by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are very quiet again this morning in front of the employment data on Friday.  Here is what we are watching this morning:

Fed chair decision: President Trump has distilled a short list for replacing (or, perhaps, reappointing) the position of Fed chair.  Below is what the prediction markets are signaling.

Bettors are putting their money on Warsh.  He does meet many of the assumed criteria of the president.  He is a Republican with private sector experience.  He is young and well connected, coming from the elite establishment, and has been a Fed governor.  He is not an economist.  It is the latter point that gives most analysts and Fed watchers pause.  He hasn’t written much, but what he has published has been skewered.[1]  In his defense, Chair Bernanke did speak well of Warsh but mostly in his work as a liaison between various parties during the Great Financial Crisis.  At the same time, Warsh might be the most compliant Fed chair Trump could appoint.  Most of the other candidates would likely support Fed independence, but it is possible Warsh would be more inclined to please the White House.  In watching the debate over who should be Fed chair and how that person would react in terms of policy, there have been persistent comments made that the combination of a new Fed chair and fiscal stimulation in the form of tax cuts could lead to a 1980s dollar bull market.  That outcome is possible.  However, there is another possibility that is almost never discussed, probably because most commentators were not even zygotes when that other outcome occurred, which is the combination of fiscal expansion and loose monetary policy, personified by Fed Chairs Arthur Burns and G. William Miller, that led to a significant dollar bear market.  If Warsh is willing to be the most pliable chair, he could get Trump’s nod.  If Warsh doesn’t win, we are leaning toward Jerome Powell, a current governor.  He is a Republican but we would characterize him as a moderate on policy, sort of another Yellen.

The Iran deal: There are numerous reports this morning that Trump may not certify Iran’s compliance to the nuclear deal.  We do note that Gen. Mattis, his SOD, has indicated he believes Iran is complying.  Part of the problem is that there has always been a lack of consensus about what the Iran deal means.  On the surface, it is a limited pact that probably prevents Iran from developing a nuclear weapon—nothing more, or less.  However, during the process of negotiating the deal, the Obama administration seemed to believe that it might be the first step in normalizing relations with Iran.  This is hugely important.

Before the end of WWII, when President Roosevelt met with King Ibn Saud on the Bitter Lake aboard the U.S.S. Quincy, the U.S. established itself as the enforcer of stability in the Middle East.  The U.S. has significant military assets in the region and has acted as “offshore rebalancer” to intervene in various conflicts to prevent any regional power from becoming dominant.  This position ensured a free flow of oil from the region and denied the Soviets a warm water port.  However, with the end of the Cold War and the onset of shale production, the U.S. has been reconsidering the balancer role.  The whole concept of “pivoting” to the Far East required the U.S. to pivot away from the Middle East.  Thus, if the U.S. isn’t going to maintain that role, who should get it?  The Obama administration seemed comfortable with giving that to Iran.  Such a decision sent shock waves through the neo-conservative wing of the GOP who are focused on the security of Israel.  And so, the election of Trump has led to a Sunni recovery in the region.  At the same time, the Trump administration has essentially viewed the Iran nuclear deal with a broader mandate—that it should be designed to contain Iran and reduce its regional influence.  Thus, rejecting the nuclear deal isn’t just about the strict reading of the treaty; it’s a reversal of unstated Obama-era policies to abandon the region to the tender mercies of the Persians.  So, strictly speaking, Mattis is right…Iran is meeting its obligations.  But to say that ignores the broader context, which is who will keep the Middle East stable?

Debt forgiveness for Puerto Rico?  President Trump suggested that Puerto Rico’s debt could be written off.  Although we do expect a restructuring, the comments did surprise and Budget Director Mulvaney is trying to walk them back.  We note that it seemed to have an impact on the island’s debt prices.  As the chart below shows, this representative GO bond has seen its prices fall by almost half since mid-September.

