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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  It’s a down day for equities this morning.  Our coverage begins with a recap of the situation in Israel, a second look at the retail sales data, and the Atlanta FRB’s GDPNow forecast.  Our update on economics and policy is up next, followed by China news.  The international roundup is next in line, and we close with the pandemic update.

Israel:  Despite international calls for a ceasefire, violence continued unabated over the weekend.  For now, Israel says it will continue operations against Hamas in Gaza.  The IDF is conducting airstrikes against Hamas infrastructure, targeting its office facilities and tunnels that allow Hamas fighters to find shelter and conduct operations.  Hamas has been steadily launching missiles into Israel.  An office building used by the Associated Press was hit by airstrikes over the weekend; Israel claims it was also used by Hamas.  The usual pattern is for international pressure to increase to the point where Israel calls off the offensive.  It is likely that, expecting such pressure, Israel is moving quickly to attack as much of Hamas’s infrastructure as it can before operations end.  The U.N.S.C. met over the weekend to discuss this issue, but no action was taken.

So far, this tragedy has not affected financial markets to any significant degree.  Geopolitically, we note that outside nations are reluctant to get involved.  The Arab states have been mostly quiet.  These nations have been normalizing relations with Israel and are not all that fond of Hamas.  Its ties to the Muslim Brotherhood make Arab state leaders disinclined to help.  Iran has become perhaps the most notable foreign ally, but its ability to assist has limits.  Turkey has made negative comments towards Israel, but we doubt Ankara’s actions will go beyond jawboning.  The difference this time is that foreign nations are bringing less pressure to bear on Israel, meaning that the current conflict may drag on longer than normal.

About that retail sales data:   For the inflation data, we used a two-year change to avoid the base effect impact on CPI.  We did the same thing with regard to the retail sales data, which was flat relative to March.  The longer-term look shows that retail activity is robust.

The latest data has the Atlanta FRB’s GDPNow forecast running at 10.5%.

(Source:  Atlanta FRB)

Individual data releases have shown wide dispersion recently, but the GDPNow calculation reveals that the economy is doing quite well.  Reading too much into individual data releases is probably ill-advised.

 Economics and policy:  Semiconductor issues will persist, and the fog of data may reduce the likelihood that the president’s tax and spending policies will be enacted.

• Industry analysts warn that the semiconductor chip shortage could last until 2023.
• We have been surprised at the pace of policy coming from the administration, especially given the narrow margins the Democrats have in Congress. However, it is starting to look like momentum is slowing.  On taxes, there is a growing pushback against the current tax plans.  As the Democratic Party increasingly represents big business, its lobby is growing confident that it can stem the drive for tax hikes.  Although “soaking the rich” is still popular among many Democrats, we tend to side with the business lobby.  Meanwhile, the current “fog of data” is muddling the political message and making it difficult for the administration to craft a plan forward.
• The expanded childcare credit will be sending up to $300 per month to households with children starting July 15. What is significant about the new credit is that it will be distributed monthly and has the makings of a basic income grant to households with children.
• In the wake of the Colonial cyberattack, government authorities are taking a harder look at cryptocurrencies, which are often used in ransomware attacks. Binance Holdings[1], the world’s largest crypto exchange, is under investigation by the DOJ in a probe of money laundering and tax violations.  The IRS is forcing crypto exchanges to provide customer information for tax investigations.
• California is bracing for an extended fire season as drought and early hot weather create ideal conditions for wildfires.
• In the aftermath of the Great Financial Crisis, sawmills consolidated as lumber demand fell. As demand has soared due to strong housing demand, the industry is not boosting investment to any significant degree, concerned about the cyclicality of the industry.  This lack of capacity expansion will tend to keep lumber prices elevated.  Meanwhile, the administration is facing pressure to reduce tariffs on Canadian lumber.
• Retailers are undertaking extensive training of employees to boost staff productivity.
• Former ECB economists warn that current policy may put the central bank in a debt trap. If the ECB raises rates, its large holdings of sovereign debt will put its balance sheet at risk.

China:   The administration is taking a longer look at Chinese disinvestment policy.

• The Pentagon has delayed a report to Congress detailing Chinese companies with ties to the People’s Liberation Army. The report, mandated by an executive order from the Trump administration, banned Americans from investing in Chinese companies with military ties.    The deadline for implementing the rule is May 27, but the U.S. military says it won’t have the report ready until fall.   It appears the Biden administration is inclined to keep the rule but will likely adjust it.
• A Chinese agricultural consultancy mysteriously suspended operations on April 29, and the company’s offices were sealed by security forces. The company, Cofeed, provided price data and analysis of grain and oilseed prices.  There is speculation that the CPC wants to keep the information secret, and thus, closed the firm and may have arrested the principals.
• One of the inconsistencies of administration policy is that it wants to reshore investment and jobs to the U.S. while building a coalition to contain China. During the Cold War, an element of coalition-building allowed potential partners access to U.S. consumers.  In other words, the U.S. tolerated trade deficits and the loss of jobs to trade for foreign policy purposes.  That policy has come under fire in recent years.  The Obama administration was unable to move the Trans-Pacific Partnership (TPP) through Congress, and in the 2016 presidential election, both major party candidates vowed to pull the U.S. from the trade pact.  The remaining partners in the TPP went ahead without Washington and created the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPATPP).  Interestingly enough, the Senate Finance Committee is pressing the USTR Tai to engage in talks to potentially join the CPATPP.  The support is based on the idea that the U.S. needs trade to build support for allies in Asia.
• China’s credit rating agencies have been rapidly downgrading Chinese corporate debt. Foreign rating agencies have been critical of the domestic agencies, which have tended to give favorable grades to Chinese corporations.  However, as Beijing cracks down on corporate defaults, the rating agencies are also moving in that direction.
• Although China’s industrial sector continues to recover, retail sales have been disappointing. This divergence could lead to higher Chinese exports.

International roundup:  Armenia and Azerbaijan are seeing tension rise, and Venezuela moves against the last independent newspaper.

• Armenia has accused Azerbaijan of violating its territory by moving Azerbaijani troops into areas controlled by Armenia. The two sides are in talks, but tensions remain elevated.  Armenia is asking for support from Russia, which has tried to mediate the dispute.   Last year, Armenia and Azerbaijan had a war, which led to the latter gaining territory.
• The Maduro government seized the headquarters of the last remaining independent newspaper. Ostensibly, the action was to satisfy a court judgment against the paper, but Venezuela’s authoritarian government has been steadily working to control the media for years.  The paper El Nacional has been online since 2018 when the government, which controls the supply of newsprint, denied the paper supplies.  Although it is hard to conceive of relations between the U.S. and Venezuela getting worse, this action certainly won’t help.

COVID-19:  The number of reported cases is 163,112,783 with 3,380,404 fatalities.  In the U.S., there are 32,941,053 confirmed cases with 585,970 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 344,503,495 doses of the vaccine have been distributed with 273,545,207 doses injected.   The number receiving at least one dose is 157,485,596, while the number of second doses, which would grant the highest level of immunity, is 123,282,685.  The FT has a page on global vaccine distribution.

• Although U.S. cases are declining, the rest of the world is seeing infections rise.
  • Hong Kong just announced it will require a 21-day quarantine for all arrivals from Singapore; the latter has seen a surge in cases recently tied to its airport.
  • Japanese towns are canceling plans to house Olympic athletes due to infection fears. This development could adversely affect training for some teams, as the lack of housing near training facilities could pose a logistical problem.
  • Taiwan, which had mostly managed the pandemic well, is implementing social distancing controls in an effort to slow the rise in cases.
  • Cases of the Indian variant have been reported in the U.K., threatening plans to relax restrictions.
• A letter signed by 18 scientists in the journal Science argues the fact that COVID-19 escaped from a lab has not been disproven and indicated that further investigation is warranted.  This development will likely anger Beijing.

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[1] The company is Chinese and has issued a coin that is $603.60.

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 following reports that the Fed will likely not be withdrawing monetary support anytime soon despite the Consumer Price Index rising faster than expected in April. Today’s report starts off with a brief update on the Colonial Pipeline cyberattack. International news follows, with details about elections in Northern Ireland and Venezuela, a new conflict between Armenia and Azerbaijan, and escalation in the Israel-Palestine conflict. Economics and policy news are up next, including the debt ceiling talks, a possible end to the gasoline shortage, and the impact the semiconductor shortage will have on the auto industry. China news follows, and we close with our pandemic coverage.

Colonial Pipeline update: It was revealed on Thursday that Colonial Pipeline Company paid nearly $5 million to hackers last week to regain access to its computer network. The ransom was paid in “difficult-to-trace cryptocurrency” in exchange for a decrypting tool to help the company restore access to its computer system. So far, it isn’t clear who is responsible for the attack but President Biden has stated there is a “strong reason” to believe the attack was based in Russia, although he does not suspect that the Russian government was involved. The cyberattack on the pipeline exposes the vulnerabilities in U.S. infrastructure to attacks by opportunistic hackers and U.S. enemies. In addition, the ransom payment highlights the growing importance of semi-anonymous cryptocurrencies in facilitating criminal activity.

