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

[Posted: 9:30 AM EDT]

(NB: We will publish an abbreviated report on Friday.  Because of the all-important labor market data, we wanted to provide our coverage of that issue and the usual energy market update as well.  Additionally, the AAW will be updated.  But the headings in yellow on Friday will not be updated.)

There is a lot of central bank news today.  The media is abuzz over the July 4^th parade.  U.S. and European equities are doing well this morning.  Here is what we are watching today:

The EU returns to the back room:  In the last election cycle, the EU built an open process for choosing new leaders, ending a backroom process where France and Germany would essentially make the selections.  The open process failed in this cycle to settle on new leaders and so the EU presidents and chancellors returned to the backrooms to make their picks.  Ursula von der Leyen, the German defense minister, was the selection for EU Commissioner.  She is a somewhat controversial pick and still requires MEP approval.  Chancellor Merkel abstained from voting for her; there is speculation that her coalition partner, the Social Democrats, were still smarting from the rejection of a socialist for the commissioner role.  However, it is also quite possible that Merkel is quietly cheering her selection because it removes a potential competitor for her role.  Although Merkel intends to leave office when her term ends, one can never be too sure.   At the same time, there are increasing concerns about the chancellor’s health, which may speed her exit from public life.

The other major announcement was that Christine Lagarde was named to replace Mario Draghi as president of the ECB.  Lagarde has deep experience in managing financial crises—she was the French finance minister during the 2008 Great Financial Crisis.  In addition, she can clearly manage large public sector entities, as shown by her management of the IMF.  However, she isn’t an economist and thus we would not expect her to develop any new plans to what Draghi has already put in place.  Needless to say, the French are happy and policymakers are pleased that they won’t be dealing with a German hawk as ECB president.

Meanwhile, one thing Lagarde won’t have to deal with is a fiscal crisis in Italy.  A deal between Rome and Brussels was made today.

Fed Governors:  President Trump announced two candidates for the two open spots on the Fed’s Board of Governors.  Christopher Waller, the director of research for the St. Louis FRB and Judy Shelton, were named as candidates.  Waller is a more traditional pick; Jim Bullard, the President of the St. Louis FRB, was reportedly asked about a governor’s spot but he demurred.  Selecting Waller is probably the next best thing as we suspect Waller reflects the dovish views of his boss.  Shelton is much more controversial.  She has argued for a return to the gold standard as a way to prevent competitive devaluations.  The gold standard was part of the supply side economist toolbox, but it was never seriously considered for policy.  There are a plethora of reasons why the gold standard would be problematic, the biggest is that the gold standard failed when suffrage expanded after WWI. The gold standard requires the cost of policy adjustment to be borne by labor; when common people got to vote, they opposed such policies.  In addition, the gold standard tends to be a hawkish position, which seems to counter what the president wants from policymakers.  It is possible that President Trump believes Shelton will be politically reliable but there is no guarantee that is the case as she could prove to be an ideologue and a hawk.

We expect the Senate to easily approve Waller, adding a dove to the policy vote.  Shelton will likely have a more difficult time with her approval.   It should also be noted that the Senate probably takes around six months to approve Fed governor nominations and so by the time either or both would be approved, the easing might be done.

A Russian military accident:  A Russian submarine had a fire earlier this week, killing all on board.  It is unclear exactly what happened, and we will continue to monitor this situation.

Iran:  Tehran has announced it will expand its enrichment activities in the very near future.  Iran continues to evade sanctions but it is clear it’s economy is suffering.  For now, we expect Iran to stall on any potential negotiations until the 2020 elections; if Trump is reelected, we would expect talks to occur shortly thereafter.  If a Democrat wins, look for the JCOPA to return.

