by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Welcome back from the long weekend.  Equities are in the red this morning mostly on worries about global growth.  Here is what we are watching today:

The IMF, global growth and Davos: The IMF has reduced its world growth forecast to 3.5% for this year (down 0.2% from its October estimate) and 3.6% in 2020 (down 0.1% from October).[1]  Noted concerns were widespread, including a hard Brexit, worries about Italy’s budget and global trade.  The IMF noted that global direct investment fell 19% in 2018.[2]  The Davos meetings are underway in Switzerland.  The lineup is “lighter” than in previous years; of the G-7, only Germany, Italy and Japan are sending national leaders.  The U.S. has no official representation due to the shutdown.  PM May and President Macron are not at the forum due to domestic turmoil.  Xi Jinping and India’s Modi are also taking a pass.  Although climate change is the topic of this year’s meeting, concerns about global growth are the unofficial worry.[3]

China’s GDP: Over the holiday, China announced its weakest GDP growth since 1990[4] as reported growth fell to 6.4% in Q4.  In general, GDP growth in China is often overstated; a better approximation is probably closer to 5.3%, which is still rather strong but also weakening.  The details of the data are worrying.  They confirm that real estate and retail sales slowed.  China needs to reform its economic model away from investment and exports toward consumption; slowing retail sales is bad news.

Information technology remains very robust but is slowing.

As growth slows, there is evidence that China is “returning to the one that brought you,” or construction.

Essentially, China can achieve any growth level it wants by accumulating debt.  But, the Xi government is trying to deleverage in an attempt to ease bad debt and excessive investment.  Unfortunately for China, it can either reduce debt or grow fast, but it can’t do both.

Xi and the CPC: In a recent speech, Chairman Xi warned of the need to maintain stability under conditions of growing stress.  Although such speeches are not exactly unusual for Xi, this one seemed to be a bit more strident that normal.  For the most part, China abhors chaos; throughout its history, periods of weak governance have led to either foreign invasion or internal breakdowns that led to warlords dividing the country.  History also shows that the coastal regions tend to have the strongest economic growth but only during periods when the coasts are exporting to the world.  The divergence between the coasts and the interior can be sources of division that undermine governance.  Mao unified China by turning the country inward; thus, China was united but poor.  Deng was willing to risk that division for growth; now, China has a robust economy but also severe income and regional inequality.  Xi is trying to address these issues.[5]  The trick is that communism, for the most part, is a spent ideology.  Xi often talks in terms of a dialectic, the familiar “thesis-antithesis-synthesis” language that Marx borrowed from Hegel.  What makes that construct attractive is that it implies progress—an existing system or power structure faces a threat and the threat is absorbed by taking the best of both.  Of course, after that, the new synthesis eventually becomes the next thesis and the process repeats.  However, there is another alternative; there is no progress and history merely cycles between two polar positions and progress is often an illusion provided by better technology.  Xi is worried.  Since no one really buys into Marxism anymore, the legitimacy of the CPC is mostly derived from its ability to deliver growth and improve living standards.  However, that growth has led to its own problems—pollution, income inequality, etc.  The last two governments have tried to address both with mixed success.  But, it has become difficult to address these other issues and maintain strong growth.  To do so, the party has relied on debt growth, which is now becoming problematic.

Brexit and Plan B: PM May revealed her “Plan B”; essentially,[6] it is “Plan A” with the hopes that the EU will give her some room on the Irish backstop issue.  Her offer was mostly panned by the MPs.[7]  However, divergences are starting to show.  May has maintained all along that she cannot take hard Brexit off the table, but there is a growing rebellion among Tory MPs to do just that.[8]  The official line from the EU is that there is no room to negotiate on “red lines,” which means the U.K. must stay in the customs union in order to avoid a hard border in Ireland.  That position was reiterated by the lead EU negotiator, Michel Barnier.[9]  However, the Polish foreign minister, Jacek Czaputowicz, suggested that May’s Brexit deal might pass Parliament if the backstop is temporary, for five years, perhaps.[10]  On the one hand, it isn’t obvious that Poland is leading negotiations; on the other, the EU requires unanimity and if Poland is willing to allow a temporary backstop then there might be a crack in the EU negotiating strategy.  Poland is quite interested in the Brexit negotiations as nearly one million of its citizens reside in the U.K.  Poland would likely be willing to give a time limit on the backstop in return for protection for Poles in Britain.  To some extent, this crack may be what May was hoping for all along.

At the same time, Labour’s Corbyn appears to be supporting a second referendum, something he has been reluctant to back.  His concern is that there is some support for Brexit among the hard left (the Blair Labourites were solid on Remain) and, if a second referendum were to yield a reversal of Brexit, it might not only split the Tories but could also divide Labour.

The EU is also making it clear that it won’t extend the Article 50 deadline without good reason, and a disruptive hard Brexit isn’t a good enough reason.  Only elections or a needed extension for additional Parliamentary votes will pass muster.  We note that May’s widely panned Brexit strategy is getting a second look by some Brexit supporters, fearing that a rejection of May’s plan may lead to no Brexit at all.[11]  Thus, the Polish offer might be enough to swing May’s coalition to her plan.  Or, in the words of Monty Python, her plan’s “not dead yet.”[12]

At last, Sweden gets a government: It took 133 days from the last election but the Social Democrats have cobbled together a minority government.  In the last election, the Sweden Democrats, a right-leaning, anti-immigrant populist party, won 62 out of 349 seats in the Swedish parliament.  The Social Democrats bloc, a mostly center-left coalition, won 144, while the center-right coalition, led by the Moderate Party, won 143.  That outcome meant the Sweden Democrats had the power to determine the next government.  However, neither of the traditional coalition blocs wanted to form a government with the populist Sweden Democrats, meaning that the new government would either be a minority arrangement or the centrist blocs would need to form a grand coalition (like what happened in Germany to avoid a coalition with the AfD). The center-left formed a minority government but has gotten support from the Liberals and Center Party, who lean libertarian and are usually part of the center-right bloc.  To form a government, the Social Democrats had to accept mandatory language testing for naturalized citizens, tax cuts and labor market deregulation.  We doubt the government will survive a full four-year term.  Both the left and right were critical of the deal but, at least for now, Sweden finally has a government.[13]

As we have seen elsewhere in Europe, centrist parties are trying to deal with the rise of populism.  In France, the run-off system prevented the National Rally from winning the presidency.  In Germany, it took a grand coalition that essentially emasculates the Social Democrats in order to govern.  In Italy, the populists have won but both left- and right-wing populists share power, which may not survive.  Although populists are not necessarily the majority, they are getting powerful enough to disrupt what has been the normal power arrangements.  This is how populism has operated in proportional representation systems.  In “first past the post” systems like the U.K. and U.S., populism is rapidly changing earlier arrangements.  In Britain, it has led to Brexit; in the U.S., it has led the GOP to become the party of protectionism and is producing divisions in the Democrats on how to manage and regulate technology companies.  Sweden is just the latest country to deal with this trend.

