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

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with just one U.S. issue related to cryptocurrency regulation.  We then review a number of foreign items that could impact the financial markets today, including news of another apparent Iranian attack on a ship in the Persian Gulf.  We close with many new developments related to the coronavirus pandemic.

Cryptocurrencies:  SEC Chairman Gensler said in a speech that his agency would make full use of its existing authorities to step up regulation of the cryptocurrency markets, which he described as rife with “fraud, scams and abuse.”  In addition, he called on Congress to grant the agency more scope and resources to oversee the sector.

• Gensler’s statements indicate the SEC is likely to become more active in policing crypto trading and lending platforms, as well as so-called stablecoins, as it seeks to protect investors and consumers, reduce crime, promote financial stability, and protect national security.
• Previously, Gensler told House lawmakers that investor protection rules should apply to crypto exchanges, similar to those covering equities and derivatives. Regulated exchanges are required by law to have rules that prevent fraud and promote fairness.

Persian Gulf:  Less than a week after a suspected Iranian drone attack killed two crew members on an Israeli-linked oil tanker in the Arabian Sea, suspected Iranian gunmen seized a tanker in the Persian Gulf.  Reports this morning say the situation has been resolved, and the gunmen have left the ship, although details remain sketchy.  In any case, besides raising tensions in the area and increasing the risk of a military confrontation, the attacks may be putting the final nails in the coffin of President Biden’s effort to revive the 2015 nuclear deal with Iran.

Spain:  As electricity prices in Europe surge to a record high, the Spanish government has called on the EU to protect ordinary citizens from the impact of the bloc’s strategy to reduce carbon emissions.  Based on an argument that high prices and surcharges could provoke a backlash against the carbon-cutting measures, Spain is advocating for a price ceiling on residential electricity rates.

Pakistan:  The Pakistani national security adviser has complained about President Biden’s failure to contact Prime Minister Imran Khan as Washington seeks help to stop the Taliban from taking over Afghanistan following U.S. troop withdrawals.  The Pakistanis want a broader relationship with the U.S. that goes beyond simply asking for help in dealing with the Taliban.

Brazil:  President Bolsonaro is facing yet another set of legal challenges after a court opened an investigation into his unsubstantiated warnings of voter fraud in presidential elections next year.  The probe could potentially lead to him being disqualified from running.

COVID-19:  Official data show confirmed cases have risen to 199,750,828 worldwide, with 4,250,090 deaths.  In the United States, confirmed cases rose to 35,242,207, with 614,317 deaths.  Vaccine doses delivered in the U.S. now total 401,229,975, while the number of people who have received at least their first shot totals 192,120,576.  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, 57.9% of the U.S. population has now received at least one dose of a vaccine, and 49.7% of the population is fully vaccinated.
• With the Delta mutation of the virus now constituting the biggest challenge, a new study by the U.K.’s Imperial College has provided better detail on how vaccines work against the variant in a real-life community setting.  The new study shows full vaccination reduces transmission by approximately 50% and cuts the number of symptomatic cases by some 60%.  Previous studies have shown today’s vaccines to be even more effective in cutting serious illnesses, hospitalizations, and deaths.  Overall, the accumulating evidence suggests that vaccines remain a key tool to reduce the impact of the pandemic going forward.
• Despite the U.S. progress on vaccinations to date, the spread of the more transmissible Delta variant and low vaccination rates in some locations continues to drive up cases and hospitalizations.  In Florida, COVID-19 hospitalizations have reached a record high of 11,515, compared with only about 2,000 one month ago.  According to the Florida Hospital Association’s chief executive, approximately 90% of those hospitalized have not been vaccinated.
• As the Delta variant spreads, some hospitals are now treating more COVID-19 patients than ever, just as patients are finally returning for care related to other ailments.  As a result, some facilities and healthcare workers are being overwhelmed.
  • Surgeries and treatments for cancer, heart disease, and other common conditions have rebounded this year, filling beds at many hospitals.
  • At the same time, other respiratory viruses, such as RSV, have re-emerged with public gatherings, adding to hospital strain.
• With the spread of the Delta variant, rising cases and hospitalizations, and some renewed social-distancing measures, new Harris polling again shows a majority of Americans now think the worst of the pandemic is still ahead of us.  About 54% of respondents believe the worst is yet to come, while 46% think it’s behind us.
• The U.K.’s vaccination program will be extended to 16- and 17-year-olds today, bringing the country more closely in line with its international counterparts, such as the U.S. and Israel, which have already jabbed substantial numbers of children.
• In India, rebounding infection numbers after weeks of steady decline are fueling anxieties about a possible third wave in the country, even as it is still recovering from the disease’s last devastating surge during the spring.

 Economic and Financial Market Impacts

• We’ve talked a lot about the large cash balances held by households and many businesses because of the pandemic, which should provide added fuel for further economic growth and rising asset prices in the future.  Bank executives, however, say that in recent months, their business clients have also ramped up requests for expanded credit lines.  Those credit lines could help fuel continued economic growth and better earnings because they can be drawn quickly for spending on inventory, labor, or expansions.
• The Thai baht has gone from being one of Asia’s strongest currencies before the pandemic to one of its worst performers this year as the coronavirus crisis ravages Thailand’s crucial tourism sector.  The currency is down more than 9% against the dollar since the end of 2020, placing it among this year’s weakest performers globally alongside peers such as the Turkish lira and Peruvian sol.

U.S. Policy Response

• Responding to pressure from progressive Democrats and President Biden, the CDC issued a new federal eviction moratorium covering the 80% or so of U.S. counties experiencing “substantial or high” levels of COVID-19 transmission.  According to the president, the new moratorium may not pass constitutional muster, but even if a legal fight over it ensues, it will buy time for state governments to distribute the $47 billion in rental assistance still available under recent pandemic relief laws.
  • The CDC said its new order would last through October 3, “but is subject to further extension, modification, or rescission based on public health circumstances.”
  • Even if the new federal moratorium is deemed unconstitutional, states representing some 80% of the U.S. population have their own moratoriums in place.

Foreign Policy Responses

• According to British officials and bankers, as much as £5 billion of state-backed government emergency loans to U.K. businesses are at risk of not being repaid.  However, defaults at that level would be much lower than initially feared.

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with a review of various U.S. developments related to fiscal policy, the labor market, and the natural gas market.  We discuss several international items that could affect the financial markets today.  Finally, we take a look at the latest news related to the coronavirus pandemic.

U.S. Fiscal Policy:  New details are finally emerging on the 2,700-page, $1 trillion “hard” infrastructure bill that a bipartisan group of senators agreed to Sunday night.  Among the key funding provisions, the bill would provide:

• $110 billion in funding for roads, bridges, and similar major projects, as well as approximately $11 billion for highway and pedestrian safety upgrades
• $39 billion to modernize and make public transit more accessible to the disabled and elderly.  Significant chunks of that money will go to major city transit systems, like New York City’s, based on federal funding formulas.
• $66 billion for rail maintenance, modernization, and expansion, most of which will go to Amtrak.
• $42 billion for ports and airport upgrades
• $65 billion for broadband infrastructure and development
• $55 billion for water systems
• $73 billion to upgrade and expand the nation’s electricity grid

U.S. Labor Market:  A hearing officer with the National Labor Relations Board has reportedly recommended nullifying the results of a closely watched vote in which warehouse workers employed by Amazon (AMZN, $3,331.48) in Alabama rejected a plan to join a union.  If a regional NLRB director reviewing the decision agrees, a new vote to unionize could be held.

U.S. Natural Gas Market:  Even though the recent heatwave in the West has dissipated, natural gas prices remain high as utilities strive to make up for parched hydropower markets and provide enough electricity for air conditioners.  Importantly, the highest summer gas prices since 2014 have yet to entice producers to send many more drilling rigs into their fields, raising the prospect that supplies will remain tight, and prices will stay high through the end of the summer.