Japan:  Despite the general momentum toward a re-loosening of monetary policy around the world, it’s important to remember that there is also a significant subset of policymakers who want to delay or minimize any rate cuts.  For example, Bank of Japan board member Yukitoshi Funo said today that Japan doesn’t need to loosen policy right now because a moderate economic acceleration is expected later this year.  That comes as U.S. monetary policy officials like Cleveland Fed President Mester said this week that they’re still not yet convinced that rate cuts are necessary.  In other news from the Land of the Rising Sun, Japanese officials said they were considering making more products subject to restrictions on exports to South Korea beyond the high-tech goods announced earlier this week.  The move is in retaliation against South Korean demands for compensation for forced labor by the Japanese during World War II.

India:  Monsoon rains in the region around Mumbai have reached the highest level in more than a decade, leaving more than 80 people dead, partially closing the airport, raising concerns about crops, and putting pressure on Prime Minister Modi to improve infrastructure.

Brazil:  A special committee of Brazil’s Congress looks set to pass a watered down version of President Bolsonaro’s proposed pension reform, which would then allow the bill to be presented to the full chamber for a vote.  The amendments reduce the projected savings from the bill to approximately $245 billion over the next ten years, but that still is widely seen as insufficient to avert a fiscal crisis as the country’s pension costs continue to explode.  The proposed pension reform has been a key reason for the rise in Brazilian stocks since Bolsonaro’s election.

UAE/Yemen:  Western officials say the United Arab Emirates have been pulling tanks, attack helicopters, and other military assets out of Yemen, as it tries to extricate itself from the Saudi-led campaign against the country’s Iran-backed Houthi rebels.  The sources say one reason for the UAE’s action is fear that its continued participation in the campaign could spark retaliatory strikes from Iran.

Australia looks at tax cuts:  The conservative government is close to passing a major tax cut.  This cut might give the Australian markets a boost.

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

[Posted: 9:30 AM EDT] We are seeing quiet financial markets this morning after a strong equity rally faded throughout the day yesterday.  Hong Kong, a new threat of tariffs on the EU and the Iran nuclear violation are topping the news.  Also, an apology—we forgot to mention one of our favorite holidays yesterday.  July 1 is “Bobby Bonilla Day,” the day the Mets send Mr. Bonilla a check for $1.19 mm as part of a deferred compensation plan that was affected by the Bernie Madoff scandal.  Here is what we are watching today:

Hong Kong: This is starting to get ugly.  Protesters broke into the legislature building yesterday and defaced the interior before being forcibly removed by security forces.  Carrie Lam has condemned the violence, but the real issue is the patience of Chairman Xi.  Our concern is that Beijing isn’t going to tolerate these protests much longer and may force a serious crackdown on the former British colony.  There is some evidence to suggest the protest movement itself is divided, that a smaller group of protesters invaded the legislature but that action wasn’t supported by a broader group.  The protests do not seem to be supported in the mainland all that much.

One of the lessons from Tiananmen Square was that the West will protest and put China in a sort of geopolitical “penalty box” for a crackdown, but ruptures are not permanent.  Simply put, the interests of doing business with China will weigh more than defending the civil rights of Hong Kong residents.  The protesters are clear representation of the frustration and fears that Hong Kong residents have of encroachment from the mainland.  However, as much as they would prefer otherwise, this encroachment is likely to continue.

If Beijing deploys troops and forcibly restores order, there will be an immediate pullback in Chinese equities.  Protests in the West will be loud; stern letters will be written.  Even sanctions might result.  But, no foreign government is going to come to the aid of Hong Kong against the mainland.  We suspect that capital flight from Hong Kong will increase.  Taiwan will view what is happening in Hong Kong as a warning that it cannot allow the PRC to take over; look for a strong lobbying effort from Taipei to woo the U.S. to support its continued separation from China.

Iran breech: The U.N. has confirmed that Iran finally increased its uranium enrichment to violate the JCPOA and admitted to it.  The action, by itself, isn’t all that significant.  The level of enrichment is consistent with nuclear power but not nuclear weapons.  However, the symbolism is clear and the real test now comes from Europe.  The Europeans don’t want to completely kill JCPOA, or at least be seen as doing so.  Nevertheless, it is hard for the EU to continue to support an arrangement where the U.S. is applying sanctions while Iran is increasing enrichment.  European leaders are trying to maintain order in a situation that has become disorderly.

