by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] There is much to discuss this morning.  Let’s get to it:

Cohn out: Gary Cohn, Director of the National Economic Council, resigned yesterday evening.  Although reports suggest he has been considering the move for a couple of months, the proximate cause was the inability to turn the president on tariffs.  The financial market reaction was swift—equity futures plunged after the announcement, although they have regained some of their initial decline.

At this point, the broader market reaction has been rather scattered.  A turn to protectionism is, over time, inflationary (using the structural/cyclical model discussed in the AAW below, this is a structural component), but Treasuries have rallied and gold has declined.  This would suggest more worries about an economic downturn and less about inflation.  Some of this reaction may be based on expectations that the Fed will maintain inflation expectations by lifting rates.  Supporting that notion were comments late yesterday from Governor Brainard who suggested that growth “tailwinds” may speed policy tightening.[1]  What makes this remarkable is that Brainard is one of the most dovish members of the FOMC, a consistent voter for accommodation.  For her to turn even modestly hawkish does indicate tighter policy is likely.

How important is Cohn’s departure?  From day one we framed the administration as made up of factions, populists and establishment.  The former support policies that harm capital and support inflation, while the latter want policies that boost capital and contain inflation.  The backdrop of the Trump presidency has been a consistent battle between these two sides.  At first, the populists were winning, with Bannon and Miller seemingly driving policy.  The ouster of Preibus and the installation of Kelly as Chief of Staff brought order and the rise of the establishment.  The tax cuts were the clearest evidence of establishment power.  Cohn’s departure suggests a populist counterinsurgency.  But, it is clear that Trump doesn’t consistently favor one side over the other.  Instead, he seems to foster an “ebb and flow” between the two sides.  This is partly a function of his management style.  He seems to like to watch conflict and use it to make decisions.  So, now that it appears that the populists are winning, it wouldn’t be a shock to see him do something that flips the script.  One signal of that would be replacing Cohn with Larry Kudlow, an avowed supply side economist who would also strongly oppose trade barriers.  And, Cohn might not be completely gone.  There have been rumors that he could replace Kelly as Chief of Staff.

So, there are two core ideas that we are using to analyze policy.  First, pundits are turning themselves inside-out trying to divine the “real” Trump and watch him develop a consistent set of policies only to see constant vacillation.  This isn’t a bug in Trump’s management, it’s a feature.  No faction ever gets complete control because that would mean Trump loses the ability to change course.  Trump does believe, at a visceral level, that trade deficits are “losses.”  That is a common belief, but the reality is much more complicated.  As a clear example, there is only one autarky in the world, which is North Korea.  No other nation is trying to emulate the Hermit Kingdom’s economy.  In other words, trade is good for an economy.  In fact, if the president really wants to affect trade, he should have signed on to the border adjustment tax idea that was floated as part of the corporate tax reform.  That would have raised import costs, likely reduced the trade deficit and made tax reform revenue neutral.  But, that would have also taken away the president’s ability to bargain by offering and taking away benefits.  In other words, the border adjustment tax would have affected trade in his favored direction efficiently at the cost of negotiating flexibility.  The president seems to prize the latter over everything.

Second, although we watch the administration, we firmly believe in trends, not people.  The rise of populism and a revolt against the establishment and capital is underway.  Election results in Italy last weekend are just another example of this phenomenon.  Trump’s election was part of this wave.  However, he isn’t a perfect “vessel” of the trend because he does want the support of the establishment at times.  So, we have tax cuts, which populists don’t necessarily favor.  But, trade impediments are clearly part of the populist package.  Although the Cohn news dominated, we also note Bloomberg is reporting that the U.S. is considering broader action against China for violating intellectual property rules.[2]  That’s a much bigger deal.  Thus, there is likely more protectionism to come.  One of our paradigms is that economies go through 30- to 50-year cycles of efficiency versus equality.  During the former, deregulation and globalization are supported, while it’s just the opposite during the latter.  We have been in an efficiency cycle since 1978.  We are moving into an equality cycle, although it may take another decade for it to become completely obvious.  But, the tipping point is being reached.  Trade impediments and reregulation are a likely outcome.

