by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Bond yields continue to decline while equities come under pressure.  Here is what we are watching this morning:

The FOMC: A dovish outcome was expected and the Fed delivered.  First, the dots plot was lowered, projecting no rate changes this year and only one more rate increase next year.  On the chart below, December is in gray and March is in yellow with a green line.

Here is another way of looking at the evolution of the dots.  On the chart below, the December meeting is shown as large dark blue dots and yesterday’s meeting is in red.  Note the significant decline in projections.  The history of the dots makes very clear that the FOMC thought a normal recovery would develop and support a return to “normal” fed funds levels.  Continued low inflation has prevented the FOMC from moving the target rate higher.

Second, in the statement, the FOMC acknowledged the slowdown in growth and low inflation.  The economic expectation data showed that the committee is forecasting GDP less than 2% for the foreseeable future with controlled inflation.  In general, there is no reason to lift rates.

And third, the Fed will likely end QT in September.  Again, we view this change as mostly psychological but, in the bigger scheme of things, reducing the balance sheet was unnecessary.  Simply holding it steady would have reduced its impact over time (e.g., its share of GDP would have declined), so QT was, to some extent, a kind of “unforced error.”

Although equities rallied initially, the lift failed to hold as financials suffered.  Long-duration bond yields fell and the dollar weakened as well.  To a great extent, equity markets had already discounted more dovish policy.  However, without a steepening yield curve and dollar weakness, a major lift in stocks will require a pop in earnings.

There has been some discussion by financial pundits that the Powell Fed is caving into the financial markets but the move in policy may have more to do with fears of an economic downturn.  We note that the OECD’s broad leading indicator and the U.S. leading indicator are showing signs of weakness.

And, comparing the NY FRB yield curve-based recession indicator with the Atlanta FRB GDP recession indicator warns of trouble ahead.

The NY Fed indicator gives us a year lead; any reading above 20 is a cause for concern.  The two combined indictors are rather powerful.  This tells us that the U.S. needs to steepen the yield curve if the U.S. is going to avoid a recession.  And, history shows the normal way to have this occur is for policy to ease.  The expectation of one more hike in 2020 from the dots plot suggests the FOMC isn’t quite ready to lower rates.

From our perspective, the continued rally in long-duration Treasuries is a concern.  If investors were concerned about inflation, the dovish Fed policy change would have caused higher long-term rates.  The fact that long rates are continuing to decline suggests no inflation fear and greater worries about weaker economic growth.

Brexit: We realize this topic is really getting old but the drama is unending.  It’s pretty clear there is no consensus in Parliament.  PM May’s plan all along was to eliminate other alternatives and have a vote on her deal or a hard Brexit.  It appears she will now get her wish.  The EU has made it clear that it will grant a short extension to the Article 50 deadline only to give U.K. MPs more time to vote on May’s plan.[1]  Otherwise, it’s a long delay or hard Brexit.  May is wagering that the hard Brexit supporters will prefer her deal to a long delay.[2]  However, there is an element within the Tory Party that would welcome a hard Brexit.[3]  Their position seems to be that the expectations of a sudden break are dire but the outcome probably won’t be as bad as expected and thus a hard Brexit would end up being ok.[4]  In addition, the hard Brexit supporters have tended to believe the EU will blink.  Then again, it appears to us that the EU is better prepared and has more to benefit from a hard break than the British supporters realize.  The hard Brexit supporters also believe that the U.K. can quickly make free trade deals with other nations, including the U.S.  They will likely be shocked at how hard a bargain the U.S. will drive; we doubt U.S. negotiators would tolerate any restrictions on American agriculture, for example.

We still think the odds favor some outcome that avoids a sudden break.  But, it is also clear that this outcome won’t occur until the last minute and the odds of stumbling into a crisis are rising.

Auto tariffs: The Commerce Department has submitted its report to the president on auto tariffs; this triggered a 90-day review period where the president can decide if he wants to implement them.  So far, the White House has refused to distribute the findings despite requests from Congress.[5]  The concept of auto tariffs are generally panned among his advisors, with the exception of Peter Navarro.  The problem is that the auto industry is deeply globalized; tariffs by the U.S. will invite retaliation and could very well paralyze the industry and lead to a sharp downturn in industrial activity.  The auto tariffs are especially critical to EU/U.S. trade talks.[6]  Although we still expect the administration to make a short-term deal with China and avoid a significant disruption, the EU talks could become the next trade-related disruptive event.

Energy update: Crude oil inventories fell 9.6 mb last week compared to the forecast rise of 2.0 mb.

In the details, refining activity rose 1.3% as winter maintenance steadily ends.  Estimated U.S. production rose 0.1 mbpd to 12.1 mbpd.  Crude oil imports rose 0.2 mbpd, while exports rose 0.9 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.  The continued decline puts the market further behind the storage injection curve and is bullish.

