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

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday, the last one in April!  U.S. equity futures are mostly steady this morning as investors await a plethora of earnings reports this week.  Our coverage begins with the pandemic, and we are watching India’s caseloads rise.  International news follows, with the U.S. decision to label the 1915 Armenian situation a genocide.  An economic roundup follows (it’s all about chips), and we close with China news.

COVID-19:  The number of reported cases is 147,238,543 with 3,110,511 fatalities.  In the U.S., there are 32,077,477 confirmed cases with 572,200 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 290,692,005 doses of the vaccine have been distributed with 228,661,408 doses injected.  The number receiving at least one dose is 139,978,480, while the number of second doses, which would grant the highest level of immunity, is 94,772,329.  The FT has a page on global vaccine distribution.

Virology

• India is suffering through a strong surge of COVID-19 infections of an undetermined strain, one that is being called a “double mutation.” Anecdotal evidence from crematoriums suggests that the death count is higher than the official numbers denote.  Shortages of basic medical supplies, including oxygen, are prompting airlifts to support the nation’s beleaguered medical system.  The EU and member states are all promising help, and the U.S. is sending materials for vaccines.
• Japan has declared a state of emergency in Tokyo and Osaka due to a rise in cases. Japan will host the Summer Olympics in three months.
• The FDA will allow the Johnson & Johnson (JNJ, USD, 165.52) vaccine to be distributed after a one-week halt due to blood clotting concerns. There is a certain degree of vaccine hesitancy, and the J&J news was not helpful in encouraging those concerned about vaccine safety.  However, as U.S. vaccine rates slow, there are growing worries that the country will fall short of herd immunity, which would leave COVID-19 in an endemic state.
• The medical sector is now starting to focus on the problem of “long COVID,” the situation where a patient has chronic maladies caused by an infection. Surprisingly, even some patients who had a mild case of the disease can exhibit long-term problems.  These patients had a higher risk of mortality compared to those who were never infected.
• As the global economy emerges from the pandemic, we continue to monitor what will return to pre-pandemic life and what will change. A clue emerged; European banks announced they won’t be sending their bankers to see customers to the same degree, bad news for airlines and hotels.

International roundup:  Turkey, Iran, and Ukraine lead the news.

• As expected, President Biden has declared that Turkey’s attack on the Armenians in 1915 was a genocide. This article offers background on the event.  American presidents have avoided the declaration so as to not cause issues with Turkey, a NATO ally.  Thus far, the response has been modest, suggesting it is being treated as mostly symbolic.  Turkey has summoned the U.S. ambassador, but nothing suggesting the U.S. removing its military installations has been signaled.
• Financial market turmoil has led Turks to buy cryptocurrencies to protect against inflation and currency depreciation. Although cryptocurrencies are often lauded for their portability, an exchange in Istanbul, called Theodex, is being accused of fraud, with the government claiming that $2.0 billion may have left the country.  Sixty people have been detained, and an international arrest warrant, a “red notice,” has been issued for the CEO.  Although cryptocurrencies are, in theory, safe, they are often traded through exchanges that have proven to be less than secure.
• An oxygen tank at a Baghdad hospital exploded, trigging a fire that killed at least 80 people.
• Debris from the lost Indonesian submarine has been spotted, suggesting that it has been lost.
• PM Johnson is in a bit of a difficult spot, dealing with allegations he illegally used donor money to fix up his residence at 10 Downing Street. His former controversial aid, Dominic Cummings, made the allegations last week.
• After Russia ordered a pullback of troops on the Ukraine border, President Zelensky of Ukraine is calling for a revamp of the peace process to end the constant tension in eastern Ukraine. Zelensky would like to see the U.S., U.K., and Canada increase their diplomatic involvement.
• It has generally been believed that the Iran Revolutionary Guard Corps (IRGC) had a high level of political influence. After all, the IRGC controls large parts of the economy and provides the hard edge to civil control.  A leaked audio tape suggests the IRGC is mostly running the country.  With Ayatollah Khamenei aging, it will be interesting to see, when he dies, if the IRGC supports a replacement or dispenses with the control of the clerics.
• Across the West, the political center has been coming under pressure. It isn’t always as evident in a two-party system, but in multiparty systems, centrist parties have seen their influence shrink.  In Spain, the loss of influence of Ciuadadanos, a centrist party, is a cautionary tale about how voters have deserted the party, which once looked poised to take power.

Economics and policy:  Inflation and financial regulation lead this morning.

• As we have reported, the global semiconductor shortage is playing havoc with the auto industry. Now, it is spreading to the consumer appliance market.  Although the shortages may not necessarily end up in the inflation statistics, there is another worry about supply constraints.  The lack of goods can raise fears of shortages and prompt firms and consumers to stockpile goods when they start to become available.  In other words, in the 1970s, shortages were also part of the inflation psychology.[1]
  • Rents have been under pressure for most of the past year, but there are signs that the rental market is starting to firm. That news suggests that prospective tenants are starting to shop.
  • There are widespread reports that service firms are using various perks to fill job vacancies. We suspect there are several reasons for this change.  The Federal distributions are widely blamed and probably are playing a role, although research we did earlier this year suggested this was probably a minor factor.  One area we are watching is the exit of older workers.  Given that COVID-19 tended to have greater lethality for older people, there is evidence to suggest that many of these workers opted to take retirement rather than risk employment.[2]  In comparing over 65-year-old participation to a model based on the percentage of Americans of that age, participation is running well below forecast.

We doubt these workers are coming back.  If so, the pool of workers will be lower going forward, and this fact will tend to tip the balance of power toward labor.  Of course, globalization and technology will still tend to offset these factors, but only to some degree.  Over time, this factor will lead to (a) higher inflation or (b) lower profit margins.  Most likely, it will be a bit of both.

• As we noted last week, the end of LIBOR is leading the financial industry to scramble for a replacement. Regulators are pushing SOFR, but as we noted, it is for Treasury secured repo and won’t necessarily reflect bank cost of funds. This report is a good primer on the issues involved.
• We continue to closely monitor regulatory efforts for money markets. Money markets are the primary funding source for the non-bank (shadow) banking system.  Participants fear that protecting the funds from runs will either make them indistinguishable from bank deposits or reduce their liquidity to the point where depositors won’t use them anymore.  At the same time, the funds were “ground zero” in both the Great Financial Crisis and the March 2020 crisis.  Clearly, the current structure is unsustainable.
• The FOMC meets this week. We don’t expect any change in policy, but we will be watching the press conference for clues about future policy.
• With all the rhetoric about greening the economy and reducing carbon emissions, a factor that does get overlooked is that of energy density. The history of the industrial revolution has an element of consistently adopting power sources of increasing density; in other words, getting more power for less fuel.  Crude oil and its derivative products are hard to improve upon.  Batteries won’t be able to contain the same degree of power as a gallon of gasoline.  The consumption side of the equation can offset some of this problem (lighter car materials can offset some of the loss of energy efficiency), but there is a notable risk that the future will have slower growth because of the lack of energy density.  However, one way to overcome this problem is nuclear, the densest of all fuel sources.  There has been a quiet bull market in uranium and metal miners recently and there is growing optimism that, at some point, regulators will decide to accommodate nuclear power to address climate change.
• Although there is much being written about tax increases, we do note that the current plans do include tax relief for lower-income households.

China:  EU policy tries to cope with an aggressive China, Jack Ma battles the CPC over data, and industrial policy collides with environmental policy.

• President Biden is expected to visit with EU leaders next month. One of the topics of discussion will be the EU’s relationship with China.  The EU issued a progress report on trade relations with China.  The report suggests there has been little progress on trade issues and that these problems may be intractable.  Overall, the report indicates that China’s integration into the EU economy may be reaching its limits.
• There has been a running battle between the Chinese government and Jack Ma. At its heart is data.  The CPC wants the consumer data maintained by Ant Financial, and the company doesn’t want to give up this valuable asset.  We suspect that the state will eventually prevail.
• As Beijing moves to achieve environmental targets, its heavy industry is struggling to support the efforts. Steel firms are being forced to close due to environmental concerns.

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[1] A joke by Johnny Carson led to a run on toilet paper and a subsequent shortage.

[2] Anecdotally, we note that before the pandemic, grocery baggers at my local stores were about 50% workers over the age of 60 (at least they looked like it).  Those workers have completely disappeared, replaced with younger workers.

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 optimism grows over a potential infrastructure package.  We have a full slate of news to cover today.  The report will start with a discussion on Biden’s tax proposal.  International news follows, with Russia withdrawing from Ukraine, Israel objecting to nuclear talks, and more.  Economics and policy are up next, with an examination of the Republican counteroffer to the infrastructure bill.  China news follows, and we will close with our pandemic coverage.

