Earnings season is upon us. We normally don’t report on earnings season since we discuss it every day and update the P/E chart weekly, but we are seeing significant growth in earnings which warrants some reflection.
The primary reason for the jump in earnings has been the decline in corporate tax rates.
The chart on the left shows corporate profits from the National Product and Income Accounts, the profits data calculated as part of GDP. This chart shows the pre- and post-tax profits as a percentage of GDP and the lower line shows the spread between the two. A narrower spread indicates fewer profits lost to taxes. The chart on the right shows the spread with a forecast derived from the highest marginal corporate tax rate. There are two important factors to note. First, we are seeing the spread narrow as the forecast would have suggested, shown by the narrowing of the Q1 spread. Second, the forecast signals that post-tax corporate profits over the rest of the year should approach 10% of GDP.
The consensus forecast for Q2 is $39.20 per share,[1] which is up 19.9% over last year. In addition, companies are repatriating money from their overseas accounts.
This chart shows foreign earnings retained abroad on a flow basis. In Q1, nonfinancial corporate businesses moved $632.7 bn back to the U.S.[2] Note the last time this occurred was in 2005 when a tax holiday on foreign earnings was relaxed. The hope of policymakers was that these inflows would be used for investment to boost growth and, eventually, employment. However, at least one-third has been used by S&P companies to buy back stock.[3] The hopes of policymakers were always questionable; a decade of low interest rates meant that the investing environment was already favorable. It would be odd for a project to need the implementation of a tax cut with historically low interest rates already in place.
If buybacks remain elevated, the number of shares outstanding will contract which will tend to support multiple expansion.
This chart shows the S&P 500 Index divisor; it takes mergers, share buybacks and new issuance into account. Since 2011, the divisor has been steadily declining due to mergers and share buybacks overwhelming new issuance. Note the difference from the 1990s bull market which was characterized by a rising divisor. During this period, rising equity prices led to an increase in stock issuance. That has not been the case in this bull market. It is also interesting that the divisor fell from 9000 to 8700 after the 2005 tax holiday, suggesting that the last episode likely led to share buybacks as well.
The combination of rising earnings and a falling divisor will lead to a contraction of the P/E multiple without higher equity prices. Although trade issues are a serious concern, we remain bullish on equities due to earnings and falling share levels. If the trade situation stabilizes, we should see equity values rise into autumn.
[Posted: 9:30 AM EDT] Equity markets are mixed this morning as investors balance expectations of stronger earnings and rising trade tensions. The British pound fell due to political uncertainty and the dollar has strengthened against global currencies. Below are the news stories we are following today:
No U.K.-U.S. trade deal? Yesterday, in an interview with the British tabloid The Sun, President Trump scolded PM Theresa May for attempting to negotiate a “soft” Brexit. In the interview, he stated that the current deal being negotiated with the EU would likely undermine U.K. efforts to secure a bilateral deal with the U.S. He went on to say that her possible challenger for the premiership, Boris Johnson, would be a great choice for prime minister. President Trump’s criticism is likely to add to the political turmoil surrounding PM May as she struggles to maintain her government. Although we still do not expect a leadership challenge in the immediate future, the chances of one happening are slightly elevated, which is the reason for the drop in the pound. As we have mentioned, Tory Eurosceptics can launch a leadership challenge once every twelve months, therefore if they were to challenge and lose they would have less clout in Brexit negotiations as the deadline to secure a Brexit deal expires in eight months. Currently, Tory Eurosceptics have enough support to start the process but still lack the support needed to oust PM May. That being said, President Trump’s ultimatum to PM May on Brexit further supports the belief that he favors bilateral agreements over multilateral agreements, which is a break from prior administrations. Prior to the publication of this report, President Trump in a joint press conference with PM May walked back the idea that the U.S. would not be willing to trade with the U.K. if it pushes for a “soft” Brexit.
