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

[Posted: 9:30 AM EDT] | PDF

Good morning.  U.S. equity futures are mostly steady this morning.  Financial markets are broadly steady, consistent with late summer trading.  Our coverage kicks off with news from China followed by the international roundup.  Economics and policy follow, and we close with our usual pandemic update.

China: U.S./China relations are taking on Cold War characteristics and Lithuania has Beijing upset.

• One of the features of the Cold War was how the U.S. and U.S.S.R. used various tactics to steer nations into their respective camps. The Soviets used force (Eastern Europe) and supplied critical exports (Cuba) or military equipment (Egypt, India).  The U.S. provided security at low cost (Japan, Europe, Canada), market access (South and Central America), shared intelligence (U.K., Australia, New Zealand, Canada), and military aid (Southeast Asia).  After the Cold War ended, much of the U.S. assistance remained, although the domestic political support has waned over the years.  As relations between the U.S. and China devolve into a cold war, both nations are offering carrots and sticks to build alliances.  Although the U.S. has officially indicated that it won’t force nations to choose, recent actions suggest otherwise.  In Brazil, the U.S. is pushing the country to abandon Huawei (002502, CNY, 5.17) telecommunications equipment.  Brazil is a longtime user of China’s technology and getting it to give up on Huawei will be difficult.  According to reports, Jake Sullivan offered NATO membership if Huawei is forced out of Brazil.  Brazil is deeply reliant on China so prying the country away from Beijing will be difficult.
• Lithuania has become a problem for Beijing. The Baltic nation has allowed Taiwan to open an office in the country under its own name, which smacks of statehood, something China opposes.  China has recalled its ambassador to Lithuania in protest.  As expected, state media is making all sorts of threats against Lithuania, including severing diplomatic relations, but there are limits to Beijing’s actions.  Lithuania is a small country, but it is a member of the EU and if China pushes aggressively, it could trigger a broader European reaction.
• Evergrande (EGRNF, USD, 0.80), the troubled Chinese property developer, confirmed it is in talks to sell assets in a bid to improve its financial situation. China’s growth since the Great Financial Crisis has been debt-fueled and trying to bring debt growth under control will almost certainly lead to lower growth.
• Michael Spavor, a Canadian citizen, has been sentenced to 11 years in prison on spying charges. It is improbable that Spavor is a spy (although that doesn’t mean Canadian intelligence doesn’t talk to him); instead, he is being used as leverage in the extradition case of Ming Wanzhou, the CFO of Huawei whom the U.S. accuses of violating Iranian sanctions.  The U.S. has protested the sentencing, but we doubt this will have much of an effect.
• General Secretary Xi has been steadily reversing the policies of Deng. The latter opened the economy and, to some extent, opened the country socially as well.  As Xi has consolidated power, behavior control has become part of his policy.  The latest area seeing a crackdown is post-work bar tours and “harmful karaoke.”
• There are reports that China is using subsidiaries controlled by the Xinjiang Production and Construction Corps to export goods produced in the region that may involve detained labor.
• Another element of Xi’s policies is the favoring of state-owned enterprises. This bias is undercutting small enterprises, which were important to the Chinese economy during the Deng years.  According to reports, small businesses are closing, putting pressure on the economy.
• Although data for female participation isn’t calculated in China, anecdotal reports suggest women are increasingly working in construction as male workers become less available.
• China has built two aircraft carriers and is working on a third. Interestingly enough, analysts are not all that concerned as there is a growing consensus that these vessels are becoming vulnerable to countermeasures.  Thus, it begs the question as to why China is building these, especially when it has developed missiles dubbed as “carrier killers.”
• The Belt and Road project is facing rising criticism over human rights abuses. On a related note, Beijing is increasing its investments in Myanmar.

 International roundup: North Korea won’t be ignored and details on the activities of Russian mercenaries comes to light.

