by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equity futures are modestly higher this morning in a quiet news environment.  Here is what we are watching this morning:

Brexit: As expected, PM May’s plan failed again;[1] although the vote was closer this time, it was nowhere close to passing.[2]  Today, Parliament votes whether to allow or prevent a hard Brexit.[3]  May is allowing Conservative MPs a “free vote,” meaning party whips won’t press members for any particular outcome.  Voting will begin at 7:00 PM GMT (3:00 EDT).  Although it is possible, there isn’t much evidence to suggest that MPs will accept an outcome that allows a hard Brexit (the economic disruption would cause a backlash among voters).  Assuming a hard Brexit option is eliminated, the next step is for a vote tomorrow to ask for an extension from the EU.  The EU has made noise that it won’t grant an extension without cause, but, in reality, the EU doesn’t want a hard Brexit either so we expect an extension will be granted.

Meanwhile, there is much drama going on behind the scenes.  There is growing talk of a second referendum.[4]  Brexiteers seem poised to bring down May and replace her with one of their own.[5]  Labour wants to do the same.  These plays at power are the most likely avenue for a chaotic exit.  So far, however, financial markets are betting that there will be an extension of the deadline and muddling will continue; the GBP is trading in a tight range awaiting some clear outcome.

Venezuela: As the country spirals into the “heart of darkness,”[6] there is one news item of note—opposition leader Guaido has indicated he would reopen Venezuela’s oil industry to foreign investment.[7]  Venezuela, unusual for an OPEC nation, welcomed foreign investment in the era before Chavez.  Chavez chased the foreigners out; as he did so, oil production steadily declined.  Guaido’s promise will be popular with developed nations but, over time, would be a serious threat to OPEC.  Saudi Arabia’s decision to take market share away from Venezuela in the late 1990s led oil prices to near $10 per barrel.  Given the current chaos in Venezuela, it would take a few years to rebuild the nation’s oil industry.  But, the longer term implications would be bearish for oil prices.

Bouteflika’s presidency nears its end: Algerian president Abdelaziz Bouteflika has postponed the April 18^th elections and has indicated he won’t stand for a fifth term.[8]   Even though he has promised not to run for a fifth term, protests are continuing in a bid to oust him.[9]  So far, civil order has mostly held.  But, if the regime begins to feel threatened, a harder response and potential oil flow disruptions are possible.

The college bribery scandal: Although we don’t expect any direct market effects, at least in the near term, the bribery scandal could have important political and social effects.  Unless you have been in a news vacuum over the past 24 hours, the outline of the scandal is this: wealthy parents took a number of extreme measures to get their offspring into elite colleges.  The actions included fake athletic entries and falsified college entrance exams.[10]

The well-heeled already have advantages in the college admissions process.  Their parents probably went to college and understand the process.  The parents can pay for test tutors and multiple attempts at the exam, whereas poor kids can maybe buy or borrow a test prep book and can afford one try at the exam.  Rich kids have enriching summers, while poor kids work at menial jobs; these experiences create bias for acceptance letters.  So, even when criminal action isn’t taken, the playing field is far from even.  And, at the very wealthy levels of society, legacy admissions tied to large donations have been around for a while.  None of this is some great revelation.  However, this scandal takes the process even further, showing that some families of means are willing to resort to fraud.  So, why does this happen?

We live in an age of meritocracy.[11]  Instead of being ruled by a hereditary elite, we are now, in theory, led by the best and brightest.  If we really believed that, then the parents would recognize that their less stellar offspring probably shouldn’t take the place of a less fortunate but smarter kid at that elite college.[12]  But, in this case, natural affinities overruled good sense and the newly rich of the “best and brightest” went beyond what is already unfair to criminal to advantage their children.

Here is the social and political problem this scandal brings—the less fortunate kids in the middle who don’t get the benefits of legacy or wealth or the help of affirmative action will view this scandal as further evidence that the deck is not just unfairly stacked against them but is criminally so.  Therefore, when someone from the best and brightest class tries to explain why policies, let’s say, climate change policies, are worthy, those outside the meritocracy class will view this not as wise and well thought out policy but probably just another government action to disadvantage them further.  Meritocracy as a system can be justified but if it is delegitimized by the behavior exhibited in this scandal, then faith in those who have positions of power are undermined.  Such actions support the rise of populism.

Chinese trade: USTR Lighthizer was encouraging in his comments yesterday.[13]  And, Congress is pushing back against auto tariffs, reducing their likelihood as well.[14]  The news is supportive for equities.

Coffee bear: Coffee prices fell to their lowest level in more than a decade and supply exceeds demand.[15]  A weak BRL lowered production costs (one of the reasons a strong dollar is bearish for commodities is that most commodities are priced in dollars but production costs are in local currencies, so a stronger dollar encourages more production) which led to more tree investment that is now producing more beans.  However, the drop in wholesale prices will not lead to lower prices at the consumer level, at least not immediately.  Instead, it will boost margins for roasters.

Mankiw Rule update: The Taylor Rule is designed to calculate the neutral policy rate given core inflation and the measure of slack in the economy.  John Taylor measured slack by the difference between actual GDP and potential GDP.  The Taylor Rule assumes that the Fed should have an inflation target in its policy and should try to generate enough economic activity to maintain an economy near full utilization.  The rule will generate an estimate of the neutral policy rate; in theory, if the current fed funds target is below the calculated rate, then the central bank should raise rates.  Greg Mankiw, a former chair of the Council of Economic Advisors in the Bush White House and current Harvard professor, developed a similar measure that substitutes the unemployment rate for the difficult-to-observe potential GDP measure.

We have taken the original Mankiw rule and created three other variations.  Specifically, our model uses core CPI and either the unemployment rate, the employment/population ratio, involuntary part-time employment and yearly wage growth for non-supervisory workers.  All four models compare inflation and some measure of slack.  Here is the most recent data:

Three of the models would suggest the FOMC is well behind the curve and needs to be increasing the policy rate.  However, the employment /population ratio does suggest some slack in the economy and implies the Fed has already lifted rates more than necessary.  Until recently, the wage growth variation was also suggesting caution.  In September, it was signaling a neutral rate of 2.78%.  However, as the line shows, the projected rate has moved up sharply as wages have increased.  We suspect some of this wage increase has been mandated by various state and local increases in minimum wages.  If so, the rise in wages should slow later this year.