Tax proposal: The White House announced a plan to increase the capital gains tax from 20.0% to 39.6% for taxpayers with adjusted income greater than $1 million.  The additional revenue will aim to help fund the Biden administration’s social spending programs and partially help fund Obamacare.  The plan is expected to receive some backlash from Republicans who fear the tax could lead to a reduction in investment and employment.  Because it is unlikely that any Republican would support the bill, President Biden would likely need to rely on his slim majority in both the Senate and House to get the tax increase passed through Congress.  The two possible holdouts that could stop the proposal from becoming law are Senator Kyrsten Sinema (D-AZ) and Senator Joe Manchin (D-WV).  Earlier this month, Manchin balked at a proposal that would raise the corporate tax rate from 21% to 28%.  In addition, the proposal would still need to be passed through budget reconciliation in order to avoid being filibustered.  Given the extreme jump in the tax rate, we suspect the bill has a moderate chance of passing.

Although the increase in the capital gains tax doesn’t come as a surprise, the scale of the rise has caught many investors off guard.  When news broke of the potential tax hike, stocks sold off immediately.  On its face, this proposal does appear to be bearish for equities, but that may only be true leading up to its implementation.  Before the implementation of higher capital gains taxes, investors can maximize profits by selling their most profitable holdings before the new tax is implemented.  It will likely hurt the tech sector disproportionately as it has seen the most significant gains over the last decade or so.  After its implementation, investors will tend to be incentivized to hold onto stocks for a longer period.  This may reduce market volatility and short-term trading behavior.  Historically, capital gains changes have adversely affected stocks the year before implementation, but less so afterward.  At the same time, there is a modest tendency for higher capital gains rates to reduce market multiples.

International news:  Israel objects to restoring the nuclear deal, Russia withdraws from the Ukraine border, and more.

• Israeli Prime Minister Benjamin Netanyahu has instructed his delegation to object to the strategic talks between the U.S. and Iran. Israel believes that Iran is a threat to its national security and would like the U.S. to walk away from discussions.  PM Netanyahu took a similar position in 2015, but his objection fell on deaf ears.  The delegation is expected to inform Washington that it will not abide by any agreement and would be willing to engage in military operations against Iran alone if it feels that its national security is threatened.
• Russia has agreed to withdraw its military from the Ukraine border by May 1, according to state media. The decision has allowed Ukraine to breathe a sigh of relief as the move appears to mark a de-escalation between itself and Russia.  The buildup of Russian troops along the Ukraine border led many to fear a possible invasion.  However, there is some speculation that the action was a way to gauge the West’s future response if Russia decided to invade.
• Denmark is the first European country to begin revoking residents’ permits from some Syrian refugees. The move comes as hostilities within Syria have moderated.  As a result, some places that were considered dangerous are now deemed safe.

 Economics and policy: The Republican infrastructure bill, self-driving cars spark concerns, D.C. statehood.

• Senate Republicans introduced a $568 billion infrastructure package on Thursday. The bill defines infrastructure more narrowly than the $2.3 trillion plan proposed by the White House.  It includes funding for roads and bridges, rails, public transit, airports, and broadband.  Although many Democrats have called the plan too small, the White House has stated that it would welcome “any good-faith effort by the Republicans.”
• Consumer Reports, a nonprofit organization, has stated that it could “easily” trick the autopilot feature in a Tesla (TSLA, $719.69) vehicle. In a test conducted this week, engineers were able to trick the Tesla vehicle into believing someone was operating it by placing a small weighted chain on the steering.  The engineer reported that at no time did the vehicle signal it was aware that there was no driver in the driver’s seat.  Tesla’s autopilot feature has come under scrutiny after two men were killed in a Tesla sedan last week.  Although it isn’t clear whether autopilot was to blame, authorities claimed that no one was in the driver’s seat when they recovered the vehicle.  Following this report, two senators have called for a probe into Tesla regarding the recent crashes.
• Voting along party lines, the House passed legislation that would make Washington, D.C. the 51st state. The legislation would give the city one representative and two senators.  Despite the Democrats’ majority in the Senate, the bill is not expected to pass.

 China:  Rising tensions with Australia, China’s target of terrorist attacks, and the PBOC targets Ant Group.

• Tensions between Australia and China continue to escalate after Australia canceled two accords between Victoria State and China’s Belt and Road Initiative. PM Scott Morrison claimed the move was designed to prevent local governments from straying away from the federal government’s foreign policy of promoting a “free and open Indo Pacific.” Australia has implemented a new policy that forces states to consult with the foreign ministry before signing agreements with foreign nations.  China has criticized the move as part of a larger plot by the West to contain it and warned Australia to end its “cold war mentality.”  China has struggled to punish Australia as it heavily relies on the country’s iron ore.
• A suicide bombing in Pakistan is being investigated after it appears to have targeted a Chinese ambassador. The attack in the western province highlights growing resentment of China’s Belt and Road Initiative.  Groups have complained that China is draining their country of its natural resources.  The Pakistani Taliban has taken credit for the attack.  As the U.S. withdraws from the Middle East, it is becoming clear that China may be forced to fill the void; the region now poses a greater geopolitical risk.
• Beijing has ramped up its fight against Jack Ma by asking Ant Group to turn over its consumer lending data to the People’s Bank of China (PBOC). Ant Group’s data is one of its most valuable assets and is the core of its business model.  The PBOC wants access to this data in order to better assess the creditworthiness of consumers.  The move comes during a time in which China is struggling to contain an increase in consumer defaults.

COVID-19:  The number of reported cases is 144,217,276 with 3,064,345 fatalities.  In the U.S., there are 31,903,230 confirmed cases with 569,928 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 282,183,915 doses of the vaccine have been distributed with 218,947,643 doses injected.  The number receiving at least one dose is 135,791,031, while the number of second doses, which would grant the highest level of immunity, is 89,245,776.  The FT has a page on global vaccine distribution.  The weekly Axios map shows rising cases in about half the country.

Virology

• The health effects from contracting COVID-19 can potentially last much longer after a person has recovered. A study released from the journal Nature looked at the effects of COVID-19 on patients from the Veterans Health System.  According to the study, patients suffered from chronic diseases that stretch beyond just the respiratory system.  There have been cases of neurological, cardiovascular, and gastrointestinal problems following the diagnosis.  Additionally, patients who were suffering from chronic conditions before contracting the virus have seen their symptoms worsen.
• A study by Epic Health System showed that only 0.4% of the people who contracted COVID-19 were reinfected within the next 90 days. Before this study, doctors were largely unsure whether it was possible to contract the virus twice.  The finding in this study will likely relax concerns of a never-ending pandemic, and it raises the possibility of the country eventually achieving herd immunity.
• Health officials are expected to resume administering the Johnson & Johnson (JNJ, $165.18) vaccine as soon as this weekend on the condition that it comes with a warning. The vaccine was suspended earlier this month over concerns that it might be linked with severe blood clotting.  The resumption of the vaccine is unlikely to come with an age restriction.
  • On Thursday, South Africa announced that it would resume administering the Johnson & Johnson vaccine.
• The latest wave of COVID-19 cases may have already peaked in the EU as cases have been declining across the bloc. Although France and the Netherlands still have cases well above the EU average, the decline is a welcome sign as more people are vaccinated.
• California now has the lowest per capita COVID-19 infection rate in the country after being one of the hardest-hit states at the start of the year. There may be several reasons for the decline, ranging from an estimated 40% of the population has contracted the virus already to lockdown restrictions, but there is no definitive answer.  That being said, the steep decline has led to a reopening of businesses and restaurants throughout the state.

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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 Earth Day! It’s a busy Thursday, with lots of items to cover.  U.S. equity futures are steady to lower this morning.  Our coverage begins with Biden’s two-day climate summit.  The ECB holds its meeting, and we cover that too.  We update the Archegos event.  Russia and China news follow.  Our update on economics and policy is up next.  Then comes an international news roundup, some technology news, and we close with our regular pandemic update.

Climate summit:  The U.S. is holding a virtual Climate Summit today with 40 world leaders invited.  In anticipation of the meeting, the Biden administration announced it would reduce U.S. greenhouse gas emissions by 50% before 2031.[1]  Although the administration disputes the claim, it is hard to see a path to that goal without the proposed infrastructure package passing in Congress.

• Despite elevated tensions, Vladimir Putin will join the meeting. General Secretary Xi will too.
• Canada was the only G-7 nation that had higher CO² emissions last year.
• Brazil, which has tended to downplay environmental issues under President Bolsonaro, has changed its position, likely in the hope it will be paid to avoid cutting down its forests.
• An interesting sidelight; cattle methane emissions are reduced if the animals are fed seaweed.

Overall, we view summits such as these as PR campaigns, and we suspect this one will be too.  International environmental policy suffers from two problems.  First, everyone is for the environment as long as the costs are modest, but once it starts to hurt, it gets difficult to make changes.  Second, there is a strong temptation to “free ride.”  In other words, a nation benefits from cutting emissions but does even better if other nations do so while theirs does not.  But what is important about this one is that China and Russia are participating, even with tensions high.