International news: Northern Ireland chooses a new leader, Olympic athletes are finding it difficult to find accommodations in Japan, and violence in the Gaza Strip.

• Northern Ireland’s Democratic Unionist Party will pick its new leader on Friday. Agricultural minister Edwin Poots is expected to win but he faces stiff competition with Jeffrey Donaldson, who represents the DUP in the U.K. parliament.
• The rise in COVID-19 cases may put the summer Olympics in jeopardy as hosting camps are refusing to accommodate athletes. On Thursday, Japan unexpectedly added three more prefectures under state of emergency.
• Armenia’s defense ministry complained that Azerbaijan has infringed on its territorial sovereignty. This could pave the way for more fighting between the two countries.
• Venezuela is preparing to hold regional and local elections on November 21. Parliamentary and presidential elections have not been announced.
• Violence in the Gaza Strip escalated on Friday as Israeli ground forces fired artillery into the area. Appeals for de-escalation have gone unheeded. Furthermore, the prospect of a possible Israeli invasion of the Gaza Strip is becoming more likely.

 Economics and policy: Colonial Pipeline is fully operational, Senate Democrats are considering alternatives to raising corporate and wealth taxes, and the semiconductor shortage is expected to have a more severe impact on the auto industry in the second quarter.

• The states that have suffered the most during the gasoline shortage will find some relief starting this weekend. The largest pipeline in the country is expected to resume operations over the weekend after a ransomware attack forced the pipeline to shut its operations late last week.
  • That being said, a lack of tanker trucks could prolong the shortage as there aren’t enough trucks to transport fuel to gas stations.
• Some Senate Democrats have expressed an openness to increase user fees such as gas taxes and raising money from electric car drivers as a way to pay for the infrastructure bill. The push for user fees is seen as an alternative to raising taxes on corporations and the wealthy to pay for the additional infrastructure spending.
• The semiconductor shortage is expected to cost automakers $110 million in lost revenue and 3.9 million cars in lost production. The industry does not expect to see signs of a recovery until the end of the year, and some automotive companies have warned that the second quarter could be worse than the first.
• Senate Democrats are disinclined to work with their Republican counterparts in the Senate to negotiate a new debt ceiling agreement. With the majority, Democrats have the ability to increase the debt ceiling without negotiating.
• Federal Reserve Governor Christopher Waller stated that the Fed will need to see several months of data before deciding whether to scale back monetary easing. St. Louis Fed President James Bullard shared a similar sentiment on Wednesday.

China:  Defaults for Chinese companies are rising, and China will start taxing dirty fuel.

• Mosques appear to have “disappeared” in Xinjiang as China seeks to contain separatist elements within the Uighur-dominated province. Beijing has denied taking actions to halt the practice of Islam within the country, but reporters have seen evidence to the contrary.
• Defaults on U.S. dollar-denominated debt by Chinese companies continue to put stress on China’s financial system. Last year, Chinese companies defaulted on $7.3 billion of offshore dollar debt and $22.7 billion worth of renminbi-denominated debt. This year, companies have defaulted on $3.3 billion of dollar debt. The growing debt burden puts pressure on Beijing to bail out these companies.
• China will start taxing the dirt fuel that it imports in order to curb pollution.

COVID-19:  The number of reported cases is 161,206,768 with 3,345,317 fatalities.  In the U.S., there are 32,852,998 confirmed cases with 584,487 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 337,089,765 doses of the vaccine have been distributed with 264,680,844 doses injected.  The number receiving at least one dose is 153,986,312, while the number of second doses, which would grant the highest level of immunity, is 117,647,439.  The FT has a page on global vaccine distribution.  The weekly Axios map shows rising cases in about half the country.

• The CDC announced on Thursday that anyone who has been fully vaccinated against the coronavirus, meaning those who received their last dose at least 14 days ago, can stop wearing masks or maintaining social distance in most indoor and outdoor settings.
• Following the CDC approval of the Pfizer (PFE, $40.24) vaccine for 12- to 15-year-olds, mass vaccinations for teenagers began on Thursday.
• A study published by the JAMA network and the Journal of Obstetrics & Gynecology released studies suggesting that Pfizer and Moderna vaccines are safe and effective during pregnancy.
• Several coaching and support staff for the New York Yankees tested positive for COVID-19, despite receiving the Johnson & Johnson (JNJ, $169.69) vaccine. Only one of the members showed any symptoms associated with the virus.
  • Comedian Bill Maher also tested positive for COVID-19 after being vaccinated.
• Cuba has developed its own COVID-19 vaccines and has begun administering shots before the vaccines have been given regulatory approval. The Abdala and Soberana II shots have been used for residents 60 years and older and for frontline workers.
• The president’s Chief Medical Advisor Anthony Fauci announced that schools should be able to open five days a week starting in the fall.

Extending the time between Pfizer vaccines from three to 12 weeks may boost the antibody response, according to a study released by Birmingham University. The study suggests that a longer interval between shots could reduce the need for a subsequent booster for the elderly.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  Our coverage begins with a few comments about yesterday’s CPI report.  We take a quick look at the deteriorating situation in Israel.  The Colonial pipeline has reopened.  Economic and policy news follows, with China news next.  The international roundup comes after that, and we close with the pandemic update.

About that inflation data:  Yesterday’s CPI data was clearly a surprise.  Although we expect prices to accelerate into late summer, the surprise effect will diminish over time.  Usually, economists overcompensate when they miss widely, so even with rising CPI in the coming months, the market reaction should be lessened.  As we have warned before, base effects from last year would tend to boost inflation this year.  April data showed that and then some.  However, some of the price spikes won’t last.  Rising prices will eventually lift supply and will probably curtail demand.

Here’s another way of looking at the data.  Since an event last year affected the yearly comparisons, it might make sense to look at the price changes from two years ago.  That data suggests an increase, but nothing that indicates an outlier.

The Fed’s position is that the increase we are seeing in inflation is transitory.  We tend to agree with this position.  Rising prices will trigger a supply response and bring down prices at some point.  However, there is a risk to this position, which is that inflation expectations change.  If households begin to buy now for fear of higher future prices and firms begin to treat inventory as an asset, inflation could become a much more serious problem.  We don’t think that is happening yet, but we are watching closely.

Clearly markets were not happy.  Outside of shorting, there really was no area of the market that hasn’t suffered over the past few days.  Rising yields boosted the dollar and depressed commodities, stocks, and bond prices.  In equities, the market has become richly valued, so a period of pullback isn’t the worst thing.

The FOMC is getting the first real test of its shift to a focus on labor markets and less emphasis on inflation control.  There will be increasing worries about the Fed allowing inflation expectations to get out of hand.  We think it is more likely that we see a few months of elevated inflation followed by a moderation.  Current Fed policy will, over time, raise inflation, but there are several long-term factors that will continue to weigh on keeping inflation under wraps.  These include aging demographics, the preponderance of intangible investment and capital, inequality, and the openness to trade.  We do expect the latter two factors to eventually reverse, but for now, they remain factors that will dampen inflation.

The Israel problem:  There is a persistent level of tension between Israel and the Palestinians.  When violence flares, it can be tricky to determine whether the situation is a short-term event or something more serious.  The current one is starting to worry us.  The tensions are ostensibly about the eviction of a group of Palestinians from East Jerusalem to allow Israeli settlers to move in.  The broader situation appears to be tied to a conflict between Hamas and Palestinian Authority.  The Palestinians were expected to hold elections this year, and Hamas was projected to gain power, mostly due to divisions within Fatah.  To prevent this from occurring and to remain in power, the leader of the Palestinian Authority, Mahmoud Abbas, postponed the vote.  This decision has led Hamas to try to find a way to retaliate against Abbas.  It appears Hamas has decided to attack Israel using the evictions as a reason.  Unfortunately, the fighting is escalating rather quickly.  Casualties are occurring on both sides as Hamas fires volleys of rockets into Israel from Gaza, and the IDF retaliates with airstrikes.  Civil unrest in Jerusalem is leading to additional casualties.  There is also increasing unrest in Arab parts of Israel and Israeli cities.

As the violence increases, outside parties are being drawn in.  The U.S. is reluctantly becoming involved, with President Biden offering support for Israel.  Turkey and Russia are calling for peacekeepers, something Israel will oppose.  Complicating matters is the uncertainty surrounding the Israeli government.  Successive U.S. presidents have been trying to reduce American involvement in the region, in part, to focus on the great power competition with China.  This tragedy could undermine the Biden administration’s domestic agenda.  There is one other interesting factor; the silence from the Arab states that has been improving relations with Israel is notable.  The Abraham Accords have changed the diplomatic situation in the Middle East, meaning that the Palestinians can no longer rely on support from these nations during uprisings.  That factor may reduce the duration of the current tensions.

