Author: Donna O'Donnell

Daily Comment (June 9, 2021)

Posted on by Donna O'Donnell

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with some early responses to the G7’s call for a global minimum tax rate on corporations.  In a word, it looks like pretty tough sledding for the proposal.  Next, we move to U.S. fiscal and regulatory policy developments, with a particular focus on President Biden’s decision to abandon his talks on infrastructure spending with Republicans in the Senate.  We then move to various international news items before wrapping things up with the latest items of note on the coronavirus pandemic.

Global Minimum Tax for Corporations:  Responding to the G7’s call for a global minimum tax of 15% on corporations, the finance spokesman for Ireland’s second-largest opposition party backed a “small increase” in the country’s 12.5% rate.  Yet, the proposal is likely to get significant pushback as the G7 tries to sell it to the broader G20 grouping.

  • Even Poland and Hungary have already come out against the plan unless it includes carve-outs for certain businesses.
  • And, of course, the idea would face immense hurdles getting through the U.S. Congress.
    • Assuming the plan would take the form of a treaty, it would require the approval of two-thirds of the Senate.  That would be very difficult to achieve in today’s polarized political environment and the current 50-50 split in the chamber between Democrats and Republicans.
    • Senior Republican lawmakers have already lined up to slam the fledgling accord, citing the potential harm to U.S. competitiveness and sovereignty.
  • For now, at least, we think the proposal is unlikely to be implemented anytime soon.

U.S. Fiscal Policy:  President Biden called off an effort to craft a bipartisan spending package on infrastructure and other economic initiatives after negotiations with Republicans stalled.  Instead, Biden is shifting his focus to a separate set of negotiations with a group of Republicans and Democrats in an effort to salvage a bipartisan deal on the issue.  Senate Majority Leader Schumer said Democrats are preparing to pass elements of Biden’s original, $2.3 trillion infrastructure plan through reconciliation, a budget maneuver allowing lawmakers to avoid the 60-vote threshold for most legislation in the Senate.  Democrats are probably able to pass some infrastructure spending on their own through the reconciliation process.  The amount ultimately approved may be significantly smaller than President Biden’s original proposal, but it could still provide a significant boost to economic activity and inflation pressures.

U.S. Cryptocurrency Regulation:  Hester Peirce, one of the two Republicans on the five-member Securities and Exchange Commission, in a statement to the Financial Times, warned against attempts by her colleagues to regulate cryptocurrencies more strictly, saying that doing so runs the risk of discouraging investors.

United States-Japan-Australia-India:  White House Indo-Pacific Coordinator Kurt Campbell said the U.S. will host the first in-person summit of the “Quad” countries–the U.S., Japan, Australia, and India–this fall in Washington.  At the summit, the countries’ leaders will further discuss strategies to counter China’s geopolitical, military, and economic aggressions throughout the Indo-Pacific region.

Chinese Inflation:  The May producer price index (PPI) was up an astounding 9.0% year-over-year, well above the expected increase of 8.5% and far worse than the April increase of 6.8% (see data tables below).  Driven by vast price increases in industrial commodities like crude oil and iron ore, the annual gain in May was the biggest since September 2008.  The large rise in costs could help reignite concerns about persistent high inflation around the world.

  • However, one important question is the extent to which higher producer costs will be passed on to the consumer.
  • China’s May consumer price index (CPI) was up just 1.3% on the year, higher than the 0.9% growth in April but lower than the anticipated increase of 1.6%.

Chinese Housing Market:  Fast-rising home prices have also become a problem in China, prompting many local governments to impose new restrictions.  Among the most interesting is a move by Shenzhen to publish “guidance prices” for about 3,500 different housing developments.  In effect, the guidance prices are taken as a cap on the size of a mortgage that a bank can offer on a property.  If a buyer wants to pay more than the guidance price, he or she can do so, but the buyer then needs to make a larger down payment.

South Korea:  The ruling Democratic Party today said it was trying to regain public trust by asking 12 lawmakers to leave the party over a property scandal that has alienated voters.  The insider land trading scandal, alongside skyrocketing home prices and deepening inequality, has contributed to President Moon Jae-in’s approval ratings plunging to record lows and his party’s abject defeat in key mayoral elections in April.

COVID-19:  Official data show confirmed cases have risen to 174,060,099 worldwide, with 3,749,148 deaths.  In the United States, confirmed cases rose to 33,393,813 with 598,330 deaths.  Vaccine doses delivered in the U.S. now total 372,100,285, while the number of people who have received at least their first shot totals 171,731,584.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

 Economic and Financial Market Impacts

  • A new COVID-19 outbreak in southern China is curbing activity at some of the country’s biggest ports, stoking fears of further disruption to international trade and more upward pressure on prices.
    • More than 100 new cases have been reported since late May in Guangdong province, one of China’s most important manufacturing hubs, leading to strict countermeasures from the government.
    • Processing at the Yantian container terminal in Shenzhen, which suspended exports for almost a week last month after workers tested positive, has plummeted. There has also been a sharp decline in the number of ships berthing as authorities enforce coronavirus prevention measures.
  • Despite the new outbreak in China, infections in the U.S. continue to fall, and businesses continue to reopen.  Some observers thought the quick U.S. reopening would convince companies to put some of their enormous cash holdings to work, but that isn’t happening so far.  Banks are now pressuring some companies to take their cash elsewhere, especially since excess deposits could force some banks to raise extra cash.

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Daily Comment (June 8, 2021)

Posted on by Donna O'Donnell

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

[Posted: 9:30 AM EDT] | PDF

We open today’s Comment with a range of reports that ultimately touch on technology, Taiwan, and China.  We also explore important trade news out of Europe and new developments in the Peruvian presidential election, where it now looks like a Marxist firebrand will take power.  We conclude with the latest news on the coronavirus pandemic, including the news of a major U.S. intelligence report that last year lent credence to the hypothesis that the virus could have escaped from a Chinese laboratory.