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[1] https://www.reuters.com/article/us-davos-meeting-imf/imf-fears-trade-war-and-weak-europe-could-trigger-sharp-global-slowdown-idUSKCN1PF19S

[2] https://www.ft.com/content/d0413d18-1d72-11e9-b126-46fc3ad87c65

[3] https://www.ft.com/content/27926bca-1d99-11e9-b2f7-97e4dbd3580d

[4] https://www.ft.com/content/d0413d18-1d72-11e9-b126-46fc3ad87c65

[5] https://www.yahoo.com/news/china-apos-xi-calls-political-103056500.html

[6] https://www.youtube.com/watch?v=5IsSpAOD6K8 and https://www.washingtonpost.com/world/theresa-mays-brexit-plan-b-leaves-parliament-underwhelmed/2019/01/21/1b7e43bc-1b5b-11e9-b8e6-567190c2fd08_story.html?utm_term=.ba0790bd662a&wpisrc=nl_todayworld&wpmm=1

[7] https://www.ft.com/content/9d93394d-779b-3bf7-9c23-db4d0ce8dd04?emailId=5c46b2c4b8863d0004cb5f85&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[8] https://www.thetimes.co.uk/edition/news/dozens-of-ministers-ready-to-quit-over-brexit-xq6rh80sj

[9] https://www.ft.com/content/ee06a784-1d77-11e9-b126-46fc3ad87c65?emailId=5c46b2c4b8863d0004cb5f85&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[10] https://www.politico.eu/article/brussels-scrambles-to-deal-with-polands-brexit-curve-ball/?utm_source=POLITICO.EU&utm_campaign=5045bde362-EMAIL_CAMPAIGN_2019_01_22_04_47&utm_medium=email&utm_term=0_10959edeb5-5045bde362-190334489

[11] https://www.ft.com/content/2e488214-1d9f-11e9-b126-46fc3ad87c65?emailId=5c46b2c4b8863d0004cb5f85&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 and https://www.ft.com/content/04ac790a-1a4e-11e9-b93e-f4351a53f1c3

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

[13] https://www.nytimes.com/2019/01/18/world/europe/sweden-government.html

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Friday!  Equities are moving higher this morning.  Here is what we are watching today:

About those tariffs: Yesterday, equity prices were jolted higher on reports that the Trump administration was considering rolling back tariffs on China.

This chart shows March S&P futures; note the jump around 1:30, where the index rose 25 full points.  The report came from the WSJ[1] and indicated that Treasury Secretary Mnuchin is spearheading a negotiating tactic to remove some or all of the Chinese tariffs to show good faith to Beijing and use this action to make a longer term deal.  Needless to say, the Lighthizer/ Navarro wing of the party will reject this tactic out of hand.  Instead, this report suggests that this story was a Mnuchin-led leak to show the president how positive equities would react to a significant reduction in trade tensions with China.  If our take is correct, the real audience for the report was President Trump.  The report was denied soon after and equities fell about as fast as they rose, which bolsters the case that the equity markets would look quite favorably on an easing of the trade front.  At the same time, equities have been drifting higher, most likely on hopes of a trade thaw.

As we noted yesterday, there is a strong incentive on both sides for a short-term cessation of trade hostilities.  China and the U.S. are dealing with slowing economic growth and President Trump is dealing with the run-up to elections in 2020.  At the same time, the long-term outlook for relations between China and the U.S. is becoming a serious risk factor.  Therefore, any short-term peace must be viewed in the context of problematic long-term relations.

Brexit and the EU: There really isn’t much more to say on this topic from the U.K. perspective.  PM May and opposition leader Corbyn are at an impasse as the latter wants May to guarantee there won’t be a sudden exit on March 29, which she has no interesting in doing because it would remove most of her bargaining leverage.[2]  Thus, British politics is in deadlock with no clear way forward.

Meanwhile, the EU is discovering Wilde’s observation.[3]  The EU did not want to make the U.K. exit easy.  Its leaders feared that a smooth exit would encourage others to leave the EU as well.  The EU especially didn’t want to give the impression that a departing country could deal with the EU on an “a la carte” basis, picking the parts it wants and rejecting the rest.  In the case of Britain, the EU has made it clear that the only way to have access to the free trade area is to accept the free movement of peoples within the EU.  Given that goal, the EU plan has worked splendidly.  The U.K. is in political chaos and the potential for a hard Brexit, which is only wanted by a minority, is rising.

However, the EU is discovering there are costs to it as well.  The economic disruption from a hard break will hurt the U.K. significantly as 40% of its trade is with the EU, but that also means it will be disruptive to the EU.  In addition, a U.K. out of the EU changes the balance of power within the union; France has been moving quickly to fill the void created by London’s exit.  France has always viewed the EU as a force multiplier for its policy goals but the rise of Germany and the U.K.’s inclusion, along with the massive increase in the union with the addition of Eastern European nations, has diluted France’s impact.  In addition, the U.K. is important to continental security as most of Europe has weak militaries.  A U.K. separate from the EU makes Europe less safe.[4]  Unfortunately for the EU, there really isn’t anyone to negotiate with in the U.K.  PM May was politically damaged by the historic loss of her Brexit plan; if anyone else wanted to be PM, they surely should be able to win after that drubbing.  However, Parliament also showed that Corbyn isn’t a popular replacement.  Now, if the EU wants to avoid a U.K. exit, it isn’t clear who they would tell.

Financial markets are mostly convinced that both sides will agree to extend the March 29 deadline.  For now, we agree that such an extension makes sense.  However, it is important to note that EU Parliamentary elections will be held in May.  It would be rather awkward for the U.K. to participate given that it wants to leave but, if the deadline is extended, it may be hard to prevent British voters from casting ballots for representatives who, at some point, will no longer be in the EU.  In addition, the EU is facing its own demons.  The European Parliament has backed a plan to make EU fund access conditional to nations that “back the rule of law.”[5]  That is a direct swipe against Hungary but also other Eastern European nations, such as Poland.  The EU is finding it difficult to integrate both Western and Eastern Europe; funding support is one lever the West can use against the East.