So, where does this leave us?  The economy is still doing very well.  Earnings are robust.  The path of equities really comes down to the multiple.  Based on consumer confidence, the multiple should be fine but what we saw yesterday can upend confidence and eventually lead to a falling P/E.  For now, we still think the risk for equities is to the upside.  If Cohn’s replacement is an establishment figure, equities will likely recover.  We are much more worried about 2019; a tighter Fed and a lessening of the fiscal boost have the potential to weaken the economy and earnings.  But, for now, we still think odds favor rising equity prices.

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[1] https://www.bloomberg.com/amp/news/articles/2018-03-07/brainard-suggests-growth-tailwinds-may-speed-fed-rate-hike-pace?__twitter_impression=true

[2] https://www.bloomberg.com/amp/news/articles/2018-03-06/u-s-said-to-consider-broad-curbs-on-chinese-imports-takeovers?__twitter_impression=true

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] Risk markets are higher this morning, building on yesterday’s afternoon recovery.  Here is what we are watching this morning:

Trade wars—the establishment strikes back: They don’t call it the establishment for nothing.  The GOP establishment playbook—tax cuts, open trade, deregulation—has always been a less than perfect fit for a president with populist leanings.  This was a worry in the president’s first year but it has generally been accepted that the president mostly tweets like a populist but governs like the establishment.  That conclusion is facing a strong challenge from Trump’s anti-trade policies.  While some were working on tax cuts, parts of the administration were working on trade impediments and retaliation.  Commerce Secretary Ross was working on trade actions on metals and against China, and tough NAFTA negotiations were ongoing.  But, the president’s announcement of across-the-board tariffs on steel and aluminum were mostly unexpected, at least in terms of timing.

However, after the initial shock, the GOP establishment is pushing back.  First, Gary Cohn, Director of the National Economic Council, is assembling a summit meeting where companies adversely affected by the proposed tariffs can inform the president and the administration of the negative effects of the action.  Second, House Speaker Ryan has also openly warned against the tariffs and hinted that the House may create legislation to reduce the president’s ability to implement trade actions.  We suspect that some sort of “deal” will be cut; the president can’t lose face by not getting anything on this issue, but the across-the-board nature of the proposed tariffs can be scaled back to the point where they don’t significantly affect trade.  In other words, the goal will be to give the president enough to let him claim a win but not so much as to actually affect trade.  Hopes that this will be the outcome are probably why equities rallied yesterday and are higher this morning.

Unfortunately, this trade debacle doesn’t address the real issue, which is the management of the reserve currency.  The U.S. benefits greatly from running a trade deficit; we get a plethora of goods and services from the world that contain inflation and improve our efficiency.  In return for goods and services, we give foreigners Treasuries, which are cheap to produce!  This only works for us because there is a natural demand for dollars as foreigners use dollars to conduct trade with other nations who trust dollars over local currencies.  However, the process of providing the reserve currency, a key element in our program to win the Cold War, creates distortions in our economy that are unhealthy.  Our financial system is very large and our sales and logistics systems are overly large as well (to handle foreign investment when foreigners with dollars don’t spend them right away and need to invest in dollar assets).  And, we struggle to create enough buying power for all the imports the world wants to sell us; our answer from 1980 to 2008 was to allow a massive expansion of household debt.  Much of this was due to the fact that sectors of our economy have been severely harmed by trade and as a result these workers no longer have the wages to buy the imports the world wants to sell to us.  The Great Financial Crisis showed that our ability to lift debt has reached its natural limit.  The nation definitely needs a new course on trade and the dollar.  Widespread protectionism probably isn’t the answer but what we have now isn’t working.  One thought would be to penalize nations with high current account surpluses with automatic trade penalties.

