by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Monday!  Although we are in spring, a massive winter storm is moving over the northern plains and will delay planting in the northern Corn Belt.  It will also increase flooding in the major river systems in a couple of weeks.  Here is what we are watching:

Elections this week: Israelis go to the polls tomorrow as PM Netanyahu tries to win another term.  In Israeli politics, no major party ever wins a majority and must form a coalition government with smaller parties.  Although we expect Netanyahu to prevail, he does face a formidable opponent in Benny Gantz, a retired general with extensive national security experience.  It will likely take a few weeks after the election for a government to be formed.  On Thursday, India, the world’s largest democracy, starts the election process that will take several weeks to complete.

Brexit: At least on paper, this is the deadline week for Brexit.  In reality, we expect a delay of at least until the end of June,[1] and perhaps much longer.  PM May and Labour’s Corbyn have been talking off and on but no signs of progress have emerged[2]; the talks themselves have upset party leaders on both sides.[3]  Meanwhile, the EU will also be meeting this week to discuss Brexit.  French President Macron has been taking a hard line against the U.K. but we doubt his position will carry the day.[4]  The “natural” path is to “kick the can down the road” a bit further.

China/U.S. trade: Both sides continue to tout progress but admit that hard decisions remain to be addressed.[5]  We continue to expect an agreement to emerge, perhaps by the end of April.

War in Libya?  American forces operating in Libya have been evacuated[6] as Gen. Khalifa Hifter faces stiff resistance in his march on Tripoli.  Hifter’s forces control the eastern part of Libya and last week moved on the western part of the country.  Although it is difficult to confirm, it appears that Hifter believed he had arrangements with militias[7] in the western regions to support his incursion.  Unfortunately, the militia groups splintered, meaning Hifter’s forces are facing much more resistance than he expected.  The fighting has given oil prices a boost.[8]

OPEC: Russia is indicating it may lift oil output in H2 as oil prices trend higher.[9]  Russian oil companies face a tax regime that essentially has a windfall profit tax.  In other words, the higher the oil price, the more tax liability Russian oil firms face.[10]  Thus, support for higher prices tends to wane among Russian oil firms as prices rise.  Saudi Arabia, on the other hand, continues to press for higher prices.  Also, we reported last week that unnamed Saudi officials were threatening to move away from dollar pricing for oil.[11]  The Saudi oil minister indicated today that such a change isn’t going to occur.[12]  Although we have been supportive of oil prices, at current levels, we would expect to see temptations rise for OPEC cheating.

IRGC a terrorist organization?  According to reports, the U.S. is considering naming the Iranian Republican Guard Corp a foreign terrorist organization (FTO).[13]  If the administration follows through on the threat, it would be the first time a government entity would be given this designation.  The FTO designation would greatly increase the financial sanction tools against Iran.  At the same time, it would invite strong retaliation from Iran.[14]  This designation will increase tensions with Iran and would be supportive for oil prices.

Cain for the FOMC: The establishment backlash against Herman Cain continues, while the administration continues to back his appointment.[15]  The FT is warning that the administration may take an even more aggressive line against the FOMC and directly threaten the Fed’s independence by firing Chair Powell.[16]  On the one hand, we rather doubt that President Trump would take such aggressive action against Powell.  On the other hand, the fact that a well-respected financial paper would even suggest such an attack is possible is remarkable by itself.  As we have noted before, central bank independence is not scriptural.  There is nothing sacred about central bank independence.  In fact, such stature is instrumental; if you want low inflation, an independent central bank is helpful to that effort.  But, if your goal is to reflate then an independent central bank can impede that process.  If the goal is reflation, a less independent FOMC would make sense.

China’s foreign reserves: China’s foreign reserves rose $8.6 bn in March.[17]  For the most part, reserve levels remain steady.

Chart du jour: We have noticed that retail wage growth has been very strong recently.

At the end of 2017, wage growth in retail was only about 1.0%.  Since then, it has soared to nearly 5.0% annual growth, far exceeding overall private sector wage growth.  Two factors appear to be driving the rise.  First, state and local government regulations have been boosting minimum wage laws.  This action, coupled with announced pay increases by high-profile firms, is lifting retail wages.  Second, anecdotally, there is evidence to suggest that tightening labor markets are forcing retailers to boost pay.[18]

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[1] https://www.bbc.com/news/uk-politics-47825841?wpisrc=nl_todayworld&wpmm=1

[2] https://www.theguardian.com/politics/2019/apr/07/how-cross-party-brexit-talks-left-both-sides-frustrated-labour-tories and https://www.nytimes.com/2019/04/07/world/europe/theresa-may-brexit-compromise.html?emc=edit_MBE_p_20190408&nl=morning-briefing&nlid=5677267ion%3DwhatElse&section=whatElse&te=1

[3] https://www.ft.com/content/a45bf41e-5935-11e9-939a-341f5ada9d40?emailId=5caabdd68e66890004718a32&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[4] https://www.ft.com/content/bd91c0a6-5243-11e9-b401-8d9ef1626294

