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. Today’s report begins with a discussion on the surge in reverse repos. International news follows, with reports on the Iranian presidential election and Nicholas Maduro hinting at a possible truce with the U.S. We review economics and policy news next, including a new federal holiday and the House’s withdrawal of authorization for the Iraq war. China news follows, and we close with our pandemic coverage.

Reverse Repos: The Federal Reserve’s reverse repos rose to a record $756 billion following the central bank’s rate increase in the interest it pays banks for its excess reserves (IOER) and overnight reverse repo facility. The attractiveness of reverse repos may be due to a collateral shortage caused by a lack of Treasury bills. Recently, the Treasury Department has been reluctant to issue new bills in fear of surpassing the debt ceiling before its deadline in July. This has forced financial institutions to obtain Treasury bills through the reverse repo facility. Although these financial institutions could have gone to money market funds, the yields on those funds, in some cases, were approaching zero. Hence, the rise in rates made reverse repos relatively more attractive when compared to the alternative.

The surge in reverse repos is likely a signal of the growing imbalances within the financial system. Over the last year, financial institutions have been flush with cash due to both fiscal and monetary expansionary policy. These institutions now have excess cash and, as a result, have struggled to find places to store it. Ironically, it was the opposite problem in September 2019, when the lack of cash caused repo rates to skyrocket. The issue illustrates the growing complexity of the financial system and the Fed’s inability to foresee problems before they occur. The problem also highlights the Fed’s need to pay closer attention to how its decisions may impact financial markets.

International news: Nigeria forces dealers to get rid of dollar holdings, Iran votes for a new president, and Maduro seeks a deal.

• The U.S. and the EU have joined forces to develop technology to counter Russia and China. Both groups are boosting their investment spending in order to reduce their dependence on tech imports. Additionally, it appears that the two sides will work together in improving their technology related to artificial intelligence.
• Nigeria’s forex trading body has asked dealers to sell their stock of dollars in an attempt to narrow the spread between spot price and illegal market price. The country has struggled to maintain its peg with the U.S. dollar in recent months.

• In the U.K., the Conservative Party lost a party seat in one of its strongholds. On Friday, a Liberal Democrat – a centrist, pro-EU group – was able to win a by-election in the constituency of Chesham and Amersham. The region is a few miles away from West London, where PM Boris Johnson holds a parliamentary seat. The Liberal Democrat victory in the region highlights a growing fracture within the Conservative Party.
• The Iranian elections are taking place on Friday and it is expected that ultra-conservative candidate Ebrahim Raisi will win. The election appears to be a formality as other serious contenders were barred from the race. Raisi is a close ally of the Supreme Leader Ayatollah Ali Khamenei and his election could signal a more isolationist Iran. Although Raisi is known to be skeptical of the West, he has come out in favor of the nuclear deal.
• In an interview with Bloomberg Television, Venezuelan President Nicolas Maduro hinted that he is ready to make a deal with the U.S. to remove sanctions. Venezuela is in desperate need of foreign investment as economic conditions continue to deteriorate. The gesture by Maduro highlights the crippling effects of the sanctions and could be a sign that he may be losing influence within the country. In 2018, the U.S., along with other countries in South America and Europe, recognized a member of his opposition, Juan Guaido, as the rightful leader of the country. The move came after Maduro’s 2018 re-election victory was declared fraudulent. As a result, it will be difficult for President Biden to make a deal that will allow Maduro to stay in power. At this point, it is unclear whether Maduro will consider stepping down, but it is obvious that he doesn’t have much leverage.

 Economics and policy: Juneteenth becomes a federal holiday, the house revokes authorization of the Iraq invasion, and the Affordable Care Act survives.

• The Supreme Court rejected a challenge to the Affordable Care Act. The ruling, however, left the door open for another lawsuit.
• The House voted to revoke authorization of the 2002 Iraq invasion. The authorization was used in the fight against Islamic State in Iraq as well as the killing of Iranian general Qassim Soleimani. The vote symbolizes the growing withdrawal of the U.S. from the superpower role.
• The Federal Communications Commission voted unanimously to study the effect of banning U.S. companies from purchasing telecommunications equipment from Chinese companies. Additionally, it voted to consider revoking previous authorization of equipment from five Chinese companies that were deemed to be a national security threat.
• On Thursday, President Biden signed legislation that officially made Juneteenth a federal holiday. So far, government agencies and financial institutions have struggled to determine whether their offices should be closed on Friday in acknowledgment of the holiday.

China:

• Chinese astronauts have made their way to the Tiangong space station. They will be in the space station for three months.
• Bitcoin miners are now leaving China and coming to the U.S. China has begun to crack down on the industry due to the amount of energy it consumes, and the shift to the U.S. comes as investment firms are becoming more accepting of the digital commodity.
• A pro-democracy tabloid Apple Daily was raided by Hong Kong police officers on Thursday. Authorities cited potential violations of its national security law.
• China is hoping that the higher than expected inflation will encourage the U.S. to remove tariffs.
• Officials in China are discussing the possibility of lifting birth restrictions completely by 2025 as the country continues to struggle with low birth rates.

COVID-19:  The number of reported cases is 177,201,586 with 3,836,092 fatalities.  In the U.S., there are 33,505,563 confirmed cases with 600,880 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 377,215,060 doses of the vaccine have been distributed with 314,969,386 doses injected.  The number receiving at least one dose is 175,867,860 while the number of second doses, which would grant the highest level of immunity, is 147,758,585.  The FT has a page on global vaccine distribution.

• The U.K. reported its highest number of cases since February of this year. The rise in cases highlights the dilemma as to whether the country should reduce its restrictions. There are growing concerns that if the virus isn’t contained, the U.K. could see another surge in cases in the winter.
• The U.S. plans to invest more than $3 billion into developing an antiviral pill to treat COVID-19. The money will come from the coronavirus relief package that was passed in March. Although the vaccine will remain the centerpiece to ending the pandemic, the pill will be looked at as a way to treat those who may have contracted the virus.
• The Japanese government has stated that it is considering relaxing some of the lockdown restrictions as it prepares to host the Olympic Games. Although the country has seen a decline in cases, it hasn’t been successful in convincing people to get vaccinated.
• A new coronavirus variant has made its way to Moscow and it appears to be more aggressive and infectious than previous variants.

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

[Posted: 9:30 AM EDT] | PDF

We begin this morning in the wake of the Fed surprise.  As we discuss in detail below, the Fed made a hawkish turn, and we are getting the expected reaction—equities are lower, the dollar is up, and precious metals and commodities are lower.  We are seeing a rally in bonds this morning after they sold off yesterday.  Following our recap of the Fed meeting, our coverage continues with China news and the international roundup.  Economics and policy follow, and we close with the pandemic update.

The Fed:  The actual statement held no surprises; rates didn’t change, and neither did QE levels.  But, the dots plot, as we show below, signaled a profound shift.  Market reaction was swift and negative.  If there was any doubt that the recent strength in financial markets was dependent on accommodative monetary policy, yesterday’s FOMC meeting should dispel such notions.  Interestingly enough, changes to growth forecasts were rather modest, and expectations about inflation still show a drop in the growth rate over the next two years.  Even without expectations of stronger growth or higher inflation, the dots plot signals that rate hikes will commence in 2023 and may occur sooner.