Bipartisan tariff backlash: Yesterday, Treasury Secretary Steve Mnuchin testified before the House Financial Services Committee. During his testimony, he was hit with a barrage of questions from Republicans and Democrats alike about the effects trade tariffs will have on the U.S. economy. To date, the U.S. has imposed tariffs on steel and aluminum imports from Mexico, Canada, the European Union and China. In addition, the president has hinted at imposing more tariffs in the future, possibly targeting cars. The various countries have responded to the tariffs in kind. There are growing concerns that trade tariffs are likely to hurt individual states. In response to questions on this issue, Mnuchin stated that the U.S. is not in a trade war but rather in a trade dispute, and the administration is currently monitoring the effects that tariffs are having on the economy.
A letter from North Korea:Yesterday, President Trump sought to counter reports suggesting that little progress is being made on North Korean denuclearization by releasing a letter he received from North Korean Leader Kim Jong-un. In the letter, Kim Jong-un expressed his appreciation for Trump’s efforts to improve relations between the two sides. Despite this letter, recent negotiation have been a bit rocky. Last week, North Korea accused the U.S. of acting “gangster-like” during negotiations and on Monday failed to show up to an agreed upon meeting site in the demilitarized zone. The U.S. has accused China of being responsible for North Korea’s behavior as of late, while China has denied its involvement. We continue to monitor this situation.
[Posted: 9:30 AM EDT] Equity markets have rebounded following signs that the U.S. and China will likely resume trade negotiations. Oil prices have also stabilized following the bullish EIA report—yesterday oil prices fell 7% following reports that Libya would resume shipments. Below are the stories we are following today:
NATO defense spending: Earlier today, President Trump announced that NATO members have agreed to increase defense spending, but warned that he is willing to “do his own thing” if spending doesn’t increase immediately. This announcement came after an impromptu emergency meeting was called to discuss the president’s concerns on defense spending. Yesterday, the president caused an uproar by demanding that NATO members increase their defense spending to 4% of GDP, which is double the target in the NATO agreement. At this moment, it is unclear what the president means when he says “immediately” or how much each member would need to increase its defense spending. The NATO guidelines stipulate that countries should increase their defense spending to 2% of GDP by 2024.[1]
Afghanistan review: The White House is expected to undertake a review of its strategy in Afghanistan as President Trump is reportedly frustrated with the lack of progress being made. Last year, on the advice of his advisors, President Trump agreed to deploy an additional 3,000 troops to Afghanistan in the hopes of forcing the Taliban to the negotiating table with the Kabul government. After a year, it appears there has been no progress toward achieving this goal. The president has never been in favor of the U.S. fighting international wars. As a result, this review could be a forerunner to future withdrawal from the region. We will continue to monitor this situation.
Russian arms talks: Yesterday, Reuters reported that during President Trump’s meeting with Russian President Putin they will likely discuss extending the “New Start” treaty. The treaty allows Russia and the U.S. to monitor each other’s nuclear programs to ensure that neither country is expanding its nuclear weapons program. The deal was put in place to avoid another arms race between the two countries. In the past, President Trump and National Security Advisor John Bolton have criticized the deal as being a bad deal for the U.S.; Bolton went so far as to call it “unilateral disarmament.” That being said, the fact that discussions might occur suggests that President Trump could be favoring an extension of the agreement, which expires in 2021. The two will also likely discuss North Korea denuclearization and developments in Syria.
Energy recap: U.S. crude oil inventories fell a whopping 12.6 mb compared to market expectations of a 3.9 mb draw.
The above charts show 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 are falling rapidly. We would consider the overhang closed if stocks fall under 400 mb.
As the seasonal chart below shows, inventories are well into the seasonal withdrawal period. This week’s decrease in stocks is normal, although the amount was a stunner. If the usual seasonal pattern plays out, mid-September inventories will be 399 mb. If this level is reached, we will have absorbed the inventory overhang.