ECB:  Policy, as expected, was left unchanged.  In the press conference, Lagarde is clearly getting better at managing the art of central bank speak, which is to express lots of works but say little of substance.  We note her comments that the ECB doesn’t set a target for the EUR did lead the currency to rally.    The June meeting may be more problematic.  Hawks would like to start withdrawing bank purchases in the second half of the year.  We doubt this will occur due to the slow action on EU vaccinations, but this will bear watching.

• The ECB is moving to issue a digital currency.

Archegos:  As we note below in the China section, regulators there are dealing with a serious financial problem.  Meanwhile, the fallout from Archegos continues.  Credit Suisse (CS, USD, 10.38) appears to be bearing the brunt of the losses.  It was revealed the bank had more than $20 billion of exposure to Archegos.  It is rather stunning to have that much exposure, but apparently, the caused was improper accounting for derivative risk.    Senior executives are leaving, including the heads of the prime brokerage unit that oversaw the lending to Archegos and the risk managers.  The losses (estimated at around $4.7 billion so far) are causing the bank to raise $1.9 billion of capital.  The Swiss banks used to be the apex of high net worth banking.  However, in this incident, they were clearly outclassed by their U.S. rivals.  The bigger issue?  The earlier outperformance of Swiss banks appears, in the end, to be due to its country’s bank secrecy laws. As those have been rolled back, they have lost their edge.

The bigger concern we have with the recent financial firm crises is that if we are seeing such blowups when monetary policy is arguably the most accommodative since WWII, what happens when policy tightens?

Russia:  Putin conducted his annual press conference yesterday, and worries about the military buildup are front and center this morning.

• Every year, President Putin holds a press conference where he addresses the nation. It is a sort of state of the union address.  A number of topics were discussed, including Ukraine, U.S. sanctions, and Navalny.  Although he stated that he would protect Russian security, he did not offer any specific actions in retaliation for recent sanctions or diplomat explosions.  Putin made it clear that Russia will react if the West crosses any “red lines,” but he didn’t detail what those red lines were.  While Putin was holding his conference, protestors called for the release of Alexi Navalny.
• The military buildup around Ukraine continues unabated. Although we don’t expect Russia to invade Ukraine (it would be difficult to win and even harder to control; it might trigger a stronger response from the West than Putin could manage), the escalation is hard to miss.  We suspect this action is mostly to intimidate Ukraine and test Biden, but there is still a degree of uncertainty that hasn’t been discounted by financial markets.
• Eastern European nations are becoming increasingly uncomfortable with Russia’s actions. The Czech Republic released a statement explaining why it expelled Russian diplomats and is asking for EU support in opposing Russia.
• The U.S. military suspects Russia used directed energy weapons on American troops. There were no details offered about the incident.

China:  Xi argues for a new world order, and we are watching yet another financial system problem.

• In a speech earlier this week at the Boao Forum, General Secretary Xi argued for a new world order, a slightly veiled message against U.S. hegemony. The thinking in the U.S. and China has changed markedly in the past four years.  In the prior period, the accepted wisdom was that China, following the pattern of other Asian tigers, would gradually democratize.  In fact, market liberalization would foster this shift to democracy, so supporting globalization was based on reforming China.  The consensus has clearly shifted.  Although there were dissenting voices in the prior period, now the consensus is that China is and always will be a revisionist power tied to a particular version of Marxist/Leninist thought that will never liberalize.  But it should be noted that China’s thinking has also changed.  It realizes it now faces a hostile environment and thus is preparing for a world of trade restrictions.  The “dual circulation” strategy is part of this change.  Xi also believes that the decline of the U.S. is inevitable, and thus, the world is heading into a period without a global hegemon.  To some extent, China wants to gain some control over the world the U.S. has built by raising its stature in multilateral organizations, e.g., World Bank, IMF, U.N., etc.
  • A problem China faces in this evolving order is that it lacks allies, and the Biden administration is openly courting allies in the region.
  • Japan is blaming the Chinese military for a series of cyberattacks. The U.S. has suffered numerous attacks as well.
  • Australia has revoked the state of Victoria’s agreement to participate in the belt and road initiative.
  • The EU and India are formulating an alternative to the Belt and Road Initiative.
• The Chinese financial system continues to spawn debt, and some of it goes bad. The latest credit event we are watching is Huarong Asset Management (2799, HKD, 1.02).  This company was created to absorb and liquidate bad debt created in the period following the Asian Financial Crisis.  Chinese regulators created “bad banks,” designed to be workout groups.  Bad banks try to manage distressed assets, maximizing the return from the bad debt.  Under normal circumstances, such banks eventually wind themselves up after disposing of what debt has value and liquidating the rest.  However, Huarong took on a life of its own, becoming a normal bank and making new loans.  It borrowed heavily and had a number of loans go sour.  The chairman of the company, Lia Xiaomin, was executed in January for his crimes tied to the company, essentially, corruption and accepting bribes.
  • For world financial markets, the concern is $22 billion of USD-denominated bonds that have plunged in value on fears of default. Foreign investors tend to treat bonds issued by SOE’s as obligations of the central government.  In other words, they expect the government to prevent default.  This belief creates a serious moral hazard problem.  On the one hand, the government wants to force investors to be more careful in what they purchase and allow the bonds to default to send this message.  However, it doesn’t want a debt crisis either.
  • China is rapidly moving to expand its CBDC.
• China’s voracious demand for commodities exposes a geopolitical vulnerability. Although tensions with the U.S. are elevated, China is importing record levels of American corn, and the need for iron ore is undermining Beijing’s attempt to punish Australia.
• China has expanded its naval base in Djibouti to accommodate its aircraft carriers. It is also working on a third aircraft carrier that appears to be similar to the U.S. Ford-class carrier.
  • China’s massive fishing fleet is becoming a geopolitical force.
• Tesla (TSLA, USD, 744.12) has made a major push into China. It is finding that to be a difficult road.  First, the company’s spotty record on reliability is leading to an uproar of consumer complaints.  Initially, the government quashed the protests.  But, as they have increased, Beijing has turned its fire on the company.  Unsavory sales tactics are also undermining the brand.
• Reports suggest that the CPC is systematically rooting out banned religious groups.

Economics and policy:  Taxes, inflation, and infrastructure are today’s headlines.

• Inflation worries have been rising; we have been hearing more questions on the issue and mentions are rising too.

(Source:  Google Trends)

Searches for inflation peaked in late February, but interest remains elevated.  Reports that consumer products companies are planning on raising prices have increased concerns.  In earnings reports, companies are complaining about rising costs.  These reports are consistent with the ISM data on prices paid.

The key unknown is the degree to which firms can pass along higher costs. We fully expect some of these costs will filter through to consumer prices.  We continue to maintain that the price increases will be temporary due to the lack of inflation expectations, but we are monitoring conditions closely.  We do note that Chair Powell vows to react to a “substantial” overshoot of inflation.

• There are continued concerns about the labor market as well. Although the labor force is clearly lower in the wake of the pandemic, it is unclear if some of those workers will return anytime soon.  Generous fiscal aid, fear of the virus, and perhaps rethinking career choices may make finding workers difficult.
• On the other hand, there is growing evidence of a surge in business formation. It is possible that workers are using the fiscal spending to venture out into their own businesses.  If so, we could see a renaissance in small businesses, which would expand supply.
• We have been positive on residential real estate and homebuilders. Recent data shows the strongest buying from Hispanics in two decades, supporting this sector of the economy.
• GOP senators are offered a counter to the Biden administration’s infrastructure package.  It does not include changes to corporate taxes.  It is also smaller, at $800 billion over eight years.  Senate Democrats are unimpressed.
• The semiconductor shortage continues to hamper auto production, both in the U.S. and Europe.
• Weak lending in Europe is slowing the recovery there.
• LIBOR is in its waning days.  U.S. regulators are pushing a replacement called the Secured Overnight Financing Rate (SOFR), which is a collateralized rate based on Treasury repos.  However, Rich Sandor, who is considered the father of interest rate derivatives and futures and also the creator of carbon trading, has created an alternative, called the American Interbank Offering Rate (AmerIBOR).  Corporations are favorable to this alternative to SOFR because it is not collateralized by Treasuries, and it is not just an overnight rate.  Here is a broadcast on this issue from the Odd Lots podcast.
• The Bank of Canada appears poised to tighten policy, the first of the G-7 nations to signal a change.
• High yield spreads in the U.S. have narrowed to historically narrow levels.

International roundup:  Turkey, Myanmar, and Europe lead the news.

• President Biden is reportedly prepared to declare that Turkey’s actions against Armenians during WWI were genocide. U.S. presidents have tended to avoid this declaration, as Turkey vigorously disputes this position.  If the reports are accurate, it tends to show how much U.S. and Turkish relations have cooled over the past 20 years.
  • The Erdogan government is facing pressure over the rapid decline in foreign reserves. We suspect the reserves were spent to support the exchange rate.
• Continued protests in the wake of the recent coup are causing the economy of Myanmar to implode. There are growing fears the country is becoming a failed state.  However, that isn’t stopping China from investing in the country.
• In Europe, Denmark is considering sending Syrian refugees back, arguing that conditions there have improved. Lithuania is opening its doors to Belarusian businesses that have been adversely affected by instability.  President Draghi of Italy says his government will spend the EU aid on high-speed rail and technology.  As we noted yesterday, German courts have opened the way for German participation in the fiscal transfer.
• Indonesia appears to have lost a submarine.