(Source: The Federal Reserve)

This chart shows the dots plots from March and June.  In March, only four members signaled a rate hike in 2022 and seven in 2023.  Yesterday, the Fed said that seven members are looking for a hike next year, and a clear majority looks to raise rates in 2023.  In fact, the weighted average fed funds rate for 2023 is 0.86% which is three rate hikes.

What happened here?  It appears that the FOMC has become spooked about higher inflation risks, even though the base forecasts suggest the committee doesn’t think inflation will persist in the future.  The clue is in the uncertainty polls.

(Source: The Federal Reserve)

In March, the committee had high uncertainty surrounding core PCE but thought the risks were mostly balanced between rising or falling.  In June, the clear majority was worried about higher inflation.

Although Chair Powell has moved to change the Fed’s focus to the labor markets and intends to no longer engage in policy pre-emption, this position doesn’t appear to have been fully accepted by the rest of the committee.  This signal of rate hikes suggests to us that the Fed still seems to be focused on quelling inflation expectations.  Yes, it’s true that the Fed didn’t raise rates, which would be true pre-emption (in fact, it is arguable the hikes should have already occurred).  However, the committee does want to signal the market participants that they are (a) worried about inflation and (b) are indicating they intend to do something about it.

Market reaction was swift; equities fell, longer duration rates rose, commodities declined, the dollar rose, and bitcoin and gold fell.  In trying to assign who is on each dot, one clue is that there were no dissenters in the statement.  That probably means that the two highest dots are George (KC) and Mester (CL), who are not current voters.  We would not be surprised if Brainard, Evans (CHI), and Rosengren (BOS) lifted their forecasts.  They are worried about overheating asset markets and thus would probably join the hawks in wanting to express concern.  Most of the remaining members are still likely holding to the Phillips curve view of the world and thus are uncomfortable with never-ending accommodation.

The Chair tried to downplay the dots as his predecessors have done[1] when they get an outcome that they probably disagreed with.  To quote Powell in full:

These are of course individual projections, they’re not a committee forecast, they’re not a plan, and we did not actually have a discussion of whether lift off is appropriate at any particular year. Because discussing lift off now would be highly premature, it wouldn’t make any sense . . . the dots are not a great forecaster of future rate moves and that’s because it’s so highly uncertain, there is no great forecaster of future rates, so [the] dots have to be taken with a big grain of salt.

Such statements beg the question…if the dots are so immaterial, why have them at all?  Despite this sentiment, the dots should be taken seriously.  The Chair has lost control of the narrative.  The members of the FOMC have become unnerved by the rise in inflation and are signaling that rate hikes are likely coming unless uncertainty about inflation eases.  In 2026, the Fed will release the full transcript of this meeting.  If we are still north of the dirt when it comes out, it will be at the top of our reading list.

What now?  The key we will be watching in the coming days is the reaction from the financial markets and the political class.  Occasionally, the FOMC and Fed Chairs float an idea to gauge the reaction of both.  What comes to mind is Greenspan’s “irrational exuberance” speech which was widely panned.  The political class wants an accommodative Fed forever; a tenant of MMT is a non-independent central bank that is in the service of the Treasury.  It will be interesting to see how political leaders react.  We fully expect the left-wing populists to lash out.  On the other hand, the establishment of all stripes will quietly cheer the FOMC for being responsible.

The other item to watch carefully is that if inflation does prove to be transitory, we could see the dots take a dovish turn in the future.  That idea is tempered by the fact that financial conditions have become remarkably easy.

For example, for the first time ever, as this chart indicates, real high yield levels are negative.  The FOMC members who are sensitive to financial market froth will likely continue to press for policy tightening.

This potential shift in policy will lead to some degree of recalibration for financial markets.  Generally speaking, higher short-term rates are dollar bullish, equity bearish, commodity bearish.  Part of the recalibration will be further information that comes in the next few weeks.  FOMC members will fan out in the next few days and be questioned about this meeting.  The tenor of comments will be weighed carefully.  So, there is still more to come.  But a warning shot has been made and will be taken seriously.

China:  Beijing reacts to the Biden trip, and tensions between the U.S. and China remain elevated.

• As President Biden’s meetings wind down, we now begin the process of seeing what will follow from his visits.
  • There are increased concerns about China’s closer links to Russia. Although the two nations have traditionally been enemies (nearly going to war on several occasions in the 1960s and 1970s), shared hostility toward the U.S. has led to increased cooperation between Moscow and Beijing.
  • The Europeans are not as willing to confront China as the U.S. is; the G-7 is, thus, divided on this issue. Still, we note the Germans, who are probably the most reluctant to criticize China, did come out against Beijing’s new sanctions law.  Despite these divisions, Beijing is angry about being a topic of discussion for NATO.
  • China’s foreign direct investment into Europe is declining.
• The Pentagon is considering assigning a permanent naval task force to China. This action would be a clear signal that the U.S. sees China as a serious threat.  Meanwhile, China has been adding ships at a furious pace; the PLA Navy usually names vessels after large cities but is running out of names.
• General Secretary Xi is increasingly rewriting China’s history, especially of historical CPC figures.
• Any casual look at a map around China can see a chain of islands, called the “first island chain,” that is key to containing Beijing’s aspirations. A key nation in that chain is the Philippines.  The Biden administration is trying to improve relations with the former U.S. colony, but overall, the relationship is far from cordial.
• Earlier this week, we noted there was a reported nuclear leak at a Chinese nuclear power plant. China denies it occurred but did admit fuel rods were damaged.  State media is indicating “nothing to see here.”
• Alibaba (BABA, USD, 209.32) was hit with a data leak where a hacker pulled over a billion pieces of user data.
• Among the tech firms, work life is based on “9-9-6,” or nine in the morning until nine at night, six days a week. This grueling schedule has been increasingly criticized.  Now we are seeing a backlash against surveillance software that is used to monitor workers.  Another development, noted at the bottom of this linked report, is a development among the youth of China to engage in “lying flat” or to simply turn inward and stop striving.  There are reports that Xi is cracking down on the private test prep industry in a bid to ease pressure on families.  As China’s growth slows, the opportunities for advancement will contract, and this outcome will be a major threat to the CPC rule.
• We continuously monitor the Chinese financial system for signs of stress.
  • The Chinese retailer Suning (002024, CNY, 5.59) has seen its share trading suspended due to concerns over its debt.
  • Regulators are increasing scrutiny of bank-issued cash management products; new rules require higher-rated debt to be held in these products, meaning that about $390 billion of these products will soon be out of compliance.

International roundup:  Biden and Putin meet; North Korea is facing crop failure.

• The Biden trip ended with a meeting in Geneva with Russian President Putin. Recent presidents have vacillated on Russian relations.  Bush looked into Putin’s eyes, Obama called for a “reset,” Trump tried personal relations.  None of these worked particularly well.  It looks like Biden and Putin have set low expectations and met them.  The U.S. wants Russia to stop harboring cybercriminals.  Moscow wants NATO expansion to stop.  Both are interested in some form of nuclear weapons control.  The fact that the diplomats are returning is a good sign.  We don’t expect much improvement, but it also looks like both sides are taking a realistic view of relations.
• North Korea admitted it is facing a major crop problem, blaming flooding for falling output. Kim Jong Un has described the food situation as “tense.”
• The U.K. has signed its first major trade deal since Brexit with Australia. British farmers are likely going to see their market share decline.
• The World Bank won’t assist El Salvador in its transition to bitcoin.