Colonial pipeline:  The pipeline managers announced that operations have restarted.  That’s good news.  The bad news is the flow in the line is between three to five miles per hour, meaning it will be several days before product begins to flow at adequate levels.  Meanwhile, gas lines, reminiscent of the 1970s, have emerged.  The southeast appears to be seeing the fastest price increases.  We should see supply issues improve by the end of next week.

An observation:  The Colonial pipeline, the inflation spike, and the tensions in Israel all have one common effect—they will tend to become a distraction for the administration’s policy progress.  All new presidents enter office with plans.  But, as Clausewitz noted, “No campaign plan survives the first contact with the enemy.”  Although these events are not all related, they do show that governments operate under conditions that can distract and delay policy progress.  Given that political capital is perishable, such events make it difficult to meet policy goals.

 Economics and policy:  Comments on crypto assets and credit cards.

• As crypto assets become more widely adopted, regulators are warning investors to be careful about what they are investing in. One of our concerns is that the financial system tends to deploy leverage in ways that can be difficult to monitor.  If crypto assets are leveraged, they could go from a useful diversion of liquidity to an asset without ties to the rest of the economy to a factor that may affect the broader financial system.  In other words, there may be more risk to a sharp drop (or for that matter, a sharp rise) in crypto asset prices if leverage is involved.
  • Block.one is starting a new crypto exchange with high-profile backing.
  • Tesla (TSLA, USD, 589.89) announced, due to environmental concerns, it will no longer accept bitcoin for payment.
  • Facebook (FB, USD, 302.55) announced it will restart its Libra crypto project, with changes designed to address regulator concerns.
• We are seeing steady signs that the stimulus checks are being saved or used to reduce debt. Banks are worried about the decline in credit card balances, which would reduce the interest income from this lending.  Interestingly enough, banks are looking to issue credit cards to those without a credit score.  Although this effort is being framed as a way to help the “unbanked,” we wonder if it is more about reviving a slumping business.
• Further evidence of financial overheating is showing up in the deepest recesses of the high yield market. Some new issues allow firms to expand borrowing in the future.  These clauses are being dubbed “pick your poison.”
• In the wake of Archegos, regulators are reviewing margin rules.
• In U.S. real estate, lower-cost existing homes are showing the fastest price appreciation.
• LIBOR is to be replaced, but it looks like it will take a while for a single alternative to emerge.

China:  China is expanding its use of social media, and the population issue continues to dominate the news.

• According to a recent study, China is aggressively using social media to shape foreign opinion. It is also trying to affect how the regular media frames China and the PRC.
• The fallout from China’s population issues continues to resonate. One issue that undermines China’s ability to boost childbearing is that the CPC loathes to give up control, especially at the local level.  The PRC created a bureaucracy designed to monitor the one-child policy and hasn’t been able to fully break it down, as the members of these monitoring groups prefer to remain employed.  Thus, the policy to restrict births continues, at least partially, to remain in place.  In addition, against some non-Han groups, China actively works to suppress population growth.
• Although the U.S. trade deficit continues to expand (mostly a function of U.S. growth relative to the rest of the world), imports from China have declined, mostly due to tariffs. This situation highlights a fact about trade; tariffs don’t cure an overall trade deficit, just a bilateral one.
  • Loan growth in China is slowing. There is increasing evidence that China is reining in stimulus as the U.S. expands, which will likely lead to a widening trade deficit.  Although it may not be a wider bilateral trade deficit with China, Beijing could see its sales rise to other nations as those countries boost their exports to the U.S.
• Chinese bond defaults continue to rise at a record pace.
• The American Chamber of Commerce in China is calling for Chinese authorities to give foreign firms in China a “fair” chance to compete for business.
• Although the U.S. is trying to restrict the use of Chinese technology, Chinese companies are having some success in the courts against these provisions.
• China’s best ally in the EU is probably Hungary. Germany has criticized Hungary for blocking EU criticism of China.  The EU often requires a unanimous decision, so one nation can block an action.
  • Meanwhile, at the U.N., the U.S., the U.K, and Germany were critical of China’s treatment of Uighurs. The U.S. described Xinjiang as an “open air-prison.”
• One of the goals of the Biden administration is to build a base of allies to oppose Chinese expansion. However, this goal is conflicting with trade policy.  As the U.S. retreats from globalization, it is reducing the economic incentive to align with Washington.
• In an attempt to reduce the cost of childrearing in China, authorities are restricting private tutoring. Tutors are used to give students an advantage in testing, but it becomes something of an arms race.

International roundup:  Russia is seeing a worker shortage and is looking at gun control.  Austria’s chancellor is being investigated.

• Russia is seeing a decline in migrant workers from central Asia, leading to worker shortages in construction and agriculture.
• A school shooting in Russia is leading the government to consider new gun regulations.
• Austrian Chancellor Kurz is under investigation for perjury.
• Lord Frost, the U.K. minister for EU/U.K. trade, suggested that the Northern Ireland protocol is probably unsustainable in its current form. The U.K. wants the EU to relax its rules; the EU fears that if it does, the U.K. will use those rules to “backdoor” trade to Europe.  We tend to agree with Lord Frost, but we don’t see the EU relaxing rules.  If the current situation is unsustainable, it will likely be the U.K. that adjusts.

COVID-19:  The number of reported cases is 160,513,476 with 3,333,245 fatalities.  In the U.S., there are 32,815,408 confirmed cases with 583,690 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 337,089,765 doses of the vaccine have been distributed with 264,680,844 doses injected.  The number receiving at least one dose is 153,986,312, while the number of second doses, which would grant the highest level of immunity, is 117,647,439.  The FT has a page on global vaccine distribution.  The Axios map shows a clear improvement in the U.S.

• A panel of medical professionals and political figures reviewed the WHO’s actions during the pandemic. Their report was critical of governments and the WHO, but it isn’t obvious whether the report will trigger any changes.  The WHO doesn’t have the power to intervene in nations; in a sense, this is an issue for all international organizations.  Without a hegemon enforcing rules, it is left to moral suasion to change behavior.
• Pandemic conditions in the U.S. are improving rapidly. We are seeing a steady reopening of public facilities, and travel is rising.
• However, conditions overseas are getting worse.
  • Uruguay, which had mostly been keeping infections under control, is seeing a surge in infections. The emergence of new variants and sharing a border with Brazil are blamed for the rise.
  • The world’s most vaccinated country, the Seychelles, is seeing rapid infections as well. The island nation inoculated its citizens with the Sinopharm (SHTDY, USD, 16.16) vaccine.  The increase in infections raises concerns that the Chinese vaccine may be less effective in preventing infection or may not be effective against new variants.
  • India continues to suffer from rising infections. There is some evidence suggesting that new variants are emerging in the country and may be undermining vaccine effectiveness.  The rise in India’s cases appears to be spreading across south Asia.  Singapore is reporting a cluster tied to its airport.
  • The appearance of the Indian variant in the U.K. is increasing concern as the British reopen.
• A U.K. trial that mixed vaccines suggests that doing so increases the side effects.
• The CDC is recommending the Pfizer (PFE, USD, 39.69) vaccine for 12 to 15-year-old patients.
• To overcome vaccine hesitancy, Gov. DeWine (R-OH) is offering college scholarships and participation in lotteries.
• A German researcher may have isolated the reason why some vaccines trigger blood clotting. It appears to be an immune response to preservatives.
• A University of Washington study concluded that the fatality count from COVID-19 may be double the number reported. This sort of outcome isn’t a huge surprise; the death count from previous pandemics usually is undercounted.

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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 an update on the Colonial Pipeline ransomware hack and the panic buying of gasoline that it has sparked in the Southeast.  We next cover various news related to U.S. fiscal policy, the energy industry, inflation, and Chinese trade issues (there is more detail on the latest U.S. inflation data in the “U.S. Economic Releases” section below).  We wrap up with the latest developments related to the coronavirus pandemic.

Colonial Pipeline Hack:  As we warned in our Comment yesterday, motorists worried about gasoline shortages arising from the Colonial Pipeline ransomware attack began panic buying on the East Coast yesterday, resulting in long lines and shortages.  Colonial continues to express confidence that it can restart normal operations by the end of the week, but the crisis is already wreaking havoc in the Southeast, where there are fewer alternative pipelines or refineries to serve as backup sources of supply.

• According to the AAA, the average price for regular gas in Georgia yesterday was up $0.11 per gallon from the previous day.  In North Carolina, the average price was up $0.05 per gallon.
• Georgia Governor Brian Kemp signed an executive order temporarily suspending the state’s gas tax and Virginia Governor Ralph Northam declared a state of emergency. North Carolina Governor Roy Cooper also declared a state of emergency Monday because of the outage.

