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

[Posted: 9:30 AM EDT] | PDF

It’s Monday, the last week of October.  U.S. equity futures are weaker this morning.  A big reason has been a global resurgence of the virus.  It leads off our coverage this morning.  Next up is international news.  In this week’s Asset Allocation Weekly, we discussed how the economy has been shaped by the pandemic; the bottom line is that there has been a definite shift to goods and away from face-to-face services.  We update the economy next.  And finally, we close with China news, where leaders are meeting to discuss the 14^th 5-year plan.  Here are the details:

COVID-19:  The number of reported cases is 43,117,883 with 1,154,703.  In the U.S., there are 8,636,995 confirmed cases with 225,239 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.

Virology: 

• Europe is reeling from a surge in new cases—here are the details:
  • Spain has declared a national emergency and a nationwide curfew.
  • Italy has adopted new measures, including early closing hours for restaurants and the closure of gyms and cinemas.
  • Brussels has extended its curfew and closed arenas and cultural venues. It has also banned trick or treating.
  • Sweden, who famously avoided national lockdowns, isn’t completely immune; the region of Uppsala has instituted a voluntary lockdown.
• Meanwhile, the U.S. is also seeing an upswing in cases. The majority of new cases are occurring away from the coasts, for the most part.
  • VP Pence’s office has reported that several members have tested positive.
  • In an interview over the weekend, Chief of Staff Meadows indicated that the Federal government is not planning any new national measures. To a great extent, his comments likely reflect the fact that there is widespread fatigue over new measures.
• The Oxford/AstraZeneca (AXNCF, USD, 105.21) vaccine trial reports a robust response from its vaccine on the elderly, which is good news. Those over 60 are particularly vulnerable to the disease, so triggering an immune response from this age group would tend to reduce fatalities from COVID-19.

International news:  There was a plethora of international news over the weekend.  Here is the latest:

• The U.S. has brokered a ceasefire between Azerbaijan and Armenia; although one earlier this month failed almost immediately, so far, this one does appear to be holding for now. We view this ceasefire as a temporary halt in hostilities.
• President Erdogan of Turkey has suggested that President Marcon of France may need “mental” treatment after the latter supported measures to uphold France’s secularist laws, which allow for actions that Muslims view as offensive. France recalled its ambassador in response to the remarks.  Erdogan has called for a boycott of French goods.
• Last week, DEA agents arrested the former defense minister of Mexico on drug charges. The U.S. has evidence that General Salvador Cienfuegos aided drug cartels operating in Mexico.  Despite this evidence, State and Justice Department officials worry that the arrest may severely damage relations and undermine future U.S./Mexican cooperation on illicit drugs.
• Although Sudan did not give Israel full diplomatic recognition, it indicated it was willing to have talks with Israel on improving economic relations. The U.S. took Sudan off the State Sponsors of Terrorism list.  Still, issues surrounding the bombing of the USS Cole and Sudan’s role in supporting Osama bin Laden in the attacks of 9/11 have not been fully resolved.  Thus, there was some movement toward greater recognition of Israel in the Middle East, but the one with Sudan remains complicated.
  • The UAE will be able to purchase the F-35.
• Chile has voted overwhelmingly to write a new constitution. However, it is still unknown what will change in the new set of laws.  We do believe this action increases the risk of investing in Chile.
• The opposition in Venezuela continues to fray. One of its main leaders, Leopoldo Lopez, who has been holed up on the Spain’s embassy for over 18 months, has left the country and joined the rest of his family in Spain.  His departure makes it clear that President Maduro maintains his hold on the country.
• Protests continue in Belarus; the next move is a general strike.

China:  Communist governments have set out their economic plans in five-year increments.  The Soviets implemented their first one in 1928.  Interestingly enough, the Gorbachev government set the 13^th one in place in 1990, but it lasted only one year, as the U.S.S.R. dissolved in 1991.  China’s first 5-year plan was established in 1953 under Mao, adopting the Soviet structure.  Despite the reliance on market structures since 1979, China continues to establish 5-year plans.  Leaders are meeting to discuss China’s 14^th 5-year plan (note that this one would exceed the Soviet number); a couple of ideas have been circulating.  First, General Secretary Xi has discussed a “dual circulation” plan that would maintain exports but try to lift domestic consumption.  Such a policy is in direct contradiction to the macroeconomic identities, as lifting domestic consumption will tend to reduce exports.  We suspect Xi doesn’t want to suffer the drop in growth as the economy transitions from exports to domestic demand.  Thus, he wants a bit of both, which probably means he will end up with a bit of neither.  Second, the U.S. threat to cut off China’s semiconductor supply will likely trigger a goal of tech self-reliance.

Keeping up with the shift:  In this week’s AAW, we noted the historic reversal in the long-standing trend of goods and services consumption.  Since the end of WWII, there has been a steady increase in relative services consumption to goods consumption.  The pandemic has led to what is probably a temporary, but still notable, increase in relative goods consumption.  There are increasing reports that goods producers are scrambling to boost production to meet this new demand.  This situation is leading to a disconnect; services, such as restaurants, travel, etc.  continue to struggle while factories are looking for workers.  Although we do expect the long-term trends to eventually return, in the meantime, the economy will tend to find support from goods production.

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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 Friday!  U.S. equity futures are modestly higher this morning.  The last presidential debate came and went; it was more orderly than the last one.  At this late date, we doubt it will have a significant effect on the race.  The response overnight from the betting sites suggests nothing has changed.  We lead off coverage today with the pandemic update—cases around the world continue to rise.  The news from China comes next.  Negotiations for further stimulus continue, but we still doubt there will be a deal before the election.  We close with odds and ends.  And, being Friday, there is a new Asset Allocation Weekly, along with the accompanying podcast and chart book.  Starting in January, in a bid to shorten this report, we will no longer publish the AAW at the bottom of the Daily.  It will be available only as a stand-alone report but will be linked within the Daily Comment.  Here are the details:

 COVID-19:  The number of reported cases is 41,791,766 with 1,138,671.  In the U.S., there are 8,411,262 confirmed cases with 223,059 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 R_t data show a deteriorating picture; only four states have a reading less than one.  Mississippi has the lowest infection rates, with New Jersey having the highest.

Virology: 

• In light of rising infections, local lockdowns are starting to return. Chicago is resorting to a curfew, and other upper Midwestern states are enforcing local restrictions to slow a trend of rising infections.
• A similar pattern is emerging in Europe with similar responses. Hospitalizations are rising in Europe, and there is evidence the surge in infections is beginning to affect the economy.
• There has been a debate about pandemic response, arguing for and against lockdowns. Those for lockdowns argue it is the only way to slow the spread of the disease.  Those arguing against them say that lockdowns are an overtly blunt tool, and the economic damage they cause is likely greater than the benefit of avoiding infections.  However, missing in this debate are the actions of individuals who may decide, even in the absence of mandatory lockdowns, to stay at home.  Some states never implemented a lockdown, but that didn’t prevent the economy from slowing.  Although lockdowns do have some impact, there is a growing body of research that suggests an individual’s fear is more important.  Therefore, easing restrictions may have a less positive impact on the economy; at the same time, this data likely signals that a working vaccine or improved antiviral treatments would probably have the most beneficial impact on the economy.
• When making decisions about lockdowns, one of the factors policymakers must measure is how many lives will be saved from the virus compared to the potential economic loss. This calculus requires some forecast of fatalities and infections. Thus, a good forecasting model is critical.  The most reliable model emerging is the one that collects an ensemble of forecasts and generates a sort of “meta-forecast” from these models.