Economics and policy:  The EU has begun issuing Eurobonds, the FTC is taking a new look at antitrust, and bottlenecks are lifting prices.

• The EU has begun to issue the Eurobond, backed by the full faith and credit of the entire Eurozone. Brussels admitted it really can’t track how the money is spent.
• Lina Kahn has been appointed to the chair of the FTC. She is a 32-year-old law professor from Columbia Law School who became famous after publishing a paper essentially critical of the Bork standard for antitrust.  That standard argued that as long as consumers were not harmed, industry concentration was irrelevant.  Kahn suggested otherwise in her paper.  Her appointment signals are more critical view toward technology, which has seen significant concentration in the past two decades.
• One issue causing inflation concerns is logistical bottlenecks. Container rates are rising as there are more containers to be shipped than space on vessels and in ports.[2]  Critical infrastructure is in need of repair.
• At the same time, we are seeing some high-flying commodities pull back. Metals are under pressure on reports that China may try to contain prices by releasing inventory from strategic stockpiles.  Homebuyers are reportedly balking at soaring home prices, and this news has started to bring down lumber prices as well.
• Although we have seen a jump in used car prices, that hasn’t stopped Americans from holding on to their current vehicles. The average age of an American vehicle is 12 years.
• During the pandemic, retail landlords began charging rent based on the store’s revenue. This practice may continue into the future.
• The ECB is holding a retreat to discuss policy goals.
• Brazil’s central bank has lifted rates for the third time this year.

COVID-19:  The number of reported cases is 177,105,723 with 3,834,719 fatalities.  In the U.S., there are 33,499,190 confirmed cases with 600,656 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 375,186,675 doses of the vaccine have been distributed, with 312,915,170 doses injected.  The number receiving at least one dose is 175,053,401, while the number of second doses, which would grant the highest level of immunity, is 146,456,124.  The FT has a page on global vaccine distribution.

• There is some evidence to suggest that COVID-19 might have been circulating as early as December 2019. There is no evidence that transmission was widespread.
• Curevac’s (CVAC, USD, 94.79) vaccine failed to meet effectiveness criteria in clinical trials, which probably means it won’t be used. The EU had invested heavily in the firm, so this is a blow to European hopes.
• The U.K. will delay reopening due to the delta variant of COVID-19.
• China continues to deliver vaccines to the emerging world, boosting Beijing’s status.
• One of the better explanations of the lab leak hypothesis is discussed in this podcast.

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[1] “I think that one should not look to the dot plot, so to speak, as the primary way in which the Committee wants to or is speaking about policy.” – Janet Yellen, March 19, 2014

“I think you could also retitle this conference “Why We Don’t Like the Dot Plot.” I think the dot plot is like the advanced level of the video game. If you haven’t been to the first 12 levels, forget about the dot plot.” – Ben Bernanke, November 30, 2016

[2] A good podcast on this issue can be found here.

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

[Posted: 9:30 AM EDT] | PDF

We open today’s Comment with loads of U.S. policy news, followed by remarks on today’s U.S.-Russia summit meeting.  We next discuss a wide range of international developments.  We close with the latest news about the coronavirus pandemic.  Finally, with the summer holidays upon us, we should mention that the Senate yesterday unanimously approved a bipartisan bill making Juneteenth a national holiday.  If passed by the House, the end of slavery in the U.S. will be celebrated every June 19.  In the coming years, it should be fascinating to see what traditions develop around this new holiday (already this Saturday, yours truly will be attending this Africa-inspired fashion show in St. Louis).

U.S. Monetary Policy:  The Fed yesterday kicked off its latest policy meeting, with a decision scheduled to be released at its conclusion this afternoon.  The officials are widely expected to leave their benchmark interest rate unchanged at essentially 0% and make no immediate adjustment to their asset purchase program.  However, investors will be looking for any hint that policymakers might bring forward their plans for policy tightening.

• Importantly, the officials will release an update of the “dot chart,” laying out when policy changes may have to be implemented in the coming few years.  The last update, in March, showed the policymakers expected to hold policy steady through 2023.  The update will probably show they now expect to lift interest rates somewhat earlier.
• Naturally, equity and bond markets could face a bout of volatility if investors get confirmation that the policymakers may now hike interest rates and cut their bond purchases earlier than expected.  Nevertheless, we still expect the officials to stay on the sidelines for some time.  For the time being, monetary policy will remain loose, which should tend to support risk assets.

U.S. Fiscal Policy:  To appease progressives unhappy with the ongoing bipartisan negotiations over a slimmed-down version of President Biden’s proposed infrastructure spending program, Democratic leaders in Congress have begun to discuss the contours of a broad-ranging spending package on child care, climate, and education that would require just 50 votes in the Senate in order to pass.

• The progressive package would have to pass separately from the $974 billion infrastructure deal agreed to last week by a bipartisan group of ten Senators.  About half of that spending would be new money over and above current spending projections.  It would be financed by indexing the gas tax to inflation, increasing enforcement at the Internal Revenue Service, creating public-private partnerships, repurposing existing federal funds, and collecting fees from electric vehicles.  That proposal was discussed by the Senate GOP conference at a lunch meeting yesterday.
• Despite the effort to appease progressives, it is unclear whether they will sign off on the two-bill plan unless they get an ironclad guarantee that Democratic leaders will push through the liberal second bill.  As things stand now, discussions on the bills are likely to continue until there is some determination of what can and will pass Congress.  As they say, politics is the art of the possible.

U.S. Housing Market:  The National Association of Realtors has issued a report claiming U.S. home construction over the last two decades has been far weaker than needed.  The report argues that funds for housing construction should be included in the big infrastructure program being discussed in Congress.  On a related note, real estate investment trusts (REITs) have been on a tear this quarter as investors look to the property-owning companies and their ability to raise rents as a hedge against inflation.

United States-Russia:  In Geneva this morning, President Biden will have his first summit meeting with Russian President Putin.  Backed up by the unity he achieved through his summits this week with the G7, NATO, and the EU, Biden will try to convince Putin to rein in his aggressive behavior in areas such as election interference and cyberattacks so the U.S. can focus its energy on the rising threat from China.

• Intriguingly, the European Commission this morning released a statement accusing Putin of deploying “aggressive actions” and warning that the EU must “prepare for a further downturn of its relations with Russia as the most realistic outlook for the time being.”  The statement also called for tougher EU action against Russian malign behavior.
• The 14-page statement, available here, was almost surely drafted ahead of President Biden’s summits in Europe over the last week.  However, it was likely at least tweaked to reflect any consensus gained between Biden and the EU leaders.  Its tough language on Russia, therefore, could be a harbinger of friction at the Biden-Putin meeting.
• Separately, it’s also important to keep an eye on growing European skepticism about China and the economic impact that could have.  For example, consultants at the Rhodium Group have issued a report showing Chinese investment in Europe hit a ten-year low in 2020, reflecting not only the pandemic but also political tensions.