U.S. Fiscal Policy:  For the first time since his inauguration, President Biden today will meet at the White House with all four of the top Democrats and Republicans in Congress.  The purpose of the meeting is to begin hammering out an agreement on the president’s spending plans, including his $2.3 trillion package of spending on infrastructure and other economic programs and his $1.8 trillion proposal to strengthen the country’s social safety net.

• Although Biden quickly gave up on a bipartisan approach to his pandemic relief program earlier this year when he assessed the Republican counteroffer as insufficient, aides say he is likely to be more flexible this time around.
• Even if that’s the case, it’s not entirely clear that the Republicans have been chastised by being shut out of the pandemic program’s process so quickly.  There is still a significant chance that they will offer far too little for the administration’s taste, although we would still expect the Democrats to push through some level of new spending addressing Biden’s priorities.  Any additional fiscal stimulus would help accelerate the budding economic recovery, although it would also feed into the market’s growing fear about a prolonged new era of high inflation.

U.S. Energy Industry:  The Interior Department yesterday gave final federal approval for the nation’s first major offshore wind farm.  The Vineyard Wind project, to be built off the coast of Massachusetts, will consist of up to 84 turbines and produce enough electricity to power 400,000 homes and businesses when it becomes operational in about 2023.  According to its developers, the project will be the first of many in a broad, new regional energy industry.

Global Inflation Scare:  In the latest news feeding into fears of a prolonged new era of high inflation, tin prices have surged to record highs for the first time in a decade.  The price jump reflects increased demand for consumer electronics and difficulties shipping the metal out of Asia, resulting in a shortage of tin.

China-Hong Kong:  In the latest poll by the American Chamber of Commerce in China, the number of people saying they are considering leaving Hong Kong has risen sharply, with a significant number citing last year’s new national security law as the primary driver.  About 40% of respondents said they were considering leaving, which was a bit lower than the share in a poll last August.  However, a much larger number of people responded, so the actual number who said they were thinking of abandoning the city increased.  The increased response rate also suggests a greater concern and desire to express their views.

China-Sweden:  A newspaper affiliated with the Communist Party of China warned that Ericsson (ERIC, USD, 13.29), the Swedish telecom equipment giant, will not be invited to participate further in constructing China’s 5G network unless Sweden reverses its ban on equipment from Chinese telecom giant Huawei (002502, CNY, 3.21).  The warning is another instance of China using the heft of its domestic market to pressure foreign countries and companies to respect its interests, just as it imposed import restrictions against Australian products to punish Canberra for proposing an investigation into China’s role in the coronavirus pandemic.  As a rising China continues to chafe against the international system crafted by the U.S. and its allies, such punishments could impose heavy costs on the global economy and weigh on investors.

Chinese Financial Industry:  The China Banking and Insurance Regulatory Commission today granted final approval for U.S. financial services behemoth BlackRock (BLK, USD, 844.10) to begin operating its 50.1%-owned wealth management joint venture on the mainland.  Despite China’s heavy-handed trade and investment policies targeting foes abroad, the government has continued to selectively open parts of its economy to foreign investors.  However, that opening is probably aimed, at least in part, at creating a pool of foreign firms that will pressure their home governments to take a soft stance toward Beijing.

• Despite the Chinese government’s lobbying to keep advantageous trade rules in place, the tariffs imposed by the Trump administration and continued under the Biden administration continue to impede U.S. purchases of Chinese goods.
• New data show the tariffs have led to a sharp decline in Chinese imports, with purchases of telecommunications gear, furniture, apparel, and other goods shifting to other countries.

Israel-Hamas:  Israel and the militant Palestinian militia Hamas kept up their deadly barrage of rocket launches and airstrikes on Tuesday night, escalating a conflict that a UN envoy warned could spiral into an all-out war.  In the worst violence seen since the 2014 war, Israeli airstrikes toppled two high-rise buildings in Gaza City that it said were used by Hamas, prompting retaliatory launches of hundreds of rockets at large Israeli cities.

COVID-19:  Official data show confirmed cases have risen to 159,732,343 worldwide, with 3,319,169 deaths.  In the United States, confirmed cases rose to 32,779,414, with 582,848 deaths.  Vaccine doses delivered in the U.S. now total 334,081,065, while the number of people who have received at least their first shot totals 153,448,316.  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 fell to approximately 33,000 yesterday, well below both the seven-day moving average of 38,826 and the 14-day moving average of 44,222.  New deaths related to the virus came in at a moderate 684.  Meanwhile, the nation’s mass vaccination program continues to make progress.  According to the CDC, 44.7% of all adults in the U.S. are now fully vaccinated against COVID-19.
• Testifying before a Senate committee yesterday, administration officials said there should be enough evidence by late fall to potentially extend the use of COVID-19 vaccines to many children under age 12.  Administration medical adviser Anthony Fauci told the panel that such steps to vaccinate younger children would probably occur in stages, progressing younger and younger, as study evidence accumulates.
• A late-stage human trial of China’s first vaccine candidate using mRNA technology will soon be launched in Mexico, according to Mexican Foreign Minister Ebrard.  The mRNA technology is the same one used in the highly effective, two-dose vaccines produced by Pfizer (PFE, USD, 39.35) and Moderna (MRNA, USD, 158.99).
• Even though investors are fixated on the huge new waves of infection in places like India and Brazil, a recent resurgence in Taiwan is suddenly getting attention as well.  The island has had very few infections over the course of the pandemic, but because of 16 newly discovered cases of domestically transmitted infections, Health Minister Chen Shih-chung warned that Taiwan was very likely to raise its epidemic alert level to its highest level since the onset of the pandemic.  The news has sparked fears over the island’s key semiconductor industry and pushed the stock market down sharply over the last few days.  The country’s main stock index is now nearly 10% below its record closing high reached on April 27.
• A review panel convened by the World Health Organization issued a scathing report criticizing both the Chinese authorities and the WHO for being too slow to recognize that the novel virus was spreading between people in Wuhan and then warning the world about human-to-human transmission.  The report contends that a swift international response could have stopped the 2019 COVID-19 outbreak in China from becoming a global catastrophe in 2020.

 Economic and Financial Market Impacts

• Today, the European Commission sharply raised its economic forecasts for the coming two years, as an accelerating vaccination campaign helps the Eurozone recover from the historic blow delivered by the pandemic.  The EC now forecasts that the Eurozone’s gross domestic product (GDP) will expand by 4.3% in 2021 and 4.4% in 2022, compared with previous forecasts for 3.8% growth in both years. As a result, all member states are now expected to regain their pre-crisis output levels by the end of next year, following a historic 6.6% slump in 2020.
• In a positive sign for equities moving forward, a data tally by Goldman Sachs shows U.S. companies announced $484 billion in share buybacks in the first four months of this year, the highest such total in at least two decades.
  • Not only did firms rush to raise precautionary cash at the outset of the crisis last year, but now they’ve come through a blockbuster earnings season and have much more clarity on the future trajectory of the economy.  That’s encouraging firms to put their cash to work through new investments, dividend hikes, or share buybacks.
  • While we’ve often mentioned that stocks are likely to be buoyed by continued loose monetary policy, new fiscal stimulus, economic reopening, and rebounding consumer demand, share buybacks could offer further noticeable support for equities this year.

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with the latest on the Colonial Pipeline ransomware hack.  We then turn to a variety of news items relating to the global energy industry, international relations, eurozone monetary policy, Chinese population data, and the Israeli-Palestinian conflict.  We end with the latest developments on the coronavirus pandemic.

Colonial Pipeline Hack:  U.S. cybersecurity officials said they have been investigating the DarkSide ransomware used in the Colonial Pipeline hack since last October and that it constitutes a commercial-style “software as a service” model.  In other words, DarkSide sells the right to use the ransomware to other criminal groups, who then share any proceeds from its use with the DarkSide developers.

• It remains unclear whether Colonial has paid or is planning to pay the hackers to release the company’s data.  Biden administration officials have opened a debate on how companies should handle such ransom attacks in the future.  Of course, the Colonial hack will also invigorate other industry-led efforts to harden companies’ cyber defenses, as outlined here.
• Meanwhile, Colonial said it is working on a plan to phase operations back in by the end of the week.  If the pipeline remains substantially shut beyond that, there would be an increased chance on the East Coast and elsewhere of panic buying or significant price hikes for gasoline and other refined products.

Global Energy Industry:  The International Energy Agency today issued a report showing renewable power capacity grew at its fastest pace this century in 2020, with a rise of more than 45% from the prior year.  The increase of 280 gigawatts was driven partly by a rush to complete projects before government subsidies elapsed in China, the U.S., and Vietnam.  All the same, the data illustrate the extent to which the build-out of renewable power capacity is now well entrenched and has become a phenomenon that investors probably can’t ignore.

