by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s Friday and equities are taking on water again this morning.  Today’s weakness is due to disappointing earnings from two tech giants, Amazon[1] (AMZN, 1782.17), which is down 7.7% in pre-market trading, and Alphabet[2] (GOOGL, 1103.59), down 4.2% in the pre-market.  We cover Q3 GDP in detail below but it did come in a bit better than forecast.  Here is the news we are watching today:

Establishment versus populist redux: After the election, we offered extensive comments about the differences within the parties, noting that the policies favored by the establishment (low taxes, deregulation, free trade, immigration) are not the policy goals of the populists (regulation to protect jobs, trade impediments, reduced immigration).  For much of the first year of President Trump’s term, he talked like a populist but governed like an establishment member.  Taxes were cut and regulation was reduced.  Equity markets clearly favored his policies.  Like his GOP predecessors, he seemed to give lip service to populist goals; he didn’t aggressively condemn alt-right groups, for example.  But, if one ignored the commentary, Trump governed mostly as an establishment GOP president.

That scenario began to change this year.  The administration became increasingly aggressive against immigration.  This has led to scattered complaints from some agriculture sectors.[3]  In late January, it became clear that the president was serious about implementing sanctions and changing trade.  Attacks on the Federal Reserve have become more frequent and pointed.  As policy turned populist, the president’s approval ratings have improved.[4]  The establishment may be starting to push back.  We note this morning the WSJ editorial board[5] has criticized the president’s handling of the Fed.  GOP lawmakers have been quietly unhappy with the president’s trade policy.[6]  For Republican politicians, openly opposing the president appears, at this point, to be a political suicide mission.  And so, as long as the president maintains his popularity with the base, the rest of the GOP will be forced to go along, occasionally implementing establishment goals when the president is not paying attention (e.g., the establishment FOMC appointments).

What investors need to consider is that a GOP president might not be good for equities.[7]  Although earnings are still strong, we have been seeing a steady drop in the multiple; rising interest rates do affect the P/E but ultimately it’s a measure of market sentiment.  Investors are becoming worried and thus stocks are under pressure even with good earnings.

We have worried for some time that a policy shift toward equality and populism was inevitable regardless of who is in power.  After all, capital has been gaining on labor since 1990 and is one of the reasons populism has been surging.  Although it’s still too early to tell, the policy mix of globalization and deregulation, supported by both the left- and right-wing establishment, is under threat.  It would be reasonable to expect that this pressure is expressed in the P/E.

CNY under pressure:  The CNY fell to nearly 7.0 this morning, the weakest in 10 years.[8]  China has vowed to prevent a move above 7.0 by spending its foreign reserves.[9]   Chinese officials could use a weaker CNY to offset tariffs but fears of currency weakness will lead to capital flight.

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[1] https://www.wsj.com/articles/amazon-reports-another-profit-but-sales-underwhelm-1540498816

[2] https://www.wsj.com/articles/google-parent-alphabet-delivers-surging-profit-but-slowing-sales-growth-1540498892

[3] http://www.latimes.com/projects/la-fi-farm-labor-guestworkers/

[4] https://www.realclearpolitics.com/epolls/other/president_trump_job_approval-6179.html NB: the president’s approval rating bottomed in January, just after the tax cut.  After turning populist, his approval ratings have improved.

[5] https://www.wsj.com/articles/trump-flunks-fed-politics-1540423551

[6] https://www.cnbc.com/2018/07/06/republicans-criticize-trump-tariff-trade-war-with-china.html

[7] https://www.bloomberg.com/opinion/articles/2018-10-26/trump-is-bad-for-the-stock-market

[8] https://www.ft.com/content/4fa1fbc0-d8d5-11e8-a854-33d6f82e62f8

[9] https://www.cnbc.com/2018/10/26/reuters-america-exclusive-guarding-stability-china-likely-to-slow-yuans-slide-to-7-per-dlr-sources.html

 

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s the fourth day of what has been a tough week.  Yesterday’s equity market sell-off was clearly a shocker.  Although there is other news this morning, including the ECB meeting, we start today with thoughts about equities:

Equity thoughts: Two weeks ago, in the Asset Allocation Weekly, we touched on this issue of politics, focusing on the potential impact of political polarization on Fed policy.[1]  In that report, we noted a chart on political polarization that we show again below.