Global Copper Market:  After our comment yesterday on the pullback in lumber prices, copper prices fell yesterday to their lowest level in eight weeks in anticipation of today’s move by Chinese authorities to tamp down on rising commodity prices.  Following up on official statements from the State Council last month, China’s National Food and Strategic Reserves Administration said it would hold a series of public auctions offering copper, aluminum, zinc, and other metals to domestic processors and manufacturers.  Copper prices are again softer today, but whether it and other metals prices keep softening will likely depend in large part on the volumes of metals that China ultimately releases onto the market.

Israel-Hamas:  Violence has once again broken out between Israel and Hamas.  Israeli police fired rubber bullets at Palestinians trying to disrupt a right-wing nationalist march in Jerusalem, and Hamas militants launched incendiary balloons into Israel.  In response, the Israeli military launched airstrikes in the Gaza Strip, raising the specter of renewed warfare in the region and testing whether Prime Minister Bennett’s two-day-old coalition government can prevent the violence from escalating into a new war.

Colombia:  The National Strike Committee, which has been leading a series of nationwide demonstrations and blockades over various economic and social issues since late April, announced that it would suspend its protests until July in order to reduce violence and help arrest the country’s new COVID-19 surge.  However, reports indicate that protesters in multiple locations refuse to dismantle their barricades, raising concerns that the protests’ economic damage will continue.

Peru:  Right-wing presidential candidate Keiko Fujimori, who received 49.9% of the votes against 50.1% for her far-left rival Pedro Castillo in the elections held early this month, is calling for an audit after alleging “grave irregularities.” Election officials have rejected her fraud claims, and international election observers say the vote was transparent and clean, yet, the election remains up in the air as the election board decides whether to accept Fujimori’s appeal.

COVID-19:  Official data show confirmed cases have risen to 176,703,553 worldwide, with 3,824,115 deaths.  In the United States, confirmed cases rose to 33,486,925 with 600,287 deaths.  Vaccine doses delivered in the U.S. now total 374,865,165, while the number of people who have received at least their first shot totals 174,674,144.  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, 52.6% of the U.S. population has now received at least one dose of a vaccine, and 43.9% of the population is fully vaccinated.
• A clinical trial run by Oxford University in the U.K. showed that an antiviral cocktail from Regeneron (REGN, $527.49) significantly reduces the risk of death among hospitalized COVID-19 patients whose own immune systems have failed to fight the virus. The combination of drugs cuts mortality by one-fifth among patients who did not mount an antibody response of their own.
• Also in Britain, the government is considering requiring nursing home staff who work with elderly patients to be vaccinated against COVID-19 and potentially against the flu.  Those who refuse to get vaccinated would risk losing their jobs.

 Economic and Financial Market Impacts

• The benefits of economic reopening and federal fiscal stimulus in the U.S. are now spilling across the border into Mexico, providing hopes for at least a temporary boost to economic growth.  In fact, consultancy Oxford Economics says Mexico is now recovering from the pandemic faster than any other country in Latin America.
• In North Korea, things evidently aren’t going quite as well.  Leader Kim Jong Un has warned of food shortages and urged officials to boost agricultural production as the country struggles with pandemic-related border closures, crippling economic sanctions, and a series of typhoons and floods.

Foreign Policy Response

• European Commission chief Ursula von der Leyen will travel to Spain, Portugal, and Italy over the coming days to formally approve those countries’ spending plans under the EU’s massive, €750 billion “Next Generation EU” pandemic recovery program.

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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 news related to President Biden’s trip to Europe.  Not only is there a lot of political news in Europe, but European stocks have posted a string of records.  We also discuss the start of the latest policy meeting at the Federal Reserve and other noteworthy U.S. and international developments.  We end with news related to the coronavirus pandemic.

NATO-Russia-China:  At the end of their big summit meeting yesterday, President Biden and the other NATO leaders issued a lengthy communique highlighting their intent to stand up to both Russia and China.  In the background, however, much of the discussion revolved around how to balance the alliance’s response to the traditional, longstanding threat from Russia versus its response to the more novel and recent issue of China’s geopolitical and economic aggression.  In an important innovation, the communique also stated that Article 5, the principle of collective defense enshrined in the treaty that established NATO in 1949, can be invoked on a case-by-case basis in response to a cyberattack.

• Regarding Russia, the communique criticized Moscow’s military buildup, cyber and disinformation attacks aimed at the West, and its annexation of Crimea from Ukraine.  Biden also warned of consequences if jailed Russian opposition politician Alexei Navalny dies. In a news conference at the end of the summit, Biden said, “Navalny’s death would be another indication that Russia has little or no intention of abiding by basic fundamental human rights . . . . It would be a tragedy. It would do nothing but hurt his relationships with the rest of the world, in my view, and with me.”
• Regarding China, the communique said China presents “systemic challenges to the rules-based international order.”  The communique also highlighted concerns over Beijing’s rapidly expanding nuclear arsenal and military cooperation with Russia.
• Over time, it appears that the Biden administration is heading toward an updated version of the 1990s-style doctrine of being able to defend against two major regional conflicts at the same time.  The major difference is that Russia and China don’t just represent regional threats.  They both have the power to represent true global threats, and they are increasingly finding themselves very much aligned in terms of international security goals and perspectives.  Although Biden is probably oversimplifying when he casts today’s geopolitics as a competition between liberal democracies and authoritarian leaders, it is probably true that Russian President Putin and Chinese President Xi perceive an opportunity to make the world safe for authoritarians.  The U.S. and the other liberal democracies have their work cut out for them in terms of figuring out how to balance their responses to those two threats.

China-Taiwan-United States:  In an apparent show of defiance against the U.S. push for a stronger stance against China in Europe, the Chinese military yesterday sent 28 warplanes into Taiwan’s air defense identification zone — the largest-known incursion to date.  According to Taiwan’s defense ministry, the latest mission included 14 J-16 and six J-11 fighter jets and four H-6 heavy bombers, capable of carrying nuclear weapons, as well as various surveillance and early warning aircraft.

• The ministry said Taiwanese aircraft were dispatched to warn away the Chinese warplanes, while missile systems were also deployed to monitor them.
• Separately, a U.S. aircraft carrier group led by the Japan-based USS Ronald Reagan has entered the South China Sea in what the Navy said is a routine mission.

United States-European Union:  At their summit today, President Biden and EU leaders are expected to sign off on a deal to end the 17-year-old U.S.-EU dispute over aircraft subsidies.  Although details are still sketchy, earlier reporting suggests it will involve a five-year agreement to limit the types of financial support each side can give to its major aircraft manufacturers.  Of key importance, the deal would also lift the punitive tariffs each side has imposed on each other.  If it is indeed confirmed, the agreement would remove a major irritant in the U.S.-EU relationship and help unify their positions on other important global issues, even if the two sides have other disagreements.

U.S. Monetary Policy:  The Fed kicks off its latest policy meeting today, with a decision scheduled to be released when the meeting ends tomorrow.  The officials are widely expected to leave their benchmark interest rate unchanged at essentially 0% and make no immediate adjustment to their asset purchase program.

• However, investors will be looking for any hint that the policymakers might bring forward their plans for policy tightening.
  • Importantly, the officials will release an update of the “dot chart” laying out when they think they will have to implement policy changes in the coming few years.  The last update, in March, showed the policymakers expected to hold policy steady through 2023.

