by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT]

Big tech under fire: Tech companies are coming under increased scrutiny from both left- and right-wing populists.  Yesterday, Breitbart released a video of Google executives showing disappointment after President Trump’s victory over Hillary Clinton in the 2016 election.  Prior to this incident, President Trump and other conservatives have accused the tech companies of censoring conservative viewpoints.  In response to the backlash, Attorney General Jeff Sessions has expressed interest in investigating big tech social media firms, while the Federal Trade Commission opened a hearing on Thursday to investigate possible antitrust violations.  Meanwhile, Senator Elizabeth Warren has suggested that Amazon (AMZN, $1,989.87) has become too big and should be broken up.  As we have discussed in the past, the big tech firms have taken advantage of litigation arbitration caused by deregulation and technological advancement to the detriment of labor wages, and this will become a growing issue as populism grows in popularity.

Koreas establishing ties: As denuclearization talks between North Korea and the United States appear to be in a lull, South Korea has taken steps to build closer ties with its northern neighbor.  Today, North Korea opened a liaison office along its border with South Korea.  The office will allow the two sides to discuss issues directly on a day-to-day basis.  Although Kim Jong-un has stated that he would like to secure a denuclearization deal with the U.S. before the end of President Trump’s first term in office, it is unclear what is stalling the process.  There is growing speculation that countries such as Russia and China may be contributing by helping North Korea flout sanctions.  Although it is unclear whether opening the liaison office will hamper the denuclearization negotiations, the U.S. appears to be a bit uneasy about the pace at which the two countries are recreating ties.  Following the announcement, the U.S. State Department stated that Inter-Korean relations should follow the same pace as the denuclearization talks.  We will continue to monitor this situation.

New York primaries: Last night, New York Governor Andrew Cuomo was able to beat populist-backed Cynthia Nixon to win the Democratic Party nomination.  Although Cuomo had a comfortable lead in the polls throughout the entire campaign, it did appear that Nixon had much of the momentum going into the primary.  Following the surprise victory of Alexandria Ocasio-Cortez over Joseph Crowley in June, there was growing speculation that the Bernie Sanders wing of the party could pull off a Tea Party-style route in the primaries.  Governor Cuomo’s victory will likely calm fears of a possible populist takeover of the Democratic Party; however, the battle between the establishment and populists is far from over.

Hurricane Florence: Hurricane Florence has made landfall along the North Carolina coast.  Upon hitting the coast the hurricane is expected to weaken into a tropical storm before making its way to South Carolina and Georgia.  The storm is expected to cause damage due to large amounts of flooding.  As a result, we expect economic numbers for this month to come in relatively weak as the states affected by the storm recover.

Merkel under pressure: German Chancellor Angela Merkel’s grand coalition has come under pressure due to comments made by Germany’s intelligence chief, Hans-Georg Maassen.  On Wednesday, Maassen claimed that video footage of foreign people being hunted down by far-right protestors was fake—a direct contradiction to Chancellor Merkel’s statements.  Members of Merkel’s own coalition as well as members of her opposition have called for Maassen’s resignation, with the most vocal group being the Social Democrats.  Nevertheless, it does appear that Maassen still has the support of Christian Social Union Leader Horst Seehofer, who has stated he doesn’t believe Maassen has done anything wrong.  The coalition that was reached in March between the CDU/CSU and Social Democrats appears to be on thin ice.  A meeting regarding possible disciplinary actions is due to take place on Tuesday.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Thursday!  Here is what we are watching today:

Trade talks back on: Equities are elevated this morning after it was revealed that the U.S. and China are open to restarting trade negotiations.  This breakthrough came on the heels of President Trump’s threat to impose tariffs on an additional $200 billion of Chinese goods.  Recently, President Trump has received flak from businesses about the escalating trade conflict.  Last week, Apple (AAPL, $221.07) wrote a letter to the president stating that tariffs would force the company to raise its prices; the president shrugged off the criticism and said the company should relocate its facilities back to the U.S.  Although we do not expect a deal to be made prior to the midterm elections, this development does suggest that the two sides have softened their stances.