United States-Global Cybersecurity:  On a day filled with reports that key commercial and government websites are down across the globe, sparking fears of a coordinated hacker attack, there is also an important report that underlines our belief that the U.S. probably has greater offensive capabilities in cyberspace than many people realize.  According to the report, the FBI was able to use “Trojan horse” technology to gain access to a criminal internet network and, in conjunction with allied police forces in other countries, has monitored millions of encrypted criminal messages over the last three years.  In Australia alone, the program has allowed police to disrupt 21 murder plots and seize 3.7 tons of illegal drugs.

United States-Taiwan:  Secretary of State Blinken revealed the Biden administration is launching talks with the Taiwanese government on a “framework agreement” relating to trade and investment.  Although Blinken declined to elaborate and referred any questions to U.S. Trade Representative Tai, it appears the effort would revive lower-level talks that the two governments have pursued off-and-on for years.  Coupled with the revelation of a U.S. intelligence report that lends credence to the hypothesis that the coronavirus pandemic could have resulted from a Chinese laboratory accident (see below), the announcement of closer economic ties with Taipei will certainly exacerbate U.S.-China tensions and keep risks elevated for investors.

United States-China:  As a result of President Biden’s call in February for a review of supply chain security for key products, the Commerce Department will investigate whether imported rare earth magnets made largely in China pose a national security threat that could warrant the imposition of tariffs.  The magnets, made from the rare-earth element neodymium, are used to manufacture everything from smartphones to electric vehicle motors.  Tariffs on the magnets could be imposed under Section 232 of a 1962 trade law, which was rarely used until former President Trump employed it to justify tariffs on steel and aluminum imports from U.S. allies.

  • The investigation and potential imposition of tariffs is another example of how President Biden is not only continuing many of the Trump administration’s trade policies but has also sharpened their focus on China.
  • According to press reports, Biden will release further results of the supply chain probe later today.

European Union-United Kingdom:  EU Brexit Commissioner Maros Sefcovic warned that Brussels would intensify its retaliation if the U.K. continues to delay implementing the post-Brexit trade treaty’s provisions on Northern Ireland.  The EU has complained that Britain is failing to implement basic parts of the new arrangements, such as building and properly staffing border control posts for goods and sharing data with Brussels.

Germany-Ukraine:  In testimony before Congress yesterday, Secretary of State Blinken said Germany is discussing ways to compensate Ukraine for the financial loss it will suffer from the completion of Nord Stream 2, the controversial pipeline that will carry Russian natural gas under the Baltic Sea to Germany.  By providing an alternate route for gas that had previously flowed through Ukraine, the pipeline is expected to deprive Kyiv of billions of dollars in annual transit fees if completed.

Peru:  With 96% of the vote in Sunday’s presidential election now counted, Marxist politician Pedro Castillo has extended his lead over conservative Keiko Fujimori and appears to be poised for victory.  Many of the remaining tallies should come from rural areas, where Castillo is strongest.  Although ballots from Peruvians living abroad are likely to favor Fujimori, it appears there will not be enough to tip the balance back in her direction.

  • In an effort to reassure markets, the Castillo team published a statement outlining an economic plan that is considerably more moderate than the platform approved by Castillo’s “Peru Libre” party.  While it reiterated Castillo’s plan to raise taxes on natural resources companies to pay for increased health and education spending, the plan also asserted, “We have not considered nationalization, expropriation, confiscation of savings, exchange controls, price controls or import prohibitions . . . [We would] respect the autonomy of the central bank, which has done a good job [of] keeping inflation low for more than two decades.”
  • However, despite those reassurances, Peruvian stocks and bonds have been dropping dramatically, and the country’s currency, which has depreciated sharply in recent weeks in anticipation of a possible Castillo victory, has lost over 2% against the dollar to trade at an all-time low of 3.93.

COVID-19:  Official data show confirmed cases have risen to 173,694,649 worldwide, with 3,739,238 deaths.  In the United States, confirmed cases rose to 33,378,767 with 597,983 deaths.  Vaccine doses delivered in the U.S. now total 371,520,735, while the number of people who have received at least their first shot totals 171,310,738.  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, 51.6% of U.S. residents have now received at least one dose of a vaccine, and 42.1% are fully vaccinated.
  • As U.S. infections and deaths continue to fall and more people get vaccinated, both Carnival Cruise (CUK, $26.50) and Norwegian Cruise Line (NCLH, $33.11) said they will finally resume sailing from U.S. ports this summer.  Given that infections on cruise ships were some of the most notorious incidents early in the pandemic, the announcement marks an important milestone in the post-pandemic economic reopening.
    • The announcement from the companies comes after protracted negotiations with the CDC over the safety measures that will be required.
    • Passengers must have a final dose of a coronavirus vaccine approved by U.S. authorities.
  • New reporting shows the Lawrence Livermore National Laboratory issued a classified report in May 2020 that concluded, based on a genomic analysis of the SARS-CoV-2 virus (which causes COVID-19), the virus might have leaked from a Chinese lab in Wuhan.  The report, vetted with other U.S. intelligence agencies, called for further investigation into the hypothesis.  It was referenced by the State Department when it conducted an inquiry into the pandemic’s origins during the final months of the Trump administration.  It also appears to be one reason President Biden last week directed the U.S. intelligence community to send him a report on how the virus emerged.
    • The study is important because it came from a respected national laboratory and differed from the dominant view in spring 2020 that the virus almost certainly was first transmitted to humans via an infected animal.
      • Specifically, the report came from the laboratory’s intelligence division, which has deep expertise in biological warfare issues.
      • Notably, when President Biden announced his request for a study of the pandemic’s origins, he said the federal government’s national laboratories would contribute to the effort.
    • Because of Lawrence Livermore’s strong reputation in biological warfare issues, its view that the pandemic could plausibly be traced to a Wuhan lab leak will likely keep that hypothesis alive in the near term.  Not only will that help keep tensions high between the U.S. and China, but it might even lead to the Biden administration explicitly blaming China for the pandemic at some point.  After all, the administration has already shown it is willing to be tougher on China than Trump was.  For example, it has highlighted Chinese human rights abuses and has worked hard to corral U.S. allies into a coalition that will stand up to China’s destabilizing geopolitical, military, and economic behavior.  Explicitly blaming China for the pandemic in a multilateral way would further sour relations between the liberal democracies and China, with unpredictable consequences for investors.