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[1] https://www.nytimes.com/2019/03/12/world/europe/uk-brexit-vote.html?emc=edit_mbe_20190313&nl=morning-briefing-europe&nlid=567726720190313&te=1

[2] https://www.ft.com/video/b8a9776f-3766-4537-ac2a-e4464ef7fe5a?emailId=5c8885c89bf68b0004839367&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.ft.com/content/391ed220-44ef-11e9-b168-96a37d002cd3?emailId=5c8885c89bf68b0004839367&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[4] https://www.washingtonpost.com/politics/2019/03/12/could-there-be-second-brexit-referendum/?utm_term=.7db5360f03f2&wpisrc=nl_todayworld&wpmm=1

[5] https://www.ft.com/content/dff1acce-44ec-11e9-b168-96a37d002cd3?emailId=5c8885c89bf68b0004839367&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6] https://www.amazon.com/Heart-Darkness-Joseph-Conrad/dp/1936594145

[7] https://www.reuters.com/article/us-venezuela-politics-energy-law/venezuelas-guaido-readies-to-open-up-oil-industry-after-years-of-nationalization-idUSKBN1QT2HP

[8] https://www.nytimes.com/2019/03/11/world/africa/algeria-president-election.html?emc=edit_mbe_20190312&nl=morning-briefing-europe&nlid=567726720190312&te=1

[9] https://www.washingtonpost.com/world/protests-continue-after-algerian-leader-drops-bid-for-fifth-term/2019/03/12/628be796-44cd-11e9-94ab-d2dda3c0df52_story.html?utm_term=.6f7d76d1696b&wpisrc=nl_todayworld&wpmm=1

[10] https://www.washingtonpost.com/world/national-security/fbi-accuses-wealthy-parents-including-celebrities-in-college-entrance-bribery-scheme/2019/03/12/d91c9942-44d1-11e9-8aab-95b8d80a1e4f_story.html?utm_term=.7e32ab03dcdd&wpisrc=nl_todayworld&wpmm=1 ; https://www.theatlantic.com/education/archive/2019/03/college-admissions-scandal-fbi-targets-wealthy-parents/584695/?wpmm=1&wpisrc=nl_todayworld ; https://www.nytimes.com/2019/03/12/us/college-admissions-cheating-scandal.html?emc=edit_mbe_20190313&nl=morning-briefing-europe&nlid=567726720190313&te=1

[11] https://www.nytimes.com/2018/12/05/opinion/george-bush-wasps.html

[12] https://www.youtube.com/watch?v=eiRGRvE_Wqg

[13] https://www.wsj.com/articles/u-s-china-trade-deal-is-getting-closer-lighthizer-says-11552407913

[14] https://www.wsj.com/articles/momentum-slips-for-auto-import-tariffs-11552383000

[15] https://www.axios.com/newsletters/axios-markets-2397805b-f1f9-4fd9-909d-1c17966edcdf.html?chunk=5#story5

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equity futures are flat this morning after a strong run yesterday.  Here is what we are watching this morning:

Brexit: In an 11^th hour attempt to seal a deal,[1] PM May and EU Commissioner Juncker offered statements to clarify and ease the Irish backstop issue.  Although May suggested that she had secured “legally binding” assurances that the U.K. would not be forever trapped in the backstop, Geoffrey Cox, her attorney general, disagreed.[2]  In reality, if Juncker had offered something new it would have needed ratification from the 26 other members of the EU; since he didn’t ask, these “assurances” were not a real change.  Cox’s decision is probably a deal killer.  If Cox would have agreed with May’s description, his approval might have swayed Tory Brexiteers.  But, his assessment likely means that when the vote on May’s plan is held at 7:00 GMT (3:00 pm EDT) it will almost certainly be defeated.  That sets up tomorrow’s vote, which will determine whether or not there can be a hard Brexit.  We expect hard Brexit to be defeated, which means a delay in Brexit is coming; the exit could be delayed for up to a year.

When the May/Juncker agreement was announced, the GBP rallied strongly.  It has given up nearly all of its gains.

A customs workers’ strike in France, protesting the lack of French preparation for Brexit, could be a sign of how chaotic a hard Brexit would be.[3]  Trucks are reportedly backed up for miles.  Current arrangements allow for the seamless movement of goods.  After Brexit, cargos will need to be inspected.

Venezuela blackouts: The blackouts in Venezuela are continuing with no clear end in sight.[4]  The U.S. is pulling all of its embassy staff from the country.[5]  The persistent power outages are affecting oil production and exports.[6]  There are unconfirmed reports that oil production may have fallen to 0.5 mbpd; for world markets, the lack of exports means that Venezuela is no longer contributing to global supply.  Oil prices moved higher on the news.

Bouteflika’s presidency nears its end: Algerian president Abdelaziz Bouteflika has postponed the April 18 elections and has indicated he won’t stand for a fifth term.[7]  Algeria has been hit with protests against the president, who is 82 years old and incapacitated from a stroke.  It appears a caretaker government will take control of his administration until new elections are held.  Bouteflika has been in office since 1999.  The fact that it appears there will be a peaceful transition of power is remarkable and modestly bearish for oil prices (although Venezuela’s news is probably a more important factor).

Chinese trade: Chinese Vice Premier Liu discussed the text of a trade agreement with USTR Lighthizer yesterday evening.[8]  Although there is no date for a Xi-Trump trade summit, the fact that these two high-ranking officials are talking is a good sign that there are attempts at progress.