• In our “2021 Geopolitical Outlook,” we warned that Pyongyang would likely test the new administration at some point. It looks like we may be coming to that point.  The U.S. and South Korean military exercises are scheduled for next week.  These regular actions tend to upset the Kim regime and the pattern apparently persists.  Kim Jong Un’s sister, Kim Yo Jong, is warning that the Hermit Kingdom will be increasing its military activity in light of these games, including boosting its nuclear arsenal.  North Korea is apparently also refusing to answer the hotline with South Korea in response to the exercises.  We doubt much else occurs from this incident, but it bears watching.
• The Wagner group is a Russian organization that provides mercenaries who have been active in Eastern Ukraine and Africa. The group allows Russia to have influence with a degree of plausible deniability.  It appears the group has been active in the Libyan conflict.  The BBC acquired a table from a Wagner operative which details its operations in Libya.  Some of the actions, which apparently include the deliberate killing of prisoners, would fall into the category of war crimes.
• Russia is positioning its new military aircraft, the “Checkmate,” as an alternative to the F-35.
• The Taliban continues to roll up gains in Afghanistan. Nine provincial capitals are either under Taliban control or are being contested.  Yesterday, Afghan government forces surrendered a base near Kunduz in northern Afghanistan.  Although the Taliban appears poised to take control of the country, maintaining that control will be problematic.  The most likely outcome is that a civil conflict will develop following the U.S. withdrawal.
• With German elections about six weeks away, the SDP member, Finance Minister Scholz, is seeing his party’s polling improve. The SDP has been part of a couple “grand coalitions” with the CDU/CSU and the SDP has faded from relevance.  Scholz is personally the most popular candidate for chancellor but is polling much better than his party.  Unfortunately, Germany has a parliamentary system so the only way Scholz can take power is if his party can dominate a coalition, which isn’t likely.  Meanwhile, the CDU/CSU candidate, Armin Laschet, is languishing in the polls; his personal support numbers are in single digits.  It is becoming evident that forming a government after the election will be difficult and it currently looks impossible to build a government without Green Party participation.
• Lithuania is also on the frontlines of the Belarus situation. As we noted in earlier reports, Belarus has taken a page from Turkey’s playbook, allowing Middle Eastern refugees to come to the country to traverse into the EU via Lithuania.  The Baltic state is getting border aid from the EU in response.
• Wildfires have been devastating parts of Greece over the past couple of weeks. Algeria is reporting wildfires as well.

Economics and policy:  Policy tightening beckons and tax revenues rise.

• The evidence that the FOMC is going to start withdrawing stimulus soon is becoming overwhelming. San Francisco FRB President Daly, whom we rank as a dove, has now indicated that some stimulus could be withdrawn this year.  While we don’t think Chair Powell is in favor of removing any stimulus in the near term, of this year’s voting members on the FOMC, three of the four rotating members (Barkin, Bostic, Daly) are on record calling for tightening, joining Governor Waller.  Although four dissents would not be enough to force a policy change, this level of dissent isn’t all that common.  The last time we had four dissents was in October 1992.  Since the Fed gained independence, there have been 21 dissents of four or more, or about 2.8% of the time.  We suspect Powell will try hard to avoid removing stimulus until he is reconfirmed as Fed chair, which means that he will try to hold off tightening until early next year.
• Yesterday, the Senate held its amendment session for the upcoming budget. For the most part, this session is all about making the other party look bad.  But the key takeaway is that the Democrats are going to try to push through their budget on a party-line vote.  Getting $3.5 billion in new spending along with a debt ceiling increase looks unlikely.
• As the economy recovers, tax revenue is increasing and that has led the fiscal deficit to narrow by $2.5 trillion. Tax revenue rose 18% to $3.3 trillion over the first 10 months of the fiscal year.
• One observation from the infrastructure bill is that the crypto industry was unprepared to be targeted as a revenue source. However, they did move quickly to respond.  Although their efforts failed, we doubt they will fail the next time.  At the same time, the move by regulators to bring crypto into the “fold” of financial products will tend to increase its usage.
  • On a related note, non-fungible tokens have become another tool for money laundering.
  • BitMEX paid fines and agreed to not allow American citizens to use its platform for trading cryptocurrencies.
  • Hackers took more than $600 million from a Poly Network, a distributed finance facility. The network asked for the “money” back and hackers returned about a third of it.
• Home demand remains robust and builders are slowing down accepting contracts to try to boost housing inventory. This activity is lifting home prices further.