 Economic and Financial Market Impacts

  • As Taiwan suffers its first large COVID-19 outbreak, the spread of infections in the island’s globally important semiconductor industry is raising the prospect of reduced production and a worsening in the global computer chip shortage.
    • For example, chip testing and packaging company King Yuan Electronics said an outbreak among its workers could reduce its June output and revenue by up to 35%. Of KYEC’s 7,300 staff, 238 are confirmed to have been infected.  Multiple firms are testing their entire workforces or have closed entire factories for days at a time in order to conduct disinfecting.
    • As we have often noted, Taiwan occupies a critical place in the global semiconductor industry.  For more details, see Part I and Part II of our recent WGR on the Taiwanese chip industry and how it fits into the U.S.-China geopolitical rivalry.
  • Reflecting on the new strategies companies are adopting to deal with the tight labor market, Southwest Airlines (LUV, $58.28) is leaning more on digital job placement tools, including chatbots, to speed up the hiring process.
  • All the same, high-frequency data suggests that while job openings are still climbing, they’re beginning to moderate.  The data suggests labor demand is already leveling off in some sectors, such as manufacturing and retail trade, and it may even be falling a bit in construction.

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Daily Comment (June 7, 2021)

Posted on by Donna O'Donnell

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

[Posted: 9:30 AM EDT] | PDF

Good morning, and happy Monday!  In the wake of Friday’s rally, U.S. equity futures are mostly steady this morning.  Our coverage begins with a look at the G-7 agreement to set a minimum corporate tax.  Up next is the president’s trip to Europe.  There were three major elections over the weekend; we look at the outcomes.  Economics and markets are next, with a look at cryptocurrencies and Treasury Secretary Yellen’s comments about rising interest rates.  China news is next.  Technology news follows, and we close with pandemic coverage.

The G-7:  Corporate taxes are an area of contention in public finance economics.  Two broad theoretical problems are in play.  First, there is the problem of incidence, which is the economic word for “who pays?”  If firms were fully profit maximizers, corporate profits are paid by the firm.  However, in real life, firms don’t always maximize profits in a given time frame.  They may reduce profits today through research and development spending or by increasing worker training.  If firms don’t always maximize profits, then the incidence may fall on consumers (via higher prices) or on workers (through lower wages).  In practice, it appears that the corporate tax incidence eventually is paid by others, which has created a vocal group of economists who argue it should be abolished.  That leads to the second issue, which is the question of ownership, or put another way, what is a corporation anyway?  Legally, we treat a corporation as if it were a person, but that’s a bit silly.  A corporation is more of a legal construct that someone owns.  Since that owner almost certainly is a person, the earnings that corporation produces eventually go to that owner…who is also taxed as a person.  Now, if there were no corporate tax, earnings could be retained indefinitely and no tax would ever be paid by a person, but, as we see with dividends, they are taxed twice in the U.S.  In other words, the corporate tax often ends up being a second tax on an individual who is a beneficial owner.

Complicating matters further is the globalization of business.  Firms have become remarkably adept at moving earnings to low-tax states and reducing the corporate tax.  In the U.S., we see a “race to the bottom” on state and local taxes as these entities try to attract businesses to locate in a certain area.  This activity occurs at the international level, too.  A solution for state and local governments would be to agree to a minimum level of local and state taxes to remove the incentive for businesses to shop for lower taxes; this is also a solution at the international level.  Over the weekend, the G-7[1] nations agreed on a minimum corporate tax rate of 15% and would tax them based on activity in each nation and not on where the profits are booked.  Is this a big deal?  Yes, but it’s not too big.  None of the seven nations in this group is a tax haven, like Ireland, for example.  Selling the idea within these nations won’t be easy, but it pales in the difficulties in expanding the minimum’s reach.  France, Germany, and Italy would be on board with this idea, but other nations within the EU won’t.  Broadening out to the OECD will be even more difficult.  There have been proposals among U.S. state and local governments to do something similar, but the temptation to defect from the agreement to attract a business is hard to overcome.  So, this is an important development, but it’s also too early to start expecting lower after-tax earnings from this deal.

Off to Europe:  President Biden is making a trip to the EU this week.  There is great fanfare about uniting the world’s democracies.  However, the underlying reality is that Europe isn’t that important to the U.S. anymore (China is a much bigger issue), and if the U.S. is going to become a proper empire, it means we do less of the dirty work while making allies do more.  The U.S. hegemonic model from the Cold War was designed to contain the Soviets, so we made it attractive to work with the U.S. by providing security for low cost and allowing nations to run large trade surpluses with America.  Those days, regardless of who occupies the White House, are over, and the world will either (a) have a world without a hegemon, a G-0 world, which history says is a world at war, or (b) a more traditional hegemon that is disliked, feared, and obeyed.  Our position is that option “a” is the more likely outcome, but we cannot say, with certainty, that a “b” outcome isn’t impossible.  For Europe, which dominated the world for centuries, both outcomes are attractive.  Either they will face the tender mercies of Russia and China on their own or be directed by the U.S. to do what Washington wants.  Europe wants a return to the Cold War policies; that outcome isn’t politically feasible anymore in the U.S.  We expect lofty sentiments, but the reality is that the EU will be spending more on defense, and it will again face the internal dissension within Europe on its place in the world.

Election special:  Germany and Mexico held local elections, and Peru had its presidential runoff.