• According to the IEA, renewables were the only energy source for which demand increased in 2020, with COVID-19 lockdowns hitting consumption of all other fuels as government restrictions shut factories, grounded planes, and kept people at home.
• The agency also raised its 2021 and 2022 capacity growth forecasts by around 25%, with an addition of 270 gigawatts in capacity expected this year and 280 gigawatts next year.

United States-Japan:  Sources say President Biden has chosen Rahm Emanuel to be the next U.S. ambassador to Japan.  A close confidante of the president, Emmanuel is a former Illinois congressman, mayor of Chicago, and chief of staff to President Obama.  His nomination, therefore, would resurrect a U.S. tradition of sending influential former lawmakers to Tokyo, which Japanese leaders have appreciated because of their perceived gravitas and direct access to the White House.

United States-Iran:  In the third such incident in the last five weeks, a U.S. ship was forced to fire warning shots against a swarm of Iranian fast-attack boats that were harassing it in the Persian Gulf yesterday.  The Iranian moves are likely an effort to pressure the Biden administration for concessions amid talks in Vienna over restarting the 2015 deal limiting Iran’s nuclear program.  Even though none of the incidents so far has resulted in damage, the aggressive moves are risky and could lead to bloodshed that seriously escalates into a crisis, in which case global oil prices would likely spike.

Eurozone:  Ollie Rehn, the chief of the Finnish Central Bank and a board member of the ECB, said in an interview with the Financial Times that the ECB should follow the lead of the U.S. Federal Reserve by accepting an overshoot of its inflation target to make up for years of sluggish price growth.  In the interview, Rehn argued that changes in the eurozone labor market and the world economy had weakened wage inflation pressures, meaning lower levels of unemployment wouldn’t necessarily spark rapid inflation.  Although it’s not clear whether the ECB would take such an explicit stance as the Fed, the argument by Rehn offers additional evidence that monetary policymakers around the globe may tolerate higher inflation and hold interest rates lower for longer than investors envision.  Indeed, Isabel Schnabel, an executive director at the ECB, separately sought to soothe concerns about an expected increase in German inflation above 3%, saying such a rise was unlikely to cause a tightening of monetary policy.

China:  After an unusual delay, the government finally released the results of its 2020 census and said the country’s population grew to 1.41 billion last year.  However, the annual increase was marginal, and the data show that the country’s population growth rate averaged just 0.6% per year over the last decade (essentially matching the U.S. growth rate).  As in major economies, the culprit to the population slowdown has been a steep drop in births.  Falling birth rates are also pushing up average ages around the world, which will tend to retard economic growth and inflation over the longer term.

Israel:  Apparently reacting to an Israeli-Palestinian housing dispute, Palestinian demonstrators have been rioting in central Jerusalem, and Hamas forces have fired rockets into Israel.  In response, Israeli security forces are clamping down on the rioters, and Israeli warplanes are attacking Palestinian sites in the Gaza Strip.

COVID-19:  Official data show confirmed cases have risen to 159,031,885 worldwide, with 3,306,038 deaths.  In the United States, confirmed cases rose to 32,744,471, with 582,162 deaths.  Vaccine doses delivered in the U.S. now total 329,843,825, while the number of people who have received at least their first shot totals 152,819,904.  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 rose to approximately 35,000 yesterday, but that was still far below both the seven-day moving average of 40,873 and the 14-day moving average of 45,041.  New infections are now running at their lowest level in 11 months.  New deaths related to the virus remained relatively low at 401.  Meanwhile, the U.S. mass vaccination program continues, with 34.8% of the total population now fully vaccinated.
• For the first time since the pandemic began, fewer than half of Americans (43%) see returning to their “normal” pre-coronavirus lives as risky, according to a new poll from Axios/Ipsos.  The finding lends support to the notion that consumers will soon embrace getting back to something like normal, which should give a significant boost to the economy.
• The FDA has approved giving the vaccine developed by Pfizer (PFE, $39.86) to children as young as 12, compared with the previous minimum age of 16.  The approval was granted in response to a trial of the shot in about 2,500 adolescents.  The move could reinvigorate the nation’s mass vaccination program and allow millions of kids to be vaccinated before summer activities like camps and swimming lessons.
• In contrast with the good news on the Pfizer vaccine, Novavax (NVAX, $160.50) said it would have to delay applying for the authorization of its vaccine until the end of September due to slow progress in its clinical trials.  In addition, the company said raw material and other shortages would prevent it from reaching full production of the vaccine until the fourth quarter.  The news will likely delay some vaccination programs, especially in poorer, less developed countries that are banking on the Novavax shot.
• The World Health Organization designated the new B.1.617 variant first noticed in India as a “variant of concern” because it may be more transmissible than other mutations.
  • However, the advisory didn’t take a stand on whether the variant would be any less controllable with current vaccines.
  • Other mutations carrying the same designation are the B.1.1.7 variant first discovered in England, the B.1.35 variation first found in South Africa, and the P.1 variant first found in Brazil.
• Infections remain at catastrophic levels in India, and Prime Minister Modi’s administration continues to bicker with state governments over insufficient supplies of oxygen and other medical goods.  As a result, the Supreme Court said it is establishing a task force to better allocate needed supplies to states and hospitals.  The move comes after the court has criticized the government over its handling of the pandemic.

 Economic and Financial Market Impacts

• As further evidence that the post-pandemic inflation surge is gathering force, China’s April producer price index (PPI) was up 6.8% year-over-year, beating expectations and accelerating from a rise of 4.4% in the year through March.  In fact, the increase was the strongest in more than three years.  So far, however, wholesale inflation in China hasn’t yet had a large impact on consumer inflation.  The April Consumer Price Index (CPI) was up just 0.9% year-over-year, for its strongest gain in seven months.
• Soaring commodity prices and supply shortages have driven up shipping costs as well.  The Baltic Dry Index, which tracks rates for the three largest classes of ships, has risen to its highest level in more than a decade, soaring over 700% in the last year.

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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!  What an active weekend!  After spending time watching the skies, worried about falling Chinese space debris, U.S. equity futures are mostly higher this morning. We begin with the Colonial Pipeline cyberattack.  Up next are some thoughts about last Friday’s employment report.  We then have some information about the U.K. elections.  On Wednesday, we get the CPI report, so a few comments about inflation are in order.  General economics and policy news are up next.  China news follows, and international news comes after.  We close with pandemic coverage.

 The Colonial pipeline:  The Colonial pipeline is a key piece of U.S. energy infrastructure; about 45% of all product flow from Houston to the Eastern Seaboard moves on this 5,500-mile pipeline.  The pipeline transports about 2.5 mbpd of products from refineries in Texas and Louisiana to the states shown below.

(Source:  RBN Energy)

On Friday, the system was hit by a cyberattack that involved ransomware.  Reports suggest that hackers took data on Thursday before deploying the ransomware.  In a sense, this was a two-part attack.  The stolen data was used to threaten the company with a data dump while hackers encrypted parts of the network, demanding payment to decrypt.  The last official statement indicates that the four main lines are still closed.  However, as the map shows, there are numerous lateral lines, and some of them have resumed operations.  Although the culprit hasn’t been officially determined, the Darkside ransomware group is thought to be involved.  It is an eastern European criminal organization that has struck infrastructure before.  The fact that it is a criminal group doesn’t necessarily mean a state sponsor isn’t involved.  This is by far the most extreme attack on U.S. infrastructure and raises concerns that this and other critical infrastructure may be vulnerable to similar actions.

As of this morning, the pipeline remains closed, and there is no clear restart time.  The government has declared a state of emergency that will ease regulations on shipping fuel, and officials are working with the company to restart operations.  If the shutdown persists, gasoline, diesel, and jet fuel prices in the affected states will likely rise.  Over time, the U.S. can ship fuel by railcar and tanker, but these solutions will be costly, and the logistics will take time to manage.  The market reaction thus far has been modest.  Although we did see a spike in product futures prices yesterday evening, prices have been drifting lower since.  If the outage is contained this week, markets should remain calm.  However, if we are not back online by Friday, we will expect higher retail product prices.

