by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Welcome back!  The three-day weekend is now past and it’s back to work.  Global equities are weaker this morning and U.S. equity futures are too.  Here is what we are watching this morning:

The world goes dovish: The FOMC is reconsidering its balance sheet policy[1] and it looks like the reduction will end sooner than originally planned.  It also appears the rate policy is on hold.  But, the Fed isn’t the only central bank considering easier policy.  The BOJ warns that a weaker JPY could trigger additional stimulus,[2] the ECB says it will react to slowing growth[3] and the PBOC is signaling further stimulus.[4]  Where will all this lead?  We wonder if the actions of foreign central banks are hinging on preventing dollar weakness.  If the world’s central banks all move to stimulate growth, we would expect gold to benefit.

Trade: Trade talks with China resume this week.  Although the administration’s policy is designed to change America’s trade relationship,[5] this goal is running into the issue of the 2020 elections.  A change in policy that puts up trade barriers to reduce inequality will have an adverse effect on the economy, at least initially, while the system recalibrates.  If that coincides with the election, it could doom the president’s hopes for reelection.  Thus, we expect the president to take a deal rather than the comprehensive agreement trade hawks are hoping for.  However, if we are wrong and the president stays the course, then the economy could face a shock that would weaken growth and undermine market confidence.

Taiwan tensions: Although they never really go away, we are seeing rising tensions between China and Taiwan.[6]  When the Nationalists fled to the island after Mao won the mainland, both governments maintained that they were the legitimate government of China.  However, as the years have passed, more people in Taiwan view themselves not as Chinese but as Taiwanese.  Beijing views Taiwan as a renegade province.  For the most part, both governments deploy strategic ambiguity to maintain peace.  But, Chairman Xi has made nationalism part of his governing strategy and thus he is becoming increasingly intolerant of Taiwan’s defiance.  We note the U.S. is increasing freedom of navigation patrols in the South China Sea,[7] which may be in response to the idea that Taiwan could be in peril.

Labour splinters: Although the numbers aren’t large, we note that a group of seven MPs broke off from the Labour Party over Corbyn’s policy on Brexit.[8]  The group isn’t big enough at this point to change Corbyn’s policy path, but it could grow, and it highlights the growing divergence in British politics between those who want to stay in the EU and those who wish to leave.  And, that divergence cuts across party lines.

Return of the populists: This morning, Vermont Senator Bernie Sanders announced he is running for president again in 2020.  This announcement came as a surprise to no one as it was widely speculated that he was going to run again after falling short against Secretary Hillary Clinton in 2016.  To say this time is different would be a bit of an understatement.  Last election cycle, Bernie Sanders’s brand of left-wing populism led many to label him as a fringe candidate.  Today, however, left-wing populism has become mainstream in the Democratic Party.  As of now, there are several candidates who have already announced or are presumed to be considering a run for the Democratic nominee.  The list includes Elizabeth Warren, Sherrod Brown, Kamala Harris, Joe Biden, Julian Castro, Amy Klobuchar, Corey Booker and Kirsten Gillibrand.  There is no clear favorite at this time, but Bernie Sanders is widely considered to be a front-runner.  It is possible there will be no centrist nominee for president in 2020; we doubt financial markets will take that outcome well.

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[1] https://www.ft.com/content/14f833ee-3173-11e9-8744-e7016697f225

[2] https://www.bloomberg.com/news/articles/2019-02-19/kuroda-says-stronger-yen-could-force-boj-s-hand-on-stimulus

[3] https://www.bloomberg.com/news/articles/2019-02-18/praet-says-ecb-could-change-rate-guidance-if-outlook-worsens

[4] https://www.reuters.com/article/us-china-pboc-perpetuals/china-pledges-more-support-for-banks-perpetual-bonds-to-boost-lending-idUSKCN1Q80BG

[5] See WGRs, The Malevolent Hegemon: Part I (11/26/2018), Part II (12/3/2018) and Part III (12/10/2018).

[6] https://www.washingtonpost.com/opinions/2019/02/18/chinas-xi-jinping-is-growing-impatient-with-taiwan-adding-tensions-with-united-states/?utm_term=.3fd403ceec33

[7] https://www.scmp.com/news/china/diplomacy/article/2186461/us-steps-freedom-navigation-patrols-south-china-sea-counter

[8] https://www.ft.com/content/924b9286-335e-11e9-bb0c-42459962a812?emailId=5c6b85d15495b7000468513c&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equity futures are steady to higher this morning in quiet trading.  There is some optimism on the China/U.S. trade talks and on the Fed’s balance sheet.  Here is what we are watching this morning:

Trade talks: Although there isn’t much evidence of real progress (e.g., no memorandum of understanding emerged),[1] the two sides are continuing to talk[2] and President Trump has indicated that he is willing to extend the deadline.  Treasury Secretary Mnuchin described the talks as “positive,” which was seconded by Larry Kudlow.[3]  Both have been dovish on Chinese trade; no such characterization came from USTR Lighthizer, a trade hawk.  Chairman Xi also lauded progress on talks.[4]  There are reports that China will offer to end subsidies to Chinese exporters but, so far, such plans lack details.[5]  Other reports suggest China really hasn’t moved on exporter subsidies or forced technology transfers but is making the usual offer of large purchases in a bid to end trade pressure.[6]  Our expectation hasn’t changed.  President Trump needs to avoid a trade war with China because it will weaken the U.S. economy going into the critical election year in 2020.  Thus, we expect a deal but not the deal that would really change China’s behavior.