Based on oil inventories alone, fair value for crude oil is $60.78.  Based on the EUR, fair value is $53.37.  Using both independent variables, a more complete way of looking at the data, fair value is $55.25.  We are seeing widening fair value readings on the two individual models, with oil stocks very supportive for prices while the dollar is not.  The Fed news could weaken the dollar which could lift oil prices as well.  Although we may see a push over $60 in the near term, a sustained rally will probably need some dollar weakness to maintain the rise.

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[1] https://www.ft.com/content/971250a4-4ae0-11e9-8b7f-d49067e0f50d?emailId=5c931623bcd2b90004d98730&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 and https://www.nytimes.com/2019/03/20/world/europe/theresa-may-brexit-european-union.html?emc=edit_mbe_20190321&nl=morning-briefing-europe&nlid=567726720190321&te=1

[2] https://www.reuters.com/article/us-britain-eu-deal/may-has-a-good-shot-of-getting-brexit-deal-approved-next-week-uk-junior-minister-idUSKCN1R20OF

[3] https://www.ft.com/content/3d6f76da-4b1c-11e9-8b7f-d49067e0f50d?emailId=5c931623bcd2b90004d98730&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[4] https://www.ft.com/content/1376ce46-4b2b-11e9-8b7f-d49067e0f50d?emailId=5c931623bcd2b90004d98730&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.politico.com/story/2019/03/20/trump-tariffs-automobiles-commerce-1228344

[6] https://www.cnn.com/2019/03/20/politics/eu-talks-trump-tariffs/index.html

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Fed Day!  The FOMC finishes its meeting today.  Other than that, markets are very quiet.  Here is what we are watching this morning:

The FOMC: As we noted on Monday, the financial markets have the Fed on hold for the foreseeable future.  This is a quarterly meeting, so we will get dots; the financial markets will be looking to see if their position on steady policy is confirmed by the committee.  There are also expectations that the Fed will establish a terminal level for the balance sheet.  While we continue to have doubts that the balance sheet matters all that much (excess reserves sit idle on bank balance sheets, earning just below fed funds), it will matter psychologically.  The market hopes QT ends in the fall.  We would expect a modest downgrade in economic expectations and no change in the inflation target.[1]  We do have one concern about today’s meeting—expectations have turned so dovish that there is almost no chance of a bullish surprise and any hint of worry about inflation or disappointment on the balance sheet could lead to a bearish reaction.  It’s not a long-term issue, but it could affect today’s trade.

Kazakhstan: Nursultan Nazarbayev, the only president in the 28-year history of the country, announced his resignation yesterday.[2]  Although he had indicated he was planning to resign at some point, his signals were generally ignored given that he is in good health.  At the same time, the news isn’t all it seems.  Nazarbayev intends to maintain control over the security apparatus, meaning the next president will not have the same degree of control.  Kazakhstan has a resource-dependent economy; oil represents about 35% of the country’s GDP and 75% of its exports.  The currency has steadily depreciated during Nazarbayev’s reign, with a large drop in 2015 as oil prices fell.

Geopolitically, Kazakhstan faces two major threats, Russia and Uzbekistan.  Russia likes to keep its former Soviet regions under control (see Belarus, Georgia and Ukraine as examples), and Uzbekistan has the largest population of any of the “stan” nations.  Recent regulatory changes in Uzbekistan, which make foreign investing easier, are lifting the Uzbek economy and may pose a threat to Kazakhstan’s economic dominance of the former Soviet “stan” states.

Nazarbayev has stayed in power by balancing various powerful factions within Kazakhstan, including the head of the energy sector and the security forces.  He is expected to promote the status of family members in the transition.[3]  As long as Nazarbayev remains active in the country’s political system, Kazakhstan will remain stable.  However, once he exits the scene, a period of instability is likely.

Brexit: PM May’s plan to keep running her Brexit deal in front of MPs until they blinked was scotched by Speaker Bercow yesterday.  May announced she would see a 90-day extension simply to avoid a chaotic exit.  May’s government is trying to determine how to get around Bercow’s decision.  They could ask MPs to secure a majority and ask Bercow to allow for a third vote.  Although we expect Bercow to allow another vote in the face of a majority, it isn’t obvious that May can muster one.  May could end this parliamentary session and call another one.  Or, the Queen could prorogate the current parliament and bring a new session.  All these outcomes are possible, but long shots.  The market’s take is that an extension will occur but, with the deadline looming in a mere nine days, the chances of a hard break are still active.

Chinese debt defaults: China’s private sector debt defaults jumped in 2018 to $23.8 bn, up fourfold from 2017.[4]  Although the increase is a bit jarring, total non-financial corporate debt is around $13.0 trillion, so the amount, on its own, is clearly manageable.  However, credit quality in China remains a concern because the government tends to foster growth levels that require increasing levels of debt.

Japan downgrades economy: Japan downgraded its assessment of the economy for the first time in three years, citing the U.S./China trade dispute.[5]  Global growth has been slowing and Japan’s announcement simply confirms the weakness.

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[1] For our take on the inflation target issue, see the Asset Allocation Weekly (3/8/19).