• • Tomorrow’s update may reveal that the policymakers now expect to lift interest rates somewhat earlier.
  • Naturally, equity and bond markets could face a bout of volatility if investors get confirmation that the policymakers now expect to hike interest rates and cut their bond purchases earlier than expected.  Nevertheless, we still expect the officials to stay on the sidelines for some time.  For the time being, monetary policy will remain loose, which should tend to support risk assets.

• The policymakers are also likely to address growing concerns that the flood of money in the financial system may drive U.S. interest rates into negative territory.  Resurgent flows into money market funds coupled with reduced issuance of short-term Treasury securities have pushed many fund managers to turn to the Fed’s reverse repo, which pays no interest at all.
  • Some market participants want the central bank to jolt short-term rates higher by agreeing to pay more than zero on the RRP.
  • It could also raise the rate it pays banks on excess reserves that they hold at the Fed.

United Kingdom-Australia:  British Prime Minister Johnson and Australian Prime Minister Morrison signed off on the broad terms of a post-Brexit trade deal.  In addition to lowering tariffs and quotas between the countries, including agriculture, the deal would make it easier for individuals to work and travel between the two countries.

• If the trade deal can be finalized and signed before the end of the year, it would mark the first substantial bilateral agreement entirely negotiated by the U.K. since it left the EU in early 2020.
• Deals announced with Japan and Norway were built upon existing arrangements negotiated while the U.K. was a member of the EU.

Belarus-Lithuania:  The foreign minister of Lithuania has accused the Belarusian government of weaponizing illegal immigration in retaliation for Lithuania’s welcoming political dissidents from Belarus and supporting EU sanctions against Minsk.  According to the official, Belarus is enticing migrants with package deals from a state-owned tourist agency that includes flights from Baghdad or Istanbul, as well as travel to the Lithuanian border.  So far this year, Lithuania has detained almost double the number of migrants who crossed the frontier from Belarus than the combined total for the three previous years.

COVID-19:  Official data show confirmed cases have risen to 176,329,887 worldwide, with 3,813,679 deaths.  In the United States, confirmed cases rose to 33,475,305 with 599,960 deaths.  Vaccine doses delivered in the U.S. now total 374,398,105, while the number of people who have received at least their first shot totals 174,234,573.  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, 52.5% of the U.S. population has now received at least one dose of a vaccine, and 43.7% of the population is fully vaccinated.
• In the U.K., Prime Minister Johnson pushed forward England’s planned economic reopening to mid-July due to resurgent infections stemming from the Delta mutation first identified in India.  That variant, which is much more transmissible and dangerous than the original coronavirus, has been spreading rapidly among young, unvaccinated Britons and those who have only had one dose of a vaccine.
  • The decision to push out the reopening for one month illustrates the risk from the Delta variant, even in countries with high vaccination rates.  It also shows the downside of Britain’s decision early this year to delay the second dose of the vaccine in order to maximize the number of people receiving at least one dose.
  • Scientific advisors recommended the U.K. government delay vaccinations to younger age groups to ensure older people have received the double dose needed for maximum protection.
  • Separate studies from researchers in England and Scotland published Monday found that while protection against the Delta infection was somewhat diminished compared with more established variants, two doses of the vaccine offered considerable protection against severe illness and hospitalization.
• Meanwhile, the COVID-19 antibody treatment under development by AstraZeneca (AZN, $58.76) failed to meet targets in its latest trial, even though it did show that it could prevent people exposed to the virus from developing the disease if administered early enough.
• In Japan, the government is considering placing Tokyo under a quasi-state of emergency during the Olympic Games starting there on July 23, given that a number of health experts have expressed concern over a potential spike in COVID-19 cases resulting from the influx of participants and spectators.

 Economic and Financial Market Impacts

• Although it seems like just yesterday that we were reporting on record-high prices for lumber, the cost of wood has now plunged by almost half since the beginning of May.  Some market participants are even suggesting prices could fall much further as supply bottlenecks get resolved and some hoarding behavior reverses.  The rapid change in course is a reminder that today’s inflation pressure could well prove transitory, as the Fed suggests, once companies and consumers adjust to the normalizing post-pandemic economy.
• Although many economic sectors, such as travel and leisure, are facing boom times as the economy reopens, office towers and nearby businesses in central business districts are missing out on the strong economic recovery, largely because the rise in vaccinations and easing of mask restrictions haven’t propelled most employees back to work.
• On a more positive note, the chief of the entertainment division at NBCUniversal, a unit of Comcast (CMCSA, $57.28), said pent-up demand for major sporting events could make the company’s broadcast of the Tokyo Olympics its most profitable ever.
• Despite the positive progress on reducing infections and boosting vaccinations in many countries, the pandemic and its negative impact on oil prices, until recently, has produced an intense strain on Algeria’s economy.

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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!  U.S. equity futures are mostly flat this morning.  We are seeing sharply lower gold prices, most likely because cryptocurrencies have stopped declining.  Our coverage begins with the FOMC, which holds a policy meeting this week.  The international roundup follows.  China news is next, followed by economics and policy news.  We close with the pandemic update.

The Fed:  The FOMC meets this week, a meeting that will have new economic and policy projections.  There is growing speculation that the committee will move up the beginning of policy tightening in their projections.  It is certainly possible that some of the more hawkish members could move their dots higher, but we doubt the consensus will move to lift rates or taper them in the near term.  Among the orthodox economists, there are persistent calls to signal policy tightening.  Although we understand the sentiment, what they are missing is that the FOMC has clearly signaled a regime change.  Most significant is that the focus on policy is not inflation but employment.  There are risks to this policy, especially for financial markets.  Multiple contraction in equities is possible, not just from higher inflation but also from rising inflation volatility.  We suspect that is one reason why equity momentum has slowed recently.

International roundup:  It was a busy weekend.  The G-7 wrapped up, President Biden talks to NATO today and meets with Turkey’s President Erdogan and Russian President Putin later.  There is a new government in Israel and K-pop comes under fire.

• The G-7 meeting wrapped up. In our initial take on the new administration, we likened the Biden administration to the counterreformation.  It is an attempt to halt the populist trend toward either the end of American hegemony or the creation of a different model.  We expect the effort to fail (it lacks domestic support), but the attempt will continue while Biden is president.  The G-7 meeting was consistent with this view.  Biden, unlike Obama and Trump, is a transatlanticist; he likes Europe and thinks it’s important.  The prior two presidents were less interested and wanted to focus more on Asia.  So, the personal politics went well.  There were many warm photo-ops.  However, underneath it all, not much changed.
  • The U.S. wanted to build a united front against China. Europeans are much more lukewarm on this issue.  There were lots of vague promises but little evidence that anything concrete or sizeable was agreed upon.
  • Trade issues were not resolved. The EU hoped that many of the Trump-era tariffs would be lifted.  Biden has kept most of them in place.
  • The squabbles in Europe are always a problem. One of the great tragedies of humankind is that the Europeans, generally due to accidents of geography, were never able to unite.  In fact, we doubt the EU project can last unless (a) the U.S. continues to fund Europe’s defense, and (b) Germany accepts the role of regional hegemon, and other nations acquiesce.  If neither occurs, the U.K. won’t be the last nation to exit the EU.  And, the tensions between the U.K. and the EU were evident.
• At today’s NATO meeting, Biden will press the group to counter China. We don’t expect much.  Most NATO members fear mission creep.  They want to maintain focusing on Europe and countering Russia.
• There is one clear indication of how China is using its financial power to sway the region; it has created currency swap lines with Turkey, which is facing an inflation and currency crisis.
• Meanwhile, the hazards of campaigning in France continue. Last week, President Macron was slapped in the face.  Over the weekend, Jean-Luc Mélenchon was hit with flour.  What is notable is Mélenchon is the standard-bearer of the hard left, and such leaders are usually not attacked in this manner.  The pelting shows the deep divisions in French politics.
• In Israel, the incoming government survived the narrowest possible confidence vote, and thus, took power over the weekend. This act ended the longest-running leadership in Israeli history.  We would not count Netanyahu out, however.  The coalition aligned against him is hardly unified.  In fact, about the only thing it agrees on is ousting Netanyahu.  Israeli politics is normally fractious, and it would surprise us to see this government in a few months.
• Kim Jong Un has labeled K-pop, the South Korean youth bands, a “vicious cancer” and vows to prevent its spread into the Hermit Kingdom. Totalitarian regimes want to control every aspect of life.  Popular activities can be an alternative to what the regimes are projecting.  Hence, they are a threat.  The strong reaction from Kim does suggest there is a lack of confidence in the North Korean government.