[5] https://www.wsj.com/articles/u-s-china-tout-progress-vow-to-continue-trade-talks-11554509376?mod=hp_lead_pos3

[6] https://www.washingtonpost.com/world/middle_east/american-troops-in-libya-moved-out-of-country-as-violence-escalates-near-capital/2019/04/07/bf754a6c-58b2-11e9-aa83-504f086bf5d6_story.html?utm_term=.22e373f40e68&wpisrc=nl_todayworld&wpmm=1

[7] https://www.nytimes.com/2019/04/07/world/africa/libya-us-troops.html?emc=edit_MBE_p_20190408&nl=morning-briefing&nlid=5677267ion%3DwhatElse&section=whatElse&te=1

[8] https://www.wsj.com/articles/libyan-crisis-presents-new-worry-for-white-houseand-oil-markets-11554503741?mod=hp_lista_pos3

[9] https://www.reuters.com/article/us-russia-opec/russia-signals-opec-and-allies-should-raise-oil-output-from-june-idUSKCN1RK0TW

[10] https://www.nytimes.com/2016/03/24/world/europe/russia-light-on-cash-weighs-risks-of-a-heavy-tax-on-oil-giants.html

[11] https://www.reuters.com/article/us-saudi-usa-oil-exclusive/exclusive-saudi-arabia-threatens-to-ditch-dollar-oil-trades-to-stop-nopec-sources-idUSKCN1RH008

[12] https://www.nasdaq.com/article/saudi-arabia-says-no-change-to-policy-of-trading-oil-in-dollars-20190408-00098

[13] https://www.wsj.com/articles/u-s-to-designate-iranian-guard-corps-a-foreign-terrorist-organization-11554499401?mod=hp_lead_pos2

[14] https://www.reuters.com/article/us-usa-iran-lawmaker/iran-to-blacklist-u-s-military-if-washington-designates-guards-as-terrorists-mp-idUSKCN1RI04X?feedType=RSS&feedName=topNews

[15] https://www.wsj.com/articles/herman-cain-expects-cumbersome-scrutiny-if-he-is-nominated-to-fed-board-11554559518?mod=hp_lead_pos1

[16] https://www.ft.com/content/d04270c6-57a5-11e9-a3db-1fe89bedc16e

[17] https://www.reuters.com/article/us-china-economy-forex-reserve/chinas-march-forex-reserves-rise-to-seven-month-high-idUSKCN1RJ05Q

[18] https://www.axios.com/newsletters/axios-markets-3dc392f3-edf6-46fe-9177-4688f4bb2f8b.html  see #2

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s employment Friday!  We cover the data in detail below, but the quick take is that it is a nearly perfect report.  Payrolls recovered, unemployment remained low and wage pressures eased.  Here is what we are watching today:

Trade progress: President Trump[1] and Chairman Xi[2] made positive comments on the potential for a trade deal but the two sides still haven’t resolved the most difficult parts of the negotiations.[3]  One emerging issue is biotech crops.[4]  The comments do suggest both sides want some sort of agreement in the near term.  Financial markets have mostly discounted a positive outcome, although the actual news of an agreement might give equities a short-term boost.

Brexit: About the only thing new is that the May government has asked the EU for an extension to June 30.[5]  European Council President Tusk has floated the idea of a one-year extension with the flexibility of cutting it short if a deal is reached.[6]  Talks between Corbyn and May don’t appear to be going anywhere,[7] although there is growing talk of a second referendum.[8]  The House of Lords, the upper house in the U.K. legislature, is also pressing the PM to consult with them before any debate.[9]  Meanwhile, the government is monitoring its citizens’ buying behavior, worried that panic buying tied to Brexit could lead to shortages.[10]

War in Libya?  General Haftar, whose forces control the eastern half of Libya, has ordered his troops to march on Tripoli in a bid to take control of the country.[11]  Although current maps are difficult to confirm, this linked one in the footnote suggests Haftar does control most of the country and has decided to complete the takeover.[12]  If Haftar is able to bring the country under singular control, it would likely increase oil output.  However, history of warfare shows that conquering is one thing, while controlling is another.  His attempt to take over could lead to increasing unrest and, if his bid fails, disruption of oil supplies may follow.  We would not be surprised to see a drop in Libyan supplies in the coming days as tensions rise.

Anger in Riyadh?  Reuters[13] is reporting that unnamed Saudi officials are threatening to stop pricing oil in dollars if Congress follows through and subjects OPEC to U.S. antitrust rules.  The reaction is rather odd.  First, the chances of this legislation passing through Congress is nil, and even if it does the president would veto it.  Second, for much of its history, the oil market has had a cartel-like body that manages output.  From Standard Oil to the Texas Railroad Commission to OPEC, the oil market has always had a body that holds excess capacity off the market to prevent price volatility.  This bill in Congress is counterproductive to that essential role.  Third, although there would be all sorts of claims of the demise of the dollar if the Saudis were to abandon the greenback, the reality is far less dire.  Where would the Saudis go—would they use euros?  What bond would they hold in reserve—German bonds with a negative yield, or maybe Italian bonds with credit concerns?  Would they hold the yuan?  And, would China be comfortable with its financial system being affected by the price of oil?  The bigger concern is if Iran were to attack Saudi Arabia, would the country rely on Beijing or Berlin to come to its aid?