[2] https://www.ft.com/content/7bff2594-4ab8-11e9-8b7f-d49067e0f50d

[3] https://www.ft.com/content/beeb26dc-4af9-11e9-8b7f-d49067e0f50d

[4] https://www.cnbc.com/2019/03/20/chinese-companies-had-record-amount-of-corporate-bond-defaults-in-2018.html

[5] https://www.reuters.com/article/us-japan-economy-report/japan-government-downgrades-economy-view-as-u-s-china-trade-war-bites-idUSKCN1R10SD?stream=business&utm_campaign=newsletter_axiosmarkets&utm_medium=email&utm_source=newsletter

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are broadly higher this morning; the only exception is the dollar, which is coming under some modest pressure.  Other than that, it’s a very quiet morning as we await the Fed.  Here is what we are watching this morning:

Brexit: PM May was dealt a probably fatal blow to her chances of getting her plan through as Speaker of the Parliament John Bercow ruled that the PM cannot keep cycling a bill before the legislature without making substantial changes, citing precedent dating back to 1604.[1]  For now, May and her team are feverishly trying to make changes to the bill that Bercow might deem “substantial” without triggering protest from the EU.  This pretty much means the outcome at the end of March is either (a) a chaotic exit, or (b) a long extension.  Most likely, outcome (b) will be the result.  The GBP did decline on the news but recovered and is higher this morning.  A long delay is a middling outcome and will probably keep the currency about where it is now.  A decision to remain would be quite bullish, whereas a hard Brexit would likely take the currency to around $1.10.

Populism in the Netherlands: We have been seeing a steady stream of reporting in recent months suggesting the populist threat in the West is overblown.  There is an element of truth in this claim; in parliamentary systems with proportional representation, no populist party has gained control of a government.  Instead, these parties have become “kingmakers,” in a way, since no established parties will put them in coalitions.  However, we think the brave talk from the establishment-centered media is probably misunderstanding the threat.  The problem is that the populists are forcing restructuring on political alignments.  In the Netherlands, Mark Rutte’s government is facing a serious threat from the nationalist Forum for Democracy, led by Thierry Baudet, who has replaced Geert Wilders as the standard bearer for the populist right.  Unlike Wilders, who has a difficult relationship with the media and has thus been characterized in the harshest terms, Baudet seeks out media coverage and manages it well.  The Netherlands hold elections on March 20; we will be watching to see how the vote plays out but there is a chance that PM Rutte’s coalition will fail to hold and new leadership could emerge from this important European country.[2]

Rising tensions between Germany and the U.S.: It is no secret that Chancellor Merkel and President Trump have a frosty relationship.[3]  Merkel represents the liberal establishment and leads the largest economy in Europe.  Trump is keen on overturning the liberal order.  In recent weeks, we have been seeing several areas of dispute between the two nations.  First, Germany has been among a number of nations that have been cool to the idea of banning Huawei (002502, Shenzhen, CNY 4.57) equipment on fears that the Chinese government has compromised the tech gear.[4]  Second, Germany indicated today it would not boost defense spending, reversing an earlier pledge.[5]  President Trump has been threatening the EU (read: Germany) with trade impediments if progress isn’t made on trade talks.[6]  The president has specifically included tariffs on autos,[7] which would be especially damaging for the German economy.[8]  In our opinion, the U.S. does have legitimate concerns about German behavior; its macroeconomic policies have essentially colonized the Eurozone and forced the currency bloc to become a net absorber of global domestic demand.

Although the Eurozone, as a whole, mostly had balanced trade until 2011 (when the PIIGS crisis developed), Germany has been running very large current account surpluses since 2005 and has led the Eurozone economy to become a microcosm of the German economy in the wake of the PIIGS crisis.  At the same time, U.S. policymakers appear to have forgotten how dangerous the German Problem is for Europe; from the time of its founding, Germany has been a threat to European security and its economic strength coupled with its geopolitical vulnerability was the underlying cause of two world wars.  It has only been the U.S. security domination of Europe that has led to extended peace on the continent.  If the U.S. presses Germany to take a larger role in European security, the outcome might not be what American policymakers intend.

A couple of unintended consequences: First, in the 2016 election, both candidates from the major parties vowed to reject the Trans-Pacific Partnership (TPP), a multi-lateral trade deal that effectively encircled the Pacific Rim and isolated China.  This trade deal, along with its twin for Europe (the TTIP), would have put the U.S. in the middle of the global trading system and forced the rest of the world, especially China and Russia, to accept the terms of the arrangement.  However, the trade agreements were structured along the lines of those made in the 1990s that extended globalization at the cost of living standards for the Western middle class.  By rejecting both TPP and TTIP, the U.S. (and, in fairness, Europe too) signaled an end to the trend of globalization that accelerated in the 1990s.  Interestingly enough, USTR Lighthizer has noticed that the rejection of TPP was a significant blow to American farmers who now face trade barriers in a number of countries that accepted TPP without the U.S.[9]