Technology:  The industry continues to face the threat of regulation.

• It is becoming a global phenomenon; regulators around the world are taking steps to reduce the power of technology firms. In the U.S., the administration’s appointment of Lisa Khan is especially negative due to her calls for returning to a pre-Bork antitrust legal standard.
• British tabloids are suing Google (GOOG, USD, 2,293.29), arguing the firm adversely manipulated search results.

COVID-19:  The number of reported cases is 143,962,157 with 3,061,748 fatalities.  In the U.S., there are 31,862,987 confirmed cases with 569,404 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 277,938,875 doses of the vaccine have been distributed with 215,951,909 doses injected.    The number receiving at least one dose is 134,445,595, while the number of second doses, which would grant the highest level of immunity, is 87,592,646.  The FT has a page on global vaccine distribution.  The weekly Axios map shows that infection rates have stabilized but have stopped falling.

Virology

• The vaccine process is becoming a “good news/bad news” story.
  • A look at various countries shows that vaccines are reducing cases, fatalities and, hospitalizations. But, as this article shows, the data also shows rising cases in India and Latin America.  In fact, Indian infections hit a global record, and the health system there is showing signs of stress.
  • In the U.S., it appears we may be reaching the apex in vaccinations. This is mostly because the population of people willing to be vaccinated is near completion, and those who remain are vaccine-hesitant.  This hesitancy will tend to reduce the likelihood the U.S. will achieve herd immunity.  Meanwhile, U.S. infections and hospitalizations are rising; much of this is due to lockdown fatigue.  Global data show that each successive lockdown was less effective, likely due to lockdown fatigue.
  • At the same time, wealthy South Americans are flocking to the U.S. for vaccination.
• All this means that the optimism about opening up the economy should be tempered by the continued problems with moving past the pandemic.
• Texas A&M researchers have isolated yet another variant of COVIC-19 that appears related to the British B.1.1.7 type. It is not clear if this variant is a problem, but it has raised concerns because the aforementioned variant has been more potent.
• Pfizer (PFE, USD, 39.52) has discovered that criminal groups in Mexico and Poland are selling counterfeit versions of its vaccine.
• China is criticizing the WHO over the Wuhan leak theory. This criticism shows that Beijing will not tolerate any notion that it bears any responsibility for the pandemic.
• The Los Angeles Dodgers are planning to create vaccination sections that will not have strict social distancing, further evidence that the private sector is going to enforce some form of vaccine passporting.
• Otters, apparently, can contract COVID-19.

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[1] To be specific, that’s 50% below 2005 levels.  In 2005, U.S. CO² emissions were 6.0 BN tonnes.  Last year (abet with the pandemic), the DOE estimates emissions were 4.61 billion tonnes (for reference, 2019’s number was 5.13 billion tonnes).  So, we are talking about a reduction to 3.0 billion tonnes, about a 35% reduction from last year’s number.

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

[Posted: 9:30 AM EDT] | PDF

Today’s Comment opens with a few key U.S. developments that are likely to affect financial markets today.  President Biden will reportedly call for an aggressive 50% cut in U.S. greenhouse gas emissions, which will likely raise concerns about new regulations and reduced corporate profitability going forward.  There are new signs of increasing U.S.-Russia tensions, especially with today’s mass protests in Russia supporting jailed opposition activist Alexei Navalny.  Finally, we review the latest news on the coronavirus pandemic.  Germany’s top court has removed an obstacle to the EU’s big pandemic spending package and the launch of mutualized EU debt, which will likely make the Euro a more viable reserve currency over time.

U.S. Climate Policy:  At his climate summit on Thursday and Friday, President Biden will reportedly set a goal of cutting U.S. greenhouse-gas emissions by approximately 50% by 2030 from their 2005 levels.  At least some scientists see such a goal as achievable but ambitious.  More important for the financial markets, such an ambitious goal raises concerns about the kinds of regulatory or fiscal policies that might be put into place to achieve it.  Over time, efforts to achieve the goal could have disparate impacts on different sectors of the market.

United States-China:  Sources at the White House say President Biden will name veteran diplomat R. Nicholas Burns as U.S. ambassador to China.  Early in his career, Burns served as State Department spokesman and ambassador to Greece in the Clinton administration. In the George W. Bush administration, he was ambassador to the North Atlantic Treaty Organization and helped organize NATO’s response to the Sept. 11, 2001, terrorist attacks. He then became undersecretary for political affairs, a senior State Department post, during the Bush years until he retired from the foreign service.  By naming such an experienced and skillful diplomat to the post, Biden will signal that he intends to take a serious and careful approach to the U.S. relationship with China.

United States-Russia:  The Russian space agency announced that it will withdraw from the International Space Station program in 2025 and leave the facility to the U.S.  Instead, Russia plans to launch its own space station by 2030.  The move will also give Russia a freer hand to increase its space cooperation with China, as it faces increasing political pushback from the U.S. and Europe.

Russia-Islamic State:  The Russian military said it launched airstrikes in central Syria against Islamic State insurgents who were threatening government-held oil facilities, killing some 200 militants.

Russia:  Supporters of jailed opposition activist Alexei Navalny have launched mass protests calling for his release.  However, police are aggressively rounding up and arresting major figures in the movement, and it is not yet clear how large the demonstrations will actually get.  The Navalny issue does put pressure on President Putin, but not yet enough to threaten him politically.

COVID-19:  Official data show confirmed cases have risen to 143,076,046 worldwide, with 3,047,222 deaths.  In the United States, confirmed cases rose to 31,793,715, with 568,475 deaths.  Vaccine doses delivered in the U.S. now total 272,030,795, while the number of people who have received at least their first shot totals 133,266,995.  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 approximately 54,000 yesterday, well below both the seven-day average of 67,122 and the 14-day moving average of 67,940.  New deaths related to the virus totaled a relatively modest 767.
• Because of rebounding infections in Japan, the government is preparing to reintroduce a state of emergency in Tokyo and Osaka with just three months to go before the Summer Olympics are set to kick off in Tokyo.  However, Osaka’s governor is facing severe backlash for requesting such a tight lockdown.
• Infections in India have now skyrocketed to the point where the pandemic is worse than at any other time.  The surge in infections is due to multiple factors, including new, more transmissible mutations, a lagging vaccination campaign, and political and religious superspreader events.
• Despite rebounding infections in countries such as Japan and India, a new analysis by the Financial Times shows that mass vaccination programs appear to have a positive impact no matter what the overall trend in infections looks like.  Countries with extensive vaccination programs giving first priority to older, more vulnerable age groups show significantly lower rates of infection, hospitalization, and death than their less vaccinated cohorts.  The data should be comforting to investors concerned about rebounding infections and new virus mutations.  If borne out by further analyses, the study suggests that economic reopening could generally continue regardless of the fits and starts in some countries.  If so, the news should be supportive of risk assets going forward.
• In a vote of confidence for the vaccine from Johnson & Johnson (JNJ, $166.48), the European Medicines Agency said the best way to handle the shot’s possible connection to blood clots was to make it carry a warning that clots could be a very rare side effect, but the benefits of the vaccine still outweigh the risks.
  • The finding by the European agency leaves it up to EU governments whether to use the vaccine and whether to impose any restrictions. J&J said after the EMA announcement that it would resume European deliveries.
  • The injection remains under a pause in the U.S., at least until Friday, when an advisory committee is scheduled to recommend a way forward to the CDC.
• Meanwhile, Pfizer (PFE, $39.03) said it found the first confirmed instances of counterfeit versions of its vaccine in Mexico and Poland.

 Economic and Financial Market Impacts

• According to a report from the testing company Renaissance Learning, elementary students continue to test below their pre-pandemic expectations, but the gap is shrinking as schools open up and return to in-person learning.
• A survey by business advisory firm Vistage Worldwide shows 44% of small businesses reported temporary shortages or other supply chain problems as the economy began to reopen from the pandemic in March.  Supply disruptions and shortages are likely to feed into increased inflation pressure in the coming months, although that pressure will likely decline eventually as those shortages get resolved.

U.S. Policy Response

• President Biden told a meeting of lawmakers yesterday that he would back a multi-year extension of the enhanced child tax credit included in the $1.9 trillion pandemic relief bill passed earlier this year.
  • The enhancement raised the tax credit to $3,000 from $2,000, setting it at $3,600 for parents of children under age six and making parents of 17-year-olds eligible.
  • The credit, which scales down above certain income thresholds, is fully refundable and was designed to be paid in intervals rather than in one lump sum.