China:  Two items are of note today.  First, the State Department approved a $1.8 billion arm sale to Taiwan.  We are seeing more analysis suggesting the U.S. will need to base missiles on land in the theater because of China’s improving missile systems that may deny access to aircraft carriers.  Missiles on Taiwan would be a potent threat to China, one they probably can’t counter.  This deal would include two missile systems.  Second, there is a growing element of nationalism in China that is squelching internal criticism as unpatriotic.  This sort of behavior isn’t new in China; Mao tapped it during the Cultural Revolution.  In the modern version, social media is used to react to what appears to be legitimate criticism of local official’s actions.  Although such nationalism can be useful for a leader, it also prevents him from ever hearing anything contrary, and thus, hidden problems begin to fester.  This is one of the dangers of authoritarianism—how does the leader maintain control but also have an accurate picture of what is happening in the country?  In democracies, the press and the ballot box act as correctives.  Although technology and social media have the potential to provide something similar, these work only if dissent is allowed.

Policy:  What continues to emerge about the stimulus talks is an odd “dance” involving three figures—Speaker Pelosi, Treasury Secretary Mnuchin, and Senate Majority leader McConnell.  The odds of an agreement coming before the election in less than two weeks are very low and falling.  So, why are the talks continuing?  All three have an interest in the discussions, even if they have less interest in actually making a deal.  The Speaker probably doesn’t want a deal unless it clearly looks like she won on all counts.  Otherwise, she is giving a win to the White House.  The Treasury Secretary wants to avoid a market selloff that is more likely if talks break off.  So, even if the odds are long, keeping talks in place has value.  And, Majority Leader McConnell has no interest in a large spending package.  Most of the GOP Senate is right wing establishment (RWE) which supports balanced budgets and views the only legitimate fiscal stimulus as being (a) defense spending and (b) tax cuts.  Government spending outside of defense isn’t welcome.  In addition, McConnell is thinking past this election.  His goal is for GOP control of the Senate, and a big spending package doesn’t really help that goal.  In fact, if the Senate remains in GOP hands but Biden wins the White House, he may obstruct any new spending.  So, the market’s expectations that future stimulus will come at some point aren’t as likely as generally held.

Odds and ends:  Here is the list of individual “short stories” we are watching this morning:

• The K. and Japan have reached a trade agreement, the first in the post-Brexit era. Although there isn’t anything necessarily novel in this deal, getting an agreement is a sign that Britain is adjusting to its new independence.
• Chileans go to the polls on Sunday to vote on a referendum for a new constitution. The current one, from the Pinochet era, is considered overly favorable to capital.  For investors, the process of forming a new constitution is a risk factor.  Chile has been a capital friendly standout in South America, and if a new constitution is coming, that status would be at risk.  Although we expect voters will opt for a new constitution, it is still uncertain what form it would actually take.  It is possible the new one would look more like a refresh than a revolution.  But, until the new constitution is approved, there is a new element of risk for Chilean investments.
• We have been seeing a quiet rally in bitcoin recently. One of the factors supporting the cryptocurrency is currency turmoil in Turkey and Argentina. As we noted yesterday, the Turkish lira plunged to new lows.  In Argentina, the government is implementing capital controls, and there is widespread fear of devaluation, leading Argentines to buy dollars, gold and bitcoin.
• One of the more unappreciated elements of economics is the risk of investment. Keynes was keenly aware of the issues surrounding investment, arguing that it was driven by “animal spirits.”  In our opinion, investment is the hardest task for an economy, regardless of how it is organized.  Why?  Because it always involves a prediction about the future.  A report about the shipping industry highlights this issue.  The shipping container industry decided that bigger boats were the wave of the future on the idea that globalization would continue to expand.  However, after the Great Financial Crisis, the trend in globalization flattened, and these vessels have proven to be completely inappropriate for the new world.  They sail too slowly; their size makes them hard to manage in ports, slowing logistics, and the industry would have been better off with smaller vessels.  We view this as a cautionary tale.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  U.S. equity futures are a bit weaker as the financial markets continue to watch for some sort of fiscal action.  We start today’s coverage with policy news, including an update on the latest with the fiscal stimulus talks and the Fed’s Beige Book.  Election tampering comes next.  Brexit talks have restarted, which boosted the GBP yesterday.  China news is next.  The pandemic update follows, and we discuss the latest with technology.  We close with international odds and ends.  And, being Thursday, the Weekly Energy Update is available.  Here are the details:

Policy:  Two items of note—the fiscal talks and the Beige Book.

• Although talks continue, it is looking less likely that a deal will be passed before the election. It still doesn’t look like the Senate will go along with whatever Speaker Pelosi and Treasury Secretary Mnuchin negotiate, so any sort of deal with substance may not occur until next year.  For the most part, financial markets have discounted this outcome.  The lack of fiscal assistance will probably lead to weaker H1 economic growth next year, but if we do see a package in Q1, H2 will likely show a rebound.
  • Fed officials are warning that more fiscal support is necessary to help lift growth.
• Some of this weakness is already starting to show in the economy, at least according to the Beige Book. The survey of the Fed districts suggests that the economy continues to grow, but the pace of recovery is decelerating.  The report noted that housing and auto sales are strong and constrained by the lack of supply, which portends better future growth and supply is expanded.  Labor markets remain mixed, with goods production worker demand high but services spotty.
  • There are media reports that the Fed is not providing the stimulus it promised in March. This is a misread of what the Fed is actually doing.  The Fed is providing a backstop to the shadow banking system by ensuring working markets for assets that are often used in repo lending.  This backstop is usually at a rate above the market, which means that in a crisis it provides support, but in normal times, the lines are “untapped.”  This is actually good news; it suggests the financial markets are functioning.  But, if one thought the Fed was going to buy the world, they were mistaken.
  • Meanwhile, in the CMBS market, the use of special servicers, who supervise distressed debt, is rising.

Election tampering:  There are reports that foreign actors have acquired voter registration data.  Russia and Iran are accused of this action, but we suspect others have the information as well.  There are reports that emails from right-wing groups threatening registered Democrats have been distributed in Alaska and Florida.  The administration has accused Iran of the spoofing; given the obvious and ham-fisted nature of the threats, it probably was not from more sophisticated actors, such as China or Russia.  We did discuss the possibility of foreign interference in our May WGR series on the elections; we would expect more to come as the actual election day looms.

Brexit:  PM Johnson set a deadline; the EU ignored it, and the U.K. broke off talks.  After some groveling, the EU agreed it would have to make concessions too, giving Johnson a win and talks have restarted.  For the most part, the differences aren’t all that wide.  A deal of some sort should be possible.  An EU negotiating team will meet in London today to resume talks.

China:  China has been experiencing a solid recovery from the pandemic.  But its path to success is one it has used for years—exports and investment. Infrastructure spending has led to a sharp rise in steel production.  Brad Setzer of CFR tracks foreign flows and makes a strong case that China’s recovery is being built by absorbing foreign demand, a trend that will almost certainly trigger a backlash.  The pattern of recovery will create rising foreign reserves that will need to be invested, and China is already planning to boost outward investment.  How should the U.S. react?  The most effective tool would be to take steps to appreciate the CNY.

• China has unveiled a new law to ban exports of goods tied to national security. We would expect these laws to reduce exports of rare earths.
• In this week’s AAW, we discussed the notion that inventory restocking will likely support growth in the coming quarters. Of course, not all of that rebuilding will come from domestic sources.  There are reports that shipping costs are rapidly rising on goods from China, part of the drive to rebuild inventories in the U.S.
• The leader of Tibet’s government in exile, Lobsang Sangay, has met with Robert Destro, the new special envoy to Tibet. As one would expect, Beijing was not happy.
• After the 2008 Financial Crisis, China started its own bond-rating firms. They are apparently easy graders as the majority of issuers are rated AAA.