This data reads as follows—the higher the level, the greater the degree of polarization.  Our position has been that deep political divisions are the norm and the decline in polarization that began at the turn of the last century that accelerated into WWII is the outlier.  The pressures of the Cold War and the outside enemy of communism functioned as a unifier.  Soon after the fall of the U.S.S.R., polarization returned with a vengeance.

For financial markets, political polarization isn’t necessarily bad.  If it results in gridlock, legislative and regulatory policy tends to remain stable and leads to conditions that are supportive for investment.  But, in a nearly equally divided society, there is a certain attractiveness to jettisoning the restraints of the constitution and democracy.  We have seen this tendency before.  In the two decades before the Civil War, Congress more resembled an open brawl.  Are we there yet?  Although members are not openly fighting, the crowds around them certainly are.

It is rare that a market decline not tied to a clear financial event (major financial firm failure) or geopolitical event (war, major terrorist act) can be pinned to a single reason.  Given that caveat, what happened yesterday was, we think, due to a combination of events:

1. Fed tightening: The trading pattern in equities since 2009 has all the look of a secular bull market. However, previous secular bulls have occurred, in part, due to the perceived resolution of serious economic or societal problems.

Each one of these previous secular bulls coincided with a new consensus.  With regard to the last two, for example, the 1952-69 bull was due to the idea that policymakers had resolved the conditions that caused the Great Depression and equities rose with that fear resolved.  The 1982-99 bull was due to the resolution of the 1970s inflation crisis.  We haven’t added shading but if we did it would be around 2013, when new highs were made.  However, we doubt that any societal issues have been resolved.  The big issues, resolving the superpower role and addressing inequality, have not been fixed.  Instead, the bullish impetus was mostly due to very accommodative monetary policy coupled with fiscal and regulatory policy that favored capital.  If that is the case, the removal of monetary policy accommodation may be a much bigger negative factor than it normally would.

2. Political polarization has become bad for business: As noted above, if polarization leads to gridlock, it isn’t necessarily negative. But, if polarization leads to violence and divisions make the nation ungovernable, this makes investing very difficult because the path of policy becomes impossible to determine.  Large demonstrations from both the right and left, the shooting of Majority Whip Scalise and the most recent bomb mailings are not conducive to a high P/E.
3. Trade policy: The uncertainty surrounding trade policy is a concern. A key factor supporting corporate efficiency has been global supply chains.  It appears to us that one of the goals of the administration’s trade policy is to bring investment back to the U.S., which will boost employment but likely undermine margins or boost inflation.
4. At the same time, it’s important not to overlook what is going well: Earnings remain very elevated. Yes, the growth may slow but the level is historically high.  The economy overall is still doing quite well.  There are areas of concern; housing is losing momentum rapidly.  But, even slowing to 2.5% growth isn’t bad.  Inflation, though somewhat higher, is still low especially given the length of the expansion and the low level of unemployment.  In the absence of political and trade uncertainty, we would likely have an S&P 500 around 3200 and we would be talking about a bubble. 
5. The bottom line: History shows that market declines that don’t coincide with recessions tend to be short-lived and are usually buying opportunities. We suspect we are coming close to a bottom and would expect a recovery from here.  In addition, the post-mid-term election period tends to be quite bullish.

