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Strategic Global Intelligence Brief for March 11, 2020

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—US Economy

Mortgage Rates Plummet
Not much good can come of the market collapse, but as investors frantically seek out havens, they are driving the yields on treasury bills to record lows. That has an impact on mortgage rates. The basic idea behind lowering the fed funds rate is to do exactly this—stimulate people to buy expensive things like houses. Unfortunately, there are other factors limiting the enthusiasm of homebuyers. The homes are expensive as there has been a shortage developing for years. The lack of labor has slowed new home building and even existing homes are feeling the lack. Add in the new worry about the economy and the potential of lost jobs, and the demand for homes is off.

Oil War Escalates
Not only have the Saudis and Russians worked to lower their price per barrel for oil, they are now escalating their production to put even more pressure on prices. The ostensible reason is to preserve cash flow while demand is down, but it is very clear this has been an attack on their U.S. competitors, and that assault has been felt. The stock price for the big oil companies has been cratering, while the smaller operators are now facing some dire circumstances. The estimate is that almost a third of the U.S. capacity could be lost if demand stays low for the next three to six months. There are already signs of some significant consolidation. The price war will accelerate that process.

Not Much Good News for Airlines
Things were bad enough with the debacle over the Boeing 737 Max. Now it's the sudden drop in travel that has resulted in mass cancellations and flying "ghost" planes. The hope that some resolution would emerge with the 737 Max has faded. Most of the airlines are not expecting the planes to be back in service until late in the year (and that is still wishful thinking). Right now, the demand for the grounded planes is not great, but these were supposed to be the future of their fleets in terms of fuel efficiency and operating costs.

Short Items of Interest—Global Economy

Italy Hit Hard by Virus—Why?
The COVID-19 virus has made an impact on many of the states in the EU, but none has been hit as hard as Italy. Why this has been the case is not that hard to determine. The oldest population in Europe is in Italy. The oldest population in Italy is in the region where the COVID-19 has broken out. The efforts to contain the virus have been extreme. That signals more about the government than the disease. The coalition of the Alliance and the Five Star Movement has been in real trouble for weeks; public support is rapidly fading. They simply can't be seen as unable to deal with the crisis, but the draconian reaction seems to be alienating more people than it manages to impress.

Hiding from the Restrictions
From the start, there have been warnings from health authorities that people will fail to cooperate with efforts to quarantine and contain. The Chinese had the ability to force compliance as this is essentially a police state where people know not to challenge the authorities. In Europe and the U.S., there are many people who are avoiding the doctor and denying they have an issue as the symptoms are mild. They do not want to be isolated and quarantined for weeks on end. They would prefer to keep their jobs and not be rendered penniless. This guarantees the spread of the virus.

Putin Denies Accusations of a Power Grab
According to Vladimir Putin, the changes to the constitution that will allow him to remain as president for the next 100 years (slight exaggeration) is not about holding on to power. It is what the people want and not what he wants. One has to wonder why the people are not being asked to vote on this if this is what they want. Perhaps, just perhaps, this is really a power grab by a dictator who has no intention of departing office until his death.

Very Long and Slow Recovery for the Global Economy
The COVID-19 crisis was not expected to be this severe. Quite frankly, there are many who remain dumbfounded as to its impact. In many respects it seems to defy logic. As serious as the threat has been, it is not any more challenging than previous disease outbreaks (SARS, MERS, flu). The numbers are significant, but still pale in comparison to more familiar threats from the flu—4,365 vs. 18,000 thus far this year. In all of 2019, there were close to 600,000 flu deaths. The overwhelming majority (93%) of deaths have been in the population that is over 80. The vast majority of infections have been among people over 70. The fact is the reaction to the outbreak has been the factor that has damaged the economy as a whole—not the virus itself.