Turkish Central Bank: This morning, Turkey’s central bank raised its main interest rate from 17.75% to 24.00% in order to combat rising inflation; as a result, the lira strengthened against the dollar.  Rising inflation and high amounts of foreign currency debt have called into question Turkey’s solvency.  Although Turkey’s economic crisis is far from over, the central bank’s decision did restore some degree of confidence in the lira.

Beige Book and the Fed: Reports on growth were surprisingly mixed.  The St. Louis, Kansas City and Philadelphia districts reported below-trend growth, while the Dallas district indicated above-trend growth.  Residential real estate was mixed, with the New York district reporting a sharp decline in New York City real estate activity.  The Federal tax law changes were cited as a reason for the weakness.  All the districts reported tight labor market conditions.  The Minneapolis district reported that anecdotal comments from businesses said it was difficult to attract recruits with hourly wages of less than $15 per hour.  Half of the districts reported that labor shortages were constraining economic activity.  There were also reports of signing bonuses, increased benefits and training as a way to attract workers.  Price pressures remain somewhat elevated, but not at levels that seem to be a significant problem.

A rate hike at the September 26^th meeting is a near certainty.  More importantly, we are seeing the financial markets discount a rising probability of another increase at the December 19^th meeting.

The current probability of a 25 bps hike at the December meeting, taking the target’s upper limit to 2.50%, is 76.3%.

The three-month implied LIBOR rate, two-years deferred, from the Eurodollar futures market has ticked higher, reaching 3.10%.  Recent history has shown that the FOMC tends to end its tightening cycle when this implied rate and the target rate inverts.

This rise in the implied LIBOR rate suggests a terminal rate closer to 3.25%.  That would mean two more hikes this year and three next year.

Real family income: The Census Bureau released its annual report on median household and family income.  We prefer the latter number because it has a longer track record.  We have a new record at $75,938 in 2016 dollars.  Household income also made a new record on the same basis at $61,375.

This chart shows real family income data; we have regressed time trends through the numbers, one trend line for the period 1947-69 and the other from 1970 to the present.  The compound annual growth rate in median real family income in the 1947-69 period was 3.3%; in the latter period it’s a mere 0.5%.  If the country had stayed on the earlier trend line, real median family incomes would be $110,910.  This trend change goes a long way in explaining the political and social unrest we are seeing in the country.

Energy recap: U.S. crude oil inventories fell 5.3 mb compared to market expectations of a 2.3 mb draw.

This chart shows current crude oil inventories, both over the long term and the last decade.  We have added the estimated level of lease stocks to maintain the consistency of the data.  As the chart shows, inventories remain historically high but have declined significantly since March 2017.  We would consider the overhang closed if stocks fall under 400 mb.  Refinery utilization rose to 97.6%, up 1.0% from last week.  Oil production dipped to 10.9 mbpd.  Imports fell and exports increased; between falling imports, lower production, high refinery runs and higher exports, oil inventories continue to slide.

As the seasonal chart below shows, inventories are near the end of their seasonal withdrawal period.  This week’s decline was rather high.  As we discussed in the recent Quarterly Energy Comment,[1] oil exports may change the seasonal pattern and lead to a less cyclical stock situation.

Based on inventories alone, oil prices are below fair value price at $75.27.  Meanwhile, the EUR/WTI model generates a fair value of $59.51.  Together (which is a more sound methodology), fair value is $64.78, meaning that current prices are well above fair value.   However, the most bearish factor for oil is dollar strength.  It will be difficult for oil prices to move higher without some reversal in the greenback.  Oil prices have been bolstered by concerns surrounding Hurricane Florence and the expected increase in product demand.  That issue should dissipate in the next few days.