New York tax: State and city officials are considering a “pied-à-terre” tax[9] on second homes in New York City.  The city is a destination for the wealthy to purchase apartments and homes that are not their primary residence.  The tax would apply to non-primary homes worth $5.0 mm or more.  What makes this tax interesting to us is that New York residential real estate has been attractive to foreign capital flight for years.  It is unclear if the tax will be enough to deter these funds to other venues, but other cities that are also areas for capital flight, such as London, may be watching to see if the city remains a destination for capital flight after the tax is enacted.

Populism v. establishment: Since the election, we have characterized the Trump presidency as a battle between the populists and the establishment.  Trump shrewdly determined that populists, especially the right-wing variety, had perceived themselves as being shunted aside.  By running as an anti-global Jacksonian, he was able to capture that vote.  At the same time, Trump also catered to the right-wing establishment.  In governing, Trump mostly acted as an establishment figure, at least on domestic economic policy, until January 2018.  After the tax bill passed, Trump’s policies of trade impediments and border security were pure right-wing populism.

However, on foreign policy, Trump has been more consistently populist.  The establishment supports America as hegemon, which means the U.S. acts to bring global security and provides the reserve currency.  In the latter role, the U.S. is open to trade and willingly accepts a trade deficit.  It also remains open to immigration, which provides the capital-owning class an expanding (and compliant) labor force.  Trump has put up trade barriers and moved U.S. trade policy to a bilateral stance, which virtually guarantees that the U.S. will dominate every trade relationship (at the cost of undermining U.S. security projection).  Trump has also moved to restrict immigration.

The right-wing establishment has an uneasy relationship with Trump.  Although it clearly supports the tax cuts and aggressive deregulation, it would prefer the U.S. maintain the superpower role and have relaxed immigration policy.  The WP is reporting that, in a discussion with VP Pence, former VP Dick Cheney accused Trump of running a foreign policy similar to his predecessor, Barack Obama.[10]  In terms of substance, Cheney is closer to being accurate.  Trump’s unilateral decision to leave Syria is reminiscent of Obama’s hasty retreat from Iraq.  Obama’s “pivot to Asia” required a reduction in resources to the Middle East.  One of the common mistakes made in the current environment is to analyze politics from the traditional right/left, Republican/ Democrat or conservative/liberal viewpoints, but the real underlying trend, in our view, is populist/establishment.  And, it isn’t just a U.S. issue.  Europe is being riven by similar trends.  The noted exchange between Cheney and Pence is an interesting example of the populist/establishment divide.

Turkey slips into a downturn: Last year’s currency crisis in Turkey has weighed on growth and finally taken GDP into negative territory for the second consecutive quarter, which is considered a “rule of thumb” definition of recession.

However, it wasn’t all bad news.  The drop in the TRY has led to a significant improvement in net exports, which will, over time, support the economy’s recovery.  The improvement in trade confirms that a floating exchange rate is a powerful tool to combat a downturn.

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[1] https://www.washingtonpost.com/world/europe/in-a-big-week-for-brexit-parliament-will-vote-on-theresa-mays-deal-and-possibly-a-delay/2019/03/11/52d3f5d4-4403-11e9-94ab-d2dda3c0df52_story.html?utm_term=.fc13b814458f&wpisrc=nl_todayworld&wpmm=1

[2] https://www.ft.com/content/bbb893a6-44b8-11e9-b168-96a37d002cd3

[3] https://www.nytimes.com/2019/03/11/world/europe/france-border-protest-brexit.html?emc=edit_mbe_20190312&nl=morning-briefing-europe&nlid=567726720190312&te=1

[4] https://www.nytimes.com/2019/03/11/world/americas/venzuela-blackout-maduro.html?emc=edit_mbe_20190312&nl=morning-briefing-europe&nlid=567726720190312&te=1

[5] https://www.wsj.com/articles/u-s-to-withdraw-remaining-embassy-staff-families-from-venezuela-11552370940

[6] https://oilprice.com/Geopolitics/South-America/Blackout-Shuts-Down-Venezuelas-Oil-Exports.html

[7] https://www.nytimes.com/2019/03/11/world/africa/algeria-president-election.html?emc=edit_mbe_20190312&nl=morning-briefing-europe&nlid=567726720190312&te=1

[8] https://www.scmp.com/news/china/diplomacy/article/3001162/chinese-vice-premier-liu-he-discusses-trade-deal-text-us

[9] https://www.nytimes.com/2019/03/11/nyregion/mta-subways-pied-a-terre-tax.html?action=click&module=Top%20Stories&pgtype=Homepage

[10] https://www.washingtonpost.com/politics/former-vice-president-cheney-challenges-pence-on-trumps-foreign-policy/2019/03/11/ecddbff6-4436-11e9-aaf8-4512a6fe3439_story.html?utm_term=.f2b69fdea40d&wpisrc=nl_todayworld&wpmm=1

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Equity futures are mostly higher this morning, although Dow futures are lower on the Ethiopian airlines crash.[1]  Here is what we are watching this morning:

Chinese trade: It appears the trade summit between China and the U.S. will likely be delayed, probably into April.[2]  There was some movement on the enforcement mechanism.  China is uncomfortable with giving the U.S. unilateral power to decide whether China is violating the terms of the agreement, but would be willing to accept a joint plan.[3]  China has also indicated it won’t engage in competitive devaluations,[4] most likely because any threat of a weaker CNY would trigger capital flight.  We still expect the Trump administration to make a deal with China as a failure of talks would harm the president’s reelection campaign.[5]

Meanwhile, we note that China’s exports appear to be rebounding this month.[6]  There is evidence that China’s economy is starting to benefit from recent stimulus measures.[7]

Brexit: It’s decision week for Brexit.  There are three votes this week.  The first occurs tomorrow on May’s exit deal.  Although her administration has been negotiating with the EU, there has been no discernable progress made.[8]  Thus, we are assuming her plan will go down in defeat again.  The following day Parliament will vote on whether it wants a “no-deal” Brexit.  That will likely also be defeated as few MPs want to be seen as supporting the chaos that a fast, hard break would bring.  On Thursday, assuming our assessment of Tuesday’s and Wednesday’s votes are correct, Parliament should vote to ask for an extension.[9]  Although it would appear logical that they should vote for an extension, stranger things have happened.