Goodfriend out?  In November 2017, President Trump nominated Professor Marvin Goodfriend to the Federal Reserve Board of Governors.  The choice always seemed odd to us.  President Trump has made it abundantly clear he wants a dovish FOMC and Goodfriend is a hawk.  Goodfriend’s positions were always controversial, but one policy he supported was a codified 2% inflation target; since there is no codified unemployment rate, a congressional mandate for 2% (or less) inflation would turn the Fed into the Bundesbank or its successor, the ECB.  Again, one can make a perfectly reasonable argument for ending the dual mandate because it can put the Fed into a position where meeting one target necessarily requires violating the other.  But, if one wants a perpetually dovish Fed, a codified 2% inflation mandate isn’t the way to accomplish this goal.  So, we have been expecting the president to nominate someone else.[6]

One factor in the choice of filling open governor seats has been the evolution of the Trump presidency.  All presidents tend to lean on experienced advisors early in their terms.  Thus, the first cabinets and advisor groups tend to be “all-stars” from the major political parties.  However, these all-stars also have their own policy agendas and use their White House positions to achieve these agendas.[7]  Over time, presidents realize the goals of the all-stars can differ from those of the president.  For example, President Obama’s foreign policy was spearheaded by Hillary Clinton in his first term; in his second term, Ben Rhodes was the leader.  The Fed governor selections, thus far, appear to be centrists out of central casting, likely recommended by Treasury Secretary Mnuchin.  Trump has two remaining vacancies; we expect the president to take control of these open positions and pick two doves.  Although we have seen no indications, we would offer Minneapolis FRB President Kashkari and St. Louis FRB President Bullard as dovish candidates who would likely make it through the nomination process.  Two doves would seriously undermine Chair Powell’s attempts to raise rates as two governor dissentions would make the chair look weak and likely lead to his resignation.

Oil talk: The potential for additional sanctions on Venezuela is leading some Gulf Coast refiners to scramble for heavy crude.  Crude oil comes in grades based mostly on viscosity (heavy/light) and sulfur content (sour/sweet).  Gulf Coast refineries invested heavily in equipment that would allow them to efficiently process heavy/sour crude oil, which is usually cheaper than light/sweet.  However, fracked oil tends to be light/sweet, so the bulk of the new U.S. output isn’t ideal for these refiners.  The two primary sources for heavy/sour have been Mexico and Venezuela.  The former has seen production steadily decline, while the latter is not only facing falling output but sanctions could further reduce supplies.[8]  This has led several oil companies to quietly inform the White House that further sanctions on Venezuela may be counterproductive.  Meanwhile, the State Department is clarifying its positon on Iranian sanctions waivers.  It looks like five nations will get further waivers, three will be cut off and Iranian oil exports will be capped at 1.1 mbpd.[9]  If true, that would reduce the odds of a major supply disruption.

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[1] https://www.wsj.com/articles/u-s-weighs-lifting-china-tariffs-to-hasten-trade-deal-calm-markets-11547754006

[2] https://www.ft.com/content/c0138c7c-1a4b-11e9-9e64-d150b3105d21?emailId=5c41582afd5a4e000407e783&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] “When the gods wish to punish us, they answer our prayers.”

[4] https://www.nytimes.com/2019/01/17/world/europe/brexit-eu-brussels.html?emc=edit_mbe_20190118&nl=morning-briefing-europe&nlid=567726720190118&te=1

[5] https://www.politico.eu/article/budget-hungary-poland-rule-of-law-european-parliament-backs-plan-to-link-eu-funds/?utm_source=POLITICO.EU&utm_campaign=6fcd43d665-EMAIL_CAMPAIGN_2019_01_18_05_37&utm_medium=email&utm_term=0_10959edeb5-6fcd43d665-190334489

[6] https://www.cnbc.com/2019/01/17/goodfriends-nomination-to-the-fed-appears-in-doubt.html

[7] We note reports that SOS Pompeo is being wooed for the open seat in the Kansas Senate.  Pompeo’s neoconservative (Wilsonian) views on foreign policy are clearly in opposition to President Trump’s Jacksonian policy stance.  The Senate seat would give Pompeo a graceful exit now and prevent a fight in the future.  https://www.washingtonpost.com/powerpost/mcconnell-courting-pompeo-to-run-for-open-senate-seat-in-kansas/2019/01/17/aa29f4aa-1aaf-11e9-9ebf-c5fed1b7a081_story.html?utm_term=.a0bc3c5762a7&wpisrc=nl_todayworld&wpmm=1

[8] https://www.reuters.com/article/us-usa-refineries-venezuela/u-s-refiners-scramble-as-white-house-eyes-venezuela-sanctions-idUSKCN1PB2ZX?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosmarkets&stream=business

[9] https://af.reuters.com/article/energyOilNews/idAFL3N1ZI1ID

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Equities are drifting lower this morning.  Here is what we are watching:

Brexit: After facing the largest defeat in modern Parliamentary history, PM May survived a no-confidence vote but not by a great margin.[1]  We have been discussing Brexit at length, so we don’t have much to add this morning.  But, here are a few points:

1. To some extent, Brexit is probably signaling realignments within the major U.K. parties.[2] Although it’s still unclear what exactly the British want, we think there are majorities for two goals—leaving the EU for border protection and having as little trade disruption as possible.  To achieve those goals, the U.K. political system needs to realign, with centrists in both Labour and the Conservatives banding across party lines to build a Brexit that people can live with.  Perhaps the Liberal party makes a resurgence as the home for these potential defectors.  But, it looks like neither Labour nor the Tories, as currently constituted, can come up with a workable solution.
2. The EU isn’t giving anything more to the U.K. They want the British to offer a new plan.  And, the EU is starting to make active plans for a hard Brexit.  Overall, a hard Brexit won’t be pleasant for the EU either.[3]
3. Given the uncertainty on both sides, it is reasonable to think that the March 29 exit date will be delayed.[4] However, that will require a change on the part of the EU, which has indicated it won’t give an extension without a good reason, e.g., new elections, new referendum, new plan.  We suspect this is a bluff on the EU’s part, but it is possible that the lack of a Plan B from London and intransigence from Brussels will lead to a hard Brexit.  The financial markets are probably underestimating the chances of this outcome.

Trade and China: One the one hand, we are seeing talks progress.  Vice Premier Liu has confirmed he will visit the U.S. for talks at the end of the month.[5]  On the other hand, actions against Huawei (002502.sz, CNY 4.23) and other Chinese tech firms are accelerating.  There is legislation in Congress designed to ban the sale of U.S. components to Chinese companies that violate U.S. sanctions or export control laws.[6]  These laws would force the administration to reduce tech trade between China and the U.S.  Meanwhile, the DOJ is investigating Huawei for stealing trade secrets.[7]  Essentially, U.S. and Chinese negotiators are trying to make some sort of trade deal while there are active steps being taken to restrict technology trade between the two nations.[8]  Although this would seem to doom current talks, we think both Presidents Trump and Xi are working on two time frames, short term and long term.  In the long run, both leaders realize the relationship between China and the U.S. is fracturing into a classic established versus rising superpower clash, a factor that will dominate the next decade.  However, in the short run, both need a deal that will boost confidence and economic activity.  Xi can clearly see that the Chinese economy is slumping and needs trade relief.  Trump can clearly see the U.S. economy is slumping and needs something to bolster confidence.  Thus, we can have a short-term agreement in the midst of what may turn out to be the next major global conflict.

