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

[Posted: 9:30 AM EDT] | PDF

U.S. equity markets continue to tick higher, buoyed by expectations of continued stimulus.  The stronger EUR is lifting European stocks, while Chinese equities fell on U.S./China tensions.  Relations with China continue to deteriorate; that’s our lead-off story this morning.  We update the latest policy news as a plethora of programs are due to end by July 31.  We update the pandemic news, recap other foreign developments and wrap up with economic and market news.  The new Weekly Energy Update is available.  Off to the details:

China news:

• Yesterday, the U.S. announced it was forcing the closure of a Chinese consulate office in Houston. The Houston fire department was on the scene of what appeared to be a massive burning of documents by consulate personnel.  There have been accusations by the U.S. of Chinese espionage, especially related to medical information.  The closure of the consulate is part of that issue and the burning of documents lends credence to that accusation.
• There are reports that the Chinese consulate in San Francisco may be harboring a Chinese military researcher wanted for questioning by the FBI.
• It is becoming obvious that tensions between Beijing and Washington are escalating.  The reasons for the increase in tensions will be a topic of an upcoming WGR, but there is speculation that the upcoming elections may be a factor.  China hawks within the administration may believe that they need to set the tone of the future relationship regardless of who occupies the White House.  Since we tend to view history through the viewpoint that trends matter more than personalities, we expect relations with China will be fraught regardless of who is president.  The problems are structural, not personal.
• On that note, the Senate is working on legislation that would give policymakers additional tools to prevent the confiscation of intellectual property, which would be a lasting change.
• Rules requiring supply chains to certify that imported goods are free of unpaid labor are raising worries among U.S. firms.
• Railroad infrastructure firms are pressing the U.S. for sanctioning tools against Chinese firms who are said to have ties to the Chinese military.
• China is arranging for charter flights to allow its citizens who have expiring visas to exit the U.S.
• The PBOC, seemingly concerned about China’s huge debt levels, indicated it is pausing its stimulus.
• We continue to monitor heavy flooding in southern China.

Policy news: 

• The GOP Senate leadership says it has an agreement with the White House and will announce the details later today. We will be watching to see the size of the next direct payment to households.  We do note there is growing opposition to additional spending among GOP budget hawks; although we doubt their opposition will be enough to derail the bill, it could mean the GOP leadership will more closely track Democratic proposals to ensure passage.
• The Fed is deliberating additional stimulus before its July 28-29 meeting. In the background, the Fed continues to debate structural policy changes that would adjust how the central bank reacts to inflation.  In the aftermath of Paul Volcker, the Fed has tended to try to preempt inflation.  The trauma of the high interest rate years led a generation of officials to try at all costs to prevent rising inflation expectations.  The policy worked so well that they now find themselves in the position of feeling the need to signal that they will not act preemptively to prevent a rise in price levels.  To some extent, future policy decisions will depend on this structural policy change.
  • In related news, it does appear that Chris Waller and Judy Shelton will be confirmed by the Senate for the last two open positions on the FOMC. Waller will be a traditional dove, but Shelton appears to be more sensitive to politics.  It may turn out that she doesn’t act as she has been portrayed, but, for now, we are assuming she will be dovish with a GOP president and hawkish with a Democratic president.  However, if we are correct in our assessment, the impact of her dissents will likely be small.

COVID-19:  The number of reported cases is 15,255,093 with 606,206 deaths and 8,670,684 recoveries.  In the U.S., there are 3,971,343 confirmed cases with 143,193 deaths and 1,210,849 recoveries.  For those who like to keep score at home, the FT has created a an interactive chart that allows one to compare cases across nations using similar scaling metrics.  Axios has updated its state infection map; the pace of infections appears to have leveled off.

Virology: 

• Pfizer (38.56, +1.87) and the privately held German firm CureVac have received a $2.0 billion contract from the U.S. government for 100 million doses of their vaccine for December.
• U.S. testing firms warn they will struggle to meet the demand for COVID-19 testing along with their other testing demands.
• One interesting development to watch is the pace of influenza in the southern hemisphere. It’s winter there in the midst of flu season, but, so far, influenza infections are lower than normal.  It appears that prophylactic measures to prevent the spread of COVID-19 have also worked to reduce the spread of the flu.  There have been worries that the combination of COVID-19 and the usual influenza season this fall and winter would overburden U.S. hospitals.  That may not be the case.
• In the news surrounding vaccine testing, the focus tends to be on antibody production. That is the first reaction the human body has to the introduction of the virus or a vaccine.  Reports have indicated that antibodies have dwindled rather quickly, raising worries that a vaccine may only offer limited benefits to COVID-19.  However, there are other elements of disease resistance that tend to be more durable but take longer to emerge.  Specifically, the body creates T cells and B cells that also counteract diseases, but these often don’t emerge for several months after infection.  Unfortunately, we won’t be able to determine whether the proposed vaccines generate these secondary effects, but lasting immunity could develop if they do.
  • If this is the case, what about reports of people getting infected a second time? Researchers are finding evidence that these apparent reinfections were much more likely to be the first infection that was long-lasting.  In other words, a person was sick, seemingly got better, but wasn’t fully recovered and thus suffered a relapse.  If this is true, it increases the likelihood that lasting immunity does occur.

Foreign news:

• EU negotiators are warning the U.K. that time is dwindling to make a trade deal. We still expect the two sides will come to an agreement but would not be surprised if the agreement isn’t complete until the last minute.
• Meanwhile, the U.K. is also trying to secure a trade agreement with the U.S. American negotiators are warning Westminster that the British digital tax puts the talks at risk.  The U.S. is taking a strong anti-digital tax position, viewing it as a tactic to raise revenue and shift the incidence of the tax to foreign firms.
• European trade negotiators are working on creating legislation that will give them power to levy trade sanctions similar to America’s Section 301.

Market and Economy news:

• The WSJ does a recap of the new Eurobond and its potential to boost European economic growth.
  • Related to the European fiscal package, the dollar has been weakening on expectations that the EUR will now be a more powerful alternative for reserve purposes. Dollar weakness and falling interest rates have given a boost to precious metals.
• As the stimulus pipeline begins to dry up, small businesses are worried that decreased spending will force them to reduce workers or completely close.  The next round of stimulus or the Fed could offset these concerns.

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