COVID-19: The number of reported cases is 204,917,702 with 4,327,872 fatalities.  In the U.S., there are 36,193,574 confirmed cases with 618,496 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 409,566,315 doses of the vaccine have been distributed with 353,205,544 doses injected.  The number receiving at least one dose is 196,077,952, while the number receiving second doses, which would grant the highest level of immunity, is 167,105,507.  The FT has a page on global vaccine distribution.

• Texas hospitals are nearing capacity and are delaying elective surgeries to ensure enough beds for COVID-19 patients. Doing so will reduce hospital earnings.
• One overlooked element of the pandemic is that there is some degree of immunity that comes from surviving the virus. This means we may be closer to herd immunity than the vaccination data would suggest.  Unfortunately, neither vaccines nor infection give sterilizing immunity, meaning that new variants and weakening immunity over time can lead to reinfection.  This condition isn’t unique to coronaviruses.  Influenza is similar.   That means periodic booster shots will likely be necessary.
  • The FDA is expected to authorize a third dose to immunosuppressed individuals.
• China has partially closed the Ningbo-Zhoushan port due to COVID-19 infections.
• The IEA confirmed that the delta variant has adversely affected crude oil demand. Oil prices are off their highs due to the upswing in infections.
  • Southwest Airlines (LUV, USD, 51.84) reports that bookings have slowed and cancellations increased due to the rise in infections.
• An increasing number of firms are mandating vaccinations. Mandates have been problematic as long as the FDA’s approval of the vaccines is for emergency use.  But once vaccines get regular approval, mandates will likely expand.  The rise in the delta variant is also disrupting office reopenings.
• U.S. intelligence agencies have drafted their report on the origins of COVID-19.  Although the report is confidential, sources suggest it won’t definitively determine the origin as being either from a lab or from natural causes.

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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 a discussion of U.S. policy actions, with a focus on yesterday’s Senate passage of the bipartisan “hard” infrastructure bill and this morning’s Senate passage of a budget blueprint encompassing the Democrats’ big antipoverty and climate proposal.  We next turn to a review of key international news and end with a discussion of various developments related to the coronavirus pandemic.

U.S. Fiscal Policy: The Senate yesterday passed the $1 trillion, bipartisan “hard” infrastructure bill by a vote of 69 to 30.  The bill now must be passed by the House, where Democrats have yoked the fate of the infrastructure effort to passage of their broad $3.5 trillion antipoverty and climate effort.

• As promised, Senate Majority Leader Schumer launched a budget bill encompassing the antipoverty and climate package immediately after passage of the infrastructure proposal.  That bill was approved by the Senate early this morning.  Up next: Schumer has set a deadline of September 15 for committee leaders to submit their individual components of the package.
• Separately, in the midst of voting on the antipoverty and climate bill, almost all Republican senators signed onto a pledge not to help Democrats raise the debt ceiling, even though the Treasury Department is already bumping up against the current limit and risks of a default are rising if the ceiling isn’t lifted in the coming weeks.
  • With Republicans insisting that the Democrats take responsibility for the increased spending in their plans, one idea they are considering is a standalone vote to suspend the debt limit.  That move could put pressure on Republicans to support the measure or risk rattling financial markets if the vote fails.
  • Lawmakers could also attach the measure to another must-pass bill, like government funding, to force the issue.

U.S. Monetary Policy: Chicago FRB President Evans, a voting member on the FOMC this year, said he expects recent employment gains to continue, which would allow the Fed to declare that the economy has achieved the “substantial further progress” it targeted last December.  In that case, Evans said it would be appropriate for policymakers to start reducing their asset purchases, although he warned against tightening policy too early and accidentally forcing core inflation down below the Fed’s 2% target.

Cryptocurrencies: Poly Network, which links some of the world’s most widely used digital legers, said it suffered a cyberattack in which thieves stole crypto tokens worth approximately $600 million.  The loss will probably feed into growing concerns about the fast-growing cryptocurrency markets.