On a side note, President Trump’s obsession with trade tariffs remains unabated.  He is expected to threaten car sanctions on the EU in order to open European agricultural trade.[9]  The EU has opposed opening the European market to American agriculture because it would upset the delicate system of preferences and subsidies that maintains peace in the EU.[10]

A depressed Beige Book: The Federal Reserve released the Beige Book yesterday, which is an overall survey of economic activity at the regional district level.  Although eight of the 12 district banks reported “modest to moderate” growth levels, and all reported tight labor markets, company sentiment is weakening on trade uncertainty and financial market volatility.  We note that many of the regional Fed manufacturing reports have weakened recently as well. We suspect the Beige Book report reflects the recent shift of a pause in tightening.[11]

An important defense signal: Germany is nearing a decision on replacing the Luftwaffe’s 85 Tornado fighters, a mid-1970s air platform.[12]  Berlin is considering either the Typhoon, an Airbus (EADSY, USD 26.37) plane built by a group of European nations, or one of three American platforms, the F-35, F/A-18E/F or the F-15E.  Selecting a U.S.-built aircraft would be welcomed by the Trump administration and might ease trade tensions.  However, shunning the Eurofighter will likely doom Airbus’s defense business to near irrelevance.  To some extent, it all comes down to Germany’s perception of NATO and future relations with the U.S.[13]  If Germany sees Trump as a “one-off,” a political accident that won’t be repeated, then it should select a U.S. airframe.  The Typhoon can’t carry nuclear weapons and thus can’t fulfill its treaty obligations with the U.S. that state European nations must provide aircraft for U.S. pilots carrying American nuclear missiles to protect Europe.  On the other hand, if Germany views Trump as a symptom of a deeper retreat from U.S. hegemony, a reflection of a trend rather than a fluke, then it will likely choose the Eurofighter, the Typhoon, because Europe will need its own indigenous airframe as the relationship with the U.S. becomes uncertain.  We will be watching to see what Germany decides in the coming months.

Tsipras survives: Greek PM Tsipras survived a no-confidence vote following the name-change vote in Northern Macedonia.  The margin was close, 151-148.  It looks like Greece will be heading toward elections soon as Tsipras is now running a minority government.[14]

A take on the labor markets: One of our most iconic graphs in this recovery has been the divergence between the employment/population ratio and the unemployment rate.

From 1980 to 2010, the correlation between these two series was -95% (the employment/population ratio scale is inverted on the above graph).  Adding the next eight years has reduced the correlation to the current level of -76%.  This chart represents the biggest unknown for monetary policymakers.  If the unemployment rate is the accurate representation of slack in the economy then the policy rate is too low and the Fed needs to tighten aggressively.  If the employment/population ratio is actually the better measure of slack then the Fed has achieved policy neutrality.

Confirming data supports both sides of the argument, although the preponderance of data tends to favor the employment/population ratio.  Until recently, wages have been stagnant and it is unclear whether the recent rise is due to demand or minimum wage legislation.  The labor force has tended to rise even when the unemployment rate would suggest that additions to the labor force should be difficult.  On the other hand, the JOLTS report shows that hires exceed job openings by a persistently wide margin.

A recent report from Axios[15] suggests that firms, facing a tight labor market, have taken unusual steps to draw the long-term unemployed back into the labor market with training and other forms of unconventional job support.  These include helping homeless people find housing, reliable transportation and childcare as part of the hiring process.  This population includes the recently incarcerated[16]or currently incarcerated.[17]

These reports suggest there is much more slack in the labor market than the unemployment rate indicates.  It is true that reducing this slack will depress profit margins; firms are required to deploy measures to find and employ these workers, costing money that they otherwise wouldn’t have to spend.  But, socially, this is a trend the Fed should support.

Energy update: Crude oil inventories fell 2.7 mb last week compared to the forecast decline of 2.5 mb.

In the details, estimated U.S. production rose 0.2 mbpd to a record 11.9 mbpd.  Crude oil imports fell 0.3 mbpd, while exports rose 0.8 mbpd.  Refinery runs declined 1.5% and should continue to fall in Q1.  Product inventories rose significantly and the rise in product stockpiles will soon lead to a seasonal decline in refining activity.

This is the seasonal pattern chart for commercial crude oil inventories.  Starting next week, we would expect to see a rapid increase in inventories that will peak in early May.  If we follow the usual pattern, oil inventories will peak at 489 mb (excluding pipeline oil; including this oil adds approximately 31 mb, putting the total estimate at 520 mb).  Last year, inventories didn’t rise mostly due to oil exports.  We will be watching to see if that pattern repeats this year.

Based on oil inventories alone, fair value for crude oil is $61.61.  Based on the EUR, fair value is $56.08.  Using both independent variables, a more complete way of looking at the data, fair value is $57.37.  By all these measures, current oil prices are generally in the neighborhood of fair value.  However, we still expect prices to move toward $60 in the coming weeks.

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[1] https://www.nytimes.com/2019/01/16/world/europe/brexit-theresa-may-no-confidence-vote.html?emc=edit_mbe_20190117&nl=morning-briefing-europe&nlid=567726720190117&te=1

[2] https://www.nytimes.com/2019/01/16/world/europe/brexit-jeremy-corbyn.html?emc=edit_mbe_20190117&nl=morning-briefing-europe&nlid=567726720190117&te=1 and https://www.ft.com/content/e3cb91d0-1985-11e9-9e64-d150b3105d21?emailId=5c3fd5fda9dcea00042c1321&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22  and https://www.ft.com/content/9b40ef02-1974-11e9-9e64-d150b3105d21?emailId=5c3fd5fda9dcea00042c1321&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.nytimes.com/2019/01/16/opinion/what-to-expect-when-youre-expecting-brexit.html?emc=edit_mbe_20190117&nl=morning-briefing-europe&nlid=567726720190117&te=1 and https://www.washingtonpost.com/world/2018/12/13/heres-what-eu-has-lose-event-no-deal-brexit/?utm_term=.557c02f715b7&wpisrc=nl_todayworld&wpmm=1

[4] https://www.politico.eu/article/brexit-what-now-theresa-may-jeremy-corbyn-no-confidence-vote-no-deal/?utm_source=POLITICO.EU&utm_campaign=15a77a5fb6-EMAIL_CAMPAIGN_2019_01_17_05_42&utm_medium=email&utm_term=0_10959edeb5-15a77a5fb6-190334489

[5] https://uk.reuters.com/article/uk-usa-trade-china-visit/china-confirms-vice-premier-liu-to-visit-u-s-for-trade-talks-jan-30-31-idUKKCN1PB0K5

[6] https://www.reuters.com/article/us-usa-china-huawei-tech/u-s-legislation-steps-up-pressure-on-huawei-and-zte-china-calls-it-hysteria-idUSKCN1PA2LU

[7] https://www.wsj.com/articles/federal-prosecutors-pursuing-criminal-case-against-huawei-for-alleged-theft-of-trade-secrets-11547670341

[8] It’s not just the U.S.  https://www.reuters.com/article/us-germany-china-huawei/germany-considering-ways-to-exclude-huawei-from-5g-auction-report-idUSKCN1PA32B