View the complete PDF

---

[1] http://economistsview.typepad.com/timduy/2017/01/was-kevin-warsh-really-a-fed-governor.html

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are very quiet this morning.  Because it’s quiet, let’s take a look at Europe:

Catalonia, Spain and the EU: Every nation is a construct.  It is built on a social contract that offers various public goods in exchange for membership.  First and foremost, states offer protection from outside threats.  A nation that cannot protect its citizens from outside invaders has a difficult time demanding allegiance.  Second, it also must create internal conditions that make membership attractive.  These include public goods like security, which include policing protections for life and property, and usually some socialization from the vicissitudes of life.  These can include old age pensions, unemployment insurance, health insurance, price protections for basic life staples, etc.  Third, most states also support social goods, such as parks, the arts, etc.

It is not uncommon for divisions within nations to develop.  Regional, ethnic or religious differences can trigger aspirations for separation.  For the most part, modern democracies manage these differences in two ways.  Most democracies are federal; they offer some degree of local autonomy to deal with regional differences.  Laws are usually put in place to protect some degree of religious and ethnic freedom.  Usually, the combination of federalism and legal protection is enough to manage internal differences and maintain a nation.

However, these mechanisms are imperfect and there are numerous examples of internal divisions becoming so acute that civil conflict develops.  The history of Europe shows floating borders.  Our first example is the map of Europe in early 800 AD.  Notice that most of central and eastern Europe were tribal.

By 1200 AD, various nations, kingdoms and principalities were starting to emerge.

Three hundred years later the remnants of the Byzantine Empire were gone, replaced by a group of nations in the Balkans.  France was starting to develop.  Note that the Iberian Peninsula was five nation states, including Aragon, which is much of modern-day Catalonia.

Below is a map of Europe at WWI.

Note that many of the various principalities and kingdoms were absorbed into large empires.  This consolidation occurred for two reasons.  First, powerful groups conquered these areas to build large nations.  Second, war was common in Europe and smaller nations found they had more protection by banding together to form empires.

Finally, this map shows Europe today.  In the aftermath of two world wars, Europe once again became a continent of smaller nations.  Europe has generally been stable despite these smaller states because the continent outsourced its defense to the U.S. under the guise of NATO.  In comparing this map to earlier maps, one cannot help but notice that the Balkans, who were united under the nation of Yugoslavia, have seen significant devolution into a series of small nations.  Why should France, Germany, Spain, Italy, et al. not see a similar breakdown?

This is the conundrum the EU faces.  The EU is attempting to consolidate Europe into a loose, single federal entity; however, within European nations, there are growing efforts for self-determination.  It’s not just Catalonia…Scotland has been flirting with independence, Czechoslovakia divided into two states and Belgium has been on the brink of division for years.  The EU has generally tried to discourage the breakup of current nations within Europe, but the trends on the ground appear to be moving in the direction of increased local control.

So, how does Madrid keep Barcelona in Spain?  Truncheons and rubber bullets may have won a temporary stay but at the cost of looking desperate.  How does London keep Edinburgh in the U.K.?  If we revert to our first paragraph, it would seem that the key is being able to offer internal and external security along with an environment that supports economic growth and an attractive culture.  Suppression doesn’t work forever.  If Europe faced a significant external threat and the U.S. wasn’t there to protect it, the drive to self-determination would likely be stifled.  However, in the absence of an external threat, self-determination and the trend for devolution appear difficult to suppress.  In other words, if nations want to hold together, making membership attractive is probably the most effective way, in the long run, to maintain territorial integrity.  If Europe continues to devolve, interestingly enough, the economic benefits of being in the Eurozone rise, as would the development of a Eurobond.  If the EU continues to insist that nations stay together, it may be creating conditions that weaken the benefits of joining the single currency.