Our take is that such leaks suggest either panic or inexperience.  We lean toward the latter.  MbS, the de facto ruler of the kingdom, has a history of overreacting to slights.  To leak this sort of response to a bill that has no chance of passage is uncalled for.  However, it does suggest a degree of insecurity at the leadership level of the royal family.

Cain for the FOMC: President Trump has two vacant seats on the FOMC.  Although Marvin Goodfriend did go to Congress for interviews, his performance was less than stellar and his appointment has been in limbo ever since.  Recently, the president has offered Stephen Moore, a controversial option.  Yesterday, he indicated he would nominate Herman Cain.  Although Cain isn’t an economist, he has experience as a member and chairman of the K.C. FRB.

The national media will suggest neither man is especially qualified for the role, but we view both as defensible choices.  However, the real issue is loyalty.  President Trump, like a significant number of his predecessors, rightly views the Fed as an influential government entity that he has little control over.  Since the Rubin/Clinton/Greenspan peace accord in the 1990s, we have had unusually serene relations between the FOMC, the chairs and the White House.  However, Truman, who signed off on Fed independence, did so with great trepidation.  President Johnson reportedly pushed Bill Martin against the wall in protest of higher interest rates.[14]  Nixon leaked that Arthur Burns wanted an exorbitant pay raise and then offered to scotch the rumor in return for compliant policy.[15]  Reagan ordered Volcker not to raise rates in 1984[16] and loaded the FOMC with loyalists to undermine Volcker.[17]  The Rubin/Clinton/Greenspan detente worked mostly because of falling inflation; the fact that it held as long as it did was remarkable.

It is clear that undermining the independence of the Federal Reserve can affect inflation expectations.  If investors, consumers and firms become convinced that the Fed will accommodate inflation impulses, then they will act to accentuate these impulses by accelerating purchases and building inventories.  We are nowhere close to that being a problem now, but the fact that Fed independence is being seen mostly as unnecessary suggests the public is becoming inured to low inflation and can’t conceive of it becoming a problem.

The table below shows our “hawk/dove” estimates.  We are assuming that the nominees will be hardcore doves, although only under a Trump administration.  They might shift with a Democrat in the White House.  The change in policy stance is significant.  The overall composition of the board goes from 3.00 to 3.32.  The members this year jump the average to 3.25 from 2.90, and next year moves from 3.00 to 3.33 (scale is 1 being most hawkish, 5 being most dovish).  Although these two new members (we are assuming they will be confirmed) can’t move policy by themselves, they will likely never vote to hike while Trump is president and may always vote to ease, leading to a higher level of dissention.  Historically, three governor dissents is considered a no-confidence outcome for a chair, thus Powell may find himself in an untenable position at some point.

All this points to policy accommodation, which should be supportive for equities but might be bearish for longer duration debt.

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[1] https://www.nytimes.com/2019/04/04/business/economy/trump-xi-china-trade-meeting.html?emc=edit_MBE_p_20190405&nl=morning-briefing&nlid=5677267tion%3DtopNews&section=topNews&te=1

[2] https://finance.yahoo.com/news/trump-says-china-trade-deal-215844061.html

[3] https://www.wsj.com/articles/u-s-china-trade-talks-in-end-game-but-no-final-deal-yet-chamber-leader-says-11554382517?mod=hp_lead_pos6

[4] https://www.reuters.com/article/us-usa-trade-china-biotech/biotech-crops-still-a-sticking-point-in-u-s-china-trade-deal-sources-idUSKCN1RH02X

[5] https://finance.yahoo.com/news/britains-may-asks-eu-brexit-083130235.html

[6] https://www.politico.eu/article/eu-brexit-flextension-plan/

[7] https://www.ft.com/content/9496494c-56da-11e9-a3db-1fe89bedc16e?emailId=5ca6c94d6008f300048dd485&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[8] https://www.ft.com/content/b01c7c02-56cd-11e9-91f9-b6515a54c5b1?emailId=5ca6c94d6008f300048dd485&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[9] https://www.ft.com/content/86afb140-56cd-11e9-91f9-b6515a54c5b1?emailId=5ca6c94d6008f300048dd485&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[10] https://www.politico.eu/article/uk-government-employs-firm-to-track-brexit-stockpiling-data-food-supply/?utm_source=POLITICO.EU&utm_campaign=7a46094dbb-EMAIL_CAMPAIGN_2019_04_05_04_54&utm_medium=email&utm_term=0_10959edeb5-7a46094dbb-190334489

[11] https://www.aljazeera.com/news/2019/04/chief-deeply-concerned-military-escalation-libya-190404081217912.html?wpisrc=nl_todayworld&wpmm=1

[12] https://libya.liveuamap.com/  Haftar’s region is in red.