The balance sheet: The Fed’s balance sheet is a controversial topic.  There has been a good bit of market consternation about the reduction of the balance sheet, or quantitative tightening (QT).  Our research has suggested that the impact of quantitative easing (QE), or the expansion of the Fed’s balance sheet, was mostly psychological; if the FOMC was seen as out of tools after fed funds reached zero percent, the perception likely would have led to market panic.  However, the impact on the real economy (impact on interest rates, lending behavior) from QE was nil.  Still, it clearly did affect investor sentiment.[7]  This chart shows why QT has become such a hot topic.

This chart shows the S&P 500 along with the fair value from a regression where the S&P is the dependent variable and the balance sheet is the independent variable.  The match between the two series is very tight from 2009 to 2016, with an R2 of 96.5%.  Equities departed from the model during the discussion of tax cuts after President Trump’s election but now that the tax cuts have passed, the focus appears to have returned to the balance sheet just in time for QT.  Again, if the impact of the balance sheet is psychological, it makes sense that its reduction would have an impact on investor sentiment.

Governor Brainard indicated yesterday that the FOMC may be winding down QT much sooner than the markets expected.[8]  That news would be supportive for equities if true.

Q4 looking soft: The Atlanta FRB GDPNow forecast for Q4 has plunged to 1.5%, being hit by the soft retail sales data released yesterday.

The contribution to growth table shows that the slide in consumption was the primary culprit for the forecast downgrade.

If this forecast holds, the odds of the Fed moving rates higher will likely be off the table until H2, if it occurs at all.  Today’s IP data (see below) will likely depress the forecast further.

Brexit:  In what appears to be a classic “own goal,” PM May suffered yet another Parliamentary defeat on a bill that was non-binding.  The bill was an endorsement of the government’s ability to negotiate with the EU and show EU negotiators that May had the support of the legislature.  May wanted the vote to show the EU that she could bring a deal to fruition if they were more flexible.  It failed 303-258.[9]  Financial markets still believe that a hard Brexit will be avoided.  If it is, it looks increasingly like it will take a MP revolt of lawmakers in both the Conservative and Labour parties to defy their leaders and force an extension or a second referendum.  Such a revolt may require new parties to emerge or destroy the existing ones.

Chinese inflation data: CPI eased modestly from 1.8% to 1.7% on a yearly basis.  However, producer prices (which tend to reflect company profitability) fell into negative territory at -0.1%.

Weakening PPI will likely prompt the PBOC to consider further credit easing, which would be supportive for Chinese equities.

Correction: In Wednesday’s comment, we noted that car loan delinquencies were up for older Americans.  That isn’t really true.  A sharp-eyed reader noted that we were a bit colorblind on this chart.

We mistakenly thought the blue line showing the highest level of delinquencies represented the 50-59 age bracket.  To quote John McLaughin, “WRONG!”[10]  Our apologies.  The highest delinquency age bracket is actually 18-29.

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[1] https://www.ft.com/content/c2783d84-30ce-11e9-8744-e7016697f225?emailId=5c6643dc26450200045b796d&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[2] https://www.wsj.com/articles/chinese-u-s-negotiators-expected-to-show-progress-on-trade-deal-framework-11550212318 and https://www.scmp.com/economy/china-economy/article/2186338/china-and-united-states-make-progress-beijing-trade-war-talks

[3] https://www.scmp.com/news/china/diplomacy/article/2186292/us-china-trade-talks-good-vibes-and-laughter-venue-rivals-work

[4] https://www.reuters.com/article/us-usa-trade-china/mnuchin-says-u-s-had-productive-trade-meetings-with-china-idUSKCN1Q40S0

[5] https://www.reuters.com/article/us-usa-trade-china-subsidies-exclusive/exclusive-china-offers-to-end-market-distorting-subsidies-but-wont-say-how-idUSKCN1Q32X6

[6] https://www.wsj.com/articles/china-seeks-to-lure-u-s-with-pledges-to-boost-chip-and-other-purchases-11550151263

[7] For a more in depth view, see Asset Allocation Weekly (1/4/2019).