Analysis: What started as a supply chain crisis centered in China has now become a global economic threat with at least four dimensions. The original assumption was that the damage would be limited to the second quarter and a rebound would be swift. That is no longer the assumption. The first issue is still a problem. There seems little on the horizon that changes the situation. The Chinese seem to have gained some control over the outbreak as evidenced by the visit to the stricken area by President Xi Jinping. This seems to signal their confidence, but the supply chain from China remains broken. It could be months before the country resumes normal business activity. Meanwhile, the virus has become an issue in nations such as the U.S., Italy, South Korea, Japan and others. These outbreaks are affecting more than the supply chain as the consumer is now engaged. The decline in activity has affected a host of sectors—oil demand is way off, travel has all but stopped, consumption has plunged. That almost guarantees a decline in GDP growth.

A third impact area is productivity. As people are prohibited from attending meetings and traveling, there has been a drop-off in every aspect of business. The advice has been to work from home, but many are not in a position to do that. It is pretty awkward for a manufacturing worker to get that machine delivered to their house. Salespeople are going to struggle to get their customers to drop by the apartment. Whole industries will be shut down as airlines and cruise ships already have been. Resorts are closing, hotels are laying off staff, theme parks are looking at an entirely lost season.

Then, there are the markets and their continued free fall. There is no way of knowing when the panic will subside and how long it will take people to resume their normal patterns. That means months of market instability. The combination of the virus reaction and other blows such as the oil war launched by Saudi Arabia and Russia means a correction of thousands of points is very likely and recovery will be slow. Fear has taken control and investors are focused on the negatives exclusively.

Where Did Health Authorities Fail?
As the world tries to cope with the outbreak of the COVID-19 epidemic, there are questions regarding the response and why things have become this bad. It started with the reluctance on the part of the regional powers in China to report what was actually going on. By the time China faced up to the threat, it was already at epidemic status. There is still a great deal of skepticism regarding the data coming from China. The next failure was attributed to the slow response from governments in the U.S., Europe, Japan and others. There were woefully inadequate supplies of testing kits and local health authorities were not allowed to do their own testing. The outbreak in the Seattle area was concentrated in one nursing home weeks ago. They have only been tested in the last few days.

Analysis: The most serious economic impact has been due to lack of information, an incoherent message and outright panic as a result. There has been little in the way of coordinated communication with commentary coming from all directions and with different conclusions. One statement would be full of urgency and despair and the next would be urging people to calm down. Part of the issue was that there was too little known, but the biggest problem was that nobody was really in charge. Today, the message is clearer, but it has not been able to get ahead of the panic response.

The official word now is this disease is a potent threat to people over the age of 70 who have respiratory issues or a weak immune system. The vast majority of people who do contract the virus will get a very mild version that will be little different than a bad cold or flu. The draconian response to containment is largely unnecessary. The action people should take is to simply wash their hands and observe normal hygiene habits. Too bad that message was not sent earlier and with more emphasis.

A Shot Across the Bow from OPEC
The timing was impeccable. As the world grapples with the COVID-19 crisis by attempting to shut down whole cities and even countries, the Saudi Arabians and Russians have elected to lower the price per barrel of oil, and by a significant degree. The ostensible reason for the decision is that demand has been off sharply in China and other Asian states. That means there will be less oil purchased. In past years, this would prompt oil producers to limit output so as to create a shortage and thus force prices up. This time, the decision was to cut prices to maintain market share and ensure some kind of cash flow. There is a far bigger motivation at work, however.

Analysis: Since the start of the "shale revolution" in the U.S., the world of oil has been unalterably changed. The U.S. was the world's biggest consumer of oil and had long ago lost its status as a major oil producer. As recently as 2006, the U.S. imported some 60% of all the crude it used. That import percentage is now less than 10% and the U.S. has been selling crude oil to the Saudi refineries. The U.S. swiftly became the major global competitor to the OPEC states. This has not been popular. Various moves have been made to put pressure on the U.S. industry, but these have not been generally successful.

The Saudi oil sector can still make a profit if oil prices fall as low as $25 a barrel. Russia seems to be able to make money at $35. The oil shale operations in the U.S. need the price of oil to be at $50 or above to stay profitable. Slashing the price of oil puts immense pressure on the U.S. at a time when there is an oil glut. It is estimated that as much as 60% of the sector could well go out of business. Even the largest oil companies are getting pounded in the markets.