EU tariffs?  The U.S. is considering imposing additional tariffs on $4.0 bn of goods exported to the U.S. from Europe.  The action would be in retaliation to EU aircraft subsidies.  Currently, the U.S. has imposed tariffs on $21 bn of goods over this issue.  Although the financial market’s focus has been on China, trade frictions with the EU continue at a “slow boil.”

Israel missile strikes: The IDF carried out missile strikes in Syrian territory[1] against suspected Iranian and Hezbollah targets.  The broader geopolitical implications are interesting.  Syria is managing the influence of two important outside powers, Iran and Russia.  Israel wants to eliminate the influence of the former; interestingly enough, Moscow probably supports that goal.  Thus, the Russians, who might be able to prevent such airstrikes, clearly allow them to occur probably because they don’t want Iran in Syria either.  At the same time, Russia doesn’t want a direct confrontation with the Islamic Revolutionary Guard Corps or Hezbollah; both are more familiar with conditions on the ground and would draw Russia into a protracted asymmetric war that is probably unwinnable.  As a result, Russia will likely try to at least give the appearance of being on the sidelines, while quietly cheering Israel’s actions against Iran and its allies in Syria.

What to do with Huawei (002502, CNY, 3.59)?  Now that the U.S. has granted Huawei a reprieve, the bigger issue is what will policymakers do with the company?  In the short run, the company is a major customer of American chipmakers, who lobbied hard to see export controls eased.  These companies will continue to try to influence policymakers to continue to do business with the company.  At the same time, Huawei appears to be a significant commercial and national security threat and moving to address this issue would be the natural progression.  Often, the short-run/long-run tensions yield to the former in capitalist democracies.  We will be watching to see how this plays out.

And, finally: Yesterday, we noted that European leaders appeared to have a deal for the new EU commissioner.  That deal unraveled in what now looks like a major political blow to Chancellor Merkel.  Overall, this is another indication that the German leader is losing power, putting Europe into a situation of uncertainty.

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[1] Which, in itself is something of a misnomer, in that what was “Syria” really no longer exists.

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

[Posted: 9:30 AM EDT] Global equity markets are sharply higher in a relief rally from the G-20 meeting.  Oil is up on OPEC+ news.  Although it’s not exactly official yet, we are unofficially enjoying the longest economic expansion in U.S. history.[1]  Here is what we are watching today:

The G-20: We pretty much got what we expected from the G-20.  Presidents Trump and Xi agreed to a set of items that were mostly anticipated.  Huawei (002502, CNY 3.59) got a modest reprieve; it will be allowed to trade with the U.S., although there will be restrictions.  The U.S. agreed to not implement another round of tariffs.  China agreed to buy some soybeans.  All this was anticipated but, despite the expectations, we are seeing a strong risk-on rally today.  Equities and the dollar are higher, while gold and Treasury prices are lower.  On the one hand, not much was resolved.  On the other hand, it clearly could have been much worse.

The G-20 did manage to agree on a communiqué but only because it didn’t promise much.

One of the benefits of the G-20, despite its unwieldy nature, is that side meetings can occur among leaders.  EU leaders looked like they had put together a plan to end the leadership fight over the European Commission.  Chancellor Merkel agreed to give up the commissioner job to Frans Timmerman, a Dutch center-left socialist.  Manfred Weber would get the European Parliament presidency as a consolation prize.  A Frenchmen would get the ECB presidency; a dark horse candidate could be Christine Legarde, the current managing director of the IMF.  However, it appears the deal fell apart on opposition from the smaller EU nations.