It does look like PM May’s remarkable run could be coming to a close.[10]  Although she has suffered historic losses in Parliament, she has hung on to power, in part, because no one else has any better ideas on how to proceed.  However, the Tories are concluding that the party needs a new leader to negotiate trade arrangements with the EU.  From our vantage point, we don’t see a leader in the Conservatives who will have any easier of a time concluding Brexit.

Meanwhile, the BOE has ordered banks to triple their “easy to sell” asset buffers on fears of a hard Brexit.[11]  Businesses are in varied states of preparation.[12]  So far, the GBP has held its value on the belief that a hard Brexit will be avoided.  We suspect this supposition is true, but there remains a chance that Britain stumbles into a crisis.

Venezuela blackouts: Venezuela suffered massive power outages over the weekend[13] that are continuing into this workweek.[14]  The Maduro government has accused outsiders of sabotage, but the most likely reason is the ineptitude of the regime.  Protests against the government continue despite the blackout,[15] but it increasingly appears that the opposition cannot swing the military to its side.  Thus, the slow-motion collapse continues.[16]

Saudi oil cuts extended into April: Saudi sale intentions for next month are signaling that oil production cuts will continue, which is supportive for oil prices.[17]

Indian elections begin mid-April: The world’s largest democracy will begin elections on April 11.  Six subsequent elections will be held over the next five weeks, ending on May 19 with final results due on May 23.[18] 

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[1] https://www.washingtonpost.com/world/ethiopian-airlines-flight-bound-for-nairobi-crashes-with-157-on-board/2019/03/10/0be5826c-4310-11e9-90f0-0ccfeec87a61_story.html?noredirect=on&utm_term=.1847abc5605e&wpisrc=nl_todayworld&wpmm=1

[2] https://www.wsj.com/articles/u-s-china-trade-deal-isnt-imminent-ambassador-branstad-says-11552031163 and https://www.ft.com/content/e089b6de-42b4-11e9-b168-96a37d002cd3

[3] https://www.nytimes.com/2019/03/09/business/china-trade-talks-trump.html?action=click&module=Latest&pgtype=Homepage

[4] https://www.wsj.com/articles/u-s-china-near-currency-deal-beijing-vows-not-to-devalue-yuan-to-help-exports-11552204378

[5] https://www.bloomberg.com/news/articles/2019-03-08/trump-says-china-deal-will-mean-very-big-spike-for-markets

[6] https://www.scmp.com/economy/china-economy/article/2189454/china-exports-rebound-strongly-early-march-after-februarys-20

[7] https://www.ft.com/content/c085c2e4-4235-11e9-b168-96a37d002cd3

[8] https://www.ft.com/content/dceee028-43ca-11e9-a965-23d669740bfb

[9] https://www.nytimes.com/2019/03/08/world/europe/brexit-uk-may-endless.html?emc=edit_mbe_20190311&nl=morning-briefing-europe&nlid=567726720190311&te=1

[10] https://www.ft.com/content/618ad20c-4316-11e9-a965-23d669740bfb?emailId=5c85da12a114dd0004a40895&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[11] https://www.ft.com/content/7450737a-4356-11e9-b168-96a37d002cd3?emailId=5c85da12a114dd0004a40895&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[12] https://www.washingtonpost.com/world/europe/will-brexit-happen-when-and-how-the-uncertainty-is-maddening-for-business/2019/03/09/900525fe-3468-11e9-8375-e3dcf6b68558_story.html?utm_term=.48613f282d57&wpisrc=nl_todayworld&wpmm=1

[13] https://www.washingtonpost.com/world/the_americas/rotting-food-and-endangered-patients-how-venezuelans-are-faring-during-continuing-nationwide-power-outages/2019/03/10/137e14a2-4343-11e9-94ab-d2dda3c0df52_story.html?utm_term=.2b67fedfc403&wpisrc=nl_todayworld&wpmm=1

[14] https://www.ft.com/content/65940e9a-3c6d-11e9-b72b-2c7f526ca5d0

[15] https://www.washingtonpost.com/world/the_americas/demonstrators-jam-venezuela-anti-government-protest-despite-blackout/2019/03/09/75c328c0-404e-11e9-85ad-779ef05fd9d8_story.html?utm_term=.eb167a5fa2a4&wpisrc=nl_todayworld&wpmm=1

[16] https://www.washingtonpost.com/opinions/2019/03/10/venezuela-is-truly-verge-collapse/?utm_term=.ab11763ea5f8

[17] https://www.bloomberg.com/news/articles/2019-03-11/saudi-arabia-is-said-to-extend-deep-oil-output-cuts-into-april

[18] https://www.washingtonpost.com/world/india-elections-to-launch-on-april-11-unfold-in-seven-stages/2019/03/10/8b94916e-4320-11e9-9726-50f151ab44b9_story.html?noredirect=on&utm_term=.9cac09849a42&wpisrc=nl_todayworld&wpmm=1

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy employment Friday!  We cover the data below but the quick read is that it’s mixed.  The payroll data came in very weak (+20k vs. +180k expected).  The unemployment rate dropped to 3.8% from 4.0% last month, and wages rose more than expected.  Market reaction is treating the numbers as bad for the economy—long bond yields and the dollar both fell and equities turned lower.  Here is what we are watching this morning:

Chinese trade: Just as it seemed a trade deal was moving steadily toward fruition, reports emerged yesterday that China is getting cautious.  Apparently, the Chinese side is worried about the monitoring system that could be used by the U.S. to trigger actions against it.  As a result, the summit expected later this month might be delayed, or not occur.[1]  There are a couple of issues here.  First, China’s goal throughout this process has been to buy stuff in key sectors but maintain its industrial policy.  Last year, when Wilbur Ross thought he had an agreement, the president scotched it because he wanted something more comprehensive.  USTR Lighthizer is clearly focused on an enforcement mechanism that will hold China accountable and, not surprisingly, China is having second thoughts about being held in such a manner.  Second, Chinese negotiators may be trying to create daylight between Lighthizer and the president, working on the assumption that the president wants a deal to help his reelection chances.  However, the president does have to carefully weigh the trade issue.  A deal revealed to be superficial just to maintain equity market levels may not help him politically; perhaps an even bigger issue is whether his working class base cares at all about the stock market.  They may prefer a deal that punishes China and probably couldn’t care less about stocks.  So far, we haven’t seen enough new information to change our view that both sides need an agreement[2] and, as such, will come to one that is less than complete.  But, we remain in the realm of probabilities and not certainties.