  • Germany holds national elections in September, and with Merkel retiring, there is uncertainty about who will be in power in the wake of the vote. In the last local election before the national polls, voters in Saxony-Anhalt kept the CDU in power and reduced the influence of the AfD.  This outcome was a boost for the incoming CDU leader Armin Laschet; he is considered a lackluster campaigner, leading to worries about his leadership going into September’s election.  The win this weekend is good news for Laschet.
  • AMLO’s coalition, Morena, appears to have maintained its majority in the legislature but lost its supermajority in the lower house, meaning AMLO will be less likely to make changes to Mexico’s constitution. Morena continues to dominate Mexico’s political situation, but the opposition was able to reduce AMLO’s power to some extent.
  • The Peru outcome is uncertain at this time. Fujimori does hold a slim lead over Castillo, but it may be a few days before the outcome is determined.  The differences are stark; Fujimori is seen as conservative and business-friendly, while Castillo wants to push a hard-left agenda.

  Economics and policy:  Yellen prepares the markets for tighter monetary policy, and cryptocurrencies continue to make news.

  • Although Janet Yellen no longer runs the Fed, her perch as Treasury Secretary is high profile. She is usually painted as an uber-dove on policy, a characterization that isn’t really accurate.  She pressed Greenspan to tighten policy in the late 1990s when the economy was strong.  He demurred, arguing that productivity gains meant policy could remain easy.  Instead, we view Yellen as more of a left-of-center orthodox economist who believes in pre-emption in terms of monetary policy and would not advocate MMT.  Note that in her support of the administration’s spending, she is also pushing for higher taxes.  Over the weekend, she made the argument that the Fed should support higher interest rates and inflation which would represent a “normalization” of the economy.  We see her point but note this normalization would not be welcomed by the financial markets.
    • One item to watch here is that it is not at all uncommon that when a party has been out of power, when they return to government, there is something of an “all-star team” of policy people waiting to fill roles. It is usually after a year or two a president begins to realize that he needs people to execute his ideas rather than to advise him on what to do.  It will be interesting to see if Biden continues with Yellen or moves to someone less orthodox down the road.
  • Cryptocurrencies are all the rage. They are great for journalists—they are obscure in their origin, and the volatility means that headlines are easy to find.  But for investors, it’s caveat emptor.  The FTC says that $80 billion has been lost by investors in scams, and, as we will discuss later this month in an upcoming WGR series, it is the payment choice for organized crime.
  • We have been bullish on commodities as the world recovers from the pandemic. Grain prices have been soaring, and soybean oil, used for both cooking and in biofuels, is on a tear.
  • Home prices are also strong, and price strength is spreading into modest homes and smaller towns.
  • Semiconductor chip shortages will crimp auto supply until mid-2022.
  • One factor roiling the labor markets is a growing reluctance to relocate. There is some evidence that the pandemic has caused some reconsideration of priorities and leading some workers to decide to stay put.

China:  Biden continues some of Trump’s China policies, Hong Kong has changed, and Beijing is cracking down on tech.

  • The media never seem to get the fact that policy is often shaped by circumstance. A president may want to change things, but the reality is that conditions restrict choices.  As we noted above in the EU comments, Biden may be more polite to Europe than Trump, but the policy direction means that Europe can’t go back to the Cold War situation.  China is a strategic competitor, and thus, there will be some level of consistency in policy.  For example, the U.S. expanded its blacklist on Chinese companies that have ties to China’s military.
  • For years, Hong Kong was seen as a capitalist haven in the Far East. As Deng moved to expand China’s economy, the former British colony became a bridge to the rapid growth in China that still offered the “comforts” of a Western legal system and the freedoms that come with it.  That has all changed under Xi, and businesses are starting to realize that being in Hong Kong offers no special status.
  • Technology firms are facing increased regulatory threats around the world. Their tendency toward monopoly market structures and their pervasive influence make them a target.  Beijing is moving quickly to bring these firms to heel.

Technology:  Google (GOOG, USD, 2451.76) agrees to a fine, and Apple (APPL, USD, 125.89) faces scrutiny.

COVID-19:  The number of reported cases is 173,360,912 with 3,730,506 fatalities.  In the U.S., there are 33,363,364 confirmed cases with 597,631 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 371,520,735 doses of the vaccine have been distributed with 301,638,578 doses injected.  The number receiving at least one dose is 170,833,221, while the number of second doses, which would grant the highest level of immunity, is 138,969,323.  The FT has a page on global vaccine distribution.

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[1] U.S., U.K., Canada, France, Germany, Italy, and Japan.

Daily Comment (June 4, 2021)

Posted on by Donna O'Donnell

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. International news follows, with reports of new sanctions on Belarus and the EU-U.K. probing of a major U.S. tech firm. Economics and policy news are up next, including stories about the House Democrats’ transportation funding bill and a new U.S. investment ban on Chinese companies. China news follows, and we close with our pandemic coverage.

Infrastructure plan developments: On Thursday, President Biden announced that he is willing to make additional concessions in order to fund a bipartisan infrastructure package. Biden has lowered his price tag from $1.7 trillion to $1 trillion and has backed off plans to undo parts of the 2017 tax plan. In its place, he has proposed a minimum corporate tax rate of 15% for companies that have lots of tax credits and deductions. Additionally, he would like to repurpose $75 billion of unused COVID-19 relief aid that was approved under the previous administration. Last week, Republicans unveiled a plan that would provide $928 billion in infrastructure spending, up from the initial offer of $568 billion. Even though this is close to what the president is seeking, he is still holding out hope for additional funding. Senate Republicans are scheduled to meet with President Biden on Friday to discuss the matter further.

Although negotiations with Republicans are ongoing, President Biden is facing pressure from his fellow Democrats to go it alone via budget reconciliation. However, this plan has its own set of obstacles. On Thursday, Senate Parliamentarian Elizabeth MacDonough ruled that only one more automatic budget reconciliation is permissible this year. Hence, Democrats would need to ensure that everyone is on board before going through with this process. Possible holdout Senator Joe Manchin (D-W.V.) has stated that he doesn’t feel comfortable backing the bill without Republican support. At this time, it still appears that the infrastructure plan is likely to make its way through Congress.

International news: Alternatives to the vaccine patent waiver, Netanyahu tries to cling to power, and new sanctions on Belarus.

Economics and policy: Biden’s ban on investment in Chinese companies and House Democrats’ transportation funding bill.