Second, social technology platforms have severely damaged print media.  Swap sites killed classified advertising and platforms that aggregated news essentially made reporting free to users even if the papers had to pay reporters for their work.  That creates an unworkable business model for local print media and, over the past 15 years, around 1,800 newspapers have gone out of business.  Facebook (FB, 160.47) has been building a service that would provide local news information to users.  However, it is discovering a profound lack of original reporting it can steal from local areas to publish on its platform.  All those newspapers that have been driven out of business by the swap and social platforms are no longer reporting local news stories.  The company notes “it doesn’t have the answers,” but “doesn’t plan to launch newsgathering efforts on its own.”[10]

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[1] https://www.ft.com/content/2c470dce-4995-11e9-bbc9-6917dce3dc62?emailId=5c907bace90de800047e326f&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[2] https://www.politico.eu/article/the-netherlands-prime-minister-mark-rutte-last-stand-populism-far-right/?wpmm=1&wpisrc=nl_todayworld

[3] https://www.politico.eu/article/the-donald-trump-angela-merkel-doctrine-of-mutually-assured-detestation-nato-huawei/?utm_source=POLITICO.EU&utm_campaign=58847ecac2-EMAIL_CAMPAIGN_2019_03_15_05_52&utm_medium=email&utm_term=0_10959edeb5-58847ecac2-190334489

[4] https://www.nytimes.com/2019/03/17/us/politics/huawei-ban.html?emc=edit_mbe_20190318&module=inline&nl=morning-briefing-europe&nlid=5677267mbe_20190318&te=1 ; it should be noted that Germany isn’t the only European nation being targeted by the U.S. on this issue:  https://www.ft.com/content/12e42a00-499b-11e9-8b7f-d49067e0f50d?emailId=5c907bace90de800047e326f&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.wsj.com/articles/germany-plans-to-renege-on-pledge-to-raise-military-spending-defying-trump-11552922721

[6] https://www.ft.com/content/ce0cc7ea-4678-11e9-a965-23d669740bfb?emailId=5c8aeeb0cc534f000485fbec&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22&fbclid=IwAR1CzZL7FcWbK-zg0lhDEdmqN_dJxjSqfG3rwdmOfUHW2GEeyjZzJ0Ke2KE

[7] https://www.wsj.com/articles/trump-continues-to-weigh-eu-auto-tariffs-11550693479

[8] https://europe.autonews.com/automakers/german-automakers-most-risk-trump-tariffs

[9] https://www.ft.com/content/07d14730-4831-11e9-bbc9-6917dce3dc62

[10]https://apnews.com/790d194cbec347149be8b598009ad1c4?utm_source=Twitter&utm_medium=AP&utm_campaign=SocialFlow

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a modest risk-on day on this Monday in late winter.  Here is what we are watching this morning:

Fed meeting: As noted last week, the FOMC meets this week.  Although there are hopes that the Fed may set the terminal level for the balance sheet,[1] this action may not occur at this meeting.  The dot plot will be watched carefully to see if the FOMC is taking a dovish turn.[2]  Meanwhile, financial markets are clearly signaling that the Fed is on hold.

This chart shows the fed funds target with the implied three-month LIBOR rate on the two-year deferred Eurodollar futures market.  Historically, this rate has coincided with policy actions.  We have placed vertical lines where this spread between the target and the implied rate inverts.  The Greenspan Fed tended to cut rates when the spread inverted.  The Bernanke Fed did stop raising rates once the inversion occurred, but didn’t cut; this lack of action probably contributed to the 2007-09 recession.  The spread is currently sitting at zero.  The financial markets are not signaling a rate cut but they are clearly indicating that further tightening will increase the odds of a policy mistake.

OPEC+: OPEC and Russia are meeting in Baku to discuss oil policy.  This morning, the OPEC minister, Khalid al-Falih, suggested that inventories are still too high (we would agree) and that production cuts should remain in place.[3]  Oil prices have moved higher on the news.  However, Russia has been more cautious about cuts and future talks.[4]  The sticking point seems to be around extending the cuts into H2.  It appears the cartel and Russia will likely defer that decision until May.

Trade talks: It looks like China and U.S. trade negotiators are hitting the most difficult elements of the negotiations because we are starting to hear reports suggesting longer delays in a summit.[5]  The latest out of China is that a meeting might not occur until June.  Apparently, the U.S. is considering keeping the threat of tariffs in place to ensure Chinese compliance to the agreement.[6]  Not only will China probably not accept such a deal, but the continued threat of sanctions will affect U.S. domestic company behavior.  That is, the mere threat of trade sanctions will affect how American companies behave.  If the trade talks fail, it would have an adverse effect on U.S. equities as the stock market has mostly discounted an easing in trade tensions.