North Korean thaw: North and South Korea have agreed to hold direct talks next month and Pyongyang indicated it would be willing to abandon its nuclear program in return for security guarantees.  At first glance, this is difficult to believe but it actually does make sense.  Since the “axis of evil” speech, North Korea has had to assume that America’s policy goal is regime change.  Thus, having weapons to prevent such an outcome is a reasonable step on its part.  However, none of this is new.  What has changed is the realization by the two Koreas that none of their allies are really looking out for the interests of either one.  The talk of war to prevent North Korea from acquiring nukes essentially showed that Washington is willing to sacrifice South Korea to protect the U.S.  In other words, a conventional war with North Korea would devastate South Korea but leave the U.S. untouched.  At the same time, cool relations between Pyongyang and Beijing suggest that China would probably not oppose regime change in North Korea if the resulting new government is generally friendly to China’s interests.  Therefore, the incentive for North and South Korea to negotiate their own peace makes sense.  If North Korea can (a) get a working deal with South Korea to improve and modernize its economy, and (b) get the U.S. to stop threatening regime change by negotiating a security deal for nukes, it’s probably worth it.  This recent progress also shows that Kim Jong-un is apparently unconcerned about shifting the nuclear policy, which probably means that any opposition to his rule has been eliminated.

Update on National People’s Congress: China’s National People’s Congress (NPC), the state legislature of China, is holding its meetings.  Although it is the most powerful body in China on paper, in practice, it’s a “rubber stamp” for the Communist Party of China (CPC).  Yesterday, the NPC agreed to a 6.5% GDP growth target.  What’s important about this decision is that it was made at all.  China can achieve any GDP number it wants; the key driver is debt.  If China is serious about deleveraging, the first step we would expect to see is a reduction or elimination of the growth target.  This number is too high to lower debt.  Although we still believe that Xi’s actions to extend his rule will eventually lead to a period of deleveraging, this decision suggests it won’t occur in 2018.  This target also suggests that the CPC is still uncomfortable with allowing growth to slow.  Marxism has been thoroughly discredited and, in its place, the CPC promises high growth.  The CPC needs a new goal other than growth for legitimacy and thus this 6.5% growth goal for 2018 suggests it hasn’t found a new one yet.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] Happy Monday!  Here is what we are watching this morning:

Trade wars: As details emerge on how the president decided to recommend across-the-board tariffs on steel and aluminum, it has become clear it was more of a reaction than a well-thought-out plan.  There is no actual executive order for this action so the “globalists” within the administration are working furiously to soften the tariffs.  The president tweeted this morning that he would consider dropping the tariffs if a new NAFTA deal is negotiated.  It’s hard to tell whether this latest tweet suggests he is looking for a face-saving way to walk back the recent tariff recommendations, or if he’s establishing an impossible bar to remove the tariffs.  Although the NAFTA negotiators are working to adjust the current treaty, it should be remembered that the original NAFTA negotiations took about two years to complete.  So, if the president really means he will require a completely new treaty, the steel and aluminum tariffs, if implemented, will be with us for a while.

Below are a few charts to highlight some points.

Primary metal industrial production in the U.S. has been stable for some time.  There is nothing in this data that would suggest collapse.

For contrast, this next chart shows what collapse looks like.

What we are seeing is excess capacity in primary metals.  Current capacity utilization is only 70% and has been weakening in each business cycle over the past three decades.  This suggests the industry has been too slow to reduce capacity.  Excess primary metals capacity isn’t just a U.S. problem—it’s a global problem with nations trying to hold onto jobs by subsidizing production to maintain employment.  Everyone in the industry realizes there needs to be a reduction in capacity and is waiting for someone else to take the action so they can stay in business.  This issue would argue that if the White House is actually worried about the national security effects of cutting steel capacity, the correct policy would be to subsidize the industry.

