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

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s employment Friday.  We cover the data in detail below, but the quick take is that labor markets are tightening.  Although the unemployment rate rose, both the labor force and underemployment fell.  August can have seasonal adjustment issues (it can be difficult to capture school/employment flows) and thus we will likely see revisions.  The financial markets are taking the data as evidence of overheating, likely due to the faster than expected rise in wages.  Interest rates are higher, the dollar is stronger and equity values have declined.  Here are the other items we are watching today:

Brexit optimism: Comments suggesting some degree of thaw between the EU and the U.K. sent the GBP higher this morning.  EU negotiators indicated that a modified border in Northern Ireland could be workable.  Earlier in the week, Chancellor Merkel called for compromise and relaxing the border issue would be an important step in that direction.  If there were a hard Brexit with no deal, border checks on the Ireland/Northern Ireland frontier would return and potentially increase tensions between Protestants and Catholics that have rocked the region for decades.

Brazilian elections: Brazil will hold its first round of presidential elections on October 7.  On October 28, there will be a run-off to determine a majority for president.  This election season has been quite unusual.  For example, the leading candidate, former president Lula da Silva, cannot run…because he is incarcerated.  Polls suggest he would capture around 35% of the first round’s vote.  His replacement, Fernando Haddad, is only polling at around 6%.  And, he has come under investigation on corruption charges.[1]  In another twist, the current official front-runner, Jair Bolsonaro, a hard-right-wing candidate, was stabbed at a campaign rally yesterday.[2]  Initial reports suggested that Bolsonaro, currently polling at around 22%, was not seriously injured.   However, these reports turned out to be inaccurate.  According to his family,[3] Bolsonaro was in critical condition and is now listed as “stable” but in serious condition[4] after treatment.[5]  The Brazilian real has been under pressure recently, in part due to the disarray surrounding the upcoming election.

Trade: It doesn’t look like we will get a NAFTA deal before the weekend but talks continue.  Optimism remains that the U.S., the EU, Canada and Japan will reconcile differences.  However, there is no sign of peace with China.  We are past the deadline for implementing another round of tariffs with China, this tranche reportedly on $200 bn of imports with a 25% rate.  We do expect an announcement at any time, although no timetable is in place.  Once announced, we expect China to retaliate in kind.  We may be seeing an evolving trade policy that is designed to focus on China.  Reports from China suggest that is Beijing’s take.

Social media under the gun: High-ranking executives from some of the most prominent social media firms have been testifying in the Senate over competition and free speech issues.  Now, the DoJ is considering an investigation into the free speech and competition issues with these companies.  Public scrutiny has been building against these tech giants for some time.[6]  However, the momentum against them does appear to be increasing.

Threats to U.S. troops in Syria?  Russia has warned U.S. military officials that Russian forces, combined with Syrian troops, are preparing an attack in an area where U.S. military personnel are in place.[7]  The region of concern is in southeastern Syria in an area called At Tanf.  This is one of the two remaining strongholds of rebel troops in Syria, the other being Idlib (which will be the topic of next week’s WGR).  Although we doubt Russian troops would directly attack American soldiers, it could create a major international crisis if they do.

Swedish elections:[8] The Swedes go to the polls on Sunday in what has been a very divisive election season.  For most of the postwar era, Sweden has been dominated by a center-left coalition led by the Social Democrats.  This party and its coalition partners are currently polling at 40.2%.  Center-right parties, the traditional opposition, are polling at 37.7%.  The major change has come from the Sweden Democrats, a populist, anti-immigration party, which is polling at 19% and was seeing support above 22% just a couple of weeks ago.  The key issue appears to be immigration, which has been a critical issue in the West in recent years.  Neither the center-right nor center-left has indicated it would allow the Sweden Democrats to join in a coalition but a strong showing by this populist party will make it difficult to put a majority coalition in place.  If polls are accurate, Sweden will represent another example of the problem Western nations are facing in dealing with immigration.

Energy recap: U.S. crude oil inventories fell 4.3 mb compared to market expectations of a 2.8 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.  This week’s decline in inventories is in line with seasonal trends.  Refinery utilization rose modestly to 96.6%, up 0.3% from last week.  Oil production reached 11.0 mbpd.

As the seasonal chart below shows, inventories are late in the seasonal withdrawal period.  This week’s decline is normal but the size of the withdrawal was higher than usual.  Over the next few weeks, we look for inventories to approach 400 mb, which would signal the end of the storage overhang that has developed over the past few years.

Based on inventories alone, oil prices are below fair value price at $73.62.  Meanwhile, the EUR/WTI model generates a fair value of $58.13.  Together (which is a more sound methodology), fair value is $63.12, 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.