(Source: DOE, CIM)
Based on inventories alone, oil prices are near the fair value price of $72.49. Meanwhile, the EUR/WTI model generates a fair value of $61.22. Together (which is a more sound methodology), fair value is $64.77, meaning that current prices are above fair value. Currently, the oil market is dealing with divergent fundamental factors. Falling oil inventories are fundamentally bullish but the stronger dollar is a bearish factor. The action to suppress Iranian oil exports has boosted oil prices, but the rapid decline in oil inventories over the past week is very supportive for prices. It should be noted that a 400 mb number by September would put the oil inventory/WTI model near $90 per barrel. Although dollar strength could dampen that price action, oil prices should remain elevated.
[Posted: 9:30 AM EDT] Equity markets are lower due to concerns of global trade tensions. Below are the issues that we are paying close attention to today:
NATO summit: In the opening hours of the NATO summit, President Trump sparked controversy by criticizing Germany’s relationship with Russia and its unwillingness to increase spending on defense. In a meeting with NATO Secretary General Jens Stoltenberg, President Trump accused Germany of being held captive by Russia due to its support of the Nord Stream 2 gas pipeline it is constructing with Russia. In the past, the construction of the pipeline was criticized as undermining U.S. efforts to punish Russia for its annexation of the Crimea as it would make it easier for Russia to cut off Ukraine’s gas supply by siphoning the gas that is bound for the EU. Germany has been pressed to secure the deal due to its strict renewable energy goals which prompted it to close its coal and nuclear plants despite criticisms that the country is putting its own national interests above the European alliance. Although the timing and manner of the president’s comments were a bit odd, they were not all that surprising. That being said, his comments will further feed speculation that he prefers closer ties with Russia over Europe.
Oil supply: During the NATO summit, Secretary of State Mike Pompeo set up meetings with NATO members to assist them in finding alternatives to Iranian oil. Last month, the U.S. requested that all countries stop purchasing Iranian oil before November 4 as a way to force Iran to end its nuclear program. Since the request has been made, countries have struggled to find alternative sources due to unrest in both Libya and Venezuela as well as OPEC’s inability to come to an agreement to significantly increase oil production. As a result, there is growing speculation that the U.S. may be forced to push back the deadline or offer sanction waivers to certain countries. Recent developments in Libya may ease some of those concerns but at this point it is unclear – today, ports in eastern Libya were able to resume shipments after the state energy producer regained control of the terminals. We will continue to monitor that situation.
Chinese Middle East Police: Yesterday, Chinese President Xi Jinping told members of the Arab League that China would like to “become the keeper of peace and stability” within the region. In addition, China pledged $25 billion in loans and aid to Middle Eastern countries as part of its Belt and Road infrastructure initiative. China’s push to boost economic and security ties is likely due to its desire to become less dependent on the West for its exports, increase its access to natural resources and build additional military bases throughout the world. Currently, the Belt and Road initiative covers two-thirds of the world’s population and involves three-quarters of its energy resources.[1]
New tariffs: Yesterday, President Trump initiated the process of imposing additional tariffs on $200 billion of Chinese goods. The response was over China’s decision to impose tariffs on $34 billion of American exports. The market reacted negatively to the news; as a result, Chinese equities and renminbi have fallen. According to the June Federal Reserve minutes, rising trade tensions have deterred businesses from making future investments. We will continue to monitor this situation.
Leadership challenge in the U.K.? Yesterday’s resignations of both Boris Johnson and David Davis have raised concerns of a possible Tory leadership challenge against U.K. Prime Minister Theresa May. Tory Eurosceptics have criticized PM May’s handling of Brexit negotiations for not doing enough to cut ties between the U.K. and Europe. Although the Eurosceptics have enough support to muster a challenge, they are expected to struggle to get the votes needed to oust May. At this point, it may be in May’s best interests to force a leadership election while she still has the leverage. A win in the election would ensure she remains in power for the remainder of negotiations as the rules stipulate the leadership cannot be challenged for another 12 months. Negotiations are expected to finish in March 2019.