 Foreign Policy Response

• Ahead of tomorrow’s ECB policy meeting, hawkish monetary officials like German central bank chief Weidmann and Dutch central bank chief Knot are urging a quick end to the ECB’s massive bond-buying program.
  • At the ECB’s last monetary policy meeting, council members all agreed to conduct the purchases at a “significantly higher pace” in the second quarter to avoid a sell-off in bond markets, pushing up borrowing costs before a recovery had taken hold.  Since then, however, the ECB’s weekly net purchases have increased only marginally, leaving analysts scratching their heads and wondering if the recent rebound in sovereign bond markets led officials to have second thoughts.
  • Despite the pushback from Europe’s inflation hawks, the ECB is more likely than not to continue its loose policies, especially given the resurgence of infections and the relatively lagging rollout of vaccinations in Europe.  All the same, if the pushback from the hawks gets worse, it could lead to bouts of volatility in European financial markets.
• More important for the long-term future of Europe, Germany’s constitutional court rejected an emergency motion to stop the country from ratifying the bloc’s €750 billion pandemic relief fund and its provision allowing mutualized EU debt backed by the full faith and credit of all EU member countries.
  • The court said it would consider a lawsuit challenging the fund but would not put ratification on hold while its decision on the main case was pending.  According to the judges, their initial review indicated that it was unlikely they would find the recovery fund violated the German constitution.
  • The judges also ruled that giving the European Commission powers to raise it up to €750 billion on capital markets to finance the recovery fund “does not create direct liabilities for Germany or its federal budget.”
  • The decision removes a key threat to Europe’s pandemic relief program, but more importantly, it also removes a threat to the mutualized debt program, which could help make the Euro a more viable reserve currency over time.  That probable development is one key reason why we think the dollar is likely to lose value versus the common currency over time.

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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 developments on President Biden’s proposed package of infrastructure and other economic measures.  We then pivot to the international news most likely to affect the financial markets today.  As is often the case, there are new signs of friction between the U.S. and China, and the Russian buildup of military forces on the Ukrainian border looks more threatening than previously known.  We end with an overview of the latest developments on the coronavirus pandemic.

U.S. Fiscal Policy:  In the latest White House meeting regarding President Biden’s plan to spend $2.3 trillion on infrastructure and other economic measures, the president and a bipartisan group of lawmakers discussed a smaller increase in the corporate tax rate and possible changes to the size and scope of the package.  As the meeting got underway, Biden asserted, “I am prepared to compromise, prepared to see what we can do and what we can get together on.”

• Some Senate Republicans, critical of the corporate tax increases and the broad scope of Biden’s plan, have started discussing making a counteroffer in the realm of $600 billion to $800 billion.  A group of Republicans met yesterday to discuss that possibility, with lawmakers aiming to release their own plan soon.
• If the White House is really as flexible as it says regarding the infrastructure and economic plan, there is probably a greater chance that a significant bill will get passed, perhaps even with some Republican support.  That prospect, along with continuing monetary stimulus and economic reopening from the coronavirus pandemic, would help buoy risk assets and keep alive fears of higher inflation and interest rates going forward.

United States-China:  Speaking at a major Chinese business conference, President Xi delivered a forceful call for a new world order no longer dominated by the U.S. and its values.  Although he never mentioned the U.S. by name, Xi argued that “International affairs should be handled by everyone . . . The rules set by one or several countries should not be imposed on others, and the unilateralism of individual countries should not give the whole world its rhythm.”

United Kingdom-China:  British national security officials led by the intelligence agency MI5 are launching a campaign warning that China and other hostile countries are using professional networking sites such as LinkedIn to recruit new sources and steal classified information.

• Starting this week, the campaign will warn 450,000 civil servants and partners in industry and academia that Britain’s adversaries are creating fake online accounts to ensnare people who are privy to classified information.
• Posing as recruiters, foreign spies lure their targets to meetings in person where they may be subjected to bribery or blackmail in order to obtain intelligence.

Russia-Ukraine:  While we’ve been reporting on the buildup of Russian military forces on the country’s border with Ukraine, new data suggest the surge is even bigger than previously known.  Commercial satellite imagery shows Russia has now deployed a wide range of assets in the area, including airborne troops, motorized rifle and armored units, attack helicopters, smoke generators, reconnaissance drones, jamming equipment, and a field hospital.  All told, U.S. and European officials estimate Russia has deployed 100,000 or more troops on the border.  Leaked Ukrainian military, analysts also say Russia has blocked off more than a quarter of the Black Sea, ostensibly for “military exercises,” but in reality to disrupt Ukrainian trade and provoke a Ukrainian response that would serve as a pretext for incursion.

• The amount of military assets that Russia has on or near the border will significantly increase its ability to intimidate the Ukrainian government or mount an incursion into Ukraine, although a major objective of Russia might simply be to test the new Biden administration’s resolve.
• Biden administration officials have been preparing options to provide lethal and nonlethal military aid to Ukraine in the event of a Russian attack. The options include antitank, anti-ship, and antiaircraft systems, though they haven’t yet been presented to President Biden for a decision.  Naturally, Russia’s actions could also spark new economic sanctions.
• In any case, rising tensions or an outright military incursion into Ukraine would likely be unsettling for risk assets, although any violence would likely spark strong buying in safe-haven assets such as gold.

Germany:  Armin Laschet has won the race to succeed Angela Merkel as head of the ruling center-right CDU/CSU party, after rival Markus Söder, the prime minister of Bavaria, threw in the towel.  With Chancellor Merkel retiring and the CDU/CSU trailing badly in the polls, the unpopular Laschet will lead the party against the resurgent Greens in national elections scheduled later this year.

COVID-19:  Official data show confirmed cases have risen to 142,217,752 worldwide, with 3,032,909 deaths.  In the United States, confirmed cases rose to 31,739,364, with 567,729 deaths.  Vaccine doses delivered in the U.S. now total 264,505,725, while the number of people who have received at least their first shot totals 132,321,628.  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 67,000 yesterday, but that was still slightly lower than the seven-day moving average of 67,451 and the 14-day moving average of 68,636.  Meanwhile, new deaths related to the virus totaled a relatively modest 473.
• Even though all adults are now eligible for a COVID-19 vaccination in all U.S. states and territories, hitting President Biden’s deadline of April 19, about one-fifth of those aged 65 and older still haven’t been vaccinated.  The shortfall illustrates the risk that vaccination rates soon could taper off, leaving plenty of U.S. residents at risk of contracting and/or spreading the disease.
• The experience of the U.K., Israel, and Chile, all of which rapidly vaccinated a large proportion of their citizens, shows that risks remain even after a major vaccine program is implemented.
• In India, the government ordered a tight new lockdown on New Delhi to combat a resurgence of infections that have brought the healthcare system to the brink of collapse.  As of 10 p.m. local time, shops and businesses were forced to shut, and people’s movements were restricted to accessing and providing essential services.  Other regions have also imposed fewer sweeping lockdowns.
  • It appears that one reason for the rebounding infections is the presence of various mutations that are more transmissible than the original coronavirus, including the strains first found in the U.K., Brazil, and South Africa.
  • There is even a new, highly transmissible “double mutation” variant, which gets its name because it has two mutations seen separately in other variants but not in the same variant.
• Because of the pandemic’s resurgence in India, the British government said it would add the country to its “red list” of nations from which travel into Britain is restricted.  For example, British and Irish nationals traveling from India will have to quarantine in a hotel for ten days following their arrival. Individuals who are not U.K. or Irish citizens will not be permitted to enter the U.K. if they have been in India in the previous ten days.

Economic and Financial Market Impacts

• According to the European Central Bank’s latest lending survey, resurgent infections and renewed lockdowns in Europe led to decreased corporate loan demand and tighter credit standards during the first quarter.  The weak data is weighing on EU bank stocks and driving EU bond yields lower so far this morning.

Foreign Policy Response

• In a sign that U.S. policymakers aren’t the only ones who want to avoid a repeat of the tight fiscal policy that arguably held back the recovery from the Great Financial Crisis, the Canadian government today proposed an expansive budget for the coming fiscal year.  However, despite massive new spending and another enormous fiscal deficit in the coming year, the plan foresees the deficit falling to just 1.1% of gross domestic product by 2025.

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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!  Global equity markets are mixed this morning, with U.S. equity futures taking a breather.  Our coverage this morning starts with bitcoin, which had a rather wild weekend.  Russia news follows and includes several items.  China news is next, followed by an update on German politics.  There is an economic roundup, and we close with the pandemic update.

Bitcoin:  Prices fell hard over the weekend.

(Source:  Coindesk)

Although the plunge over the weekend isn’t all that unusual, the reasons behind the pullback are unclear.  There are reports that the Treasury is contemplating a crackdown on digital assets, which are often used for money laundering.  We note that Turkey’s central bank has banned cryptocurrency payments as well; one of the greatest dangers to cryptocurrencies could come from government regulation.  This decline could also be part of the post-market Coinbase (COIN, USD, 342.00) IPO.  As the chart above shows, prices had rallied into the IPO, and thus some of this decline could be profit taking.  Although China has made it more difficult to mine bitcoin because of the drain on electricity, the PBOC has taken a rather sanguine position on cryptocurrencies.  We doubt this will last; General Secretary Xi tends to take a dim view on things he can’t control.