U.S.-China Telecom Equipment Industry:  Just as the U.S. and many of its allies have restricted the use of 5G cellular equipment made by China’s Huawei Technologies because of security concerns, it now appears Beijing is doing the same to Huawei’s Western rivals.  China Mobile Ltd., a government-owned wireless carrier that is the world’s largest by subscribers, in July awarded just 5.4% of its latest 5G-equipment tenders to non-Chinese suppliers, down from 11% in its previous round in 2020.

China:  It appears the Chinese government is opening yet another front in its battle to tame the country’s big technology companies after a state-owned newspaper criticized online gaming as “opium for the mind.”  In response, a number of Chinese tech companies linked to online gaming saw their stocks fall sharply, and social media giant Tencent (TCEHY, $61.32) announced it would heed a request by authorities to restrict how long minors can play its online games.

• Hours later, the story was no longer accessible on the paper’s website, and the affected stocks recovered some lost ground.
• All the same, we continue to see growing regulatory risks for any large, powerful Chinese tech firms that the government may see as threatening or aiming to become too independent.
• More broadly, the government continues to rein in the country’s broader private sector and other economic entities that threaten to embarrass or challenge the government.  Chinese regulators say they will “spare no effort” as part of a clampdown on high-risk financial institutions, including using targeted anti-corruption investigations, amid a flush of liquidity generated by coronavirus-related stimulus and increased fiscal spending.

Beijing Olympic Games:  With just six months to go before the Winter Olympic Games open in Beijing, the People’s Bank of China plans to use the event as a further testbed for its first-in-the-world central bank digital currency, the “digital yuan.”

• The tens of thousands of athletes and fans descending on the Chinese capital in February will provide an opportunity to test the new currency with foreign participants.
• Athletes may be given tech-enabled gloves, badges, or uniforms that they can use to spend the digital yuan, also known as e-CNY.  Foreigners will be allowed to open digital wallets and pay with e-CNY, though exactly how they will load their wallets with digital yuan remains to be seen.
• The further testing of the Chinese currency comes despite the IMF’s warning in a late July blog post that widespread use of cryptocurrencies would threaten “macroeconomic stability” and potentially harm financial integrity through crypto’s links with illicit activity.

Mexico:  A referendum pushed by President Andrés Manuel López Obrador to investigate and prosecute wrongdoing by several past presidents had a participation rate of just 7%. Even though the vast majority of those who did participate voted to advance the investigations, the participation rate was far below the 40% required by law for it to be effective.  The result is, therefore, seen as a rebuke of the president.

Iran:  At an endorsement ceremony marking his official elevation to the presidency, hard-line conservative Ebrahim Raisi said he would take steps to have “unjust” U.S. sanctions lifted, but his priority was to improve the Iranian economy.

COVID-19:  Official data show confirmed cases have risen to 199,099,061 worldwide, with 4,239,882 deaths.  In the United States, confirmed cases rose to 35,133,969, with 613,758 deaths.  Vaccine doses delivered in the U.S. now total 400,674,965, while the number of people who have received at least their first shot totals 191,818,585.  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, 57.8% of the U.S. population has now received at least one dose of a vaccine, and 49.7% of the population is fully vaccinated.
• As the Delta variant of the virus continues to spread and CDC studies show that even vaccinated people can transmit it (despite being well protected from serious illness), more local governments are reimposing mask requirements in indoor public settings.  Starting today, seven counties in Northern California will reimpose the requirement, just as Sacramento and Los Angeles counties did earlier.  In addition, Louisiana will reimpose a similar mask mandate starting on Wednesday.
• Sen. Lindsey Graham (R., S.C.) has tested positive for COVID-19 despite being vaccinated, raising concerns about the highly transmissible Delta variant on Capitol Hill.
  • Graham and other senators were on a houseboat belonging to Sen. Joe Manchin (D., W.Va.) for a bipartisan get-together on Saturday, according to attendees. Mr. Graham started feeling sick on Saturday night and went to the doctor Monday morning.
  • Graham described his symptoms as mild—similar to a sinus infection—and credited the vaccine for ensuring he wasn’t more seriously ill.
• In China, authorities are rushing to trace and control the country’s first widespread appearance of the Delta variant, as its worst coronavirus outbreak in more than a year spreads to at least 14 provinces.  The National Health Commission today reported 83 locally transmitted symptomatic infections.  That takes the total number of infections linked with a cluster found last month in Nanjing, the capital of eastern Jiangsu province, to more than 400.
  • Many of the new cases have been “breakthrough infections” of vaccinated people, raising further questions about the efficacy of Chinese vaccines.
  • With the rising threat of the Delta variant, the government is further tightening restrictions on travel to Beijing from affected areas.

 Economic and Financial Market Impacts

• The spread of the Delta mutation is already having a noticeable negative impact on economic activity in East Asia, where the pandemic had previously been under control, and little progress had been made on vaccinations.  Sicknesses, social distancing measures, and lockdowns are having an especially large impact on exports and manufacturing in the region.
• Tourism-dependent emerging economies that were already struggling before the pandemic with stretched finances and ballooning debt are facing their second successive summer season slump as the spread of coronavirus keeps visitors away.
  • Data from the World Tourism Organization show that in the first five months of 2021, global international arrivals were down 85% from the pre-pandemic total of 540 million in 2019.
  • That’s even worse than the same period last year when arrivals were down 65% year-over-year.
• As young professionals return to their offices in major cities and many remain locked out of the market for single-family homes because of the booming housing market, urban apartment rents are rising fast.  The median rent has risen more than 10% over the past year, according to the homesearch website Apartment List.
  • Stock prices of publicly traded apartment companies have jumped in stride.
  • The FTSE Nareit Equity Apartments Index, which tracks these landlords, is up roughly 42% since January.

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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 the first trading day of August (a time of the year often unfriendly to equities), and U.S. equity futures are pointing to a higher open.  Our coverage begins with an incident off the coast of Oman.  Economics and policy are up next.  China news and the international roundup follow, and we conclude with pandemic coverage.

Drone attack:  Over the weekend, an oil tanker, the MV Mercer Street, was attacked by drones and killed two people, a Briton and a Romanian.  Zodiac Maritime, an Israeli company, manages the vessel; it is owned by Taihei Kaiun (1968, JPY, 2723).  According to reports, the drones, which apparently carried explosive charges, crashed into the ship’s bridge, killing two crew members.  The U.S., U.K., and Israel have blamed Iran for the attack.  Tehran denies its involvement.  This attack has been part of a series of strikes between Iran and Israel.  We noted in June that Iran’s largest warship, the Kharg, caught fire and sank under suspicious circumstances.  Market reaction has been mostly non-existent.  Oil prices are lower this morning on pandemic concerns.  However, an attack on oil shipping in the region around the Strait of Hormuz does raise the potential for a supply disruption.

Economics and policy:  The infrastructure bill is now printed, real estate is in the news, and there is a potential strike in Chile.