Since I was in the neighborhood: In a bold move, President Trump made history yesterday by being the first sitting president to cross into the demilitarized zone separating North and South Korea.  He met Kim Jong-un and promised to restart nuclear talks.  There is a proposal that would halt new weapons but allow the current arsenal to remain in place.  Perhaps the most telling item from this visit is that National Security Director Bolton was apparently in Mongolia.  Bolton has been a target of Pyongyang’s ire, so the optics of sending him to exile are significant.

Historic trade deal: The EU and Mercosur, the South American trading bloc, has reached a trade agreement.  Mercosur is a trading zone made up of Argentina, Brazil, Paraguay and Uruguay.  Something that should give the U.K. pause is that negotiations for this deal have been going on for two decades.  If the British think the EU will make a trade deal with them quickly they are probably mistaken.  A lesser free trade deal was also finalized with Vietnam.

OPEC+: Russia and Saudi Arabia have reached an agreement to extend the current output restrictions for another six months.  Although it is possible the rest of OPEC might balk, it isn’t likely.  Iran will probably complain but it has little influence on the final decision since its exports have collapsed.

Iran: Friday’s talks with the EU were not enough to forestall Iran from increasing uranium enrichment.  We expect tensions to continue to rise.

Something to watch: President Trump indicated that he wants to change the U.S./Japan security agreement, a plan that was crafted after WWII.  Under that plan, Japan agreed to not project offensive military power and only have forces for self-defense, and the U.S. agreed to guarantee its external security.  The point of the plan was two-fold; Japan, a leading industrial power, had almost no natural resources and is heavily dependent on secure sea lanes for raw materials.  The rest of Asia was always worried about Japan’s power projection to secure these resources.  By taking over Japan’s security, it no longer needed to worry about being cut off from raw materials and other Asian nations no longer had to fear Japan’s power.  The arrangement has prevented a mass industrialized war from occurring in Asia.[2]  Changing this arrangement could open the door to pre-WWII conditions that would likely destabilize Asia.

Venezuela: There were two items of note.  First, the U.S. has extended sanctions to the son of Maduro.  Second, the number of Venezuelans fleeing the country continues to increase; the Organization of American States warns that the total number of Venezuelan refugees could reach as high as 8.2 mm by the end of 2020.  That volume would make the Venezuelan refugee crisis larger than the Syrian crisis.  So far, the U.S. hasn’t seen a major influx of Venezuelans.  It is hard to imagine that we won’t at some point.

Hong Kong protests: Protests have developed on the 22^nd anniversary of the handover of Hong Kong from the British to China.  The protests have become violent; if they continue, we will be watching closely for Beijing’s reaction.  You can follow along here.

Protests in Sudan: Protests have also developed in Khartoum against the provisional military government in Sudan.  The potential for a crackdown is high.

A spat with Switzerland: Until today, Swiss equities could be traded on EU exchanges due to a process called equivalency.  But, the agreement has expired and now such stocks can only be exchanged on the Swiss bourse.  The same shares cannot be traded on European exchanges.  The root of the problem is a dispute between the EU and Switzerland over political ties.  So far, the shares are trading without incident but the issue could emerge later this year if we get a hard Brexit.  If hard Brexit occurs, British companies may not be able to trade on EU exchanges after Halloween.

Fed talk: Although we have no additional speakers today, Vice Chair Clarida did talk early this morning in Finland.  As expected, he suggested the Fed would “act as appropriate.”  Richmond FRB President Barkin cooled expectations for a rate cut, suggesting such a move might be premature.

Turkey and Libya: Turkey has accused forces allied with Khalifa Hifter of detaining six Turkish nationals.  In addition, these same Libyan forces claimed to have destroyed a Turkish drone parked on the tarmac of Tripoli’s airport.  Outside forces have been turning Libya into a proxy conflict.  Turkey has been siding with Islamist forces in the western part of the state, while the UAE and others have been supporting Hifter.

Odds and ends: Taiwan’s president is scheduled to visit the U.S. later this month, an event certain to upset Beijing.  African Swine Fever may be killing much faster than reported.