We comment on market action this morning in part because bitcoin and other cryptocurrencies have siphoned off liquidity from the financial markets.  If prices reverse, that liquidity could look for a new home.

Russia:  Navalny’s health, Czech Republic expels Russian diplomats, and the Ukraine’s military buildup are raising concerns.

• Alexei Navalny, on the 19^th day of a hunger strike to receive the medical treatment of his choice, is said to be near death. He is likely still dealing with the aftereffects of his poisoning last year, and tuberculosis is common in Russian prisons.  Navalny’s allies are calling for protests.  The U.S. is considering its options should Navalny die in Russian custody.  Although the Kremlin has moved him to a prison hospital due to his condition, there doesn’t appear to be much concern in the government if he dies.
• For weeks, the Russian military has been building up its forces around Ukraine. Speculation has been rising about what Putin is doing.  One possibility is that he could engineer an incursion to open a canal that brings fresh water to Crimea.  Or it could be to send a signal to NATO that Russia remains a threat.  There is even speculation that Putin could cause an incident to disrupt the U.S. climate summit this week; reducing greenhouse gases is an existential threat to Russia’s hydrocarbon-based economy.  The general worry is that anytime there is a buildup of troop strength, there is always the potential for a mistake, leading to an unintended escalation.
• The Czech Republic has blamed Russia for an explosion at an ammunition dump in 2014. The unit responsible for poisoning Sergei Skripal is being blamed for this attack.  The Czechs have expelled 18 Russian diplomats over the incident.  Russia has countered by expelling 20 Czech Republic diplomats.  The Czech Republic has been on good terms with Moscow; this incident has clearly cooled relations.
• The Russian media is touting a coup plot in Belarus, claiming U.S. involvement.

 China:  U.S. and China agree to cooperate on climate issues, and Japan and the U.S. agree to counter Chinese coercion.

• Relations between the U.S. and China are at a low ebb. The Trump administration ended the policy of accommodation, applying sanctions, and the Biden administration has not only maintained the trade tariffs but is working to build a coalition to isolate China.  Despite these difficulties, the two countries have vowed to work together on climate issues.  Although such agreements are welcome, we doubt China will actually do much on this issue without a broader group of nations involved and higher levels of coercion.
• Japan and China have close economic ties; these relations have tended to keep Tokyo from making aggressive statements toward Beijing. But, we note that, after the Biden/Suga meetings, the Japanese PM clearly stated the U.S. and Japan would oppose China’s aggression in the region.
• Chinese authorities appear to have extracted their penalty for Jack Ma’s position on financial regulation of Ant Financial. It appears he is being forced out of his controlling stake in the company.
• We have viewed China’s belt and road project as a thinly veiled return to 18^th century imperialism. Like the European powers of that era, China has excess capacity and needs a captive economy to absorb its production.  The latest nation to find itself facing excessive debt to China is Montenegro.  The country accepted Chinese financing for a massive road project that the EU was critical of when it was announced.  In a twist, the EU and NATO member is asking for help from the EU to service the debt; Brussels is not inclined to do so.  After all, if small European countries can accept lending from Beijing and then rely on the EU for bailouts, the moral hazard problem will simply worsen.
• The Biden administration is targeting rare earths for industrial policy in a bid to loosen China’s hold on that market.
• The Treasury is warning Taiwan that it is manipulating its currency. Given the geopolitical importance of Taiwan, we would not expect the U.S. to move aggressively to resolve the manipulation.
• The CPC is pushing a traditional “family values” role for Chinese women. This is being done to address a serious demographic problem.  We doubt Chinese women will be swayed by party messages.

Germany:  Germany will hold national elections in the fall, and the CDU/CSU is struggling to agree on a leader in the midst of a slump in the polls.  Meanwhile, the Greens, who are seeing their poll numbers rise, have selected Annalena Baerbock as party chair.  If the party wins in the upcoming elections, she would become Chancellor.  The Greens are an environmental party, but over the years have become increasingly centrist.  Perhaps more important for the U.S., the Greens are much more strongly opposed to Russia and China compared to the CDU/CSU, who loath to harm business relations.  The conservatives are more closely aligned with the “metal banging” part of the economy.  The Greens are closer to the technology and services sectors.  It is notable that the Greens oppose the Nord Stream 2 project.

 Economics and policy:  Tax negotiations continue, and the economy starts to emerge from the pandemic.

• It looks increasingly like centrist Democrats are not going to support a 28% corporate tax rate. Media reports suggest that the highest they will accept is 25%.  Meanwhile, the high income tax state members are pressing to end the cap on “salt” deductions, which mostly affect affluent taxpayers.
• The pandemic has reportedly led to the closure of 200,000 businesses. Although we don’t doubt the reports (a casual drive around our area shows lots of storefront space for rent), it should also be noted that many of the industries affected have few barriers to entry.  Thus, we would expect a rapid recovery to develop in the coming months.  One key unknown is how rapidly hiring will follow.
• We have been documenting the high level of household liquidity in the U.S. Reports suggest this is not just an American phenomenon.  Globally, savers are sitting on $5.4 trillion.

COVID-19:  The number of reported cases is 141,499,661 with 3,021,912 fatalities.  In the U.S., there are 31,670,706 confirmed cases with 567,217 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 264,505,725 doses of the vaccine have been distributed with 209,406,814 doses injected.  The number receiving at least one dose is 131,247,546, while the number of second doses, which would grant the highest level of immunity, is 84,263,408.  Half of U.S. adults have received at last one dose of a COVID-19 shot, and 25% are fully vaccinated.  All adults are now eligible for a vaccination.  The FT has a page on global vaccine distribution.

 Virology

• It is expected that the Johnson and Johnson (JNJ, USD, 162.24) vaccine will return to use later this week, although it may be restricted to older patients.
• On the international front:
  • Turkey is seeing a new surge in cases. Gatherings for Ramadan are probably helping spread the virus. New cases appear to be the more contagious strains.
  • Chile is discovering that the Sinovac (SVA, USD, 6.47) vaccine was not all that effective. After a mass vaccination campaign and the easing of lockdown constraints, the country is facing a surge of infections.  In fairness, it appears Chileans began circulating after one dose, which doesn’t confer high levels of immunity.
  • Another country facing a crisis is India. The most recent wave of infections is tied to new variants.  The economic impact is hitting India’s middle class and has sent its currency lower.
  • The U.K. is undertaking challenge trials. Previously infected but unvaccinated volunteers will be deliberately exposed to the virus to see if their previous infections grant immunity.  The U.K. is the only nation in the world conducting official challenge trials.

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

[Posted: 9:30 AM EDT] | PDF

Good morning, all! It has been a relatively quiet news day so far. U.S. equities are expected to open higher following strong earnings from financial firms. We will begin our coverage with more details about the Russian sanctions. International news follows, with Castro stepping down from leadership, the Brexit fallout in the finance sector, and more. Economics and policy are up next along with information about the housing shortage. China news follows, and we close with our pandemic coverage.

As anticipated, the Biden administration imposed new sanctions on Russia due to its involvement in the SolarWind (SWI, $18.20) hack and other cyberwarfare activities. The sanctions included 32 individuals and entities. Additionally, 10 Russian diplomats, who were also suspected of being operatives, were expelled from the Russian Embassy, and American banks were banned from purchasing newly issued Russian government debt. As an olive branch, the Biden administration walked back claims that the Russian government had put bounties on American soldiers, claiming low to moderate confidence in the intelligence. The administration also stated it would like to establish a “stable and predictable relationship” with the Russian government.

In all, the measures taken against the Russian government weren’t the most stringent, but they do provide a guidebook as to what the Biden administration has in store for countries it doesn’t like. By banning the purchase of Russian government bonds, the Biden administration is signaling it is willing to use financial markets as a weapon. Although this isn’t a new strategy, as the country frequently has used the SWIFT network to the same end, it does suggest an escalation. By targeting government debt, the Biden administration is expressing its willingness to make it more expensive and possibly more destabilizing to finance itself. We suspect this decision will likely encourage other countries to develop more elaborate workarounds to the U.S. financial system. This could mean an embrace of digital currencies, which is why we suspect China has begun developing a digital yuan. Accordingly, this could mean that other countries build closer relationships with China, which also has its own issues. Most importantly, if the U.S. continues to use its financial system, it could further accelerate a trend away from globalization as countries will begin to view it as a threat to their sovereignty. Although this deglobalization is unlikely to happen in the foreseeable future, there are increasing signs that the world may be growing fatigued with global integration. We will continue to monitor this situation closely.

International news: Raul Castro steps down, financial firms are leaving London, and Hungary is blocking the EU.