Yellow Vest unrest: The Yellow Vests returned to France over the weekend and targeted areas of elite wealth in violent riots.[7]  In some respects, the numbers in the protests are falling but the protests themselves are becoming increasingly destructive.  The Macron government continues to condemn the protests but it looks like its plan to deal with them is to simply wait out the movement.[8]

Brexit: Political machinations continue in Britain and the EU.  PM May could delay another vote on her exit proposal until next week, which would put it very close to the exit date.  May is pressing the junior partner in her coalition, the DUP, to support her exit plan.[9]  The EU is indicating that the U.K. can extend the deadline to July 1 and not participate in May’s EU Parliamentary elections.[10]  Otherwise, the U.K. would be required to participate in the vote, which is not the EU’s preference.  EU officials fear British participation would bolster the populist cause.

But, the most interesting insight on the issue may be a recent election in Fall River, MA, of all places.[11]  The mayor of the town, Jasiel Correia, was accused of defrauding investors, including some local residents, in a marketing app scheme.  Because of his alleged transgressions, the town mustered enough signatures to trigger a recall vote.  Correia, who denies any wrongdoing, was decisively voted out of office.  He received 38% support, or 4,911 votes; obviously, 62% of the electorate opposed him.  Thus, the recall effort was successful and he was removed from office.

However, the good citizens of Fall River needed a mayor if the recall effort was successful so they held a second ballot simultaneously with the first.  Correia boldly ran for mayor against four other candidates.  In the second ballot, he received about the same level of support but because of the multiplicity of candidates he won the mayoral race.  So, on the same day, Correia was ousted and elected to office.

So, how did this happen?  The Fall River vote highlights a weakness in voting.  Voting as a decision process is only effective if the choices are clear.  Otherwise, voting can lead to indeterminate outcomes.  That is why many nations use a run-off vote after an initial voting round to clarify choices.  Other political entities have tested rank choice voting,[12] where voters list their preferences if there are multiple candidates.  This weighted preference method tends to be better for situations of multiple candidates or voting decisions.

The Brexit referendum was poorly constructed.  The way the vote was perceived was either the status quo or something different.  Voters who were unhappy with their economic or social condition opted to leave.  But, the leave decision is actually quite complicated because what that looks like was never fully expressed.  In recent voting, Parliament has told us that it doesn’t like May’s plan, but it doesn’t want a hard break either.  Much like the Fall River vote, British voters opted for one outcome, to leave, but there probably isn’t a majority for any other outcome.  In Fall River, voters paradoxically voted to remove and elect the same man on the same day.  With Brexit, voters opted to exit the EU but with no clear preference for what comes next.

Perhaps PM May’s plan, after all, is the best there is to offer.  It won’t garner a preference of the majority but it may be the best outcome that can be negotiated.  If a new referendum is held, a rank choice vote may at least reveal a plurality that the British people and the EU can live with.

An interesting twist on bitcoin: Bitcoin has become popular in nations with capital controls or currencies in collapse due to hyperinflation.  Venezuela has both conditions.  Another coincidence is that Venezuela has cheap electricity due to hydropower.  Bitcoin mining absorbs a tremendous amount of electricity.  As a result, despite the government’s effort to prevent the use of bitcoin, which included the creation of its own cryptocurrency, Venezuelans have tried to produce bitcoin in a bid to create a store of value.  The recent power outage has created a crisis in bitcoin mining, which led to a 40% decline in volume.[13]

The Cheollima Civil Defense:A group^[14] by this name infiltrated the North Korean Embassy in Madrid during the Trump/Kim summit in Vietnam.  The shadowy group, which wants to oust the Kim regime, briefly took control of the embassy and got away with a treasure trove of confidential information.  We will continue to monitor this group going forward.

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[1] https://www.wsj.com/articles/federal-reserve-rate-projections-could-show-greater-confidence-in-extended-pause-11552820400

[2] https://www.wsj.com/articles/fed-officials-wrestle-with-a-dot-plot-dilemma-11552901401

[3] https://www.reuters.com/article/us-oil-opec-falih/saudi-falih-optimistic-on-continued-commitment-to-opec-oil-supply-cut-idUSKCN1QY09C

[4] https://www.reuters.com/article/us-oil-opec-novak/russias-novak-says-talks-needed-in-may-to-decide-opec-next-steps-idUSKCN1QY0O8?il=0 and https://www.wsj.com/articles/opec-russia-deepen-oil-output-cuts-but-disagree-on-their-duration-11552860517?mod=hp_listc_pos3

[5] https://www.scmp.com/news/china/diplomacy/article/3001943/trump-xi-meeting-end-trade-war-may-be-put-back-june-sources

[6] https://www.nytimes.com/2019/03/17/business/trade-war-china-tariffs.html?action=click&module=Top%20Stories&pgtype=Homepage

[7] https://www.nytimes.com/2019/03/16/world/europe/france-yellow-vests-protest.html?emc=edit_mbe_20190318&nl=morning-briefing-europe&nlid=567726720190318&te=1

[8] https://www.politico.eu/article/french-politicians-condemn-violent-street-clashes-in-paris-yellow-jackets/?utm_source=POLITICO.EU&utm_campaign=3bf9274f14-EMAIL_CAMPAIGN_2019_03_18_05_49&utm_medium=email&utm_term=0_10959edeb5-3bf9274f14-190334489