A couple of items on the oil markets—first, Saudi Arabia is boosting its oil exports[9] to the U.S. in response to President Trump’s pressure to reduce oil prices.  This decision could lead to an interesting situation.  If the Saudis sell more oil to the U.S., it could widen the spread between WTI and Brent, encouraging U.S. producers to export more U.S. oil.  If the U.S. had adequate infrastructure in place, the Saudis’ actions would certainly lead to a “merry-go-round” of oil flows.  However, the U.S. doesn’t yet have the infrastructure in place to make U.S. exports seamless, so the likely outcome is weaker WTI but stronger Brent.  Second, the U.S is warning[10] European firms not to break sanctions with Iran.  Washington threatens that the U.S. will retaliate against Europeans, perhaps denying them access to the U.S. financial system, if sanctions are not honored.

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[1] https://www.ft.com/content/18918e34-b062-11e8-99ca-68cf89602132?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[2] https://mobile.reuters.com/article/amp/idUSKCN1LM2YJ?__twitter_impression=true

[3] https://twitter.com/FlavioBolsonaro?wpisrc=nl_todayworld&wpmm=1

[4] https://www.reuters.com/article/us-brazil-election-bolsonaro/brazil-far-right-candidate-bolsonaro-in-serious-condition-after-stabbing-idUSKCN1LM2YJ

[5] https://www.washingtonpost.com/world/the_americas/right-wing-brazilian-presidential-candidate-jair-bolsonaro-stabbed-while-campaigning/2018/09/06/62381332-b20b-11e8-8b53-50116768e499_story.html?utm_term=.9164938c7e22&wpisrc=nl_todayworld&wpmm=1

[6] See our review of The Four: https://www.confluenceinvestment.com/research-news/reading-list/

[7] https://amp.cnn.com/cnn/2018/09/06/politics/syria-russia-attack-warning-pentagon/index.html?__twitter_impression=true

[8] https://www.ft.com/content/63d25936-b199-11e8-8d14-6f049d06439c?emailId=5b91d7f20f6a6e000401f543&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[9] https://www.worldoil.com/news/2018/9/7/saudis-ramp-up-oil-exports-to-the-us

[10] https://www.ft.com/content/f6edbfc8-b1ec-11e8-8d14-6f049d06439c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] For financial markets, it’s fairly quiet (especially compared to the political turmoil in Washington) with EM still coming under pressure.  Here is what we are watching today:

New Chinese tariffs?  One of the effects of the Woodward book and yesterday’s anonymous editorial is that there appears to be some distraction on trade.  Today is the deadline for deciding on new Chinese tariffs; these would be an additional $200 bn in size.[1]  There doesn’t appear to be any talks of substance underway and we do expect some kind of announcement today.  Anything less than $200 bn at 25% would likely be taken as bullish by equities.  If a tariff announcement is made, we would expect China to retaliate, although China is starting to approach limits to what it can do because of the trade disparity.  And, as yesterday’s data showed, the goods deficit with China continues to widen.  On a rolling-12 month basis, the deficit is $393.5 bn.

NAFTA: According to reports, U.S. and Canadian negotiators made progress in NAFTA discussions.[2]  If an agreement is reached, it would be bullish for equities.

Government shutdown?  Although Congressional Republicans appear cool to the idea, President Trump seems open to shutting down the government to force funding for a border wall.[3]  Government funding is set to lapse on September 30.  A government shutdown could further undermine the GOP’s chances to retain the House.  For financial markets, we would not expect too much of a reaction.  Shutdowns in the past have been bullish for Treasuries and bearish for equities but, given that we have seen a few of these now, the financial markets will likely look beyond the initial event and assume a timely resolution.

Another North Korean thaw?  Kim Jong-un was quoted as saying he wants to achieve Korean peninsula denuclearization by the end of President Trump’s first term.[4]  President Trump responded positively.  Our take on the overall negotiations is that Kim would like to improve relations with the U.S. in order to be less dependent on China.  We note that China has openly flouted sanctions[5] in the aftermath of SoS Pompeo’s recent difficult talks with North Korean officials.  Beijing does not want a thaw between the U.S. and North Korea; a potentially hostile power on its border would be an unwelcome development.  At the same time, Pyongyang does not want to denuclearize without getting something substantial in return.  Normalization of relations and the chance to see better economic growth are probably minimum requirements.

Italian populists blink: The leadership in Italy has indicated it will adhere to EU fiscal constraints.[6]  Until these comments, Italy appeared ready to challenge the EU and expand beyond the 3% deficit/GDP limit.  However, rising Italian yields appear to have sent a message to the government and this climb down is likely designed to reduce Italy’s borrowing costs.