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[1] See Quarterly Energy Comment, 9/7/2018

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are mostly quiet this morning.  PPI (discussed below) came in lower than expected.  Here are the other items we are watching today:

EU pushes back against Hungary: With populists gaining political leverage in the EU, the establishment is fighting back and targeting Viktor Orban, the PM of Hungary.  Orban has been aggressively promoting populism.  He has erected barriers to African and Middle Eastern refugees, curtailed the domestic press and has described his government as “illiberal democracy.”  The European Parliament will vote today[1] on whether to suspend Hungary’s voting rights within the EU.  Sanctioning Hungary will require a “yes” vote from 28 leaders of nations in the EU, which might not be possible; it is not certain that Italy[2] will vote to sanction Hungary.  The sanction vote, called “Article 7,” is described in this reference.[3]

Trade: There does appear to be some progress on NAFTA.  According to reports, Canada is willing to offer at least some degree of access to its dairy market.[4]  The American business sector is beginning to ramp up objections to tariffs.[5]  As we noted earlier, U.S. trade actions against China have led Beijing to improve relations with Japan, which is also facing threats from the U.S.[6]  The United Steelworkers are pressing steel companies to boost wages in light of tariff-driven price increases on domestic steel.  We believe this outcome is what the Trump administration wanted but will be unwelcome for financial markets.[7]

Tech under the gun: Although anti-trust theoreticians are debating the underlying principles of enforcement, any change in policy could be years in the making.  A more immediate threat could come from the Federal Trade Commission.  The FTC will hold public hearings tomorrow which could set the stage for regulation surrounding data, privacy and other corporate behaviors.[8]

Rupee recovery?  The Indian rupee (INR) has come under pressure along with other emerging market currencies, recently falling to new all-time lows against the dollar.

This weekend, PM Modi is holding an economic review meeting[9] to come up with measures to bolster the exchange rate.  Indian equities and the INR bounced on the news.

Tropical situation: Hurricane Florence remains a significant threat, although we have seen a change in the path forecast over the past 24 hours.  Yesterday, we were expecting a more northerly path.  The current forecast has the storm turning south, making landfall near the border of South and North Carolina and heading toward Georgia.  Most of the Eastern Seaboard, excluding Florida, will be affected by the storm.  We have seen a jump in oil prices due to expectations of rising gasoline demand for evacuation.  The other event we are tracking, a disturbance now over the Yucatan, probably won’t develop into anything more than a tropical depression.  It is expected to reach the Texas coast later this week but probably won’t disrupt energy flows. 

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[1] https://www.nytimes.com/2018/09/11/world/europe/viktor-orban-european-peoples-party.html?emc=edit_mbe_20180912&nl=morning-briefing-europe&nlid=567726720180912&te=1

[2] https://www.lapresse.it/politica/ue_berlusconi_sente_orban_fi_vota_contro_sanzioni-571360/news/2018-09-11/?utm_source=POLITICO.EU&utm_campaign=6c7501ff37-EMAIL_CAMPAIGN_2018_09_12_04_34&utm_medium=email&utm_term=0_10959edeb5-6c7501ff37-190334489

[3] https://www.politico.eu/article/graphic-what-is-article-7-the-eus-nuclear-option/?utm_source=POLITICO.EU&utm_campaign=6c7501ff37-EMAIL_CAMPAIGN_2018_09_12_04_34&utm_medium=email&utm_term=0_10959edeb5-6c7501ff37-190334489

[4] https://www.cnbc.com/2018/09/11/reuters-america-update-1-canada-ready-to-allow-u-s-dairy-access-in-nafta-talks-sources.html

[5] https://www.wsj.com/articles/u-s-businesses-ramp-up-lobbying-against-trumps-tariffs-1536724811

[6] https://www.wsj.com/articles/japan-and-china-find-common-ground-in-trumps-tariffs-as-leaders-meet-1536732536

[7] https://www.wsj.com/articles/steel-workers-demand-higher-pay-raises-as-tariffs-lift-profits-1536668815

[8] https://www.axios.com/ftc-hearings-competition-tech-industry-innovation-58c116fa-5e93-485f-9a30-4c0163fdf857.html