[9] https://www.ft.com/content/449be1d0-4899-11e9-bbc9-6917dce3dc62?emailId=5c8f15f2584aeb00046099a6&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 and https://www.ft.com/content/4a10a60e-48b3-11e9-bbc9-6917dce3dc62?emailId=5c8f15f2584aeb00046099a6&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[10] https://www.politico.eu/article/document-brexit-by-july-1-unless-uk-votes-in-eu-election/?utm_source=POLITICO.EU&utm_campaign=3bf9274f14-EMAIL_CAMPAIGN_2019_03_18_05_49&utm_medium=email&utm_term=0_10959edeb5-3bf9274f14-190334489 and https://www.ft.com/content/030dce3c-4749-11e9-a965-23d669740bfb

[11] https://www.nytimes.com/2019/03/16/world/europe/brexit-referendums.html

[12] https://www.fairvote.org/rcv#where_is_ranked_choice_voting_used

[13] https://bitcoinist.com/bitcoin-trading-plummets-in-venezuela-blackout-as-government-struggles-to-pay-money-printers/

[14] https://www.washingtonpost.com/world/national-security/a-shadowy-group-trying-to-overthrow-kim-jong-un-raided-a-north-korean-embassy-in-broad-daylight/2019/03/15/ae4208a4-c451-4886-b608-f5ac1f182d3d_story.html?utm_term=.babdc8624b28

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Ides of March Friday!  The National Party Congress (NPC) ended in China and New Zealand is reeling from a mass shooting.  U.S. equity futures are higher.  Here is what we are watching this morning:

The National Party Congress: Unlike previous events, this one was relatively quiet.  Three items emerged.  First, China will return to stimulus, with an increase of 0.8% of GDP in off-budget bond issuance for infrastructure spending.  Although tax cuts have captured the headlines, they are mostly a head fake as spending cuts elsewhere in the budget will tend to offset them.  There could also be some easing of bank reserve requirements.[1]  The stimulus is not all that great but should be enough to stabilize growth.  Second, there was much talk about changes in industrial policy, including little mention of the Belt and Road Initiative or China 2025.  But, the policies still remain in place.  Second, a leveling of the playing field for foreign firms was announced to great fanfare[2] but, in reality, such laws are not terribly meaningful in a nation where “rule of law” really means “do what the Party says.”  The law is mostly there to help bring a trade deal with the U.S.  Third, although there has been some easing of property controls in cities, the national level policy remains restrained.  There had been hopes for change.  Overall, the NPC will support China’s economic growth and likely increase the odds of a trade deal with the U.S., but it won’t lead to an economic boom.

Fed next week: The FOMC will meet next week.  Although no action on rates is expected, we will be watching for two signals.  First, it is quite possible that the FOMC will indicate it will be on hold for most of this year.  Although the usual commentary on data dependency should remain, financial markets are signaling to policymakers that the fed funds should not increase this year.  We will be watching to see if the dots plot reflects this.  Second, the markets will be looking to see if the FOMC signals anything on the balance sheet.  There is growing speculation that the Fed will target a level between $3.8 trillion to $3.5 trillion.[3]  If the FOMC does signal no rate hikes this year and a higher terminal number for the balance sheet, then equities will take this news as supportive.

North Korea: In the aftermath of the recent summit, it appears North Korea may be moving back to a more hostile stance.[4]  Relations between the U.S. and North Korea are complicated.  It appears to us that Kim Jong-un thought he could get a lot from the U.S. and give up little; President Trump clearly figured this out and walked out of talks.  Pyongyang probably wants to pull the U.S. back into talks and thus is using threats to accomplish this outcome.  However, we note the recent comments about restarting warhead and missile tests didn’t come from Kim but from other officials.  We would expect Kim to write another letter or two to Trump to try to get another round of talks.  In addition, a turn toward hostility would be a help to China, who may offer to help out for some easing of trade tensions.

Tehran to Baghdad: Iranian President Rouhani visited Iraq this week, his first state visit to his neighbor.  The visit appears to be designed to undermine U.S. sanctions.[5]  Given the degree of influence that Iran has in Iraq, we expect Iraq to offer a “leaky border” for smuggling.  What was interesting about Rouhani’s visit was that the Iranian president was given a rare audience with Iraq’s leading religious authority, the Grand Ayatollah Ali Sistani.[6] Sistani has always been a political moderate; he does not ascribe to Iran’s “rule of the clerics” model developed by Ayatollah Khomeini, preferring the traditional quietist[7] position of the Shiites.  Sistani opposes Iran’s paramilitary influence in Iraq and apparently noted this in his conversation with Rouhani.  The meeting will lift Rouhani’s position in Iran among moderates and will likely tighten relations between the two governments.