[8] https://www.cnbc.com/2019/02/14/fed-gov-brainard-downside-risks-have-definitely-increased-on-the-economy.html and https://www.wsj.com/articles/fed-officials-near-plan-to-finish-portfolio-wind-down-11550180143

[9] https://www.nytimes.com/2019/02/14/world/europe/brexit-parliament-vote-theresa-may.html?emc=edit_mbe_20190215&nl=morning-briefing-europe&nlid=567726720190215&te=1

[10]https://www.nbc.com/saturday-night-live/video/mclaughlin-group/n9987

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy St. Valentine’s Day!  U.S. equity futures are trending higher this morning in quiet trading.  Here is what we are watching:

White House calming markets: The president is reportedly considering pushing back the trade deadline by 60 days and backing a border security bill that would avoid another shutdown.  As we have mentioned in the past, the president, who is likely gearing up for reelection, will look to tie up loose ends going into 2020.  As a result, we expect market volatility to simmer down as the president is unlikely to push for legislation that could endanger his reelection chances.

Money market fund levels remain elevated: Although equity markets have recovered, the level of retail money market funds remains elevated.

This chart shows the weekly close for the S&P 500 with the weekly level of retail money market funds.  Beginning in early 2018, money market funds have been rising rapidly, eerily tracking what we saw in 2007.  This suggests to us that some of this liquidity preference was being driven by investor fear.  It is true that money market yields have increased but we doubt they have moved up enough to account for this desire to hold cash.

During this bull market, the S&P has tended to stall when retail money market levels fall below $920 bn, suggesting the equity market “ran out of liquidity”; these events are shown by vertical orange bars.  At present, even with the rally we have seen in equities this year, money market funds remain high.  If investor sentiment shifts, we would expect equities to benefit substantially.

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 using 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 measure of potential GDP.

We have taken the original Mankiw rule and created three other variations.  Specifically, our models use 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 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 imply some slack in the economy and would suggest the Fed has already lifted rates more than necessary.  Until recently, the wage 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.

Overall, FOMC behavior seems to be tracking the employment/population ratio, which makes sense given the modest increases we are seeing in inflation.  If inflation follows the path of the manufacturing ISM, we could see a modest uptick in price levels later this year.

The current employment/population ratio with 2.5% core CPI would generate a neutral policy rate of around 2.5%, suggesting the FOMC should not raise rates further assuming the projected rise in inflation is correct.

Energy update: Crude oil inventories rose 3.6 mb last week compared to the forecast rise of 2.4 mb.

In the details, estimated U.S. production was unchanged at 11.9 mbpd.  Crude oil imports fell by 0.9 mbpd, while exports fell 0.5 mbpd.  Refinery runs fell sharply, by 4.8%, compared to expectations of a 0.9% decline.

The decline in runs was significant and is a clear signal that the refinery maintenance season is underway.

On average, refinery utilization should stabilize at these levels through most of March and then rise as spring comes to the Northern Hemisphere.  This will tend to reduce U.S. oil demand for the next several weeks and usually lead to rising crude oil inventories.

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.  Note that inventories are rising at a slower pace than normal.  This is mostly due to crude oil exports.  If this slow pace continues, it would be a bullish factor for oil prices.

Based on oil inventories alone, fair value for crude oil is $58.26.  Based on the EUR, fair value is $54.26.  Using both independent variables, a more complete way of looking at the data, fair value is $54.89.  By all these measures, current oil prices are generally in the neighborhood of fair value.  However, we still expect prices to move toward $60 later this year on rising oil exports.

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by Bill O’Grady and Thomas Wash

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

Brexit: PM May has asked for more time to negotiate with Brussels.[1]  Apparently, she is still seeking changes to the Irish backstop, although there isn’t much evidence at this point to suggest the EU is willing to adjust.[2]  Remainers are increasingly worried that May intends to accept a no-deal Brexit.[3]  However, there are reports, supposedly coming from an overheard conversation in a bar, that May’s real plan is to run out the clock until close to the deadline, when the EU will make a concession on the backstop.  May will then bring this change to Parliament and indicate this is the best she can do…and if they don’t take this deal, Brexit will be forever postponed![4]  There is a ring of truth to this idea.  The EU would be stupid to grant concessions well before the deadline as this would signal to the hardline Brexit supporters that they had been right all along and the U.K. should pressure for even more compromises.  In addition, May is likely betting that the Brexit supporters are a minority in Parliament so the threat should be against this group, not the remainers.  So, her threat of, “Take my deal or Brexit will be indefinitely postponed, maybe forever,” makes sense because it fits both May’s predisposition (she didn’t support Brexit) and the EU’s usual bargaining action (nothing gets done until the deadline looms).  We tend to view all leaks with a degree of skepticism; the goal of this leak may be to shape the EU’s behavior.  But, the plan put forth does make sense in that May would turn on the Brexit group within her own party with the threat of perpetual Brexit delay.  That would not only make her deal successful but also keep the Tories intact.

