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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Friday! The Olympics officially open today (although the competition has already started).  Sadly, for the organizers, things are not going all that well.  The pandemic has led to empty arenas, the opening music has been scrapped over a scandal, and the opening ceremony director has been fired.  In the financial markets, U.S. equity futures continue to move higher, while bond yields are up a bit as well.  In today’s report, we update a few things from yesterday, including the ECB announcement, more on the fallout from the Nord Stream 2, and a few comments on home prices.  The coverage begins with economics and policy, with the international roundup next.  China news follows, and we close with pandemic coverage.

Economics and policy:  The ECB and home prices are today’s focus.

• Yesterday, the ECB announced what appears to be a flexible inflation target. The mechanism was left vague, much like what we saw from the Fed on this topic.  Central banks want to preserve flexibility and don’t want to be held to some sort of formula.  Of course, analysts want to predict their behavior and try to create models that will do just that.  However, there is another reason central bank leaders keep targets “fuzzy.”  It can reflect the fact that there is dissension on the governing boards.  A hard target will make some members unhappy, so having a soft target is a way of managing dissent.  In the end, the ECB has promised to keep policy accommodative for a long time.
• Yesterday, we learned that existing home prices reached a new record. There is growing speculation that home prices might be the trigger for tighter monetary policy.  On the one hand, the Fed is rightly concerned about another housing bubble.  Prices scaled to wages suggest we are near bubble highs.

This chart divides the seasonally adjusted median existing home price by the hourly wage and calculates how many years of work a person would need to buy that house.  We are currently at 6.6 years, just below the high of 6.8 years set in May 2005.  However, we do not see the type of risky behavior seen in the last bubble.  For example, 61.5% of refinancing is done at the same loan amount; in 2005, that percentage was 9.4%.  The median credit score on new mortgages is 787, a record high; in Q4 2006 it was 709.  In Q1 2007, $113 billion of mortgages were originated with a credit score of less than 620; currently, that is $17 billion.  So, the signs of froth are not evident.

• Meanwhile, the administration is trying to expand assistance for mortgage borrowers who may face foreclosure through modification. Evictions may begin in earnest soon as state and local governments struggle to distribute assistance.  Paradoxically, in the face of evictions, rent increases are emerging, complicating the inflation picture.
• We are also starting to see potential buyers balk at current prices.
• Although lumber prices have fallen from their recent peaks, wildfires are restricting supply and may bring another round of price hikes.
• On the inflation front, there are reports of companies testing high prices to see how consumers react. A ploy used during the 1970s, the “incredible shrinking package” is also back.  The latest metal to see higher prices is tin.
• Worker shortages continue, with railroads being the most recent industry to report problems. Industry treated workers similar to the way it treated inventory in recent years.  Staff redundancies were rare, and as the pandemic led some workers to retire, companies are scrambling to find employees.
• Intel (INTC, USD, 55.96) warns that the semiconductor chip shortage could last into 2023. This news contradicts earlier reports that the supply situation might improve soon.
• On the regulatory front, the SEC is taking a second look at the swaps market. Increasingly, distributed finance, which uses technology to create financial markets, is moving offshore to avoid regulation.  In our opinion, DiFi is nothing more than regulatory arbitrage, doing to finance what ride-hailing did to taxis.  However, the history of finance shows that eventually, somebody gets overleveraged and defaults.  In the DiFi world, there is no lender of last resort.
• And, on a weekend note, several grill manufacturers are looking to list.

International roundup:  Nord Stream 2 problems continue, and U.S. forces look to leave Iraq soon.

• The fallout from Nord Stream 2 continues. Although the U.S. and Germany have a deal, it can’t be fully implemented without the cooperation of Russia and Ukraine.  That looks like a long shot.  There are growing concerns that since Russia has an outlet for natural gas that avoids Ukraine, will Moscow try to extend its influence?  In other words, increasing the conflict with Ukraine is now less risky.
• As the U.S. finishes the troop withdrawal from Afghanistan, it appears Iraq is next. Our take is the U.S. is moving on from the Middle East. We continue to watch developments.
• The EU has told the U.K. that it won’t renegotiate the Brexit deal.
• Poland is threatening to pull the broadcast license on a U.S. news outlet.

China:  Hong Kongers look to leave, and Wendy Sherman spends the weekend in China.

• In April, the Hong Kong legislature passed several bills restricting the right to protest and leave the former colony. The exit ban goes into effect next month, and Hong Kongers are scrambling to leave.  According to reports, the police have watch lists and will arrest anyone on these lists who tries to leave.  The lists, though secret, are said to be populated with activists and journalists who are currently out on bail and awaiting trial.  On cue, Senate bill S.295, the Hong Kong Safe Harbor Act, has been introduced by Sen. Rubio (R-FL).  It has 13 co-sponsors, nine Democrats, and 4 Republicans.  Although this bill offers hope, it probably won’t pass fast enough to offer a path for Hong Kongers affected by this travel ban.
• Wendy Sherman goes to Beijing over the weekend. Expect a frosty reception.
• The death toll from recent flooding continues to rise.

COVID-19:  The number of reported cases is 192,699,963 with 4,138,605 fatalities.  In the U.S., there are 34,284,455 confirmed cases with 610,192 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 391,998,625 doses of the vaccine have been distributed, with 339,763,765 doses injected.  The number receiving at least one dose is 187,216,168, while the number of second doses, which would grant the highest level of immunity, is 162,174,165.  The FT has a page on global vaccine distribution.

• Although the global economy continues to improve, worries about the impact of the Delta variant are increasing. For example, PMI data from Australia have slipped as lockdowns have been implemented.
• China is continuing to reject WHO requests to investigate the lab-leak hypothesis.
• Medical researchers are increasing their work on “long COVID,” a set of symptoms that have affected up to 30% of those infected by the virus. Symptoms include persistent muscle aches, shortness of breath, sleep difficulties, and “brain fog.”  There is some evidence that COVID-19 causes an autoimmune response that is behind these persistent symptoms.
• Media companies in the past provided content which attracted viewers or readers. The companies would then sell advertising along with their content.  The ingenuousness of social media is that users provide the content; social media companies don’t have to pay for making content and can still sell the advertising.  The downside is, as is true of all media, the most lurid is what attracts attention.  Broadcasters, because they used the public spectrum, were regulated by the government.  Print could avoid that oversight but was still subject to libel rules and social constraints.  But the social media firms were mostly left with no constraints and created algorithms designed to push the worst material to the most people because that’s what they wanted to see.  The impact on society has become problematic, and we have been watching to see how the firms will eventually become regulated.  We note that Sen. Klobuchar (D-MN) has introduced a bill that would remove protections from lawsuits over the platforms hosting misinformation on public health emergencies.

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

[Posted: 9:30 AM EDT] | PDF

Good morning, all!  U.S. equity futures were higher, and long-duration interest rates were rising overnight, but comments from the ECB (see below) have pushed equity futures into the red and have lifted bond prices.  We are also seeing lots of volatility in grain prices; this time of the summer is important.  Corn pollinates from July into August, so temperature and rain matter.  Prices can swing violently on hourly weather forecasts.  Since the May FOMC meeting, expectations surrounding monetary policy have been in flux.  Complicating matters is that there could be some personnel changes on the Board of Governors this fall and winter.  We begin today with comments on the odds of Chair Powell’s reappointment and other Fed matters.  The ECB comes next.  Like a bad penny, Brexit has returned to the headlines.  And, the U.S. and Germany have come to an agreement on Nord Stream 2.  Our usual coverage begins with economics and policy, with China news up next.  The pandemic update follows, and we close with the international roundup.

