by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] There isn’t a ton of news in the financial markets this morning.  The most discussed is the DOJ decision to levy a $14 bn fine against Deutsche Bank AG (DB, $14.76).  In European trading, shares were off over 8% overnight.  The bank was anticipating a fine but the size far exceeded expectations.  Other banks in Europe will likely also face fines, so how much Deutsche Bank actually pays is broadly important.  In addition, Deutsche Bank has other woes, so this fine came at an inopportune time.  This event raises fears that the Eurozone banking system may be suspect; the problems plaguing Italian banks have been known for a while, for example.  There is a solution—European banks will likely have to raise capital and consider international mergers.  So far, this outcome hasn’t been embraced.

EU leaders are holding informal meetings in Bratislava today to discuss Brexit.  In a speech today, Chancellor Merkel said that the EU is at a “critical point.”  We would tend to agree.  Brexit exposed real differences within the EU.  Southern Europe wants more financial support and an easing of debt and deficit rules.  Northern Europe, being the creditor, disagrees.  Central and Eastern Europe are seeing rising nationalism and oppose Brussel’s rules on immigration, refugees and other issues.  At the same time, the northern European nations are dealing with a rise of nationalist parties themselves.  How the EU manages Brexit is part of this debate; some nations want to pressure Britain with harsh conditions on the hope that the British will change their minds.  After all, several referendums on EU treaties have failed in other nations only to be eventually ratified.  The danger of going this route is that Britain’s position will harden even further, disrupting trade and investment flows.  On the other hand, going too easy on the U.K. may prompt others to follow suit and leave the EU.  It is these conditions that prompted Merkel’s aforementioned comment.

With the release of CPI data, we can update our versions of the Mankiw rule model.  This model attempts to determine the neutral rate for fed funds, which is a rate that is neither accommodative nor stimulative.  Mankiw’s model is a variation of the Taylor Rule.  The latter measures the neutral rate by core CPI and the difference between GDP and potential GDP, which is an estimate of slack in the economy.  Potential GDP cannot be directly observed, only estimated.  To overcome this problem, Mankiw used the unemployment rate as a proxy for economic slack.  We have created three versions of the rule, one that follows the original construction by using the unemployment rate as a measure of slack, a second that uses the employment/population ratio and a third using involuntary part-time workers as a percentage of the total labor force.

Using the unemployment rate, the neutral rate is now 3.85%, suggesting the FOMC is well behind the curve.  Using the employment/population ratio, the neutral rate is 1.41%, indicating that, even using the most dovish variation, the FOMC needs a rate hike of at least 100 bps to achieve neutral policy.  Finally, using involuntary part-time employment, the neutral rate is 2.98%.  Although we don’t expect the FOMC to raise rates next week, the pressure to raise rates is intensifying.  Of course, there is an ongoing debate as to the wisdom of the Taylor/Mankiw Rule framework.  Although there are clearly doubts about the model (the current wide deviation is clear evidence that the FOMC is deviating from these models), there is no obvious replacement.  Thus, we believe policymakers view the current deviation from the Taylor/Mankiw Rule models as temporary and policy rates will rise sharply at some future point.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] The big overnight news was the BOE’s decision to hold rates and bond-buying steady, which was expected.  The committee vote was 9-0 in favor of the current policy.  The bank did indicate, however, that it was still on course to lower rates later this year and this news caused a modest selloff in the GBP.  Although the British economy didn’t collapse as some feared it would after Brexit, we believe the longer term situation is still rather negative in the wake of the referendum.

In other news, Italy’s PM Renzi says he will announce the date for the upcoming referendum on government restructuring on September 26.  This restructuring is seen as a “make or break” moment for Italy.  The referendum would streamline the Italian government by reducing the power of the upper house and allowing policy to be more easily implemented.  Renzi, who was not elected to the PM post, says he will resign if the referendum fails.  The fear is that if the referendum does not pass, populist forces that may support Italy’s exit from the Eurozone could become ascendant.