China:

  • Hong Kong police arrested the organizer of the Tiananmen vigil the day before the anniversary of the crackdown on pro-democracy protesters. The police are expected to patrol the streets of Hong Kong to prevent any new protests from springing up.
  • Banks continue to ramp up hiring in Hong Kong despite China’s growing control over the special administrative region.

COVID-19:  The number of reported cases is 171,964,959 with 3,697,399 fatalities.  In the U.S., there are 33,325,218 confirmed cases with 596,391 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 368,375,195 doses of the vaccine have been distributed with 297,720,928 doses injected.  The number receiving at least one dose is 169,090,262, while the number of second doses, which would grant the highest level of immunity, is 136,644,618.  The FT has a page on global vaccine distribution.

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Daily Comment (June 3, 2021)

Posted on by Donna O'Donnell

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

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with an overview of yesterday’s “Beige Book” report from the Federal Reserve, which pointed to accelerating economic growth but continued inflation pressures.  Sticking with the inflation theme, we then review the latest UN data on global food prices.  Various international news items follow, and we wrap up with the latest developments on the coronavirus pandemic.

U.S. Monetary Policy:  In its latest Beige Book analyzing business anecdotes on the state of the economy, the Fed said activity expanded “somewhat faster” in April and May than it did in the previous period, driven largely by increased coronavirus vaccinations, the easing of pandemic lockdowns, and rebounding consumer demand for services.  The report discussed how supply disruptions and shortages across many industries are driving up costs, but it noted that rebounding demand often allows firms to pass on those costs to their customers in the form of higher prices.  In summary, the report judged that “. . . expectations changed little, with contacts optimistic that economic growth will remain solid . . . Looking forward, contacts anticipate facing cost increases and charging higher prices in coming months.”

  • The Beige Book focuses on current conditions as seen by local business leaders rather than the policymakers’ future expectations.  It is, therefore, no surprise that yesterday’s report didn’t address head-on the key issue of whether today’s high inflation will really be transitory, as Fed officials insist.  All the same, it was notable that the report offered little evidence that the supply disruptions, labor shortages, and other issues driving up prices will dissipate soon.
  • For now, we remain optimistic that the current supply issues will get sorted out as the economy continues to recover from the pandemic, especially as the rebound in demand will likely be sated at some point.  Moving past today’s unfortunate inflation base effects will also help bring down the measured inflation rate, while other longstanding issues such as population aging should reassert themselves and put a damper on prices.  We suspect that will eventually help calm inflation concerns and put a lid on bond yields if no other inflation pressures arise.

Global Food Inflation:  The UN Food and Agriculture Organization said its May index of global food prices was up 39.7% from the same month one year earlier, marking its biggest annual increase since 2011.  The report attributed the surge in food inflation to a range of factors, including the increased use of vegetable oil for biodiesel, China’s soaring appetite for grain and soybeans, and a severe drought in Brazil.  As a result, the annual price increases were especially large for vegetable oils and cereals (see chart below).

  • Not only will the data feed into current global concerns about the impact of inflation on the economy and financial markets, but it will also raise the specter of political unrest in less developed countries.
  • Indeed, the FAO Food Price Index has now essentially risen back to the high levels it reached a bit more than a decade ago when soaring food prices helped touch off the Arab Spring.

Source: FAO

United States-United Kingdom, et al:  U.S. Trade Representative Katherine Tai said the Biden administration would impose punitive tariffs on the U.K., Italy, Spain, Austria, India, and Turkey in response to their digital-services taxes on U.S. technology companies.  However, Tai said the administration would suspend the levies for six months while it seeks to negotiate an international resolution to the issue under the auspices of the G20 and the OECD.

  • The proposed tariffs, at a rate of 25%, would target imports worth nearly $2 billion from the six countries, including imports worth over $800 million from the U.K. and more than $300 million each from Italy and Spain.
  • Even though the tariffs will be suspended at first, the entire issue of global taxes on digital services is yet one more dimension of the increased regulatory risk hanging over U.S. technology giants.

United States-Russia:  Officials at the White House said President Biden will pressure Russian President Putin to crack down on his country’s computer hackers when the leaders meet later this month.  The officials said Biden would also not rule out retaliating against the Russian criminal gangs that carried out the recent ransomware attacks on Colonial Pipeline and meat company JBS.  We suspect the U.S. has greater offensive cyberwarfare capabilities than is widely known, so the administration could impose a painful punishment on the hackers if it is willing to reveal some of its weaponry.  Ultimately, however, addressing the problem will probably require pressuring the Russian government to not give the hackers a safe haven for launching their attacks.  That implies further U.S.-Russian tensions.

Israel:  Consistent with the reports we’ve been writing about, right-wing politician Naftali Bennett, centrist Yair Lapid, and other opponents of Prime Minister Netanyahu agreed to form a coalition government that will oust him.  If the government is sworn in within the next two weeks, Netanyahu would cede power to the most diverse coalition in Israel’s history, including,  for the first time, an independent Arab party.

  • The proposed coalition is not yet a done deal.  The group would only have a razor-thin majority in the Knesset, and Netanyahu would only need to peel off a couple of its members to scuttle the plan.
  • Even if the coalition successfully takes power, the slim majority and contradictory ideologies among the member parties would likely leave the government unstable.  That could well paralyze policymaking and prompt yet another round of elections in the near term.

Iran:  One of the largest ships in the Iranian navy caught fire and sank in the Gulf of Oman yesterday, followed hours later by a major fire at an oil refinery near Tehran.  The mysterious incidents immediately raised suspicions that they could have resulted from Israeli sabotage.  If those suspicions lead to fears over Persian Gulf oil supplies, they could give a further boost to the commodity markets.

Nicaragua:  Police arrested President Ortega’s most prominent political opponent, Cristiana Chamorro, after searching her home for at least five hours in what her family said was the latest attempt to keep her from challenging the authoritarian Ortega in November’s presidential elections.