• First Secretary of the Cuban Communist Party and former Cuban President Raul Castro is expected to step down from his position. His departure will mark the first time since the revolution that the country is not being run by a Castro brother. Cuban President Miguel Diaz-Canel is expected to succeed Raul Castro as the leader of the Communist Party. At 60 years old, the relatively young Diaz-Canel is expected to be in favor of economic reforms to grow the Cuban economy. Tourist-reliant, the Cuban economy has been struggling as of late due to the pandemic. His reforms are expected to meet resistance from the elders within the party who don’t want the country to become more capitalist. As a result, it isn’t clear how successful he will be in implementing much-needed reforms within the country.
• The impact of Brexit is already showing itself in the city of London. Over 400 financial firms have shifted activities and $1.4 trillion in assets out of the city to the European Union. The U.K. and EU failed to come to an agreement that would accommodate U.K. financial services. As a result, these firms were forced to adapt. The biggest beneficiaries of this shift have been Dublin, Luxemburg, Paris, Frankfurt, and Amsterdam.
• Hungary blocked the EU from issuing a statement criticizing China over Hong Kong’s new security law. The statement was to be made at a meeting of EU foreign ministers, and it needed to be approved by all 27 EU members. In the past, Hungary, which is a major recipient of Chinese investment, has regarded such statements as pointless. The inability of the EU to agree to address China’s supposed human rights violations highlights the bloc’s difficulty to project soft power.

Economics and policy: The housing shortage, U.S.-China tensions, the infrastructure package, and student debt proposal.

• There is a 8 million single-family home shortage, says mortgage financing company Freddie Mac. According to the report, the shortage of homes is due to a lack of homebuilding. The pandemic has likely made this problem worse as supply chain bottlenecks have made it difficult for homebuilders to keep up with demand. It is believed that 1.1 to 1.2 million homes need to be built each year in order to meet the long-term demand. Even then, that would not be enough to shrink the deficit. A plausible solution would be to reduce regulation, but as more and more families rely on their homes as a substitute for savings, policymakers have been reluctant to do so. Meanwhile, rising materials and labor costs continue to hamper homebuilders. Thus, it is unlikely that this problem will be solved anytime soon.
• The IMF believes the technological rift between the U.S. and China could have a worse impact on global growth than the trade tariffs. The IMF estimated that technological fragmentation could lead to a 5% reduction in GDP for many countries, while the trade tariffs reduced global GDP by an estimated 0.4%. The relationship between the two countries continues to deteriorate as globalization as a whole could also be impacted.
• A group of bipartisan senators has agreed to support an infrastructure package of $800 billion. The package has received tacit endorsement and skepticism from both parties. Republicans have stated that the price tag is still too large, with some asking for a package closer to $600 billion. Democrats have argued that the bill is too little, and it falls well below the targeted $2.25 trillion proposed by the Biden administration. That being said, the bill does seem to have broad support, with many speculating that Democrats could get this bill through Congress and pass the rest through the controversial budget reconciliation.
• Senators Mitt Romney (R-Utah) and Krysten Sinoma (D-Arizona) announced a plan that would help low-income students pay for college. Under the Learn to Earn Act, for every $1 placed into a savings account, states and nonprofit institutions could match it with $8. The legislation is similar to a program offered in Arizona that has helped students graduate debt-free.

China:  Chinese growth is not as impressive when looked at closely, and China in Afghanistan.

• The Chinese economy rose 18.3% in the first quarter from a year ago. Although the number seems impressive on its face, the quarterly numbers suggest the economy may be slowing. Looking at growth compared to the previous quarter, the Chinese economy contracted at an annualized pace of 3.25%. The slowdown in GDP is largely due to a reduction in consumption and investment spending.

• China is considering sending its troops into Afghanistan following the U.S. withdrawal on September 11. China, which shares a tiny border with Afghanistan, is concerned that unrest caused by a U.S. withdrawal could spill over into Xinjiang. The occupation could be the first test for China as it tries to get an idea of its own level of military prowess.

COVID-19:  The number of reported cases is 138,581,232 with 2,977,619 fatalities.  In the U.S., there are 31,455,995 confirmed cases with 564,715 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 255,400,665 doses of the vaccine have been distributed with 198,317,040 doses injected. The number receiving at least one dose is 125,822,868, while the number of second doses, which would grant the highest level of immunity, is 78,498,290. The FT has a page on global vaccine distribution. The weekly Axios map shows rising cases in about half the country.

Virology

• Pfizer’s (PFE, $37.60) CEO announced on Thursday that vaccine recipients will likely need a third vaccine six months to a year after receiving their second dose. As new variants begin to circulate, boosters will be given to ensure that people remain immune.
• Pharmaceutical companies have been pushing back against requests from developing countries to have patent rights waived in order to combat the virus. Developing countries have complained that the patent restriction has made it difficult for them to administer more vaccines throughout their countries.
• The Center for Disease Control and Prevention (CDC) announced that 5,800 fully vaccinated people have contracted the virus out of a possible 75 million. This suggests that the vaccines are performing in line with trial data expectations. Out of those 5,800, only 74 died. The data suggest that the chance of death after receiving the vaccine is exceptionally rare. However, the CDC recommends people continue to wear masks and practice social distancing.
• Denmark may allow its citizens to choose whether to receive the AstraZeneca (AZNCF, $102.00) vaccine. On Thursday, Denmark’s government began exploring the possibility of allowing its citizens to choose whether they would like to receive the vaccine, possibly reversing its decisions last year to remove the vaccine from its rollout.
• Hong Kong has begun expanding vaccinations to include people 16 years and older. The city has done a fairly good job of containing the virus but has seen a relatively low turnout for vaccinations. Less than 10% of the population has received one dose of the vaccine since its February rollout.
• The spring wave of the virus has affected almost every state over the past week, leading to a sharp uptick in hospitalizations. Thirty-eight states reported an increase in cases last week, with Michigan being one of the hardest hit. The recent surge has disproportionately affected young and middle-aged adults.
• The United Nations is urging developed countries to donate excess vaccines to developing countries through the COVAX vaccine-sharing facility. Developed countries have been reluctant to share vaccines as logistical hurdles have prevented them from providing vaccinations to their own citizens.

In related news, the United States is seeing a rise in unused vaccines as demand has significantly slowed as of late. About 37% of Americans have received the first dose of the vaccine, far below the estimated  80-85% needed for the country to achieve herd immunity.

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

[Posted: 9:30 AM EDT] | PDF

Good morning all!  Risk assets are higher this morning in a quiet trade.  We have a long roster of economic data this morning which we cover in detail below.  Our coverage begins with the Beige Book, which turned equities lower yesterday.  International news follows, with the U.S. announcing the withdrawal of American troops from Afghanistan and sanctions on Russia.  Economics and policy are up next, with a discussion of money markets.  China news follows, and we close with our pandemic coverage.

Beige Book:  The Beige Book is a report from all the Fed district banks that discusses economic conditions.  The goal is to offer a regional picture of the economy.  Overall, the report showed a stronger economy, which is good news, but rising price pressures, which were negative for equity markets yesterday.  In related news, Chair Powell spoke to the Economic Club of Washington yesterday, reiterating that policy rates will stay low for an extended period.  However, he also noted that bond purchases would be tapered before rate hikes would occur.

International news:  The withdrawal from Afghanistan begins, and the U.S. will sanction Russia.

• Yesterday, President Biden announced that the U.S. would end its military involvement in Afghanistan on September 11. When American troops leave, it will officially end the longest war in U.S. history.  For hegemons, conflicts in minor nations always present problems.  On the one hand, leaving suggests that the hegemon lacks staying power and is weak.  On the other, staying in a conflict with no clear endpoint becomes a distraction and a drain on resources.  Afghanistan was always a problematic conflict.  The country has a reputation—it’s called the “graveyard of empires” for a reason.  Both the British and the Russians failed to win conflicts in the country.  Is there a risk to leaving?  Yes.  The Taliban will almost certainly take control of the government and implement its medieval rules.  Afghans who oppose the Taliban will either try to leave, creating a refugee problem, or create an ongoing civil conflict. In other words, instability will likely follow (not that what is in place now is at all stable).  And, as the Viet Cong realized, the U.S. can be outlasted in areas that are not of vital concern.  That knowledge will limit America’s power to project into similar areas.  This experience should also be a warning to U.S. leaders that if you are going to use the military in places like Afghanistan, “mission creep” should be avoided.  NATO allies are not happy that the U.S. made this decision unilaterally; to some extent, the lack of concern about NATO from Washington reflects American dominance of the group.  Interestingly enough, America’s withdrawal now becomes a problem for China.  Unrest in Afghanistan could spill over into Xinjiang.
  • By ending American involvement in Afghanistan, the U.S. can increase its focus on other areas of the world, e.g., China. Ending the conflict in Afghanistan also marks the end of the War on Terrorism so the U.S. can prepare for great power conflicts with China.
• In response to the SolarWinds (SWI, USD, 17.99) hack and other activities, the U.S. announced it would impose additional sanctions. These include reducing U.S. banks’ participation in the Russian bond market and expelling 10 Russian diplomats.
• Initial presidential elections in Peru have led to a runoff between two starkly different candidates. Pedro Castillo is a trade unionist running on a left-wing populist platform.  He will be challenged by Keiko Fujimori, the daughter of the former (imprisoned) president who is under scrutiny for corruption.  Castillo wants to nationalize various industries and is running on a hard-left platform; Fujimori will appeal to market-friendly voters.
• In September, Germans will vote for a new government. The current ruling coalition government of Chancellor Merkel, dominated by the CSU/CDU, is in turmoil. Markus Söder, from the CSU, would be a different conservative from the CDU’s line.  He is much more socially conservative and would be less supportive of the EU.  At the same time, he is much more popular than the CDU candidate, Armin Laschet.  If Merkel blocks Söder, it is much more likely the CDU/CSU will not govern.  But, if Söder becomes the candidate, German policy might change significantly.
• There was an attack on an Israeli-owned vessel in the Gulf of Oman. It is likely the attack was at least sponsored by Iran.  It is the third attack on an Israeli vessel in the Persian Gulf area.