[9] https://www.reuters.com/article/us-autos-trade/trump-inclined-to-impose-new-u-s-auto-tariffs-senator-idUSKCN1PA31S and https://www.ft.com/content/a852539e-19d7-11e9-9e64-d150b3105d21?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[10] https://www.ft.com/content/59735580-18e1-11e9-b93e-f4351a53f1c3?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[11] https://www.ft.com/content/0a942fde-19d6-11e9-9e64-d150b3105d21?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[12] https://www.ft.com/content/8a3ef664-8373-11e8-96dd-fa565ec55929

[13] https://www.ft.com/content/34a7a78e-15cf-11e9-a581-4ff78404524e?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[14] https://www.nytimes.com/2019/01/16/world/europe/greece-tsipras-confidence-vote.html?emc=edit_mbe_20190117&nl=morning-briefing-europe&nlid=567726720190117&te=1

[15] https://www.axios.com/companies-cities-help-long-term-unemployed-fb8fd55a-450c-4924-b294-7b06cdf4cbd9.html

[16] https://www.cnbc.com/2018/09/18/why-companies-are-turning-to-ex-cons-to-fill-slots-for-workers.html

[17] https://www.nytimes.com/2018/01/13/business/economy/labor-market-inmates.html

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] All eyes are on the U.K. but financial markets are coping with the uncertainty rather well.  Here is what we are watching this morning:

Brexit: PM May suffered a historic defeat.

It is the largest defeat in the modern era, with her margin of defeat at 230 votes.[1]  Of the 317 Conservative MPs, 118 rejected the proposal.  In response, as expected, Labour leader Corbyn tabled[2] a no-confidence vote which will occur later today at 7:00 GMT (around 2:00 EST).  However, it is unlikely that Corbyn’s motion will pass as the Tories who defected on the Brexit vote will likely not want to see early elections and a potential Labour victory.  If Corbyn’s motion passes, by some chance, then Parliament would have 14 days to appoint a new PM.  Given that May has already survived a Conservative leadership challenge, there isn’t really an obvious alternative from her party to replace her.  New elections would likely devolve into a de facto referendum on Brexit.

Now that it is clear May’s plan is dead, what is the plan going forward?  Well, there really isn’t one.  Here is what we know for sure:

1. The EU isn’t changing its position.[3] This isn’t necessarily because the EU wants to punish the U.K. (although some members clearly do) but because achieving consensus among all the members is really difficult.  Because it allows any member to veto important measures, the EU is, by design, inflexible.  Thus, changes are really hard.
2. Only a minority support a hard Brexit. Although some of the more doctrinaire Brexit supporters relish the upheaval caused by a sudden break with the EU, the majority of U.K. citizens don’t want this outcome.  Neither does the EU.  A hard Brexit would likely look like the abrupt changes that occur in wartime when supply chains are suddenly broken.  However, a hard Brexit will lack the fiscal spending that accompanies war and the spirit of unity that also follows.
3. Although denials continue,[4] odds favor a delay to the March 28 deadline.[5] One path being considered is the Boles amendment,[6] which would set up a committee in Parliament to negotiate the exit while specifically rejecting a hard Brexit.  May opposed this plan because she felt she needed the threat of a hard Brexit to swing support to her plan.  Clearly, that tactic failed and so the Boles plan is getting a new look.  We suspect the Boles plan, in the end, would end up with the U.K. in a similar position as Norway, which is part of the EU free market but not a voting member.  Unfortunately, it isn’t obvious that the EU would allow Britain to follow this option due to the size of its economy.  Thus, the Boles plan may be a non-starter.
4. Labour is more focused on taking power and less on executing Brexit. Part of the reason is that Corbyn’s position on the EU is ambiguous; he thinks it’s too friendly to business and doesn’t like interference from Brussels on foreign policy.  Therefore, Labour has done nothing to address the Brexit issue.  The risk for Labour is that it would find itself in power and then actually have to develop a Brexit policy.  At this point, it isn’t clear that the party has one.[7]  This means there is no real leadership on the Brexit issue that commands a majority.
5. There is increasing talk of a new referendum. The problem is that it is unclear what decision would be put to the voters.  We think a politically feasible plan is one that would keep Britain in the EU but with a carve-out on immigration and free movement of peoples.  While the Schengen Area is considered by many to be sacrosanct (it allows for any member of the EU to move through Europe without visas or passports), growing populist opposition to the free movement may make a British exception more palatable.  Nevertheless, the danger of a second referendum is that it could lead to an inconclusive result if not carefully crafted.

Assuming May survives the no-confidence measure, she will have three days[8] to offer an alternative plan.  It is unlikely she can provide an alternative measure.  She may simply decide to resign, although that seems unlikely.  She might propose her own referendum.  But, the most likely response would be to try to extend the deadline, which we suspect the EU would approve.

So, how did we get into this mess?  The original vote on Brexit was a reflection of populist uprisings seen across the West.  Much of the anger toward the EU was driven by rapid changes in society caused, in part, by high levels of immigration.  The EU’s open borders were a factor in rising immigration.  Brexit became symbolic, much like the border wall debate in this country.  However, the Brexit supporters offered a vision of the future that was never going to happen.  They sold a story that the U.K. could leave the EU but retain all the trading benefits of the EU free market, not pay dues, control the border and be free to make new trade deals.  The reality is clearly less attractive.  The EU is going to put up trade barriers as it does against any non-member and the U.K. needs to start the painful process of negotiating a trade deal with the EU that will likely take years to complete.  And, a U.K. outside the EU is really a small island nation that will lose much of its financial services industry to Frankfurt or, more likely, New York, and it will simply not be high on anyone’s agenda for trade negotiations.

The next referendum, which is a growing possibility, would need to reflect the reality of what Brexit really means, and not one based on an impossible fantasy.  Figuring out how to phrase that will be really hard.  In the end, the U.K. might simply decide it is better off inside the EU and negotiate hard for some degree of border protection.

So far, financial markets are taking all this political chaos rather well.  Some commentators have remarked that the GBP is not paying attention at all.[9]  This stance is questionable; based on parity, the GBP should be around $1.63, so there is some degree of “Brexit penalty” in the current exchange rate.  However, a hard Brexit likely takes the pound to a range of $1.10 to $1.20.  The financial markets are expecting a delay.  The risk to the financial markets is a condition similar to the cascade of events that led to WWI; no one wanted the war that followed but their decisions led to war as the outcome.  Although support for a hard Brexit is low, the likelihood grows because both sides are using the potential for a really bad outcome to sway opinion.  If neither side blinks, we have the classic bad outcome from the game of chicken; neither side defects so both suffer greatly from the result.

China: China has announced a massive monetary injection of $84 bn into the banking system.[10]  Although some of this money is to support the economy, much of it is to build cash levels in the system before the Chinese New Year, which falls on February 4 this year.

A hawk turns dovish: Perhaps one of the most interesting (and shocking[11]) developments from the FOMC is that KC FRB President Esther George is now supporting a pause.[12]  She is arguably the most hawkish member of the FOMC.  With her shift, we suspect the FOMC will be on hold for a significant period.