COVID-19:  Official data show confirmed cases have risen to 171,746,400 worldwide, with 3,693,280 deaths.  In the United States, confirmed cases rose to 33,307,976 with 595,839 deaths.  Vaccine doses delivered in the U.S. now total 366,977,535, while the number of people who have received at least their first shot totals 168,734,435.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

 Economic and Financial Market Impacts

  • Investors these days talk about a “Fed put” whereby asset prices are buoyed by the Fed’s near-certain intervention against any sign of market volatility.  Well, now we can also talk about a “Draghi put.”  Investors have noticed that ever since former ECB chief Mario Draghi became prime minister of Italy to help the country get through the pandemic and manage Italy’s share of the EU’s new pandemic relief fund, Italian bond yields have become unusually low and stable.

U.S. Policy Response

  • To coax workers back into the job market amid widespread labor shortages as the economy reopens, Congressional lawmakers from both parties are considering incentives such as providing federal funding to pay for hiring bonuses and expanded tax credits for employers. A handful of states are moving to implement such programs on their own, without waiting for action from Washington.
  • The Fed said it will soon start selling off the corporate bonds and bond ETFs it bought last year through an emergency facility set up to keep credit flowing during the initial stages of the pandemic.  According to the Fed, the $14 billion or so in bonds and bond ETFs held in the Secondary Market Corporate Credit Facility should be sold off by the end of the year.
    • The Fed promised it would attempt to conduct the sales to minimize any disruption to the corporate bond market; given the relatively small size of the holdings, it could well be successful in that effort.
    • The SMCCF is separate from the Fed’s balance sheet and its trillions of dollars in Treasury and Agency securities.  Yet, if investors interpret the move as a sign that the Fed is moving toward a reduction in its balance sheet, it could spark renewed volatility in the broader bond market and push yields higher again.

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Daily Comment (June 2, 2021)

Posted on by Donna O'Donnell

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 sideways open this morning as investors remain cautious following recent market events in oil and cybersecurity. Today’s report begins with a summary of the cyberattack on the largest meat producer in the world. International news follows, with the OPEC decision on oil production and a new Israeli government.  Economics and policy news are up next, including possible friction at the Federal Reserve and the U.S. withdrawal from Afghanistan. China news follows, and we close with our pandemic coverage.

Another cyberattack: A cyberattack on JBS (JBSAY, $12.14), the largest meat producer in the world, forced the company to shut down all of its U.S. beef plants on Tuesday. The attacks started on Sunday and led the company to suspend its North American and Australian computer systems. Although the company announced that most of its plants would be operational by Wednesday, the attack highlights vulnerabilities in the critical infrastructure of the U.S. food supply chain as well as the growing capabilities of hackers.

Cyberattacks have picked up dramatically during the pandemic. There have been 40 publicly reported ransomware attacks against food companies since March 2020. This recent attack comes only weeks after Colonial Pipeline was forced to shut down some of its operations following a hack on its computer system. The rise in these attacks coincides with the increased adoption of cryptocurrency and a decreased level of skills required to carry out these cyberattacks. Although Russian criminal groups have received most of the blame, these types of attacks will likely continue from criminals worldwide as long as computer systems are not updated and cryptocurrencies remain unregulated. In the meantime, the Department of Homeland Security has issued a directive that requires notification from pipeline operators when they are victims of a cyberattack. We suspect other critical industries will also follow this directive going forward. As the pandemic fades out of public focus, we expect cryptocurrencies will receive more scrutiny as it is becoming apparent that the semi-anonymous payment system poses severe national security risks.

International news: OPEC will slowly increase its production, Russia is looking to add more military units, and Benjamin Netanyahu is possibly out as Prime Minister.

Economics and policy: STL Fed President James Bullard and Federal Reserve Governor Lael Brainard offered opposing views on the labor market, the Afghanistan withdrawal continues to progress ahead of schedule, and the U.S. Chamber of Commerce wants to increase the number of work visas.

China:  Malaysia seeks answers from China, and rising costs and power shortages are hurting manufacturing production.

COVID-19:  The number of reported cases is 171,021,130 with 3,556,992 fatalities.  In the U.S., there are 33,286,129 confirmed cases with 595,205 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 366,317,045 doses of the vaccine have been distributed with 296,404,240 doses injected.  The number receiving at least one dose is 168,489,729, while the number of second doses, which would grant the highest level of immunity, is 135,867,425.  The FT has a page on global vaccine distribution.

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Daily Comment (June 1, 2021)

Posted on by Donna O'Donnell

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with significant demographic policy changes in China, followed by various signs of increased inflation and potentially tighter monetary policy in both Europe and the United States.  Next, we review a range of international and U.S. news from the holiday weekend.  We end with the latest coronavirus pandemic news.

China:  Just weeks after the country’s latest census report showed China’s population is on the cusp of a prolonged decline, the government unexpectedly announced that it will allow all married couples to have as many as three children.  That’s an increase from the previous two-child policy, in place since 2015, and the one-child policy enforced for decades before that.  As a further incentive to childbearing, the government also said it would boost family financial support for education and childcare.

  • At this point, it isn’t at all clear that the new policies will significantly boost China’s birth rate and help arrest its population aging.  The move to a two-child policy in the middle of the last decade had little discernible impact on births.  Other countries facing a similar shortage of births, such as Japan and South Korea, have found that increased support to families and other such policies don’t necessarily lead to a lot of new babies.  China will still have one of the largest populations in the world for some time to come, but it probably can’t avoid being overtaken by India’s population in the next few years.  It will gradually lose its preponderant population advantage in geopolitics as its population shrinks and ages dramatically, while the U.S. population, supplemented by immigration, keeps growing and remains relatively younger (see chart below).
  • It appears that these dynamics have not only caught the attention of President Xi but have sparked some sense of panic.  Major changes to China’s population policy have typically been made by the Communist Party conferences held late in the year.  The new three-child policy was decided yesterday at a meeting of the Politburo, chaired by President Xi himself.
  • As China’s population shrinks and ages, it is also facing major economic and financial issues.  For example, a shrinking population will tend to slow overall economic growth.  Population aging will also worsen the country’s underfunded pension system.  The Politburo on Monday also said it would gradually raise the national retirement age.  That unpopular move could even spark political unrest in the coming months and years.