Budget deal: Although the president did indicate he opposed the budget deal, it looks like he will sign it, averting a shutdown.[5]  The White House will likely try to shift funds from other areas of the budget to add more funding for a wall.

China trade talks: Although significant differences remain, both nations are seeking a “broad outline” of a deal.  President Trump did indicate there is some “give” on the deadline, something we have expected.[6]  We note there are reports that Chairman Xi will meet with U.S. negotiators, which we would view as a positive sign.[7]  We still expect “a deal” but not “the deal” on Chinese trade.  The bigger problem is that China has been taking advantage of the global trade system that the U.S. has developed since WWII.  It is not the first nation to do so but, at some point, all have had to adjust once a certain degree of economic scale is reached.  The U.S. wants China to stop shielding its state-owned enterprises (SOE) from foreign competition and scrutiny.  From the U.S. perspective, the actions China takes gives it an unfair advantage; from China’s perspective, what the U.S. is asking for is a violation of sovereignty.[8]  As we noted in a recent WGR series,[9] China has become a threat to U.S. hegemony and the Trump administration is taking steps to address that threat.  In doing so, the path of globalization that has been in place since the mid-1990s would be seriously undermined and the global economy would be disrupted.  The White House would likely want to avoid this disruption in the critical year before the next election.

Car loans: A number of outlets are citing a New York FRB report on auto delinquencies[10] as a sign of trouble for the economy.  There has been an increase in sub-prime auto loans in recent years so it is no surprise that is where the delinquencies lie.

Auto finance companies have the greatest exposure compared to their balance sheet, representing 50% of the $150 bn these firms hold.  Banks with assets over $50 bn hold about 25% of their overall auto loans in this category.  The big banks are not a worry; the auto finance companies, on the other hand, are likely at risk.  However, a couple of things should be noted.  First, unlike houses, cars have a much shorter lifespan, lasting around 10 years or so.  Second, cars are easier to repossess—they roll!  Thus, the systemic impact from this issue can probably be contained.  What is encouraging is that we are not seeing credit card delinquencies at the same frequency.

In the last recession, credit card delinquencies rose about three years after the trough in auto delinquencies.  So far, that hasn’t occurred, which reduces the systemic concern.

However, there may be a political issue.  In looking at the age of the delinquent borrower, the bracket of 50-59 is the largest.  Politically, this has been characterized as the “left behind” age bracket.  The rise here could be a sign that the economic conditions of this age range haven’t improved and may put them in play in 2020.

Italy and gold reserves: Yesterday, we reported that the populist coalition in Italy was considering the seizure of the central bank’s gold reserves.  As a follow-up, government officials claim the goal of acquiring the gold is to establish ownership.  But, the government has no intention to use the gold to plug holes in the budget.[11]

China in contact with the Venezuelan opposition: Chinese officials have been in discussions with the Guaido administration to protect China’s massive loans to Venezuela.  This would suggest that China’s real motivation is financial and not geopolitical.  In other words, China has no great affinity for Maduro—it just wants to get its debt serviced.  That is not good news for the Maduro regime.[12]

An old bad idea resurfaces: The Oregon legislature approved measures that will install rent controls on rental properties in the state.[13]  This is a topic that is usually taught in Micro 101 in discussions of price floors and ceilings.  Under nearly all circumstances, such actions lead to shortages of rental properties.  This is because such legislation comes because people feel the rent is too high.  The goal is to lower rents.  The schematic below shows the result.

Under price control (Pc), the supply falls to Q1 but the demand is Q4; things are good for those fortunate to get property at Pc/Q1, but there will be others who cannot rent at those prices because the property won’t exist.  The degree of shortage is a function of the price sensitivity (elasticity) of each curve; if the supply is perfectly inelastic (a vertical supply curve) then the impact of rent control is a drop in landlord revenue as there will be no fewer units available but shortages will still develop because more renters will be enticed by the lower rental cost.

The high rent problem is mostly about zoning.  Existing residents tend to oppose new apartment developments because it increases demand on local services and homeowners worry about reducing the value of their homes.  Rent controls won’t increase the supply of new apartments.  What the legislature failed to understand, it seems, is that the high rent issue is a supply side problem; the best way to achieve Q4 would be to increase supply to where the intersection of the supply curve reaches the Pc/Q4 point.  But, that would collide with the NIMBY sentiment that opposes new developments.  A good podcast on this issue is cited here.[14]

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[1] https://www.nytimes.com/2019/02/12/world/europe/theresa-may-stalls-on-brexit-again-and-again-and-again.html?emc=edit_mbe_20190213&nl=morning-briefing-europe&nlid=567726720190213&te=1