View the complete PDF

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It was a violent weekend.  Here is what we are watching:

The mess in Catalonia: Catalonia did hold an independence referendum over the weekend in the midst of a strong central government crackdown.  Latest media reports suggest over 760 people were injured in clashes with central government riot police.  The vote overwhelmingly supported independence (over 90%) but that was mostly the result of anti-independence groups telling their supporters not to vote.  We are seeing a weaker EUR this morning, due in part to the chaos caused by this vote.  It gets even more complicated; PM Rajoy leads a conservative minority government that governs with occasional support from the liberal and center-left parties.  The opposition will be less likely to cooperate with Rajoy in the aftermath of his heavy-handed response.  So, it is quite possible the government will fall because of this event and Spain could be looking at new elections.

A massacre in Las Vegas: In a shooting somewhat reminiscent of the University of Texas massacre in 1966,[1] Stephen Paddock, a local resident, began shooting randomly from the 32^nd floor of a local casino/hotel into a crowded music festival.  At the time of this writing, 50 people have died and over 400 are injured.  Although this event probably won’t have a major market impact, it is a horrific event and our thoughts and prayers go out to the victims.

“Save your energy, Rex”: The Sunday NYT reported[2] that the U.S. was in direct communication with North Korea, raising hopes that negotiations were actually making progress.  There have been reports for months that the U.S. was engaged in backchannel talks with North Korean officials; for the Secretary of State to openly reveal that such talks were underway was a hopeful sign.  However, in a series of tweets, President Trump essentially undercut any discussions.  How could any North Korean negotiator take Tillerson’s promises with any degree of certainty? We do note that there is a North Korean holiday coming on October 10^th and there are expectations that the Kim regime will use the event to launch another missile test.  Trump’s comments raise the likelihood that a conflict occurs.  We still believe the odds remain low (>15%), but they are increasing.

Fed talk: President Trump is turning his attention to the three (and soon to be four) open Fed governor positions. Current Governors Jerome Powell and Kevin Warsh are said to be the leading candidates for Fed Chair.  Powell is a moderate on policy.  Warsh’s public statements have been hawkish but he isn’t an economist and our read is that he is more of a political operator than an independent voice on policy.  Thus, if the president wants a dove, Warsh can do that.  There are reports that Warsh may favor increased political oversight of the Fed; although central bank independence is accepted wisdom, in reality, independence is a function of anti-inflation policy.  For years, central banks were expected to accommodate fiscal policy and all central banks serve at the pleasure of some political master.  But, if we start to see a retreat from independence, the chances of reflation rise.

View the complete PDF

---

[1] https://en.wikipedia.org/wiki/University_of_Texas_tower_shooting

[2] https://www.nytimes.com/2017/09/30/world/asia/us-north-korea-tillerson.html

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy end of quarter day!  Q3 comes to a close today and next week we begin the march to Q4.  Markets are quiet at quarter end.  Here is what we are watching:

Social media and Russian bears: For the past several weeks, Facebook (FB, 168.73) has spent time in the proverbial barrel, facing rising criticism for facilitating the circulation of information that appears to have come from Russia.  Yesterday, it was Twitter’s (TWTR, 16.85) turn.[1]  The social media companies are arguing that they are merely facilitators of media and should not be held accountable for the information that others put on their platforms, even if it comes from foreign governments or terrorist groups.  There are two problems with that argument.  First, as anyone who uses these social media platforms notices, advertisements and articles start appearing on your phone or desktop that seem tailored to your search patterns or what you read.  By design, social media companies are not neutral but instead support a user’s bias, which suggests a level of power to persuade that is potentially quite powerful and prone to manipulation.  Second, if one’s platform can be used for nefarious activities and the facilitator argues it can’t control the content, it opens itself up for regulation.  This is where broadcast media found itself in the 1950s and 1960s and led to “fairness clauses” and the FCC.  Information technology has been able to operate in a permissive regulatory environment for decades but if the social media platforms can become conduits for manipulation then regulation is much more likely.[2]  Part of what makes tech firms so profitable is the revenue per employee[3]—the heavy use of technology and algorithms eliminates the need for workers.  However, it is apparent that the social media firms have been unable to screen for foreign sources, fake accounts and social media bots that would probably require human oversight to discern.  Regulations that would force increased hiring would weaken the profitability of these companies.  This is an issue that bears close watching in the coming years.