Powell:  It appears that Chair Powell is getting enough support to probably be reappointed to a second term as Fed Chair.  Aides to President Biden have indicated that they generally support his reappointment, which will be in February.  Randal Quarles, the vice-chair for regulation, has been a target of LWP criticism.  His term in his current role ends October 13, but he could stay as a governor until 2032.  Although it is customary for vice-chairs to resign when their leadership term ends, there are indications that Quarles may stay on.  Vice-Chair Clarida’s term expires in January.  Currently, there is one vacancy on the Board of Governors.  The end of Clarida’s term would give the president two positions to fill on the FOMC.  Although the LWP is pining for a heterodox appointment (Stephanie Kelton perhaps?), the Trump years proved that out-of-the-box governor appointments can’t get through the Senate.  Look for Biden to nominate mainstream left-of-center types.  However, we do note that some research does suggest age matters; younger FOMC members tend to be dovish, likely because they missed out on the 1970s.  Therefore, even a mainstream younger candidate could be a reliable dovish vote.

• The FOMC meets next week; we expect the topic of discussion to focus on balance sheet management.

The ECB:  ECB President Lagarde has been making comments this morning about policy and the new inflation targeting regime.  Although the policy comments suggest that accommodation will continue for the foreseeable future, financial markets are taking the news as bearish.  It is possible that financial markets were hoping for even more policy support (given current levels, that looks like a long shot).  It is also possible that we are seeing position squaring during her comments on worries about an unexpected surprise.  If this is the case, look for a recovery when the statements end.

Brexit returns:  The situation in Northern Ireland has remained a sore spot with Brexit.  The current agreement has established a trade checkpoint in the Irish Sea, meaning Northern Ireland is, for purposes of trade, still in the EU.  The Tories have never been comfortable with this arrangement since the unionist parties tend to affiliate with Johnson’s party.  David Frost, a member of Johnson’s cabinet, wants to reopen negotiations that would create a mixed border.  Essentially, goods destined from Britain, Scotland, or Wales to Northern Ireland alone would no longer need to pass customs, whereas goods exported or imported from the U.K. for the EU would need special customs arrangements.  The EU has already rejected this proposal, as it will create a hard border on the frontier with Ireland.  In addition, it will be nearly impossible to prevent U.K. goods from ending up in the EU via Ireland.  The Johnson government is taking a risk here; the return of a hard border with Ireland will almost certainly lead to a rise in civil unrest, and the U.S. has indicated it won’t tolerate such a development.  We will be watching to see how hard the U.K. pushes on this issue, but there is a risk of serious turmoil that might adversely affect U.K. assets.

Nord Stream 2:  The Biden administration has made it official; the U.S. will go along with the German/Russian Nord Stream 2 project.  We must admit this is a head scratcher for us.  The administration is arguing that the pipeline was nearly done, so it was counterproductive to try to stop it, but the approval rewards Russia and allows Germany to adversely affect nations east of it which earn transit fees from existing pipelines.  It’s hard to see how being nice with Russia will reap rewards, and Merkel will be out of office in less than two months.  This is giving out favors and seemingly getting little in return, although the U.S. did make an agreement on climate investment with Germany.  The president of Ukraine, Volodymyr Zelensky, is scheduled to visit Washington in August.  Reports indicate the U.S. has told Ukraine to be quiet about the deal.  This is going to be an awkward meeting.  Meanwhile, criticism, both foreign and domestic, is pouring in.  Governments do, at times, make pacts that can be hard to accept, but usually, it’s to get something important in return.  This one seems to get the U.S. little of substance and will drain some of the president’s political capital.

Economics and policy:  The debt ceiling is looming, the infrastructure debate continues, and house supply is still tight.

• Although the debt ceiling expiration is looming, the Treasury can postpone a crisis probably into October. However, these actions may reduce the availability of T-bills, potentially pressuring the money market industry.  The GOP wants to use the debt ceiling to push for spending cuts.  Although these debt ceiling events eventually get resolved, they give the party out of power some leverage.  In the past, any drama tends to lead to risk-off market activity.
• Debate on the bipartisan infrastructure bill was blocked in the Senate but it appears negotiations are continuing. Majority leader Schumer is trying to create deadlines for both the infrastructure bill that will be voted on in regular order and the much larger bill that will go through reconciliation.  Schumer’s worry is that if the bills aren’t passed by the August recess (August 9), lobbyists will hammer on members back home, making passage more difficult.  Taking the approach of two bills carries risk, but given the narrow majority the Democrats hold, this is the only way to get a package through.  We still expect these measures to pass, but this event will probably be the last item of significance to be legislated.
• The Distribution Financial Accounts data from the Federal Reserve shows that residential real estate is the largest asset held by the bottom 90% of households. The steady encroachment of financial firms into home rental could potentially compete with households for home ownership.  So far, this hasn’t been a political issue, but we would not be surprised to see a pushback in the coming months.
  • Regulators note that the supply of lower-cost “starter” homes is very tight, making it harder for young families to enter the housing market.
  • Although Congress has provided around $47.2 billion in rent relief, the states have only distributed about $3.0 billion, or about 6.5% of the total. If the pace of aid doesn’t accelerate, we could see mass evictions in the coming months.
• So far, the states that ended extra unemployment benefits early have not seen a surge in new hiring.
• The Biden administration is expanding its antitrust activity. The Federal Maritime Commission announced an audit of seaborne carriers.  In the wake of the Great Financial Crisis, global trade contracted, leading to industry consolidation.  This action by the U.S. is to investigate whether this industry is engaging in anti-competitive practices.
• Non-compete clauses in labor arrangements have been slowly expanding over the years into areas that would not appear to need them (including fast food). Non-compete clauses bind the worker to the company and reduce competition for that worker, reducing their potential wages.  The U.S. is looking to limit these clauses in a bid to improve conditions for workers.
• Internal polling is showing that Americans are becoming concerned about inflation. The administration is trying to address the issue, but in reality, there isn’t a good solution to current supply-driven inflation other than time.  However, if inflation doesn’t begin to decline soon, it will be an important issue in 2022’s midterms.
• Recent research shows that the Midwest offers a large number of jobs that have high wages but don’t require a bachelor’s degree.

China:  China is struggling with flooding, Sherman will go to Beijing after all, and tensions between Washington and Beijing are elevated.