• The bipartisan infrastructure bill is now available, all 2,702 pages. Although we are going to have a period to discuss amendments, we don’t expect major changes to occur.  All signs suggest it will pass the Senate.  However, this deal isn’t done yet; the House leadership wants the Senate to pass a larger infrastructure package via reconciliation before the House takes up this bipartisan measure.  If that requirement remains in place, none of this may get passed.  What is our expectation?  The Senate will pass a smaller additional measure, around $1.5 trillion to $2.0 trillion, and force the House to either get nothing or settle for less.  Our bet is that, after much anguish, the smaller measure along with the bipartisan one will make it through the House.
• Real estate markets have been roiled by the pandemic. We see a global jump in home prices, raising fears of a repeat of 2008.  We believe these fears are overblown; credit standards have held up remarkably well in this cycle.  Calls to raise interest rates to cool the housing market look to us to be misguided.  This isn’t a demand problem but a supply problem.  We need to build more homes and apartments.  While the housing boom is going on, the eviction moratorium appears to have expired, which may soon lead to mass evictions.  It is unclear how this will all work.  Landlords rightly are unhappy with months of unpaid rent and want paying tenants, but if thousands are turned out, it could lead to a situation where rentals are empty because the newly evicted can’t afford to rent out the property.  And, it isn’t just renters; mortgage delinquencies rose during the pandemic, and foreclosures could come next.  There may be enough buyers to purchase foreclosed homes, but you still have the problem of the newly homeless.  The sad part is that Congress has provided massive funding to smooth out the problem; state and local governments have failed to administer the funding.  The area most affected appears to be the South.
• The global supply chain remains under stress. There are a number of crosscurrents.  At the onset of the pandemic, firms prepared themselves for a long and deep recession.  They cut orders and reduced inventory.  Unfortunately, they were half right; it was deep but the shortest on record.  Demand roared back into lean inventories and canceled orders.  Exacerbating the problem was a rise in goods demand relative to services demand, a legacy of the lockdowns.  We are still months from seeing supplies normalize.
  • One item we are watching is whether we end up with inventory instability. Until the 1980s, inventory recessions were rather common.  Technology has completely changed inventory management.  Before the 1980s, firms would overestimate demand and end up with excessive inventory.  It would lead to layoffs as the inventory was sold off.  With modern inventory technology, the supply chain typically knows where everything is.  That has allowed inventory levels to decline overall as sales and stockpiles are closely matched.  Until now.  We are hearing anecdotal reports of double and triple ordering to ensure that products will be available.  It is quite possible that all this “stuff” will show up at once, and firms will find they have an overstock problem.  Such a situation will scramble economic projections.  We doubt anyone’s economic models have inventory reactions from 60 years ago built into them.
  • Complicating matters further is the administration’s regulation policy toward logistics. Ocean shipping and rail have become concentrated over the past 20 years (unlike trucking, which is remarkably competitive), and the administration is looking to open competition in these areas.  Not a bad idea but doing it at this moment may be difficult.
• Chipmaking facilities report gas contamination may affect semiconductor production.
• Workers at Chile’s La Escondida copper mine voted to strike. If a work stoppage occurs, it could constrain already tight supplies for this metal.
• China became dominant in solar panel production, mostly due to lax environmental standards and the willingness to forgo profit for market share. As a result, Chinese solar panels dominated supply.  In response, in 2018, the U.S. implemented an 18% tariff on the product.  That tariff is scheduled to end next year; U.S. firms are lobbying for an extension.  The extension puts the administration in a bind.  The environmental policy supports the expanded use of solar energy, and one factor in adoption is low cost.  Yet, protecting domestic suppliers is a goal as well.
• As entry-level wages rise, established workers are finding their pay relative to new hires has declined. This development is creating problems for employers and may encourage established workers to seek new jobs.
• We continue to monitor news about Chair Powell’s reappointment. He is facing criticism regarding regulatory policy.  Although we expect him to be reappointed, it may mean a populist will get the role of Vice-Chair for regulation.  That position is currently held by Randal Quarles.  His term in this role ends in October.
• An anti-dumping measure in the fertilizer market may lead to higher prices.
• Germany’s pork industry is facing a threat from African Swine Virus. The bug is being found in wild boars, and the fear is that these boars will spread it into farms.
• How do you feel about flying without a pilot? Airlines are considering pilotless aircraft for short flights.

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

• For the past few weeks, Chinese regulators have taken aim at several industries in China, including for-profit tutoring, e-commerce, and social media. Although this crackdown continues, it is worth noting that it isn’t just Beijing involved in this effort.  The U.S. is pressing Chinese firms looking to list in the U.S. to provide additional risk disclosures.  And Chinese regulators are expanding their oversight of foreign listings as well.
  • We view China’s actions so far as part of industrial policy. We note that hardware firms have not faced any sanction thus far.  The U.S. restrictions on technology goods exports are spurring an expansion in hardware production and investment.  However, China’s behavior does highlight that, for investors, another consideration is a company’s position in terms of China’s industrial policy.  In other words, there may be more firms subject to increased scrutiny.
  • The crackdown on the tutoring industry is being seen as a way to level the playing field in terms of education. After all, a meritocracy that “loads the dice” for the better connected is bound to create social unrest.  However, there are reports that some parents worry that without the tutoring, their children will be at a disadvantage.  It remains to be seen how this plays out, but one way to reduce the pressure for education is to reduce the stakes of not getting it.  So, if the lot of the normal person improves relative to the upper class, the drive to enter the upper ranks is less interesting.
• Japan’s defense minister renewed his linking of Taiwan’s security to Japan’s safety.
• The Biden administration has taken notice of China’s treatment of foreign journalists. Last week, we noted that foreign reporters who were covering recent flooding were harassed.  Apparently, the harassment was encouraged by the Communist Youth League, meaning the CPC essentially endorsed the action.
• Earlier this summer, we reported on problems at the Taishan Nuclear Power Plant in Guangdong province. Chinese authorities claimed there were no problems despite evidence of higher radiation readings.  Last week, the plant was closed for maintenance, raising the possibility of additional problems.
• Amazon (AMZN, USD, 3355.50) has removed a number of Chinese firms from its platform, ostensibly over fake reviews. However, the firms believe the action is coming from orders from Washington.
• We reported earlier this summer that Beijing has been removing LGBT groups from social media. Although an official crackdown against these groups isn’t evident, the restrictions on social media suggest one might be coming.  The German consulate in Guangzhou posted a note about an LGBTQ film festival.  Beijing has banned the consulate from social media for doing so.  We have not seen the U.S. respond to this issue, but the rising number of them will likely spark a reaction at some point.
• Facebook (FB, USD, 356.30) is banned in China. That doesn’t stop the company from earning advertising dollars in China.  Interestingly, Chinese state media outlets have four of the top 25 spots in most liked accounts.
• There are reports that China is encouraging ethnic Tibetans to move to cities; by doing so, the countryside becomes depopulated. This includes the border regions, making them less secure.  In response, Beijing is encouraging the dominant Han ethnic group and other loyalists to move to the frontier regions.
• China has suspended fertilizer exports to ensure ample supplies for China’s farmers. Cutting off these exports will hurt Pakistan and India.

International roundup:  The Philippines renews military relations with the U.S.

• Since coming to power in 2016, President Duterte has had a difficult relationship with the U.S.; he once slurred President Obama after American criticism of Duterte’s drug enforcement activities. Duterte has threatened, over the years, to severe America’s long-standing security relationship with the Philippines.  However, recently, China has been aggressively encroaching on the Philippines.  For China, getting effective control of this island nation would allow it to break out of the first island chain that envelops China.  Last week, Duterte moved to resume security relations with the U.S., likely because he sees the threat from China.
• During the Syrian crisis, Turkey effectively weaponized refugees from the war. After causing a refugee crisis in Europe, Chancellor Merkel worked out an arrangement with President Erdogan.  The EU paid Turkey money, and Turkey kept the refugees out of Europe.  On occasion, when Turkey isn’t happy with Europe, the refugee flow resumes.  It appears that Belarus is taking a page out of Turkey’s playbook.
• Myanmar’s military intends to remain in power into 2023.

COVID-19:  The number of reported cases is 198,425,839 with 4,227,258 fatalities.  In the U.S., there are 35,004,592 confirmed cases with 613,228 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 400,674,525 doses of the vaccine have been distributed, with 346,456,669 doses injected.  The number receiving at least one dose is 191,498,983, while the number of second doses, which would grant the highest level of immunity, is 164,757,423.  The FT has a page on global vaccine distribution.