Shutdown issues: The president has ordered tens of thousands of government workers to return to their jobs without pay to ensure the government continues to function.[13]  This announcement is occurring as the chair of Economic Advisors warns that GDP is falling 0.13 percentage points per week during the partial government closure.[14]  So far, financial markets have mostly ignored the shutdown, but if the effects on the economy increase we may start to see equities weaken until progress toward a resolution is seen.

Iran oil: We noted yesterday that the State Department indicated the Trump administration was not planning to issue further oil export waivers.[15]  Even with the waivers in place, Iranian oil exports have been under pressure as December export data show oil exports only at 1.1 mbpd, down from 2.5 mbpd last spring.[16]

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[1] https://www.prospectmagazine.co.uk/politics/could-the-vote-on-mays-deal-end-in-an-historic-government-defeat and https://www.ft.com/content/9f45ab16-18fb-11e9-9e64-d150b3105d21?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[2] https://www.ft.com/content/6443d1d8-18ff-11e9-9e64-d150b3105d21

[3] https://www.ft.com/content/efabfd1c-1964-11e9-b93e-f4351a53f1c3

[4] Ibid.

[5] https://www.ft.com/content/e6f2cb52-1918-11e9-b93e-f4351a53f1c3

[6] https://www.ft.com/content/cf8ddb16-181c-11e9-9e64-d150b3105d21

[7] https://www.ft.com/content/a55c3abe-18b6-11e9-b93e-f4351a53f1c3?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[8] https://www.nytimes.com/2019/01/10/world/europe/theresa-may-brexit-bercow.html?module=inline

[9] https://www.axios.com/british-pound-rises-brexit-deal-theresa-may-20db0b5d-c549-4a29-88d6-d2346b410374.html (Interestingly enough, because of the government shutdown, the Commitment of Traders report from the CFTC has been suspended so we don’t know the current positioning of the GBP on the futures exchanges.)

[10] https://www.ft.com/content/7136dfa8-1944-11e9-9e64-d150b3105d21

[11] https://www.youtube.com/watch?v=O3ZOKDmorj0

[12] https://www.ft.com/content/870a0ec6-18f5-11e9-9e64-d150b3105d21?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[13] https://www.politico.com/story/2019/01/15/shutdown-employees-work-without-pay-1088020

[14] https://www.nytimes.com/2019/01/15/us/politics/government-shutdown-economy.html?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top

[15] http://www.arabnews.com/node/1434591/business-economy

[16] https://www.ft.com/content/5f414c6c-18ad-11e9-9e64-d150b3105d21?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equity futures are roughly flat, giving up most of their overnight gains.  Asia was higher on hopes of Chinese stimulus, but the big news is that today is Brexit Day.  Here is what we are watching this morning:

Brexit: So, it all comes down to this.[1]  A vote on PM May’s Brexit plan is scheduled for 7:00 GMT, (which is 2:00 EST).  The only real question is how badly will the measure fail?  We note that MP Gareth Johnson, an assistant whip,[2] resigned from government, the 13^th member of May’s government to resign over Brexit.  The loss could be colossal, perhaps by more than 200 votes.  After the loss, we expect two things to occur.  First, May will have three days to come up with a “Plan B.”  Second, Labour leader Corbyn is expected to call for a no-confidence vote.  We have no idea what a Plan B will look like; we expect the MPs to offer tons of new amendments to the plan that May proposed but, since there is no consensus on what Brexit should look like, it seems unlikely that the House of Commons will draft a plan.  Thus, in three days, look for the government to ask for an extension of the March 29 deadline.  Corbyn’s bid to bring down the government will be interesting to watch.  Although May isn’t popular, the Tories loathe Corbyn and we suspect they will coalesce around May to prevent her loss.

Financial markets continue to lean toward some sort of resolution that avoids a hard Brexit.  Although that is the desired outcome by nearly everyone involved, there is no obvious plan to achieve this goal.  The fear is that, in the absence of a plan to go forward, Britain and the EU will stumble into a hard break that would be expected to crush the U.K. economy and the GBP.  Since neither side wants this outcome, the most likely result of all this is a delay.  That’s why the currency is holding up.  But, the risks of an unwanted hard Brexit are rising.

China: Bank lending for December came in a bit better than expected, rising CNY 1.08 trillion ($198 bn).  However, given the drop in reserve requirements, this level of loan growth won’t keep growth at the 6% level.  The Chinese government announced plans for tax cuts and other stimulus measures.[3]  Hopes surrounding those measures sent Asian equities higher overnight.  However, for growth to be sustainable, more of it needs to come from the household sector and less from investment.  We believe the most effective measures China could implement in support of consumption growth would be to extend the social safety net, including health care and pensions.  Both actions would reduce households’ incentives to save.  However, it would also deprive the powerful members of the Chinese Communist Party cheap money for investment.  Thus, aggressive action that would be effective in restructuring the economy isn’t likely.

China and Canada: China has issued a death sentence for Robert Schellenberg,[4] a Canadian citizen living in China.  He was arrested on a drug trafficking charge.  Ottawa strongly suspects that China is arresting Canadians in response to Canada’s arrest of Meng Wanzhou of Huawei.  Tensions between the two countries remain elevated with no obvious path to easing short of releasing Meng, who awaits extradition to the U.S. on sanctions-busting charges.

Shutdown issues: TSA absences are increasing rapidly, now representing 7.6% of the workforce, more than double normal levels.[5]  So far, the system is dealing with the security issues but if the absences increase, which appears likely, it will eventually affect the air transportation system.  There is no sign of budging from either side.

Iran oil: The State Department indicated yesterday that the Trump administration is not planning to issue further oil export waivers.[6]  If they stick to that position, Iranian oil exports will be further curtailed by the end of May.  Although we would not expect Iranian oil exports to fall to zero, they will decline from current levels.

Iranian populism?  U.S. sanctions have hurt the Iranian economy.  Interestingly enough, we are hearing reports of a backlash against the well-connected wealthy in Iran.  The ones catching most of the flack are the young of those connected to the government who have a habit of flaunting their lifestyles on social media (sound familiar?).[7]  What makes this trend dangerous for the ruling class is that they are pushing policies that have led to American sanctions and are calling for shared sacrifice in response.  If it isn’t seen as shared, they could face civil unrest.

Oil sales to China: The U.S. is exporting oil to China, likely part of the trade talks currently underway.[8]  Three cargos departed from the Gulf of Mexico on their way to China, the first oil sale in three months between the two countries.  We suspect this news lifted oil futures this morning.