[13] https://www.reuters.com/article/us-saudi-usa-oil-exclusive/exclusive-saudi-arabia-threatens-to-ditch-dollar-oil-trades-to-stop-nopec-sources-idUSKCN1RH008

[14] https://www.nytimes.com/2017/06/13/business/economy/a-president-at-war-with-his-fed-chief-5-decades-before-trump.html

[15] https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.20.4.177

[16] https://www.businessinsider.com/ronald-reagan-fed-chair-volcker-trump-2018-10

[17] https://www.latimes.com/archives/la-xpm-1986-10-03-fi-4106-story.html

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Markets are quiet this morning; initial claims fell to a 49-year low.  Here is what we are watching:

Trade progress: President Trump and Vice Premier Liu are scheduled to meet at the White House today, a sign that trade talks are heading toward some sort of conclusion.[1]  Most of the outstanding issues have been resolved, although execution and enforcement remain undecided.[2]  The fact that the president is meeting with the chief Chinese negotiator is a good sign of progress.  However, the enforcement issue remains a concern.  China will probably not agree to a procedure that allows the U.S. to unilaterally apply trade sanctions on perceived shortfalls in Chinese behavior.  But, without the ability to have a “stick,” the U.S. will have no leverage after the deal is negotiated.[3]  We would expect some sort of mechanism to deal with disputes that triggers a round of meetings that might result in tariffs.  China will attempt to avoid a mechanism that gives unilateral power to the U.S.  If that issue can be overcome, the deal will likely be signed.

As a side note, Europe is struggling with Chinese trade issues as well.[4]  Much of this scrutiny is due to China’s size.  As China’s economy has grown, its mercantilist trade policies have had an increasingly negative impact on the rest of the world; thus, the pushback from the U.S. and EU are consistent with this issue.

Brexit: There were a couple developments.  First, meetings between PM May and Labour Leader Corbyn were said to be “constructive”[5] but “inconclusive.”[6]  Second, Parliament narrowly voted to order May to extend the deadline for Brexit.[7]  Thus, we are probably seeing a “can-kicking” exercise to avoid an immediate hard Brexit.  That outcome is mostly neutral for the GBP.

Rethinking negative nominal rates: Monetary theory argues that there is a “zero lower bound.”  In other words, nominal interest rates cannot go below zero because private actors will simply disintermediate—or, take their money out of the banking system rather than have the value erode due to a negative nominal rate.  When the FOMC hit the zero rate on fed funds, it deployed two other policies, forward guidance (rates will be low for a long time) and quantitative easing (flooding the banking system with reserves).  The ECB, on the other hand, along with a couple other central banks in Europe, decided to test the zero lower bound theory.  What we found in practice is that the nominal rate can fall below zero without triggering a flight to cash.  Essentially, banking services—security and the ease of transferring liquidity for payment—have some value and thus overcame the negative rate issue.  We tend to think the lowest one can go is -75 bps, but that is merely an observation on our part.  However, we have seen that negative nominal rates are a significant penalty to banks.  Banking is a spread business; banks perform a duration transformation, taking short-duration liabilities and turning them into long-duration assets.  Flat yield curves undermine bank profitability as do the levels of rates themselves.  Thus, negative nominal rates and flat curves are terrible for banks.  According to reports, the ECB is rethinking its negative nominal rate policy due to the adverse effect it has had on banks.[8]  If the ECB reverses, it would likely be supportive for Eurozone banking.

Acknowledging weakness in Europe: The European economy is struggling.  Germany’s five leading economic institutes have lowered their GDP forecasts by nearly 50% compared to September.  They now project growth of a mere 0.8% this year for Germany compared to the 1.5% forecast developed in Q3 of last year.[9]  Italy also reduced its growth forecast to 0.3% this year, down from the initial forecast of 1.0% made in December.  This action would boost the deficit-to-GDP level to 2.3% from 2.0%.  Unfortunately, due to the fiscal “straightjacket” of the Eurozone’s government spending rules, the only stimulus available is either from the ECB, which may be exhausted, or through a weaker EUR.  Although we remain dollar bearish, economic weakness in Europe remains a concern.

The chart below shows the yearly change in the OECD’s leading indicator for the Eurozone, with the gray bars showing Eurozone recessions.  Although we are not in recession territory quite yet, the slowdown is unmistakable.

Meanwhile, the U.S. is doing better: The Atlanta FRB’s GDPNow forecast is showing marked improvement.

This model is now projecting 2.1% growth, up from 0.2% in early March.  Here is the contribution table.

Inventory rebuilding, some modest recovery in consumption and a rise in government spending are all combining to lift Q1 GDP estimates.  Since there has been a tendency for Q1 to be affected by adverse seasonal adjustments, this level of growth would likely signal GDP somewhere between 2.5% to 3.0% this year.

Energy update: Crude oil inventories rose 7.2 mb last week compared to the forecast decline of 0.9 mb.