[2] https://www.politico.eu/article/theresa-may-tells-mps-shes-still-seeking-backstop-changes/?utm_source=POLITICO.EU&utm_campaign=152a68c1f1-EMAIL_CAMPAIGN_2019_02_13_05_42&utm_medium=email&utm_term=0_10959edeb5-152a68c1f1-190334489

[3] https://www.ft.com/content/21363782-2ed5-11e9-8744-e7016697f225?emailId=5c63a2f9701a160004084307&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[4] https://www.ft.com/content/2de2cfc0-2ec3-11e9-ba00-0251022932c8?emailId=5c63a2f9701a160004084307&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.washingtonpost.com/business/economy/white-house-wont-commit-to-congress-border-deal-to-avert-shutdown/2019/02/12/16275638-2ed9-11e9-813a-0ab2f17e305b_story.html?utm_term=.46c0fefcc3a7

[6] https://www.wsj.com/articles/china-u-s-seek-to-narrow-gap-on-trade-for-trump-xi-to-close-at-summit-11549976897

[7] https://www.scmp.com/economy/china-economy/article/2185928/china-president-xi-jinping-meet-top-us-delegation-friday

[8] https://www.ft.com/content/aeba2484-2b91-11e9-a5ab-ff8ef2b976c7?emailId=5c63a2f9701a160004084307&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[9] See WGRs, What to do with China: Part I (1/28/2019) and Part II (2/4/2019).

[10] https://libertystreeteconomics.newyorkfed.org/2019/02/just-released-auto-loans-in-high-gear.html?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosmarkets&stream=business

[11] https://www.reuters.com/article/us-italy-gold-borghi/italy-government-wont-sell-a-gram-of-gold-reserves-league-lawmaker-idUSKCN1Q20Q1

[12] https://www.wsj.com/articles/china-holds-talks-with-venezuelan-opposition-on-debt-oil-projects-11549993261

[13] https://www.oregonlive.com/politics/2019/02/oregon-senate-approves-statewide-rent-control-tenant-protections.html?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosmarkets&stream=business

[14] https://www.npr.org/templates/transcript/transcript.php?storyId=633224790

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equity futures are trending higher this morning after a mostly flat day yesterday.  The big news is that negotiators have reached a deal to avoid a government shutdown.  Here is what we are watching this morning:

Shutdown averted: Negotiators have reached a deal to avoid a government shutdown which would have occurred Friday night without action.  The deal does not give the president the funding he asked for with regard to a border wall.  Although there are some doubts he will sign the bill, we expect him to sign it and then try to shift funds from other sources or declare a national emergency to get the wall built.[1]

Some commentators are suggesting today’s rally was driven by the budget deal.  Perhaps; however, the shutdown didn’t have a strong negative impact on financial markets so it seems a bit of a stretch to presume the avoidance of a shutdown brought support.  However, avoiding a shutdown does remove a potential negative factor for the economy and thus is good news.

Italy and gold reserves: Matteo Salvini, the head of the League and deputy PM, proposed yesterday that the government should seize gold reserves held at the Bank of Italy and use them for spending.  Italy holds the world’s third largest official gold reserves, around 2,451.8 tonnes, or about $102.5 bn.  It is a sizable amount of money, about 20% of GDP.  The populist government has been attacking the independence of the Bank of Italy,[2] a common action by populists.  In general, populists represent the debtor class which benefits from cheaper money.  It is not clear if such a move is legal but it raises serious questions about the reaction from the EU and Germany; under normal circumstances, a massive gold liquidation such as this would tend to undermine a currency’s exchange rate.  However, because Italy is a member of the Eurozone, it isn’t obvious if the EUR would weaken on the news.  Nevertheless, the psychological threat to the EUR would likely raise German worries about currency stability.  In one sense, such a sale shouldn’t matter.  If it is nothing more than an asset sale, one would not expect the currency to weaken.  After all, if a government privatized a state-owned asset (e.g., government-owned utility) it wouldn’t usually depress the exchange rate.  But, gold sales have the look of selling the family jewels; when I did country risk for an international bank we viewed gold sales as an indicator of future default.  Although the government’s intention to sell looks more like a way to boost government spending, in reality, a gold sale will rattle Eurozone confidence and lower gold prices as well.