 Economics and policy:  Regulators are making another attempt to reduce the risks from money markets.

• The money market fund was initially created as a sort of regulatory arbitrage to a retail banking industry constrained by Regulation Q, which set maximum deposit rates.[1] The money market has become a key supplier of funds for the non-bank financial system.  Unfortunately, as the Great Financial Crisis showed, money market funds are “runnable.”  During 2008-09, money market funds came under pressure as some of their assets (usually commercial paper) defaulted, and the funds came under threat to “break the buck.”  Since then, regulators have struggled to address the problems of the product.  Since 2008, money market funds have faced occasional problems; for example, last March, investors pulled funds from prime money market funds, and the Fed had to put a backstop in place.

The Treasury is considering new rules to reduce the systemic risk money markets have created.  The industry is concerned that the rules will make money markets indistinguishable from bank deposits.  That development would pretty much end money markets as we know them.  But, as banking showed during the 1930s, the lack of deposit insurance can lead to bank runs.  An obvious solution would be for the value of money market funds to fall below $1 per share.  Investors wanting a higher yield should be willing to accept some degree of risk.  But the industry has built its business model as being identical to bank deposits, so they will fight such measures.  The regulatory decisions will be important because money markets are the primary source of funds for the non-bank financial system.  At the same time, it doesn’t make much sense to allow runnable funding for this part of the market.

• One of the areas we favor is homebuilding. Not only is the supply of housing tight, but demand has been strong.  One of the characteristics we have noted since the Great Financial Crisis is that commercial investment has increased in the single-family sector.  It appears that foreign investors are moving into the area of the market as well.  With the large fiscal deficit, we expect the current account deficit to widen, which (by the very nature of the saving identity) means that foreign investment will also rise.  Foreign investment into single-family homes will likely add more support to the homebuilding industry.
• Meanwhile, the pandemic led to forbearance and the postponement of evictions. As the economy reopens, mortgage holders and renters will need to address the arrears that have developed.  Because these arrears could cause disruptions to the economy, recent legislation has allocated $25 billion of relief for renters.  Local governments are now trying to figure out how to distribute this aid.
• Logistics firms are raising wages in a bid to attract workers. An increasing number of delivery options, along with rising demand, is leading to labor shortages for drivers.  At the same time, there is some good news from California ports; the backlog of ships waiting to dock appears to be lessening.
• Remember the Ever Given, the huge container ship that blocked the Suez Canal? Port authorities have impounded the vessel to force its owner to pay for the costs of the disruption.
• Amazon (AMZN, USD, 3333.00) is coming under scrutiny for its apparent practice of forcing firms that use its platform to provide data to other parts of Amazon. Before Bork, such activity was seen as a violation of antitrust rules.  Because of the steady march to a pre-Bork antitrust legal standard, this sort of activity is now being called into question.

China:  Chinese regulators continue to crack down on leverage, and tensions with Taiwan and Japan remain elevated.

• One way local governments meet their economic targets is through borrowing. They often create special purpose vehicles that raise funds for specific projects.  Lenders work under the assumption that the central government will backstop these vehicles, which makes them attractive.  Beijing is signaling that this assumed backstop isn’t reliable and wants these vehicles to be restructured if the loan goes bad.  The Xi government is starting to aggressively deal with China’s massive debt, calling it a “national security” issue.  Corralling local government borrowing is an element of slowing the debt expansion.  On a related note, the PBOC will expand its stress tests to include all that nation’s banks (all 4,024 of them).  The central bank has conducted stress tests since 2012 and usually covers about 40% of them.  Expanding to cover all of them suggests Beijing is worried about unreported risks in smaller banks.
  • One of our internal discussions since Xi took office is the purpose for his centralizing power. There is a case to be made that he centralized power (e.g., not naming a successor and making himself president for life) simply because he liked being powerful.  An alternative was that he believed China faced serious threats and needed a strong “helmsman” to ensure the country thrived.  The issue of Taiwan would be a threat; the debt would be as well.
  • At the same time, these threats are nothing new. So, why is the action on debt occurring now?  One possibility is that China is observing the U.S. fiscal expansion and realizes that it will almost certainly lead to a massive current account deficit that China can fill through exports.  In other words, as it brings its debt under control, it could maintain economic growth by expanding exports.  Even if the U.S. applied trade barriers on China, other nations would fill the gap created by the fiscal expansion, and China would export to those other nations.
  • On a side note, banks are not the only area coming under examination by regulators. Technology is as well, and most Chinese firms are cooperating with regulators.
• Tomorrow, PM Suga of Japan will visit the White House. The U.S. is pressing Japan to issue a joint statement supporting Taiwan.  This would be historic; the last time a Japanese PM issued a joint statement with the U.S. on Taiwan was in 1969.  It is possible that Suga will disappoint the U.S.  In 1969, Japan was not as closely tied to China’s economy.  That is no longer the case.  At the same time, Japan does view Taiwan with great interest.  Japan controlled the island from the late 1800s until the end of WWII, and if China controlled Taiwan, it could more easily disrupt trade flows to Japan.
• The U.S. is sending a delegation to Taiwan. In response, China is conducting military exercises, including live fire, in the waters between the mainland and Taiwan.
• John Kerry is planning to meet with Chinese officials over climate issues.
• Yesterday, we noted that the declassified National Intelligence Estimate had a focus on China. One of the key issues regarding relations with China is that Beijing views itself as a peer.  That position will complicate relations.  Essentially, China will likely challenge the U.S. in various areas of the world.
  • China is accusing the U.S. of sponsoring terrorism in Xinjiang.
• A bipartisan bill in the Senate Foreign Relations Committee, designed to weaken China’s power, would add sanctions and increase support for nations in the Indo-Pacific. If the bill makes it out of committee (which looks likely), we would expect the Senate to pass it.

COVID-19:  The number of reported cases is 138,422,960 with 2,975,830 fatalities.  In the U.S., there are 31,422,960 confirmed cases with 564,406 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 250,998,265 doses of the vaccine have been distributed with 194,791,836 doses injected.  The number receiving at least one dose is 123,917,385, while the number of second doses, which would grant the highest level of immunity, is 76,681,252.  The FT has a page on global vaccine distribution.  The weekly Axios map shows rising cases in about half the country.

Virology

• The CDC has delayed a decision on the Johnson & Johnson (JNJ, USD, 159.92) vaccine after there were reports of blood clotting in recipients. The body wants more data before making a decision.  So far, there have been six cases (one fatal) reported after 6.8 million doses have been administered.  Although the risk is clearly low, with alternatives available, it is possible the U.S. may decide not to allow the vaccine to be used in the U.S.
  • The J&J vaccine has attractive properties. It is a single-shot vaccine, and it doesn’t require the extreme freezing the mRNA vaccines require.  If the U.S. decides not to use it, the vaccine will likely be shipped to the developing world.
  • The EU is also deciding on the J&J vaccine. It is also ordering additional vaccines from other producers.
  • Former leaders are calling for patent relaxation on vaccines to expand production to the developing world.
• Researchers are testing whether various vaccines can be combined. A trial is starting where some participants who have received one vaccine are given one of the newer ones.  Scientists will see how the candidates react to different vaccine strains and check for safety and efficacy.  If the combined vaccines prove safe and effective, it would allow for greater flexibility in distributing vaccines.
• Small studies conducted at the state level suggest that vaccines offer strong protection against adverse outcomes from COVID-19. They don’t completely prevent infection, but they clearly reduce the severity of the disease.
• We have been watching the COVID-19 passport issue as vaccinations have become widespread. Globally, there is a growing issue of falsified documents, which, if not addressed, will render passports ineffective.  Despite the expansion of fake documentation, private businesses and universities are starting to insist on proof of vaccination before allowing people to use their services.
• India is trying to cope with a massive surge in infections.
• Studies show that keeping middle seats vacant on aircraft reduces virus transmission risk.
• Although lockdowns did reduce the risk from COVID-19, it almost certainly increased the risk for other problems; drug overdose deaths soared during lockdowns.

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[1] This is why one would get a toaster if they opened an account at a bank or savings and loan in the late 1970s.  The toaster represented interest the firm couldn’t legally pay the depositor.