• China is dealing with massive flooding, a trend that has been developing in recent years. Central China is receiving historic rainfall amounts; the city of Zhengzhou reported a daily rainfall record of 18”, with 7” reported in one hour.  For reference, the average annual precipitation in Zhengzhou is just over 25”.  Subways were submerged, trapping passengers.  Thousands have been displaced, and dozens have perished or are missing.  Zhengzhou is the home of iPhone’s (APPL, USD, 145.40) largest manufacturing site.  Pictures from the city show the level of devastation.
• Earlier this week, Beijing had snubbed Deputy SoS Wendy Sherman when the U.S. requested a meeting with Wang Yi, China’s foreign minister. Initially, China offered a lower-ranking diplomat; the U.S. refused to make a visit and treated the action as a snub.  Beijing has apparently relented, making Wang available for a meeting.
• In response to U.S. accusations against China hacking, Beijing has leveled similar charges against the U.S. On the one hand, the report originated in Global Times, a CPC mouthpiece.  At the same time, American cyber capabilities are strong, so we would not be shocked if the charges are true.  China is lashing out verbally against the accusations in its media.  At the same time, there is evidence that China has made strong efforts to boost its cyber capabilities.
• Evergrande Group (EGRNF, USD, 0.95), the heavily indebted Chinese property developer, appears to be heading toward bankruptcy. Banks are no longer providing mortgages to the firm’s development projects, which will likely force it to restructure.
• U.S. and Chinese firms are increasingly being forced to deal with rules and restrictions from Washington and Beijing.
  • S. tech social media firms are dealing with a new Hong Kong law against the practice of “doxing,” which is the practice of disclosing personal information online. This action is usually done in protest, encouraging social media participants to send unpleasant messages.  In some cases, this harassment can move into “real life,” which can mean protests at a person’s home or hacking their financial accounts.  The legislature gives broad latitude to security forces, including the ability to seize data from social media firms, even if they are outside of Hong Kong.  Complicating matters further is that the law never precisely defines doxing, meaning the police will define the activity on the fly.  It also allows security forces to detain employees of tech firms for failing to remove content deemed to be doxing.  In effect, this is expanding the reach of China’s “Great Firewall.”  This new law could easily force social media firms to exit Hong Kong and China altogether.
  • As the U.S. attempts to ban goods from Xinjiang, suppliers who provide components to U.S. firms are starting to move operations out of the western region to other parts of China. Their hope is by moving they can still maintain business with U.S. firms.
  • Eastman Kodak (KODK, USD, 7.74) has deleted an Instagram post showing images of Xinjiang taken by the French photographer Patrick Wack. Wack described this picture as providing a narrative of Xinjiang’s “abrupt descent into an Orwellian dystopia.”  The company took down the post suggesting the page was to display creativity, not to make political statements.  The Global Times touted Kodak’s apology.  We would not be surprised to see a backlash to the decision from the U.S.
• Despite the problems in Hong Kong, there is little evidence to suggest the turmoil is hurting its standing as a financial center.
• As the U.S. and China continue to steadily decouple, China is attempting to expand its technology hardware industry. Beijing’s ambitions in this area are suffering a setback, as Tsinghua Unigroup (002049, CNY, 172.50) appears to be on the brink of bankruptcy.
  • U.S./China decoupling is probably not fully appreciated by investors.
• Bitcoin mining is mostly coming to an end in China.
• It appears Chinese leaders have concluded that Biden is more difficult than Trump because the former is building coalitions to contain China. However, we prefer to view China policy in the context of trend rather than personalities.  Simply put, the U.S., on a bipartisan basis, is concluding that China is a problem.
• China was successful in reducing birth rates with its “one-child” policy. Now it is trying to increase births through policy as well; results thus far are not encouraging.

COVID-19:  The number of reported cases is 192,149,552 with 4,129,954 fatalities.  In the U.S., there are 34,229,841 confirmed cases with 609,870 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 391,248,955 doses of the vaccine have been distributed, with 339,102,867 doses injected.  The number receiving at least one dose is 186,819,440, while the number of second doses, which would grant the highest level of immunity, is 161,895,045.  The FT has a page on global vaccine distribution.  The Axios map shows rising cases in most of the U.S.

• The WHO is calling for a new investigation of the Wuhan lab; Beijing is not happy.
• Australia has been controlling the virus through lockdowns and social distancing. It hasn’t moved rapidly on vaccine distribution, which now looks like a mistake.
• Asian nations are dealing with high levels of Delta variant infections.
• Although we hear of “believing in science,” it is important to remember that science is a process of inquiry, not an ideology. One scientist, in analyzing new data, has moved from the lab-leak hypothesis to the theory that the virus moved to humans from an animal host.  This is how science works; a theory is constantly questioned by incoming data.  Holding that position should be based on the strength of the explanation and not on a belief.
• The CDC reports that U.S. life expectancy fell last year, mostly due to the pandemic.
• In looking at death rates and infections, nations with higher levels of vaccinations are seeing lower death rates.

International roundup:  Central Asia is in turmoil, and Cyprus might be next for unrest.

• As the U.S. leaves Afghanistan, nations in the area are preparing for instability. In response, Russia has become increasingly active in central Asia.  It has sent 17 BMP-2 vehicles to Tajikistan to support infantry.  It also moved T-72 tanks to the region.
  • Meanwhile, Turkey says it will protect the airport in Kabul if the U.S. provides funding and other support.
• The city of Varosha, on the island of Cyprus, was abandoned in 1974, when the island was divided between Turkey and Greek Cypriots. It is on the border of the dividing line between the two powers.  In a provocative move, Turkey claims it will partially reopen the city to supporters of Turkey.  The U.S. and EU have protested the decision.
• The U.S. has launched airstrikes on al-Shabab located in Somalia, the first attacks since January.
• As the Olympics begin, PM Suga of Japan is in a difficult spot. He has pushed for the games to go forward, but pandemic restrictions and the massive costs required to conduct the games have sent his approval ratings to very low levels.

Earlier this week, we noted that flooding in Germany might lead to gains for the Greens.  However, so far, no party seems to have an advantage from the disaster.

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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 begin with a preview of today’s procedural vote in the Senate on the bipartisan “hard” infrastructure bill.  We follow that with a range of U.S. and international news, focusing on the increasing regulatory risks facing the technology sector.  We wrap up with the latest developments regarding the coronavirus pandemic.

U.S. Fiscal Policy:  The Senate today is scheduled to hold a procedural vote on the bipartisan “hard” infrastructure bill totaling approximately $1 trillion, but Republicans are threatening it because the continuing negotiations on the proposal leave too many details up in the air.  Senate Majority Leader Schumer is also pushing for all 50 members of the Democratic caucus to agree today to a $3.5 trillion outline for a broad antipoverty and climate package they are pursuing parallel with the bipartisan infrastructure talks.

• Failure of the hard infrastructure vote wouldn’t necessarily kill the bill since it could be brought up again.
• There is still some chance that Schumer could delay the hard infrastructure bill until later in the week when some Republicans suggest they would likely have final details and could vote for it.

United States-Germany-Russia:  Washington and Berlin have reportedly reached an agreement allowing completion of the Nord Stream 2 natural gas pipeline from Russia to Germany.  Under the deal, the U.S. will end its opposition to the pipeline, which was based on its view that the line would boost Russia’s leverage over Europe and weaken Ukraine by draining shipments away from its major Russia-Europe pipeline.  In turn, with the threat of U.S. sanctions over the pipeline lifted, Germany would help Ukraine develop its energy independence and back it diplomatically.  The U.S. would retain the right to levy future pipeline sanctions in the case of actions deemed to represent Russian energy coercion.

• Resolving the pipeline dispute will open President Biden to allegations of being soft on Russia and unsupportive of Ukraine.  However, it also plays into Biden’s focus on improving U.S.-Europe relations so they can together focus on the geopolitical competition with China.
• Indeed, resolving the dispute could even help ease U.S. tensions with Russia, which the Biden administration has also sought to achieve in order to allow it to focus more fully on the competition with China.  As one sign of the effort to cool tensions, the U.S. and Russia will launch new arms-control talks next week.  The talks, which were agreed to by President Biden and Russian President Putin at a summit last month, would seek to build on the New START nuclear arms treaty.
• Finally, the pipeline was approximately 90% complete when Biden took office, and administration officials saw little hope of derailing the project at such a late stage.  Resolving the disagreement is a relatively inexpensive way to “throw a bone” to Germany and Russia.

United States-Somalia:  U.S. forces have conducted an airstrike targeting al-Shabab fighters in Somalia, marking the first such strike under President Biden.  The strike, which comes after most U.S. troops have left the country, supported partner Somali forces under attack in the vicinity of Galkayo.