Of course, the broader concern is that the president’s actions will trigger a trade war.  This is a legitimate concern.  Using trade to foster foreign and domestic policy goals is perfectly legitimate.  In fact, the U.S. unilaterally opened its economy to trade after WWII, supplying the reserve currency, to create allies that would allow us to contain communism.  It clearly worked to win the Cold War.  Unfortunately, the policy remained in place but the U.S. doesn’t have a working idea of what it wants from foreign policy.  Those who have been adversely affected by trade have increased their influence in Washington and their goal is obvious—lots of high-paying, low-skilled jobs.  However, as long as capitalists control the political system, that outcome isn’t likely (trade isn’t the only way to hold down wages).  However, much damage can be done to the global economy by protectionism that is unguided by foreign and domestic policy.  In the immediate term, our worry is that rising protectionism unanchors inflation expectations.  That scenario would lead to much tighter monetary policy and higher interest rates.  It’s still too early to adjust our positions but protectionism is a threat.

Populists win in Italy: Early results indicate the Five Star movement took 32% of the vote, while the right-wing coalition of the Northern League and Berlusconi’s Forza Italia combined with 37%.  However, the former, which was considered the junior partner in the group, actually outpolled Forza Italia, winning 18% compared to 14% for Berlusconi’s party (minor parties in the coalition took the remainder).  The center-left collapsed, falling to 19%, a trend that has become common all across Europe.  There is no clear path to government.  No single party or coalition has a majority.  In the past, Five Star has eschewed joining any other party.  In theory, the Northern League could join Five Star to form a government.  Although such a government would be unstable, together it would send an unmistakable signal to the EU—austerity is over.  The EU hopes for protracted coalition negotiations that end up with a mainstream minority government or new elections.  If the populists get power, the EU and the stability of the Eurozone will come under threat.

The spread between Italian and German sovereigns widened on the results.

Merkel wins: The SDP rank-and-file chose a slow demise over a quick exit and voted to join another grand coalition with the CDU/CSU.  Given the steady erosion of support for center-left parties (see above), there was a push within the SDP to reject the coalition and move left.  However, this would had led to new elections and, given recent performance, the SDP could have spiraled into irrelevance.  Instead, 66% of the SDP members decided that Merkel had given them a good deal of influence despite lousy polling numbers.  We suspect this will be Merkel’s last government.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] There is a lot going on this morning.  Let’s dive in:

Trade wars: President Trump campaigned as a trade warrior, promising tariffs and government intervention to boost manufacturing employment and give hope to his electoral base.  However, in his first year of office, if one ignores social media, Trump would be indistinguishable from an establishment Republican.  Tax cuts were the focus and were successfully passed.  Even the budget, which increased the deficit, isn’t inconsistent with previous GOP administrations.  But, lurking under the surface is a president who wanted trade retaliation.  As establishment figures within the administration fade in influence, the president is swinging toward his instincts to impede trade with the idea that this achievement would return the U.S. to a period of mass industrial employment.

In calls yesterday, advisors wondered if he might walk back this policy in light of the drop in equities.  It doesn’t appear this expectation will occur; we note the president tweeted this morning that “trade wars are good and easy to win.”  Needless to say, the establishment GOP is apoplectic.  Editorials in the national papers are calling the announced tariffs a disaster.  No one should be surprised by his actions; he won the presidency as a populist and, unless that stance was a complete sham, at some point this part of the president’s persona was going to emerge.

The problem, of course, is that trade is complicated.  First, when a nation implements trade sanctions, other countries can retaliate.  The U.S. has generally not taken aggressive steps over the past 40 years but that isn’t to say they never occurred.  Nearly all administrations since Carter have taken limited steps in various markets to send signals that nations that engage in unfair practices will face penalties.  But, economic theory rightly shows that trade barriers are a poor way to protect jobs.  For every job protected, other jobs are lost.  In this case, protecting steel jobs will likely raise prices on the end users of steel, e.g., autos.  Second, the U.S. has a particular issue in that it is the provider of the reserve currency.  The world economy is dependent upon the U.S. to run trade deficits in order to provide dollars for global trade.  We can argue for days as to whether or not a single nation should have that role, but the reality is that if the U.S. puts up trade barriers it raises the risks of a global recession.  The U.S. provided the reserve currency to win the Cold War, but policymakers haven’t come up with a more compelling reason to continue the policy since the Berlin Wall fell.  To be fair, there have been losers to trade, which is, by design, unfair.  After all, if the system creates incentive for foreign nations to accumulate dollars for trade and the safest way to get dollars is by running a trade surplus with the U.S. then the system invites unfair actions.  If the U.S. wants to maintain that policy to support world growth, the losers in trade have to be adequately compensated.  That arrangement really hasn’t occurred so some parts of the economy are harmed by trade (manufacturing), while other sectors involved with supporting trade (transportation, finance) benefit more than they would have otherwise.