Chinese debt worries: It appears that two large Chinese private borrowers missed payments this month, raising fears of more widespread credit problems in China.[3]

Tax refunds fall: Last year, the Trump administration pressed the IRS to adjust withholding tables so that households would see an immediate impact on their weekly paychecks.  Now, that action is having the perverse impact of reducing tax refunds.  Although a tax refund is, in reality, clear evidence of financial mismanagement (it’s an interest-free loan to the government), many households use the tax refund as a form of saving.  A reduction could show up as reduced consumption in Q2 and Q3.  Refunds thus far are down a bit over 8% compared to last year.[4]

Catalan trial begins: Yesterday, we noted that Spain’s PM is facing a crisis over Catalan.  Sanchez indicated he would appoint a mediator between the central government and separatists.   This has triggered a firestorm[5] that threatens to bring down Sanchez’s minority government.[6]  Today, the government begins a trial against leaders of the Catalan separatists, which could bring down the Sanchez government.[7]  For background on this issue, we have footnoted two Weekly Geopolitical Reports.[8]

A Canadian scandal: Canada’s parliamentary ethics commissioner is investigating allegations that PM Trudeau pressed his former attorney general to end a criminal investigation against a large Canadian engineering company, SNC-Lavalin (SNCAF, USD, 25.61).  The allegations include bribery by the company tied to the former regime in Libya.[9]  The company is a major employer in Quebec and an investigation is raising fears in the separatist province.  Canadian elections will be held this autumn and we would expect the opposition to use this against the PM.  The CAD is already under pressure due to fears of a NAFTA breakdown and weakening world growth.  A political crisis could add further pressure on the exchange rate.

Saudi Aramco goes international?  The state oil company of Saudi Arabia announced plans to expand investments into the world.[10]  During its history, Saudi Aramco has focused on the massive oil reserves within the kingdom, although it does own downstream assets around the world.  It is unclear why the Saudis are making this move now.  One possibility is that Saudi Arabia’s oil fields may be depleted to a point that costs are rising.[11]  If the Saudis are facing production constraints it is potentially a very bullish factor for oil.

White House presses Iraq to stop buying Iranian oil: The Trump administration is pushing Iraq to stop buying energy from Iran.  This is unlikely to happen.  Iraq needs Iranian oil products to maintain electric service and transportation and, given Iran’s influence on Baghdad, the odds are low that Iraq would comply with U.S. wishes.  It is uncertain how hard the U.S. will pressure Iraq on its relations with Iran.  However, without a significant increase in American military presence and investment, it is doubtful the U.S. can prevent Iraq from buying Iranian natural gas and oil.[12]

And, finally:A Federal Reserve research report confirms that globalization has flattened the Phillips Curve.[13]  We would tend to agree with that assessment.

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[1] https://www.washingtonpost.com/business/economy/top-lawmakers-meet-to-revive-stalled-border-talks-with-shutdown-days-away/2019/02/11/3cd0fc1a-2dff-11e9-813a-0ab2f17e305b_story.html?utm_term=.f5fb8e10f9b1 and https://www.nytimes.com/2019/02/11/us/politics/shutdown-deal.html

[2] https://www.ft.com/content/949d2c08-2d1d-11e9-8744-e7016697f225

[3] https://www.caixinglobal.com/2019-02-11/two-large-chinese-borrowers-are-said-to-miss-bond-payments-101378392.html

[4] https://finance.yahoo.com/news/the-first-wave-of-tax-refunds-are-down-8-on-average-181001645.html

[5] https://www.politico.eu/article/spains-right-wing-parties-protest-government-talks-with-catalan-nationalists-pedro-sanchez/?utm_source=POLITICO.EU&utm_campaign=31b984c7e7-EMAIL_CAMPAIGN_2019_02_11_05_48&utm_medium=email&utm_term=0_10959edeb5-31b984c7e7-190334489  and https://www.nytimes.com/2019/02/10/world/europe/madrid-protest-spain-catalonia.html?emc=edit_mbe_20190211&nl=morning-briefing-europe&nlid=567726720190211&te=1

[6] https://www.politico.eu/article/spain-pedro-sanchez-faces-backlash-over-catalan-secessionists-concession/?utm_source=POLITICO.EU&utm_campaign=31b984c7e7-EMAIL_CAMPAIGN_2019_02_11_05_48&utm_medium=email&utm_term=0_10959edeb5-31b984c7e7-190334489

[7] https://www.nytimes.com/2019/02/11/world/europe/catalonia-separatists-trial.html?emc=edit_mbe_20190212&nl=morning-briefing-europe&nlid=567726720190212&te=1

[8] See WGRs, The Situation in Catalonia: Part I (11/6/2017) and Part II (11/13/2017).

[9] https://www.nytimes.com/2019/02/11/world/canada/justin-trudeau-snc-lavalin-ethics-bribery.html?emc=edit_mbe_20190212&nl=morning-briefing-europe&nlid=567726720190212&te=1

[10] https://www.ft.com/content/e0a6775c-2e4f-11e9-ba00-0251022932c8

[11] The uncertainty surrounding Saudi oil reserves has developed a cottage industry of sorts.  A good book, though a bit dated, is by Matthew Simmons. Simmons, M. (2005). Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy. Hoboken, NJ: John Wiley & Sons.