Brexit: So, now what?  The next step is yet another vote on PM May’s exit plan.  Although this seems like a futile exercise[8] to have another vote after the plan has failed miserably twice, it may actually pass on a third turn.[9]  First, May’s minority partner, the DUP in Northern Ireland, is coming under significant pressure from the Northern Irish business community to avoid a hard border and that may mean accepting the backstop and May’s plan.[10]  Second, the EU is indicating that the only way it will agree to an extension is if there is a second referendum.  The Brexiteers are uncomfortable taking a chance on another vote, which might end up with a return to the EU.[11]  Third, it appears that the European Research Group, the collection of Tory MPs who support Brexit, is splitting.  The group, which numbers around 90, only has a core of about 20 MPs.  There are reports that the pragmatists in the group are having second thoughts about careening into a hard Brexit and may end up favoring May’s deal.[12]  And, finally, Labour is facing dissention in its own ranks[13] and may actually lose an election, based on recent polling.[14]  Labour leader Jeremy Corbyn has been pining to bring down the government and have an election, but if Corbyn can’t hold his party together then they might simply vote for May’s plan to avoid another referendum or a hard Brexit.  If May’s plan passes, look for the GBP to rally.

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[1] https://uk.reuters.com/article/us-china-parliament-economy/china-premier-says-can-use-interest-rates-other-policy-steps-to-help-economy-idUKKCN1QW09Y

[2] https://www.scmp.com/economy/china-economy/article/3001780/china-approves-new-foreign-investment-law-designed-level

[3] https://www.reuters.com/article/us-funds-pimco/fed-could-soon-announce-plan-to-stop-shrinking-balance-sheet-pimco-idUSKCN1QV2WB

[4] https://www.reuters.com/article/us-northkorea-usa/north-korea-may-suspend-nuclear-talks-with-gangster-like-u-s-diplomat-idUSKCN1QW0C9?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top

[5] https://www.washingtonpost.com/world/irans-rouhani-in-iraq-for-historic-visit-to-offset-us-sanctions/2019/03/11/24c6e88b-eb40-4da1-b091-c4eb64c0fce3_story.html?utm_term=.a056337ce629&wpisrc=nl_todayworld&wpmm=1

[6] https://www.washingtonpost.com/world/by-granting-rare-audience-iraqs-grand-ayatollah-sends-message-to-washington-and-tehran/2019/03/13/9a624870-4506-11e9-94ab-d2dda3c0df52_story.html?utm_term=.329425d52887&wpisrc=nl_todayworld&wpmm=1

[7] https://en.wikipedia.org/wiki/Political_quietism_in_Islam

[8] https://www.youtube.com/watch?v=UijhbHvxWrA

[9] https://www.youtube.com/watch?v=zMRrNY0pxfM

[10] https://www.ft.com/content/43ec8b9e-466a-11e9-a965-23d669740bfb?utm_source=POLITICO.EU&utm_campaign=154de0543d-EMAIL_CAMPAIGN_2019_03_15_06_44&utm_medium=email&utm_term=0_10959edeb5-154de0543d-190334489

[11] https://www.thetimes.co.uk/edition/news/eu-will-agree-to-extra-time-if-there-is-a-second-brexit-referendum-z6td8nvd7?utm_source=POLITICO.EU&utm_campaign=154de0543d-EMAIL_CAMPAIGN_2019_03_15_06_44&utm_medium=email&utm_term=0_10959edeb5-154de0543d-190334489

[12] https://www.ft.com/content/300a59e4-465b-11e9-b168-96a37d002cd3?emailId=5c8aeeb0cc534f000485fbec&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[13] https://www.telegraph.co.uk/politics/2019/03/14/mps-reject-second-referendum-labour-frontbencher-quits-partys/

[14] https://www.theguardian.com/politics/2019/feb/02/labour-slumps-in-polls-as-tories-open-biggest-lead-since-general-election

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Pi Day![1]  It’s a very quiet day so far this morning.  U.S. equity futures are modestly lower.  Here is what we are watching:

Brexit: As expected, MPs voted to avoid a no-deal Brexit, despite an 11^th hour plea from the PM to vote against it.[2]  May appears to want another round on her proposal,[3] suggesting that either they accept her program or put Brexit into what may be a never-ending delay process.[4]  Today, MPs vote to ask for an extension of the deadline; to be precise, they are voting on four amendments: (a) delay Brexit and try to build a new deal, (b) hold a second referendum, (c) indicate a non-binding vote on the future of Brexit proposals (e.g., joining the Customs Union), and (d) make PM May’s proposal the final version of Brexit.  An amendment to rule out a second referendum will not come up for a vote, torqueing off the hard Brexiteers.

Although we expect the EU to give the U.K. an extension, the noise coming out of Brussels does suggest the EU will need cause.[5] The EU wants to avoid a hard Brexit, but it also wants to prevent the U.K. from voting in the European Parliament elections in May.  And, finally, if the May government does allow Brexit without a hard border between Ireland and Northern Ireland, it will create conditions for a thriving smuggling economy as U.K. tariffs will become effectively unenforceable.[6]  It could also shift trade routes away from France and toward Ireland.