Odds and ends: The ECB meeting was mostly a non-event.  Policy may start tightening next year if conditions continue to improve.  China is cutting rare earth production, something it has done before when unhappy with foreign behavior.[2]  China appears to also be reducing its buying of Iranian oil in front of the November sanctions.[3]

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[1] https://www.confluenceinvestment.com/wp-content/uploads/AAW_Oct_12_2018.pdf

[2] https://www.reuters.com/article/us-china-rareearths/china-cutting-rare-earth-output-unnerving-global-manufacturers-idUSKCN1MY2GZ

[3] https://www.reuters.com/article/us-china-iran-oil-exclusive/exclusive-sinopec-cnpc-to-skip-iran-oil-bookings-for-november-as-us-sanctions-near-idUSKCN1MY1C9

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s mid-week and equity markets are trying to find their footing.  Yesterday’s action almost qualified for what a former boss of mine would call a “Hollywood finish.”  That’s one where the market takes a beating in the early part of the day only to recover to positive territory by the close.  We didn’t get out of the red yesterday but we did see a solid recovery.  Here is what we are watching this morning:

Earnings: Although there is much hand-wringing about earnings, the fact is that, overall, S&P 500 earnings appear to be coming in about as forecast.  This is positive; however, the usual pattern is to somewhat understate earnings in the estimates and then celebrate beating the forecast.  That may not happen this quarter.  At the same time, S&P 500 earnings are running above 6% of GDP, which is a record.  Earnings themselves look fine but sequential momentum is clearly fading.

Given where we are in the business cycle, this development shouldn’t be a shock.  Wage pressures are rising.  Interest costs are increasing, too.  Although it’s difficult to see the impact of trade restrictions in the macro data, individual companies are reporting adverse effects.[1]  Our margin model suggests that margins will remain elevated but growth will be flat; that would mean earnings growth may be limited to the growth of nominal GDP next year.  That’s not bad, but significant market appreciation will require multiple expansion.  Given how elevated confidence readings are now, it would take a major decline in interest rates to boost P/Es.

Fed bashing: In an interview with the WSJ,[2] President Trump lambasted the FOMC and Chair Powell.  In a telling quote from the article, the president said, “He was supposed to be a low-interest-rate buy.  It’s turned out he’s not.”  We wondered at the time Powell was selected (to replace Chair Yellen, who was perceived as dovish) whether Powell got the job because he was seen as an easy money person.  It should be noted that Treasury Secretary Mnuchin supported Powell’s nomination; Mnuchin is an establishment figure in the administration.  In fact, all the appointees for Fed governor so far have been remarkably mainstream.  It’s becoming obvious that Powell will be blamed for equity market volatility and any economic weakness.  Interestingly enough, criticism from the White House will tend to make it more difficult for FOMC policymakers to pause the pace of hikes.  There may be legitimate reasons for the Fed to pause—equity market turmoil is one.[3]  However, FOMC members may feel the need to maintain hikes simply to enforce Fed independence.

Our position is that we are on a slow pace to reflate the economy as part of reversing four decades of rising inequality.  Central bank independence was a key policy tool to bring down inflation.  Although the actual impact of monetary policy on inflation isn’t all that strong, policy does clearly affect inflation expectations.  But, when policymakers want to reflate, they can’t have the central bank undermining their policy actions.  President Trump’s statements to undermine Fed independence, though a reversal of the early 1990s détente, does fit a reflation narrative.

GDP: We get Q3 GDP tomorrow.  Here is the most recent GDPNow estimate from the Atlanta FRB.

The current forecast is 3.9%.  Here is the contribution table:

The two largest positive contributors to growth are consumption and inventory rebuilding.  The largest offset is net exports.  We would not expect as strong of a contribution from inventory in Q4, so there is a chance we will see GDP closer to 3% in Q4.