European Union:  May consumer prices in the Eurozone were up 2.0% year-over-year, marking the first time in more than two years that the bloc’s annual inflation rate beat the European Central Bank’s target of just below 2.0%.  Inflation in April had stood at just 1.6%.  Of course, much of the jump in European inflation last month came from fast-rising prices for key commodities like food and energy.  Stripping out those categories, May consumer prices in the Eurozone were up a more muted 0.9% for the year, versus a rise of 0.7% in the year through April.  All the same, the increased price pressures will likely keep some investors jittery about inflation and could keep alive concerns that the key central banks will be forced to tighten monetary policy more quickly than currently planned.  Those concerns are now prompting some investors to adjust their strategies to prepare for greater market volatility.

U.S. Monetary Policy:  In an interview with the Financial Times, St. Louis FRB President Bullard said the U.S. labor market is tighter than it looks, which could accelerate the central bank’s timeframe for removing some monetary stimulus from the economy.  According to Bullard, investors shouldn’t focus only on the nonfarm payroll data, which shows jobs are still down by about eight million compared with pre-pandemic levels.  He noted that other indicators are far closer to normal, matching anecdotal evidence of worker shortages.

  • Bullard said he was “starting to advocate” for the Fed to look at other measures of job market tightness, particularly the unemployment to job opening ratio.  That ratio was at a low of 0.8 in February 2020, spiked to 5.0 during the first lockdowns, and was then back down to 1.2 in March 2021 (see chart below, from the U.S. Chamber of Commerce).
  • Bullard’s statement could help reignite concerns about inflation and tighter monetary policy, despite those concerns calming down a bit recently.  If so, the result would likely be renewed upward pressure on bond yields and perhaps increased volatility for stocks.

(Source: U.S. Chamber of Commerce)

 U.S. Cryptocurrency Regulation:  Acting Comptroller of the Currency Hsu said he and other top regulators are developing ideas about reining in the $1.5 trillion cryptocurrency market to stop it from being used for criminal finance and prevent harm to investors and savers.  Coupled with other recent moves to control the development of cryptocurrencies, such as China’s recent prohibition against financial firms dealing in them, the budding U.S. regulatory move is likely to further weigh on the market and stoke additional volatility in the currencies.

United States-Denmark-European Union:  Over the weekend, multiple reports indicated that Denmark’s secret services helped the U.S. National Security Agency spy on European officials, including German Chancellor Merkel, during the Obama administration.  The NSA’s spying on U.S. allies first came to light in 2013 via disclosures by whistleblower Edward Snowden, but this is the first time Denmark’s role in the scandal has been made public.  According to the reports, the spying involved the NSA and Denmark jointly tapping under-sea internet cables.

  • Based on a statement by Danish Defense Minister Bramsen that “systematic interception of close allies is unacceptable,” there is probably some possibility that the spying on European officials was a residual benefit of a system built to track terrorists or other U.S. enemies.
  • All the same, the news is likely to hurt President Biden’s relationship with key EU leaders, given that he was Obama’s vice president.  That could spoil Biden’s reception at the upcoming G7, EU, and NATO summits in mid-June.
  • As might be expected, China is also jumping on the news to criticize the U.S.  Today, China has accused the U.S. of being “the world’s top hacking empire.”  We would note, however, that China’s sensitivity to the issue may well reflect the fact that it is probably subjected to many more offensive U.S. cyberattacks than the public realizes.

Global Oil Market:  The OPEC+ group of oil producers will meet today to decide whether or not to proceed with their plans to gradually increase oil production as the global economy recovers from the coronavirus pandemic and demand rebounds.  The delegates are expected to continue with their plans despite the prospect of more Iranian oil being released onto the market later this year.  Still, the rise in demand, constrained inventories, and transportation bottlenecks continue to buoy prices, with Brent rising some 2% to more than $70 this morning.

Israel:  Right-wing politician Naftali Bennett, centrist Yair Lapid, and other opponents of Prime Minister Netanyahu are reportedly closing in on a coalition agreement that would give them a razor-thin majority in the Knesset, allowing them to topple the prime minister.  Under the deal, Bennett and Lapid would serve alternately in the role of prime minister.  Lapid has a deadline of Wednesday to form a government.

COVID-19:  Official data show confirmed cases have risen to 170,771,941 worldwide, with 3,551,306 deaths.  In the United States, confirmed cases rose to 33,264,595 with 594,568 deaths.  Vaccine doses delivered in the U.S. now total 366,316,945, while the number of people who have received at least their first shot totals 167,733,972.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

  • Newly confirmed U.S infections totaled just 5,602 yesterday.  Of course, the low number probably reflects the Memorial Day holiday, yet, it was well below the seven-day moving average of 17,189.  The seven-day moving average of deaths related to the virus has now fallen to just 392.  The dramatic declines in infections, hospitalizations, and deaths can be attributed largely to the nation’s continuing mass vaccination campaign.  Data from the CDC show 50.5% of the U.S. population has now received at least one vaccine dose, and 40.7% of the population is fully vaccinated.
  • New data show that the disinfecting and hand-washing that became common during the pandemic served not only to dramatically reduce influenza cases last season but also reduced childhood illnesses such as chickenpox, stomach viruses, and strep throat.  For example, U.S. chickenpox cases this year are down about two-thirds from their levels before the pandemic.
  • In Britain, the government still plans to lift its pandemic lockdown on June 21, subject to a data assessment next week, but reports over the weekend indicate government scientists expect the “Step 4” restriction easing will be delayed because of a rebound in infections related to the Indian mutation of the virus.