China: Against the backdrop of the government’s broad clampdown on Chinese technology companies, it turns out that its crackdown on education services is also broader than earlier known.  New reporting shows that many owners of private, for-profit schools have been forced to turn over their institutions to local governments without compensation.

• China has approximately 190,000 private, for-profit schools, which educate about 20% of elementary, middle, and high school students.  Beijing wants to cut the share of elementary and middle school students studying at such institutions from 10% currently to just 5% as soon as the end of this year.
• As the Chinese government continues to crack down on some sectors, investors are shifting their asset purchases toward industries they believe are favored by Beijing, such as high-tech manufacturing and renewable energy.  Shares of Chinese semiconductor companies, electric vehicle manufacturers, and solar panel makers listed in mainland China climbed over the past month, while shares of technology giants and companies that provide after-school tutoring suffered massive selloffs.

China-Canada: A Chinese court has jailed Canadian citizen Michael Spavor for 11 years for spying, in a case that is considered retaliation for Canada’s arrest of Meng Wanzhou, an executive for Chinese telecom giant Huawei.  The sentence also includes a fine and deportation of Spavor, although the deportation may only happen after the prison sentence is completed.  In any case, the sentence will probably further strain Chinese-Canadian relations.

United Kingdom-Germany-Russia: German police have arrested a U.K. man working at the British embassy in Berlin on charges that he was passing information on to Russian intelligence agents.  The man is accused of working with the Russian intelligence agents since last November.

United States-Germany-Russia: Secretary of State Blinken has appointed former diplomat Amos Hochstein as senior adviser on energy security, with a focus on measures to “reduce the risks” posed by the German-Russian Nord Stream 2 natural gas pipeline and support energy security in Eastern Europe.  The appointment of Hochstein, who had been an opponent of the pipeline and is seen as a hawk on Russia, could signal that the Biden administration still aims to take a tough approach toward Russia despite acquiescing to the almost-completed project.

Brazil: A military parade in Brasilia that was widely seen as an attempt by President Bolsonaro to intimidate Congress apparently backfired as lawmakers voted down an electoral change championed by the president.

Afghanistan: Taliban fighters have captured three more provincial capitals as they steadily tighten the noose on the central government in Kabul.  The Islamist group has now captured nine, or more than a quarter, of the country’s provincial capitals, more than half of the country’s mostly rural districts, and a number of economically important border crossings.

COVID-19:  Official data show confirmed cases have risen to 204,192,836 worldwide, with 4,318,124 deaths.  In the United States, confirmed cases rose to 36,058,757, with 618,149 deaths.  Vaccine doses delivered in the U.S. now total 408,325,135, while the number of people who have received at least their first shot totals 195,646,711.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• According to the latest CDC data, 58.9% of the U.S. population has now received at least one dose of a vaccine, and 50.3% of the population is fully vaccinated.
• President Biden will meet today with a number of large companies and institutions that have imposed vaccine mandates on their employees, in a bid to encourage more companies to require that their workers get vaccinated.  We note that if more companies, universities, and other institutions impose vaccine mandates, it would provide political cover for the administration as it seeks to pressure more people into getting a shot.
• India is in negotiations with Western vaccine makers in an effort to secure tens of millions of COVID-19 vaccine doses in the next few months, which would ease supply shortages that have been stymying the country’s massive immunization campaign.
• In the U.K., the latest surge of COVID-19 cases is giving rise to growing optimism among doctors and scientists that the highly transmissible delta variant can be held at bay with high levels of vaccination and public caution.  Although caseloads are now ticking higher after Prime Minister Johnson dropped almost all public health restrictions in mid-July, hospital admissions have been falling and deaths are at a fraction of the level seen in earlier phases of the pandemic, according to the latest official data through early August.
• Despite the positive signs out of the U.K., the fast-spreading delta mutation is still having some impact.  Southwest Airlines (LUV, 51.11) warned that the recent surge in cases has begun to weigh on its recovery from the impact of the pandemic.
  • The carrier said it has recently seen a slowdown in both near-term bookings and a rise in trip cancellations in August.
  • It now expects operating revenue for the month will be 15%-20% below 2019 levels, compared with a prior estimate of a decline of 12%-17%.