COVID-19:  The number of reported cases is 41,388,387 with 1,132,676.  In the U.S., there are 8,338,387 confirmed cases with 222,220 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 Axios state infection map is updated.

Virology: 

• As the virus makes a comeback in Europe, Ireland has moved to implement a full national lockdown. The Czech Republic is following suit.  Hospitals across Europe are preparing for increasing caseloads.
• There is some good news; the medical system is getting better at treating the disease, and although infection rates are rising, fatalities are not. Treatment plans have improved, making the disease less deadly.
• Researchers are turning to wastewater analysis to track infection rates.
• The CDC is adjusting the guidelines about virus exposure. Instead of exposure within six feet for 15 minutes, it is now exposure within six feet for a total of 15 minutes over a 24-hour period.  The CDC has been slowly acknowledging that the virus spreads via aerosols, and this change is another element of that adjustment.
• China is promising vaccines for the emerging world, using the treatment as a diplomatic tool.

Technology:  As has been widely reported, the DOJ and several state attorneys general are accusing Google (GOOGL, USD 1585.99) of antitrust violations.  The government is accusing the company of acting to maintain a monopoly; the company is falling back on the 1980s defense, which is that no consumers were harmed by their actions.  There is a growing consensus that monopoly causes problems even if consumers are not harmed.  In addition, there is bipartisan support for the action.  The outcome of the indictment will likely take years to conclude, and it isn’t completely clear what actions the government might take against the company.  It can be hard to break up an integrated company, and the firms tend to construct themselves with this issue in mind.  If history is any guide, the company’s competitors will try to take advantage of government scrutiny to make inroads into Google’s domain.  The effect it has on equity performance remains to be seen.

Odds and ends:  The U.S. is expanding its sanctions to prevent the completion of the Nord Stream 2 pipeline. … In Nigeria, protests against policy brutality turned deadly yesterday as soldiers opened fire against protestors; at least 10 people died. … The Turkish lira fell to new lows after the central bank refused to raise interest rates to defend the exchange rate.

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

[Posted: 9:30 AM EDT] | PDF

Our Daily Comment today again opens with coronavirus news, based on investors’ strong interest in negotiations over a possible new pandemic relief bill out of Congress.  The big news there is simply that the talks are continuing.  After the pandemic news, we provide a recap of some foreign developments on what appears to be a pretty slow news day so far.

COVID-19:  Official data show confirmed cases have risen to 40,877,528 worldwide, with 1,126,251 deaths.  In the United States, confirmed cases rose to 8,275,168, with 221,083 deaths.  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 topped 60,000 yesterday, lifting the seven-day moving average to 58,397 and the 14-day moving average to 53,970.  The average of daily deaths from the virus held steady at approximately 700, but the number of hospitalizations rose to a two-month high of 39,230.
• In a report yesterday, the CDC said the pandemic has left about 299,000 more people dead in the U.S. than would be expected in a typical year.  According to the report, about two-thirds of the excess deaths can be attributed directly to COVID-19, while the rest reflect other causes.
• Studies in Germany and Norway, as well as two reviews focusing on education globally, suggest widespread school closures would have a limited effect on curbing the pandemic.  The research adds to evidence that schools are not necessarily a major vector in spreading the coronavirus.  That’s probably bullish for equities because it bolsters the argument for reopening schools, which would help bolster economic activity and allow more people to go back to work.
• Given the importance of the vaccines under development, health authorities, hospitals and pharmaceutical companies are storing them in secure, undisclosed locations and taking other steps to protect the shots from theft.
• California’s Health and Human Services Secretary, Mark Ghaly, has announced guidelines that said large theme parks can reopen at limited capacity once nearby community spread of the new coronavirus has been officially deemed “minimal.”  However, Walt Disney Co. (DIS, 124.95) blasted the protocols on the grounds that they would significantly complicate the company’s efforts to reopen Disneyland.

 Economic Impacts

• New data on labor market dynamics during September suggest the decline in the unemployment rate last month came as much from jobless people giving up and dropping out of the labor force as from people finding new work.  The figures can be volatile.  Problems in the seasonal adjustment process could be a source of inaccuracy, but the data is still consistent with other indicators suggesting the robust post-lockdown recovery to date is probably losing steam.
• New York Governor Cuomo warned that his state’s governments and authorities will face $59 billion of revenue shortfalls through 2022 because of the pandemic.  According to Cuomo, the shortfall means that services will be cut, and taxes will increase if Congress doesn’t pass another relief package.

 U.S. Policy Response

• The Trump administration and House Speaker Pelosi yesterday said they had made enough progress on a new coronavirus relief deal to warrant further talks on Wednesday, and White House Chief of Staff Mark Meadows suggested the two sides are now aiming for an agreement by the weekend.  However, that timeline may not be enough to allow a bill to be passed before the November 3 election.
  • According to Pelosi, two policy issues remained the biggest sticking points: how much funding to include for state and local governments, and what kind of legal protections to provide businesses and other entities operating during the pandemic.
  • If a deal can be reached between the Trump administration and the House, the prospect of a roughly $2 trillion package has galvanized new opposition from Senate Republicans.
  • It’s now increasingly unlikely that a deal will get passed through Congress before the election.  Investors appear to be taking solace in the apparent seriousness of the ongoing talks and/or the likelihood of a significant new stimulus bill shortly after the polling is done.  However, it’s important to remember that action could be held up by a contested election and the need to seat new legislators in January.

 Foreign Policy Responses

• With governments around the world now reluctant to reimpose draconian, nationwide economic lockdowns to combat resurgent infections, it’s becoming clear that imposing targeted, localized lockdowns is no picnic, either.  One problem is that the local communities targeted for lockdowns can argue they’re being discriminated against.  In the U.K., that has prompted the national government to offer compensation for those communities, touching off difficult negotiations and tempting officials to game each other.  This week, the government forced the Greater Manchester government to accept the highest level of lockdown after compensation talks fizzled.  Today, South Yorkshire in northern England agreed to enter the highest level of lockdown in return for £41 million to support businesses that will have to close and extra council funding to tackle the spread of the virus.  All in all, it sounds like a mess that underlines the importance of finding safe and effective vaccines to tackle the pandemic.

 Financial Market Responses

• With China recovering from the pandemic much faster than most other countries, the renminbi has appreciated to 6.64 per dollar so far today.  That marks the currency’s strongest level in more than two years, which could increase pressure on Beijing to arrest the rapid rise.

European Union-United Kingdom:  Seeking to break the logjam in EU-U.K. negotiations for a post-Brexit trade deal, the EU’s top Brexit negotiator, Michel Barnier, offered assurances that a deal was “within reach” and that the EU was still willing to compromise if needed to get it in place before the current temporary deal runs out at the end of the year.  Just as important, the British government responded favorably to Barnier’s comment.  That keeps alive the chance of a deal that would avoid a “hard Brexit,” which should be positive for British and EU stocks today.

Nagorno-Karabakh:  U.S. Secretary of State Pompeo announced that he will host the foreign ministers of Armenia and Azerbaijan in Washington on Friday in an effort to settle the fighting over Azerbaijan’s ethnic-Armenian controlled enclave of Nagorno-Karabakh.  The meeting will come two days after the Armenians and Azeris meet today with Russian President Putin in Moscow, but the real focus will probably be on whether the U.S. can put pressure on Turkey to tone down its support for the Azeris.