Trump versus the Wilsonians: As we noted yesterday, Trump tends to be best characterized by the Jacksonian archetype.[9]  However, most members of his foreign policy staff have tended to be either Hamiltonians (the early “generals”) or Wilsonians.  His current staff, Pompeo and Bolton, are clearly in the Wilsonian camp.  Wilsonians tend to have a moralistic view of foreign policy, seeing the world in terms of “good and evil,” unlike the Hamiltonians, who tend to view the world through the veil of “interests.”  Both groups have been attempting to prevent Trump from exercising his Jacksonian tendencies; Jacksonians are essentially isolationists who are driven to intervene globally on issues of “honor.”  Thus, President Trump sees no disconnect between firing cruise missiles against Assad and pulling troops from Syria.  Assad besmirched America’s honor by using chemical weapons after being told not to, but Trump has no interest in being tied up in the Middle East indefinitely.  Today, we are seeing reports that Trump was considering pulling out of NATO.[10]  Both the “generals” and the “Wilsonians” have been trying to corral the president from this action.  The paper of record, the NYT, frames the news as a “gift to Russia,” putting it in the narrative that Trump is favoring Putin.  Perhaps.  Our view is that the biggest risk to pulling out of NATO isn’t the risk of Russian influence on Europe, it’s that the “German Problem” will return, a conflict zone that was frozen by the U.S.  In other words, the real risk is the remilitarization of Germany and a return to the world of 1870-1945.

It’s worth noting that SOS Pompeo made pointed criticisms of President Obama’s policies in the Middle East during a speech in Egypt.  In our opinion, Obama was a Jeffersonian, the most isolationist of the four archetypes.  However, the primary difference between the Jacksonians and the Jeffersonians is the concept of honor.  In practice, both want to retreat from the world and avoid involvement.  Pompeo’s criticism of Obama could easily be said of Trump as well.  As time passes, we will be watching to see how long the president tolerates both his national security director and secretary of state working to prevent the execution of the president’s worldview.

And, one more thing to worry about: The world’s magnetic pole isn’t static; it moves around over time.  Usually, the movements aren’t enough to make compass readings unreliable; however, over geologic time, the North and South magnetic poles have actually flipped (the last time was estimated to have been 780,000 years ago).  The map below shows how the pole has moved over time.  The last maps adjusting to the movement of the magnetic pole were completed in 2015.  Although they weren’t scheduled to be updated until next year, the movement was enough to accelerate the process.  The new maps would have been published today, but have been delayed until January 30 due to the government shutdown.[11]  These maps are needed for navigation; not only do ships at sea and aircraft use them, but they are also now part of our everyday lives as they assist in smartphone navigation.

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[1] https://www.ft.com/content/efb7088a-17eb-11e9-9e64-d150b3105d21?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[2] A whip is a legislative role held by a member who counts and steers voters in the legislature.

[3] https://www.reuters.com/article/us-china-economy/china-signals-more-stimulus-as-economic-slowdown-deepens-idUSKCN1P9090

[4] https://www.washingtonpost.com/world/asia_pacific/china-sentences-canadian-man-to-death-in-drug-case-linked-to-huawei-row/2019/01/14/058306a0-17fb-11e9-a804-c35766b9f234_story.html?utm_term=.188f1c9e417d&wpisrc=nl_todayworld&wpmm=1

[5]https://www.apnews.com/a50e00cb683b4b9697c1c957bae39cd2?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top

[6] http://www.arabnews.com/node/1434591/business-economy

[7] https://www.washingtonpost.com/world/middle_east/crazy-rich-iranians-face-blowback-at-a-time-of-sanctions-and-economic-stress/2019/01/13/f45bc594-ffb6-11e8-a17e-162b712e8fc2_story.html?wpisrc=nl_todayworld&wpmm=1

[8] https://www.reuters.com/article/us-usa-crude-exports/first-u-s-crude-cargoes-head-to-china-since-trade-breakthrough-sources-idUSKCN1P82LN

[9] See WGR, The Archetypes of American Foreign Policy: A Reprise (4/4/2016).

[10] https://www.nytimes.com/2019/01/14/us/politics/nato-president-trump.html?emc=edit_mbe_20190115&nl=morning-briefing-europe&nlid=567726720190115&te=1

[11] https://www.livescience.com/64486-earth-magnetic-pole-moving.html

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s risk-off this morning.  Global equities are lower on fears of a Chinese economic slowdown and on the U.S. government shutdown.  Here is what we are watching this morning:

China: December exports fell 4.4%,[1] well more than forecast, but imports fell even more, slumping 7.6%.  The decline in export growth was exacerbated by a 3.8% decline in sales to the U.S.  The export decline was the largest in two years.[2]  Although tariffs played a role, the size of the decline points to weaker global demand.  Meanwhile, the drop in Chinese imports indicates a rapidly softening Chinese economy.  The combination of imports falling faster than exports led to a widening of the trade surplus.

This chart shows China’s monthly trade balance; note the sharp rise in December.

Adding to evidence of a Chinese slowdown are reports that car sales fell 13% in December compared to last year, the sixth straight month of declines.[3]  Although there are reports that Chinese officials are planning policy stimulus, we are not seeing signs that Beijing is doing anything significant.  If China fails to move aggressively, it will mean slower global growth.[4]

We have been reporting that there appears to be some progress on trade talks with China.  However, the reality may be less than meets the eye.  Much like what we saw with Japan in the 1980s, China has mastered the art of non-tariff trade barriers, using regulation and approval delays to protect critical industries.  Today we learn that U.S. credit card companies are the latest firms to have received official approval for entry into China, only to find they are facing other impediments.[5]  This is exactly the behavior that the U.S. and others complain about with China.

Brexit: PM May delivered a letter today in which she suggested that if her proposal loses the most likely outcome will be no Brexit at all.[6]  Her argument is that the majority of MPs don’t want to leave and support for a hard Brexit is nil, so if her plan is rejected it is unlikely the majority will vote for a hard Brexit.[7]  She may be right on this point.  Although support for her exit plan is very weak and it will almost certainly lose in tomorrow’s vote, there is no consensus on what should occur.  There is increasing talk that the government should suspend the Article 50 declaration until the U.K. can figure out what it really wants.[8]  Assuming May’s plan falls to a stinging defeat, Labour Leader Corbyn is promising to hold a vote of no-confidence designed to bring down the government and trigger new elections.  For the Tories, suspending Article 50 and delaying Brexit is a better outcome than a Labour government.

We have seen the GBP rise steadily on the prospects of a delay in Brexit.[9]  If the whole plan fails to occur, we could see a strong rally in the currency.  However, the prospects of a populist Labour government facing a permanently divided opposition due to the Brexit failure would tend to temper any rallies.  We are expecting a rather tumultuous week for the U.K.

Shutdown issues: Up to this point, financial markets have mostly ignored the government shutdown.  After all, markets have seen this sort of thing before and, until now, none have had lasting effects.  However, in a world where uncertainty surrounding the strength of the economy is increasing, one of the fallouts of the shutdown is that economic data will likely start to be delayed.  For example, we probably won’t see this week’s retail sales and housing data for December.[10]  Both numbers come from the Commerce Department, which lacks funding.  Financial market confidence is still rather shaky; uncertainty about the path of the economy won’t help matters.  In related news, we are hearing increasing reports of airport delays caused by falling numbers of TSA workers who have been working without pay.[11]  We are not sure how this plays out but we would not be shocked to see some airports attempt to hire private security to man the lines (we are not sure if this is legal, by the way).  When air travel starts to become affected, pressure to resolve this matter will increase.