We note that EU President Jean-Claude Juncker gave a talk yesterday in which he admitted that the EU is facing an “existential crisis,” suggesting there is little common ground between members and governments are facing nationalist and populist threats that undermine European unity.  From Brexit to the weakening of Chancellor Merkel’s party in recent elections, Europe is likely facing a crisis.

The U.S. pivot to Asia took a couple of hits this week.  First, the mercurial president of the Philippines, Rodrigo Duterte,[1] said today that “China is now in power, and they have military superiority in the region.”  Duterte announced the end of joint U.S./Philippine naval patrols in the South China Sea and expelled U.S. forces from Mindanao, an island region of the country.  U.S./Thai relations have become strained after the Obama administration criticized the current military leadership that has controlled Thailand since the 2014 coup.  In retaliation, Thailand announced it will buy three submarines from China.  Meanwhile, China is showing investment on Laos and is working to improve relations with the new Myanmar government.  Although one does not want to jump to conclusions, this information seems to be signaling that some of South Asia’s governments are seeing China as the new regional power and are beginning to accommodate the Middle Kingdom.  We suspect they would prefer U.S. hegemony but fear that America is giving up on its superpower role.  Thus, these nations are simply preparing for a new environment.

U.S. crude oil inventories fell 0.6 mb compared to market expectations of a 2.8 mb build.

This chart shows current crude oil inventories, both over the long term and the last decade.  We saw a huge 14.5 mb draw in crude stocks the previous week, which was mostly due to import disruptions caused by tropical storms.  About half of the oil imports returned to the market last week.  We would expect a rebound next week as imports normalize.

The unexpected drop in storage has put inventories below the normal seasonal trend.  Again, we would expect that drop to be reversed in the coming weeks.

Based on inventories alone, oil prices are overvalued with the fair value price of $41.07.  Meanwhile, the EUR/WTI model generates a fair value of $49.30.  Together (which is a more sound methodology), fair value is $44.67, meaning that current prices are a bit cheap.  Although the market has put great hope on an OPEC deal next month, the plan looks to be more like jawboning the market higher.  For now, oil prices are mostly marking time before OPEC meets on the 26^th.  We were somewhat surprised that oil prices fell off of yesterday’s unexpected draw, but expectations of rising inventories in the wake of the aforementioned drawdown are likely the reason.  In addition, reports yesterday that oil loadings will begin soon in two troubled areas, Libya and Nigeria, are also bearish factors.

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[1] Duterte recently referred to President Obama in crude and derogatory terms.

by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] In the next AAW (published Friday), we will discuss the very important impact of foreign issues on U.S. Treasury yields.  This is one reason why the financial markets have become focused on the BOJ’s review of its monetary policy.  There are rumors swirling as to what the BOJ is likely to do.  According to the most recent reports, the bank looks set to dive deeper into NIRP.  When NIRP was deployed in February, market reaction was probably best described as “hostile.”  The JPY rallied and the economy showed no signs of improvement.  Going lower on NIRP is, in theory, a way to steepen the yield curve.  A steeper yield curve is designed to improve the stability of the financial system.  Commercial banks are essentially spread traders; they borrow from depositors and lend to debtors.  The bank earns money based on the spread.  The bank can gain spread in two ways—by taking credit risk or duration risk.  Lowering NIRP will widen the spread and support the banks.  However, the key concern is disintermediation (disintermediation is the process of taking cash out of the banking system).  No major central bank has created conditions where retail depositors have faced negative nominal rates.  Commercial depositors have in a few countries, mainly because these depositors have cash holdings that are so large that disintermediation isn’t a real option.  However, households just might.  If cash flees the banking system, it will make Japan’s economy less efficient.

It is also possible that the BOJ could reduce its QE of longer dated maturities in a bid to raise long-term rates and steepen the yield curve.  However, it isn’t clear whether raising long-term rates will hurt the economy by raising borrowing costs.  The BOJ might also expand QE but purchase more short-dated paper in a bid to drive down short-term rates and, again, steepen the yield curve.