 Economic and Financial Market Impacts

  • The OECD boosted its forecast of global economic growth this year to 5.8%, up from its December forecast of just 4.2%.  Along with its revised forecast for growth of 4.4% in the following year, that would imply the global economy will reach its pre-pandemic level in 2022.  According to the organization, the brightening outlook will give governments leeway to switch from blanket emergency support to more targeted measures, with a focus on investing.
  • Even though leisure travel is already bouncing back nicely, there are growing signs that business travel will soon start to normalize as well.  The chief customer officer at American Airlines (AAL, $24.24) said 47 of her airline’s top 50 corporate customers plan to resume flying by the end of the year.
  • After facing a big resurgence in infections while waiting for its first vaccine shipments early this year, the Canadian government is providing hundreds of millions of dollars in funding to expand and build domestic vaccine-manufacturing plants.  It also plans to set aside more than two billion Canadian dollars, equivalent to US$1.66 billion, over the next seven years to attract new investment in the life-sciences sector.  If successful, the effort could eventually help balance out the sectoral makeup of the Canadian stock market.  Currently, the Health Care sector makes up only about 1.1% of the MSCI Canada Index, versus 11.0% for the Materials sector, 13.8% for the Energy sector, and a whopping 37.4% for the Financials sector.

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Daily Comment (May 28, 2021)

Posted on by Donna O'Donnell

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

[Posted: 9:30 AM EDT] | PDF

Good morning, all! U.S. equities are expected to open higher this morning as President Biden’s new budget proposal caused a boost in investor optimism. Today’s report starts off with a brief summary of the $6 trillion proposal. International news follows, with an update on EU relations with Belarus following the recent plane incident and a crackdown on Big Tech by French authorities.  Economics and policy news are up next, including reports of an automaker resuming production and the U.S. withdrawal from Afghanistan. China news follows, and we close with our pandemic coverage.

Biden’s budget proposal: The Biden administration is expected to unveil a budget proposal of $6 trillion over the next decade. The proposal will likely include investments in infrastructure, childcare, and cybersecurity, and Biden plans to pay for this additional spending through taxes on corporations and high earners. This budget is expected to meet stiff opposition from Republican lawmakers who fear that the increase in fiscal spending could lead to a return to the 1970s era of stagflation. On the other hand, the administration believes the increase in spending will boost the economy’s long-run health and predicts that the deficit will begin to narrow going into 2030.

The additional spending over the next decade should be supportive for equities. However, there are still concerns as to whether the increase in spending will translate into sustained economic growth. President Franklin D. Roosevelt, who President Biden is often compared to, was unable to avoid a downturn in 1938 despite the fiscal expansion. In our view, it is never wise to assume that all spending is good, and vice versa. That being said, we are optimistic that additional spending will likely provide a boost in consumer confidence after an unexpected decrease in the Conference Board Consumer Confidence Index in May.

International news: EU airlines forced to cancel flights to Moscow, French regulators agree to a settlement, and the BOJ to consider climate change.

Economics and policy: Republicans willing to add to the deficit, SOS Blinken warns of renewed conflict in Gaza, and the U.S. withdrawal ahead of schedule.

 China:

  • Angered at renewed speculation that the coronavirus may have originated in a lab in Wuhan, China has resurfaced its claim that the virus may have come from the U.S. military. In October 2019, Wuhan hosted the World Military Games which the U.S. participated in. China is suggesting that this event may have been the true source of the virus.
  • China plans to develop 12 of its top universities to rival MIT and Stanford University in science and technology. The program will focus on teaching students artificial intelligence and data science.

COVID-19:  The number of reported cases is 168,520,476 with 3,501,002 fatalities.  In the U.S., there are 33,192,974 confirmed cases with 592,432 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 359,849,035 doses of the vaccine have been distributed with 289,212,304 doses injected.  The number receiving at least one dose is 165,074,907 while the number of second doses, which would grant the highest level of immunity, is 131,850,089.  The FT has a page on global vaccine distribution.

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Daily Comment (May 27, 2021)

Posted on by Donna O'Donnell

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  It’s mostly a down day for risk assets in the U.S. this morning.  Our coverage begins with economics and policy, with a crypto update to follow.  China news is next.  Our international roundup comes after, and we close with pandemic news.

  Economics and policy:  A problem may be developing in the monetary plumbing.

  • We have been watching a development in the money markets recently; the Fed has needed to conduct rather aggressive reverse repo operations in recent days.

In these operations, the private sector is putting money on deposit at the prevailing fed funds rate.  The current target is 0.125%, but this onslaught of funds has left the effective fed funds rate at 0.06%.  There are several factors at work.  First, the Treasury has been issuing fewer T-bills, which can also absorb these funds.  Second, QE is taking Treasuries and mortgages off the market and replacing them with cash that the banks don’t need.  Third, banks are not lending; bank loans and leases have declined compared to last year for the past two months.  Thus, banks don’t have a good outlet for cash.  Here is where the problem comes in.  The closer fed funds fall toward zero, the greater the pressure on money market funds.  The Fed can address this by tapering or manually raising the fed funds rate.  Tapering would spook the financial markets but increasing the fed funds rate smacks of subsidizing banks for not lending.  Although we don’t expect a problem to develop, the rise in reverse repo activity does suggest stress and bears watching.

Cryptocurrencies:  China’s crackdown on bitcoin mining is gathering momentum.  As many things do in China, it originated from Beijing.  The last five-year plan has references to bringing emissions under control.  Bitcoin mining runs against that goal, prompting disfavor at the highest levels of the CPC.  That message is now moving its way into provincial and municipal governments who are starting to restrict mining activity.  Houbi (1611, HKD, 15.80) has indicated it would no longer sell mining equipment into China and cease operating its cryptocurrency exchange.  Bitcoin is a bit weaker this morning.

China:  It’s official; the era of engagement is over.

International roundup:  The EU and Switzerland are at loggerheads, and the business class is winning Brexit.

COVID-19:  The number of reported cases is 168,497,846 with 3,500,348 fatalities.  In the U.S., there are 33,191,164 confirmed cases with 591,957 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 359,849,035 doses of the vaccine have been distributed with 289,212,304 doses injected.  The number receiving at least one dose is 165,074,907, while the number of second doses, which would grant the highest level of immunity, is 131,850,089.  The FT has a page on global vaccine distribution.  The Axios map shows that only one state, Wyoming, has rising cases.

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