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[1] https://www.reuters.com/article/us-usa-stocks-earnings-analysis/tariffs-begin-to-take-bite-out-of-us-corporate-earnings-growth-idUSKCN1MX2W0

[2] https://www.wsj.com/articles/trump-steps-up-attacks-on-fed-chairman-jerome-powell-1540338090

[3] https://www.reuters.com/article/us-usa-fed-selloff-analysis/for-fed-sell-off-could-point-to-fading-trump-stimulus-idUSKCN1MX32L

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Global equities are under pressure this morning.  Note that China’s big rally yesterday was unable to hold.  Earnings disappointments are being cited as the reason.  However, as our earnings figures show, earnings are coming in a bit higher than expected.  What is starting to affect equities is the idea that sequential earnings growth is clearly slowing.  That notion, coupled with a declining multiple, is putting pressure on stocks.  Here are the items we are watching this morning:

Day of decision: The EC has rejected Italy’s budget.  We now begin a three-week negotiation period during which Italy will be required to submit an amended budget.  If an agreement isn’t reached, the EC could implement the “Excessive Deficit Procedure.”  This process would probably continue until the end of November.  Ultimately, fines could be imposed.[1]  Although EC rules create lots of temporary deadlines that help facilitate agreements, Italy appears ready to defy the Eurozone.  In the end, we expect the EC to blink which will undermine Germany’s hold on the Eurozone and pressure the EUR lower.

Brexit grinds on: PM May has offered a four-point plan to address the Brexit issue.[2]  The most important element is that she proposes to extend the transition period to the end of 2021.  In addition, the troublesome Northern Ireland issue would be addressed by a temporary joint border control body that would prevent a hard border.  During this period of “limbo” negotiations would continue on a free trade deal.  May’s political position within the Tories remains dicey; however, she continues to survive against all odds,[3] mostly because there is no good alternative within the party.[4]  At the same time, if the government falls and elections are necessary, the Tories may find themselves out of office.  That fear has been enough to keep May in power.

Khashoggi: Turkish President Erdogan continues to pressure the Saudis, indicating today that the Saudi journalist was killed in a “savage” manner, laying out a case that comes just short of accusing the KSA of a pre-meditated murder.[5]  Although we and others have speculated that Erdogan wants financial support for his beleaguered economy and a withdrawal of funding and support for the Kurds, there is nothing in the Turkish president’s tone to suggest that he has achieved satisfactory compensation for this act that occurred within the Turkish state.  If Erdogan changes his tone, we will take it as evidence that an agreement has been reached.

Other items:Oil prices fell today after the Saudis promised to offset any loss of Iranian oil.[6]  Although we are not surprised by the announcement, “saying is one thing, but doing is another.”  Chancellor Merkel has agreed to open up Germany to U.S. LNG imports.[7]  This is an important concession by Germany, which has mostly supported piped natural gas from Russia, even supporting projects that would avoid land pipes through Ukraine.  Finally, Canada has allowed China to install underwater monitoring devices near a U.S. nuclear submarine base.[8]  We view this as a stunning and disturbing development, perhaps done by the Trudeau government in retaliation over trade tensions.  The Canadians seem to miss that their defense relies deeply on U.S. power projection.  Participating in a Chinese project that could undermine U.S. power projection is dangerous for them as well.

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[1] https://www.cnbc.com/2018/10/22/european-commission-on-italys-2019-budget—what-could-happen-next.html

[2] https://www.ft.com/content/de915670-d60d-11e8-a854-33d6f82e62f8?emailId=5bcea6664ab701000494c62b&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.politico.eu/article/theresa-may-only-four-steps-left-to-reach-irish-backstop-brexit-deal/?utm_source=POLITICO.EU&utm_campaign=378803a464-EMAIL_CAMPAIGN_2018_10_23_04_38&utm_medium=email&utm_term=0_10959edeb5-378803a464-190334489

[4] https://www.ft.com/content/c4f357dc-d5fd-11e8-a854-33d6f82e62f8?emailId=5bcea6664ab701000494c62b&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.ft.com/content/76a34b70-d6a5-11e8-ab8e-6be0dcf18713

[6] https://www.bloomberg.com/news/articles/2018-10-23/saudi-oil-chief-says-opec-s-in-produce-as-much-as-you-can-mode and https://www.reuters.com/article/us-global-oil/oil-falls-as-saudi-arabia-says-it-will-play-responsible-role-idUSKCN1MX046