• Over the weekend, information emerged that the Delta variant spreads much more easily than earlier variants, may be more lethal, and could be spread by the vaccinated. The reports highlight a problem that has been in place during this pandemic.  The media reports on what is incomplete scientific information.  Science is an inductive process; as new information emerges, viewpoints change.  However, the public messaging becomes garbled.  Part of the scientific process is to question and review findings and what was thought to be true once changes over time.  The best we can determine is that the Delta variant does spread more easily.  It’s probably too soon to know if it’s worse than earlier variants.  It does not appear that lockdowns are returning, so we expect medical systems will remain under pressure for a while longer.
• France is seeing massive protests against its new vaccine passport policy. As France opts for sticks, Germany is trying “carrots” or specifically, bratwurst.  That’s right, get a shot, get a brat.
• China is dealing with a large outbreak of the Delta variant. Beijing has mostly used social measures to control the virus and lags on the vaccination front.  The Delta variant, which is more contagious, is leading to renewed lockdowns.

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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 lower open this morning. Equities have fallen due to concerns over the tech sector as investors fear disappointing earnings reports and a continued tech crackdown by China. Our report begins with a discussion on the debt ceiling followed by international news, where Russia fines a U.S. tech company and Peru has a new prime minister. U.S. economics and policy news are up next, including details about the infrastructure bill and a possible replacement for LIBOR. China news follows, and we end with our pandemic coverage.

Debt ceiling: On Saturday, the agreement that allowed for the temporary suspension of the debt ceiling will be lifted and the new ceiling will be set at the debt level as of tomorrow. The reimposition of the debt limit means that the Treasury will be limited in its capacity to issue new debt. As part of the suspension agreement, the Treasury is required to reduce its cash balance to $450 billion; it is currently around $700 billion. This element of the agreement was designed to prevent the administration from piling up cash in advance of the deadline, which would have reduced the leverage that comes from the debt ceiling. To reach that level, the Treasury has been curtailing the size of its T-bill auctions. We are already seeing the effects of the deadline as short-term interest rates have continued to drop and the Fed’s reverse repo facility has been unusually active.

This chart shows the borrowing made in the Fed’s reverse repo window. Borrowing is currently at $1.0 trillion. Institutions are lending at this facility due to the lack of opportunities elsewhere. Current rates on short-term instruments are running around 5 bps; the interest paid on reserve balances, which is the rate at which the Fed conducts its reverse repo facility, is 15 bps. Although the returns are minuscule, the 10-bp margin is attractive to other alternatives.

As noted above, to reach the $450 billion level, the Treasury has been issuing fewer T-bills than what is expiring, which means available collateral has declined. Although short-term interest rates are falling, paradoxically, it may lead to even less lending. T-bills are used as collateral for shadow bank activities and the lack of supply means less collateral is available for lending. The financial plumbing of the short-term interest rate markets is complicated and the likelihood of a financial accident under these conditions is elevated.

International news: 

• Google (GOOGL, $2,715.55) was fined by the Russian government for not keeping personal data belonging to Russian users on servers in Russia. Google will have to pay $41,000 to the Russian government and could face additional penalties going forward.
• Newly elected Peruvian President Pedro Castillo named a far-left party member as his prime minister. Guido Bellido, who is also recently elected, has never held public office and has shown support for communist governments. Castillo’s decision to pick Bellido reinforces concerns that he may implement more leftist policies to the dismay of international investors.
• Tunisia is in turmoil following the president’s decision to suspend parliament and seize executive power earlier this week. Tunisian President Kais Saied’s power grab has sparked concern that democracy in the country is in jeopardy. The president’s takeover comes after weeks of anti-government protests due to a weak economy and a surge of coronavirus infections.
• Natural gas prices in Europe are expected to increase as a slowdown in European production and Russia’s refusal to send additional supply have led to shortages throughout the continent.

Economics and policy:

• In preparation for the financial system’s move away from LIBOR, the Alternative Reference Rates Committee (ARRC) has endorsed the usage of Secured Overnight Financing Rate (SOFR) as the new benchmark interest rate. ARRC was created in 2014 by the Federal Reserve to oversee the transition away from LIBOR.
• President Biden has asked Congress to extend the federal eviction moratorium, which is set to expire on Saturday.
• Food and beverage makers have warned that they will keep raising prices in response to shortages in materials and labor. So far, the firms have only been able to raise prices abroad in places like Latin America, Russia, and Turkey. Prices in North America and Europe have remained low due to these companies’ contract commitments with major retailers. That being said, as the older contracts run out they will likely be replaced with ones using the updated pricing scheme.
• The Committee for a Responsible Federal Budget found that the pay-fors in the infrastructure budget deal may be overstating the level of funding. Their report concludes that much of the savings the bill relies on to fund the spending has already taken place.
• The infrastructure bill is expected to increase the IRS’s ability to surveille crypto investors. The bill will require crypto investors and brokers to report all transactions for trades above $10,000.

 China:

• Regulators from China held talks with global investors to alleviate concerns of a regulatory crackdown on Chinese tech companies listed abroad. The call led to a temporary rise in Chinese shares due to officials not offering any reassurances that the crackdown will not expand to other companies.
• A militant group that is affiliated with Al-Qaeda has sought to establish a state within Xinjiang. The group remains present in Afghanistan and is viewed as a threat to Chinese interests. China has warned its citizens to leave Afghanistan, citing concerns over the security situation.
• China insisted that it will not allow EU diplomats to visit Xinjiang if they continue to insist on visiting jailed the Uyghur scholar, Ilham Tohti. European leaders have demanded to speak with Tohti as they seek to get a better understanding of the treatment of Muslim minorities in Xinjiang. China has characterized the EU’s insistence on talking with the jailed activist as disrespect for its sovereignty.

COVID-19:  The number of reported cases is 196,741,728 with 4,201,788 fatalities.  In the U.S., there are 34,754,668 confirmed cases with 612,129 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 397,464,625 doses of the vaccine have been distributed with 344,071,595 doses injected.  The number receiving at least one dose is 189,945,907, while the number of second doses, which would grant the highest level of immunity, is 163,739,916.  The FT has a page on global vaccine distribution.

• An internal presentation from the Center for Disease Control and Prevention acknowledged that “the war” against the coronavirus has changed. The presentation states that the delta variant can spread as easily as chickenpox, causes more severe illness, and the vaccinated can transmit the strain as easily as those who are unvaccinated.
• President Biden announced on Thursday that all federal employees either need to be vaccinated or submit to regular testing and practice social distancing. New York Governor Andrew Cuomo issued a similar order. In addition, President Biden has requested state and local governments to make $100 payments to every newly vaccinated American.
• The European Union has outpaced the U.S. in vaccine doses per 100 people according to Our World in Data. The rise in vaccinations highlights the growing struggle the U.S. has had in recent months to get more people vaccinated as well as the EU’s improvement. Spain, one of the countries most affected by the coronavirus, has now reached 56.9% of full vaccinations, which is among the highest in the world.
• Israel will offer a third shot of the Pfizer vaccine to people over 60 in an attempt to halt the surge in infections from the delta variant.
• Washington, D.C., will require all people regardless of vaccination status to start wearing a mask indoors.
• Local government offices in Florida have decided to reimpose mask mandates as the delta variant continues to spread throughout the state.
• India has seen an uptick in COVID-19 cases on Friday as the country continues to struggle to contain another wave of infections.
• In Australia, the army has been sent out to neighborhoods to ensure that people who have tested positive for the virus remain isolated.
• Japan has expanded its state of emergency to include four more areas as the country continues to struggle to slow the spread of the delta variant.

 View PDF

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  It’s GDP day!  We cover the data for Q2 below in detail, but the quick view is that the annualized growth rose 6.5%, well below expectations.  Equity markets are ticking higher, but we note that gold is up strongly this morning as the dollar fell, most likely on a dovish take to yesterday’s FOMC meeting.  There are a couple of items of note.  First, the Ever Given, the vessel that was stuck in the Suez Canal, has finally arrived at its destination in Rotterdam.  And second, we would be remiss if not to recognize the passing of Ron Popeil, the inventor of the Veg-o-Matic and other gadgets usually hawked on late-night television.  He spawned a famous parody from Saturday Night Live.  Our special coverage begins with a recap of the FOMC meeting.  Next on the agenda, the Senate has opened a debate on the bipartisan infrastructure legislation (BIL).  Starting off our ordinary coverage is China news, followed by economics and policy.  The International news roundup is next, and we close with our pandemic update.