[9] https://economictimes.indiatimes.com/news/economy/policy/pm-modi-may-call-review-meet-to-check-fall-in-rupee/articleshow/65781598.cms

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a solemn day, the 17^th anniversary of the 9/11 attacks.  Here is what we are watching today:

Trade: Talks continue with Canada but reports suggest that dairy remains a major sticking point.  China has asked the WTO for authorization to impose trade sanctions against the U.S., while the U.S. is considering sanctions on Chinese officials involved with the suppression of Uighurs.[1]  The U.S. is offering a partial trade deal with the EU.[2]  For the most part, the pattern emerging appears to be the creation of a united front of sorts against China.  However, such a front would depend on Canada agreeing to a new NAFTA deal and trade reforms with the EU.[3]  Neither of these outcomes is guaranteed.

One trend we are seeing is that China is extending its reach by increased use of the CNY in international transactions.[4]  However, what we haven’t seen yet is China opening its capital account for foreign investment in a manner consistent with a reserve currency.  And, to become a real reserve currency, China would need to start running consistent current account deficits, which seems unlikely.

A more likely outcome is the use of CNY in the “one belt, one road” zone, similar to Britain’s Commonwealth area that used the GBP for trade and investment.

Another North Korean summit? Reuters[5] is reporting that Kim Jong-un has sent a “warm…positive” letter to President Trump asking for a second meeting.  The White House is apparently looking for dates.  Although meetings between SoS Pompeo and North Korean officials have been less than fruitful, there are hopes the leaders can forge an agreement.  Our read is that Pyongyang is trying to free itself from China’s grip and thus the potential for a deal is probably higher than it looks.

Attacks in Syria: Our most recent WGR[6] discusses those involved in the last major rebel stronghold in Syria.  Although we expect the U.S. to remain mostly uninvolved in this likely attack, the Trump administration has held a strict line on chemical weapons use.  Apparently, the U.S. is holding talks with the U.K. and France on coordinating attacks against Syrian forces if they deploy such weapons.[7]  Russia, consistent with its emerging doctrine on warfare, has already introduced reports that the U.S. and its allies plan to deploy chemical weapons in the region to provide an excuse for attacking Syrian troops.[8]

Brazil elections: In what remains one of the strangest election seasons we have seen, another twist emerged today.  Luiz Inácio Lula da Silva has finally admitted he cannot run for president from prison and has formally withdrawn from the race for president.[9]  Last week, we reported that the front-runner in the race, Jair Bolsonaro, had been assaulted and stabbed.  Bolsonaro was seriously wounded in the attack and will likely require additional surgery.  Interestingly enough, his poll numbers jumped after the incident.[10]

Florence, et al.: As we note below, Hurricane Florence[11] is bearing toward the Carolinas and is developing into a massive storm, likely reaching Category 4 by landfall on Friday (the storm has slowed from yesterday’s forecasts).  This storm is looking like an extreme event, perhaps another Harvey.  TS Isaac could make its way into the Gulf of Mexico (GOM), although its most likely path is into Central America.  We are also monitoring a “blob”[12] between the Yucatan and Cuba that might develop into a tropical event.  If this one does develop, it will likely disrupt oil and gas production in the GOM and could make it to the Texas coast.

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[1] https://www.nytimes.com/2018/09/10/world/asia/us-china-sanctions-muslim-camps.html?action=click&module=Top%20Stories&pgtype=Homepage

[2] https://www.ft.com/content/c0b6bb52-b508-11e8-bbc3-ccd7de085ffe?emailId=5b97422fbb7cb7000439634a&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[3] https://www.nytimes.com/2018/09/10/business/europe-us-trade-lighthizer-malmstrom.html?emc=edit_mbe_20180911&nl=morning-briefing-europe&nlid=567726720180911&te=1

[4] https://www.scmp.com/economy/article/2163421/us-china-trade-war-helping-boost-use-yuan-international-transactions

[5] https://www.reuters.com/article/us-northkorea-usa/north-koreas-kim-asks-trump-for-another-meeting-in-very-warm-letter-idUSKCN1LQ2E3