[7] https://www.wsj.com/articles/in-win-for-trump-merkel-changes-course-on-u-s-gas-imports-1540209647

[8] https://www.scmp.com/news/china/society/article/2169474/canada-installs-chinese-underwater-monitoring-devices-next-us

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Monday!  We are seeing a bit of optimism this morning as Chinese equities rallied overnight.  There was nothing in the news that was necessarily bullish for China but a constant drumbeat of supportive statements from CPC officials has likely given investors the idea that the government will directly support the economy and perhaps the equity market.  Here are the other items we are watching this morning:

The INF Treaty: It appears the U.S. is preparing to end its participation in the Intermediate Nuclear Forces Treaty, a late-Cold War agreement that limited short- and intermediate-range nuclear weapons from the European theater.[1]  There is evidence to suggest Russia has been violating the treaty for some time; Russia makes similar accusations against the U.S.  Although the demise of this treaty is worrisome, it was really a relic of America’s unipolar movement.  The INF puts the U.S. at a significant disadvantage to China in the Far East and would have needed to be scrapped at some point.  But, what this action likely shows more than anything is that the world is again devolving into competing blocs and is additional evidence that the post-Cold War world is moving from American dominance to a more unstable geopolitical situation.  If this view is correct we will likely see more modifications in other arrangements over time.

The Khashoggi affair: The Saudi Royal family is working hard to contain the uproar over the death of Jamal Khashoggi, a prominent Saudi journalist.  The current narrative around his death, which took a while for the Kingdom of Saudi Arabia (KSA) to admit had occurred, is that it was an arrest gone awry.  Obviously, there are massive problems with this story.  First, the crown prince projects the image of being in full control.  For this incident to have been a blunder undermines this image.  Second, Turkey appears to have a significant degree of signals intelligence on what happened inside the Saudi consulate.  And, President Erdogan has played his hand deftly, leaking information on a selective basis to undermine any story coming from Washington or Riyadh.  Ankara is working to extract as much as it can with the information it has.  Erdogan’s goals would be to extend Turkey’s power projection into the Persian Gulf[2] and to reduce Kurdish influence in northern Iraq and Syria.

Our key takeaway from this event is that the U.S. isn’t going to rupture its relations with the KSA over this affair because the Saudis are simply too important to isolating Iran and maintaining some degree of order in the oil markets.  But, it is also becoming clear that the crown prince is a significant danger to regional stability.  The list of his rash actions is long.[3]  Although some members of the Trump administration are clearly fond of Mohammad bin Salman (MbS), he is proving to be a dangerous actor.  Thus, we wouldn’t be surprised to see at least some steps to curtail his power; the history of the KSA shows that kings can be removed and crown princes replaced.[4]  If MbS survives this affair with no changes in power, it would suggest he has solidified his control and will be the fount of continued turmoil.

Italian chicken: Tensions between the European Commission and Italy remain elevated.  On Friday, Moody’s downgraded Italian local and foreign currency sovereign debt to Baa3 from Baa2,[5] putting its debt near “junk” status.  Although some commentators are arguing that this morning’s equity rally is partly due to “relief” that Moody’s didn’t take Italy to junk status, this appears to us to be a stretch.  For the most part, the action taken by Moody’s was about as expected.  S&P is scheduled to review Italy’s debt on Friday.  The EC continues to express displeasure with Italy’s budget and the Italian government continues to indicate that it intends to keep its budget regardless of the EC’s protests.

The Italian position is actually rather simple.  Although there is occasional talk of Italy leaving the Eurozone, polls suggest that Italians actually favor being in the single currency.[6]  The current government has made it clear that it has no plans to exit the Eurozone.[7]  Given how high Italian interest rates were pre-Eurozone, it is understandable why being part of the single currency is popular.

