by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are a bit weaker this morning—equities are signaling a softer opening while Treasuries are continuing to take on water.  There is a lot going on; this morning we are focused on the following issues.

Xi sets Standing Committee: The new Standing Committee of the Politburo is led by General Secretary Xi.  Only LI Keqiang was retained from the last committee.  The new members include Li Zhanshu, who was Xi’s chief of staff and a close ally.  He is considered an orthodox Marxist and will support Xi’s attempts to rekindle Marxist indoctrination.  Wang Yang is from the Youth League (the other main faction is represented by Xi—the “princelings,” or sons of the early revolutionaries) and was a target of discrimination by the disgraced Bo Xilai.  Wang Huning is a political theoretician who supports “neo-authoritarianism,” a platform that best exemplifies Xi’s governance.  Zhao Leji is perhaps the most obscure of the new members who has mostly had a competent, but uninspiring, career.  He replaces Xi loyalist Wang Qishan as head of the anti-corruption bureaucracy.  Han Zheng was a municipal administrator in Shanghai and rounds out the group.  Overall, there is no one on this roster who is a clear heir apparent for Xi, and none will be young enough in five years to serve a subsequent five years, a requirement for heir status.  As we noted earlier this week, Xi will be required to give up the presidency in five years due to term limit law.  However, he will very likely retain the position of general secretary.  We would view the group as mostly loyalists but all appear competent.  The fact that Xi didn’t pack the committee with diehard loyalists suggests he feels very confident in his power.

Ships at sea: Although they are not in position to conduct operations against North Korea, the U.S. is moving two carrier strike groups (CSG), the CSG Nimitz and CSG Theodore Roosevelt, into the western Pacific.  The Nimitz was in the Middle East (part of the U.S. 5^th Fleet) but will be joining the 7^th Fleet in the Pacific.  Although not entirely necessary, the U.S. usually prefers to have three carrier groups in a region if it is considering military operations because three can conduct round the clock sorties on a target.  We also note that North Korea has tested a solid fuel rocket engine; North Korea has tended to use liquid fuel missiles, which are easier to manage but are vulnerable to pre-emptive strikes during the fueling period.  Going to solid fuel allows North Korea to launch missiles with less preparation, reducing the chances of a “left of launch” strike.  Meanwhile, NBC[1] is reporting that Joseph Yun, the top U.S. diplomat to North Korea, is warning members of Congress that North Korea refuses to engage in talks, apparently upset by President Trump’s characterizations of Kim Jong-un.  Yun suggested that diplomatic efforts are on their “last legs” and told lawmakers the White House is unresponsive to his worries.  President Trump will make a visit to the region in early November, a 12-day trip.  He is creating something of a stir by refusing to attend the East Asia Summit on November 14^th; U.S. presidents usually attend such events as a show of Pacific leadership.  Although the attendees of the summit will be disappointed, the other parts of the president’s visit should indicate that the U.S. remains a Pacific power.  We monitor the region closely; bringing three carrier groups together is a worrying development that may simply be a show of force.  Nevertheless, having these assets in place does give the president a platform to launch a war with North Korea.

Iraqi Kurds: On the one hand, the Iraqi Kurdish government has offered to freeze progress toward independence in a bid to ease tensions.  At the same time, Kurdish and Iraqi forces clashed yesterday.  Both sides accused the other of an ambush, although it does appear the Kurds got the better of Iraqi forces.

Fed update: In a meeting with the GOP senators yesterday, the president had a show of hands for the Fed chair position.  It appears that John Taylor was the preferred candidate, although Jerome Powell also received some votes.  Yellen noticeably did not.  However, we do note that President Trump may be Chair Yellen’s strongest advocate,[2] if for no other reason than the equity markets would cheer the decision.  President Trump has pointed to the strong equity markets as confirmation of his successful administration; if picking Taylor were to trigger a sell-off (and it very well could), then Trump would probably want to avoid this.  We still think this is a race between Powell and Taylor, but reappointing Yellen does hold some positive features for the president.

GOP mutiny: Senators Flake and Corker have indicated they won’t run for re-election and have come out with harsh criticisms of the president.  Flake was almost certain to face defeat in the primary.  The GOP is turning populist and establishment Republicans are being forced, at a minimum, to acquiesce to the president.  For senators, especially, criticizing the president looks like a path to becoming a private citizen.  The key unknown is how these senators will vote on taxes.  Corker is a deficit hawk and Flake probably leans that way, and there is little chance the tax plan (it’s no longer being called reform) will be revenue neutral.  If Flake and Corker decide to vote against the plan, the GOP is at 50/50 in the Senate.  Losing any other senators will doom the process.  If tax cuts fail to materialize, the failure could have significantly adverse effects on the GOP at the mid-term elections.

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[1] https://www.nbcnews.com/news/north-korea/lack-talks-north-korea-sounds-alarms-capitol-hill-n813951?utm_source=Sailthru&utm_medium=email&utm_campaign=New%20Campaign&utm_term=%2ASituation%20Report

[2] https://www.bloomberg.com/news/articles/2017-10-24/yellen-is-said-to-find-unlikely-advocate-at-white-house-trump