The employment report:  Friday’s employment report caught the market off guard.  Pundits, economists, and strategists are all creating narratives to account for the surprise.  Friday’s report may be the largest true forecast miss we have ever seen.  Although the March 2020 miss was epic, it also occurred while lockdowns were being implemented.  Most of the forecasts were in place pre-lockdown.  Here are a few thoughts:

• The employment data is a volatile report. It is not uncommon for misses to occur, and the “misses” then absolved in later revisions.  You don’t get much out of one month’s report.  It would probably be a mistake to read too much into this surprise.
• Of course, that didn’t stop the narrative machines from churning out reasons for the disappointing data. It is important to remember that there are several cross-currents at work in the labor markets.
  • In Friday’s Daily Comment, for example, we showed the sharp drop in over 65 labor participation from the pre-pandemic level. The loss of older workers, which had been a rapidly growing part of the labor market, could be contributing to worker shortages.
  • We suspect underlying changes are occurring in the labor markets from the pandemic. Jobs in foodservice and retailing can be grueling.  The work is hard; the hours are uncertain, and facing the public can be challenging.  Many of these workers lost their jobs in the pandemic and found other ones.  They may have decided they aren’t going back.  That means retailers and restaurants may be forced to improve working conditions and pay to find workers.  Anecdotal reports are appearing that suggest this may be the case.  We are always careful with such information, but it can signal emerging changes.
  • Some states are ending Federal government COVID-19 benefits. This will act as a natural experiment to see if it was high transfer payments that were keeping workers away from jobs.
• There is some evidence to suggest the Bureau of Labor Statistics may have a seasonal adjustment problem. The non-seasonally adjusted non-farm payroll report was up 1.089 million compared to the seasonally adjusted data of 266 thousand.  The pandemic has clearly played havoc with the payroll data, and we suspect that the BLS is struggling to separate the seasonal effects that may be skewed due to the pandemic recovery.

U.K. elections:  It was good news and bad news for PM Johnson.  The good news was that the Tories continue to dominate Labor.  The bad news was that the SNP in Scotland narrowly missed an outright majority (it captured 64 seats with 65 being a majority), but since it is widely expected to make a government with the separatist Green Party, it will control 74 seats in the 129 seat legislature.[1]  It is also expected that Nicola Sturgeon, the head of the SNP, will use this election as a springboard for an independence referendum.  PM Johnson has called for crisis talks on this issue.

So, what happens now?  Expect a long, drawn-out process for a referendum.  PM Johnson opposes granting a separation vote and will use every option to delay it.  Expect Johnson to argue that since the SNP didn’t win an outright majority, it really doesn’t have a mandate.  It will be difficult for Johnson to postpone a vote indefinitely, but the SNP’s lack of an outright win will likely give him fodder to slow the process.

The primary issue driving Scottish independence is the EU.  Scotland wanted to remain; England wanted to leave.  Of course, in any issue like this, personalities matter, and Johnson’s divisive persona makes Sturgeon’s position easier to sell.  However, don’t underestimate the difficulties of independence.  Scotland may want out, but the EU might be reluctant to let it in.  Leaving will require Scotland to accept some of the U.K. debt.  The amount will be negotiated, but its debt level could be high enough to give the EU pause.  In addition, Spain has been reluctant to accept Scotland, fearing its Catalan independence movement would be bolstered by such an event.  The vote to accept a member requires unanimous consent, so Spanish opposition could doom the effort.  Scotland would not have a currency before it joins the EU.  Sturgeon says the country would continue to use the GBP, but that would give the BOE control of its monetary policy without any input.  And, joining the EU doesn’t make entering the Eurozone automatic.  Current polls suggest a narrow plurality would rather stay in the U.K.  However, undecided voters are around 8%, so there is room for the vote to go in either direction.  Although this issue will be on the minds of investors going forward, the GBP is higher this morning on the fact that the SNP didn’t win an outright majority.

Inflation:  We will get our first inflation reading that will matter on Wednesday; this will be the first one that takes into account the base effects of last year’s drop in prices.  Much of the price pressure we see is coming from supply constraints.  Bottlenecks and production disruptions are clearly leading to higher prices.  The unknown is whether households, flush with cash, will spend the money to buy things that cost more or balk at the increases and reduce spending.  Obviously, some items are staples and hard to economize.  Nevertheless, we could see changes in spending patterns as prices increase.

There is no doubt we are seeing reflation and debasement.  The Fed has made it abundantly clear that the focus on inflation control, the policy emphasis since Volcker, has been reversed.  This 1970s-style inflation requires a change in attitude, a fear that prices will be higher in the future, and thus the only option is to buy now, which will solidify price increases.  As we noted last week, it also requires a change in the thinking about inventories.  Stockpiles need to be seen as an asset instead of a cost to be managed.  Our take is that this current inflation event, to paraphrase Obi-Wan Kenobi, “is not the inflation you are looking for.”  We suspect consumers will wait out these price increases, and as supply chains normalize, inflation pressures will ease.  That doesn’t mean inflation isn’t going to be a serious issue in the future.

 Economics and policy:  European bond markets and contemplating the end of easy money are in the news.

• There are some oddities developing in the European bond markets.
  • Some European governments are moving to cap the amounts of new sovereign issues that hedge funds can buy. Apparently, hedge funds, which like using leverage, are purchasing large amounts of new issues only to sell them to the ECB at a small profit.  The ECB is not allowed to purchase new issues (that would be debt monetization, something that bothers Germans and other northern Europeans greatly) and must buy in the secondary market.  This situation creates an opportunity for private buyers to buy at the auction and quickly sell to the ECB. Since is it common for the price to be a bit below par at the auction, the likelihood of quick profit emerges.  Countries prefer buyers to be of the type that holds the bonds for a long period to dampen potential price volatility, not hedge funds looking to hold the bonds for a few hours.
  • Is the German Bund becoming the new widow maker? For years, traders have shorted Japanese government bonds and have nothing but massive losses to show for their efforts.  As expectations of higher yields emerge, traders are betting that the Bunds, with their low yields, will offer the best opportunity to profit from higher interest rates.  The risk?  There are primarily two.  First, any whiff of trouble in the Eurozone sends money to Bunds for safety.  Second, the ECB will likely limit the rise in this key bond market.
• The northern European nations tend to support hard money policies. So, we were surprised to see Olli Rehn, the governor of the Bank of Finland, suggest the ECB should mimic the Fed’s policy on inflation and accept periodic “overshoots” of the target.  We suspect he is worried about an overly strong EUR.
• As interest rates rise, the boom in refinancing mortgages is fading. Paradoxically, this is helping homebuyers, as mortgage brokers are cutting fees to attract business.  However, this benefit is usually fleeting; over time, mortgage brokers will begin to reduce capacity by laying off personnel.
• Now that workers are fleeing the high-cost tech cities, secondary cities are starting to benefit.
• Regulators are cracking down on the widening crypto markets, especially the ones that represent an equity interest.
• The common theme lifting financial markets is easy monetary policy. Once this policy ends, the fallout could be a problem.

China:  The EU is steadily expanding its toolbox to contain China’s influence.

• The EU is facing a China that has multiple tactics and policies to expand its reach. The EU is reacting by creating numerous trade responses to address these actions.  It has created a set of policies that will allow members to react to China’s subsidies which expand their exports.  Anti-dumping rules have been bolstered.  Technology restrictions have been put into place.  It has rules in place that force EU firms to enforce European labor standards.  However, the real problem is both the EU and China use export promotion economic models.  They both need nations to be willing to absorb their exports, and when neither is open to that sort of policy, frictions naturally develop.
• U.S. military leaders are increasingly concerned about China’s expansion into Africa.
• The PRC is restricting phone news notifications to limit the flow of information.

International roundup:  Tensions are rising in Israel and the EU, and India starts trade talks.

• Israel is planning to evict some Palestinians from East Jerusalem to house Israeli settlers. This decision has led to widespread violent protests, which will delay the evictions for now.
• The EU and India, likely in response to worries about China, have agreed to restart trade negotiations. The two countries had talks from 2007 to 2013 but failed to make progress in several areas, so discussions were suspended.

COVID-19:  The number of reported cases is 158,400,711 with 3,294,657 fatalities.  In the U.S., there are 32,708,028 confirmed cases with 581,755 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 329,843,825 doses of the vaccine have been distributed with 259,716,989 doses injected.  The number receiving at least one dose is 152,116,963, while the number of second doses, which would grant the highest level of immunity, is 114,258,244.  The FT has a page on global vaccine distribution.

• The idea of global herd immunity is fading. The uneven rollout of vaccines and the rapid evolution of new variants is pointing to a situation where COVID-19 becomes endemic.  That means that some degree of caution will remain in place, but the current level of concern will likely fade over time.
• As vaccine cards become a passport to various activities, a market for fraudulent cards is emerging.
• On the vaccine front, the WHO has approved China’s Sinopharm (SHTDF, USD, 3.35) vaccine. Some nations are changing guidance for the use of the AstraZeneca (AZN, USD, 53.81) vaccine.  The most likely decision is to limit distribution among those under 40.
  • Although vaccine distribution in the U.S. has slowed, the pace of infections is falling.
  • The pace of vaccinations in Europe is rising.
  • Erie County in Pennsylvania is finding a way to overcome vaccine hesitancy: free beer.

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[1] We also note that the breakaway party of Alex Salmond, the Alba party, failed to secure a seat.  This will be taken as clear evidence Sturgeon is the leader of the separatist movement.

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 the jobs report continues to support market optimism; we will go into further detail in the economic releases section of this report. Our report starts off with a summary of the Financial Stability Report. International news follows, with details about the Pentagon’s plan to leave Afghanistan, Morocco’s decision to recall its ambassador to Berlin, the U.S.-Iran nuclear talks, and more. Economics and policy are up next, including the Biden administration’s decision to limit U.S. investment in China and Biden lowering his tax rate demands. China news follows, and we close with our pandemic coverage.