The euro started in 2000, as shown by the vertical line on the chart, but note that yields between Germany and Italy converged in the late 1990s in anticipation of Italy joining the Eurozone.  Even in the worst of the Eurozone crisis in 2011-12, Italy’s yield spread with Germany didn’t reach the pre-euro peaks.  The chart also makes it obvious why a spread of 4% is psychologically important.

Italy wants to stay inside the Eurozone but to ignore the fiscal restraining rules.  Although Italy has enjoyed lower interest rates, its economic growth has been stagnant.

This chart shows Italy’s industrial production. We have placed a vertical line showing the start of the Eurozone.  Note that production growth has been nil since entering the single currency.

The populist government has a mandate to (a) boost growth, and (b) keep interest rates low, which likely means staying in the Eurozone.  The EC does not want to see a large Eurozone economy flagrantly defy the fiscal rules.  These are incompatible goals.  Thus, we have a classic game of “chicken.”  We don’t expect Italy to blink here.  The enforcer of fiscal rules in the EC is Germany and Chancellor Merkel’s political situation has deteriorated enough to likely prevent a strong response from the Merkel government.  If Italy is allowed to violate the fiscal rules, at least initially, it’s bearish for the EUR.  However, if we end up with a wider easing of fiscal rules that leads to tighter monetary policy, we could see the EUR eventually strengthen.

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[1] https://www.washingtonpost.com/world/national-security/bolton-pushes-trump-administration-to-withdraw-from-landmark-arms-treaty/2018/10/19/f0bb8531-e7ce-4a34-b7ba-558f8b068dc5_story.html?noredirect=on&utm_term=.4d4ffd595242

[2] https://www.al-monitor.com/pulse/originals/2018/10/turkey-gulf-rapprochement-with-kuwait-may-cause-tension.html

[3] For example, see: Weekly Geopolitical Reports, Moving Fast and Breaking Things: Mohammad bin Salman, Part I (11/20/17); Part II (12/4/17) and Part III (12/11/17).

[4] See Weekly Geopolitical Report, Saudi Succession (1/20/15).

[5] https://www.ft.com/content/848c8f7e-d3e1-11e8-a9f2-7574db66bcd5

[6] https://www.reuters.com/article/us-italy-euro-poll/polls-show-most-italians-want-to-stay-in-euro-idUSKCN1IW0MT

[7] https://www.ft.com/content/9b324788-d4b2-11e8-ab8e-6be0dcf18713

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Global equities are mixed this morning due to concerns about a possible stand-off between the EU and Rome along with slower than expected GDP growth in China.  Here are the stories we are following today:

Italy budget: In a rebuke to Rome, the European Commission (EC) presented the Italian government with a letter stating its budget was in breach of EU budget rules.  The EC’s comments suggest it will likely take the unprecedented step of rejecting the budget proposal.  The Italian government was given until Monday to issue an official response.  Concerns of escalating tensions between Rome and the EU are likely overblown as Italy has suggested it is unwilling to entertain discussions of an EU exit.  Following the report, 10-year Italian bond yields rose about 20 bps and then saw a slight retreat.

 

Chinese economy: Chinese officials were forced to offer reassurances to financial markets after the GDP report showed the economy has slowed more than expected.  In response to the GDP report, Vice Premier Liu He stated that the impact of the trade war with the U.S. is more psychological than actual and that the two countries plan to meet during the G20 summit.  Nevertheless, the National Bureau of Statistics of China warned that the economy could experience “greater downward pressure” in the future.  In response, Chinese regulators stated the Chinese government is willing to facilitate private equity investments, speed up merger approvals and support bond prices.  Chinese equity markets rebounded as a result of the news of additional government support.