Trump goes to Europe: Today, the president is expected to land in Brussels for the NATO Summit. He is expected to chide NATO members for not spending enough on defense. According to NATO guidelines, each country should spend 2% of GDP on defense expenditures; currently, only four countries exceed that guideline.[1] Preempting President Trump’s visit, European Council President Donald Tusk stated that Europe spends more than Russia and as much as China on defense. Markets will pay close attention to how President Trump treats his European counterparts as the U.S.-European alliance seems to be on shaky ground after his outburst during the G-7 summit. Furthermore, there is growing speculation that the president favors building closer relations with Russia as opposed to Europe, whereas others believe the president is using defense spending as leverage in U.S. trade negotiations.
Supreme Court choice: Yesterday, President Trump nominated Brett Kavanaugh to fill the Supreme Court seat vacated by Anthony Kennedy’s retirement. If confirmed, many believe Kavanaugh will make the Supreme Court the most conservative in decades.[2] Although Kennedy is viewed as moderate, he generally favored conservative causes. This can be seen in the latest Supreme Court rulings in which Kennedy voted against government unions and in favor of the president’s travel ban. Moreover, Kavanaugh’s place on the Supreme Court would be significant as his nomination could also impact Mueller’s Russia investigation. In the past, Kavanaugh has argued that sitting presidents should effectively be given immunity from prosecution and questioning while in office, stating it could cripple the federal government.[3] Democrats are expected to push for the confirmation hearing to occur after the mid-terms, but that is unlikely to happen.
Erdogan appointee: Yesterday, Turkish President Recep Tayyip Erdogan appointed his son-in-law, Berat Albarak, to lead the Treasury and Finance ministries. Fears that the independence of the central bank is in jeopardy as well as pessimism about the health of the Turkish economy led to a sharp sell-off in the Turkish lira. There has been growing speculation that President Erdogan might pressure the central bank to lower rates despite the Turkish economy showing signs of overheating. The chart below shows the immediate market reaction to the news. We will continue to monitor this situation closely.
On July 1, Andres Manuel Lopez Obrador, or AMLO for short, became Mexico’s first leftist president in over three decades,[1] running on anti-establishment and anti-corruption platforms. The 64-year-old activist won with over 53% of the vote, the most since Mexico moved to a multi-party system. For the first time in nearly a century, Mexico elected a president who did not belong to either of the two traditional parties, PRI or PAN. Furthermore, his political party, the National Regeneration Movement (MORENA), was also victorious, winning the majority in both the Senate and the Chamber of Deputies. As a result, AMLO will be the most powerful Mexican president since the PAN party ended PRI’s 70-year rule in 2000.
AMLO, who had run for president twice before, overcame stiff opposition from establishment candidates in the PRI and PAN parties. Since winning the presidency, AMLO has promised to balance the government budget, lower the crime rate and negotiate with the Trump administration on immigration and trade. His victory has caused market uncertainty as many people are not sure how he will handle Mexico’s relationship with the United States. The U.S. and Mexico have been re-negotiating NAFTA since last August and are expected to resume negotiations again next year. In addition, the U.S. and Mexico are still trying to find a solution to the immigration problem. In this report, we will examine how and why AMLO was so successful, briefly describe his history and then discuss how he might run his government. As usual, we will conclude with possible market ramifications.
[Posted: 9:30 AM EDT] Happy Monday! It looks like a risk-on day so far, with Treasury prices lower and equities higher. The dollar is a bit soft which has lifted metals prices. The lack of comment from the White House about trade appears to be helping equity markets. Here is what we are watching:
BREAKING NEWS: Boris Johnson, the U.K. foreign minister, has resigned. Below we discuss the earlier resignation of David Davis. Johnson’s resignation is far more serious as he could mount a leadership challenge to PM May. The GBP is falling on the news.
North Korea disappointment: SoS Pompeo was in North Korea over the weekend and his visit didn’t go very well.[1] The U.S. wanted to begin talks on North Korea dismantling its nuclear program, but North Korea wanted “goodies” before even beginning to talk about denuclearization. North Korea called the U.S. “gangsters,” criticizing U.S. negotiating tactics.[2] For anyone who has watched North Korea since the fall of the Soviet Union, this behavior isn’t a surprise. North Korea’s negotiating stance has been mostly “Lucy with the football.”[3] The West thinks it has a promise from Pyongyang but finds out that either the promise was broken or that the North Koreans never intended to take such actions and the West’s disappointment is merely a misunderstanding.