The FOMC:  As expected, the Fed didn’t change monetary policy; QE continues at the same pace, and policy rates remained unchanged.  In the press conference, Chair Powell admitted that the economy was making progress, but it hadn’t reached the level of “substantial.”  However, he also noted the committee discussed at length the conditions required for tapering to commence.  For obvious reasons, the Chair didn’t detail what is necessary for tapering to begin, but most likely, continued improvement in the labor markets is necessary.  It doesn’t look like there will be a cut in mortgage securities separate from Treasuries, although the Chair left some level of flexibility.  Inflation is still deemed to be transitory, meaning that policy won’t be tightened yet to address it.

In what might be the most important action taken by the Fed yesterday, the central bank established a domestic and foreign repo facility.  The program will allow both domestic and foreign banks to acquire liquidity for collateral at a rate 25 bps higher than the prevailing repo rate.  These new facilities will act as a permanent backstop to the non-bank banking system.  During the March 2020 financial crisis, the inability of financial institutions to borrow short-term led to a spike in rates and caused several markets to “freeze up,” meaning liquidity was nearly impossible to secure at any price.  These facilities should alleviate most of these types of problems.

Infrastructure:  The Senate easily passed a measure to begin debate on the BIL.  This action means that although the bill isn’t completely written, there is enough in place to begin debate.  There is still much that could derail the measure; as the bill gets debated, all the Democrats and at least 10 GOP Senators need to remain on board with the bill.  It is notable that the CBO hasn’t scored the bill.  If it turns out to be a budget-buster, it could undermine support among centrists.  And, just getting it through the Senate doesn’t mean it will pass easily through the House.  Left-wing populists (LWP) are worried that centrist Democratic senators will only support this bill and scuttle a much larger measure that is expected to be passed through reconciliation.  The LWP in the House are threatening to kill the BIL if they don’t see support for the larger second measure.  Other establishment elements in the House are not happy they have had little say in the Senate bill.  So, this is far from a done deal.  However, getting this far is impressive and increases the odds that the $1.2 trillion measure becomes law.

China:  Policymakers try to calm markets, and flooding continues.

• After convulsing the financial markets in China over the past week, it appears that authorities are concerned about financial stress. State media have started “jawboning” the market to improve sentiment, and regulators are trying to reassure investors.  Banks are also being told to “restore calm.”  Given China’s past behavior in intervening in equity markets, we could see some “bottom-fishing” activity start to occur.  Still, it doesn’t appear the government is finished with its intervention.
  • The property market appears to be the next target of enhanced scrutiny. Evergrande (EGRNF, USD, 0.75) continues to be a threat to financial stability.
  • The context of this crackdown is important. As we are seeing in the U.S., China appears to be also implementing an equality cycle and ending an efficiency cycle.  This quote nails it:
    • “Chinese entrepreneurs and investors must understand that the age of reckless capital expansion is over,” said Alan Song, founder of private equity firm Harvest Capital. “A new era that prioritizes fairness over efficiency has begun.”
    • Due to the authoritarian nature of China’s government, it can move much faster on policy once a decision is in place.
    • This means the regime is likely to be more focused on equality and accept slower growth. The crackdown on wealth, the restrictions on tutoring, and the reining in of major business leaders are all part of this shift.
  • Although the firm denies it, Didi (DIDI, USD, 8.87) reportedly considered going private to pacify regulators and compensate shareholders after the government reacted against the company listing in the U.S.
  • Ultimately, these actions are all about protecting the CPC. Gaining control of data, making the tech firms less predatory toward consumers, and keeping listings in China, is all about control.
• One way China is retaliating against Chinese overseas activists is to arrest family members. Increasing numbers of Chinese citizens are seeking asylum during Xi’s reign.
• We have noted recent flooding in China; according to reports, foreign journalists covering the tragedy have become targets of harassment, with apparent government encouragement. The typhoon that affected the Olympics has now reached the Chinese mainland and is exacerbating recent flooding.
• Satellite reconnaissance shows that China is constructing additional missile silos most likely for nuclear weapons. China has generally had a smaller nuclear missile inventory than Russia and the U.S., and this recent addition won’t bring parity.  But, it will give China a more formidable deterrent.  It is worth noting that these facilities are deeper in the Chinese interior and are out of range of U.S. cruise missiles.
• China foreign minister Wang Yi has met with the Taliban in Afghanistan.
• The government is revising the population law to try to increase the birth rate.
• Chinese cellphone manufacturers have developed their own semiconductor chips.

Economics and policy:  Semiconductor shortages continue, institutional money in single-family homes is a worry, and the poverty rate likely fell.

• Apple (APPL, USD, 144.98) and Tesla (TSLA, USD, 646.98) are the latest companies warning that the semiconductor chip shortage is affecting the production of its products. Both companies warned the shortages would slow growth.
• One item we have become concerned about is the incursion of real estate investment into the single-family residential market. This buying is reducing the supply of homes available for ordinary homeowners and lifting prices.  Although current homeowners clearly benefit through higher prices, housing represents the largest portion of wealth to the bottom 90% of households.  Making it difficult to acquire homes at reasonable prices could become a political flashpoint in the near future.
• GOP members of the Federal Trade Commission expressed criticism of the majority Democratic Party members, arguing that changing from the Bork Standard was ill-advised. Although we understand the concern, the political winds appear to be shifting away from Bork to the neo-Brandeis position that size alone is enough to trigger antitrust concerns.
• One effect of the massive income support tied to the pandemic is a notable drop in the poverty rate.
• Coffee prices have jumped to a six-year high, as frost in Brazil threatens the crop.
• This year’s back-to-school season is expected to be very strong.
• As investors search for yield, banks are creating securities that directly share the risk of mortgages. In the past, Fannie Mae (FNMA, USD, 1.305) and Freddie Mac (FMCC, USD, 1.14) acted as guarantors for investor losses.  In the 2008 Financial Crisis, mortgage loan losses overwhelmed these two entities, causing the government to effectively nationalize them.  These bonds, a common feature of financial engineering, are structured to allow investors to accept various levels of risk.  The point here is that, as a consequence of low yields, the industry is creating instruments with more yield but have higher levels of risk.
• The Economist magazine’s Big Mac index confirms the dollar is overvalued.

International roundup:  The Eurozone economy continues to recover, and Crimean water may be the next problem in Ukraine.

• Eurozone economic sentiment hit a record high in July, although the pace of improvement is slowing.
• The latest flashpoint in Ukraine is over the water supply in Crimea. Ukraine has blocked a canal that provides 85% of the peninsula’s fresh water, and there are concerns that Russia will use military force to reopen the canal.
• In the wake of massive flooding in Germany and Belgium, the cleanup is now underway.
• Russia and the U.S. are holding talks on nuclear missile inventories.
• The U.S. has sanctioned members of the Assad regime in Syria over alleged human rights violations.
• The fallout from Nord Stream 2 continues; GOP senators are holding up Treasury nominees in retaliation.

COVID-19:  The number of reported cases is 196,095,694 with 4,189,011 fatalities.  In the U.S., there are 34,677,412 confirmed cases with 611,809 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 395,974,515 doses of the vaccine have been distributed, with 343,361,524 doses injected.  The number receiving at least one dose is 189,494,180, while the number of second doses, which would grant the highest level of immunity, is 163,588,042.  The FT has a page on global vaccine distribution.