A nuclear dyad?  It appears North Korea is working to add a second nuclear delivery method to its arsenal.  According to 38 North, North Korea is investing in infrastructure to build a sea-launched ballistic missile.[4]  If North Korea does develop submarine launching capabilities, it will give the country a credible “second strike” capacity, meaning it could retaliate against a nuclear strike by a foreign power.  Although this is an unwelcome development, we do note that it would also create conditions of Mutual Assured Destruction (MAD) which, paradoxically, tends to stabilize nuclear power relations.  A nation that is a nuclear monad faces a “use it or lose it” decision if it thinks it will be attacked.  Thus, it has to be more open to using its nuclear weapons under threat.  On the other hand, a nation with a nuclear dyad (or, in the case of the U.S. and Russia, a triad) can credibly signal to an attacker that although you may destroy our nation, be assured that we will counter with an equally devastating follow on attack…or, MAD.  Currently, North Korea either has, or is near, a nuclear monad.  So, if it believed the U.S. was preparing to attack, it would be severely tempted to strike first; although it knows that it would be hit with a devastating attack (Gen. Powell called it “turning North Korea into a briquette”), at least it didn’t come to that fate without launching its own nukes.  However, if North Korea had a dyad, it would likely be less “hair trigger” in using its nuclear weapons.  This assumes, of course, that North Korea eventually adopts the behavior patterns exhibited by all the current nuclear powers.  We suspect it would, not because we have faith in the Kim regime but because this is what game theory suggests would happen and the history of the Cold War shows it works.  In other words, the U.S. and U.S.S.R. avoided nuclear holocaust not because of the content of their characters or rationality but because they were locked into an equilibrium that made it stupid to behave otherwise.  Even China under Mao eventually followed the same path.  Simply put, a nuclear North Korea is terrifying but we may be approaching a balance of terror that characterized the Cold War, which was frightening but remarkably stable.

View the complete PDF

---

[1] https://www.axios.com/twitters-reality-check-on-russian-election-meddling-2490707290.html?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top-stories

[2] https://www.axios.com/the-walls-close-in-on-tech-2473228710.html

[3] http://www.businessinsider.com/top-tech-companies-revenue-per-employee-2015-10/#2-google-1154896-per-employee-11 and http://www.visualcapitalist.com/top-20-tech-companies-revenue-per-employee/

[4] http://www.38north.org/2017/09/nampo092817/

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are mostly quiet today.  There is a modest reversal of recent trends as the dollar eases a bit, but long-duration bonds are continuing to weaken.  Here is what we are watching today:

Tax talk: The GOP leadership sketched out the tax plan.  Tax reductions tend to excite equity markets.  Since the late 1960s, there is a broad inverse correlation between the highest marginal tax rate and equity values.

This chart comes with a plethora of caveats.  The rise in the S&P that correlates with the drop in tax rates is true as far as it goes, but a lot of other factors led to the bull market that developed, including falling inflation, a secular bull market in bonds, deregulation, globalization, etc.  In addition, the biggest positive market impact from tax cuts mostly comes from the early cuts, which were substantial.  Moving from 39% to 35% on the highest marginal rate is nothing compared to moving from 70% to 30%.  Still, it makes sense that the equity markets have a positive reaction to the thought of tax cuts, especially corporate tax cuts, which will boost after-tax net income for corporations.  As we noted yesterday, we are not going to invest a lot of time and effort into discussing tax changes until we get closer to a final draft.  As a note of caution, the politics of tax reform are devilish because there are winners and losers and the latter try to prevent changes from occurring.  There are reports that the president is cool to the proposal.[1]  Senator Hatch (R-UT) has indicated he may draft his own tax plan.  Senator Corker has suggested that taxes are much harder than health care.[2]  It’s going to take months for anything to happen on taxes and what eventually emerges may or may not be favorable.

