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

[Posted: 9:30 AM EDT] | PDF

Good morning, and happy Monday!  U.S. equity futures are mostly flat this morning.  We are seeing sharply lower gold prices, most likely because cryptocurrencies have stopped declining.  Our coverage begins with the FOMC, which holds a policy meeting this week.  The international roundup follows.  China news is next, followed by economics and policy news.  We close with the pandemic update.

The Fed:  The FOMC meets this week, a meeting that will have new economic and policy projections.  There is growing speculation that the committee will move up the beginning of policy tightening in their projections.  It is certainly possible that some of the more hawkish members could move their dots higher, but we doubt the consensus will move to lift rates or taper them in the near term.  Among the orthodox economists, there are persistent calls to signal policy tightening.  Although we understand the sentiment, what they are missing is that the FOMC has clearly signaled a regime change.  Most significant is that the focus on policy is not inflation but employment.  There are risks to this policy, especially for financial markets.  Multiple contraction in equities is possible, not just from higher inflation but also from rising inflation volatility.  We suspect that is one reason why equity momentum has slowed recently.

International roundup:  It was a busy weekend.  The G-7 wrapped up, President Biden talks to NATO today and meets with Turkey’s President Erdogan and Russian President Putin later.  There is a new government in Israel and K-pop comes under fire.

• The G-7 meeting wrapped up. In our initial take on the new administration, we likened the Biden administration to the counterreformation.  It is an attempt to halt the populist trend toward either the end of American hegemony or the creation of a different model.  We expect the effort to fail (it lacks domestic support), but the attempt will continue while Biden is president.  The G-7 meeting was consistent with this view.  Biden, unlike Obama and Trump, is a transatlanticist; he likes Europe and thinks it’s important.  The prior two presidents were less interested and wanted to focus more on Asia.  So, the personal politics went well.  There were many warm photo-ops.  However, underneath it all, not much changed.
  • The U.S. wanted to build a united front against China. Europeans are much more lukewarm on this issue.  There were lots of vague promises but little evidence that anything concrete or sizeable was agreed upon.
  • Trade issues were not resolved. The EU hoped that many of the Trump-era tariffs would be lifted.  Biden has kept most of them in place.
  • The squabbles in Europe are always a problem. One of the great tragedies of humankind is that the Europeans, generally due to accidents of geography, were never able to unite.  In fact, we doubt the EU project can last unless (a) the U.S. continues to fund Europe’s defense, and (b) Germany accepts the role of regional hegemon, and other nations acquiesce.  If neither occurs, the U.K. won’t be the last nation to exit the EU.  And, the tensions between the U.K. and the EU were evident.
• At today’s NATO meeting, Biden will press the group to counter China. We don’t expect much.  Most NATO members fear mission creep.  They want to maintain focusing on Europe and countering Russia.
• There is one clear indication of how China is using its financial power to sway the region; it has created currency swap lines with Turkey, which is facing an inflation and currency crisis.
• Meanwhile, the hazards of campaigning in France continue. Last week, President Macron was slapped in the face.  Over the weekend, Jean-Luc Mélenchon was hit with flour.  What is notable is Mélenchon is the standard-bearer of the hard left, and such leaders are usually not attacked in this manner.  The pelting shows the deep divisions in French politics.
• In Israel, the incoming government survived the narrowest possible confidence vote, and thus, took power over the weekend. This act ended the longest-running leadership in Israeli history.  We would not count Netanyahu out, however.  The coalition aligned against him is hardly unified.  In fact, about the only thing it agrees on is ousting Netanyahu.  Israeli politics is normally fractious, and it would surprise us to see this government in a few months.
• Kim Jong Un has labeled K-pop, the South Korean youth bands, a “vicious cancer” and vows to prevent its spread into the Hermit Kingdom. Totalitarian regimes want to control every aspect of life.  Popular activities can be an alternative to what the regimes are projecting.  Hence, they are a threat.  The strong reaction from Kim does suggest there is a lack of confidence in the North Korean government.

China:  There were two items that caught our attention this weekend.  First, there are reports of a radioactive leak at a Chinese nuclear power plant.  Detectors recorded higher than acceptable levels of radiation at the Taishan Nuclear Power Plant, which is in the Guangdong province.  The level would have triggered a shutdown, but officials raised the acceptable limit.  The plant is jointly operated by China and France, and the latter has contacted U.S. officials for assistance.  Second, the senior editor of the Global Times is coming under social media pressure from ultra-nationalists.  This development is quite unusual.  The Global Times is a CPC mouthpiece. The idea that the publication or one of its editors isn’t Chinese enough is an indication that years of patriotic education may be creating conditions similar to the Cultural Revolution.  This development may make it difficult for Xi to manage policy, especially foreign policy.

Economics and policy:  The pandemic has distorted labor markets, and LIBOR is coming to an end.

• The pandemic and recovery have created one of the most unique sets of economic conditions. As we noted in the above Fed commentary, the FOMC is facing pressure to tighten policy, but there are indications from the labor market that the economy is far from back to normal.  At the same time, there is no doubt that the pandemic has distorted the labor markets, making it hard to discern what is actually happening.  For example, we have seen a jump in baby boomer retirements, which will tighten labor markets.  Another new development has been that workers, facing the unusual circumstance of the pandemic, may have adjusted their goals for work.  Some may want an employer who has few office restrictions.  Others may prefer to continue to work from home.  There has been a surge in quits, which may lead to a period of re-assorting and could distort labor market indicators.  Disruptions in travel are keeping foreign workers from coming to the U.S. and further tightening labor markets.  Policymakers will need to exercise care in interpreting the data.  Simply put, we may never see a full recovery in labor markets, and therefore, the need to raise rates may occur sooner than expected.
• S. regulators are pressing banks and other financial firms to end the use of LIBOR. The problem is that there is no generally accepted alternative.

COVID-19:  The number of reported cases is 176,011,118 with 3,805,212 fatalities.  In the U.S., there are 33,462,286 confirmed cases with 599,769 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 374,398,105 doses of the vaccine have been distributed with 309,322,545 doses injected.  The number receiving at least one dose is 173,840,483, while the number of second doses, which would grant the highest level of immunity, is 143,921,222.  The FT has a page on global vaccine distribution.

• The U.K. will delay easing lockdown measures due to a rise in infections from the delta variant.
• The G-7 did promise to prepare for the next pandemic.
• Russia is seeing a rise in infections as the Kremlin struggles to get its citizens to accept the Sputnik vaccine.
• Novavax (NVAX, USD, 209.68) showed a greater than 90% effectiveness level in a large clinical trial, increasing the likelihood that it will be approved as the U.S.’s fourth vaccine. It is a two-dose vaccine but does not require freezing.  This will make it more popular in the emerging world.

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