• China is seeing a strong rise in cases in Jiangsu province. The city has closed the airport after tourists are thought to have brought new infections to the area, which is considered a tourist destination in China.
• Steadily, we are seeing governments around the world learn to live with COVID-19. Although mask recommendations and mandates have increased in the U.S. and other parts of the world, mass lockdowns appear to be out.  Even though vaccine distribution has stalled, the combination of vaccines and infections does appear to be giving populations some degree of immunity.  Unfortunately, vaccines and infections don’t seem to grant sterilizing immunity, but both seem to prevent more serious cases of the disease.  The move away from lockdowns should support continued economic recovery.
• Unfortunately, the current dominant strain of the virus is much more contagious than earlier versions.

 View PDF

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

[Posted: 9:30 AM EDT] | PDF

We begin today’s Comment with several items related to U.S. fiscal, monetary, and regulatory policy.  We next turn to a range of international developments that highlight the growing risks of great-power military conflict in the future.  We end with the latest news on the coronavirus pandemic.

U.S. Fiscal Policy:  Lawmakers negotiating over the bipartisan “hard” infrastructure bill totaling approximately $1 trillion said yesterday they were approaching a resolution to some of the issues that had bogged down the final stretch of talks.  However, partisan sniping continues over a few final disputes.  As of last night, the key remaining issues included how much money to allocate to public transit facilities and how to pay for the proposal.  We expect the negotiators will agree on a deal soon, although the impact on the economy and the financial markets will depend on the details.

U.S. Monetary Policy:  The Federal Reserve will finish its latest two-day policy meeting today, with a decision and a press conference by Chair Powell this afternoon.  We expect no change to the Fed’s benchmark fed funds interest rate or its bond-buying program.  However, with multiple renegades on the policymaking committee calling for tighter monetary policy sooner rather than later, the officials may signal intensified discussion about the timing of an asset-purchase taper later in the year.

U.S. Regulatory Policy:  To bolster his “Buy American” program and help address international supply chain vulnerabilities, President Biden is preparing a new executive order that would sharply increase the domestic content requirement for products sold to the federal government.  The order would lift the current 55% requirement to 60% and phase in further increases to 75% over the next eight years.

• Since the order could encourage additional domestic manufacturing, it may help reduce U.S. dependence on foreign goods over time.  However, since domestic products are often more expensive than foreign ones, it could raise costs for the government.
• The order would also risk unnerving international suppliers to the government and could raise tensions with allies in Canada and Europe that have long resisted Washington’s attempts to tighten procurement rules.

United States-China-Russia:  In a speech at the Office of the Director of National Intelligence, President Biden warned that cyberattacks would be the most likely cause of any shooting war between the U.S. and China or Russia.  According to Biden, “If we end up in a war, a real shooting war with a major power, it’s going to be as a consequence of a cyber breach.”

• Biden’s remark is at odds with the views of many national security analysts and observers, who are more concerned about a potential Chinese takeover of Taiwan.  The remark may, therefore, be a deliberate attempt to express the administration’s frustration over continued Chinese and Russian cyberattacks and warn off any further attacks.  The prepared nature of the statement and the venue at the ODNI would be consistent with that hypothesis.  The remarks did not appear to be off-the-cuff.
• Given that Biden also stressed the burdens and disruptions of cyberattacks in his speech, we think it’s an important reminder that a lot of tension between the U.S. and its great-power rivals is probably building up unseen by the public in the realm of cyberwarfare, intelligence operations, and secret weapons developments.  Although we still subscribe to the idea that Taiwan is probably “the most dangerous place in the world,” geopolitical risks are probably also rising well beyond the shores of that island.

China:  The Federation of American Scientists yesterday issued a report saying China has begun building out a second network of nuclear missile silos in the far west of the country.  According to the report, based on commercial satellite imagery, the site near the city of Hami in Xinjiang province could eventually include about 110 silos, making it similar in size to the network that a separate think tank identified earlier this year near the city of Yumen in Gansu province.

• The U.S. still has approximately ten times as many warheads as China’s 400 or so, with a similar advantage in delivery systems.  However, China is rapidly building out its strategic forces with a focus on survivability.  It is working to complete a full “triad” of basing options, including air-, sea-, and land-based missiles (which include mobile systems deployed on rails in deep underground tunnels).
• The more missiles China can deploy in hardened or difficult-to-target launching systems, the more likely at least some of its weapons could survive a U.S. first strike.  The possibility of some missiles surviving would act as a powerful deterrent against U.S. forces.

Russia-Afghanistan:  As the U.S. completes its military withdrawal from Afghanistan and Taliban forces continue to seize territory, Russia is building ties with Taliban leaders to ensure it can influence future developments in the region.

U.K. Industrial Policy:  The Ministry of Defense has agreed to buy Sheffield Forgemasters, one of Britain’s oldest steelmakers, for £2.5 million. The deal paves the way for the ministry to invest up to £400 million in new equipment and infrastructure at the steelmaker’s facilities over the next 10 years, intending to ensure the company can continue to produce key components for the Royal Navy’s nuclear submarines.

• After three decades in which politicians and business leaders across the world emphasized building hyper-efficient, global supply chains, and just-in-time inventory systems, we are seeing increased signs that the ideal is being reversed.  One reason is that the pandemic-related supply disruptions have exposed the commercial, economic, and social vulnerabilities produced by such a production system. The global shortage of semiconductors has become the world’s poster child for that issue.
• In addition, however, we also see signs that great-power geopolitical rivalries are also undermining the efficiency focus.  As the U.S. and its allies confront a world of threats from great powers like China and Russia, they put more emphasis on old-fashioned concerns like mobilization capacity in the defense industry and ensuring they can make critical defense goods at home.

U.K.-Brexit:  Despite the government’s program to grant secure immigration status to European citizens living long term in the U.K. after Brexit, many people who experienced the enforcement of the rules complain they are applied in a harsh and inflexible way.  The tough enforcement not only affects millions of foreigners living and working in the U.K., but it also endangers the country’s aspiration to be a “global Britain.”

European Union-Serbia-Albania-North Macedonia:  The leaders of Serbia, Albania, and North Macedonia have hit out at Brussels over the slow pace of EU enlargement, vowing to press ahead with their own border-free travel and business zone as they wait for the bloc to admit them.

COVID-19:  Official data show confirmed cases have risen to 195,498,370 worldwide, with 4,180,770 deaths.  In the United States, confirmed cases rose to 34,606,631, with 611,304 deaths.  Vaccine doses delivered in the U.S. now total 395,460,845, while the number of people who have received at least their first shot totals 188,996,475.  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, 56.9% of the U.S. population has now received at least one dose of a vaccine, and 49.2% of the population is fully vaccinated.  However, new polling shows stark differences between vaccination status and willingness to be vaccinated among different religious groups.  According to the polling, white evangelicals are the most resistant, with only 56% of that group saying they have been vaccinated or plan to get the shot as soon as possible.  Among all Americans, 71% have been vaccinated or are willing to be.
• Saudi Arabia has become the latest major country to impose a vaccine mandate on its citizens.  Starting Sunday, Saudis will need to show proof on a mobile app that they have received at least one vaccine dose to enter public and private institutions such as schools, shops, malls, markets, restaurants, cafes, concert venues, and public transportation. Beginning August 9, they will need two doses to travel abroad.
• In Israel, where the Delta mutation is again pushing up infection rates, the government authorized using the vaccine from Pfizer (PFE, $42.10) for vulnerable children between five and 11 years old.  The authorization allows administering the vaccine to the children if they have a high likelihood of serious illness or death from COVID-19 because of underlying conditions such as severe obesity, chronic lung disease, immunosuppression, or heart failure.
• Back in the U.S., President Biden said he was considering requiring all federal government employees to be vaccinated.  Separately, the CDC issued revised recommendations that vaccinated people in areas with “substantial” levels of COVID-19 start wearing masks again in indoor public places.