India and Iranian oil: U.S. and Indian officials are in talks regarding Iranian oil imports.[7]  The U.S. is implementing sanctions on Iran and is pressing all of Iran’s export customers to cease buying Iran’s oil.  India has indicated it will likely continue to purchase Iran’s oil but is probably willing to make concessions to the U.S. and at least reduce imports from Iran.  If the U.S. is successful in that effort, it will put further pressure on the Iranian regime. 

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[1] https://www.reuters.com/article/us-usa-trade-china-analysis/as-next-round-of-u-s-tariffs-on-china-looms-both-sides-dig-in-idUSKCN1LM0YN

[2] https://www.reuters.com/article/us-trade-nafta/nafta-talks-make-progress-u-s-canadian-officials-to-work-into-night-idUSKCN1LL0CM

[3] https://www.politico.com/story/2018/09/05/government-shutdown-conservatives-border-wall-807989

[4] https://www.reuters.com/article/us-northkorea-southkorea/north-koreas-kim-says-wants-to-denuclearize-in-trumps-first-term-seoul-idUSKCN1LM07M

[5] https://www.nbcnews.com/news/north-korea/china-eases-economic-pressure-north-korea-undercutting-trump-admin-n906166

[6] https://www.politico.eu/article/matteo-salvini-italy-eurozone-softens-tone-pledges-to-respect-eu-deficit-rule/?utm_source=POLITICO.EU&utm_campaign=5eb385e814-EMAIL_CAMPAIGN_2018_09_06_04_40&utm_medium=email&utm_term=0_10959edeb5-5eb385e814-190334489

[7] https://www.reuters.com/article/us-india-usa-iran/u-s-india-in-very-detailed-talks-about-halting-iran-oil-imports-state-department-official-idUSKCN1LM0FW

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a risk-off day this morning as worries about global trade and emerging market contagion continue to mount.  Here is what we are watching this morning:

BREAKING: There are reports that Germany is willing to make concessions to the U.K.  The GBP jumped on the news.  However, there are no details at this time. 

NAFTA: After taking a five-day break, U.S. and Canadian negotiators are back to the bargaining table today.  Here are the five major sticking points.[1]  First, dairy.  Canada has a milk board that allocates production.  This leads to less supply and higher prices in Canada; to prevent the milk board from being overwhelmed by cheaper U.S. dairy, Canada restricts trade in this area.  If the U.S. wins on this one, the Canadian dairy industry will be hammered.  Protecting agriculture is common in many nations (people have a visceral reaction to food insecurity).  On the other hand, Canadian consumers would greatly benefit.  Second, the dispute management system is under threat.  The current system for resolving disputes is a panel of representatives that determines if anti-dumping or countervailing duties should be implemented.  The Trump administration opposes this body because it restricts U.S. sovereignty.  Third, another part of the dispute management system allows firms to sue governments.  The U.S. opposes this measure as well.   Fourth is the steel and aluminum tariff issue.  The U.S. implemented tariffs on these items and is threatening to do the same on autos.  It’s hard to have a free trade zone when one nation can unilaterally apply tariffs.  Lastly, culture protection is in question.  The original agreement was made before the digitization of the economy.  Patent and copyright protection need to be addressed but Canada has concerns about protecting the cultural integrity of French-speaking Quebec.

So, is a deal possible?  Yes, but the Trump administration appears to be offering Canada the agreement already in place with Mexico or nothing.  If PM Trudeau takes that deal, which is probably the best decision economically, the political ads for next year’s election almost write themselves.  His opponents will run as leaders who will protect Canada.  On the other hand, if Canada balks, the disruption to the Canadian economy will be massive.  We suspect Canadian negotiators will try to get some modest changes to save face but will accept the bulk of the agreement the U.S. has in place with Mexico.

South Africa in the barrel: South Africa is the next EM country to see increasing pressure.  Recent economic data indicate the country is in recession.[2]  The ZAR continues to slide.

Although there is hope that the new Ramaphosa government will overcome the scandal-ridden Zuma administration, unfortunately the government will be starting under weak economic conditions.

EM thoughts: We are seeing that nations with current account deficits are coming under pressure on fears they won’t be able to fund these shortfalls.  Although it does feel a bit like the 1997-98 Asian Economic Crisis, there are some important differences.  During that event, most nations were pegging their currencies which led to unsustainable foreign currency debt growth and “hard stops” when the pegs failed.  This time around, currencies float, which means they can fall to a sustainable level quickly and signal to domestic borrowers in EM nations to slow or reverse debt growth.  That doesn’t mean there won’t be austerity and pain but the path will likely be less jarring.  On the other hand, the only way a current account deficit nation can pay back dollar debt is by running trade surpluses with the U.S.  If the Trump administration continues to put up trade barriers, the ability of these EM nations to service their debt becomes questionable.  