Global Technology Industry Regulation:  The Chinese government has opened yet another new front in its battle to get control over its burgeoning technology companies.  This time, the Cyberspace Administration of China has fined and warned several big companies, including Alibaba (BABA, $210.59) and Tencent (TCEHY, $69.85), over explicit material and exploitation of children on their platforms.  We continue to believe major technology firms worldwide are facing increased regulatory risks, especially those that could be caught up in the U.S.-China geopolitical competition or in Beijing’s effort to clamp down on rich and powerful tech firms.

• The technology sector is also facing increased regulatory risks in the U.S.  President Biden yesterday said he would nominate Jonathan Kanter to run the Justice Department’s antitrust division.
• Kanter has been a vocal critic of Google (GOOG, $2,622.03), so the nomination provides further evidence that the administration will take an aggressive posture on enforcing antitrust laws, not just in the technology sector but across industries.

China Demographic Policy:  Following up on its May decision to allow couples to have up to three children, the government launched several new initiatives to boost the country’s birth rate and stave off population decline by making it cheaper and easier to raise kids.  Under the guidelines, provincial and local governments will be encouraged to increase the number of daycare slots, give preferential treatment to parents looking for housing, and offer tax breaks to parents for their childrearing costs.

• We note, however, that similar efforts by other demographically challenged countries have done relatively little to reverse their falling birth rates.  Once the process of population decline has started, it can be very difficult to reverse.
• Over the longer term, falling birth rates will lead to further population aging, slower economic growth, and less economic dynamism in China.  Over time, that will likely have a negative impact on Chinese economic and financial prospects.  It could also put President Xi under even more pressure to boost Chinese geopolitical power as soon as possible before the negative impact of its demographics really starts to take hold.

China Flooding:  Severe flooding has killed at least a dozen people in Zhengzhou, the central Chinese city that is home to the world’s largest iPhone assembly plant, and record rainfall is threatening to burst through nearby dams.

• The torrential rain was described by meteorologists as a “once in a millennium” event that surpassed anything recorded since 1951.
• Coupled with Europe’s “once in a millennium” flooding over the last week, the catastrophe is likely to feed into calls for stricter climate-change policies in advanced countries.

Iran:  Angry demonstrations calling for better access to electricity, water, and other public services have broken out all over Iran during the last week, posing an immediate challenge for incoming president Ebrahim Raisi when he is inaugurated on August 4.

Olympic Games:  Strict quarantine and self-isolation rules are sparking intense anger among athletes, staff, and media professionals at the Tokyo Olympics.  For example, athletes who have come into contact with a person who has tested positive have been told to quarantine and train alone under strict rules.  They will still be allowed to participate as long as they continue to pass daily tests.  Stricter rules apply to media and other delegates, who have been forced to quarantine for two weeks in cramped hotel rooms.

COVID-19:  Official data show confirmed cases have risen to 191,549,981 worldwide, with 4,121,042 deaths.  In the United States, confirmed cases rose to 34,177,406, with 609,536 deaths.  Vaccine doses delivered in the U.S. now total 390,735,975, while the number of people who have received at least their first shot totals 186,474,836.  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, 56.2% of the U.S. population has now received at least one dose of a vaccine, and 48.7% of the population is fully vaccinated.  All the same, the more transmissible and lethal Delta variant of the virus continues to spread rapidly, especially among the unvaccinated.  The result is that U.S. infections, hospitalizations, and deaths continue to rebound after a long period of decline.
• According to CDC Director Walensky, the Delta variant of the virus now accounts for 83% of COVID-19 cases analyzed by the agency.  That’s up from 50% in the week of July 3.  Despite the spread of the Delta variant and the resurgence of infections, however, local officials are generally trying to avoid stringent new lockdowns like those imposed at the beginning of the pandemic last year.  That could help minimize the negative economic impact of Delta but wouldn’t necessarily eliminate it, as many individuals are likely to respond by self-isolating and pulling back on shopping and other activities.
• Provisional data from the CDC indicates that the pandemic drove U.S. life expectancy down 1.5 years in 2020.  Life expectancy in 2020 was calculated at 77.3 years, basically back to where it was in 2003.
• Apple (AAPL, $146.92) told its workers yesterday that their planned return to the office would be delayed from September until at least October, based on the recent resurgence of cases.
• Throughout Southeast Asia, surging infections have started to disrupt operations at major firms related to the electronics industry.  Of particular concern is the risk that rising cases in Southeast Asia could exacerbate the global semiconductor shortage.
• Just as the Tokyo Summer Olympics are due to open officially on Friday (some competitions have already begun), Tokyo reported 1,832 new COVID-19 cases today, rising by nearly 700 and surpassing the week-before figure for the 32nd consecutive day.  Today’s figure in Tokyo was the most since January 16, and it was the sixth-highest daily tally ever in the capital.

 Economic and Financial Market Impacts

• As rebounding demand and supply disruptions continue to buoy prices, increased housing costs are getting more focus as a source of inflation, not only among investors and economists but also among policymakers at the Fed.
• On a related note, new data shows that as remote work became more common, home buyers have started to put much less emphasis on the length of a commute.  In some of the nation’s most expensive metro areas, home prices rose faster during the pandemic in areas with longer morning commutes to business districts versus neighborhoods with short commutes.

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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 new threats to regulate cryptocurrency-related assets.  Coupled with the surging concerns about the new Delta mutation that pushed down prices for a variety of assets yesterday, the new regulatory threat helped push down cryptocurrency values as well.  We next turn to a variety of foreign, economic, and political news.  We close with the latest developments on the pandemic.

U.S. Cryptocurrency Regulation:  At yesterday’s meeting of President Biden’s working group on financial markets, Treasury Secretary Yellen “underscored the need to act quickly to ensure an appropriate U.S. regulatory framework in place” over stablecoins.  According to the Treasury Department, participants in the meeting discussed the rapid growth of stablecoins and their potential use as a means of payment, as well as potential risks to consumers, the financial system, and national security.  The new threat of regulation put further downward pressure on cryptocurrencies yesterday, helping to drive Bitcoin below $30,000.

United States-Vietnam:  In a joint statement yesterday, Treasury Secretary Yellen and Vietnam State Bank Governor Nguyen Thi Hong said Vietnam’s central bank pledged not to manipulate its exchange rate to give its exporters a competitive advantage.  If the pledge is honored, it could be an important benefit since Vietnam has become a major source of U.S. imports in recent years.

• Last year, the Trump administration labeled Vietnam a currency manipulator and threatened to impose sweeping tariffs on imports from Vietnam.
• The Biden administration reversed the “manipulator” designation in April, saying it found insufficient evidence that the country was manipulating its currency but is still holding out the possibility of imposing tariffs if Vietnam doesn’t meet its pledge.

European Union:  In a report on the health of the EU’s rule of law due today, the European Commission is set to highlight “serious concerns” about judicial independence in Poland and Hungary and clientelism, favoritism, and corruption in the Hungarian government.  The language on Poland and Hungary is particularly sensitive, as the two countries are currently seeking approval for their plans to receive their share of the EU’s €800 billion pandemic recovery fund.

• Poland and Hungary have often been at odds with the rest of the EU over issues such as media freedom and judicial independence.  Since many EU decisions require unanimity among the bloc’s members, those disputes have weakened the EU’s cohesion and hamstrung it on some issues.
• The EU’s continuing cohesion and decision-making hurdles are an ongoing challenge to the bloc’s competitiveness and economic heft.

Olympic Games:  A day after Toyota Motor (TM, $176.30) said it wouldn’t show any commercials related to the Olympics in Japan during the games, other major Japanese sponsors are also announcing reduced activities related to them.  Today, companies ranging from Nippon Telephone and Telegraph (NTTYY, $25.95) to Fujitsu (FJTSY, $36.36) and NEC Corporation (6701-JP, JPY, 5,550) said they would not be sending any senior officials to the opening ceremony on Friday.  The news suggests that the Tokyo Summer Games will be a bust for many of those involved, including the athletes who will compete without an audience.