The Fed: The Federal Reserve released its Financial Stability Report on Thursday. Here are the highlights:

Asset Valuations: Although the rise in asset prices is generally backed by an improvement in the economic outlook, the Fed fears that much of the rise may be due to an increase in risk appetites. The report cites declining corporate spreads, particularly for firms that were negatively impacted by the pandemic, as evidence of elevated risk appetites. As a result, the Federal Reserve believes that asset prices could fall following a setback in the recovery such as a relapse in virus containment, a market scare, or possibly a slowdown in the recovery.

Borrowing by Businesses and Households: Debt for businesses and households continues to fall, but still remains elevated, particularly for small businesses. Funding for smaller firms appears to have tightened, thus making it harder for these firms to maintain day-to-day operations. Generally, smaller firms are given less priority than larger firms for credit access. As a result, these firms are vulnerable to shocks and are financially strained even after receiving government support.

Leverage in the Financial Sector: Leverage for banks and broker-dealers remains low, while leverage is elevated for hedge funds and life insurance companies. Although the Fed did mention that life insurance leverage is high, its primary concern was with the leverage of hedge funds. Particularly, it argues that the lack of transparency has made it difficult to determine the level of risk hedge funds pose to the financial system. To support this claim, the Fed highlighted the losses hedge funds took due to the “meme stock episode” in January 2021 and the market turmoil caused by Archegos Capital Management. Their concern is that hedge funds could potentially be a source of financial distress.

Funding Risk: Large banks have relatively low risk of liquidity and maturity mismatches, while money market funds as well as bond and bank loan mutual funds remain a source of concern. Specifically, investors are finding it difficult to meet their liquidity needs when they have trouble selling their underlying assets (such as commercial paper and short-term government notes). Additionally, bond and bank loan mutual funds may have a hard time meeting their liquidity needs due to increased holdings of U.S. corporate bonds. The Fed is currently working with other international organizations to address these concerns.

International news: The Pentagon terminating contracts, Morocco recalls ambassador, and U.S.-Iran nuclear talks.

• The Pentagon has started the process of removing all contractors working with the U.S. from Afghanistan. The removal of contractors is seen as the first step taken by the Biden administration to withdraw all U.S. forces from Afghanistan by September 11.
  • The U.S. is considering training Afghan forces in different countries after it fully withdraws from Afghanistan.
• Morocco recalled its ambassador to Berlin in response to Germany’s stance regarding Western Sahara. Following the U.S. decision to recognize Morocco’s claim over the disputed territory in December, Germany called a United Nations Security Council meeting to discuss the issue further. Additionally, Morocco has accused Germany of sharing intelligence with an alleged Jihadist.
• The U.S. and Iran are still engaged in nuclear talks. The two sides remain far apart on securing a deal as Iran would like more sanctions to be lifted before agreeing to comply with restrictions on its nuclear program. The two countries would like to have an agreement before the Iranian elections on June 18 as it is believed it may be harder for the two sides to agree afterward.
• Rising currency pressure has led a member of Taiwan’s central bank to imply that over the next two years the bank could allow the currency to appreciate. Taiwanese firms have seen an influx of investment as rising trade tensions between the U.S. and China have incentivized U.S. companies to diversify their supply chains. The increased investment has put upward pressure on the Taiwan dollar.
• Norway’s central bank governor, Oystein Olsen, has expressed hesitancy in removing the country’s monetary support in the near future as Europe continues to struggle with the vaccine rollout.

Economics and policy: The U.S. continues the investment ban, corporate tax rate demand drops, and vaccine/pandemic policy updates.

• The ban on U.S. investments in Chinese companies with links to the Chinese military is expected to remain in place under the Biden administration. The restrictions were initially imposed by the preceding administration and have heightened tensions between Beijing and Washington.
• President Biden announced that he is willing to lower his demand of a 28% corporate tax rate down to 25% on Thursday. Increasing corporate taxes is one of the ways the Biden administration has sought to fund the $2.3 billion infrastructure proposal.
• The intellectual property (IP) waiver for vaccines isn’t expected to resolve shortages in the near future. The process that is needed to lift the patent protections could take months or even years as it will likely involve intense negotiations. Germany’s resistance to the proposal will likely complicate the issue further. The removal of IP is designed to help developing countries produce the vaccine domestically as these countries have lacked the shots needed.
• South Carolina is the second state to announce it will end pandemic unemployment benefits early to address labor shortages; Montana was the first state. Governor Henry McMaster has ordered pandemic-related unemployment programs to end June 30.

China:  Conflict in the South China Sea and Chinese census delay.

• The Philippines rejected China’s fishing ban in the South China Sea. The dispute regarding claims over the South China Sea has complicated China’s relationship with countries in Southeast Asia. On Thursday, the National Task Force for the West Philippine Sea had to disperse several Chinese militia vessels in the Sabina Shoal.
• The Chinese census is expected to be delayed as the country has struggled to track migrant workers. The report was supposed to be released sometime in April but has now been postponed indefinitely.
• China’s Long March 5B rocket is expected to re-enter the earth’s atmosphere this weekend. U.S. Defense Secretary Lloyd Austin has stated that the Pentagon has no plan to shoot down the rocket upon its re-entry. The debris from the rocket is not expected to cause any harm.

COVID-19:  The number of reported cases is 155,425,409 with 3,246,844 fatalities.  In the U.S., there are 32,573,436 confirmed cases with 579,572 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 321,549,335 doses of the vaccine have been distributed with 249,566,820 doses injected.  The number receiving at least one dose is 148,562,891, while the number of second doses, which would grant the highest level of immunity, is 107,346,533.  The FT has a page on global vaccine distribution.  The weekly Axios map shows rising cases in about half the country.

Virology

• Due to a shortage of critical ingredients, Brazil could possibly run out of the CoronaVac vaccine as soon as next week. The shortage is believed to be related to a growing rift between Brazil and China. Over the last few months, Brazilian President Jair Bolsonaro has angered many in Beijing due to his assertion that the virus may have been an act of biological warfare. More than 410,000 Brazilians have died of complications related to the virus, second only to the U.S.
• The Indian virus variant has been detected in the African countries of Kenya, Uganda, and Morocco.
• New York baseball stadiums will be open to all baseball fans starting May 19. The New York Yankees and Mets will create separate sections for vaccinated and unvaccinated fans. The vaccinated section will be allowed to sit together at full capacity, while the unvaccinated sections will be required to wear masks and sit six feet apart.
• Quality control problems at a Baltimore plant have forced countries to halt the distribution of the Johnson & Johnson vaccine (JNJ, $167.18). The pause will be in place while countries ensure the vaccines are safe following a contamination in March. None of the Johnson & Johnson vaccines administered in the U.S. came from this plant.
• Assuming enough people get vaccinated, the Centers for Disease Control and Prevention has stated it believes the pandemic could be under control by July.
• Japan is expected to extend the virus state of emergency until the end of May. The move comes as Japan tries to slow the virus in preparation for the Olympics. Most major cities are now operating under states of emergency, including Tokyo.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  U.S. equity futures are mostly steady this morning.  Our coverage starts with Facebook.  Next is coverage of the U.K. local elections along with other international news followed by our pandemic coverage, including a look at the Biden administration’s decision to temporarily suspend patent protection for COVID-19 vaccines.  Economic and policy news comes next.  We close with comments on China.

Facebook:  Facebook’s (FB, USD, 316.32) oversight board declined to reinstate President Trump to its platform but did say it would review the case again in six months.  The fact that the media treated the news as if it were a key economic release or a Supreme Court decision is notable.  As expected, GOP leaders were displeased, but the bigger issue is why.  As a society, we grant such power to a private company with little regulatory oversight.  We do expect this situation to be addressed at some point.  It is unclear if it will be good or bad for the company or other social media companies.  After all, regulation often solidifies a company’s market position by increasing the cost of entry.

The creation of the oversight board was, in a way, an attempt to shift the burden of decision away from Facebook.  The oversight board has the veneer of independence; the 20-member committee is comprised of political leaders, human rights activists, and journalists and is based in London.  Although nominally independent, the company funds the operation to the tune of $130 million.  Thus, it is hard to say the company has no influence on its decisions.

President Trump isn’t the only political leader who has been a problem for the company.  It has blocked the Myanmar military.  Venezuela’s President Maduro has had his page frozen.  Brazil’s President Bolsonaro has also had posts removed.  Poland and Mexico have called for curbs on the company’s power.