In this week’s Asset Allocation Weekly Comment (see below) we discuss the difference between cyclical and structural inflation.  Much of the current worries about inflation are cyclical; economic slack is being steadily absorbed and there are legitimate reasons for concern.  However, this cyclical inflation pressure is in the context of disinflationary structural forces.  As long as the U.S. allows the free implementation of technology and is open to trade, inflation tends to remain depressed even during periods of cyclical tightness.  The president’s actions raise the risk that the structural forces that have been steadily depressing price inflation may be reversed.  One measure on steel doesn’t make a complete reversal.  However, even the idea that these trade measures are proper raises the potential that this recent tariff is the opening move in a much broader policy to restrict trade.  If this is the case, the somewhat benign environment for financial assets over the past four decades will evolve into something much more difficult.  We are not there yet, but it is a condition we are closely watching.  Market action so far is worrisome.  Today we are seeing the dollar tumble and interest rates rise.  If the world is concluding that the U.S. is no longer a reliable steward of the reserve currency, we could be heading into a world of great financial tumult (stagflation, higher volatility).  It’s too early to make this call, but market action so far is a concern.

It wasn’t just Trump: At the end of Chair Powell’s testimony yesterday, NY FRB President Dudley suggested in another speech that four rate hikes this year would be considered “gradual.”  That statement also contributed to the equity decline yesterday.

Brexit: PM May is giving a speech at the time of this writing, discussing her government’s position on separating from the EU.  Thus far, it’s mostly platitudes with no substance.  We think May is stuck; the majority of her party wants a hard Brexit but the majority of Parliament wants a soft Brexit, with the U.K. staying in the customs union.  At some point, there will be a vote of no confidence, new elections and the real possibility of PM Corbyn.

Italian elections: The Italians go to the polls this weekend.  We don’t have any new polling data (polling is not allowed before elections so the last poll was Feb. 16^th).  Markets are expecting an inconclusive result but, as we discussed in recent WGRs,[1] all parties want fiscal expansion.

SDP decides: The rank and file of the SDP decides this weekend whether the center-left party should join in another grand coalition with the CDU/CSU.  The SDP faces a real problem.  If it votes not to join the coalition, new elections are likely and current polling suggests the party might be less popular than the AfD.  On the other hand, joining the conservatives further blurs the difference between the center-left and center-right and could simply lead to the extinction of the SDP.  We think the 460k members of the SDP will decide to join the coalition but the vote will be very close.

BOJ at the end?  BOJ Governor Kuroda indicated today that the Japanese central bank is planning to begin the process of withdrawing from excessive accommodation in 2019.  The JPY jumped on the news.

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[1] See WGRs, The Italian Elections: Part I (2/12/18) and Part II (2/26/18)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] Risk assets are coming under pressure this morning as equities struggle.  Here is what we are watching today:

Powell, Part 2: Chair Powell testifies before the Senate Banking Committee today.  Usually, the second testimony is not closely watched; after all, we have already seen the formal testimony and Q&A either a day or two before and accordingly there shouldn’t be much new information.  However, we have seen instances when a Fed chair, concerned that the financial markets misunderstood the earlier message, attempts to adjust market expectations.  Thus, if Powell didn’t intend to signal that a fourth hike is possible this year, look for him to make a point that inflation remains under control despite economic strength.  He can make this case fairly easily with the Fed’s preferred measure of inflation, core PCE, remaining below target (see discussion below).