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[1] There are two caveats.  First, the NBER, which dates the business cycle, doesn’t establish when recessions start for months after one begins.  Thus, if a downturn starts soon, the NBER could decide that a recession started in June, meaning we are not at a record.  Second, the dating of cycles didn’t begin until 1850, so, strictly speaking, a longer expansion may have occurred at some point between 1789 and 1850.

[2] The Vietnam War, though significant, was not a mass industrial war similar to WWI and WWII.

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

[Posted: 9:30 AM EDT] U.S. equity markets are higher this morning on hopes of a trade deal at this weekend’s G-20 meeting.  The second leg of the first Democratic debate was held last night.  Vice President Biden had a tough night; there are concerns that if Biden falters the odds of a left-wing populist winning rise, which is potentially a negative for health care.  Here is what we are watching today:

The G-20: We have covered our thoughts on the G-20 over the past few days and don’t have a whole lot more to add.  The key meeting of the weekend occurs at 10:30 EDT tonight when Trump and Xi hold their meeting.  Consensus is that there will be a ceasefire; no new tariffs and promises to continue talking will be the outcome.  U.S. hardliners on China are worried that the president could negotiate away the stiff sanctions on Huawei (002502, CNY 3.44).  So far, President Trump has struck an optimist tone, not only with China, but with other free trade talks currently underway.  The U.S. and Japan have agreed to accelerate talks, for example.  In addition, Trump and Chancellor Merkel (who has been having her own problems recently) seemed to get along rather well.  At the same time, the G-20 is deeply fractured; it is possible they won’t be able to put together a joint communiqué at the end of the meeting.  We also note that Peter Navarro was a late add to President Trump’s entourage.  Navarro is arguably the most hawkish member of the president’s advisors on Chinese trade and having him at the meeting might signal a harder stance than the markets are currently discounting.  We also note that the U.S. and Turkey will hold leader talks at this meeting.  This may be the last chance for Erdogan to avoid losing access to the F-35 fighter and undermining NATO.

Iran: President Trump made some hawkish statements on Iran, suggesting that a military conflict would not last long.  That notion is probably wishful thinking.  It does appear the U.S. is considering tanker escorts and an expanded monitoring system, which makes sense.  Meanwhile, the EU is preparing to launch its payments system that would allow Iran to trade with it.  So far, it looks like it won’t lead to a significant improvement in Iran’s faltering economy.   The EU is trying to bring about enough trade to keep Iran in compliance with the current Iran deal and avoid upsetting the U.S., a tough line to hew.  Although nothing too significant is happening today, we would expect traders to cover shorts into the weekend, which could support oil prices.

Bank stress tests: The Fed held its bank stress tests.  All got a participation trophy.

Trump and the dollar: President Trump said today that he wanted the Fed to ease in order to weaken the dollar.  Chair Powell correctly noted that dollar policy isn’t the purview of the Fed.  This discussion continues to frame a growing narrative that would support a “Plaza Accord II,” albeit a unilateral one, where the U.S. purposely depresses the dollar for trade advantage.  We also note the BOJ is considering easing policy, which could lead to a weaker JPY and further anger the White House.

Capital gain cut?  The Trump administration is apparently mulling the indexing of capital gains to inflation.  Although this would infuriate the populists on both wings, it would be quietly cheered by the establishment.

Odds and ends: Tensions are rising in North Africa again.  There have been terror attacks in Tunisia and simmering issues in Algeria.  The U.S. is increasing its military investments in Iceland.  Cocaine production is soaring.  Russell indexes rebalance today; expect lots of equity action on today’s close.