In the details, refining activity fell 0.2% when a 1.0% rise was forecast.  Estimated U.S. production rose 0.1 mbpd to a new record of 12.2 mbpd.  Crude oil imports rose 0.2 mbpd, while exports fell 0.2 mbpd.

This is the seasonal pattern chart for commercial crude oil inventories.  We would expect to see a steady increase in inventory levels that will peak in early May; the pattern coincides with refinery maintenance.  Even with the build this week, the market is well behind normal which is supportive for prices.

Based on oil inventories alone, fair value for crude oil is $57.52.  Based on the EUR, fair value is $53.06.  Using both independent variables, a more complete way of looking at the data, fair value is $53.82.  Current prices are running well above fair value, suggesting that the market is expecting falling inventories once the summer driving season begins.  If inventories don’t fall, oil prices are vulnerable to a correction.

View the complete PDF

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[1] https://www.ft.com/content/7564b478-5680-11e9-91f9-b6515a54c5b1?emailId=5ca57ca8531b510004d1e4c5&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[2] https://www.ft.com/content/ca4b76e2-5645-11e9-91f9-b6515a54c5b1?emailId=5ca57ca8531b510004d1e4c5&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.wsj.com/articles/tariffs-take-center-stage-in-u-s-china-trade-talks-11554328971?mod=hp_lead_pos3

[4] https://www.politico.eu/newsletter/brussels-playbook/politico-brussels-playbook-presented-by-naftogaz-of-ukraine-dining-with-a-dictator-sweating-over-china-is-it-brexit-yet/?utm_source=POLITICO.EU&utm_campaign=b8f54c4fc3-EMAIL_CAMPAIGN_2019_04_04_04_53&utm_medium=email&utm_term=0_10959edeb5-b8f54c4fc3-190334489 (see the “next big thing”)

[5] https://www.politico.eu/article/theresa-may-jeremy-corbyn-hold-constructive-talks-on-brexit/?utm_source=POLITICO.EU&utm_campaign=b8f54c4fc3-EMAIL_CAMPAIGN_2019_04_04_04_53&utm_medium=email&utm_term=0_10959edeb5-b8f54c4fc3-190334489

[6] https://www.nytimes.com/2019/04/03/world/europe/theresa-may-jeremy-corbyn-brexit.html?emc=edit_fd_20190404&nl=&nlid=567726720190404&te=1

[7] https://www.ft.com/content/a4c5bf54-5636-11e9-a3db-1fe89bedc16e?emailId=5ca57ca8531b510004d1e4c5&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 and https://www.ft.com/content/02492618-5630-11e9-91f9-b6515a54c5b1?emailId=5ca57ca8531b510004d1e4c5&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[8] https://www.ft.com/content/e095d00e-5556-11e9-a3db-1fe89bedc16e?emailId=5ca57ca8531b510004d1e4c5&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[9] https://www.bloomberg.com/news/articles/2019-04-04/german-institutes-slash-2019-growth-forecast-by-more-than-half

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a “risk-on” morning.  Equities are up around the world.  It’s also the 70^th anniversary of NATO.[1]  Here is what we are watching this morning:

A trade deal with China: Reports suggest the U.S. and China are nearing an agreement on trade.[2]  The two sides are still hashing out enforcement issues and the path of implementation, but most of the longstanding differences have apparently been ironed out.  Meetings in Washington are scheduled for this week.[3]  Optimism about a trade agreement is boosting equities this morning.

Brexit: After a difficult cabinet meeting, PM May has reached out to opposition leader Corbyn to work out a Brexit deal.[4]  Up until now, May has tried to manage Brexit within the Tory Party but has apparently decided that continuing on that path will lead to a hard Brexit, which she wants to avoid.[5]  Corbyn has avoided a direct outreach because his ultimate goal is to become PM; rescuing May tends to undermine that objective.  However, if Corbyn can work with May and deliver a workable exit that doesn’t lead to a sudden economic shock, then he can claim the mantle of statesman and enhance his future chances.  Needless to say, hardline Tories are angry.[6]  The hardliners are perfectly fine with a hard Brexit, assuming that forecasts of an economic crisis are simply scare tactics.  May’s decision to work with Corbyn runs the risk of splitting the Tory Party and rendering the Conservatives to minority status for years.

So, May and Corbyn will work on a common plan.  If they come up with one, both leaders will present it to Parliament and a vote will be held.  If it passes, the U.K. will petition the EU for an extension of Article 50.[7]  If they don’t come up with a common plan, May will likely ask for an even longer extension.

The White House and the Fed: There is more reporting suggesting that President Trump is profoundly unhappy with Chair Powell, apparently viewing his appointment as one of the bigger mistakes of his presidency.[8]  According to reports, the president has indicated to Powell that he is “stuck” with the current chair.  He has also criticized Treasury Secretary Mnuchin for pushing Powell’s nomination, and reportedly preferred Kevin Warsh for the job.[9]  Warsh was not considered to be a strong choice for the role.[10]  At the same time, the president may have believed that Warsh would be more open to the White House’s position on rates.  We would not be surprised to see Warsh resurface for one of the two open governor positions on the FOMC, especially if Trump can get Moore through the nomination process.