• On at least one level, the games will also be a bust diplomatically.  South Korean Prime Minister Moon has reportedly decided not to attend the Friday opening ceremony.
• That means he won’t be meeting Japanese Prime Minister Suga, dashing hopes of a breakthrough to better relations between the two countries.

Russia-Tajikistan-Uzbekistan-Afghanistan:  Russia, Tajikistan, and Uzbekistan will hold joint military maneuvers near the Tajik-Afghan border in early August amid increasing security concerns in Central Asian nations over Taliban offensives against government troops in northern Afghanistan.  The drills underscore the deep concerns that the U.S. military pullout and an imminent Taliban takeover of Afghanistan could destabilize the entire region.

Ukraine:  Even as Russian-backed separatists continue to hold territory and fight the government in eastern Ukraine, some economic reform efforts are proceeding in the country.  The government has just proposed new laws to combat graft and promote good governance in financial institutions, which central bank governor Shevchenko said was an essential step towards the planned privatization of Ukraine’s state-owned lenders.  Those lenders still make up about 55% of the country’s banking sector.

Peru:  The National Electoral Jury finally gave official confirmation that leftist candidate Pedro Castillo won the June presidential election.  Castillo will be sworn into office next week after one of the longest and most bitter electoral battles in the country’s history.

COVID-19:  Official data show confirmed cases have risen to 191,057,501 worldwide, with 4,099,017 deaths.  In the United States, confirmed cases rose to 34,133,951, with 609,268 deaths.  Vaccine doses delivered in the U.S. now total 390,174,755, while the number of people who have received at least their first shot totals 186,317,651.  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, 56.1% of the U.S. population has now received at least one dose of a vaccine, and 48.6% of the population is fully vaccinated.
• Despite the progress to date on vaccinations, the seven-day average of new infections in the U.S. has risen to 32,287, more than double the level 10 days ago. The uptick in cases has touched every state and Washington, D.C., with the seven-day average of newly reported cases exceeding the 14-day average in each jurisdiction for the past four days.  Hospitalizations and deaths are also beginning to rise again, driven in large part by those who have not gotten their vaccinations.
• A federal judge has ruled that Indiana University may require its students to submit proof of COVID-19 vaccination before returning to campus this fall, dealing a setback to legal efforts against vaccination requirements in higher education.
  • According to the judge, the university system acted reasonably to protect public health when it required all of its students, faculty, and staff to be fully vaccinated against COVID-19 by July 1, with limited medical and religious exceptions.
  • However, an attorney who represented the students who brought the suit said they would appeal the ruling.
• The Canadian government said it would allow fully vaccinated Americans to enter Canada for recreational or tourist activities beginning August 9, more than a year after authorities closed the 5,500-mile border to most travelers to limit the spread of COVID-19.
• Even though China’s strict, zero-tolerance strategy to contain the pandemic helped quickly bring it under control and has prevented any broad resurgence of the disease, analysts now note that the strategy means the country will probably not be able to open up internationally until the end of the year.

 Economic and Financial Market Impacts

• The National Bureau of Economic Research, the official arbiter of U.S. economic cycles, declared that the pandemic-induced recession lasted only during March and April 2020, after which the economy began to recover.  That means that the recession was the shortest on record, owing in large part to the rapid governmental response in terms of loosening monetary and fiscal policy.
• Rebounding demand and a shortage of workers continue to give workers the leverage to demand higher pay.  Information technology tools such as online courses and social media may be helping to give workers more leverage over employers, just as unions did in the past.
• With the dollar surging again in response to concerns over the Delta mutations and the prospect of higher interest rates, emerging market investors are bracing for increased volatility.  Further appreciation of the greenback would be a negative for emerging-market stocks going forward.

U.S. Policy Response

At the White House yesterday, President Biden touted the burst of job creation and economic growth during his first six months in office as pandemic restrictions were lifted and households benefited from large doses of fiscal stimulus.  However, he also took pains to say that the administration would remain vigilant about rising prices, and he expects the Fed to take action if needed.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  U.S. equity futures continue to trend lower this morning.  A resurgence in COVID-19 infections and worries about the economy and inflation have weakened investor sentiment.  Oil prices are sharply lower this morning, and bond yields are falling as well.  Our coverage begins with reports that the U.S. is accusing China of instigating the hack of Microsoft (MSFT, USD, 280.75).  German flooding is up next, followed by the OPEC+ deal.  We then move to a discussion of cryptocurrencies, economics and policy, and the pandemic update.  We close with China news and comments on Lebanon.

The Microsoft hack:  The U.S. is accusing the Chinese government of cooperating with organized crime groups in China to engage in widespread cyber-attacks, including last year’s infiltration of Microsoft.  This accusation isn’t coming from Washington alone; the EU, U.K., Australia, Canada, New Zealand, Japan, and NATO all agree on this point.  The governments accuse China’s Ministry of State Security (MSS) of employing criminal elements to carry out these attacks.  The U.S. is expected to reveal details of the attacks later today.  This accusation is notable.  Criminal groups in Russia have carried out numerous high-profile attacks recently, but the Kremlin has apparently taken great pains to avoid direct state sponsorship.  All Russia does, at this point, is provide safe harbor for cybercriminals. Tying the attacks to the Chinese government directly requires a state-to-state response.  At a minimum, sanctions will likely be applied to officials tied to MSS.  If Beijing maintains its “wolf warrior” diplomacy, we can expect an aggressive reaction against these charges.

German flooding:  The tragedy in Germany continues.  Floods, described as a “500-year” event, are affecting areas in western Germany.  New evacuation orders have been issued, even as some areas start the clean-up process.  Chancellor Merkel visited flood affected areas of Germany yesterday.  There is growing speculation that the intensity of the flooding, which may have been affected by climate change, might help the Greens in the September elections.  So far, polling isn’t showing this development, but the prediction markets suggest a modest decline in support for Armin Laschet, the CDU candidate for chancellor, who is also the premier of the flood-affected North Rhine-Westphalia region.  Although the Federal government issued warnings, state and local governments apparently didn’t issue evacuation orders, leading to high fatality rates.  Compounding the lack of action to protect lives, Laschet was seen laughing in the background during a press conference.  Although the Greens rose in popularity in the spring, that surge didn’t last.  Recent polling trends suggested that the CDU/CSU was likely going to maintain power.  This event and Laschet’s lackluster response could change that trend.

OPEC+:  Although an agreement was indicated last week, over the weekend, the oil cartel formalized the deal.  Oil production is scheduled to rise 0.4 mbpd per month, starting in August, for the next two years.  Oil prices have fallen hard this morning on the news.  It remains to be seen just how much new oil comes to market.  At the same time, rising COVID-19 cases threaten demand.  The combination of higher output and perhaps slower consumption is weighing on prices.

Cryptocurrencies:  Regulators are taking aim at “stablecoins.”  These coins are pegged to national currencies and are used by participants in cryptocurrencies to transact business.  For example, if traders wanted to take profits on a bitcoin position and didn’t want to trigger a traceable taxable event by putting the proceeds into the banking system, they could put the funds into a stablecoin.  In theory, if the stablecoin did what it says it does, simply holds reserves of USD for each stablecoin issued, this would not create a systemic risk issue.  However, it is hard to see how the provider of the stablecoin makes any money by acting in this fashion.  The fear is that stablecoins are runnable; in other words, the provider, to make money, is likely investing the reserves in some other financial asset.  The stability of the stablecoin is dependent on the holdings in its reserves.  Since there are no regulations in this arena, the temptation is to hold higher-yielding but less liquid assets on the assumption that all the holders won’t demand the national currencies simultaneously.[1]  The fear among regulators is that a run on stablecoins could end up affecting the financial system, as the coins may have been used as collateral for lending.  The numbers are not insignificant; Tether has $64 billion in assets, USD coin, $26 billion, and Binance (BND, USD, 280.01) USD, $11 billion.