[6] See WGR, The Battle for Idlib (9/10/18)

[7] https://www.wsj.com/articles/u-s-holds-talks-with-u-k-france-on-possible-syria-strikes-1536618235

[8] https://www.telegraph.co.uk/news/2018/08/27/british-general-accuses-russia-ridiculous-propaganda-claims/

[9] https://www.reuters.com/article/us-brazil-election/jailed-lula-to-bow-out-of-brazils-presidential-race-sources-idUSKCN1LR08N

[10] https://www.ft.com/content/99d45bea-b547-11e8-bbc3-ccd7de085ffe

[11] https://www.washingtonpost.com/amphtml/news/capital-weather-gang/wp/2018/09/09/florence-strengthens-to-hurricane-and-poses-extreme-threat-to-southeast-and-mid-atlantic/?__twitter_impression=true

[12] https://www.wunderground.com/wundermap?lat=19.6&lon=-86.1&wxstn=0&satellite=1&hur=1

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Monday!  Here is what we are watching today:

Trade: There’s nothing new on NAFTA but President Trump increased the threat against China, calling for even more Chinese goods to come under tariff barriers.  China is holding a meeting with U.S. financial services executives,[1] perhaps in a bid to figure out what it will take to prevent a trade conflict.  Our take hasn’t changed; it appears the U.S. is working out new trade arrangements with most regions and nations except China.  To some extent, this was the goal of TPP/TTIP, which were designed to create trading platforms with Asia and Europe with the U.S. as the keystone, the only common element between the two trading zones.  However, those deals were in the spirit of the postwar trading arrangement, where the U.S. was the benevolent “importer of last resort.”  The TPP/TTIP deals would have favored capital over labor.  President Trump’s goal appears to be more about increasing U.S. jobs; what isn’t clear about the new program is if other nations will have any incentive to participate.  However, Chinese isolation was common to both TPP/TTIP.  China views the current trade conflict’s overarching goal as the suppression of Chinese power projection.  And, that belief is probably correct.

So, if we are correct, what should we see?  We would expect trade deals with current partners on terms that will favor moving production back to the U.S., which will boost U.S. growth at the cost of higher inflation.  Over time, nations will have less incentive to trade with the U.S. and will attempt to form regional trading blocs, an effort that will likely fail.  In the end, we will have a world with less trade, less efficiency and higher inflation but probably higher U.S. employment.  Another potential fallout will be shorter business cycles.  The big unknown is how China reacts over time.  China may try to create a trading bloc through the “one belt, one road” program.  However, we doubt that plan will succeed because, as we are seeing, nations targeted by China are beginning to realize the program is nothing more than 19^th century imperialism.[2]

Russian protests: Reuters[3] is reporting that Russia has detained more than 800 people who protested against the government’s decision to raise the retirement age.  Putin’s decision to support legislation to reduce pension spending has been unpopular.  His popularity has dipped 15% points.  The government’s plan is to raise the retirement age for men to 65 from 60, and for women to 60 from 55.  Life expectancy for men is 66 and women is 77.

Brexit optimism: The EU has given its chief negotiator, Michel Barnier, a mandate[4] to close a deal.  The fear among EU leaders, primarily Chancellor Merkel, is that if they don’t support the plan for a soft Brexit then hardliners within the Tories will press for a hard Brexit.  Over the weekend, Boris Johnson, formerly a member of PM May’s cabinet, offered scathing comments against May’s plan.  In our read, the country remains closely divided on Brexit, although a vote held today would probably yield a narrow “remain” outcome.

Swedish elections: The Swedish vote yielded a hung parliament.  The center-left coalition took 144 seats, the center right 143 and the populist Sweden Democrats 62.  Neither of the traditional coalitions can form a majority government, nor will they consider joining a government with the Sweden Democrats.  Although some sort of “grand coalition” of centrists is possible, such an arrangement will take months to form.

