Daily Comment (November 14, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It was a very quiet overnight session.  Better Eurozone growth has lifted the EUR, while global equity markets continue to struggle in what looks to us like profit taking.  PPI (see below) did come in higher than forecast; shorter duration Treasury yields rose.  Here is what we are watching this morning:

May will allow Parliament to have a say on Brexit: Initially, PM May was not going to allow MPs to add amendments to the Brexit bill.  However, in her politically weakened position she has bowed to pressure, primarily from pro-EU MPs, to have a full vote and allow amendments to be voted on as well.  It isn’t clear how this will play out.  Although the May government insists the vote can’t halt Brexit, it does seem possible that Parliament could scuttle Brexit.  May’s plan is to offer two separate bills, one that is an actual vote on Brexit and another that votes on the specifics of the process, with the hopes that party discipline will ensure Brexit occurs and then allow “meaningful but essentially meaningless” votes on the second bill.  If May had a strong majority government and Tories feared her, this would probably work.  However, this isn’t the case.  If Parliament votes to defeat the Brexit bill, it isn’t obvious what would happen.  The EU is committed to the U.K.’s exit from the organization and Parliament’s inability to pass a bill shouldn’t prevent the EU from expelling Britain.  The exit was officially triggered last year.  Brexit without a plan leads to a chaotic situation.  On the other hand, we would not be shocked if Parliament blocks Brexit and the EU (read: Merkel) allows the U.K. to stay in the EU fold.  In any case, this is turning into a mess; at the same time, the GBP would likely soar if the U.K. ends up staying in the EU.

Venezuela in default: S&P has confirmed that Venezuela missed two interest payments within the 30-day grace period on its sovereign debt, on issues maturing in 2019 and 2024.  This rating agency is the first to declare the nation in default.  The rating on these two particular bonds is now “D,” down from “CC,” and the long-term foreign currency sovereign credit rating is now “SD,” or selective default, down from “CC.”  Although Venezuela’s default was really just a matter of time, there isn’t an obvious path of restructuring.  We will be closely watching how Caracas handles its debt to China; we suspect it will default on that debt last, but eventually it will likely default on that debt, too.  Complicating matters for bondholders is that Venezuela does have assets outside the country that could be seized by creditors (CITGO, for example).  We do note that the International Swaps and Derivatives Association has delayed a decision on default; if this group agrees with S&P, it would likely trigger the payment of credit default swaps.

Another governor?  There are reports the president is considering nominating Michelle Bowman, a state bank commissioner from Kansas.  She was formerly a banker with Farmers and Drovers[1] Bank in Council Grove, KS, with about seven years of banking and bank regulatory experience.  She has a BA from Kansas University[2] and a JD from Washburn University in Topeka, KS.  She does have rather extensive experience in Washington.  She worked with Sen. Dole and was counsel to the House Committee on Transportation and Infrastructure and the Committee on Government Reform and Oversight.  She was also attached to FEMA and was deputy assistant to Homeland Security Secretary Tom Ridge.  One of the governor slots is reserved for a community banker; it has been difficult to fill this position because state regulators are usually not well liked by bankers and most community bankers don’t want to leave their posts for a government job.  Although her banking experience is a bit light, her Washington experience will probably allow her to be easily confirmed.  Historically, this position tends to vote with the chair and its primary contribution is to offer “ground level” information from the small banking sector to the FOMC.

IEA bullish on shale: In its most recent report, the IEA projects strong shale growth in the U.S., leading to total liquids production of 13 mbpd by 2025.  The Paris-based group projects that the U.S. will account for 80% of the increase in global oil and liquids supply over that time frame.   Interestingly enough, recent reports from the maturing oil shale fields in Texas paint a much less favorable supply story.  The EIA (the U.S. data arm of the DOE) says that December U.S. shale production will rise to 6.1 mbpd, a new high.  However, the EIA also reports that the legacy decline rate has reached 83.3%, meaning that 83.3% of gross new production is offsetting declines in older wells.  In May, this number was 70.5, indicating that production growth is slowing.  Industry reports suggest that increasing proppants and longer well laterals in the Permian basin aren’t boosting output.  The bottom line is that macro energy analysis appears to be holding that growth will continue at almost a linear pace, whereas the micro reports suggest that if such growth is going to occur it will likely require higher prices.

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[1] A drover is a person who moves animals over long distances.

[2] Go Jayhawks!