Chinese trade numbers: China’s export numbers were soft; from last year, February exports plunged 20.7% and imports fell 5.2%.  While both numbers were much weaker than expected, export growth was the slowest in three years.[3]  Analysts are tending to discount the data due to the Lunar New Year disruption, but the drop is large enough to be worrisome.  From our perspective, the decline in imports suggests a weakening domestic economy.  The chart below overlays the manufacturing PMI with the yearly change in imports.  In general, negative import readings are consistent with PMIs under 50.

ECB: The ECB surprised the markets with the announcement of new stimulus measures.  Apparently, Draghi caught other members of the ECB by surprise as well.[4]  The ECB’s action did not seem to have the desired effect; European bank shares fell, which were subsidized by the credit operations of the ECB.  In fact, risk markets declined across the board.  The ECB’s economic projections, which triggered the policy action, appear to have spooked the markets by raising the possibility that the European economy is on the cusp of a downturn.  One item worth noting is that the EUR plunged on the ECB’s announcement.  We are watching to see if the Trump administration frames this as a currency depreciation move by the ECB.  If so, it could affect upcoming trade talks.

EU/U.S. trade talks: Although there is some caution regarding the U.S./China negotiations, the talks with Europe look downright worrisome.  EU negotiators are clearly indicating they have no interest in a broad (read: agricultural products) trade agreement.[5]  We doubt the administration will accept that outcome.[6]  The immediate effect of a “second front” on the trade war would be dollar strength against the EUR; combined with the easier stance of the ECB, it could lead to a much softer Eurozone currency.

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[1] https://www.nytimes.com/2019/03/07/business/us-china-trade-deal.html and https://www.wsj.com/articles/u-s-china-trade-deal-isnt-imminent-ambassador-branstad-says-11552031163

[2] https://www.ft.com/content/3cf778ca-3f68-11e9-9499-290979c9807a

[3] https://www.reuters.com/article/us-china-economy-trade/china-february-exports-tumble-the-most-in-three-years-slowdown-worries-deepen-idUSKCN1QP0CA?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosmarkets&stream=business

[4] https://www.reuters.com/article/us-ecb-policy-surprise/ecbs-draghi-surprised-colleagues-with-bold-stimulus-plans-sources-idUSKCN1QO26O?il=0

[5] https://www.reuters.com/article/us-usa-trade-eu/eu-trade-chief-says-no-support-in-europe-for-comprehensive-u-s-trade-deal-idUSKCN1QO1UK

[6] https://www.nytimes.com/2019/03/06/us/politics/trade-deal-europe-usa.html?action=click&module=News&pgtype=Homepage

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Equities are lifting on the back of the ECB.  Here is what we are watching this morning:

 ECB: The ECB went a bit further than expected in its statement.[1]  There was no change in the policy rate but the statement indicated there will be a third series of long-term credit operations, which will commence in September and last two years.  Essentially, this is another round of QE.  And, the rate tightening is extended into the future as well.  The action was expected at some point because the Eurozone economy has been near recession levels in recent months, but the announcement wasn’t expected until later this year.  By moving faster than expected, the ECB is signaling that it is worried about the economy and feels the need to act.  Eurozone bond yields declined,[2] equities lifted modestly and the EUR fell.

In the press conference, Draghi announced that the ECB had downgraded both growth and inflation prospects,[3] which gave rise to the policy easing.  Although the policy measures are new accommodation, Draghi did note that they are time dependent.  In other words, they have a deadline.  That factor has reduced some of the market optimism that occurred after the statement.  We suspect they are time dependent because Draghi’s term ends in October and he doesn’t want to put a time-indeterminate policy on his successor.  Then again, accommodation that expires due to a calendar date and not based on economic and financial conditions has less impact.

Trouble in Riyadh?  The Guardian[4] reports a growing rift between CP Salman and his father, the king.  According to reports, the CP has been making appointments and taking steps without the approval of King Salman.  The king was recently in Egypt and, in a sudden move, reportedly sent his security detail home and replaced them with his own loyalists.  CP Salman tends to act fast and boldly, a major shift from the way Saudi kings have behaved over the past three decades (although, in the early years after the death of Ibn Saud, there was much intrigue and action).  There is always the potential that the CP could “get out over his skis” and need to be reined in by the king.  However, if the king has concluded that his son is trying to oust him, it could trigger a showdown and perhaps both patricide and regicide could occur.  Instability at the apex of the Saudi royal family would be a profoundly bullish event for crude oil, at least in the short run.

Beige Book: The Fed’s Beige Book, an anecdotal report on the economy from each of the 12 FRB district banks, suggests that moderate growth was seen in 10 of the 12 districts.  Philadelphia and St. Louis both reported “flat” economic activity.  Philadelphia and Richmond tend to be sensitive to actions in Washington, so the government shutdown may account for the lackluster growth reported in the former.  In all, six of the 12 did indicate there were comments about the shutdown affecting district economies.  Weather issues also affected the economy.  Tight labor market conditions were unanimously reported.  This report seldom contains major surprises but it does confirm recent data indicating a softer economy.

Regulatory easing: The Fed and the Financial Stability Oversight Council are adjusting the crisis-era regulations.  Stress tests on banks are becoming less “pass/fail,” which means the market impact will be reduced.[5]  Although there has been some hand-wringing over this easing, our take on the stress tests was always that they were mostly window dressing.  Financial crises are usually created by overconfidence, Minsky’s adage that “stability breeds instability.”  Stress tests examine known risks but it’s the unknown risks that lead to problems because they are nearly impossible to predict.  To sniff out a “black swan,” one mostly needs to see a problem that no one else thinks is an issue.  It is highly improbable that anyone involved in testing the official stress tests will look for such things or assume an outlier.  At the same time, it does highlight the new members of the Fed and their tendency to support deregulation (see below).