U.S. to send “strategic assets” to South Korea: The WP reported[3] that the U.S. is sending strategic assets to South Korea, although what exactly is being sent wasn’t noted.  We would expect strategic bombers and attack submarines capable of launching missiles to be sent.  Of course, sending nuclear weapons would be a significant signal to the North.

Navarro demoted: Peter Navarro, Director of Trade and Industrial Policy, now reports to David Cohn instead of directly to the president.  This is a win for the establishment wing of the GOP.

Iraq threatens the Kurds: The official results of the Kurdish referendum showed over 92% voted for independence.  Baghdad is threatening to invade the Kurdish region and has shut down Kurdish airspace in response.  Although we doubt an invasion is imminent, the threat of military action in the northern oil fields is lifting oil prices this morning.  The Kurdish situation is quite complicated; we expect all the surrounding nations to try to use the Iraqi Kurds to their own benefit.  On the one hand, playing the regional powers off each other increases the chances that a Kurdistan state will emerge.  On the other, if a state does develop, it will be wholly dependent upon the sponsoring power.  We continue to watch Turkey closely.

Catalonia votes (maybe): Catalonia is promising to hold a referendum on independence on Sunday.  The national government is threatening to use the national militia to prevent voting from occurring.  The Rajoy government is making a hash of this vote; polls suggest most Catalonians want to remain in Spain so allowing the vote to occur would be a politically savvy choice.  By acting in such a ham-fisted manner, Rajoy is boosting tensions.  Europe has a number of simmering independence movements which could undermine the Eurozone over time.

Japan’s snap elections: PM Abe dissolved parliament before the Oct. 22 elections in Japan.  The PM is hoping to solidify his already two-thirds majority because the opposition socialists are in deep disarray.  However, a surprise challenger has emerged as Tokyo Governor Yuriko Koike has formed a party called the “Party of Hope” to challenge the PM.  The Democratic Party, the official opposition party, has indicated it won’t compete in the Oct. 22 vote, allowing its candidates to run in the new party.  If she were to win, Koike would be the first female PM in Japanese history.  It’s not clear how Koike’s policies would differ from Abe’s, but any change from Abe might end the Abenomics experiment.  A stronger JPY may result.

Energy recap: U.S. crude oil inventories fell 1.8 mb compared to market expectations of a 2.5 mb increase.

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.  The impact of Hurricane Harvey is starting to diminish as refinery operations recover.  We also note the SPR fell by 0.8 mb, meaning the total draw was 2.6 mb.

As the seasonal chart below shows, inventories fell this week.  It appears we have started the inventory rebuild period sooner than normal this year due to the hurricane.  The key will be the path of refinery operations.

Refinery operations have recovered strongly; history suggests that the trough in maintenance ends about mid-October.  Although we could see a pullback over the next couple of weeks, if operations remain elevated it would be supportive for crude oil demand and prices.

Based on inventories alone, oil prices are undervalued with the fair value price of $50.62.  Meanwhile, the EUR/WTI model generates a fair value of $66.61.  Together (which is a more sound methodology), fair value is $61.20, meaning that current prices are well below fair value.  If the Fed does continue to tighten policy and the dollar recovers, it will tend to undermine oil prices, although we would note that oil has been underperforming the dollar’s weakness.  Thus, the adverse impact of a stronger dollar on oil should not be material. 

