The Stars May Have Just Aligned For Another Risk-Off Episode

At the risk of overstating the case, Tuesday served as a reminder that despite the surprising durability of the bounce in risk assets from the March lows, downside catalysts are myriad.

Most obviously, Anthony Fauci told lawmakers that reopening the economy in a haphazard fashion chances higher infection rates and more deaths.

There’s little utility in recounting Fauci’s every word (delivered via video conference). He said nothing we don’t already know. And, indeed, that’s the point. Fauci is clearly concerned that some state and local politicians are flouting guidance from health officials not because states are somehow unaware of what that guidance entails. Rather, they are flouting it on purpose, at the implicit (and, in some cases explicit) urging of Donald Trump.

“I feel if [states and cities] reopen without hitting checkpoints], there is a real risk that you will trigger an outbreak that you might not be able to control”, Fauci warned.

“It will set you back, not only leading to [avoidable] suffering and death but it could even set you back on the road to… economic recovery”, he added.

That latter bit is a point that isn’t well understood in the White House or, perhaps more accurately, it is understood but it’s summarily dismissed, because if the economy isn’t revived by November, what happens after that is irrelevant to Trump. And let’s face it, he would hardly be the first president to put lives in jeopardy in the interest of political expediency.

Fed officials largely echoed Fauci on Tuesday.

“The second quarter data will be brutally painful”, Philadelphia Fed boss Patrick Harker said, during a virtual discussion hosted by the Delaware State Chamber of Commerce. “What happens after that to a large extent depends on how the virus moves through our society, and our reaction to it in terms of balancing stay-at-home policies versus an intelligent – and I want to stress, intelligent – reopening”, he added, before delivering the following poignant message:

What I worry about though is if we don’t take our time to open intelligently — and again, I’m not saying not reopen, but open intelligently — that second wave could be very painful. In that case, again, consumers will vote with their feet and not show up, and we could be back in a bad situation.

There is a new reality we’re going to be facing coming out of this, like we have with every other crisis this country has gone through. The idea that we’re just going to go back to the way it was, that may be true for some people, but it will not be true for everyone.

The overarching point is that rational people believe reopening the economy in slapdash fashion in the interest of speeding the recovery may well accomplish the exact opposite.

I have repeatedly stressed that the worst outcome for investor psychology would be a hasty reopen followed by another forced shutdown.

We’re already seeing the re-emergence of the virus in South Korea, and also in Wuhan, where it all started. That’s a cautionary tale, and one US politicians would do well to heed.

Meanwhile, GOP lawmakers are pressing the issue on sanctions against China in connection with a purported “coverup”. The new bill – championed by Lindsey Graham – came less than 24 hours after Trump moved to restrict a government employee retirement fund from investing in Chinese stocks.

Read more: Lindsey Graham Presses China Sanctions. Demands Beijing ‘Provide Full Accounting’ Of Coronavirus Outbreak

This is part and parcel of what amount to reparations demands, and if the likes of Graham push the envelope too far, and Trump goes along with it, Beijing will push back, either through casting doubt on the trade agreement, sending a message via weaker CNY fixes, or both. And that’s just what’s on the menu in the early stages of any “trade war 2.0”.

I would note that Trump has a long history of siding with autocrats over Congress when push comes to shove, especially if he thinks the economy is at risk or his personal interests are at stake. You saw that when he and Mike Pompeo rebuffed lawmakers on multiple efforts to hold Mohammed Bin Salman accountable for the murder of dissident journalist Jamal Khashoggi.

This is a different ball game, but if Trump gets the idea that holding Xi to account will result in a market outcome that’s likely to deal a serious blow to his reelection chances, he would not hesitate to stonewall Congress or otherwise conjure an excuse to water down whatever punitive measures lawmakers have in mind. Recall that he only reluctantly went along with the push to support the Hong Kong protests last year.

Not to put too fine a point on it, but the PBoC knows they can trigger a global selloff at any time simply by telegraphing a tolerance for a sharply weaker yuan. Trump knows that all too well. As we get closer to the election, the president will need to balance that risk against any assumed political points he can score with his base by playing up the same “blame China” mantra which helped get him elected.

These two concerns – i.e., the worry that the rush to reopen the economy could be met with a second wave of infections and the prospect of heightened tensions with China – pushed US equities sharply lower Tuesday, even as Nancy Pelosi outlined Democrats’ proposal for generous new virus relief. The VIX rose the most in weeks. Vol-of-vol jumped the most since March 16.

The losses were tame by recent standards, but nevertheless, the mood soured materially.

Whether or not the bad taste lingers will depend, as ever, on the evolution of the virus, but now also on China’s response to threats emanating from Washington.