 Economic and Financial Market Impacts

• The IMF issued updated economic forecasts showing that while overall global growth is still expected to be 6.0% in 2021, but only because a downward revision in the growth forecast for developing countries was offset by an upward revision in the forecast for developed nations.
  • The IMF now sees the developing countries growing just 6.3% this year, largely because of resurgent infections from the Delta mutation and slow progress in their mass vaccination campaigns.
  • In contrast, the organization now expects economic growth in the developed countries to reach 5.6%, based on positive progress regarding vaccinations and large spending packages designed to support their recoveries.

 View PDF

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with multiple global and U.S. developments touching on taxes, fiscal policy, monetary policy, and labor market regulation.  Next, we discuss a variety of foreign news ranging from the sharp drop in Chinese stocks stemming from that country’s crackdown on its tech sector to cooling tensions between North Korea and South Korea.  We close with the latest developments on the coronavirus pandemic.

Global Corporate Tax Deal:  According to the Wall Street Journal, the pharmaceutical industry is already quietly mobilizing to fight the recent global deal on a minimum corporate income tax rate of 15% and other provisions to stop tax avoidance.  Lawyers and company officials estimate the tax overhaul, if adopted, could cost some of the biggest pharmaceutical companies hundreds of millions of dollars more each year.  Given the lobbying resources available to the industry and its past success in protecting its interests, the drug-industry pushback could have a meaningful impact in watering down the proposal.

U.S. Fiscal Policy:  Lawmakers negotiating over the bipartisan “hard” infrastructure bill totaling approximately $1 trillion continued to hit stumbling blocks late Monday, with the latest squabbles touching issues such as funding for water infrastructure, a requirement that federal contractors pay their employees a locally prevailing wage, and how to pay for the plan.  Meanwhile, Senate Majority Leader Schumer said lawmakers might need to work through the coming weekend to finish the deal.

U.S. Monetary Policy:  The Federal Reserve will open its latest two-day policy meeting today, with a decision and a press conference with Chair Powell on Wednesday afternoon.  We expect no change to the Fed’s benchmark fed funds interest rate or its bond-buying program.  However, with multiple renegades on the policymaking committee calling for tighter monetary policy sooner rather than later, the officials are likely to signal continued discussion about the timing of an asset-purchase taper later in the year.

U.S. Labor Market Regulation:  The Biden administration is reportedly developing a series of regulatory changes aimed at increasing workers’ pay and gaining other benefits for them.  The rule changes, most of which are still being drafted, would affect workers such as federal contractors, tipped employees, and workers who are jointly employed (such as those with jobs at franchised brands). In some cases, the changes seek to reverse Trump administration efforts. In others, the Labor Department is working to implement its own rules.

• The new rules would be separate from other administration proposals aimed at tilting the balance of power toward workers from employers, including raising the federal minimum wage for private-sector employees, increasing wages for caregivers, and making it easier for workers to organize labor unions.  In contrast with those proposals, however, the new rules would not require Congress to pass new legislation.
• If the rules successfully shift the balance of power in the labor market towards workers, they could raise costs for businesses beyond the amount firms can recoup by raising prices.  In other words, the proposals could work to push down margins over time, which could become a headwind for stocks.

Chinese Technology Stocks:  Chinese tech stocks plunged for a third day amid investor fears about the government’s mounting regulatory crackdown on the sector.  The government continues to signal its attempts to bring this sector under its control because of multiple concerns ranging from anti-competitive behavior, data security infractions, child pornography, and even the high cost of online tutoring.  We continue to note rising regulatory risks facing powerful technology companies worldwide, but perhaps most acutely in China.

• Hong Kong’s Hang Seng stock benchmark closed down more than 5% today, while the Hang Seng Tech sub-index declined 8.7%.
• The Nasdaq Golden Dragon China Index, a benchmark of Chinese tech stocks listed in New York, has dropped roughly 15% over the last two days — its worst fall since 2008.
• Some of the most widely held Chinese tech stocks fell even more.

North Korea-South Korea:  North Korea reactivated its direct communication lines with the South Korean government, raising the prospect that the Kim Jong Un regime could be ready for engagement after a protracted period of diplomatic silence.  Pyongyang had severed all communication with the Seoul government since June 2020, after Kim Yo Jong, the dictator’s sister, condemned South Korean activists for sending antiregime leaflets over the border.  More recently, the regime has shown signs it is reeling under economic and other stresses.  Faced with the threat of instability, it will most likely seek some kind of economic assistance in return for temporary good behavior.

Turkey-Ukraine-Russia:  The Ukrainian Navy has reportedly taken delivery of the first of six Bayraktar TB2 drones it is acquiring from Turkish defense firm Baykar.  Last year, advanced Turkish drones were instrumental in giving Azerbaijan the upper hand over Armenia in their conflict over Nagorno-Karabakh.  As might be expected, the Russian Defense Ministry issued a strong warning to Turkey that it shouldn’t help build up Ukraine’s military capabilities.

Brazil:  The worst frost to strike Brazil’s coffee-growing region in over 25 years will cut a chunk out of next year’s crop, just as drought cut the 2021 crop.  As a result, coffee prices have surged to six-year highs, following a years-long stretch of depressed prices that prompted many farmers to abandon their fields.

• New York arabica bean futures have jumped to $2.08 a pound, reaching their highest level since late 2014.
• Coffee futures have climbed 30% so far in July, and they have almost doubled over the past year.

Tunisia:  The country plunged deeper into a political crisis yesterday as President Kais Saied tightened his grip on power, dismissing top government officials and deploying military forces around the prime minister’s office in a dramatic move that opponents called a coup attempt.  Saied has also issued a decree declaring a nighttime curfew and banning gatherings of more than three people.

COVID-19:  Official data show confirmed cases have risen to 194,885,476 worldwide, with 4,171,445 deaths.  In the United States, confirmed cases rose to 34,535,436, with 611,007 deaths.  Vaccine doses delivered in the U.S. now total 394,949,575, while the number of people who have received at least their first shot totals 188,729,282.  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, 56.8% of the U.S. population has now received at least one dose of a vaccine, and 49.1% of the population is fully vaccinated.
• With the Delta variant driving up new U.S. infections, especially among unvaccinated people, the Department of Veterans Affairs yesterday became the first federal agency to require its workers to get vaccinated.  Department employees who work in VA healthcare facilities or provide direct care to veterans will have eight weeks to get their shots or be at risk of losing their job.
  • Meanwhile, California mandated that state employees working in healthcare facilities get their shots by August or be tested weekly for the virus.  New York City issued a similar mandate that will be effective after Labor Day for all 350,000 municipal employees.  In San Francisco, even an organization of private bar owners said patrons who want to sit inside their establishments must show proof of vaccination or a recent, negative COVID-19 test.  Vaccine or test mandates are also being imposed on people who want to enter certain facilities or venues in France, Italy, and other countries.
  • While the California and New York City mandates touched off opposition from some employees, some 60 national groups representing doctors, nurses, and other healthcare workers separately issued a call for employers to mandate vaccinations in all healthcare facilities.  The groups, including the American Nurses Association, the American Medical Association, the Infectious Diseases Society of America, and the American Academy of Pediatrics, said unvaccinated healthcare workers are putting their patients and residents of long-term-care facilities at risk for infection.
• While good progress has been made on developing vaccines against COVID-19, much less progress has been made on treatments for those who contract the disease.  Of the ten drugs cleared or recommended for use in the U.S. to date, two later had their authorizations rescinded after they failed to work, and the government paused shipments of a third because it wasn’t effective against new variants. The best medicines for early treatment are cumbersome to administer, and drugs for those in the hospital can only do so much for patients who are already severely ill.
  • Clinical trials are currently evaluating more than 225 drug treatments, including new medicines and some already approved for other conditions, to see whether they might also be effective against COVID-19.
  • A few potential therapies in development have shown promise, including antiviral drugs from Pfizer (PFE, $41.81) and Merck (MRK, $77.24).
• This week, the British government will consider loosening travel restrictions for travelers from the EU and the U.S., with one senior airport executive saying he’s confident that ministers would broaden quarantine exemptions “imminently.”  The move, which one government official said was “finely balanced,” would be a boost to the tourism sector and help to reopen the U.K. to mass foreign travelers.
• In contrast, the Biden administration said it would maintain its pandemic-related travel bans for the foreseeable future on a range of countries, including the U.K., the EU, and China, due to the spread of the Delta variant.