• Although there has been a steady parade of proposals for crypto ETFs, the SEC has not approved any in the U.S.
• It appears the bitcoin mining has moved from China to Kazakhstan.

Economics and policy:  Infrastructure legislation reaches a critical moment, and the tight labor markets are colliding with the politics of immigration.

• Senate majority leader Schumer is trying to set close deadlines for the infrastructure measures. This is a time-worn tactic in legislation; put an artificial deadline in place, and the party in power tries to force legislators to compromise quickly.  There is another reason Schumer is moving so fast.  If he doesn’t get the bills done by August 9, the Senate is scheduled to go into recess.  This absence would give lobbyists the opportunity to work against the legislation for about a month and reduce the odds of passage.  Minority members are crying foul (also a time-worn tactic by the party out of power).  One item that has emerged is that the IRS enforcement source of revenue has apparently been killed.  This struck us as a questionable tactic.  It’s a bit like a city deciding to budget more revenue from traffic tickets.  Although we expect something to get done on infrastructure, the clock is running, and if it doesn’t pass by early August, the odds that part will fail increases.
• In the “dog that didn’t bark” category, we note that recent antitrust measures didn’t get much pushback from the GOP. This is likely an indication of just how populist both parties are becoming.
• In a related area, it is well known that friction in the labor markets is elevated. The opening to hires ratio is at record levels, for example.

We note a recent editorial in a Texas newspaper suggesting that immigration could fix this problem.  We also note that there has been a surge of arrests on the Mexican/U.S. frontier.  Soaring wages (our own Dave Miyazaki sent me a report of a fast-food restaurant offering $17 per hour in Frazer, CO) are a result.  The goals of populism, margin protection, and immigration are colliding here.  Business would like more workers to keep wages dampened and thus supports higher immigration.  Populists on the right oppose immigration in order to keep wages elevated.  Immigrants, seeing the higher wages, are clearly flocking to the border.  There is no doubt this is a crisis; the issue is who will bear the cost of the crisis, capital or labor.

• Related to the stablecoin discussion above, the Fed and other regulators are taking another swing at making money markets less runnable. The industry wants to “have its cake and eat it too,” which means it wants to have investors believe money markets are as safe as bank deposits with a higher yield.  In fact, they are not.  The issue is how “less safe” are they?  It is clear that in recent financial crises, money market funds proved to be “ground zero” as they proved runnable.  However, if regulators reduce the risk, they may also reduce funding for commercial paper and other short-term debt instruments.
• Although inflation worries are elevated, the drop in oil prices and the recent decline in lumber show that markets for commodities do eventually clear. In homebuilding, builders are trying to figure out how to price their product in the face of rising material costs.
• Markets are beginning to figure out that we are probably at peak growth, and the rate of change will slow from here.

COVID-19:  The number of reported cases is 190,526,225 with 4,091,672 fatalities.  In the U.S., there are 34,080,890 confirmed cases with 609,021 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 390,100,605 doses of the vaccine have been distributed, with 337,740,358 doses injected.  The number receiving at least one dose is 186,038,501, while the number of second doses, which would grant the highest level of immunity, is 161,232,483.  The FT has a page on global vaccine distribution.

• As the U.K. officially reopens from pandemic lockdown measures tomorrow, infection rates are rising, and the PM and a few other cabinet members have gone into quarantine after being exposed to the virus. There are concerns that the U.K. may have moved prematurely.
• The U.K. is expanding its research on “long COVID,” the condition where those infected have lingering symptoms.
• Indonesia has become the world’s “hot spot” with new infections. The highly infectious Delta variant is rapidly spreading across the island nation, overwhelming the medical system there.
• China is mandating vaccines for both students and their families.
• The EU has caught up to the U.S. on vaccinations.
• Although U.S. infection rates are rising, hospitalizations and deaths are not as high as in earlier periods. Most of the hospital admissions are being reported in areas with low vaccination rates.

China:  China acts to quell inflation, and the U.S. acts to limit technology exports to China.

• Although there have been concerns that China would become a conduit for inflation, the country has, instead, taken aggressive steps to dampen price increases. The country has released strategic stocks to lower commodity prices, and companies are seeing margins fall as they absorb higher material costs.
• In further evidence that the policy of opposing China has become bipartisan, the Biden administration is continuing the Trump administration policy of blocking high-tech machine tools to China.
• Australia is providing financing to Telstra (TLSYY, USD, 13.94) to buy mobile networks in the small Pacific island states to prevent Chinese firms from purchasing them.

Lebanon:  Although it isn’t gathering much media attention, Lebanon is slipping into a massive crisis.  The exchange rate is plummeting, the government is in disarray, and now the head of the central bank is embroiled in a corruption scandal.  As conditions deteriorate, it would be reasonable to expect another refugee situation to emerge.

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[1] This is, of course, the business model of fractional reserve banking.  Until deposit insurance and regulation, bank failures were common.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  There are two meetings of note this morning.  First, President Biden meets with Chancellor Merkel for her last official visit before she leaves office in September.  Expect lots of warm comments, but the obvious drift in policy between the U.S. and Germany will continue.  Second, Chair Powell heads to the Senate today for the semiannual testimony to Congress (more on this below).  In Europe, heavy flooding has left 20 dead.  U.S. equity futures are falling this morning.  Our coverage begins with Chair Powell’s testimony and Fed policy.  Up next are comments about the EU’s new climate policy.  China news is followed by economics and policy.  International news comes after that, and we close with pandemic coverage.

Chair Powell:  The Fed Chair will testify before the Senate Banking Committee today, after talking to the House yesterday.  The takeaways are that he admitted inflation has risen faster and greater than he expected, but he continues to hold that the changes will be transitory.  There is evidence to support this position.  The Cleveland FRB trimmed mean measure, for example, up 2.9% from last year, which is elevated but still well below core CPI.  There is no doubt the Fed is trying to navigate a difficult path.  It’s important to remember that in the short run, Fed policy mostly affects aggregate demand.  When it tightens, it weakens consumption to reduce inflation.  Much of what we are seeing on the inflation front is supply driven.  The pandemic affected the economy in a myriad of ways, and many of them will be temporary.  However, some may not be (e.g., the drop in over 65 labor participation probably isn’t returning to pre-pandemic levels).  The longer inflation persists, the greater the chance that inflation expectations change, leading to balance sheet adjustments that foster future inflation (i.e., higher inventory levels, rising wages).  At the same time, tightening into temporary supply constraints will lead to falling demand just as supply is recovering, which could lead to a rapid decline in prices and risk recession.  Thus, we expect policy to remain steady at least through 2021, although pressures to at least slow the balance sheet expansion will be high.  We will have more to say on this issue in the coming weeks, but 2022 could easily become the year of dissent on the FOMC.