In the end, the plan to create an oversight board to avoid scrutiny has failed.  The board pushed the decision back to the company, suggesting that in six months, it should make a call.  As social media firms have become conduits of speech, they have also become deeply mired in politics everywhere.  In the older media environment, political systems relied on the lack of concentration to allow for a fair dispersion of information.  There were numerous newspapers and rules against concentrating ownership.  In broadcast media, where there were only three networks, the fairness doctrine regulated the way political news was managed.  Social media grew up in a deregulated environment and was not really considered media for a long time.  It looks like avoiding regulation in this arena will be impossible, although there is another alternative…the firms could be broken up, and the creation of a larger number of social media companies, with none dominant, could allow for a freewheeling media.  However, the monopoly profits that the current firms enjoy would be the cost.

U.K. elections:  The U.K. is holding local elections.  Under normal circumstances, this wouldn’t be big news.  But in the post-Brexit world, these elections have become proxies for independence movements.  There will be a close study of the outcomes to see if independence movements in Scotland and Wales gain support.  It will also tell us, to some degree, Boris Johnson’s popularity.  Although we remain favorable on U.K. assets, seeing them as undervalued in the wake of Brexit, the independence issue is a risk that, if it expands, could be a bearish factor for the U.K.

International roundup:  Fish fights, Russian troops, and worries about Peru are in the news.

• One of the more contentious concerns about Brexit was fishing rights. The British Channel was part of the EU’s fisheries area; post-Brexit, it is not.  It is complicated.  Although the U.K. could deny continental fishermen access to British waters, U.K. fishermen needed EU markets for the fish they caught.  For the most part, the deal wasn’t really resolved.  It has now become something of a farce.  The U.K. is restricting French fishermen’s vessels in the area around Jersey, one of the British Channel Islands.  The U.K. has sent two Royal Navy vessels to patrol the area.  Unfortunately, Jersey gets its electricity from France, and the French are threatening to cut off the island.  We doubt this will become a war, but it does highlight the difficulties involved with leaving the EU.
• Russia is keeping a rather high level of troops on the Ukraine frontier during NATO military exercises.
• Peru will hold elections on June 6. The candidates, Pedro Castillo and Keiko Fujimori, are polar opposites.  The former is a leftist in the mold of Evo Morales and Hugo Chavez, and the latter is a rightest similar to her father.  As the election draws near, there are reports of increasing capital flight as wealthy Peruvians become increasingly worried.
• Tax reform efforts in Colombia are leading to increasing unrest.

COVID-19:  The number of reported cases is 155,297,849 with 3,244,849 fatalities.  In the U.S., there are 32,588,066 confirmed cases with 579,280 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 321,549,335 doses of the vaccine have been distributed, with 249,566,820 doses injected.  The number receiving at least one dose is 148,562,891, while the number of second doses, which would grant the highest level of immunity, is 107,346,533.  The FT has a page on global vaccine distribution.  India’s cases continue to rise.  Although overall U.S. cases are falling, the Axios state map does show a mixed picture of rising and falling cases.

• The Biden administration shocked the pharmaceutical world by supporting a temporary suspension of vaccine patents. Lifting the patents would allow developing world manufactures to expand production rapidly.  But, the drug companies fear this step will undermine the patent system and weaken protections on their intellectual property.  Shares fell both in the U.S. and abroad.  Although it is clear there are concerns, it should be noted that this move may be more public relations than substantive.  Getting patent relief will entail negotiations, and it isn’t obvious whether developing nations have the technology to make the vaccines, even if they have the formulas.
• The CureVac (CVAC, USD, 101.20) vaccine has completed its clinical trials and is set to announce results. If it works, it will offer an mRNA vaccine that doesn’t require the freezing that earlier, similar vaccines required.  That characteristic would be a major support for the developing world.
• Preliminary results from Moderna (MRNA, USD, 162.84) indicate that its booster shots created an immune response to variants of COVID-19.
• Polls suggest that the U.S. may be reaching the point of vaccine saturation. A recent experiment shows that one way to overcome vaccine hesitancy is to pay people $100 to get vaccinated.
• Two members of the Indian delegation to the G-7 meeting tested positive for COVID-19.
• Although lockdowns likely reduced deaths and infections from the virus, it has had an adverse impact on other issues, such as opioid addiction.

Economics and policy:  Inflation, inventories, and taxes are in the headlines.

• We often are asked questions about inflation. Most of the time, the focus is on policy.  Although worrying about monetary or fiscal policy is understandable, our many years of looking at inflation have made it clear to us that the topic is deeply complicated.  At its heart, inflation is a balance sheet decision.  When a household or firm decides it would rather hold real assets instead of financial ones, it is a key element to rising price levels.
  • Although just-in-time inventory management methods appear to have started in Japan in the 1970s, they didn’t really catch on in the U.S. until the 1980s. In the 1970s, in a period of negative real interest rates, the cost of carrying inventory was theoretically negative as well.  Most firms saw the value of their inventory rise, so holding inventory was a benefit.

• This chart shows the ratio of real inventories to real GDP. It falls over time, in part, because of the economy’s steadily increasing dominance of services, which by their nature, have less inventory.  Some of this decline is also due to inventory management.  After the war into the mid-1960, a period of steadily falling inflation volatility, there was a steady decline in inventories relative to GDP.  However, as inflation began to rise in the mid-1960s, this downtrend stopped, and there was a tendency to hold inventories relative to GDP.  After inflation fell in the early 1980s, the downtrend resumed and is currently at historic lows.
• Automakers are apparently rethinking their inventory management. Insecurity of supply is the basic reason behind the change.  Yet, if firms begin to believe that holding more “stuff” is better than holding financial assets, it will tend to lift goods prices and support inflation.
• The basis of just-in-time inventory methods is the idea that inventory is a negative factor, and it is preferable to have as little as possible. That position appears to be deteriorating, at least regarding cars, and if it starts to spread to other industries, it will tend to lift prices.

• The Biden administration is attempting to move numerous tax proposals through a narrowly divided Congress. That means that individual senators and representatives can have sizeable influence.  Simply put, it is a better use of time to wait and see what happens with taxes rather than plan changes based on proposals.
  • Another issue with taxes is the incidence of corporate tax.[1] Economic theory suggests that shareholders pay, but if a firm has market power.  They may be able to pass the taxes on to consumers via higher prices or to labor through lower wages.  The debate remains unresolved, but there are worries that a hike in corporate taxes may not have the impact policymakers expect.
  • The broadest version of the corporate tax will likely require the OECD to agree to a global minimum tax. The U.K. has indicated it might agree.
• A U.S. judge tossed out the CDC’s eviction moratorium, suggesting the CDC didn’t have the legal authority to impose it. It was scheduled to end on June 30.  The administration is scrambling to move aid to renters to avoid massive evictions.  The DOJ says it will appeal the ruling.  Clearly, the current situation cannot continue.  Renters cannot continue to live in housing without paying rent, and landlords cannot be expected to forgo rental income indefinitely.  It would create a chain of defaults that would adversely affect the economy.  We suspect the final solution will be some sort of socialization of the arrears.  A mass eviction event could not only harm renters and strain social welfare systems but could also lead to falling rents.
• After several years of negative interest rates, Germans are beginning to react to the rates of return on cash by increasing their risk. Given the conservative leanings of Germans, this is a remarkable development.
• In the U.S., banks are encouraging corporations to move their cash out of deposits to avoid falling afoul of capital rules.
• The Biden administration is reversing an earlier rule on gig workers, making it more difficult for companies to claim contractor status.
• Companies are re-examining job requirement rules, suggesting that many jobs that currently require a bachelor’s degree may not need that status. Such a move could boost employment over time.
• One factor that may be affecting hiring is that the tech center cities are seeing slower hiring than the rest of the country. This might reflect the work from home changes, which would lead to less demand for services in these cities.
• At long last, the CME is closing the last of the open trading pits. The trading floors have been lightly populated for over a decade, but the end has finally come.
• We recently issued a series of reports on central bank digital currencies. A comment from the FT suggests that the central banks are not likely to protect privacy.  We also note that cryptocurrency volumes are rising rapidly.
• Hedge funds are positioning for a slow depreciation of the dollar.
• Be aware—the debt ceiling issue will return this summer.

China:  The Uighur issue continues to resonate, and Chinese equity listings remain an issue.

• There is growing reluctance among America’s allies to declare China’s treatment of the Uighurs as genocide.  This is mostly due to worries about losing trade with China.  It is also true among companies.
  • However, this reluctance isn’t true for Australia. The country revoked a 99-year lease in Darwin to the Landbridge Group, a Chinese company, on national security grounds.  Beijing isn’t happy.
• Short sellers argue that a sizeable number of Chinese listed firms in the U.S. are beyond regulation and should be delisted.
• As Ant Financial moves toward its IPO, it is trying to figure out how to bring its health alliance mutual aid network into regulatory compliance.
• China is opening Hong Kong’s bond market to the mainland, with the goal of slowly opening China’s capital account.
• China is apparently gathering data from televisions to see what households are up to. The government decided not to mention that to its citizens.

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[1] In other words, who pays?