North Korea isn’t going to give up its nukes. It may be willing to have the IAEA count some of them and it may be willing to split the U.S. alliance in the Far East by restricting its missiles to ones that cannot reach the U.S. But, complete denuclearization is a demand that is unlikely to be met. The real question is the reaction from the White House. If President Trump concludes he’s been “played” then we could move quickly from summits and handshakes to war. Although we haven’t seen any movement yet, we would not be shocked to see a rapid escalation in tensions. On the other hand, the White House will tend to react based on commentary from the right-leaning media. The fact that John Bolton is inside the government removes a prominent pundit voice that would have been harshly critical of the summit and would have likely pushed for a hard line after the Pompeo visit.[4] In addition, the potential negative impact of this news is lessened due to the expected announcement of the president’s selection for the Supreme Court, which will occur later tonight.
May moves to soft Brexit: PM May took her cabinet out to her summer place in Chequers last Friday and appeared to move her advisors to her vision of Brexit,[5] which is mostly a series of measures designed to limit the impact of leaving the EU on the U.K. economy. Initially, it appeared May had earned unanimous approval, winning over the hard Brexit members of her cabinet. However, last night David Davis,[6] the minister in charge of the EU exit, resigned. Dominic Raab has taken Davis’s ministry. Davis is hoping his sacrifice will prevent any further concessions to the EU, while May is hoping his departure from the cabinet will give her more freedom to act. We expect Davis to agitate for a hard Brexit now that he is out of the cabinet; our read is that support for Brexit has waned a bit and Davis may not have all that much sway. The GBP took the resignation well, suggesting the markets believe May will not only survive but negotiate a soft Brexit, which would be favorable for the pound.
Japan returning to nuclear power? After the Fukushima disaster, Japan pulled back from nuclear electric power. Public sentiment turned sharply against it. However, Japan faces another policy goal, energy security.[7] The Trump administration’s actions against Iran[8] have made it clear that the island nation is vulnerable to energy flow disruptions. If Japan returns to nuclear power, it could give a boost to a moribund uranium industry.
President Trump to Europe: As we noted last week, the president is traveling to the U.K., attending the NATO summit and visiting with Russian President Putin. We have been discussing this upcoming meeting for the past few reports. Fears among Europeans are elevated; President Trump has been critical of the alliance and has been pressing the EU to boost defense spending. We will be watching to see how the president deals with our EU allies this week.
Energy recap: As we noted last week, the DOE weekly energy data was delayed. As promised, we are publishing our recap in today’s comment due to the delay.
U.S. crude oil inventories rose 1.2 mb compared to market expectations of a 5.0 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.
As the seasonal chart below shows, inventories are well into the seasonal withdrawal period. This week’s increase in stocks was unusual, but some adjustment was not a huge shock given last week’s rather large decline. If the usual seasonal pattern plays out, mid-September inventories will be 411 mb.
(Source: DOE, CIM)
Based on inventories alone, oil prices are near the fair value price of $68.31. Meanwhile, the EUR/WTI model generates a fair value of $61.24. Together (which is a more sound methodology), fair value is $62.80, meaning that current prices are above fair value. Currently, the oil market is dealing with divergent fundamental factors. Falling oil inventories are fundamentally bullish but the stronger dollar is a bearish factor. The action to suppress Iranian oil exports has boosted oil prices, but the rapid decline in oil inventories over the past week is very supportive for prices. It should be noted that a 410 mb number by September would put the oil inventory/WTI model in the high $70s per barrel. Although dollar strength could dampen that price action, oil prices should remain elevated. At the same time, refinery utilization remains above 97.0%. We will be reaching a point in the near future where domestic oil consumption growth will peak for the summer season, although we expect the level to remain elevated.