A couple of observations—first, there is rumbling on the left to replace Powell next year.  His term is up in February.  The policy establishment likes Powell and is lobbying to keep him in power.  The Chair has cultivated relationships in Congress and would almost certainly be confirmed if reappointed.  The populist left thinks he is too cozy with the financial services industry and wants him replaced.  The establishment hopes that replacing Vice-Chair for Regulation Randy Quarles will placate the left (his term ends in October), but it might not.  If Powell isn’t going to get another four-year term, Biden will need to signal his intentions by September or October at the latest.  If Powell is out, who is in?  The consensus bet is Fed Governor Brainard, but we are keeping our eye on Raphael Bostic, the Atlanta FRB president.  Second, some rethinking about inflation is starting to show up in the media.  Although inflation is complicated, in one sense, it’s a measure of the relative power of labor versus capital.  The rise of profitability over the past three decades is prima facia evidence that 2% inflation is favorable to capital.  It’s also the case that in the early stages of reflation, lower-income groups can benefit.  As inflation and wages rise, the real cost of debt service falls.  This effect is not permanent; as inflation expectations change, borrowing costs rise to reflect anticipated inflation.  Another item of note: because the baby boomers are the last generation to experience significant inflation, the ageing process is removing that institutional memory and younger generations are more willing to take a chance on reflation.

The EU’s climate policy:  The EU unveiled its climate policy today, and it is aggressive.  The plan calls for ending sales of internal combustion engines by 2035.  It will expand the use of carbon pricing.  The often discussed carbon border tariff is part of the plan.  Fuel taxes will be aimed at the dirtiest fuels.  The EU is attempting to have the incidence of carbon pricing fall on European business, but we doubt households will be spared from absorbing the costs.  This plan is ambitious and will face strong opposition both in Europe and abroad.  EU automakers are getting a clear signal to electrify, and foreign firms will at some point face potential tariffs based on their production methods.  It is also worth noting that addressing climate change will fix one problem but create others; for example, mining the metals required for electrification is a dirty process that is probably unavoidable.

China:  Japan is becoming more vocal on Taiwan, and China’s GDP slows.

• Japan has published its annual Defense of Japan report and it makes clear that Japan’s defense establishment is quite concerned about the situation in Taiwan.  Earlier this month, Japan’s defense minister indicated Japan would use its military to defend Taiwan against Chinese aggression even if the U.S. refrained.  It appears that Tokyo is raising the stakes in the Taiwan/China situation.
• China’s GDP for Q2 rose 7.9% from last year, but compared to Q1, growth was a mere 0.5%. There is rising speculation the PBOC will begin to ease soon to lift activity.  However, there are also concerns about rising levels of bad debt, which may limit stimulus.
• Although there has been little written on Chinese debt problems recently, a builder in Sichuan province has apparently failed to repay a local bond, which is the first default on a domestic credit. Real estate developers have been struggling to meet their debt obligations in recent months.  The firm, Sichuan Languang Development Co (600466, CNY, 2.68) has indicated it would not be able to pay back the bond.  S&P has downgraded the firm to “D” from “CCC-.”
  • Meanwhile, the money markets in China are waiting to see how the PBOC deals with CNY 400 billion of medium-term credit facility loans that are coming due today. Financial regulators are increasingly worried about a slowing Chinese economy but are leery of easing credit too quickly and triggering another bout of new lending.
• The U.S. has further clarified its position on U.S. firms conducting business with Chinese companies with ties to Xinjiang. It appears that it will become very difficult for American firms to conduct almost any transactions related to the province.
  • In light of these restrictions, Chinese consumers are increasingly looking to purchase domestically produced goods.
• The position of the Biden administration towards China is looking a bit mixed. On the one hand, Treasury indicated it would extend the Trump-era ban on economic dialogue.  On the other, there are indications that Washington is trying to set up a summit meeting between Biden and Xi.
  • The U.S. wants to create a “hotline” with Beijing, similar to what the U.S. had with the Soviets during the Cold War.
• We continue to monitor the situation with Chinese firms looking to list on U.S. exchanges. Concerns that delisting may occur have led to a decline in the capitalization of over $800 billion in Chinese tech stocks since February.  The State Internet Information Office has published a notice clarifying new cybersecurity measures.  Another interesting development has been emerging; social media nationalists are increasingly criticizing Chinese tech firms listed in the U.S.
• Chinese authorities are increasing their discrimination measures against LGBT groups in China. Given the visibility of such issues in the U.S., we expect this factor to become another point of contention between the two countries.
• China is continuing to close down bitcoin mining operations. The latest region to deny power to miners is Anhui province.
• The Biden administration has appointed Alan Estevez to the Commerce Department. The former Pentagon official will be the undersecretary for industry and security.  This part of the Commerce department regulates technology trade with China.
• Uyghur businessmen in Xinjiang have been arrested as part of China’s security crackdown.
• An increasing number of Hong Kongers are leaving.

Economics and policy:  Chip supplies are projected to improve, and the reason workers are slow to return may be more complicated than generally believed.

• There is some potentially good news; Taiwan Semiconductor (TSMC, USD, 124.39) is indicating that the semiconductor chip shortage that has plagued industries from electronics to automaking will begin to abate in Q3. In the latest inflation data, used car prices soared in part because automakers can’t meet the demand for new cars because of chip shortages.  Increasing chip supplies should improve the supply situation and bring used car prices down.
• A survey by Morning Consult shows that childcare and pandemic fears are the two primary reasons workers are hesitant to return to work. The third reason is unemployment insurance.  Thus, without school reopening and falling infection rates, cutting unemployment benefits may not lead to a rising labor force.
• Checks for the new child care credit are starting to show up; the policy should support consumption but may have surprising tax ramifications.
• One behavior we have noticed over the years is that merchants tend to raise prices quickly when raw materials prices rise but are slow to reduce them when they fall. This is true with gasoline prices and is now being reported as lumber prices drop.
• The ECB is moving forward on the digital EUR.
• Americans are generally upbeat according to a recent Gallup survey.
• Facebook (FB, USD, 347.63) is the latest tech firm calling for Lina Khan to recuse herself from investigating the company on antitrust.

International roundup:  A hacker disappears, and Putin wants Ukraine back.

• Ransomware Evil, the organized crime group that recently launched a massive hack, has suddenly gone dark. It is unclear exactly why.
• Recent comments from President Putin seemed to intimate that Ukraine is really part of Russia and should return to the fold. Kiev is understandably uncomfortable with this position.
• Iran apparently attempted to kidnap an Iranian dissident living in the U.S. with the intent of returning her to Tehran. This news won’t help Iran in its goal to return to the 2015 nuclear deal.

COVID-19:  The number of reported cases is 188,521,901 with 4,060,815 fatalities.  In the U.S., there are 33,947,232 confirmed cases with 608,115 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 388,295,385 doses of the vaccine have been distributed, with 335,487,779 doses injected.  The number receiving at least one dose is 184,835,149, while the number of second doses, which would grant the highest level of immunity, is 160,126,516.  The FT has a page on global vaccine distribution.

• France is moving aggressively to increase vaccinations by severely restricting the movement of the unvaccinated.
• China is making vaccination mandatory in some areas of the country.
• One downside of lockdowns has been a spike in drug overdose fatalities. Isolation and the inability to maintain counseling are partly to blame.
• The U.K. is using an app created by the NHS to inform people if they have come into contact with a person infected by COVID-19. Apparently, the Delta variant is so widespread that many people have been “pinged” by the app and are required to isolate for 10 days.  The warnings are so widespread that shifts at automakers had to be canceled due to the lack of workers.

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

[Posted: 9:30 AM EDT] | PDF

We open today’s Comment with news that Democrats have agreed that their “soft” infrastructure plan will total some $3.5 trillion in spending, though details still need to be worked out, and the proposal will face tough sledding in Congress.  Next, we discuss Federal Reserve Chair Powell’s testimony before Congress this afternoon.  We then turn to various international news items, and we close with the latest developments related to the coronavirus pandemic.  Finally, we note that today is Bastille Day.  Vive la France!