China’s foreign reserves: China’s foreign reserves rose $2.3 bn to $3.09 trillion.  The data was near expectations and suggests little pressure or intervention on the CNY.

A political trend we are watching: Since the time of President Trump’s election, our working assumption has been that the president himself lacks an ideology but correctly perceived the rise of populism and used it to get elected.  But, in reality, he wanted to placate both the populists and the establishment.  As a result, we end up with inconsistent policies of tax cuts and deregulation (supported by the establishment) along with deglobalization, which includes anti-trade and anti-immigration policies (supported by the populists).  It is difficult to serve two masters, and, the longer time passes, the harder it is to maintain that position.  Yesterday, populist media figures expressed disappointment with the president, a rare occurrence.[6]  As has been discussed at length, the president uses the equity market as a real-time indictor of the success of his administration.  However, policies that support equities are not populist, but establishment.  If Trump wants a stronger equity market, he will relax immigration restrictions and undercut the strength of trade impediments.  But, if key populist media figures determine that he is “going astray,” then he risks losing his working class base.

A bit of technical analysis: Although we are not technicians, the older of us did spend years in commodity research and has a working knowledge of chart analysis.  Equity markets are looking like a correction is coming.

This is a chart of the S&P 500.  The lower sectors of the chart are momentum indicators—specifically, the RSI and stochastic.  The RSI has reached overbought levels as has the stochastic.  Merely reaching those levels doesn’t necessarily mean that prices are about to roll over, but when momentum slows from a very high level then the likelihood of a market decline increases.  We see support around 2600.  In Monday’s comment, we reported that retail MMK levels remain elevated.  Simply put, the rally seen this year appears to have had only modest retail participation.  That analysis, coupled with the above chart, suggests that we will likely remain rangebound until retail returns.

Brexit: It appears London and Brussels remain at an impasse on the Irish backstop.[7]  The vote will be held next week.  Current expectations suggest that either May’s plan will pass or Brexit will be delayed.  However, there is still the chance of a hard Brexit that the market could be underestimating.

Facebook (FB, 172.51): As our regular readers know, we only comment on individual equities when the actions of a company reflect or affect a macro issue.  Yesterday, CEO Mark Zuckerberg made an announcement over privacy policy.  By itself, this is of no interest to us, but what he seems to be signaling is a change in the company and its flagship product.  One of the developments we have noted is the evolution of WeChat, a product of Tencent (TCEHY ADR, $45.93).  WeChat is becoming a universal app—one can pay bills, chat with friends, make appointments, play games, etc.  Essentially, mobile users might not need any other application on their devices.  Facebook’s announcement appears designed to duplicate that model.  This bears watching because, if successful, it may allow the company to further dominate the mobile market and will likely trigger both regulatory and competitive responses.[8]

Venezuela: The Maduro regime detained and later expelled a U.S. journalist.[9]  He also expelled a German diplomat.[10]  The diplomat, Daniel Kriener, had met Juan Guaido at the airport when he arrived on Monday and the diplomats prevented Maduro from arresting Guaido.  The fact that Maduro is expelling Kriener suggests he did intend to risk a showdown with the U.S. and the diplomats prevented such action.

Energy update: Crude oil inventories rose 7.1 mb last week compared to the forecast rise of 1.1 mb.

In the details, estimated U.S. production was steady at 12.1 mbpd.  Crude oil imports recovered from the last report, rising 1.1 mbpd, while exports fell 0.6 mbpd.  Refinery runs rose 0.4%, 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 recovery does make up for last week’s unexpected decline but, given that there is a usual increase each week, we are still at a deficit injection to inventory levels for the season.  Overall, the data was bearish but not terribly so.

Based on oil inventories alone, fair value for crude oil is $56.39.  Based on the EUR, fair value is $53.76.  Using both independent variables, a more complete way of looking at the data, fair value is $53.86.  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.

India is asking Washington for an extended waiver on Iranian oil imports.  The current waiver ends in early May.[11]  We will be watching to see if the U.S. gives India the waiver; if the administration acquiesces, we would expect others to ask as well, which would be bearish for oil prices. 

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[1] https://www.ft.com/content/7ceb815e-40cd-11e9-b896-fe36ec32aece

[2] https://www.ft.com/content/30d501b0-40db-11e9-9bee-efab61506f44

[3] https://www.ft.com/content/f652b41a-40da-11e9-b896-fe36ec32aece

[4] https://www.theguardian.com/world/2019/mar/05/fears-grow-of-rift-between-saudi-king-salman-and-crown-prince-mohammed-bin-salman

[5] https://www.wsj.com/articles/regulators-move-to-ease-crisis-era-levers-over-financial-firms-11551906898 and https://www.ft.com/content/918bc5fc-4054-11e9-b896-fe36ec32aece?emailId=5c807fa9d19a230004893a9d&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6] https://www.axios.com/newsletters/axios-am-8f0ef389-93d0-4754-9c17-715dcee69955.html?chunk=2#story2

[7] https://www.reuters.com/article/us-britain-eu-hammond/uk-will-delay-brexit-if-lawmakers-reject-mays-deal-hammond-idUSKCN1QO0SF and https://www.ft.com/content/fe796118-3ffc-11e9-b896-fe36ec32aece

[8] https://www.axios.com/newsletters/axios-markets-e642dcf8-0246-4564-a16b-0c98f44b759f.html?chunk=0#story0

[9] https://www.washingtonpost.com/world/venezuelan-counterintelligence-forces-raid-home-of-us-journalist-take-him-into-custody/2019/03/06/0a1508ca-402e-11e9-85ad-779ef05fd9d8_story.html?utm_term=.4d93a5aaff6a

[10] https://www.bbc.com/news/world-latin-america-47474317

[11] https://www.reuters.com/article/us-usa-iran-sanctions-india-exclusive/exclusive-india-wants-to-keep-iran-oil-purchases-at-300000-barrels-per-day-in-extended-waiver-sources-idUSKCN1QO0TA

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s another very quiet news morning.  Equity futures continue to struggle.  Here is what we are watching this morning:

BREAKING: The ECB is reportedly cutting its inflation forecasts through 2021.  The reductions are said to be enough to allow the ECB to extend easy policy into the next decade.  The EUR fell on the news.