Over the past quarter, emerging market equities have weakened; the primary culprit was a strengthening dollar, although concerns about softer non-U.S. growth likely played a role as well. The dollar’s strength appears to be caused by one of two factors. The first possibility is interest rate differentials, which are partly due to the differences in economic growth. The second possibility is that the potential of a trade conflict, which would likely reduce the global supply of dollars, is leading to the appreciation of the greenback.
The problem is that relative growth rates suggest the dollar is still somewhat overvalued.
This chart shows a model using the OECD’s leading indicators for Germany and the U.S. Converting the estimated D-mark forecast to euros indicates a fair value of $1.3020. Since relative growth rates drive the interest rate differences, it suggests it is less likely that interest rate differences are pushing the dollar higher. In other words, it is obvious that U.S. interest rates exceed European rates but the exchange rate has already adjusted. At the same time, if the financial markets expect further monetary policy tightening from the Federal Reserve, the elevated value of the dollar might be justified.
On the other hand, the impact of trade restrictions is different. The U.S. has built a global trading system that was designed for steady declines in trade impediments. From GATT to the WTO, the U.S. has fostered this system by consistently lowering tariffs and allowing nations to run trade surpluses with the U.S. This wasn’t a flaw in the system; a reserve currency in a fiat currency regime essentially forces the U.S. to supply dollars to the world to facilitate trade. The persistent trade deficit does impose costs on the U.S. economy but American political leadership, up until now, was willing to absorb those costs to maintain American hegemony.
At this juncture, it is unclear if the administration intends to completely upend the postwar trading system or if its actions are designed to improve America’s bargaining position. Either outcome is possible. If it turns out that the former is the goal, the dollar is likely to continue to appreciate, perhaps reaching historic highs. If the latter is the goal, then the dollar may be vulnerable to a pullback.
This chart shows the relative performance of U.S. equities and emerging market equities; a rising blue line indicates emerging equities are outperforming emerging market equities. The red line shows the JPM dollar index; the two series are inversely correlated at the 77.5% level, which means a stronger dollar leads to U.S. outperformance. That finding is consistent with what has occurred over the past quarter.
However, there is evidence to suggest the recent U.S. outperformance is excessive. The chart below shows a regression model of the relative performance of equities with the dollar index as the explanatory variable. The lower line in the chart show shows the deviation from fair value. Since 2010, emerging markets have generally underperformed relative to the dollar. This could be due to a general avoidance of risk since the Great Financial Crisis but current levels are nearly a full standard error below fair value.
This analysis suggests that emerging markets are undervalued even in the face of recent dollar strength. If the dollar pulls back, either because the Trump trade policy is posturing or the FOMC signals some moderation in its tightening path, emerging markets could recover. In any case, they are attractive at current levels, although recovery will likely need a sign of policy restraint either on trade or the monetary front.
[Posted: 9:30 AM EDT] It’s employment day! We cover the data in detail below but the quick read is bullish. The key data point was a huge jump in the labor force, which increased 601k after falling 382k over the past three months. Thus, even with a rise in payrolls, the unemployment rate rose due to the increase in the labor force. The data is bullish for financial assets because it suggests there is remaining slack in the economy. Perhaps today is the day historians will mark as the beginning of the Great Trade War as the U.S. and China implemented tariffs against each other.