[12] https://www.nytimes.com/2019/02/11/us/politics/iraq-buying-energy-iran.html?emc=edit_mbe_20190212&nl=morning-briefing-europe&nlid=567726720190212&te=1

[13] https://www.federalreserve.gov/econres/feds/files/2019007pap.pdf

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equity futures are trending higher this morning after a later rally on Friday.  It’s the 40^th anniversary of the Iranian Revolution.[1]  Here is what we are watching today:

Trade: Talks between China and the U.S. will restart next week; the focus on this round will be intellectual property.[2]  Although last week’s dip in equities was tied to reports that Chairman Xi and President Trump wouldn’t meet until after the March 1^st deadline, that fear has been eased as market participants realize the deadline is artificial and can be extended by the U.S.  Reports suggest China is “upbeat” about the talks,[3] although there was another U.S. freedom of navigation exercise in the South China Sea that did upset the Chinese.  There were reports that the two leaders may meet next month at Mar-a-Lago; the report itself is a good sign of progress.[4]  As we have noted before, the president needs a good economic and market year in 2019 to support his re-election chances.

Chinese economy: Spending during the Chinese New Year was the slowest since 2005 as consumers held back due to rising uncertainty.[5]  Foreign reserves were mostly unchanged in January, with little evidence that the PBOC intervened in the forex markets.

Another shutdown?  Negotiations on the budget have broken down mostly over border security issues.[6]  Although there are fears of another government shutdown, we suspect it will be averted.  The president doesn’t have the votes to get a border wall through the House; we think odds favor a declaration of a national emergency followed by months of legal maneuvering.  This action would allow government funding to go forward.  It should be remembered that the U.S. will be facing the debt limit issue by early summer, so the potential for another shutdown looms later this year.

Brexit:  The U.K. economy weakened in Q4, with annualized GDP falling to 0.8%, down from 2.4% in Q3.  This is the slowest growth since 2012.

This chart shows yearly GDP growth.  Worries about Brexit are likely behind the slowing.[7]  Meanwhile, PM May is reaching out to Labour MPs,[8] offering concessions on workers’ rights in a bid to build support for her plan.  We suspect there is a working majority for May’s proposal, just not within her coalition.  The best outcome for May would be that Euroskeptic MPs within the Tories, fearful of an even softer Brexit, would then support her plan.  A less favorable outcome would be that she gets enough Labour votes to pass her bill but splits the Conservatives.  The EU showed a bit of easing as the EU chief negotiator Barnier offered to rework the political declarations.  In an FT op-ed, Wolfgang Münchau warns that negotiations are likely to go down to the wire and both sides will probably make concessions.  He reminds readers that this is normal for negotiations within the EU.[9]

Sanchez in trouble?  Spain’s PM is facing a crisis over Catalan, the province that has made moves to separate from Spain.  Sanchez indicated he would appoint a mediator between the central government and separatists.  This has triggered a firestorm[10] that threatens to bring down Sanchez’s minority government.[11]  For background on this issue, we have footnoted two Weekly Geopolitical Reports.[12]

Are right-wing populists taking control of Italy?  We have been watching Italy closely as its government is made up of populists from both wings.  History suggests that such alignments are difficult to manage, although it remains a goal among notable populist thinkers.[13]  In weekend regional elections, right-wing parties of both the populist variety and center-right overwhelmingly won, taking 48% of the vote, with right-wing populist party The League gaining 28% of the vote.[14]  Although one must be cautious about reading too much into one election, the results may be signaling that Italian voters are more inclined toward right-wing populism compared to its leftist variant.

A Thai crisis: In practice, Thailand is governed by three groups—the monarchy, the military and the legislature.  The three maintain an uneasy relationship.  The military regularly intervenes via coups when the legislature takes a direction it opposes.  The monarchy has traditionally remained above the fray, intervening only to reduce tensions between the military and the legislature.  That delicate balance was disrupted when King Bhumibol Adulyadej died in October 2016.  His son, Vajiralongkorn Bodindradebayavarangkun, succeeded him.  Unlike his father, who lived a modest and dignified life, the new king is considered less dignified.  After a coup in 2014 put the military in charge, the generals are trying to shift back toward a democracy, but only if they can prevent populists led by the Pheu Thai Party (PTP) from gaining control.  In fact, the last two leaders of the PTP have been deposed by coup and live in exile.  In a bombshell, Princess Ubolratana Rajakanya, the eldest child of the late king, aligned with the PTP and agreed to run for prime minister.[15]  This was a shocking development.  There is clearly an uneasy relationship between the military and the PTP; for the royal family to directly support the PTP threatens to undermine the balance in Thai politics.  The king has decided to step in to postpone a crisis by forbidding his sister from running for office.[16]  Although the princess gave up her royal status by marrying a commoner (an American, BTW), the daughter of the late king is still considered a royal in practical terms.  The new king clearly wants to avoid a political crisis.  If the PTP wins upcoming elections, tensions will likely rise further.