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

[Posted: 9:30 AM EDT] U.S. equity markets are higher this morning on hopes of a trade deal at this weekend’s G-20 meeting.  The first Democratic debate was held last night; although there is much analysis out in the media, keep in mind that this is like analyzing spring training.  A debate with 20 participants doesn’t tell anyone very much.  Here is what we are watching today:

G-20: Optimism is coming from reports out of China that the U.S. and China have a deal.  The U.S. will not implement further tariffs and will not prevent exports to Huawei (002502, CNY 3.61).   In addition, the U.S. will not demand additional exports from China.  Reports suggest that the delay of tariffs was China’s demand for a meeting to occur.

If the reports are accurate, it looks like a major concession from the U.S.  We note that the tone coming from the White House doesn’t line up with what we are hearing from China.  The president is threatening new tariffs on China, for example.  However, the new tariffs may not be the 25% level initially proposed and may only be implemented if the talks fail, which, in itself, may be hard to determine.

We expect both nations to issue their own statements.  It is quite possible that we end up with strategic ambiguity—both sides say what appears to be the same thing, but each interpret their statements differently.  However, the tone coming out from China seems to suggest U.S. capitulation.  It would be surprising if the U.S. caves to China at this point.  Thus, the optimism we are seeing this morning may not hold.

Presidents Trump and Xi meet Saturday morning in Osaka (a 13 hours difference from New York).  As a result, by Saturday morning in the U.S., we should know the outcome of the meeting.

In other news in front of the weekend, President Trump criticized the EU for its treatment of tech firms.  He also questioned the U.S./Japan security alliance.  French President Macron indicated that action on climate change is a “red line” and he wouldn’t sign a statement without reference to action on this issue.

The other issue that bears monitoring is the U.S./Iran situation.  Other than Saudi Arabia, the rest of the G-20 will oppose the U.S. position on Iran.  We doubt this will get much airplay, but it might be part of bilateral meetings.

The problem with trade impediments: Yesterday, we noted the problem with trade impediments.  Essentially, it comes down to the issue of arbitrage.  Arbitrage is one of the oldest methods of making risk-free money.  If one can buy in one market at a lower cost and sell the same good for more money elsewhere, it’s a good thing!  Under free markets, arbitrage is usually ephemeral; others notice it and the advantage quickly evaporates.  However, if there are regulations or trade barriers in place, the likelihood of the arbitrage holding for a longer period of time increases.  Of course, there are potential legal risks for the party trying to perform the arbitrage.  There are additional articles today about firms managing to avoid tariffs through various methods including transhipments—sending goods from the tariffed nation to a neutral nation and then shipping from the neutral nation to the U.S.  The longer tariffs are in place, the more that this sort of activity will occur and undermine the impact of tariffs.  Again, at some point, we expect President Trump to finally realize that the best way to get what he wants is to crater the dollar. 

 Iran: As noted earlier in the week, Iran is very close to breaking the nuclear enrichment threshold. The EU is looking at a plan to give Tehran a lifeline and avoid breaking the nuclear deal.  Additionally, China continues to purchase Iranian oil.  Iran continues to signal defiance.

Brexit: Boris Johnson is pledging “do or die” for Brexit.  The vote for PM occurs next month, and will be decided by a small subset of the U.K. voting population.

Odds and ends:  Tensions are high in Indonesia as the highest court determines if the last presidential election was valid.  The PM of the Czech Republic survived a no-confidence vote.

Energy update:  Crude oil inventories fell 12.8 mb last week compared to the forecast drop of 2.9 mb.

In the details, refining activity rose 0.3%, below the 0.4% rise forecast.   Estimated U.S. oil production fell by 0.1 mbpd to 12.1 mbpd.  Crude oil imports fell 0.8 mbpd, while exports increased 0.3 mbpd.  The combination of rising refinery demand and a modest drop in production, along with rising imports, all supported the larger than expected drawdown in inventories.

This is the seasonal pattern chart for commercial crude oil inventories.  We are now well within the spring/summer withdrawal season.  This week’s decline is consistent with the seasonal pattern, but the decline was much faster than normal.  After contra-seasonal increases from March to June, we are now seeing a reversal in inventory accumulation.  This drop in stockpiles is supportive for oil prices.