View the complete PDF

---

[1] https://www.axios.com/the-gops-nightmare-scenario-2490500624.html?utm_medium=linkshare&utm_campaign=organic

[2] http://thehill.com/blogs/blog-briefing-room/352762-corker-tax-reform-will-make-health-care-reform-look-like-a-piece-of

[3] https://www.washingtonpost.com/world/more-us-strategic-military-assets-to-south-korea-to-deter-the-north-seoul-says/2017/09/28/4062cc7e-a416-11e7-8c37-e1d99ad6aa22_story.html?utm_campaign=New%20Campaign&utm_medium=email&utm_source=Sailthru&utm_term=.827469c5adb0

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] The primary features of this morning’s trade are rising interest rates and a stronger dollar.  Chair Yellen is becoming increasingly hawkish; so far, equity markets are holding their own.  Here are some of the news items we are tracking:

BREAKING: German FM Wolfgang Schäuble has indicated he is willing to give up the finance ministry and lead the CDU/CSU in the Bundestag.  Schäuble is a stalwart in the Merkel government and so this move was not expected.  This action may show that Merkel is struggling to build a coalition and needs the finance mandate to woo potential coalition partners.  Initial market reaction has been bearish for the EUR as Schäuble leaving the government suggests disarray.  At the same time, it is possible the FDP is pressing Merkel for the finance ministry as a condition of joining the government.  The FDP leans anti-Eurozone and would call for a hard line against the southern tier.  Thus, an FDP finance ministry would probably be bullish EUR.

Initial tax plan to be unveiled today: A rough outline of tax reform is expected to be revealed today.  Although there will be many electrons dedicated to parsing out the details of what is released, investors shouldn’t get overly concerned about what is seen today because if a deal is struck it probably won’t look like what is proposed today.  We do expect to see a marginal cut in personal rates; corporate taxes will be adjusted lower with credits reduced.  The basic method of tax reform is to lower the rate and broaden the base.  The former is self-evident; the latter means getting rid of deductions and credits designed to steer behavior.  The problem with broadening the base is that one party’s wasteful tax expenditure and sop to special interests is another party’s critical tax relief that is elemental to the continuation of Western civilization.  We continue to pay attention to this issue but won’t go into detail until later when (or if) a real program emerges.

Yellen the hawk: In a speech yesterday, Chair Yellen reiterated the message of the Fed, indicating a path of rate hikes and balance sheet reductions.  We had expected Chair Yellen to use the latter to stall action on the former.  However, she is apparently moving to keep the two policy items separate, suggesting she doesn’t see balance sheet reduction as a removal of accommodation.  We tend to agree with her that reducing the balance sheet, by itself, won’t affect the economy much.  Although the Fed argues that expanding the balance sheet lowered long-duration yields by reducing the term premium, we suspect that falling inflation expectations, not an expanded balance sheet, caused the term premium to decline.

This chart shows the expectations of a rate hike at the December meeting, derived from fed funds futures.  Current expectations for a hike are around 70% and have increased significantly.

Why has Yellen turned hawkish?  It is important to note that Yellen came of age during the 1970s and policymakers who did their academic work in this period are more inclined to fear inflation.  It may be that she is planning on leaving in February and worries that the next Fed chair will be a dove and thus wants to remove stimulus while she can.

This chart shows the past four tightening cycles and the current cycle, shown in gray, along with the Chicago FRB National Activity Index.  A reading above zero in the latter index indicates above-trend growth.  Note that the economy was significantly stronger in past tightening cycles.  The only argument for tightening with this level of economic growth is that the policy rate is below a rate consistent with equilibrium (on-trend) growth, which seems to be a stretch.  The bottom line here is that further Fed tightening will increase the risk of a policy mistake.

Women drivers in Saudi Arabia: On its face, this isn’t market-making news, although some are trying to spin it as such as it will increase the number of autos sold in the kingdom.  Perhaps…however, the big takeaway from this move is that the crown prince is steadily modernizing Saudi Arabia.  We have been hearing rumblings that the crown prince wants to weaken the grip of the Sunni religious establishment in Saudi Arabia, believing it has become an obstacle to the changes the kingdom will need to make in order to deal with the challenges of the next 20 years.  This action is important because, symbolically, it suggests that modernizers within the royal family are gaining the upper hand.