China:  There were two items that caught our attention this weekend.  First, there are reports of a radioactive leak at a Chinese nuclear power plant.  Detectors recorded higher than acceptable levels of radiation at the Taishan Nuclear Power Plant, which is in the Guangdong province.  The level would have triggered a shutdown, but officials raised the acceptable limit.  The plant is jointly operated by China and France, and the latter has contacted U.S. officials for assistance.  Second, the senior editor of the Global Times is coming under social media pressure from ultra-nationalists.  This development is quite unusual.  The Global Times is a CPC mouthpiece. The idea that the publication or one of its editors isn’t Chinese enough is an indication that years of patriotic education may be creating conditions similar to the Cultural Revolution.  This development may make it difficult for Xi to manage policy, especially foreign policy.

Economics and policy:  The pandemic has distorted labor markets, and LIBOR is coming to an end.

• The pandemic and recovery have created one of the most unique sets of economic conditions. As we noted in the above Fed commentary, the FOMC is facing pressure to tighten policy, but there are indications from the labor market that the economy is far from back to normal.  At the same time, there is no doubt that the pandemic has distorted the labor markets, making it hard to discern what is actually happening.  For example, we have seen a jump in baby boomer retirements, which will tighten labor markets.  Another new development has been that workers, facing the unusual circumstance of the pandemic, may have adjusted their goals for work.  Some may want an employer who has few office restrictions.  Others may prefer to continue to work from home.  There has been a surge in quits, which may lead to a period of re-assorting and could distort labor market indicators.  Disruptions in travel are keeping foreign workers from coming to the U.S. and further tightening labor markets.  Policymakers will need to exercise care in interpreting the data.  Simply put, we may never see a full recovery in labor markets, and therefore, the need to raise rates may occur sooner than expected.
• S. regulators are pressing banks and other financial firms to end the use of LIBOR. The problem is that there is no generally accepted alternative.

COVID-19:  The number of reported cases is 176,011,118 with 3,805,212 fatalities.  In the U.S., there are 33,462,286 confirmed cases with 599,769 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 374,398,105 doses of the vaccine have been distributed with 309,322,545 doses injected.  The number receiving at least one dose is 173,840,483, while the number of second doses, which would grant the highest level of immunity, is 143,921,222.  The FT has a page on global vaccine distribution.

• The U.K. will delay easing lockdown measures due to a rise in infections from the delta variant.
• The G-7 did promise to prepare for the next pandemic.
• Russia is seeing a rise in infections as the Kremlin struggles to get its citizens to accept the Sputnik vaccine.
• Novavax (NVAX, USD, 209.68) showed a greater than 90% effectiveness level in a large clinical trial, increasing the likelihood that it will be approved as the U.S.’s fourth vaccine. It is a two-dose vaccine but does not require freezing.  This will make it more popular in the emerging world.

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

[Posted: 9:30 AM EDT] | PDF

Good morning, all! U.S. equities appear to be headed for a higher open this morning. Today’s report begins with an update on the infrastructure spending negotiations and an in-depth analysis of the CPI report. International news follows, with reports of sanctions being lifted on Iran and the EU ramping up its crackdown on U.S. tech firms. Economics and policy news are up next, including the meeting between President Joe Biden and U.K. Prime Minister Boris Johnson. China news follows, and we close with our pandemic coverage.

Infrastructure plan developments: A bipartisan group of 10 Senate Democrats and Republicans agreed to a $1.2 trillion infrastructure package over eight years. The package offers $579 billion in net new spending over that period, up from the more than $300 billion proposed by Senate Republicans in the previous week. The plan does not explicitly call for an increase in taxes; however, the proposal does allow for gas taxes to be indexed to inflation. The proposal appears to be a take-it-or-leave-it type of offer as it is unclear whether Senator Kyrsten Sinema (D-AZ) and Senator Joe Manchin (D-WV) will support an infrastructure package that isn’t bipartisan. At this time, it is unclear whether President Biden will agree to move forward with the proposal. Representatives from the White House seem to suggest that the president will likely push for additional changes to the bill. The gas tax provision is believed to be the president’s biggest source of tension as it would likely violate a pledge he made to not raise taxes on those making less than $400,000 annually.

Along came inflation: According to the Bureau of Labor Statistics, consumer prices rose to a 13-year high in May, surpassing the forecasts of most economists. The 5% year-over-year rise in the Consumer Price Index (CPI) has elevated concerns that inflation could be a sign of trouble within the economy. Here are a few takeaways we believe went unnoticed in the report:

• The monthly change in the report suggests that the rise in prices is being distorted by increases in durable goods and travel services. The chart below compares the monthly change in headline CPI, core CPI, new vehicles, durable goods, airline fares, and used vehicles. These distortions appear to be pandemic-related. The price of airline fares is likely the result of increased tourism, while the increase in prices of durable goods can be attributed to rental car services restocking inventory after depleting their fleets during the pandemic.

• Additionally, there are already signs of moderation in price pressures as several travel services have slowed down price increases.

• The rise in prices of perishable goods remains relatively modest, suggesting that consumer day-to-day goods may have avoided much of these pandemic-related inflationary pressures.

All that being said, we are still monitoring inflation very closely. We have noticed that certain regions have been impacted by inflation more than others. However, we still maintain that these inflationary pressures will likely be temporary. If we are wrong, we suspect it will likely be related to ongoing supply chain issues from firms that outsource some of their goods abroad. Additionally, if the labor shortage persists, it could also have an impact on inflation.

International news: U.S. lifts sanctions on Iran, EU proposes a fine, and Russia looks to help Iran.

• The U.S. lifted some sanctions targeting Iran’s energy sector on Thursday. The move highlights the easing of tensions between the two sides as the U.S. looks to reenter the nuclear pact. Although it isn’t clear whether there will be a new agreement, as nuclear talks have stalled, lessening tensions will make a deal more likely.
• Russia is looking to provide Iran with its advanced satellite system. The new system will allow Iran to surveil its military targets from space.
• Russia fined Facebook (FB, $332.46) and Telegram for not taking down content that it believed to be unlawful.
• Amazon (AMZN, $3349.65) could face a $425 million fine from the European Union. The fine is in response to the company’s data collection practices.
• French President Emmanuel Macron stated that the Northern Ireland Protocol is non-negotiable. The protocol has sparked protests within Northern Ireland as critics claim the protocol pushes the region closer to the European Union and away from the U.K.