Another ECB support package?  German bond yields continue to spiral lower, with the 10-year falling to 11 bps this morning.  The German sovereign yield curve has a negative nominal yield out to nine years as the German and Eurozone economy slows.  There are reports that the ECB is considering another round of long-term refinancing operations,[17] a form of QE.  This news is lifting European stocks this morning.

In other news: The U.S. is reportedly in direct contact with members of the Venezuelan military, trying to weaken the brass’s support for Maduro.[18]  There are reports that Russian oligarchs are pressing Putin to end cooperation with OPEC.[19]

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[1] https://www.washingtonpost.com/opinions/2019/02/10/irans-decaying-islamic-republic-is-showing-its-age/?utm_term=.79648e883e6a

[2] https://www.reuters.com/article/us-usa-trade-china/u-s-china-trade-talks-resume-next-week-focus-on-intellectual-property-idUSKCN1PX1WI

[3] https://www.reuters.com/article/us-usa-trade-china/china-upbeat-on-u-s-trade-talks-but-south-china-sea-tensions-weigh-idUSKCN1Q00KQ

[4] https://www.axios.com/newsletters/axios-sneak-peek-c1216ffb-5529-46db-94ac-f3017e693b8c.html?chunk=0#story0

[5] https://www.ft.com/content/67b9203c-2dd3-11e9-8744-e7016697f225

[6] https://www.nytimes.com/2019/02/10/us/politics/trump-border-wall.html?emc=edit_mbe_20190211&nl=morning-briefing-europe&nlid=567726720190211&te=1

[7] https://uk.finance.yahoo.com/news/brexit-black-friday-helped-punch-hole-uk-economic-growth-093155177.html

[8] https://www.ft.com/content/2c088e3e-2d19-11e9-ba00-0251022932c8?emailId=5c60e8dce4cb920004977dea&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[9] https://www.ft.com/content/2128565a-2ba9-11e9-88a4-c32129756dd8?emailId=5c60e8dce4cb920004977dea&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[10] https://www.politico.eu/article/spains-right-wing-parties-protest-government-talks-with-catalan-nationalists-pedro-sanchez/?utm_source=POLITICO.EU&utm_campaign=31b984c7e7-EMAIL_CAMPAIGN_2019_02_11_05_48&utm_medium=email&utm_term=0_10959edeb5-31b984c7e7-190334489 and https://www.nytimes.com/2019/02/10/world/europe/madrid-protest-spain-catalonia.html?emc=edit_mbe_20190211&nl=morning-briefing-europe&nlid=567726720190211&te=1

[11] https://www.politico.eu/article/spain-pedro-sanchez-faces-backlash-over-catalan-secessionists-concession/?utm_source=POLITICO.EU&utm_campaign=31b984c7e7-EMAIL_CAMPAIGN_2019_02_11_05_48&utm_medium=email&utm_term=0_10959edeb5-31b984c7e7-190334489

[12] See WGRs, The Situation in Catalonia: Part I (11/6/2017) and Part II (11/13/2017).

[13] A union of right- and left-wing populists is the goal of Ralph Nader.  We refer to such alignments as a Nader Coalition.  Nader, R. (2014). Unstoppable: The Emerging Left-Right Alliance to Dismantle the Corporate State. New York, NY: Nation Books.

[14] https://www.politico.eu/article/right-wing-parties-set-to-win-regional-italian-election-projections/?utm_source=POLITICO.EU&utm_campaign=31b984c7e7-EMAIL_CAMPAIGN_2019_02_11_05_48&utm_medium=email&utm_term=0_10959edeb5-31b984c7e7-190334489

[15] https://www.ft.com/content/013f5b92-2d00-11e9-8744-e7016697f225?emailId=5c60e8dce4cb920004977dea&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22  and https://www.ft.com/content/b7219798-2b4a-11e9-a5ab-ff8ef2b976c7?emailId=5c5d05bdd83b3f00042c1d53&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[16] https://asia.nikkei.com/Politics/Turbulent-Thailand/Thai-party-accepts-king-s-edict-barring-princess-as-PM-candidate

[17] https://www.reuters.com/article/us-eurozone-bonds-tltros-analysis/time-to-tltro-markets-home-in-on-details-of-ecbs-potential-new-booster-idUSKCN1Q00FR?il=0

[18] https://www.reuters.com/article/us-venezuela-politics-military-exclusive/exclusive-u-s-in-direct-contact-with-venezuelan-military-urging-defections-source-idUSKCN1PX22L

[19] https://www.reuters.com/article/us-oil-opec-russia-rosneft-exclusive/exclusive-russias-sechin-raises-pressure-on-putin-to-end-opec-deal-idUSKCN1PX1R7?feedType=RSS&feedName=businessNews