Slower global growth: International agencies tend to confirm what we already know; the OECD[1] today cut its world growth forecast to 3.3% this year, a drop of 0.2%, and reduced the 2020 forecast to 3.4%, a decline of 0.1%.  The agency cited Brexit, trade tensions and weaker European growth for the downgrade.  Falling world growth has been a factor in the FOMC’s pause.  Although the Fed officially shuns its global role, tied to the dollar’s reserve status, the committee is concerned that weaker global growth is affecting the U.S. economy.

Market confirmation: Bloomberg[2] is reporting that the president is pressuring trade negotiators to cut a deal with China to boost equity markets.  The president’s fixation with market performance has been well documented.[3]  The problem for the president?  Financial markets have already discounted a deal with China so the odds of a lift on official news of an agreement will be modest, at best, and could actually suffer from “buy rumor, sell fact” market action.  As we noted yesterday, trade negotiations are shifting from China to Europe, so new worries may emerge on that front.  Simply put, trade impediments are not capital friendly.

Italy and China: To the chagrin of the U.S. and EU,[4] Italy has formally endorsed China’s “one belt, one road” project.[5] In doing so, it becomes the first G-7 nation to endorse the program.  Italy’s economy has stagnated this century after joining the Eurozone, so it is likely looking for some sort of foreign investment boost.  We view China’s program as a form of imperialism; China has reached a stage of development where it has built more productive capacity than it can consume.  To deal with this problem, which left unattended leads to deflation and potentially a depression (the U.S. Great Depression occurred, in part, due to this issue), China is trying a myriad of tactics, including moving up the value chain (China 2025) and lifting exports.  The belt and road project is designed to use China’s capacity to build projects abroad and create dependent governments that will absorb China’s imports.  Imperialism was the way European nations dealt with this issue in the 19^th and 20^th centuries.  The other way to address the issue, mass mobilization war, hasn’t been tried yet (thankfully).

Brexit: U.K. negotiators are in Brussels trying to adjust the Irish backstop.[6]  Although we don’t see the EU making major changes to the current proposal,[7] we could see some assurances from Brussels that the backstop won’t be permanent and may allow the U.K. to negotiate its own trade pacts.  With the odds of a hard Brexit diminishing, votes next week will either lead to a grudging acceptance of May’s proposal or a delay.

North Korea:In the aftermath of the Hanoi summit, it appears North Korea is back in the missile business.  Pyongyang has started to rebuild its Sohae Satellite Launching station, which it had been dismantling before the summit.[8]  The missile issue is important because North Korea had stopped testing missiles and the Trump administration seemed to be moving along a path that might have offered Pyongyang aid if it gave up its ability to strike the U.S. mainland.  Returning to rocket building is likely an attempt to push the U.S. back into negotiations.[9]  However, we note that President Trump’s initial stance toward North Korea was openly hostile so if he feels like he was “played” by Kim Jong-un then he may very well return to that position.

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[1] https://www.wsj.com/articles/u-s-china-trade-deal-expected-to-give-limited-boost-to-growth-11551867256

[2] https://www.bloomberg.com/news/articles/2019-03-06/trump-is-said-to-push-for-china-deal-with-market-gains-in-mind

[3] https://www.nytimes.com/interactive/2019/01/21/business/trump-stock-market.html

[4] https://www.ft.com/content/4ba18efa-377b-11e9-b72b-2c7f526ca5d0?emailId=5c7f2fea2d8a680004667b0d&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.ft.com/content/17f91d24-3f60-11e9-b896-fe36ec32aece?emailId=5c7f2fea2d8a680004667b0d&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 ; for background: https://www.ft.com/reports/china-belt-and-road-initiative?emailId=5c7f2fea2d8a680004667b0d&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6] https://www.nytimes.com/2019/03/05/world/europe/brexit-irish-backstop-uk-brussels.html?emc=edit_mbe_20190306&nl=morning-briefing-europe&nlid=567726720190306&te=1

[7] https://www.reuters.com/article/us-britain-eu-weekend/eu-sees-no-brexit-breakthrough-before-the-weekend-sources-idUSKCN1QN10Y?feedType=RSS&feedName=worldNews

[8] https://www.38north.org/2019/03/sohae030519/

[9] https://www.washingtonpost.com/world/north-korea-rebuilds-rocket-engine-test-site-in-ominous-signal-about-attitude-to-talks/2019/03/05/de9c7e54-3faf-11e9-a44b-42f4df262a4c_story.html?utm_term=.ee7ab7aa113a&wpisrc=nl_todayworld&wpmm=1

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a very quiet news morning.  When the Chinese National Party Congress dominates the news, you can tell things are slow.  Equity futures are steady after a drubbing yesterday.  Here is what we are watching this morning:

After the Chinese trade deal: Although negotiations continue, the U.S. is moving on to other areas.  Trade talks between the U.S. and EU will begin on March 6.  It appears the EU is planning to negotiate a series of discrete deals, perhaps with the idea that a series of “wins” might distract Washington from attempting broader negotiations.  The EU desperately wants to avoid opening up its agricultural market and facing tariffs on autos.  Thus, it appears the plan is to agree to a series of small, narrow pacts to avoid the ones that would be most problematic and then hope that a new regime comes to Washington.[1]

We also note that the U.S. is ending preferential trade treatment for Turkey and India.[2]  In a sense, this change, which gives better trade arrangements for developing nations, reflects India’s size.  In other words, India is now a big enough economy that the U.S. wants it to give up its trade barriers.  Meanwhile, the decision to drop Turkey from the program reflects continued tensions between the two nations.  Turkey and the U.S. had a dispute over a detained American pastor, disagreed over the Kurds and Syria and apparently came to different conclusions over the fate of Jamal Khashoggi.  The official reason given for removing Turkey from the program was, like India, based on the size of its economy.  Overall, these moves highlight a change in U.S. trade policy.  American trade policy during the Cold War was to tie allies to the U.S. economy through trade and the dollar.  President Trump is adjusting this policy stance away from geopolitical goals to economic ones.