Gold’s quiet supporters: Gold is apparently making a comeback among central bankers concerned about the long-term stability of the dollar.[11]  Given low interest rates around the world, the opportunity cost of holding gold has fallen.  What we find interesting about this action by central bankers is that they don’t view other currencies as an attractive alternative to the dollar.  At the same time, the gold market is rather small so there will be limits to the banks’ abilities to shift reserves to the yellow metal.

A couple of taxing ideas: The Center for American Progress[12] has published a report calling for a tax on monopoly power.[13]  Such a tax fits well within the MMT framework of taxing “bads” to achieve a different result.  Market power is coming under deeper scrutiny on fears that monopolies and oligopolies are causing unusually high profit margins.  By taxing market concentration, the incentive to merge and buy competitors will likely be diminished.  Of course, regulation tends to cut in the opposite direction; increased regulatory costs tend to encourage concentration as businesses attempt to spread the regulatory costs over more units.

A tax on unrealized capital gains has been floated by Sen. Ron Wyden.[14]  Along with equalizing the difference between income and capital gains taxes, the law attempts to tax gains before they are taken.  Although such a tax is possible, it would be quite complicated; for example, one would expect the cost basis on an asset to be adjusted each tax year.  In addition, unrealized capital losses would also need to be recognized.  And, the tax should also include residential real estate.  We doubt Wyden’s bill will get any traction but the fact that it has even been written suggests we are in a new, more populist, era.

Oil news: Three of the eight nations that were granted waivers on Iranian oil have indicated they are no longer importing crude oil from that nation.[15]  Falling Iranian supply is bullish for crude oil.

As we noted last week, Saudi Aramco issued bonds to buy a Saudi petrochemical firm.  As part of the bond issue, the Saudi state oil company released public financial numbers for the first time in four decades.  It was revealed in the report that the giant Ghawar oil field, for years the world’s largest, can only produce 3.8 mbpd, which is 2.0 mbpd less than generally estimated.  That means the Permian basin is now the world’s largest producing area at 4.1 mbpd.  The kingdom still indicates it can produce 12.0 mbpd, although that number may be called into question in light of this most recent news.  The bottom line here is that there may be less oil capacity available than we think which is bullish for oil prices.

Closing the southern border?  The White House has backed away from this threat[16] after aides apparently convinced the president that doing so would cause significant economic dislocation.[17]

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[1] https://www.politico.eu/article/nato-aims-for-more-birthday-less-bash-in-trumps-washington/?utm_source=POLITICO.EU&utm_campaign=a058ec28df-EMAIL_CAMPAIGN_2019_04_03_05_02&utm_medium=email&utm_term=0_10959edeb5-a058ec28df-190334489

[2] https://www.ft.com/content/d6ac5082-5582-11e9-91f9-b6515a54c5b1?emailId=5ca423abac7473000402ba1a&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.reuters.com/article/us-usa-trade-china/white-house-sees-headway-on-us-china-trade-ahead-of-new-talks-this-week-idUSKCN1RE1Y2

[4] https://www.nytimes.com/2019/04/02/world/europe/theresa-may-labour-brexit.html?emc=edit_fd_20190403&nl=&nlid=567726720190403&te=1

[5] https://www.ft.com/content/4bad9a24-556c-11e9-91f9-b6515a54c5b1?emailId=5ca423abac7473000402ba1a&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6] https://www.ft.com/content/f42336c4-556b-11e9-91f9-b6515a54c5b1 and https://www.ft.com/content/ecadf298-5553-11e9-a3db-1fe89bedc16e

[7] https://www.ft.com/content/3924a7ac-5559-11e9-a3db-1fe89bedc16e

[8] https://finance.yahoo.com/news/trump-called-powell-march-stocks-215712662.html

[9] https://www.axios.com/newsletters/axios-am-cb573592-5eb5-4cb3-8836-1bf8a93fb9eb.html?chunk=1#story1

[10] https://www.washingtonpost.com/news/wonk/wp/2017/10/23/how-to-be-wrong-about-almost-everything-and-maybe-be-fed-chair-anyway-the-kevin-warsh-story/?utm_term=.b6ef489e917a

[11] https://finance.yahoo.com/news/gold-demand-support-central-banks-sour-on-dollardenominated-debt-151506427.html

[12] The Center for American Progress is a center-left think tank that models itself as a left-wing version of the Heritage Foundation.