Gibraltar agreement: In a rare win for UK Prime Minister Theresa May, the UK was able to broker a deal with Spain regarding Gibraltar.  Although the details of the arrangement have not been released, the deal is believed to alleviate worries of ongoing disputes between the two nations following Brexit.  Gibraltar, which was ceded to Britain under the 1713 Treaty of Utrecht, has been a source of tension between the two countries as both believe they have ownership over the sovereign territory.  Following the UK’s decision to exit the EU, tensions over Gibraltar escalated when the former Spanish foreign minister, Jose Manuel Garcia-Margallo, vowed to plant the Spanish flag in the territory after the Brexit vote and a former Conservative party leader, Michael Howard, claimed PM May was willing to go to war over the region.  With this agreement in hand, PM May still needs to find a reasonable solution for the North Ireland border, which has proven to be a sticking point in Brexit negotiations.

WTO dispute: The U.S. has requested the World Trade Organization’s dispute panel to review the legality of retaliatory trade tariffs imposed by China, Mexico, Canada and the EU.  Earlier in the year, China, Mexico and Canada filed a suit questioning the legality of the U.S.-imposed steel and aluminum tariffs.  Although the WTO does not have any enforcement powers, disputes regarding tariffs will likely test the agency’s ability to mediate rising trade concerns.  The U.S. has called out the organization for not doing enough to address growing trade imbalances.  If the WTO’s decision is unfavorable to the U.S., we expect it to withdraw from the organization.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Good morning!  Equities fell and Treasury yields rose due to the hawkish tone of the Fed minutes.  There was not a lot of overnight news but below are the stories we are following today:

EU trade truce on the rocks: The truce between the U.S. and the EU appears to be in jeopardy as negotiators trade barbs in the press, accusing each other of stalling the negotiation process.  At the heart of the dispute is the trade truce, also known as the Trump- Junker deal, which lacks any concrete parameters.  The EU appears unwilling to begin negotiations without assurances that there will be no retaliation in the event of a stalemate.  The U.S. seems reluctant to grant those assurances, likely due to fears that it could undermine its leverage.  It appears that the Trump administration has been using a series of bilateral agreements with its allies to apply more pressure on China in trade negotiations, in much the same way TPP was intended.  That being said, President Trump’s harsh criticism of allied nations, specifically, has created an environment of mistrust, which could explain why countries are hesitant to engage in trade negotiations.  Nevertheless, we expect the impasse between the U.S. and Europe to end somewhat soon given that recent trade agreements with Korea, Canada and Mexico were relatively non-controversial; hence, the EU agreement will likely follow suit.  We continue to monitor this situation.

FOMC minutes: The Fed minutes, released on Wednesday, support the case for future rate hikes.  Although there were some concerns regarding rising trade tensions and strain in emerging market economies, the FOMC believes the U.S. economy is moving in the right direction.  At the same time, members of the FOMC have expressed willingness to raise rates past the neutral rate, which is a rate that is neither accommodate nor constrains the economy, in order to address financial imbalances and to contain future inflation.  This point of view runs counter to the views of the president, who believes the Fed should consider the impact that higher rates will have on the economy.  The president responded to the minutes by calling Fed Chairman Jerome Powell a weak link.  At this point, it is unclear how high the Fed is willing to raise rates but current projections suggest a neutral rate around 3.0%.  The president’s pugnacious response could be a concern as it seems he is starting to view the Fed as an adversary.  Although Powell seems unbothered by the criticism, that position could change if the president releases the bully pulpit.

Energy recap: U.S. crude oil inventories rose 6.5 mb compared to market expectations of a 1.6 mb build.  Refinery utilization was unchanged at 88.8% and oil production fell by 0.3 mbpd to 10.9 mbpd.  Exports rose 0.1 mbpd, while imports fell by 0.2 mbpd.  The rise in stockpiles was mostly due to slower refining activity.  As the seasonal chart below shows, inventories have begun their seasonal build period.  We should see inventories continue to rise in the coming weeks as refinery operations decline for autumn maintenance.

The build up in inventories led to a drop in the price of Brent and WTI crude oil.  Rising tensions between the U.S. and Saudi Arabia, as well as the impending U.S. sanctions on Iran, have led to supply pessimism.  As a result, rising shale production is becoming important in maintaining oil price stability.

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