 U.S. Policy Response

• More than seven months after it was launched, the $46.6 billion pandemic rental assistance program has delivered just a fraction of the promised aid to tenants and landlords struggling with the impact of the pandemic.  As of June 30, just $3 billion had been distributed.

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

[Posted: 9:30 AM EDT] | PDF

In today’s Comment, we open with an update on U.S. policy news, including expectations that the Senate will pass the $1 trillion “hard” infrastructure bill this morning, even as Democrats released details on their proposed follow-on bill covering antipoverty and climate proposals.  We also discuss developments in the U.S. labor and cellphone markets.  We next turn to major foreign news items and end with the latest news related to the coronavirus pandemic.

U.S. Fiscal Policy: Senate Democrats released an outline of their $3.5 trillion antipoverty and climate plan encompassing a range of programs such as universal prekindergarten and expanded Medicare.  Democrats will focus on passing it as early as Tuesday, right after the Senate is expected to pass the $1 trillion “hard” infrastructure plan covering items like roads, bridges, airports, and broadband systems.

• The plan includes higher taxes for corporations and high-income individuals as well.
• It also includes a provision offering a pathway to lawful permanent status for certain migrants to the U.S.

U.S. Monetary Policy: Even though President Biden’s economic team generally supports renominating Federal Reserve Chair Powell to a second four-year term when his current term runs out in February, prominent progressives in the Democratic Party are increasingly agitating for someone who they think would be more closely aligned with their priorities.  Despite Powell’s forceful response to the coronavirus pandemic and his effort to push monetary policy more strongly in the direction of supporting full employment, especially for minorities, progressives are looking for a Democrat who would be more open to tighter regulation of the financial industry and perhaps even looser monetary policy.

• If Powell is not renominated, the leading contender for the chair’s job is Fed Governor Lael Brainard, an economist appointed to the board in 2014 by former President Obama.
• We think another possible choice would be Raphael Bostic, who currently serves as president of the Federal Reserve Bank of Atlanta and is a former Fed economist.

U.S. Labor Market: In the monthly JOLTS report yesterday, June unfilled job openings rose to a seasonally adjusted 10.1 million, reaching the highest level since record-keeping began in 2000.  The increase was driven largely by professional and business services, retail, and accommodation and food services as the month of June saw continued easing pandemic restrictions and thus more consumers dining out and traveling.  Importantly, the number of open jobs now exceeds the number of people counted as unemployed.  That signals a tight labor market, although it’s important to remember that this data would not yet reflect much impact from the rapidly spreading delta mutation of the coronavirus.  The chart below shows the ratio of unemployed workers to job openings.

U.S. Cellphone Market: Even as U.S. cellphone service providers reported adding some eight million new subscribers over the last year, a firm that tracks the industry said U.S. population and market trends could only explain four to six million of the new subscribers.

• According to Jonathan Chaplin, a telecom analyst at New Street Research, “There’s something fishy going on…If you look at the subscribers at the end of the period and all the net adds they report, they don’t jibe.”
• The disparity is raising concerns that the firms could be reporting inflated subscriber data, which naturally would not be taken well by investors.

China: Japan’s mammoth Softbank (SFTBY, 30.74) said it will cut its investment in Chinese start-ups until the extent of Beijing’s scrutiny of the tech sector becomes clear.  Founder Masayoshi Son said the investment conglomerate will take a “wait-and-see stance” until the situation settles in what he hopes would be a year or two.

• We’ve been writing a lot about the way Chinese companies are facing both increased regulatory risk at home and pressure from the U.S.  That has led to a lot of volatility in Chinese stocks, although we’ve been able to avoid some of that volatility in some of our own strategies, where we’ve shifted our foreign stock exposure toward non-Chinese companies.
• Not only are Chinese equities at risk from the new regulatory moves, but Chinese corporate bonds related to the companies under scrutiny have also depreciated.  Since Chinese bonds are now so widely held, the volatility is affecting investors around the world.