Nigeria:  Several people were killed as Nigerian soldiers opened fire on protestors demonstrating against police brutality in the major oil-producing nation.  Because of Nigeria’s large role in the world’s oil supply, any worsening in the violence that might threaten the country’s oil production could put upward pressure on global crude prices.

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

[Posted: 9:30 AM EDT] | PDF

Our Daily Comment today opens with the latest coronavirus news, given that optimism over a last-minute deal on pandemic relief legislation seems to be supporting the risk markets so far this morning.  As we note after the coronavirus section, however, there are also some less conducive news items today, including a likely new regulatory move against a U.S. technology giant and further geopolitical tensions with China and Russia.

COVID-19:  Official data show confirmed cases have risen to 40,464,761 worldwide, with 1,119,369 deaths.  In the United States, confirmed cases rose to 8,215,605, with 220,134 deaths.  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 more than 58,000 yesterday, lifting the key seven-day moving average to more than 56,007 and the 14-day moving average to 52,625.  The seven-day moving average of deaths held relatively steady at about 700, but hospitalizations continue to trend higher.  In Europe, new infections and hospitalizations are surging in countries including the U.K., Ireland, and France.  The infections and hospitalizations are now at their highest levels since the first wave in the spring, prompting localized lockdowns.  In contrast, new infections in Asia remain contained.
• In London, healthy volunteers who have been inoculated with various vaccine candidates will be purposefully infected with the coronavirus early next year in the world’s first COVID-19 “challenge trials.”  The trials will test which vaccines do a better job of protecting people from the disease.  The project, first disclosed by the Financial Times last month, was announced publicly today with an initial £33.6 million of public funding.
• The CEO of Moderna (MRNA, 70.96) said the federal government could authorize the emergency use of his company’s experimental COVID-19 vaccine as early as December if the company gets positive interim results in November from a large clinical trial.  Despite resurgent infections in some countries and temporary setbacks for other vaccines and treatments in development, the Moderna news shows that with the large number of compounds moving rapidly through their clinical trials, there is likely a good chance that a safe and effective shot will be approved in the coming months.  Since that could help end the crisis, the news should probably be taken as a positive for stocks.

 Economic Impacts

• Throwing a lifeline to struggling movie theaters, the Universal Pictures studio owned by Comcast (CMCSA, 44.33) said it will release several lower-budget films during the holiday in order to ensure cinemas have enough content to draw in patrons.

 U.S. Policy Response

• In negotiations yesterday, House Speaker Pelosi and Treasury Secretary Mnuchin reportedly edged closer to ironing out some of the remaining policy differences holding up a new coronavirus relief package.
  • However, it remains unclear whether they can reach an agreement by the end of today, after which Pelosi claims it would be impossible to complete the legislation before the November 3 election.
  • Even if Pelosi and Mnuchin strike a deal and the House passes a bill, any legislation with a price tag in the likely range of about $2 trillion would still face considerable opposition from Republicans in the Senate.  Those senators continue to push for much smaller, targeted bills that are rejected by the Democrats in control of the House.
• Federal Reserve Vice Chair Clarida said it is possible that the recession that began in March has already has ended, though it could take another year before broad measures of economic output fully recover to their pre-pandemic levels, and additional monetary and fiscal stimulus would likely be needed.
• As polling and decision markets continue to point toward a potential Democratic sweep in the November election, which could lead to an expanded pandemic relief bill, more investors are starting to bet on falling prices for government bonds and other safe-haven assets with longer maturities.  The so-called “yield steepening” moves can be seen in the recent rise in 10-year and 30-year U.S. Treasury yields.  However, we caution that higher long-term yields will likely force the Fed to decide whether it will actually implement yield curve control.

 Foreign Policy Responses

• In a sign that the European Union could find strong demand for its future common debt if its €750 billion coronavirus recovery package is approved as expected later this year, the bloc yesterday met with a huge demand for a €17 billion issue of new coronavirus-related bonds offered under a separate program.  These bonds will provide loans to support member states’ efforts to keep workers in their jobs during the pandemic.
  • We continue to believe next year’s big, new issuance of bonds backed by the full faith and credit of the EU member states will be instrumental in making the euro a more viable reserve currency.
  • Strong demand for EU debt helps to confirm that view and should be positive for the euro and negative for the greenback.

 U.S. Technology Sector:  The Justice Department today will file an antitrust lawsuit against Google, a unit of Alphabet (GOOG, 1,534.61), alleging the company engages in anticompetitive conduct to preserve monopolies in search and search-advertising.  The long-anticipated case will mark the most aggressive U.S. legal challenge to a company’s dominance in the tech sector in more than two decades, highlighting the growing regulatory risk to the tech stocks that have been driving the markets higher for most of this year.

U.S.-Russia Arms Control:  The U.S. and Russia are reportedly on the verge of a nuclear arms control deal that would not only extend the New START agreement for one year, but would also freeze the number of nuclear warheads on each side for that period as the Trump administration has been advocating.  However, the administration has been pressing Russia for a deal that would give President Trump a diplomatic achievement in the runup to the U.S. election in November, and the top U.S. negotiator, Marshall Billingslea, has seemed to overstate how the negotiations are going.  It therefore might be prudent to wait for confirmation from the Russian side that a deal truly looks imminent.

U.S.-Russia Cyberwarfare:  Federal prosecutors in Pittsburgh, where some of the FBI’s top cybercrime investigators work, yesterday unsealed charges against six Russian intelligence officers for some of the most infamous cyberattacks of recent years, including hacks that took down the Ukrainian electricity grid in 2015 and 2016 and the NotPetya attack that destroyed billions of dollars of computer equipment worldwide in 2017.  The indicted officers all work the same branch of Russia’s military intelligence service that was indicted for interfering in the U.S. presidential election of 2016.

Sweden-China:  The Swedish government announced that it will ban Chinese telecom giants Huawei (002502.SZ, 2.78) and ZTE (ZTCOY, 4.98) from its 5G mobile networks, as recommended by its armed forces and security services.  The move also comes after the U.S. government’s concerted warnings that the equipment could facilitate Chinese spying.  This aligns Sweden closer with the U.S., and therefore will likely worsen tensions with China.  Nevertheless, despite the increasing tensions between China and the Western democracies, new share sales are surging in China on the back of increased economic and financial optimism.

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

[Posted: 9:30 AM EDT] | PDF

Good morning; it’s Monday.  U.S. equity futures are moving higher, the World Series is set (congrats to Tampa Bay and Los Angeles), and there is a plethora of news to discuss.  China’s GDP confirms the recovery is gathering steam.  We look at the Fed’s “Tinbergen problem.”  We update the pandemic news; infection rates are rising in Europe.  There were votes held in Bolivia and Chile over the weekend.  Thailand protests continue.  Brexit is still there too.  Next up is policy and the economy, and we close with odds and ends.  Here are the details:

China:  Q3 GDP rose 4.9% which was a bit below expectations.  However, the data does appear to be accurate as it coincides with measures we use as a check on the GDP report.  For example, it matches growth from the Capital Economics growth proxy index.  Although the growth rate was less than forecast, it is one of the few places in the world showing a strong recovery from the pandemic induced downturn.

• The U.S. has been investigating, and in some cases, detaining, Chinese academics working in U.S. universities. There is ample evidence to suggest the Chinese government was coordinating a massive research gathering operation, and the investigations are part of thwarting that effort.  In a chilling warning, Beijing is indicating that U.S. citizens may be detained in response.  China has a history of detaining nationals from countries with which it is quarreling; Canadians have been arrested on flimsy charges after Meng Wanzhou was arrested in Canada.  So far, China hasn’t arrested any Americans, but this is a clear warning that it is considering such actions.
• China has passed a new export control law that increases the odds of reducing rare-earths exports.
• In a surprising move, China is aggressively buying low yielding Japanese JGBs. There are likely one or two explanations.  The first (and the one most likely) is that China is attempting to diversify its foreign reserves.  As tensions rise with the U.S., it would make sense for China to try to reduce its dollar holdings.  However, there is an alternative explanation.  Japanese investors, searching for higher yielding assets, are buying dollar bonds from China, leaving them with JPY to invest.  China is buying JGBs to use and dispose of these accumulated JPY.