Populists on the march: Earlier in the week, Germany showed how populists are gaining ground in Europe.  The GOP primary in Alabama added to the evidence.  Sen. Corker (R-TN), an establishment stalwart, announced he won’t seek re-election next year.  Politico notes that former VP Biden is considering a run for president in 2020 as an anti-populist.[1]  The establishment center-left and center-right is taking a drubbing; this is a theme we have been monitoring for a long while, but the bottom line is that it could undermine investor confidence at some point in the future if it gains momentum.

View the complete PDF

---

[1] To quote the movie Dodgeball, “It’s a bold strategy, Cotton…” https://www.youtube.com/watch?v=9HVejEB5uVk

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are generally quiet this morning.  Here are the news items we are watching:

The German elections reverberate: Although Merkel remains chancellor, the German political landscape is shifting radically.  If the ruling coalition is made up of the CDU/CSU, FDP and the Greens, it will be the first three-party government in postwar German history.  And, even putting this coalition together is problematic.  The FDP would probably prefer to be in the opposition.  How the Greens will operate in a conservative government will be interesting.  The CDU/CSU is generally considered one party but it isn’t; the CSU, mostly representing Bavaria, has more of a Catholic Church influence.  Thus, it is more socially conservative than the CDU and tends to support social spending.  The rise of the socially conservative AfD is putting pressure on the more conservative CSU to break with the CDU.  If this were to occur, new elections would be difficult to avoid.  The uncertainty surrounding the German government is putting pressure on the EUR this morning for the second consecutive day.

The Kurds vote: We won’t get the official results from the Kurdish vote for a few days, but it seems highly improbable that the vote will not support independence.  Neighboring nations are threatening the Kurds; Iraq and Turkey are holding military exercises near the Kurdish region and Iran has been making threatening comments.  Turkey has also threatened to cut off Kurdish oil exports, which is one of the reasons oil prices have lifted.  The Kurds want independence but it is obvious that the only way they can get it is to gain the protection of a local power.  The more likely candidates would be Turkey or Iran.  Usually, Turkey would oppose Kurdish statehood but having a state dependent on Turkey might be attractive.

A declaration of war: Financial markets were rattled by comments from North Korea’s Foreign Minister Ri Su Yong, who indicated that President Trump’s recent statements to the UN were a “declaration of war” and North Korea reserves the right to shoot down any foreign warplanes that venture near the country, even if they are over international airspace.  Reuters is reporting that North Korea has boosted its air defenses on its eastern border.[1]  This sort of talk is unsettling but it should be remembered that North Korea has a long history of provocations.  These include the sinking of the ROKS Cheonan in 2010, the boarding and capture of the U.S.S. Pueblo in 1968 and the 1976 “Axe Murder Incident” where North Korean troops attacked an American and South Korean tree trimming operation in the Demilitarized Zone, killing two U.S. soldiers.  North Korea also downed a civilian aircraft, Korean Air Flight 858, in 1987.  After the U.S. sanctioned Kim Jong-un in July 2016, the official news agency declared it as “an act of war.”  The same occurred after South Korea withdrew from a joint industrial complex in February 2016.  The key point here is that provocative statements and actions are standard course for the DPRK; how the U.S. reacts is important, but North Korea declaring war isn’t unusual.

Yellen speaks: As noted below, Chair Yellen speaks today.  We will be watching to see if she adheres to the generally hawkish tone of the statement or if her own position is more dovish.  We expect her to hold to the hawkish line, which may be dollar supportive.

View the complete PDF

---

[1] http://www.reuters.com/article/us-northkorea-missiles/north-korea-bolsters-defenses-after-flight-by-u-s-bombers-as-rhetoric-escalates-idUSKCN1C026A?il=0