Here are some other interesting developments from the election.  Exit polling showed that 41% of voters switched party allegiance from 2014 to now.[5]  That is a remarkable degree of political fluidity and suggests a dissatisfied electorate.  The Social Democrats, the dominant party in Sweden since 1917, only took 28% of the vote, the lowest total since 1908.  In this election, 54% were repeat supporters of the Sweden Democrats.  This populist party captured 19% from the Social Democrats (center-left) and 18% from the Moderates (center-right).  Simply put, the populists pulled votes from across the political spectrum.[6]  As we noted last week, growing opposition to immigration is leading the support for populism.

Anti-trust rethink: The NYT Sunday Business section has a profile of Lina Khan,[7] an attorney who has written extensively on the problems associated with current anti-trust enforcement.  Until the mid-1980s, the position of anti-trust was that size, by itself, was a problem and could trigger an enforcement action.  In the mid-1980s, Robert Bork suggested that the standard for enforcement should not be size but consumer welfare.  Simply put, we shouldn’t worry about size as long as consumers are better off.  So, companies adapted, getting bigger but clearly making consumers better off.  Large companies have, for the most part, treated consumers well but have a tendency to make workers miserable.[8]  As we have noted before, economics tends to separate production from consumption; this is largely because one of the most important concepts of economics, supply and demand, is based on such a separation.  In reality, consumers, labor and capital are in the same boat.  Throughout history, it tends to be a “two on one” game.  If labor and capital are favored, consumers lose out; products are bad, prices are high and service is lacking.  This condition was common in the U.S. from 1945 to 1978.  If capital and consumers are favored, products are good, inflation is low but workers suffer low wages and difficult working conditions.  That condition is similar to now.  In a capitalist economy, it is rare that consumers and labor are favored but it is very common in socialist/communist economies.  That situation usually leads to a bad outcome because if no one owns capital then you have the “tragedy of the commons.”[9]  We believe we are in the early stages of a flip from capital and consumers to capital and labor (although capital will be less favored at some point).  This article is further evidence of this shift.

Lina Khan’s argument is that very powerful companies can undermine democracy.  This concern underlies populism.

Florence: As we note below, Hurricane Florence[10] is bearing toward the Carolinas and is developing into a massive storm, likely reaching Category 4 by landfall on Wednesday.  This storm is looking like an extreme event, perhaps another Harvey.  Stay tuned…

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[1] https://www.ft.com/content/c0034cba-b2ca-11e8-99ca-68cf89602132

[2] https://www.ft.com/content/d4a3e7f8-b282-11e8-99ca-68cf89602132 and https://www.ft.com/content/06a71510-b24a-11e8-99ca-68cf89602132

[3] https://www.reuters.com/article/us-russia-politics/russian-police-detain-hundreds-protesting-against-pension-reform-idUSKCN1LP05A

[4] https://www.ft.com/content/477ac3e4-b433-11e8-bbc3-ccd7de085ffe?emailId=5b95eea45fc4ca0004c47401&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5]https://twitter.com/cseidl2/status/1038846761169768452?utm_source=POLITICO.EU&utm_campaign=741ad277c4-EMAIL_CAMPAIGN_2018_09_05_11_33&utm_medium=email&utm_term=0_10959edeb5-741ad277c4-190334489

[6]https://twitter.com/CasMudde/status/1038869925656518661?utm_source=POLITICO.EU&utm_campaign=741ad277c4-EMAIL_CAMPAIGN_2018_09_05_11_33&utm_medium=email&utm_term=0_10959edeb5-741ad277c4-190334489

[7] https://www.nytimes.com/2018/09/07/technology/monopoly-antitrust-lina-khan-amazon.html

[8] https://www.nytimes.com/2015/08/16/technology/inside-amazon-wrestling-big-ideas-in-a-bruising-workplace.html

[9] http://science.sciencemag.org/content/162/3859/1243

[10] https://www.washingtonpost.com/amphtml/news/capital-weather-gang/wp/2018/09/09/florence-strengthens-to-hurricane-and-poses-extreme-threat-to-southeast-and-mid-atlantic/?__twitter_impression=true