Energy recap: U.S. crude oil inventories rose 3.0 mb compared to market expectations of a 2.0 mb build.

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 last March.  We would consider the overhang closed if stocks fall under 400 mb.

As the seasonal chart below shows, inventories are usually rising this time of year.  What we are seeing is very bullish—the usual seasonal build in stockpiles isn’t occurring this year.  The longer this continues, the more fundamentally bullish this becomes; thus, even with the higher than expected build this week, it is important to realize that the change in stockpiles is well below where it should be.

Based on inventories alone, oil prices are undervalued with the fair value price of $66.37.  Meanwhile, the EUR/WTI model generates a fair value of $75.32.  Together (which is a more sound methodology), fair value is $72.55, meaning that current prices are below fair value.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST]

Looking for something to read?  In our travels we are often asked about books we recommend.  As a result, we have created The Reading List.  The list is a group of books, separated by category, that we believe are interesting and insightful.  Each book on the list has an associated review to help you decide if you want to read it.  We will be adding to the list over time.  Books marked with a “*” are ones we consider classics and come highly recommended.

Financial markets are treading water this morning after a hard sell-off yesterday.  The proximate cause was Chair Powell’s testimony to the House Financial Services Committee.  Here is what we are watching this morning:

The Powell testimony: Although his prepared remarks were unremarkable, his comments on the economy were rather upbeat.  He suggested that the combination of a fiscal tailwind and improving exports are leading to accelerating growth.  These comments were made in the context of a question on whether the median FOMC forecast of three hikes this year is still relevant.  Powell suggested that the economic outlook has improved since then, leaving open the possibility of four hikes this year.  Market reaction was swift and relentless.  Equities and fixed income prices fell, commodities dropped and the dollar rose.  The Fed chair is suggesting that, at long last, cash may become an asset class again, which is unwelcome news for nearly all other asset classes.

Was the market reaction justified?  Although pundits were belaboring the point that there wasn’t really anything new in what Powell said, there is another issue that bears examination.  Powell isn’t an economist.  We cannot observe a record of academic publications that would offer us any insight into what he actually believes.  His voting record as a member of the FOMC doesn’t provide any real insight, either—he voted with the chair.  So, in reality, we really don’t know how he personally leans in terms of policy.  The upbeat assessment of the economy could be an indication that he is more hawkish than assumed (we rate him as a “3” on our “1” (extreme hawk) to “5” (extreme dove) scale).  Again, it isn’t clear if what we heard yesterday signals any clarity on Powell’s actual policy stance.  We will probably need a series of comments and speeches before we can determine what Powell really thinks.  Until then, expect higher than normal volatility around his comments.  We will get an important clue tomorrow—if Powell did not want to signal four hikes and didn’t welcome the market reaction, he has the chance to soften his position when he testifies before the Senate Banking Committee.  It is a rather common practice for Fed chairs to adjust market expectations by using the first testimony as a sort of trial balloon.  Thus, we will be watching to see how Powell reacts to the sharp market response we saw yesterday.

Expectations of policy tightening are rising: In observing the implied three-month LIBOR rate from the deferred Eurodollar futures, the financial markets are now taking the dots plot seriously.  The charts below show that the weekly implied three-month LIBOR rate is well above the highest levels seen in 2011.  The right-hand chart shows that the FOMC tends to raise rates until fed funds match the implied LIBOR rate.  This chart clearly indicates the Fed has “runway” to raise rates significantly, toward 3.0%.  It should be noted that the implied LIBOR rate falls to the level of fed funds in several tightening cycles, signaling to the FOMC that it should stop raising rates (the crossovers are shown with vertical lines).  Thus, the implied rate doesn’t necessarily mean that a 3% rate is a guarantee.  But, it does suggest that, for now, the financial markets are discounting tightening.

Is the economy doing all that well?  There is no evidence of recession, but the economy isn’t all that robust, either.  Below we note Q4 GDP data.  The Atlanta FRB GDPNow assessment is that Q1 growth is going to be in line with Q4.