The bill comes due: Last year, when the tax bill passed, the administration moved to recalculate the withholding tables to increase after-tax pay.  Now, that action will likely have an impact.  Many households use the tax refund as a sort of self-funded bonus; although it is rather obvious that a tax refund is simply an interest-free loan to the government, some people who lack the discipline to save use it as a tool to receive an annual lump sum of money.  The changes to withholding mean that refunds will likely be smaller this year, which may affect the sales of consumer durables, such as autos[12] or appliances.

Turkey threatened: Although there is still confusion on the timetable of the U.S. troop withdrawal from Syria, worries that the withdrawal will spell doom for the Kurds were countered over the weekend by a threat from President Trump.  The president indicated that Turkey would face “economic devastation” if it attacks Kurdish forces in Syria.[13]  Turkey argued that it isn’t against all Kurds, just terrorists.  However, the Erdogan government has characterized the groups the U.S. is allied with in Syria as terrorists.  We will be watching to see if the White House follows through on the threats or if Turkey avoids confronting the Kurds due to Trump’s comments.

Iran war?  According to reports, National Security Director Bolton asked the Pentagon for military options to attack Iran.[14]  Bolton has a long history of supporting attacks on Iran[15] and opposed President Trump’s plans to withdraw U.S. troops from Syria.  Although it would seem that such aggression won’t be supported by the president, who seems to want to leave the Middle East, we caution that Trump leans Jacksonian and this foreign policy archetype[16] is sensitive to honor.  Thus, Trump may be swayed to act militarily if Iran does something that he perceives as besmirching the U.S.  We note the president wanted to attack Iran’s “fast boats,” which are small vessels that often harass U.S. Naval ships in the Persian Gulf.[17]  The important characteristic about Jacksonians and war is that they prefer conflicts with clear objectives and quick outcomes.  Although they will fight long wars, they want unconditional surrenders and ticker tape parades when they are over.  War with Iran would probably not have such outcomes.  Iran’s terrain consists of mountains, deserts and salt flats; imagine invading Utah.  While the U.S. would certainly prevail, it would not be a short war and it isn’t clear what the ending would look like.  Defeating Tehran is one thing, but controlling it post-conflict would be a whole other matter.  Nevertheless, the U.S. could stumble into a conflict with Iran if the Iranians did something provocative.  Our belief is that Iran understands this and will likely avoid doing anything rash.  On the other hand, it’s hard to control all your proxies.

Greek trouble: The naming issue with the former Republic of Macedonia has been a sore spot with Greece for years.  The Greeks object to the term “Macedonia” as this refers to a region that was part of ancient Greece.  However, as long as the Republic of Macedonia remained outside the EU, the tensions were mostly an issue for Greece only.  However, the Republic of Macedonia wants to join the EU and NATO and Greece can veto that goal.  So, there was an official name change over the weekend; we now have the Republic of North Macedonia.  Unfortunately for the current Greek government, accepting that outcome has weakened the ruling coalition as the right-wing Independent Greeks Party has withdrawn from the government.  The move triggered PM Tsipras to call for a confidence vote in his government.[18]  This outcome is problematic; if Tsipras wins, he will be ruling a minority government and we doubt this arrangement will endure.  New elections are more likely.  Austerity has wrecked the Greek economy and new elections might bring a radical government to power.  With tensions already simmering between Italy and the EU, new issues with Greece would not be helpful.

Political violence: The mayor of Gdansk was stabbed while on stage at a political rally over the weekend.[19]  Unfortunately, according to recent reports this morning, Pawel Adamowicz did not survive the attack.  The incident raises concerns about political stability in Poland.[20]

U.S. sanctions on Germany: The U.S. is warning German companies that their involvement in the Nord Stream 2 natural gas pipeline could trigger financial sanctions.[21]  The U.S. has been concerned that German dependence on Russian natural gas could compromise its relations with Europe and the U.S.  In addition, America would prefer that Germany buy U.S. LNG.

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[1] https://www.reuters.com/article/us-china-economy-trade/china-posts-strongest-export-growth-in-seven-years-in-2018-despite-trade-war-idUSKCN1P8047

[2] https://www.ft.com/content/713ee398-179a-11e9-9e64-d150b3105d21

[3] Op. cit., Reuters.

[4] https://www.ft.com/content/32576258-1651-11e9-9e64-d150b3105d21

[5] https://www.ft.com/content/8dee4b22-13ef-11e9-a581-4ff78404524e?emailId=5c3c19af40142700048786e9&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[6] https://www.politico.eu/article/theresa-may-brexit-deal-rejection-risks-democratic-catastrophe/ and https://www.ft.com/content/99879042-1714-11e9-9e64-d150b3105d21

[7] https://www.ft.com/content/99879042-1714-11e9-9e64-d150b3105d21?emailId=5c3c19af40142700048786e9&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[8] https://www.theguardian.com/politics/2019/jan/13/eu-preparing-to-delay-brexit-until-at-least-july

[9] https://www.reuters.com/article/uk-britain-eu-donors-exclusive/exclusive-leading-brexit-donors-say-britain-will-reverse-decision-to-leave-eu-idUSKCN1P50UU?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosmarkets&stream=business

[10] https://www.apnews.com/2eac470724434029b728f54abe364557

[11] https://www.chron.com/business/bizfeed/article/TSA-closes-security-checkpoint-at-IAH-Terminal-B-13530619.php

[12] https://www.axios.com/automobile-sales-trump-tax-plan-smaller-refunds-13c98a56-a442-4be0-98ee-9e15e3e7eea3.html

[13] https://www.ft.com/content/9967e02a-1797-11e9-9e64-d150b3105d21?emailId=5c3c19af40142700048786e9&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[14] https://www.wsj.com/articles/white-house-sought-options-to-strike-iran-11547375404

[15] https://www.nytimes.com/2015/03/26/opinion/to-stop-irans-bomb-bomb-iran.html?mod=article_inline

[16] See WGR, The Archetypes of American Foreign Policy: A Reprise (4/4/2016).

[17] https://www.countable.us/articles/19241-don-t-sink-trump-s-obsession-iranian-boats-tormented-mattis

[18] https://www.nytimes.com/2019/01/13/world/europe/greece-tsipras-confidence-vote-kammenos.html

[19] https://www.reuters.com/article/us-poland-stabbing/mayor-of-gdansk-stabbed-onstage-at-polish-charity-event-idUSKCN1P70T8?wpisrc=nl_todayworld&wpmm=1

[20] https://www.theguardian.com/world/2019/jan/13/gdansk-mayor-stabbed-on-stage-during-charity-event-in-poland?wpisrc=nl_todayworld&wpmm=1

[21] https://www.reuters.com/article/us-germany-usa-russia-pipeline/u-s-warns-german-firms-of-possible-sanctions-over-russia-pipeline-idUSKCN1P70FR