In the short term, this oil war will collapse the price of the commodity. That will translate into cheaper fuel prices. It may benefit the average driver to some degree, but it should be remembered that the crude oil cost is only a fraction of the cost of a gallon of gasoline. There are the costs of refining, transporting, distributing and marketing as well as the costs of the taxes imposed (and those vary considerably from state to state). The airline industry will see a bit of relief (and they could sure use it). The freight business will see a little relief as well. The longer-term issue is that at some point it is presumed demand will rise again. Many of the oil producers will have reduced production or have gone out of business altogether. That will lead to a big price hike as they scramble to catch up.

It is abundantly clear the Saudi/Russian tactic was deliberate—an attempt to take the U.S. down as an oil competitor. It doesn't mean the end of the U.S. as an oil producer or exporter, but it will certainly mean an immense strain on the U.S. system with many bankruptcies anticipated. This threat will not erode until demand recovers and the price per barrel of oil starts to rise again.

What Kind of Stimulus Works at This Point?
The central banks moved pretty quickly with rate cuts. The Fed shocked everyone with a half point reduction. Now there have been similar reactions from the European Central Bank (ECB) and others. The Trump White House has vacillated back and forth over a fiscal stimulus that may or may not include tax cuts and additional spending. The problem is the U.S. is already sitting on a massive debt and deficit, so any stimulus plan will add to this burden and make it all the more difficult to address the size of that obligation in the future. The most important question is whether any of this will actually help with the kind of problem facing the U.S. and the world right now.

Analysis: The short answer is that governments are mostly unable to affect this kind of economic crisis. The tactics under development right now are all predicated on a demand issue. That is usually the issue in a recession. The consumer has become reticent to spend because they are worried about their job security or financial position and business is worried about sales and revenue due to that reticence. The lowering of rates and the additional spending plus tax reduction pushes more money into the system. That is not the problem now. The crisis started with a supply chain collapse so there was less to buy. Now, it has become a shutdown crisis. How is the consumer and the business community supposed to spend its way out of a recession if there is no traveling allowed, people are not allowed to go to work, attend events, gather in crowds, send their kids to school or otherwise engage in the economy.

Tax Day Moves?
There is talk of delaying the deadline for filing taxes as a reaction to the COVID-19 virus. The ostensible reason is it gives people more time to deal with the crisis although it is hard to understand what sending your taxes to a preparer has to do with exposure. The more salient issue is the government is very likely to start sending IRS employees home in large numbers as outbreaks are suspected. The assumption is this will slow the entire process.

Analysis: In general, it is very likely almost all government services will soon be severely curtailed as there are plans in place to shut down whole segments of the government, and for an indefinite period of time.

Just When One Thinks It Can't Get Any More Ridiculous
I have been on the road the last couple of weeks—there are still meetings taking place although I have already had three cancellations. This has afforded me the opportunity to see how some people react. It is enough to make one want to give up on the human race! There are the many "creative" ways to wear a mask. Some cover their mouth but not their nose (do they understand these orifices are connected?). Some wore them like beanies. One guy wrapped himself in a black plastic bag while waiting for his flight. A woman with two kids was busy spraying them with household cleaner. I don't think that is too good for them.

Then there are the various ways that people greet now. Handshakes are out and fist bumps are in. Do people understand that whether you make a fist or not—it is still your hand? Do they think that viruses dislike the back of the hand and only live on the palm? Then there is the hand washing ritual. Even those that do it correctly immediately start touching the door, their luggage, clothes, handrails and whatever else comes their way. Some wear gloves and then feel free to sneeze or cough into their hands. Uhhh—the virus is on the OUTSIDE of the glove. I have no idea what the run on toilet paper is all about. Personally, I would rather stock up on wine.

Finally, there is the best reaction of all. A guy was walking through the airport in New Orleans in a football helmet attached to his coat collar with duct tape. Perhaps he assumed he would faint upon catching the virus and wanted to protect his head from the fall. I just wanted to know what he told the TSA.

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Monday, 30 March 2020