Based on oil inventories alone, fair value for crude oil is $51.52.   Based on the EUR, fair value is $53.28.  Using both independent variables, a more complete way of looking at the data, fair value is $51.76.  Oil prices have based and are now working higher, bolstered by tensions with Iran.  The reversal in inventory patterns is also supportive and helping to lift prices.

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

[Posted: 9:30 AM EDT] U.S. equity markets are higher this morning after taking a tumble yesterday.  Optimism on trade is lifting domestic equity futures.  The Democrats start their debates tonight and Robert Mueller will publicly testify.  Consumer confidence data deserves a second look.  Here is what we are watching today:

G-20: Treasury Secretary Mnuchin gave the markets hope this morning after indicating a deal is “90% complete.”  This comment has raised hopes this morning, but it should be noted that he made similar comments in May.  Essentially, talks stalled in early May after the U.S. accused China of reneging on the agreement.  Expectations for this weekend’s trade talks are mostly about preventing additional tariffs from being implemented, a temporary ceasefire.  However, the odds of a full agreement are nearly zero.  Still, this morning’s rally does show that the financial markets are focused on this issue and want to see a full-blown trade conflict avoided.

The problem with trade impediments: Arbitrage is one of the oldest methods of making risk-free money.  If one can buy in one market at a lower cost and sell the same good for more money elsewhere, it’s a good thing!  Under free markets, arbitrage is usually ephemeral; others notice it and the advantage quickly evaporates.  But, if there are regulations or trade barriers in place, the likelihood of the arbitrage holding for a longer period of time increases.  Of course, there are potential legal risks for the party trying to perform the arbitrage.  We note this morning that some tech firms have apparently figured out a way to skirt the trade ban with Huawei (002502, CNY, 3.53).  Although the companies involved may not have violated any laws, their actions do raise the question of compliance with the spirit of the regulations.  One of the problems with creating arbitrage opportunities with regulation is that they encourage ways to capture the gains.

The Fed—when doves cry: There is dovishness and then there is real dovishness.  First, Chair Powell gave a speech with few surprises, especially in light of his press conference.  He noted risks to the economy and worries about low inflation.  However, he didn’t clearly signal a rate cut and hinted at the problems of political pressure, and these issues spooked the equity market.  But, the real hit came from St. Louis FRB Bullard, who dissented at the last meeting, wanting the FOMC to reduce rates.  Bullard suggested that although he supports a rate reduction, he believes only a 25 bps move is warranted at this time.  The market clearly wanted more.  In response, markets reacted as one would expect—the yield curve flattened and equities slumped.  Does this mean the Fed is changing course?  Not really.  It’s just that the financial markets have gotten a bit ahead of themselves.  On the other hand, if the economy decelerates further, a more aggressive cut might make sense.

A sub-2% 10-year: The 10-year T-note yield fell below 2% yesterday.  This is the lowest rate since 2016.

Chair Powell is walking a delicate line; he is clearly getting tremendous pressure from the White House on policy and he fears the loss of institutional independence.  One way he appears to be dealing with this problem is by reducing transparency.  We are big fans of this idea; transparency has led market participants to complacency.

You heard it here first: The White House has created a “short list” of candidates for the two open governor positions on the FOMC.  St. Louis FRB President Bullard has confirmed that the administration has contacted him about the position.  We have noted in the past that Bullard and Minneapolis FRB President Kashkari would be choices for these positions that would align with the interests of the White House.  Both are consistent doves and would likely make it through the confirmation process without incident.  Bullard appears to have demurred, but we still expect him and perhaps the aforementioned Kashkari to be on the list.

A confidence problem: We rarely comment on data that comes out after 8:30 EDT because it is usually covered by the media.  However, on occasion, the information is so important that it warrants analysis.  Yesterday’s consumer confidence was that important.  The data for June came in much weaker than forecast, at 121.5 compared to forecasts of 131.1.  The May data was revised to 131.3 from 134.1.