Trade: It appears, as has been rumored, that the trade summit between China and the U.S. will be delayed until later in April.[7]  Gary Cohn, a former administration economic advisor, was quoted on a podcast as saying that President Trump is “desperate” for a trade deal with China.[8]  No surprise there, but coming from someone who was in the administration adds confirmation to other similar comments.  It appears that farmers are banking on either (a) trade relief with China, or (b) increased sales elsewhere because intentions for soybean planting remain high.  Of course, some of this decision is due to the lack of alternatives.[9]

According to reports, Democratic Party leaders in Congress are “cool” toward USMCA.[10]  If the new law fails to pass, it could lead to an end to the treaty.  This would have adverse effects on the economies of Canada and Mexico.

Facebook (FB, 173.37): The company, along with other tech firms, is being criminally investigated for data arrangements made to collect user data.[11]  Increased scrutiny of these tech firms could affect the overall equity market.

Energy update: Crude oil inventories fell 3.8 mb last week compared to the forecast rise of 3.0 mb.

In the details, estimated U.S. production fell 0.1 mbpd to 12.0 mbpd.  Crude oil imports fell 0.3 mbpd, while exports fell 0.5 mbpd.  Refinery runs rose 0.2%, roughly on forecast.

This is the seasonal pattern chart for commercial crude oil inventories.  We would expect to see a steady increase in inventories that will peak in early May; the pattern coincides with refinery maintenance.  This week’s decline puts the market further behind the storage injection curve and is bullish.

Based on oil inventories alone, fair value for crude oil is $57.63.  Based on the EUR, fair value is $52.91.  Using both independent variables, a more complete way of looking at the data, fair value is $53.76.  By all these measures, current oil prices are at the high end of fair value.  Without some dollar weakness soon, oil prices will likely be rangebound until spring.

OPEC cut production in February by 0.2 mbpd, taking the year-to-date reduction to about 1.0 mbpd.  Much of the reduction came from falling Venezuelan output.[12]  The latter situation continues to support prices.  The U.S. is taking additional steps to enforce sanctions on Iranian oil exports, with the aim of reducing Iran’s exports to under 1.0 mbpd by May.[13]

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[1] https://www.nytimes.com/2019/03/14/science/pi-math-geometry-infinity.html

[2] https://www.nytimes.com/2019/03/13/world/europe/brexit-no-deal.html?emc=edit_mbe_20190314&nl=morning-briefing-europe&nlid=567726720190314&te=1

[3] https://www.politico.eu/article/theresa-may-brexit-no-deal-uk-asks-for-one-more-week/?utm_source=POLITICO.EU&utm_campaign=e4c483d49a-EMAIL_CAMPAIGN_2019_03_14_05_48&utm_medium=email&utm_term=0_10959edeb5-e4c483d49a-190334489

[4] https://www.ft.com/content/2fc6b504-45c5-11e9-a965-23d669740bfb?emailId=5c89d5514f943b00041f8d07&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.politico.eu/article/eu-negotiatior-michel-barnier-brexit-extension-for-what-no-deal/?utm_source=POLITICO.EU&utm_campaign=e4c483d49a-EMAIL_CAMPAIGN_2019_03_14_05_48&utm_medium=email&utm_term=0_10959edeb5-e4c483d49a-190334489 and https://www.ft.com/content/c985950e-45af-11e9-b168-96a37d002cd3?emailId=5c89d5514f943b00041f8d07&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6]  https://www.politico.eu/article/smugglers-paradise-ireland-no-deal-brexit/?utm_source=POLITICO.EU&utm_campaign=e4c483d49a-EMAIL_CAMPAIGN_2019_03_14_05_48&utm_medium=email&utm_term=0_10959edeb5-e4c483d49a-190334489

[7] https://uk.reuters.com/article/usa-china-trade-stocks/european-stocks-and-chinas-yuan-hit-by-report-of-delay-in-china-us-trade-summit-idUKL8N211359

[8] https://www.washingtonpost.com/business/economy/gary-cohn-says-trump-is-desperate-for-trade-deal-with-china/2019/03/13/56af2396-45c9-11e9-8aab-95b8d80a1e4f_story.html?utm_term=.4524af084582

[9] https://www.reuters.com/article/us-usa-trade-china-soybeans/why-u-s-growers-are-betting-the-farm-on-soybeans-amid-china-trade-war-idUSKCN1QV0CP

[10] https://www.reuters.com/article/us-usa-trade-democrats/democrats-cool-toward-nafta-replacement-question-labor-standards-idUSKCN1QU2PC?il=0

[11] https://www.nytimes.com/2019/03/13/technology/facebook-data-deals-investigation.html

[12] https://www.wsj.com/articles/opec-slows-pace-of-production-cuts-11552564800

[13] https://www.reuters.com/article/us-usa-sanctions-iran-oil-exclusive/exclusive-us-aims-to-cut-iran-oil-exports-to-under-1-million-bpd-from-may-sources-idUSKCN1QU35V