In looking at the estimates of contribution to growth, weakening consumption is the largest element of the declining forecast, which began at 4.2% and has declined to 2.6%.

Brexit is evolving into a political crisis: PM May is rapidly being pulled into a political maelstrom.  Her party is a mix of “hard” and “soft” Brexit supporters.  The soft supporters accept an EU exit but want to remain in the trading union.  This would not be a good outcome; the U.K. will then be forced to accept migrants and EU rules without the benefit of representation.  However, remaining in the trading union will preserve London’s role in finance and bring less disruption to the economy.  The hard exit supporters want a complete break with the EU; this stance has proven difficult to manage.  The EU is pushing for a hard border between Northern Ireland and Ireland which could undermine the fragile peace deal between those two states.  The disruption to the economy from a hard Brexit could be massive.  PM May has been trying to weave a path between these two camps in her party; our read is that the majority of her members are hard Brexiteers but the actual majority in Parliament are soft Brexiteers.  This division is being exploited by the head of the Labour Party, Jeremy Corbyn, who has positioned the Labour Party to support a soft Brexit.  Corbyn’s position is threatening to divide the Tories, who only have a majority in government because of a coalition with a small Unionist party in Northern Ireland.  So far, 10 Conservative MPs have come out in favor of a soft Brexit.  Given that the Tory/DUP coalition only has a one-seat majority, PM May is under threat of a no-confidence vote.  If she loses, we expect elections and there is a real possibility that a Labour coalition could gain power.  A Corbyn-led government will terrify the financial markets.  For the U.S., it would be a preview of a Sanders or Warren presidency.  Although we still believe the GBP is cheap, all bets are off if the May government falls.

Rethink on TPP?  At an NPR interview, Treasury Secretary Mnuchin indicated he is engaged in “high level talks” with the other 11 members of the TPP and the U.S. might consider rejoining the group.  His comments were not a complete surprise; President Trump suggested something similar at Davos.  Without details, it’s hard to understand what rejoining TPP would look like, but we think this is further evidence of the establishment/populist divide within the Trump government.  The populists are horrified by trade and see multilateral agreements as job killers; the establishment sees agreements like NAFTA and TPP (and TTIP) as (a) ways to contain inflation and labor costs, and (b) methods of maintaining America’s superpower role.  We suspect the president uses the TPP comments as a way to encourage the establishment members of his coalition but, without actual action (and we don’t expect any to occur), this is just talk.

Consumer confidence: Yesterday, the Conference Board reported that consumer confidence hit a new cycle high.  We note that consumer confidence correlates highly with P/Es.  Thus, the rise in confidence is a bullish factor for equities.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST]

Looking for something to read?  In our travels we are often asked about books we recommend.  As a result, we have created The Reading List.  The list is a group of books, separated by category, that we believe are interesting and insightful.  Each book on the list has an associated review to help you decide if you want to read it.  We will be adding to the list over time.  Books marked with a “*” are ones we consider classics and come highly recommended.

Financial markets are very quiet in front of Chair Powell’s testimony before the House Financial Services Committee.  Here are the news items we are watching:

Powell’s formal comments: A quick reading of Chair Powell’s first formal testimony indicates that the Fed sees the economy as strong and inflation remains under control, although some of the low readings are due to transitory factors.  Thus, gradual rate increases are to be expected.  Although we have seen a mild uptick in rates since the release of his comments, in reality, nothing here is a shock.  Oral testimony begins at 10:00 EST.  While we expect Powell to conduct himself in a professional manner, since he is new to the role, there is always a chance of fireworks.

Military shakeup in Saudi Arabia: The Kingdom of Saudi Arabia (KSA) fired its top military commanders, including the chief of staff and the heads of the air force and ground forces.  We suspect two reasons for the move.  First, the war in Yemen is going badly and new leadership is probably needed.  Second, the crown prince, who is essentially the de facto leader of the KSA, is likely promoting his own loyalists to these positions.  Having the loyalty of the armed forces is a necessary component of political stability.

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