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[1] https://www.ft.com/content/2c1cfd8a-b080-11e8-8d14-6f049d06439c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[2] https://www.ft.com/content/1c538ac6-b036-11e8-8d14-6f049d06439c

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Back in session!  Summer’s over.  Today is all about the dollar, EM and oil.  Here is what we are watching:

Emerging markets: Emerging equities were mixed overnight, with China doing well but others not so much.  It’s looking like concerns are breaking into two broad categories.  The first is the fragile group.  These are nations that have borrowed in dollars and are vulnerable to dollar strength and rising U.S. interest rates.  Argentina and Turkey are the prime examples of countries that will struggle to avoid default or restructuring.  The second category includes those nations that are dependent on the U.S.-supported global trade structure; China and India are two examples of this group.  The first group is most vulnerable to tightening monetary conditions in the U.S.  The second group is being influenced by the Trump administration’s trade policies.  If this analysis is correct, the first group will remain under pressure until we see signs that the FOMC is nearly finished with tightening.  The second group may benefit if there is a change of control in Congress in November.  For the time being, there doesn’t appear to be immediate relief on the horizon.  The administration is poised to implement $200 bn of sanctions on Chinese goods by Thursday.  Recent trade actions are already affecting global supply chains.[1]  Argentina has released an austerity program.[2]  We view it as a first step in stabilizing the currency.  Turkey is also hinting at raising rates.[3]

The dollar: Continued trade friction and Fed tightening are boosting the dollar this morning.[4]  The U.S. and Canada were unable to agree on a renegotiation of NAFTA last week but talks do continue.[5]  President Trump, in an interview with Bloomberg, made off-the-record comments that made their way into Canadian media.  Essentially, the president indicated that Canada would have no choice but to accept the agreement made with Mexico.  As we noted last week, this puts PM Trudeau in an impossible position and, predictably, the Canadians balked.  The problem for the White House is that NAFTA is a treaty and Congress has input.  Already, we are hearing that Congress may force negotiators to keep Canada in the agreement.  U.S. labor leaders are pushing to maintain the pact in its current form.[6]  Simply put, Congress may trim the degree of changes the White House can make to the treaty and get it passed.  Dollar strength is weighing on most commodities this morning, including gold.  Oil, as noted below, has bucked the trend.

Oil and Gordon: As noted below, TS Gordon has formed and is moving into the Gulf of Mexico.  Oil rigs have been evacuated,[7] although some production will be maintained as many of the facilities have automated systems that will keep oil flowing until wind speeds reach certain levels.  Such storms will disrupt imports and thus could lead to a reduction in inventory levels over the next couple of weeks.  In addition to Gordon, expectations of tightening sanctions are already affecting Iranian oil flows.  Concerns over Iran have been supportive for oil prices and the tropical storm has simply added to supply concerns.

Pound down:Worries about a hard Brexit are hitting the GBP.  PM May has tried to weave a policy that will meet the goals of the “leavers” but keep enough ties to the EU so as not to harm the economy.  Unfortunately, this policy has managed to please neither side and is raising worries that the May government won’t be able to recommend a coherent policy for leaving.[8]  If no plan emerges, we will likely see further weakness in the U.K. currency.

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[1] https://www.ft.com/content/03e4f016-aa9a-11e8-94bd-cba20d67390c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[2] https://www.ft.com/content/402a9d1a-af80-11e8-8d14-6f049d06439c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[3] https://www.ft.com/content/50dbd284-af47-11e8-8d14-6f049d06439c

[4] https://www.reuters.com/article/us-global-forex/trade-and-emerging-market-worries-keep-dollar-near-one-week-high-idUSKCN1LJ02Z

[5] https://www.nytimes.com/2018/08/31/business/us-canada-nafta.html?rref=collection/sectioncollection/business&action=click&contentCollection=business&region=rank&module=package&version=highlights&contentPlacement=5&pgtype=sectionfront

[6] https://www.politico.com/story/2018/09/03/trump-nafta-labor-unions-806291 and https://www.politico.com/story/2018/09/02/trumka-trump-union-labor-day-806115 and https://www.wsj.com/articles/union-leader-says-a-new-nafta-wont-work-without-canada-1535903570

[7] https://www.reuters.com/article/us-global-oil/u-s-oil-prices-rise-as-gulf-platforms-shut-ahead-of-hurricane-idUSKCN1LK028

[8] https://www.ft.com/content/1f3a606c-af6d-11e8-8d14-6f049d06439c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56