China-Cambodia: A report from Human Rights Watch has branded a Chinese-financed dam in Cambodia as a “disaster” for indigenous and ethnic minority communities.  The report claims that the Lower Sesan 2 dam, part of China’s signature Belt and Road Initiative, has “washed away the livelihoods” of communities that relied on fishing, forest-gathering, and farming when the areas upstream were flooded.  The report adds to multiple other reports accusing the program of damaging poor, developing countries despite China’s effort to use the initiative to expand its global influence.

China-Russia: Russian forces are participating in a regular Chinese military exercise for the first time this week, stoking concerns among Western analysts that the two U.S. adversaries are developing joint operational capabilities.

Russia: Although jailed opposition leader Alexey Navalny has largely dropped out of the headlines recently, the Russian government continues to put pressure on his organization in an apparent effort to rip it out of society “by the roots.”  In the latest move, the government has opened a criminal investigation into two exiled allies of Navalny for raising funds for organizations deemed by the authorities as “extremist.”

Afghanistan: Taliban forces overran a fifth provincial capital in northern Afghanistan yesterday, putting even more pressure on the central government in Kabul.  Taliban fighters now control more than half of the country’s 400 districts and a number of economically important border crossings as government security forces retreated to local cities.

Peru: Worries about the country’s new left-wing government are already weighing on economic activity, but they’re also exacerbating inflation.  Increased political and policy uncertainty have contributed to a 13% decline in the value of the currency since the start of the year, driving up costs for imports and the goods or services that compete with them.

COVID-19:  Official data show confirmed cases have risen to 203,559,532 worldwide, with 4,307,242 deaths.  In the United States, confirmed cases rose to 35,950,379, with 617,424 deaths.  Vaccine doses delivered in the U.S. now total 407,560,705, while the number of people who have received at least their first shot totals 195,222,906.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• According to the latest CDC data, 58.8% of the U.S. population has now received at least one dose of a vaccine, and 50.2% of the population is fully vaccinated.
• In a dramatic illustration of how the fast-spreading delta variant is sparking tougher vaccine requirements, Defense Secretary Austin said he would make vaccinations mandatory for all U.S. military personnel by mid-September.  In a separate statement, President Biden expressed his “strong support for the move,” and Army Gen. Mark Milley, the chairman of the Joint Chiefs of Staff, endorsed the measure as a “key force protection and readiness issue.”
• Canada yesterday opened its borders again to fully vaccinated people from the U.S.  However, the U.S. is still not allowing Canadians to cross into the U.S. by land.
• While the main Western vaccines continue to exhibit good effectiveness against even the delta variant, China’s worst coronavirus outbreak since the virus first emerged in Wuhan is adding to concerns about the quality of its domestically developed vaccines.  Rising case numbers have focused attention on the absence of rigorous studies from state-run Sinopharm (SHTDY, 13.36) and privately owned Sinovac proving that their vaccines work against this mutation.
• Japan has now administered more than 100 million doses of COVID-19 vaccines and surpassed the U.S. in the proportion of older people who are fully vaccinated, according to government figures released Tuesday.  The country is still struggling to get its latest wave under control, and there is still some risk that the recent Olympic games in Tokyo could touch off a new resurgence.  However, the improvement in its mass vaccination program could help lower infections in Japan and allow it to ease restrictions again.
• With the delta mutation now spreading around the world, China is clamping down hard again on affected areas, and both France and Italy in recent days have broadened their requirements for people to show vaccination or immunity “health certificates” to dine in a restaurant or take part in other activities.  The reimposition of restrictions is a rising risk for the global economy, although we still doubt there will be anything like the tight, widespread economic shutdowns of 2020.

Economic and Financial Market Impacts

• Driven by the fast-spreading delta mutation, some consumers are rethinking their return to dining out, according to executives and industry data, threatening the U.S. restaurant sector’s rebound.  Recent consumer surveys show the delta variant has prompted Americans who say they are the most restricted in their activities to start pulling back again late last month.
• One key impact of the delta variant has been on the debt of U.S. firms seen to be particularly at risk of renewed lockdowns, social distancing measures, or consumer retrenchment.  Bonds issued by cruise companies, cinema operators, and retailers have all fallen in price over the last week as more businesses delayed plans to return workers to offices due to the delta escalation, with others opting to impose vaccine requirements on their staff.

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