The Fed’s Tinbergen Problem:  Jan Tinbergen was a renowned Dutch economist who specialized in econometrics and policy.  For his work, he was awarded the first Nobel Prize in economics.  Tinbergen observed that policymakers need an equal number of policy instruments for an equal number of targets.  Over the weekend, there was a report that a number of Fed officials discovered that expansive monetary policy can lead to asset bubbles.  On the one hand, this is something of a “no duh” realization.  It has been apparent for the last decade that accommodative monetary policy boosts asset prices.  But, until this article, most members of the FOMC downplayed or ignored this observation, suggesting that the economy needed low interest rates due to weak growth, and thus, the asset issues were not really a problem.  The trouble is that it is a problem.  Fed policy has evolved into volatility suppression; as the Fed has dampened volatility, it has encouraged market participants to engage in what can best be described as carry trades.  Carry trades work best when nothing happens.  The usual description of a carry trade is that it is like “gathering nickels in front of freight trains.”  To prevent the activity from getting out of hand, the usual market discipline is to allow the “train” to do its worst on occasion as a warning to others.  However, starting with the 1987 Crash, but becoming most evident in the LTCM failure, the Fed has acted as a brake on the train, preventing participants from getting hurt too badly.  This expectation of protection has, as one would expect, encouraged even more risky and leveraged behavior.  The line “privatizing the gains, socializing the risk” describes how the Fed (and to be fair, the rest of the financial regulatory system) has operated.

We were a bit surprised to see Fed officials openly discuss the asset bubble problem.  However, resolving it is much harder than talking about it.  The Fed’s main policy tool, the interest rate target (along with its sidekick, QE) is blunt.  When used to boost the economy, it works mostly by encouraging asset buying and the subsequent wealth effect.  It will be politically difficult (and likely impossible) to raise rates to overtly reduce asset prices.[1]  So, what should the Fed do?  In other words, to address the Tinbergen problem, the Fed needs additional tools other than interest rate policy.  The usual response is “macroprudential policies,” which means regulation.  We know strict regulation can stop excessive leverage and asset bubbles; the lack of financial stress from 1934 to1970 was due to Glass-Steagall and restrictions on interstate banking.  However, it will be hard to bring back such regulations.  These comments from various members of the FOMC do highlight that at least some of them realize they have created a problem, but it doesn’t look to us that they have any good plan on how to address it.  We suspect there are two directions.  The first is aggressive reregulation.  If a FDIC for MMK is introduced, that’s a sign we are on this path.  The second is actions to force MMK to break the buck on occasion, and to inject enough fear among participants to be less enthusiastic about those “nickels.”  To use an analogy, the Fed has acted like a forest manager that will allow for no fires.  It creates underbrush conditions that lead to uncontrollable blazes.  It would seem rational to allow some “controlled burns” to alleviate this issue.  Unfortunately, someone’s assets will likely be torched in these controlled burns, and they won’t see the wisdom of such actions.

COVID-19:  The number of reported cases is 40,088,893 with 1,114,391 deaths and 27,525,530 recoveries.  In the U.S., there are 8,155,894 confirmed cases with 219,679 deaths and 3,234,138 recoveries.  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.  U.S. hospitalizations are rising.

Virology: 

• WHO has released a study that indicated remdesivir did not improve the outcome for COVID-19 patients. This is a bit of a disappointment on the anti-viral front.
• Several of the vaccine candidates require a sterile “cold chain” of at least refrigeration (although some may require deep freezing) to be effective. This requirement will likely reduce distribution in the emerging world.
• Europe is seeing a mounting rise in infections.
  • Belgium has been especially hard hit and has reintroduced lockdown measures.
  • Italy is also seeing a return of cases and has tightened mobility rules.
  • France has implemented mobility restrictions in some cities.
• Researchers have warned that there was likely to be a return of the virus as winter approached. But one of the problems is that societies are reaching a point of “pandemic fatigue.”  In areas where governments have tried to implement restrictions, compliance is well below that seen earlier.
  • Data suggests the U.S. South has seen stronger economic growth due to easing restrictions; it has also seen higher infection rates and deaths.

Bolivia:  After months of delays, Bolivians returned to the polls to vote on a new president.  Although the results have not been confirmed, interim President Anez has conceded.  The new president will be Luis Arce, a member of Evo Morales’s socialist party.  Although Morales came to power with other socialists in the region—Chavez, Correa and Kirchner—his results proved to be much less radical and better accepted.  We expect a similar governance from the incoming new president.

Chile:  Meanwhile, in Chile, voters went to the polls to decide if the country wants a new constitution.  In the runup to the vote, unrest has been widespread.  Chile has been a standout performer in South America, but rising inequality has led to a backlash.  It is unclear what a positive vote for a new constitution will bring; the vote was to decide to keep or end the current one, but not on what will replace it.  But, we take the vote as a sign of caution on Chilean investments.

Thailand:  Despite threats, widespread protests continue in Thailand.  It appears that protestors are using methods similar those that Hong Kong protestors deployed.  This suggests that if Thai officials want to bring the protests under control, they will likely need to deploy methods similar to those deployed by China.

Brexit:  Although PM Johnson continues to threaten to bring a hard Brexit, the behavior of financial markets suggests he isn’t believed.  Either we are setting up for a shock, or, as the markets seem to expect, Johnson will cave.

Policy and economics:  Speaker Pelosi has set a 48-hour deadline for stimulus talks.  We don’t expect a deal to be reached but would look for a package after the election, regardless of who wins.  As research gathers, it is becoming clear that households saved a significant amount of the income support and are spending it down now that there is no further stimulus.  Although it is difficult to precisely measure when spending will decline, the longer we delay stimulus, the greater the odds are that within the next quarter or two, consumption will stall.

• As we have been documenting for some time, commercial real estate is at great risk due to the pandemic. Malls have been especially hard hit, facing additional pressure from the closure of movie theaters.  In addition, office space is coming under pressure.
• Another industry that has been roiled by the crisis is childcare. Disruptions in childcare will tend to reduce the workforce and slow the recovery.
• One of the revolutions in banking over the past four decades has been the movement to rely on data instead of the discretion of loan officers. Although the human element did a reasonably good job in allocating credit, it wasn’t the most efficient way to make loans, so banks moved to using numerical models to make loans.  However, such models are only as good as the data inputs, and there is a growing worry that FICO scores, as an example, may be overstating creditworthiness.

Odds and ends:  The U.N. arms embargo on Iran has officially ended.  However, given U.S. sanctions on Iran, there will be a limited number of nations willing to make arms deals with Tehran.  The ceasefire between Azerbaijan and Armenia has mostly failed.

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[1] Imagine a Fed Chair testifying to Congress that “we raised the fed funds target because the P/E was too high.”  Greenspan got close to that with his ‘irrational exuberance’ comments and got so much blowback that he never ventured close to it again.