[13] https://www.americanprogress.org/issues/economy/reports/2019/04/03/467613/toward-robust-competition-policy/

[14] https://www.wsj.com/articles/top-democrat-proposes-annual-tax-on-unrealized-capital-gains-11554217383?mod=newsviewer_click

[15] https://www.reuters.com/article/us-iran-sanctions-usa-waivers/three-importers-cut-iran-oil-shipments-to-zero-u-s-envoy-idUSKCN1RE298

[16] https://www.reuters.com/article/us-usa-immigration/white-house-softens-tone-after-threat-to-close-border-with-mexico-idUSKCN1RE1PE?feedType=RSS&feedName=topNews

[17] https://www.politico.com/story/2019/04/02/trump-aides-border-shutdown-disaster-1249828

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Markets are quiet after a strong rally yesterday.  Here is what we are watching this morning:

Turkey fallout: The stunning losses in local elections have put President Erdogan on notice—the economy is suffering and he needs to address the problem.  Addressing a weakening economy with rising inflation will be challenging.  The weak currency will help in the economy’s recovery but Turkey is probably looking at a year of falling real wages and stagnant growth.  The temptation to use temporary measures to lift growth will be high.[1]  Although the elections reflect economic turmoil, for the most part, it looks to us like the financial markets have mostly discounted the bad news; simply put, the elections are a lagging indicator.

Brexit: Parliament voted on four measures for Brexit and rejected all of them.[2]  It is becoming apparent that all of the ideas for leaving without disruption mean the U.K. will remain tied to the EU with less influence than it has now.  The customs union, which lost by a mere three votes, doesn’t really solve anything.  Such a union keeps the U.K. in the EU’s trade bloc on tariffs but not on product standards.  Thus, there would still be a border problem in Ireland.  Essentially, Britain is rapidly realizing that it must either (a) leave suddenly and completely, suffering an immediate economic shock in return for full independence, or (b) call the whole thing off.  There really isn’t any middle ground.

The other trend that is becoming apparent is that May can either (a) stop Brexit by cobbling together a coalition of Remain-supporting MPs in Parliament at the cost of marginalizing the Tory Party, or (b) hold the Tories together but suffer a hard Brexit.  We think she leans toward the second option.  Our position has been that no government wants a hard break, and that is probably true, but a hard break may be considered a better option than eternal Labour Party dominance.

Bouteflika out: The president of Algeria, Abdelaziz Bouteflika, will leave office on April 28.[3]  It is unclear who will replace him.  Although there is no evidence that Algerian energy production has been affected, the chances of a disruption are rising.

Fed conference: The Fed will hold a monetary policy conference in Chicago June 4-5; ideas about policy, including inflation targeting, policy transparency and employment, will be on the agenda.[4]  As we discussed recently,[5] the Fed is investigating its inflation target, considering if it should be trying to target a level or average change in inflation.  The Chicago meeting will likely overshadow the August Jackson Hole meeting this year.

September fiscal cliff? The Treasury will hit a hard debt limit by September.  At that point, the debt ceiling will need to be raised.  Congress has already begun work on a deal but both houses are closely watching the White House, which is making noise about a wholesale rewrite of recent budget deals.  Although it isn’t uncommon for these arrangements to go down to the wire, the looming election year will play a role.[6]  Thus, we will continue to monitor this issue but would not be surprised to see a crisis develop in late Q3.

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[1] https://www.ft.com/content/6ca1d484-546d-11e9-91f9-b6515a54c5b1?emailId=5ca2d4f0341b100004e47892&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[2] https://www.nytimes.com/2019/04/01/world/europe/uk-parliament-soft-brexit-may.html?emc=edit_fd_20190402&nl=&nlid=567726720190402&te=1

[3] https://www.bbc.com/news/world-africa-47776725?utm_source=POLITICO.EU&utm_campaign=647364b043-EMAIL_CAMPAIGN_2019_04_02_04_47&utm_medium=email&utm_term=0_10959edeb5-647364b043-190334489

[4] https://www.reuters.com/article/us-usa-fed-conference/fed-sets-agenda-for-chicago-framework-conference-in-june-idUSKCN1RD351

[5] See Confluence Asset Allocation Weekly (3/8/2019).

[6] https://www.politico.com/story/2019/04/02/congress-spending-budget-shutdown-1244283

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s the beginning of Q2 and April Fools’ Day.  Equities are up around the world.  Here is what we are watching this morning:

China better, but elsewhere struggles: China’s manufacturing PMI data came in better than forecast;[1] the Caixin number for March was 50.8, exceeding expectations around 50.0, and the official PMI reading was 50.5 compared to 49.2.  A lift in export orders accounted for much of the rise.  Although the improvement offered investors some relief in what has been a steady diet of weaker data, the fact that export orders drove the numbers raises fears they won’t be sustained.  In contrast, the Eurozone data was soft, with manufacturing PMI falling to 47.5 in March, the weakest level in almost six years.  Meanwhile, in Japan, the Tankan business survey fell to a two-year low.  The data from large companies was even worse, falling to a more than six-year low.