Economics and policy: U.S. not ready for another pandemic, leaders of the U.K. and U.S. meet, Puerto Rico is without power.

• A top official at the Centers for Disease Control and Prevention warned that the U.S. may not be ready for the next pandemic. CDC Principal Deputy Director Anne Schuchat stated that the agency needs additional funding to prevent a future crisis from taking place.
• Congress is still working on a bill to bolster the semiconductor industry and send the China competitiveness bill to the White House.
• Thousands of people in Puerto Rico are without power following a fire at an energy facility.
• Three members of the panel of advisors resigned from the Food and Drug Administration on Thursday. The resignations follow the approval of a controversial Alzheimer’s treatment that went against the panel’s advice. The efficacy of the treatment has been a source of debate as critics argue there is not enough evidence to support the claim that it is effective in treating Alzheimer’s.
• President Biden and U.K. Prime Minister Johnson met for the first time on Thursday. During the 90-minute meeting, the two discussed Northern Ireland, democracy, human rights, and trade. Afterwards, the two renewed the Atlantic Charter, in which the leaders pledged to counter influences of autocratic states.

 China:

• China’s parliament pushed through a bill that would make it illegal for Chinese companies to comply with sanctions imposed by foreign governments. If made into law, it would allow Beijing to punish individuals and companies implementing these sanctions. The move will likely heighten tensions between China and the West and could accelerate the decoupling of the two sides.
• China is gearing up to send its first crew to the country’s new space station.

COVID-19:  The number of reported cases is 174,729,478 with 3,768,560 fatalities.  In the U.S., there are 33,426,302 confirmed cases with 598,716 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 372,830,865 doses of the vaccine have been distributed with 305,687,618 doses injected.  The number receiving at least one dose is 172,423,605, while the number of second doses, which would grant the highest level of immunity, is 141,583,252.  The FT has a page on global vaccine distribution.

• Leaders of the G7 countries are expected to announce a plan to vaccinate the world by the end of 2022. The countries plan to donate 100 million surplus doses over the next 12 months. Additionally, the group is also looking to allocate $100 billion to developing nations in order to aid their recovery from the pandemic.
• The Food and Drug Administration announced that it is going to authorize a six-week extension on the Johnson & Johnson (JNJ,$167.08) COVID-19 vaccine expiration date. The extension will give states additional time to figure out what to do with their surplus inventory.
• The World Health Organization stated that it does not believe that African countries will be able to meet the 10% vaccination goal established by the agency. Failure to reach this goal could complicate efforts to end the pandemic.
• Vaccination rates have slowed dramatically over the last few weeks as officials have struggled to convert shot skeptics. Many of the holdouts now attribute the receding pandemic as a reason to not get vaccinated. The slowing of vaccinations could make it harder for the country to achieve herd immunity.
• The global death toll from the coronavirus this year is already higher than it was in 2020. The surge in COVID-19 deaths has primarily come from South America, Asia, and Africa. If not contained soon, this could mean that the virus will be a problem in developing countries for the foreseeable future.

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

[Posted: 9:30 AM EDT] | PDF

Good morning!  It’s ECB day as the Eurozone’s central bank holds its regular meeting.  It’s also CPI day; we cover the data below, but consumer inflation came in higher than expected.  Overnight, U.S. equity futures were mostly steady in front of the data.  In its wake, equities came under pressure.  And, here’s a fact of the day—National Geographic has named another ocean,  calling it the Southern Ocean, and it encircles Antarctica.  We begin today with short comments about the ECB.  The press conference was underway while we were writing.  Economics and policy are next, followed by the international news roundup.  China news follows, and we close with the pandemic update.

ECB:  The central bank, as expected, made no changes to policy.  In the press conference, President Lagarde suggested that risks in the economy were mostly balanced, which could be taken as hawkish.  These words, however, were not backed up by tightening.  Market reaction, so far, has been modest, although we are seeing long-duration yields rise.  That reaction may have more to do with U.S. CPI.

 Economics and policy:  Crypto is continuing to dominate the news, and payment for order flow is coming under review.

• We continue to closely monitor developments in the cryptocurrency market, especially as regulators start to recognize that much of the crypto world is looking like regulatory arbitrage. In other words, a coin that essentially gives one lending or cash transfer powers must have the same level of regulatory protections as those in the existing financial system.  Much of distributed finance creates unregulated derivatives that may be illegal to operate in that fashion. We note the Basel Committee, which is sort of a global bank regulator, is calling for much tougher capital rules for cryptocurrencies.  If regulation creeps in, we would expect the current prices of various crypto coins to become more volatile.
  • Crypto for your 401k? Coinbase (COIN, USD, 224.32) is working with 401k managers to offer various crypto coins for retirement plans.
  • China continues to crack down on bitcoin miners. Qinghai province recently closed a mining project.
  • The U.S. custody bank State Street (STT, USD, 84.57) is creating a cryptocurrency division. As cryptocurrencies steadily become embedded in the financial infrastructure, they will likely continue but face much higher regulatory scrutiny.
  • Although bitcoin was thought to be untraceable, the recent seizure of coins in the wake of the Colonial Pipeline hack shows that such secrecy may be overestimated.
• Globalization is a major benefit for the talented and powerful. That’s because it creates a broader platform allowing such people to leverage their talents on a wider scale.  Mike Bloomberg is looking to create an alternative to the World Economic Forum with the aim of fostering continued globalization.
• Although China remains behind in its Phase One trade deal obligations, we are seeing continued aggressive Chinese purchases of American grain. Current prices reflect China’s buying.
• On the G-7 corporate tax harmonization plan, we already notice broader reactions. First, the U.K. wants an exception for the City of London.  Second, Ireland, a notorious tax haven, has suggested it might be ok with a 15% rate.
  • At the same time, getting this deal through the Senate, given that it is a treaty, looks like a long shot. The Senate requires two-thirds approval for a treaty, which may be close to impossible.  The GOP is becoming increasingly hard-wired against tax increases.  As the party becomes populist, it may inadvertently become the party most likely to adopt MMT-type policies.
• There is a timeless economic adage that says “nothing cures high prices like high prices.” There are reports that the global logistics industry is ordering container ships, and shipyards are looking to invest in increasing loading capacity in response to high demand.
• Payment for order flow is a way to essentially execute a form of regulatory arbitrage. Exchanges set the standard for bid/ask spreads on equities.  These spreads reflect the risk that concentrated institutional positions could pressure the spread because they tend not to be dispersed.  On the other hand, retail flow tends to be mostly balanced between buys and sells.  So, order flow firms accumulate retail trades and execute the trades inside the exchange spread.  When you make a retail trade, and you see a line called “price improvement,” it reflects the price you received inside of the exchange spread.  Payment for order flow means these firms split the price improvement between the customer and their broker/dealer.  The firm sells the flow, and the broker/dealer, the retail customer, and the order flow firm share the benefit.  The SEC says it intends to review this arrangement.  As trade commission rates fall to zero, it is the payment for order flow that compensates the broker/dealers.  For the most part, it appears that institutional investors, who get the exchange spread, are the losers in this arrangement.  We doubt the SEC will end the practice, but we wouldn’t be shocked to see rules put into place that give the greatest benefit to the retail customer.  If that is the outcome, we might see retail-focused broker/dealer equities come under pressure.
• The economy is grappling with reopening. This is revealed in the JOLTS data, which shows a disconnect between hiring and job openings.  It has also become evident in the inflation data.  However, the key point to watch isn’t this short-term logistics issue but the longer-term reaction.  There is great fear that the current situation will trigger lasting inflation problems.  There is also a good chance that it will foster a productivity boom as firms begin to adapt to higher wages with increased investment and productivity.  Low-interest rates could foster this outcome.
• Although we are, like everyone else, watching the 10-year T-note yield dip under 1.50%, we are not sure why it’s occurring. If lasting inflation fears were rising, this drop probably wouldn’t occur.
• One of our concerns about the current political divide is that it will lead to regulatory “swings” that will make investment decisions increasingly risky. Case in point—the Biden administration is looking to change clean water regulations to make them more stringent.
• It’s a known fact that Americans have become increasingly heavier.