U.S. Fiscal Policy:  Senate Majority Leader Schumer (D, NY) said Democrats on the Senate Budget Committee have agreed to spend roughly $3.5 trillion on a broad climate, education, and anti-poverty plan.  That is down from the $6 trillion that the committee’s chair, Senator Bernie Sanders (I, VT) had demanded, but it will still face resistance from many Democrats, and its future remains uncertain.  In addition, we note that the deal only set the total spending figure of $3.5 trillion.  The committee will need to flesh out the actual policy provisions of the plan.

• The “soft” infrastructure plan would have to be passed separately from the approximately $1 trillion “hard” infrastructure package, which until now has had just enough bipartisan support to pass. Yesterday, however, Senate Republicans began to show signs they were getting cold feet over that plan, in large part regarding concerns that revenue increases in the package might not be enough to pay for it.
• In addition, some economists argue that hard infrastructure benefits often aren’t as much as commonly perceived.
• In any case, there is still a decent chance that additional fiscal stimulus will hit the U.S. economy sometime in the coming months. The actual economic and financial impact would play out over time.  For example, revenue-raising tax hikes would likely hit earlier than much of the spending, potentially producing a near-term drag on the economy before the stimulus truly kicks in.  Yet, the likelihood of new net stimulus will probably buoy expectations for continued economic growth and continued inflation risks.

U.S. Monetary Policy:  At 12:00 pm ET today, Fed Chair Powell will appear before the House Financial Services Committee to present the central bank’s twice-yearly report on monetary policy.  As with many investors, we will focus on whether Powell still believes that the current bout of inflation will be transitory and whether he continues to resist any idea of tightening monetary policy early.  We think Powell has lost control over several traditionalist, capital-friendly members of the policymaking board who are more concerned about inflation and want to hike interest rates earlier rather than later, so we’ll be looking for any clues as to the current personnel and policymaking dynamics at the Fed.  Powell will also testify before the Senate Banking Committee on Thursday.

European Union:  The European Commission today will unveil 13 policies designed to address climate change by ensuring the continent meets its goal of reducing average greenhouse gas emissions by 55% in 2030 and net-zero by 2050, compared to 1990 levels.  The “Fit for 55” program risks a backlash from poorer EU countries and some industries which argue that the pace of change and increased regulations will become a financial burden. The measures will also be examined closely by the bloc’s trading partners as their companies face penalties on exports of carbon-intensive products such as steel and cement.

• The centerpiece of the plan is to expand the Emissions Trading Scheme, a system that makes companies pay for the cost of polluting. Brussels wants to take it further to include emissions from the car industry and from heating buildings to quicken the pace of decarbonization. It would also impose new import taxes based on products’ carbon footprint.
• Depending on how quickly and stringently the policies are implemented, they could result in a net drag on European economic growth and financial assets.

China:  Calculations by the Financial Times show global investors have boosted their holdings of Chinese stocks and bonds by approximately 40% over just the last year; they now hold approximately $800 billion of the securities.  In part, the increase is driven by the inclusion of more Chinese securities in global stock and bond indexes, which forces index-driven funds to boost their exposure to them.  The increase is also driven by optimism over how quickly the Chinese government was able to get control over the country’s coronavirus pandemic and boost economic growth.

• All the same, we’ve been warning that piling into Chinese stocks and bonds carries some amount of risk at a time of rising U.S.-China geopolitical tensions related to issues like Xinjiang, Hong Kong, and Taiwan. More to the point, both the U.S. and the Chinese governments are actively taking steps that have the effect of gradually decoupling the two countries economically and financially.  For example, the U.S. government has clamped down on U.S. investors putting funds into Chinese companies connected with the People’s Liberation Army, and the Chinese government has begun to discourage Chinese firms from listing in the U.S. over auditing and data security concerns.
• Given the aggressive actions taken by the two governments so far, we cannot discount the possibility of a sudden, unexpected regulatory decision by either side that might require or encourage the unwinding of cross-border holdings. For example, sharpening regulatory moves might force index firms to ratchet down their Chinese exposure.  In any case, investors could get caught in the crossfire despite the positive performance some Chinese stocks have provided to date.

China-Pakistan:  An explosion killed at least nine Chinese nationals and at least four Pakistanis who were traveling in a bus in northern Pakistan.  The cause of the blast couldn’t immediately be determined, but Chinese building sites, symbols, and citizens have all been attacked by local insurgents in Pakistan. The incident represents the largest loss of Chinese lives in recent years in Pakistan, where China is carrying out a multibillion-dollar infrastructure building program.

Global Oil Market:  OPEC has reached a compromise with the United Arab Emirates that will allow it to boost its production as part of a wider agreement with Russia-led producers to boost global oil supplies to meet resurgent, post-pandemic demand.  Details on the compromise are still sketchy, but if it allows the OPEC+ group to proceed with something like their earlier plan to increase production by 400,000 barrels per day each month through late 2022, it could help cap surging oil prices and eventually help bring down inflation.

COVID-19:  Official data show confirmed cases have risen to 187,941,030 worldwide, with 4,051,232 deaths.  In the United States, confirmed cases rose to 33,916,927, with 607,786 deaths.  Vaccine doses delivered in the U.S. now total 387,241,530, while the number of people who have received at least their first shot totals 184,543,821.  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, 55.6% of the U.S. population has now received at least one dose of a vaccine, and 48.1% of the population is fully vaccinated.
• Despite the progress on vaccinations to date, the U.S. is now averaging more than 23,000 new cases a day, double the seven-day average of around 11,300 cases three weeks ago. On 17 of the past 18 days, the seven-day case average was higher than the 14-day average, also suggesting infections have been rising nationally.  According to the CDC, virtually all the new cases and deaths are among those who still haven’t been vaccinated.
• To encourage more young people to get vaccinated, the White House is enlisting social influencers like pop star Olivia Rodrigo to make pro-vaccination videos.
• As if the U.S. vaccination shortfalls aren’t bad enough, more developing countries are losing faith in the less effective Chinese vaccines they have been relying on.  Thailand is the latest such country, saying it will offer Western vaccines as booster shots to its health workers who have already received Chinese shots.  Similar moves have been undertaken by Indonesia and Bahrain.
  • If the Delta mutation continues to drive new infection waves in countries that have mostly relied on Chinese vaccines, the diplomatic goodwill China achieved by donating the shots will likely reverse.
  • On the other hand, many emerging markets heavily depend on exports to China or on Chinese capital, so they may be reluctant to take steps that would make China look bad.
• In China, several local governments are planning to bar unvaccinated residents from accessing public venues like schools, nursing homes, and hospitals without a valid exemption.  As in other countries that have offered benefits to the vaccinated or imposed restrictions on the unvaccinated, the moves are generating pushback and debate over personal health freedoms.

 Economic and Financial Market Impacts

• In India, inflation is surging because of supply disruptions from its recurring waves of infection and rising global demand as developed countries recover.  Retail prices are currently up about 6.3% year-over-year, exceeding the central bank’s target of 6.0%.  The increased prices are reportedly undermining support for Prime Minister Modi, although it is still too early to know whether the dissatisfaction might eventually lead to unrest or political instability.

Foreign Policy Response

• The Reserve Bank of New Zealand said it would halt pandemic-related bond purchases this month.  That will make the central bank one of the first in the developed world to step back from the monetary stimulus provided to fight the crisis. The surprise decision has pushed the local currency sharply higher against the U.S. dollar today, as economists forecast the bank would raise interest rates as early as August to prevent the economy from overheating.

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