Weekend elections: There were three elections of note over the weekend.  In Turkey, the economic recession led to local government losses for Erdogan’s AKP, including the capital Ankara and Istanbul.[2]  Although these elections don’t threaten Erdogan’s power, the results show rising discontent in Turkey and thus it would behoove the leadership to boost the economy.  In Ukraine, a comedian, Vladimir Zelenskiy, won the first round of presidential elections, capturing about 30% of the vote.  The election sets the stage for a run-off between Zelenskiy and the incumbent president Poroshenko, which will be held in two to three weeks.[3]  And, in the second round of voting in Slovakia, Zuzana Caputova won handily, 58.4% to 41.6% over Maros Sefcovic.[4]  Slovakia has suffered through a series of high-profile assassinations of journalists; Caputova is seen as a reformer.[5]

Brexit: One could be forgiven for thinking Brexit has become something like the movie Groundhog Day, where the lead character keeps reliving the same day over and over again.  There are plans for a fourth vote on May’s ill-fated plan.[6]  Also on tap is another round of indicative votes.  So far, all Parliament has been able to do is express what it doesn’t want but hasn’t been able to determine what it does want.  The upcoming votes range from May’s plan, to a custom’s union, a hard exit and other points in between.[7]  So far, the GBP is taking all this in stride, which suggests the financial markets do not expect a hard exit.

Closing the southern border?  The White House is threatening to close the southern border in response to an influx of migrants.[8]  It isn’t clear if the U.S. will carry out the threat but, if it does, it will disrupt trade between the U.S. and Mexico.  The goal of the Trump administration is for the Mexican government to stop Central American migrants from coming to the U.S. border.

The White House and the Fed: White House officials are calling for an immediate 50 bps cut in interest rates.[9]  One of the most dovish members of the FOMC, Minneapolis FRB President Kashkari, doesn’t go that far, suggesting a pause is the best policy.[10]  However, the steady pressure from the White House is having the effect of a policy easing, at least so far.  The risk is that if the economy were to pick up and inflation pressures rise, markets would view pressure from the administration less favorably.  But, for now, executive branch officials pressing for easier policy isn’t adversely affecting financial markets.

Secondary sanctions: The U.S. is considering sanctions on non-U.S. companies conducting business with Venezuela.  So far, the U.S. has not sanctioned companies that have ties to PDVSA,[11] the Venezuelan state oil company.  If the U.S. were to take this step, it would further reduce Venezuela’s sales from oil.

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[1] https://www.wsj.com/articles/china-factory-activity-rebounded-strongly-in-march-11554002297?mod=hp_lead_pos3

[2] https://www.reuters.com/article/us-turkey-election/erdogan-loses-hold-over-turkish-capital-istanbul-disputed-idUSKCN1RD130?utm_source=POLITICO.EU&utm_campaign=cd12771421-EMAIL_CAMPAIGN_2019_04_01_04_45&utm_medium=email&utm_term=0_10959edeb5-cd12771421-190334489  and https://www.washingtonpost.com/world/erdogan-faces-challenge-in-local-elections-as-turkeys-economy-struggles/2019/03/31/3794c56c-539b-11e9-a047-748657a0a9d1_story.html?utm_term=.4ce76201fd52&wpisrc=nl_todayworld&wpmm=1

[3] https://www.politico.eu/article/no-joke-comedian-vladimir-zelenskiy-to-win-first-round-in-ukraines-presidential-election-against-petro-poroshenko/?utm_source=POLITICO.EU&utm_campaign=cd12771421-EMAIL_CAMPAIGN_2019_04_01_04_45&utm_medium=email&utm_term=0_10959edeb5-cd12771421-190334489

[4] https://volby.sme.sk/prezidentske-volby/2019/vysledky?utm_source=POLITICO.EU&utm_campaign=cd12771421-EMAIL_CAMPAIGN_2019_04_01_04_45&utm_medium=email&utm_term=0_10959edeb5-cd12771421-190334489

[5] https://www.politico.eu/article/jan-kuciak-gorilla-slovakia-journalist-dead-darkest-day/?utm_source=POLITICO.EU&utm_campaign=cd12771421-EMAIL_CAMPAIGN_2019_04_01_04_45&utm_medium=email&utm_term=0_10959edeb5-cd12771421-190334489

[6] https://www.ft.com/content/c20c79ae-5384-11e9-a3db-1fe89bedc16e?emailId=5ca1834e1d4b6b000456c867&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[7] https://www.politico.eu/article/uks-brexit-options-explained/?utm_source=POLITICO.EU&utm_campaign=cd12771421-EMAIL_CAMPAIGN_2019_04_01_04_45&utm_medium=email&utm_term=0_10959edeb5-cd12771421-190334489

[8] https://www.nytimes.com/2019/03/31/us/politics/trump-mulvaney-border-close-mexico.html?emc=edit_fd_20190401&nl=&nlid=567726720190401&te=1

[9] https://www.reuters.com/article/us-usa-fed-trump/white-house-calls-for-fed-to-reverse-u-s-rate-hikes-idUSKCN1RA2MB

[10] https://www.wsj.com/articles/feds-kashkari-says-it-isnt-time-to-cut-rates-11554111001?mod=newsviewer_click

[11] https://www.reuters.com/article/us-venezuela-politics-bolton-exclusive/exclusive-trump-eyeing-stepped-up-venezuela-sanctions-for-foreign-companies-bolton-idUSKCN1RA2F0