 Economic and Financial Market Impacts

• In South Korea, second-quarter gross domestic product (GDP) was up 5.9% from one year earlier, partly reflecting base effects from the onset of the pandemic last year but also reflecting strong exports and rebounding consumption.  The year-over-year growth in the second quarter was the strongest in a decade.  The fly in the ointment: Surging infections and low vaccination rates so far in July suggest growth could slow down dramatically in the third quarter.

 View PDF

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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  U.S. equity futures are modestly in the red this morning, taking a rest from recent new highs.  Our coverage today begins with China—lots of things going on in markets and geopolitics.  From there, we move to economics and policy.  GDP is out this week, and we get benchmark revisions to the data.  The FOMC meets, too, with divisions between hawks and doves widening.  Cryptocurrency news is next as bitcoin recovers.  Comments on technology and Tunisia follow, and we close with an update of pandemic news.

China:  Chinese stocks tumble, and U.S./China meetings show high tensions.

• As noted above, Chinese equities fell hard overnight after regulators moved to essentially end the for-profit tutoring industry. Chinese families often employ tutoring firms to help their children prepare for national exams.  CPC leaders have concluded that these firms have created an educational “arms race” and have decided to curtail the practice by limiting these firms through regulation.  The decision to move in this direction led to a fire sale in these equities, with declines ranging from 98% to 10%.  The government’s move against tutoring is part of a broader crackdown that has also affected the tech industry.
  • As we reported in our series on central bank digital currencies, the PBOC has been advancing quickly on establishing a digital CNY. It appears now that the government is co-opting tech firms to “help” the central bank in its quest, which will likely hurt the firms’ profits over time, as it will undermine their own electronic payments systems.
• Deputy SoS Sherman is in China today for meetings. So far, the talks have been acrimonious.  Vice Foreign Minister Xie Feng indicated that the U.S. was to blame for the deterioration in relations and called on Washington to change “its highly misguided and dangerous policy.”  China also warned against trying to contain its rise.
  • China has imposed sanctions on former commerce secretary Wilbur Ross and six others in retaliation for U.S. sanctions on various Chinese officials. It is the first use of a recently passed counter-sanctions law.
  • ProPublica has issued an investigative report on China’s practice of retrieving Chinese citizens living abroad.
• The U.K. government is looking to force China’s state-owned nuclear energy company from its new nuclear power plant and prevent Chinese firms from participating in U.K. utilities.

Economics and policy:  Negotiations on the bipartisan infrastructure bill continue, and rising used car prices lead to an unexpected benefit.

• Although deadlines have come and gone, talks on the bipartisan infrastructure bill continue. Discussions over the allocation of public transportation and roads along with how to fund the bill are currently underway.  We expect some sort of deal to be made, and then the focus will shift to the broader infrastructure bill that will be done in the reconciliation process.
• GDP for Q2 will be released on Thursday; current expectations would suggest that this quarter will mark the line between recovery and expansion. In other words, GDP will reach a new high with this data.  However, we do note that the government will issue revisions, and given the disruptions caused by the pandemic, we would not be surprised to see larger than normal adjustments to past data.
  • One element of the pandemic is that U.S. population growth slowed dramatically, mostly due to a drop in births. Falling population will tend, over time, to depress GDP.
• Railroads are facing a backup of shipping containers in the Chicago area, further evidence that the U.S. logistical system is in disarray. Supply chain problems may affect school lunches in the fall as districts try to restock after schools closed last year.
• Used car lenders face a structural problem; the collateral they lend on declines in value over time. In a current loan, this isn’t a problem.  Amortization usually at least keeps pace with the decline in value.  However, if a loan goes into default, the spread between the value of the collateral and the unpaid portion of the debt can rise, leaving the lender with a loss.  However, in a world where used care prices are rising, lenders are actually making money on repossessed vehicles.  Lenders are reporting positive net recoveries, which is unusual.
• Phoenix is seeing a boom in residential real estate as buyers flee higher-priced areas. Congress is starting to press the Fed into curtailing its balance sheet expansion.

Cryptocurrencies:  Bitcoin recovers, and regulators are circling.

• Unconfirmed reports that Amazon (AMZN, USD, 3656.64) may create its own digital currency sent bitcoin (BTC, USD, 39,544.29) higher overnight.
  • Meanwhile, state regulators are accusing BlockFi of offering unregistered securities in violation of securities law. New Jersey, Alabama, and Texas all accused the company of illegal activity.
  • Several hedge funds have stopped conducting business with Binance (BNB, USD, 318.68) as regulators scrutinize the firm’s activities.

Disinformation for hire:  Intelligence agencies have conducted disinformation campaigns for years.  The Soviets ran one of the most successful in the early 1980s, suggesting the CIA created AIDS.  Such programs use existing media to spread falsehoods designed to accomplish some goal.  Social media has improved delivery and reduced the costs of such campaigns.  And, it appears with increasing frequency that the activity has jumped from states to the private sector.  Of course, states still conduct this activity, and there is evidence that states are using this expanding private sector to expand its reach.  But, as these disinformation programs expand, it raises the likelihood that states will move to constrain social media.

Tunisia coup?  Tunisian President Kais Saied has reportedly sacked his prime minister and closed parliament for 30 days.  Tunisia’s economy has slumped because of the pandemic, and protests are rising.  The country traditionally celebrates its “Republic Day” today, and it has been marked by widespread civil unrest.  The president is at odds with parliament; Islamist parties dominate the latter.  Saied ran as an anti-corruption independent but had the support of the Islamist parties.  It would appear he has turned on them.  Although Tunisia has a modest economic footprint, it was the starting point of the Arab Spring, and thus, this situation will be closely watched by other regimes in the region.

COVID-19:  The number of reported cases is 194,296,614 with 4,162,124 fatalities.  In the U.S., there are 34,444,770 confirmed cases with 610,892 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 394,948,975 doses of the vaccine have been distributed, with 341,818,968 doses injected.  The number receiving at least one dose is 188,472,188, while the number of second doses, which would grant the highest level of immunity, is 163,025,726.  The FT has a page on global vaccine distribution.

• One characteristic of COVID-19 is that it mostly seemed to spare children of the worst outcomes. However, reports from Indonesia suggest that the Delta variant may trigger higher morbidity among children.  Given that vaccines have not been tested on the very young, if higher death rates are a characteristic of the Delta variant, this would be a problematic development.
• Although the U.S. fiscal packages provided ample levels of rent relief, distribution has been very slow, and if it doesn’t rise, a wave of evictions is likely.
• In light of rising infections, the government is considering tightening mask guidance, recommending masks for the vaccinated. We note that St. Louis City and County have re-instituted mask mandates, effective today.  If re-instituted, we expect lower levels of compliance.
• Shionogi (4507, JPY, 5970), a Japanese firm, is starting small trials of a COVID-19 antiviral treatment that would be a once-a-day pill. Although vaccines have dominated the headlines, antiviral treatments are important as well.  It is becoming clear that current vaccines do not offer sterilizing immunity; recipients can become infected, although the likelihood of serious illness is reduced.  If effective antivirals were available, it would add another line of defense against serious illness.  Current antivirals require an IV.  Shionogi’s treatment would be in pill form, making distribution easier.
• Confirmed cases in the U.K. are declining rapidly after a sharp rise over the past seven weeks. The drop may suggest that the fast spread of the Delta variant may foster increased natural immunity.

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