Finally, on trade, there is a new realization of the fallout from bilateral agreements.  In another major change in U.S. trade policy, the Trump administration has moved from multilateral agreements to bilateral ones.  This move greatly favors the U.S.; America’s size and the dominance of the dollar mean every one-on-one negotiation is biased toward the U.S.  By design, the Cold War trade policy of multilateralism did not allow the U.S. to fully exercise its dominance which encouraged other nations to join such arrangements.  For other nations, it allowed them to trade on a favored basis with the U.S. and avoid being dominated.  However, in bilateral arrangements, what is won in one agreement may disadvantage a third nation.  For example, it appears that China will commit to large purchases of U.S. LNG.  This could crowd out Canadian and Australian producers.[3]   If this does become the trend, look for nations to rush to Washington to make deals because being the last nation to negotiate an agreement will put that nation at great disadvantage.

China meetings: As widely expected, China has lowered its growth forecast to 6.0% from 6.5%.[4]  Although the media tends to get all verklempt over China’s GDP, it should be noted that given the way China’s economy is structured it can generate any GDP it wants—it simply has to decide how much debt it wants to add to its growing pile.  So, the decline in the growth trajectory is a good sign; it shows that China is trying to slow the growth of its debt.  At the same time, we think the level of GDP that would not require higher debt is probably around 3%.  It does appear China is going to stimulate its economy but on a lower scale than seen in the past.

In another budget decision, China increased its military spending by 7.5%, making it the world’s second largest spender.[5]

We also note that the Xi regime remains cautious on market reforms.  A joint project of Beijing and the World Bank has been quashed.  It appears the Xi government was uncomfortable with the paper’s recommendation of State-Owned Enterprise (SOE) reform.[6]  It is also worth noting that China’s influence on the World Bank has increased as it pays more to the bank’s operations.

Venezuela: Opposition leader Juan Guaido returned to Venezuelan yesterday without incident.  European diplomats met him when he arrived, which may have calmed the situation.[7]  Although Guaido remains very popular, the military in Venezuela continues to support Maduro so, until that changes, the standoff will continue.  What is uncertain is which actor benefits from time.  Maduro may be waiting out Guaido on the assumption that the divided opposition will fold the longer Maduro continues to control the government.  Guaido may be betting that U.S. sanctions will begin to deprive Maduro of the funding necessary to maintain the military’s support, and the longer the money isn’t available the more vulnerable Maduro becomes.  If they both take these positions, the stalemate will continue.

Greece returns: Greece is issuing its first 10-year sovereign bond in a decade.  The spread appears to be around 340 bps over a similar German instrument.[8]

An equity market observation: In the Q4 correction, we noted there was a spike in retail money market levels.  The rise in money market funds was similar to what we saw in 2007-08 and suggested investor panic.  It is worth noting that the pace of increases in retail money market funds has slowed but is still increasing during the rally we have seen recently.  It appears the rally this year has had little retail participation.

The blue line on the chart, read off the left axis, shows the level of retail money market funds; they are currently about $1.2 trillion.  Note that in 2007-08, the level rose over $1.3 trillion before equities rolled over.  A sustained rally in stocks from the 2009 lows coincided with a rapid deployment of retail money market liquidity.  The orange bars on the chart show when the level of retail money market funds fell below $920 bn.  In this cycle, this appears to be the equilibrium level; equity markets tended to stall when money market funds fell to this area.

It is remarkable that we have seen such a strong bounce with little evidence of retail investor participation.  This leads us to one of two conclusions.  First, if retail stays away, the rally will likely stall around this level and we will remain rangebound with 2800 on the S&P as “resistance,” or the upper bound of the range.  Second, if retail returns, a strong rally is possible that will likely take us above 3000 on the index.  Unfortunately, determining which outcome is more likely is nearly impossible.  It all comes down to those eternal drivers, fear and greed.  If the former wins out, we would not expect too much more upside this year.  If the latter wins, we have a good way to move higher.  Stay tuned… 

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[1] https://www.reuters.com/article/us-eu-us-trade/eu-set-for-trade-talks-with-u-s-on-march-6-amid-concern-over-tariffs-idUSKCN1QL1BU?feedType=RSS&feedName=businessNews

[2] https://www.ft.com/content/80979472-3ee4-11e9-b896-fe36ec32aece?emailId=5c7e08d3ea828400040a8db1&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.wsj.com/articles/trumps-china-deal-could-punish-u-s-allies-11551697117

[4] https://www.ft.com/content/558d78d2-3eda-11e9-b896-fe36ec32aece?emailId=5c7e08d3ea828400040a8db1&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.ft.com/content/5956db00-3e28-11e9-b896-fe36ec32aece?emailId=5c7e08d3ea828400040a8db1&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6] https://www.washingtonpost.com/world/asia_pacific/china-is-blocking-world-bank-report-that-calls-for-state-owned-enterprise-reform/2019/03/01/15607f9a-3b72-11e9-b10b-f05a22e75865_story.html?utm_term=.4c3c837da5d0

[7] https://www.washingtonpost.com/world/the_americas/juan-guaido-attempts-to-return-to-venezuela-risking-arrest/2019/03/04/ee51c78e-3dfa-11e9-85ad-779ef05fd9d8_story.html?utm_term=.21e65f1369d3&wpisrc=nl_todayworld&wpmm=1

[8] https://www.wsj.com/articles/greece-looks-to-borrow-amid-buoyant-markets-11551722073