The FAA is requiring airlines to take this fact into account, which may lead to more stringent rules on luggage or more passengers being bumped from full flights.  What we haven’t seen yet is seat pricing by passenger weight.

• There is new research that suggests that up to half of unemployment insurance support may have been fraudulent.
• The Fed’s reverse repo has hit a new record of $500 billion, suggesting that financial institutions are overwhelmed with liquidity.

International roundup:  President Biden’s European trip kicks off today.

• President Biden and PM Johnson are set to meet today. Although we expect talks to appear agreeable, the issues surrounding Northern Ireland will likely be a sticking point.
  • It’s not just the U.S. that is troubled by the situation in Northern Ireland. The EU is considering retaliation for border trade violations.
  • At the same time, the U.K. is quietly working to improve trade with the EU in the post-Brexit environment.
• As President Biden travels to meet with EU leaders, his message is the U.S. is “back” and that America and Europe need a united front against China.
• An international sting operation that created an encrypted communications platform, secretly run by the FBI, has resulted in over 800 arrests Cash and illegal drugs were seized from Asian crime syndicates, Albanian organized crime, the Italian mafia, and motorcycle gangs.  The sting operation lasted three years.
• The leader of Boko Haram, a Nigerian Islamic terrorist group, has allegedly committed suicide.
• It looks like Pedro Castillo has eked out a narrow victory in Peru. An avowed left-winger, his election has put pressure on Peruvian equities.  However, we would note this party has little power in the legislature, so his win might not be all that bad for the Peruvian capital in the long run.

(Source:  Barchart)

This chart shows the Peru ETF.  When it appeared the right-wing Fujimori was set to win, the price rallied, but it has tumbled on Castillo’s win.

• Nicaragua’s President Ortega has hit upon a new way to improve his chances of winning reelection. He is systematically arresting his opponents.
• Russia has outlawed Alexei Navalny’s related organizations.
• The EU and Germany are debating if EU courts overrule German ones. Our money is on Berlin.

China:  The gains against poverty have probably been overstated, and tech firms are seeing tighter regulation.  Credit conditions are tightening.

• One of General Secretary Xi’s purported accomplishments is the eradication of poverty in China. It is part of Xi’s “Chinese Dream” concept.  Bill Bikales, a former U.N. economist, disputes the claim in a recent report, suggesting the “accomplishment” is more definitional than actual.  So far, we haven’t seen a reaction from Beijing, but we would expect a rejection of Bikales’s claim at some point.
• When Canada held Meng Wanzhou, the CFO of Huawei (002502, CNY, 4.43), for extradition to the U.S. on charges she violated sanctions against Iran, China arrested two Canadians on what appeared to be trumped-up charges. There are reports that there is a deal in the works for the release of these Canadians, Michael Kovrig and Michael Spavor.  It is not clear if that outcome would also mean that Meng would return to China.
• Beijing is aggressively moving to regulate China’s tech industry, which has, for the most part, operated in a favorable regulatory environment. Regulators are now moving beyond the large firms to investigate smaller firms.  The actions are affecting the overall tech sector.
• If there was any hope in Beijing that the new administration in Washington would have a lighter touch, it is becoming increasingly clear that opposition to China is more about circumstance than personalities. The Biden administration released the list of blacklisted firms, and although there are some differences, overall, it shows that accommodation to China is no longer the direction of policy.
• In the late 1990s, China established four firms that were effectively “bad banks.” They accepted bad debt from the Chinese financial system to eventually liquidate the loans.  Such bad banks are standard practice in finance to address a widespread bad loan problem.  By taking the bad loans off bank balance sheets, the banks can begin lending again (sometimes after recapitalization), and the bad banks can try to recover whatever value remains.  Usually, once the bad loans are either written off or sold, the bad bank itself winds down.  That was not the case in China.  Huarong (2799, HKD, 1.02) issued bonds against the “assets” it held, and default fears have led to (a) the value of these bonds falling to around 70 cents/dollar, and (b) led to the execution of its ex-chairman, Lai Xiaomin.  Now, China Great Wall, another one of these companies, has seen its chairman come under investigation.  Although fears of China’s corporate debt have been around for a long time, so far, the country has avoided a major debt crisis.  Yet, each scandal raises fears that one might develop.
• Meanwhile, the PBOC is steadily tightening lending, leading to slower loan growth. Weaker loan growth will tend to depress the economy and may lead to higher exports.

(Source:  Capital Economics)

• The U.S. Senate has passed $250 billion of spending to counter China’s rise. The bill had wide, but not universal, bipartisan support.  China was not pleased.
• Chinese social media firms have been given a reprieve from being closed in the U.S. However, the administration is conducting a review, which may lead to future restrictions.
• The SoD has issued a directive to accelerate efforts to counter China’s rise.

COVID-19:  The number of reported cases is 174,468,792 with 3,759,188 fatalities.  In the U.S., there are 33,414,769 confirmed cases with 598,766 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 372,495,525 doses of the vaccine have been distributed, with 304,753,476 doses injected.  The number receiving at least one dose is 172,054,276, while the number of second doses, which would grant the highest level of immunity, is 140,980,110.  The FT has a page on global vaccine distribution.

• Millions of doses of Johnson & Johnson (JNJ, USD, 165.36) COVID-19 vaccines may expire. When concerns developed about the safety of the vaccine earlier this year, inoculations were halted.  Although the halt was lifted, doses exceeded injections.
• The U.K. is dealing with the “delta” variant of the virus; the bad news is that it appears to be more contagious. The good news is that current vaccines appear to offer good protection against serious illness.
• The U.S. is purchasing 500 million doses of the Pfizer (PFE, USD, 39.81) vaccine for global distribution.
• Taiwan is dealing with a serious outbreak of COVID-19. We discussed the U.S. vaccine donation earlier this week.  The outbreak is starting to affect the critical chipmakers on the island.
• The state of Washington is offering a free joint for accepting a COVID-19 shot.
• China is aggressively inoculating its citizens. Despite the jabs, new lockdowns are occurring as outbreaks develop.
• The king of Thailand owns the company that is distributing vaccines; due to strict lèse majesté laws, it has become difficult to complain about the slow rollout of doses.

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