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

[Posted: 9:30 AM EDT] | PDF

Happy Friday!  This Friday is starting with a risk-off tone.  Worries about the economy after the rise in claims yesterday and rising tensions with China are affecting sentiment.  But the overarching worry is that Congress will fail to deliver another stimulus package.  We cover China and policy below, along with the pandemic news.  The new Asset Allocation Weekly is available in its usual place along with the companion podcast and chart book.  Let’s get to it:

Policy news: 

• Yesterday, we reported the GOP was preparing to release its new stimulus package. They failed to do so.  Disagreements within the congressional GOP caucus and the White House suggest a party in disarray.  What are the sticking points?
  • The White House wants a payroll tax cut or holiday. This isn’t necessarily a bad idea because the tax tends to fall most heavily on lower income workers.  However, in this crisis it may not be all that effective because it doesn’t help people who are not working.  Since layoffs have most adversely affected lower paid workers, the holiday would give money to those less affected by the pandemic.
  • There is disagreement over unemployment insurance. The $600 per week boost is having a distortive effect on the labor markets.  It overpays laid off workers outside major urban areas.  In these regions, the $31K per year that the payment represents, over and above what normal state insurance pays, is likely more than they would get by working.  Thus, it becomes a disincentive to return to work.  However, in higher paid urban areas, the additional benefit probably has less of this effect.  At the same time, it is hard to determine if reducing the benefit makes sense if there is no job to be had.  What remains a mystery is that these issues are nothing new.  Lawmakers have had about three months to think about the second round.  Over that time frame, it seems there would have been an effort to craft a policy that avoids the disincentive to return to work but supports those who can’t find a job.  The reaction yesterday suggests that if work was done, it didn’t get finished.
  • Here is the problem—financial markets have been assuming there would be an agreement. It would include some degree of additional unemployment insurance supplement and another stimulus check.  Aid to state and local governments should be part of the agreement as well.  Once there is evidence that another round of stimulus will be delayed or less than expected, financial markets will discount that outcome.  Even delays pose a problem because the reaction of households to uncertainty will be to save resources and reduce spending.
• One silver lining, though, is that once a deal is struck (and the odds that nothing happens in an election year are near zero), the government should be able to move stimulus checks faster this time around.

China news:

• In retaliation for closing the Houston consulate, China is forcing the U.S. to close a similar facility in Chengdu. Tensions between the U.S. and China continue to escalate; we will offer some insights on this issue in an upcoming WGR.
• The U.S. has arrested three Chinese nationals on accusations of visa fraud. They apparently failed to declare their affiliation with the People’s Liberation Army.
• The U.S. has sanctioned additional Chinese companies for alleged human rights violations in Xinjiang.
• As we expected, China is taking steps to bolster Hong Kong’s status as a financial center. China needs the financial expertise contained in the city; other Chinese financial markets, such as Shanghai and Dalian, are simply not sophisticated enough to provide the services available already in Hong Kong (an aside: it seems that Xi may have been hasty in moving on the national security law—it would have made more sense to do so if other financial centers in China could replace Hong Kong).  This decision by China means that financial institutions and their workers will likely get a “light touch” from authorities, at least for a while.  It also opens a point of vulnerability for the West.  The U.S. could force international financial institutions to either quit Hong Kong or lose access to U.S. dollar markets.  Whether this step is taken remains to be seen.
• Historic flooding continues to pressure the Three Gorges Dam. Officials have admitted parts of the dam have buckled under the pressure building behind the dam.  If the dam were to fail, the impact would be catastrophic to downstream cities, most notably Wuhan.

COVID-19:  The number of reported cases is 15,526,057 with 633,656 deaths and 8,873,385 recoveries.  In the U.S., there are 4,038,864 confirmed cases with 144,305 deaths and 1,233,269 recoveries.  For those who like to keep score at home, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  There are 12 states, including Texas, with R₀ numbers below 1, meaning the spread of the virus is weakening.

Virology: 

• A growing shortage of test kits and an overwhelmed testing industry is leading health officials to restrict access to testing for COVID-19. The impact of this change is unclear.  For those who have come in contact with someone infected, their options are to either (a) ignore that fact and run the risk of spreading the disease, or (b) perhaps needlessly self-quarantine.  These new restrictions are an unwelcome development but likely unavoidable if the industry lacks the capacity to meet testing demand.
  • At the same time, there may be another option. German researchers have trained dogs to sniff out those with COVID-19 with a 94% success rate.  So, if your dog starts acting strangely around you, perhaps he is telling you something.
• China claims it will have a vaccine ready before year’s end. Recent national deal-making on securing vaccines reveals a lack of global coordination.
• Bolivia is delaying its presidential elections again due to the pandemic.

Foreign news:

• Brexit talks appear to be stalled and probably won’t be finished by the end of July. However, we do expect negotiations to continue and note that financial markets seem to be taking these comments in stride.
• Russia appears to have tested an anti-satellite weapon.

Market and Economy news:

• One of the most difficult factors to analyze in markets is their anticipatory nature. When economics is taught, it is one of the areas that isn’t given as much emphasis as it should be.  Here is a case in point: Hershey (HSY, 146.33) is expecting a quiet Halloween and is planning to produce less themed product this year.  Since Halloween is a mask-wearing holiday, it would seem that trick-or-treating might not be affected.  And so, it might make sense to purchase Halloween goods early, just in case…besides, it’s good to have around.
• The senior loan officer survey has suggested concerns about loan loss problems. New surveys suggest banks are closing credit cards and reducing credit lines on fears that households may not be able to service additional debt.  Bank lending tends to be pro-cyclical; it rises and falls with the business cycle, exacerbating the amplitude of the cycle.  These actions by banks will tend to reduce consumer demand.

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