Big declines like this often occur before recessions.  Perhaps even more concerning is the present situation component of the data.

This is the present situation index with a two-year moving average.  Although breaking that average isn’t a perfect indicator, falling below it from a high level has tended to presage recessions in the past.  The economy is decelerating and the risks of recession are increasing.

Iran: The president appears to be setting a “red line” of sorts, indicating that a military response will occur if an American dies due to actions taken by Iran.  Although we suspect this is true, the problem with red lines is that one has to act once they are crossed; in addition, it gives an enemy a clear target if they want to escalate.  If Iran views the president as soft, it will move to cross this red line.  Given Trump’s Jacksonian tendencies, a strong response will likely follow.  Iran is expected to reach a uranium enrichment threshold in the very near future; we will be watching the response from Europe because boosting enrichment will tend to be viewed in Europe as breaking the Iran nuclear agreement.

Brexit: Boris Johnson is pledging “do or die” for Brexit.  The vote for PM occurs next month, and will be decided by a small subset of the U.K. voting population.

EU news:The EU is pushing for a trade agreement with South America.  Denmark has a new government.  NATO defense spending is, again, below the guideline of 2% of GDP.  Europe is bracing for a heatwave.

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

[Posted: 9:30 AM EDT] It’s a slow news day so far this morning.  Lots of Fed speakers throughout the day.  Here is what we are watching today:

The Fed: There is a plethora of Fed speakers today (see below), including Chair Powell.  We did see the president continue to lambast the central bank.  We doubt we will get any new information from all these speakers; we note, for example, that Dallas FRB President Kaplan continues to hold his neutral position closely.  As we have noted before, the committee is divided along four lines—the pragmatists, the Phillips Curve hawks and doves (that’s two in our count) and the financial sensitives.  Neither group commands a large enough contingent to set a definitive policy path.  In the absence of consensus, the Fed seems to be letting the financial markets dictate policy, which likely means easing in the near future.

Iran: As promised, President Trump implemented additional sanctions on Iran, including direct sanctions on its supreme leader.  Iran’s response indicated that these additional sanctions end any hope for diplomacy.  SoS Pompeo has been visiting nations in the region; it appears the U.S. is preparing for tanker escorts.  However, the president has indicated that he doesn’t like the fact that the U.S. is paying for protection that the rest of the world enjoys.  Although understandable, this is the burden of hegemony; if the U.S. does end this role, the world becomes a much more dangerous place.  Markets continue to bid up safety assets, with gold and bitcoin moving higher in recent days.  There are also reports that Iran has been increasing its cyberattacks against the U.S.

Trade talks: Hopes for a breakthrough this weekend are steadily being dashed.  Although officials on both sides continue to talk, the U.S. appears ready to either make a deal or add tariffs if a truce isn’t declared.  The U.S. is close to sanctioning Chinese banks for their trade with North Korea and added additional tech company sanctions as well.  There is also talk of forcing tech firms to move their design operations out of China, which would further hamper China’s ability to develop technology.  The Trump administration is also indicating that sanctions on China over the Uygur internment camps are “ready to go”; if implemented, these will infuriate Beijing, which sees the issue as an internal matter.  In other China news, the country is boosting pork imports due to the African Swine Virus, but so far has avoided buying U.S. pork.  The PBOC may be preparing for a rate cut.  If China cuts rates, expect the White House to further criticize the Fed for not easing policy.

Brexit: Boris Johnson is dealing with the travails of being the frontrunner for PM, replacing Theresa May.  Although we still expect him to win next month, he is mercurial enough to snatch defeat from the jaws of victory.

EU battles:The EU continues to struggle to name a new commissioner.  Germany is accusing French President Macron of being “anti-German.”  German leaders continue to stump for their candidate, Manfred Weber.  If Germany loses the EU commissioner position, look for Berlin to insist on getting the ECB presidency, which would be bullish for the EUR.

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