  In the latter, President Erdogan is facing political criticism for the response to the crisis.
• Ebrahim Raisi will be sworn in today as the new president of Iran.

COVID-19:  The number of reported cases is 200,370,643 with 4,259,874 fatalities.  In the U.S., there are 35,334,422 confirmed cases with 614,804 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 402,010,455 doses of the vaccine have been distributed, with 348,102,478 doses injected.  The number receiving at least one dose is 192,614,017, while the number of second doses, which would grant the highest level of immunity, is 165,334,987.  The FT has a page on global vaccine distribution.

• The WHO is opposing booster shots in the West before the emerging world is vaccinated. Although we understand the sentiment, the idea that an elected official would divert vaccines to foreigners is a non-starter.
• We are starting to see the Delta and Lambda surges affect the economy and sentiment. Recent polls suggest that only 40% of Americans see the pandemic situation as improving, compared to 89% in June.  Consumers are beginning to express concern about economic conditions.
• China’s primary measures for dealing with COVID-19 outbreaks are lockdowns. We note that transportation links are being closed due to Delta variant infections.
• Israel, one of the earliest nations to reopen after an aggressive vaccination campaign, is reinstituting some restrictions. However, they are less than a full lockdown.
• South Asia is facing a new surge in infections. India and Thailand are seeing higher cases, and Indonesia now has over 100,000 deaths from the virus.
• Vaccine passports remain problematic, and corporations continue to debate vaccine mandates for their employees. The U.S. is considering requiring proof of vaccination for foreign visitors.  Meanwhile, the U.K. has relaxed travel guidance for French visitors.
• One problem that has emerged in the pandemic has been just how little we know about it. Scientists continue to engage in studies to learn more, although the media reporting about these studies has been problematic.  Reporters have little ability to judge the power of a study, so the most controversial tends to get the most airtime.  With that in mind, a recent study from Imperial College suggests that current vaccines are effective in preventing serious illness.  This is consistent with other studies we have seen, and consistency is mostly how the scientific method establishes its findings.

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[1] The Odd Lots podcast has held a series of shows on various elements of the logistical snags.