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

[Posted: 9:30 AM EDT] | PDF

Good morning and Happy Friday!  Equity markets are mostly steady this morning.  Although it isn’t definitive, news out of the U.K. suggests a hard Brexit may be coming.  We start with the latest on this topic.  Stimulus news follows.  China news comes next along with an update on the pandemic.  We finish with odds and ends from around the world.  Being Friday, a new Asset Allocation Weekly, along with its podcast and chart book, is available.  And, as promised, the Weekly Energy Update is also available.  Here are the details:

Brexit:  For starters, the situation does remain fluid.  We note that the EU is reportedly sending a team of negotiators to London in the wake of comments from PM Johnson that suggest he intends to enforce today’s deadline and is preparing for a hard Brexit.  EU negotiators were mostly ignoring the deadline declared by Johnson.  We still think the U.K. is trying to force a conclusion of negotiations that the EU would rather extend.  So, this doesn’t necessarily mean a hard Brexit is unavoidable, but the risks are elevated at this point.  The best market indicator of the talks, the GBP exchange rate, did fall on the reports.

Fiscal talks:  There was some positive movement on a fiscal deal.  The White House has signed off on funding a national COVID-19 testing program, which had been one of the sticking points of the negotiations.  The White House’s position on stimulus has been different than the Senate; the former wants to “go big or go home,” while the latter is mostly for a very small spending package.  Majority Leader McConnell has already scotched the idea that he would support that which is currently under negotiation, so it isn’t likely any of this will happen before the election.

• Yesterday we cited a NY FRB report that coincided with other studies we have seen indicating much of the stimulus money transferred to households was saved or used to reduce debt. However, there is new evidence that suggests households have drawn down much of that saving since the additional stimulus programs ended last summer.  If true, it would portend slower future spending.
• The CFTC has implemented new position limits for various commodities. The exchanges have traditionally imposed position limits to prevent “cornering” of a market.  Exceptions are often made because the limits do “limit” trading by large participants.  The Dodd-Frank Act, passed in the wake of the Great Financial Crisis, had a provision to have the government install limits that would override the exchanges.  Although it is impossible to determine at this juncture what effect these will have, it is important to remember that regulatory changes can have unintended consequences.  Given the complications that are part of the shadow banking system dominating the financial system, these limits might have an unanticipated impact.
  • In other policy related news, Governor Qualls seems to have a better handle on the shadow, or non-bank financial system. At least he has become aware of it.  Yesterday, we note he thinks the Fed may need to have permanent QE to stabilize the Treasury market in the face of higher borrowing.  Today, he has expressed ‘disappointment’ that money market funds are runnable.  Although he hasn’t offered a solution to that problem (here’s a hint—MMK needs an FDIC body to prevent runs or it must be forced to break the buck under stress), the fact he’s talking about it is noteworthy.

China: 

• Chinese intelligence services have discovered Taiwan has a deep spy network on the mainland. This should not be a shock; the more important consideration to this news is why has China decided to talk about this now?  We suspect there is growing concern over the U.S. using Taiwan as a weapon against China.  According to reports, China is attempted to turn these agents.
• New polls of Americans highlight deteriorating perceptions of China. It is becoming a bipartisan issue.
• The White House has issued a new National Strategy paper on technology. Although a bit light on specifics, it does appear aimed at China.
• Daryl Morey has resigned as the Houston Rockets GM. His open support of Hong Kong last year led to China to restrict NBA broadcasts into China.  His exit is likely part of an effort by the NBA to repair relations, and it highlights business resistance to breaking relations with China.

COVID-19:  The number of reported cases is 38,998,580 with 1,099,380 deaths and 26,930,074 recoveries.  In the U.S., there are 7,980,934 confirmed cases with 217,717 deaths and 3,177,397 recoveries.  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 R_t numbers continue to deteriorate; now only ten states have a reading less than one, which means an accelerating spread of the virus.  Mississippi has the lowest data, while New Mexico has the highest.

Virology: 

• The U.S. and Europe are facing a rise in infections as it gets colder. U.S. infections rose by 60 thousand for the first time in two months.  Europe is facing even faster infection rates; areas that were not as affected before, such as central Europe, are now being affected by this wave.  Hospital capacity is starting to become strained in some areas.  Current estimates for the U.S. indicate that resources use will be at April levels by December.
• Although vaccine distribution is not widely discussed, it does appear that authorities intend to start with older Americans who are more vulnerable to the disease. There are estimates that suggest younger Americans may not be vaccinated until 2022.
• A WHO study of remdesivir suggests that it probably doesn’t have a significant impact on improving survival.
• As shoppers adjust to the pandemic, shopping habits have changed. This report discusses some of them.  A couple of interesting notes—households are doing more cooking and are becoming more sophisticated about it.  This may be bad news for restaurants.  One of the pre-pandemic characteristics was a remarkable lack of kitchen and cooking skills among many households.  The popularity of delivered boxes with single recipes (e.g., Hello Fresh, Home Chef, etc.) and instructions was a clear sign that many households were intimidated by the prospect of cooking.  The pandemic has apparently encouraged households to learn to cook, and that trend will likely be lasting.  Another trend we have noticed is that brand selection is beginning to shrink.  For example, Tab looks like it will be no more.
• An additional factor we have been watching is the sudden surge of household formation and home buying. New York City is seeing an exodus of young families, and we suspect other cities are too.

Odds and ends:  Argentina, a nation in perennial financial stress, is facing yet another USD shortage.  The government is starting to restrict imports.  Bolivia is holding presidential elections, and polls suggest the socialist MAS party candidate Luis Arce should win a plurality.  But, he will not likely win a majority as he faces strong competition from former president Carlos Mesa.  We would expect a runoff election after this one.  Kyrgyzstan’s president has resigned; the country has been dealing with unrest for weeks.

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

[Posted: 9:30 AM EDT] | PDF

Good morning.  Equity markets are pointing to a lower opening; stalled stimulus and rising COVID-19 cases are the likely culprits.  We lead with China today, with a particular focus on Taiwan/U.S. relations.  Pandemic news is next.  As winter approaches, we are seeing rising infection rates and partial lockdowns.  An update on policy news and Brexit follows.  We are also watching rising unrest in Thailand and problems in Afghanistan.  Tech news is next, with an update on real estate, the economy, and odds and ends.  Please note that due to Monday’s holiday, the DOE data is delayed until today, so the Weekly Energy Update will be published tomorrow.  Here are the details:

China: 

• Since relations were normalized with China in 1978, the U.S. has engaged in strategic ambiguity regarding Taiwan’s defense.  It didn’t want China to think we had abandoned Taipei but also didn’t want Taiwan to believe it had an ironclad security guarantee to prevent Taiwanese adventurism.  We are seeing a rising call from the foreign policy apparatus from all sides, suggesting strategic ambiguity should be replaced with a clear statement of defending Taiwan from forced unification.  The fear among analysts is that without a clear policy, the potential for miscalculation from Beijing is elevated.  Essentially, the argument is that the facts on the ground have changed; the U.S. faces little risk that Taipei will attack China.  Instead, without an overt statement of U.S. intention to defend Taiwan, Beijing may assume the U.S. won’t defend the island.  Such a policy would infuriate Beijing, but it would let China know where we stand.  Of course, if the U.S. does make such a policy, it must back it up or lose creditability.
  • We note that the U.S. is moving to sell missiles and drones to Taiwan.
• As the year has progressed, China’s economic recovery has gathered momentum.  Much of this growth is coming from the industrial sector which has been boosted by goods production.  The last time we saw significant stimulus, in the wake of the Great Financial Crisis, commodity demand lifted strongly.  We are seeing something similar this time around; copper imports rose to their second highest level on record, just down from the previous record hit in July.
• Car sales have also jumped, recording the first quarterly rise in two years.  Production is recovering too.  Households have been an important element of the recovery.  Much of the spending appears to be coming from higher debt levels.