A note on our comment—we update the U.S. petroleum weekly data on Thursday but, this week, the numbers were delayed until yesterday due to the Independence Day holiday. Because of the length of the recap and our coverage of the employment report, we will delay our energy recap until Monday’s comment. Here is what we are watching:
Trade wars: The $34 bn[1] of tariffs on China were implemented at midnight EDT.[2] China has undertaken similar measures. In 10 days, another $16 bn of tariffs will be added. And, President Trump upped the ante by suggesting he could apply tariffs to more than $500 bn in flow, essentially everything China exports to the U.S.[3] China is blaming the U.S. for the “war,”[4] which will only infuriate Trump, who holds the position that the U.S. is merely correcting what has been an unfair situation. We have talked about the trade conflict at length in recent weeks but one thing we want to reiterate is that winning a trade war is not about how much pain a nation can inflict on another but how much pain a nation can absorb. Note the difference between Europe and China. As we noted yesterday, the EU, at German urging, is considering ending tariffs on imported automobiles, something they would not have done without U.S. pressure. This suggests to us that the EU is simply not prepared to take the pain associated with a drop in car production. Consequently, they are suing for peace. On the other hand, China appears to be digging in for a long, protracted trade war.[5] The Chinese media is framing the trade war as the West’s attempt to contain China’s rise. In other words, Chairman Xi is planning on using nationalism to “steel”[6] his citizens for absorbing the pain by making the trade war more like a real war. Xi has often referred to the “century of humiliation” that began with the First Opium War in 1842. The Opium War narrative is that the Chinese failed to rally behind the emperor in 1842 and foreigners defeated and “carved up” the country and it could happen again if China fails to rally behind Chairman Xi.
In some respects, the timing of this trade war is unfortunate for China. The country is trying to deleverage while maintaining growth and the usual way to do this is to export one’s way out. The trade war will likely close that avenue of maintaining growth. At the same time, now Xi can blame any slowdown on Trump and can therefore use a slowdown to take the necessary steps to contain debt growth. In any case, China isn’t planning on backing down and our take is that the White House doesn’t think it can lose. Strictly speaking, we can’t. China has much more to lose because it runs a trade surplus with the U.S. However, a trade war will inflict pain and Americans will be less likely to rally around Trump when the economy begins to stumble because of trade disruptions. Thus, if winning a trade war is dependent upon the willingness to accept pain, China may be in a better position than generally expected.
The Fed: The Fed minutes were released yesterday and they had a little something for everyone. The Fed intends to stay on its tightening path, although it did acknowledge the risk coming from the aforementioned trade war. Interestingly enough, Fed economists didn’t view the uncertainty surrounding GDP, unemployment and inflation to be different than the past two decades. We view this position as strikingly naïve. Market reaction to the employment data suggests a dovish response from the FOMC. This reaction is probably not warranted; after all, it’s only one month’s data in a notoriously volatile series. But, the key takeaway from the minutes is that the Fed is not altering its course.[7]
Brexit: PM May is meeting with her cabinet today[8] with the goal of establishing a unified vision of the economic and trading relationship the U.K. will have with the EU after Brexit. There is the potential for a breakup; watch for resignations. If some of her cabinet members quit, a leadership challenge is likely and there is a chance the government will fall. May has remained in office by weaving a perilous path between a hard and soft Brexit but, in the end, she leans toward the latter.[9] Elections could bring a Corbyn-led Labour government which would likely be profoundly bearish for U.K. financial assets.
Trump to Europe: The president travels to Europe next week and he blasted the Europeans at a rally in Helena, MT last night, which may be a forewarning of what his talks will be like.[10] The president is also meeting with President Putin,[11] which has raised fears not only with the U.S. establishment but also with European leaders. If the U.S. abandons NATO, the Europeans will be forced to defend themselves against the Russians.
Oil: A couple of quick notes and a reminder that we will recap the weekly data on Monday. First, there are growing doubts that the Saudis will ever introduce the Saudi Aramco IPO.[12] The key sticking point appears to be the scrutiny that going public would bring to the Kingdom of Saudi Arabia (KSA). Saudi Aramco is essentially the funding arm of the KSA. When outside investors see how much profit is taken by the royal family, it would not only tell the Saudis where the money is going, but it would undermine the valuation of the stock. If the IPO isn’t going to happen, the Saudis will have less incentive to keep prices high and may decide to boost production and capacity to (a) take advantage of high prices, and (b) eventually undermine the shale revolution. Second, South Korea has suspended Iranian oil loading for this month, the first time since 2012, suggesting that U.S. sanctions are beginning to affect Iranian oil sales.[13]
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