• General Secretary Xi has presented new regulations for managing the Politburo and the Standing Committee of the Politburo.  The former is given the job of overseeing the CPC, although Standing Committee is the real power.  These new rules will give Xi even more power to shape agendas and allow him to have input on all new policies.
• Although U.S. foreign policy has shifted to a clear adversarial stance, business groups continue to try to maintain relations with China.  The foreign policy apparatus has been framing the tensions as a new Cold War.  This may be due to the force of habit.  Another analog could be Germany and Britain before WWI.  The two countries were geopolitical adversaries but had close economic relations.
• For the first time ever, China has sold a sovereign bond directly to U.S. investors.  The $6.0 billion offering was USD denominated.  The bonds had four different maturities (3, 5, 10, and 30-year maturities) with coupons of 0.40%, 0.55%, 1.20%, and 2.25%.  The 10-year note exceeds the comparable yields on Treasuries by 50 bps.  Most of the sale went to institutional buyers.
• The U.S. is considering putting Ant Group on the trade blacklist.  Ant is about to go public; it is currently an affiliate of Alibaba Group (BABA, USD, 301.04).
• The State Department is warning international banks to avoid business contacts with Hong Kong individuals who are under American sanctions.
• The U.S. has named a coordinator for Tibetan issues, a measure designed to anger the Xi government.

COVID-19:  The number of reported cases is 38,574,120 with 1,093,253 deaths and 26,720,847 recoveries.  In the U.S., there are 7,917,223 confirmed cases with 216,904 deaths and 3,155,794 recoveries.  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 weekly state Axios chart is updated.

Virology: 

• As we have been reporting, there has been an upswing in infections as the temps fall.  New York is coping with a surge.  Europe is too, with central Europe emerging as a hotspot.  Both areas are attempting to slow the spread without widespread lockdowns.  France has implemented a curfew in selected cities.  Portugal is implementing new measures.  So has Northern Ireland.  In the U.S., it is the less populated states in the interior that are seeing the fastest infection rates.  Some of this reluctance to enforce lockdowns is due to the economic damage they cause.  In addition, compliance might be low because of growing opposition to such measures.  To some extent, avoiding lockdowns is a tacit decision to accept the costs of herd immunity.
• As the race for a vaccine continues, a cautionary note has emerged from Nevada regarding a reinfection of COVID-19.  The second infection was more severe than the first, suggesting there was a mutation and the first infection didn’t protect this person from the second strain.  The problem of mutation is the reason we have to get a flu shot every year; we may find that a vaccine for COVD-19 requires something similar.  An additional complication is that we could very well have multiple vaccines, and it won’t be evident for some time which one works best (or if different vaccines work better with different groups of people).  Repeat infections do appear to be rare.
  • Polls suggest that most people will accept a vaccine but are taking a wait and see approach before being inoculated.  That will tend to slow the pace of immunity.
• In some good news, daycare facilities are unlikely to be a vector for the disease.  COVID-19 does appear to have less impact on the very young, and staffers and their charges seem to be at low risk.  Getting daycares up and running is critical to boosting employment.
• There is a raging debate underway as to whether nations should simply allow the virus to circulate to build natural herd immunity or continue with partial lockdowns.  Under this debate are unresolved philosophical questions about ethics.  Simply put, the issue of natural herd immunity isn’t really about science, it’s about moral philosophy.  Unfortunately, many of those engaged in the debate probably haven’t approached the questions of morality in any systemic manner.
• We continue to monitor studies that suggest blood type might be a factor in the likelihood of infection from COVID-19.  Regrettably, most of the studies we see are flawed (they mostly don’t adequately control for other factors).

 Policy news:  Although talks continue, and it does appear both sides are close in terms of total spending, how the funds are allocated remains a sticking point.  Treasury Secretary Mnuchin admitted yesterday that the odds of getting anything done before the election is unlikely.  We would agree.  In fact, it isn’t likely much will get done in the “lame duck” session either.  Even if we have a unified government after the election, we don’t expect a filibuster-proof Senate, meaning it may not be an easy task to get stimulus next year either.  Although we don’t expect a double-dip recession, we do think we are setting up the prospects for another slow recovery, which is actually fine for stocks but could be explosive socially and politically.

• Governor Qualls suggested that the level of Treasury borrowing may require some degree of permanent QE to allow the financial markets to function.  That policy is skirting debt monetization.

 Brexit:  Negotiations are coming down to the wire, and one trend we are staring to notice is a rising level of alarm on the EU side.  EU negotiators have assumed they had the upper hand and could dictate terms.  PM Johnson has acted all along as if this wasn’t the case.  What has started to emerge is that the EU negotiating team may have forgotten an important characteristic of the union.  They have 27 nations to placate, and if one of them decides that the pain of Britain leaving without a deal is too painful, they can push for an agreement.  We still expect some sort of deal to be made and enough “fudges” provided to allow both sides to live with the outcome, with some disruption, but nothing that won’t be manageable over time.

• EU business groups are warning against a hard Brexit.
• PM Johnson set a deadline for negotiations for today when the EU summit meeting is underway.  It looks like the deadline will pass without incident.
• One potential fallout from Brexit is that support for Scottish independence is rising rapidly.  Although the Johnson government continues to ignore the threat, it is looking more likely that the U.K. may shrink.

Thailand:  Thailand has rules against criticizing the king.  It has some of the world’s lèse-majesté laws, criminalizing even casual remarks about the royal family.  Thus, it was newsworthy when the royal family, in a rare visit to Thailand (the family spends most of its time in Germany),   faced widespread protests as its motorcade passed through Bangkok.  The government has implemented state of emergency orders, limiting organized gatherings in an attempt to reduce protests.  The king is very unpopular, unlike his father, who died in 2016.  Coups are rather common in Thailand as are military governments.  However, there has been persistent unrest in the country that may become revolutionary at some point.

Afghanistan:  As the U.S. prepares to exit Afghanistan, the Taliban is becoming bolder in its bid to take control.  The exit of U.S. troops is increasing the risk that the current government will lose control.

Technology:  Tech firms are facing new regulations from the EU.  France and the Netherlands, specifically, are taking the position that the firms need to be broken up.  In the past, successive U.S. administrations have protected these firms that are overwhelmingly American.  However,  legislators and judges are becoming increasingly hostile as well.

Real estate:  One of the initial actions taken in March was to suspend evictions.  The idea was that the pandemic would be brought under control in a few months, and between enhanced unemployment benefits and the $1,200 payment to households, renters and landlords could work out accommodations.  Unfortunately, the pandemic continues, and fiscal support has waned.  Landlords and renters are at odds over who will bear the burden of adjustment.  Currently, there is an eviction moratorium in place, but recent guidance suggests that landlords, under certain conditions, can begin eviction proceedings.  These new guidelines have emerged after landlord groups pushed back against the moratorium.  If evictions become widespread, we could see a further widening of inequality and a further down leg in the “K”-shaped recovery.

• In related news, renters have been moving to the suburbs in search of space.  The trend is starting to affect rents in dense cities, such as San Francisco.
• Vacation home demand has also increased.
• When a Commercial Mortgage Backed Security (CMBS) has problems, management of the security shifts from the “master” to the “special servicer.”  The latter acts as a sort of receiver and determines the “workout.”  We are seeing a steady rise of securities that are being transferred to special servicers, an indication of stress.

Economics:  A number of papers we have noted recently state that households have shown a strong propensity to use some of the stimulus money for either saving or debt repayment.  Although saving may eventually become spending, the decision to use the funds for debt service suggests a strong desire to improve household balance sheets.  This trend would mean that the potential inflationary impact of payments to households might be less than expected.

• Local coffee shops are closing; expect more chains to replace them.
• Majority leader McConnell has put forth a “targeted” stimulus bill worth $1.8 trillion.  Although reaction from House leadership has been cool, the difference in total funding isn’t that great and it may be difficult for the House to reject it.  Of course, if the goal is to pass something, we would see the two current versions go to a conference committee and a unified bill would emerge.  We suspect both sides are posturing, and the odds of something getting passed before the election (or even before a new Congress is seated) is unlikely.

 Odds and ends:  Japan has an agreement to sell defense goods and technology to Vietnam.  One of the overlooked issues surrounding the U.S. and China is that America has long-time allies in the region, and they have the capacity to improve the military capability of their neighbors even without U.S. involvement.  Vietnam and China have had disputes in the South China Sea.  Newer military equipment is a potential threat to Beijing.

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

[Posted: 9:30 AM EDT] | PDF

Our Daily Comment today opens with a discussion of the International Monetary Fund’s improved outlook for the global economy, though much of the improvement simply reflects China’s early exit from the coronavirus pandemic.  Other key developments today include Chinese President Xi’s reaffirmation of his economic program, new U.S.-EU trade tensions, and other geopolitical and virus issues that could mean headwinds for risk assets.

Global Economic Conditions:  In the IMF’s latest World Economic Outlook, released yesterday, the organization offered a slightly improved forecast for global economic growth in 2020 and 2021.  According to the new forecasts, the world’s gross domestic product (GDP) will decline by just 4.4% this year compared with a decline of 5.2% in the June forecast.  Global GDP is forecast to grow 5.2% in 2021 compared with 5.4% in the previous estimate.  However, those figures largely reflect the relatively better dynamics in the large Chinese economy, which is expected to be the only major economy to post growth in 2020.  All the same, the modestly improved forecasts should be positive for equities moving forward.

China:  In a major speech marking the 40^th anniversary of Shenzhen’s establishment as a special trade zone, President Xi vowed to press ahead with plans to gain the global lead in information technology and other strategic industries, despite expanding efforts from the U.S. and its allies to check China’s rise.  He also urged a greater focus on quality in order to overcome increased global uncertainty and made a pitch for greater “self-reliance.” He also reaffirmed his commitment to “opening up and reform” as a strategy for China to gain economic advantage. Overall, the speech suggested Xi is continuing to move forward with the economic program that has helped put China on a collision course with the U.S. and has raised the risk that the two countries will fall into a costly Cold War in the future.

United States-European Union:  The World Trade Organization ruled that the European Union may impose tariffs on $3.99 billion of U.S. jet airliners and other goods in retaliation for U.S. subsidies for Boeing (BA, 162.24) aircraft.  The decision is part of a long-running trade dispute; last October, the WTO allowed the U.S. to impose tariffs on $7.5 billion of European jet airliners and other goods in retaliation for EU subsidies provided to Airbus (EADSY, 18.60).  In other words, the WTO has ruled that both sides provided prohibited subsidies, but Europe did so to a greater extent. Tuesday’s pronouncement leaves the two sides with the choice of negotiating a solution or fighting a protracted trade battle.  EU officials are reportedly keen to negotiate, but U.S. Trade Representative Lighthizer has been taking a hard line so far.

United States-Russia:  President Trump’s lead arms control negotiator Marshall Billingslea said the U.S. and Russia had reached an “agreement in principle” on a new nuclear arms control deal, claiming a key diplomatic victory that the president has sought ahead of the November election.  However, Russian Deputy Foreign Minister Ryabkov disputed the claim and said the latest U.S. offer is unacceptable.  Driving home the point later, Russian Foreign Minister Lavrov said his government sees no prospects for extending the current New START arms control treaty with the U.S., but it plans to continue with negotiations on the subject.

Norway-Russia:  Norwegian Foreign Minister Ine Eriksen Soereide said her government has concluded that Russia was behind a cyberattack launched against the Norwegian parliament in August.  In the attack, the e-mail accounts of several lawmakers and parliament employees were hacked.

Nagorno-Karabakh:  Turkey has reportedly sent hundreds of Syrian militia fighters to help Azerbaijan in its conflict with Armenia over the disputed enclave of Nagorno-Karabakh, and hundreds more are preparing to go, according to Syrians involved in the effort.  While it has been reported previously that Turkey is helping the Azeris with troops and military equipment, the reports indicate it sent in the Syrians even before the latest flareup in hostilities last month.  Russia, which supports Armenia in the conflict, has warned about Turkish interference but has not taken strong steps to counter it so far.

Mexico:  Documents reviewed by the Financial Times indicate the government of President Andrés Manuel López Obrador is making low-key changes to the country’s energy regulations in order to favor state-owned Pemex and discourage private investors in areas like renewable generation and gas stations.  The news is negative for Mexican stocks because it will likely add to perceptions that the president is making Mexico’s investment climate ever more difficult.

COVID-19:  Official data show confirmed cases have risen to 38,204,270 worldwide, with 1,087,391 deaths and 26,508,893 recoveries.  In the United States, confirmed cases rose to 7,859,417, with 215,914 deaths and 3,124,593 recoveries.  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 more than 52,000 yesterday, pulling the seven-day moving average to more than 49,500.  Daily deaths remained close to their seven-day moving average of approximately 700, but since hospitalizations continue to climb, it appears there is some risk of accelerating deaths as an apparent winter resurgence takes hold.
  • As bad as that is, data show Europe is starting to surpass the U.S. in terms of infections per million residents.  This week, the European Union and the U.K. recorded 152 cases for every million residents, while the U.S. recorded about 150 cases for every million residents.
  • Europe’s coronavirus deaths have risen from about 0.2 per million in mid-summer to 1.0 per million now, coming ever closer to the U.S. death rate of about 2.1 per million.
• After trials for at least two major vaccine candidates were paused recently due to unexplained illnesses in trial participants, Eli Lilly & Co. (LLY, 150.08) said safety concerns have forced it to pause the clinical trial of its anti-body based treatment known as LY-CoV555.
• The Mexican government said it has signed purchase agreements for three of the leading coronavirus vaccine candidates in order to secure enough doses for 100 million people by the end of 2021.
  • Under the deals, Mexico will make approximately $159 million in down payments and about $1.7 billion in total payments.
  • The government will buy eventual vaccines for 39 million people from AstraZeneca (AZN, 54.48), as many as 17 million from Pfizer (PFE, 36.90), and 35 million from China’s CanSino Biologics (CASBF, 23.03).
  • Mexico is also participating in the international vaccine alliance Covax, through which it expects to obtain doses for about 26 million people.

 Economic Impacts

• JPMorgan (JPM, 100.78) and Citigroup (C, 43.68) both reported healthy third-quarter profits yesterday, suggesting their corporate and individual clients fared better than expected during the worst of the pandemic.  However, both banks said they haven’t yet changed their views that significant losses are looming in the future.
  • The banks continue to hold large reserves for potential losses, and they predicted that next year unemployment would remain high and more customers could start defaulting on their loans.
  • JPMorgan CEO Jamie Dimon warned that without more public assistance for the economy, the situation could turn out worse than expected.
• In another mixed signal for the U.S. economy, the CEO of Delta Airlines (DAL, 31.77) said the company is seeing “steady improvement” in travel demand; however, the gains are so slow that the company will continue to burn cash into next spring.

 Foreign Policy Responses

• In Japan, Prime Minister Suga will reportedly instruct his government to draw up a new pandemic relief bill aimed at boosting consumption if economic data over the next month show new stimulus is needed.  The third supplementary budget for fiscal year 2020, which ends on March 31, would be submitted to the Diet and implemented early next year.

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