If longer dated JGB yields continue to rise after the BOJ meets on the 21^st, it could have a negative effect on U.S. Treasuries.  Perhaps the best sign of success would be a dramatic decline in the JPY.  A weaker currency is probably the best policy stimulus Japan can generate.  Unfortunately, direct selling of the JPY is frowned upon by the G-7 and G-20 and could invite retaliation.  Clearly, QE with the BOJ buying U.S. Treasuries is probably the most effective tool the bank has to stimulate Japan’s economy—fully at the expense of the U.S. economy.  The other is probably direct financing of fiscal spending, otherwise known as “helicopter money.”

Finally, a word of caution about the BOJ is in order.  Governor Kuroda is a bit of an old school central banker.  In the early 1980s, when the economic theory of rational expectations was dominant, the idea was that central bankers could only affect the economy and markets by surprising them.  In other words, if a policy move was expected, its impact was mostly discounted by the time the move occurred.  The Bundesbank was notorious for “wrong-footing” financial markets with rate changes and currency interventions.  Kuroda seems to prefer surprises as well.  Thus, it is possible that none of the above discussion occurs and something totally unexpected is announced.  This uncertainty is probably a factor in recent market volatility.

Yesterday, the Census Bureau released its annual calculation of household and family income data.  The median showed a strong rise.

This chart shows median family and household incomes adjusted for inflation.  The official definition is, “Family income is income of households with two or more persons related through blood, marriage or adoption. Household income is income of family and non-family households.”  Both numbers rose sharply last year, with family income up 6.0% and household income up 5.2%.

This chart shows real median family income since 1947.  We have created two trend lines, the first showing the trend from 1947 into the mid-1970s, and a second from the mid-1970s forward.  Note that the slopes are significantly different.  Although the current improvement is notable, if real median family income had continued to track the first trend line, median inflation-adjusted family income would be $101,332.30, some $30,635.30 higher than the 2015 report.

A potential issue from this data is also the primary argument from the FOMC’s doves, which is that there is ample labor market slack.  Although inflation does remain tame, the rise in both family and household incomes will prompt the hawks to say there is now clear evidence that wages are rising faster and the FOMC needs to lift rates.  This is something we will be watching in the coming weeks.

Finally, there were three news items that deserve comment.  First, an update to this week’s WGR, Shavkat Mirziyoyev was named acting president of Uzbekistan.  Elections will be held on Dec. 4^th but will be a formality.  Elections are heavily manipulated in Uzbekistan and we are confident that Mirziyoyev will prevail.  We expect him to behave much like Karimov except that he may have closer relations with Moscow.  Second, a number of progressive groups have warned the Clinton campaign not to consider Lael Brainard for a cabinet post (perhaps Treasury) because of the “Wall Street revolving door.”  This strikes us as a bit odd; she seems amenable to left-wing populist causes and may be one of the few people standing in the way of tighter monetary policy.  If the standard from left-wing populists is that no one with financial industry experience can work for the president, about the only people who will qualify will be academics.  It almost seems that experience has become a disqualifier for populists on either wing.  Third, Bloomberg polls show Trump leading in Ohio by five points.  This is a rather big swing and shows that Sen. Clinton’s bad week has had an impact on the polls.  If Trump starts polling stronger, we may see a negative market reaction, especially in equities.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] Risk markets are lower to sideways as oil tumbled this morning after the International Energy Agency revised its global demand estimates lower and indicated that the global inventory glut will last longer than it had previously estimated.  Domestic oil inventories are expected to build this week following a week of inventory drawdowns as a result of tropical storm activity.  This will likely pressure prices lower in the short term.  We would expect OPEC members to jawbone about production freezes but, as recent OPEC talks have indicated, a production cut is unlikely.

The chart above shows domestic crude inventory levels.  The chart on the left shows data going back to 1920, while the chart on the right shows inventories for this year.  Stocks remain ample and inventories are expected to remain elevated given the expectations for falling demand.

Fed Governor Lael Brainard’s dovish speech yesterday afternoon fueled a rebound in equities.  Brainard’s comments are the last before the Fed enters a quiet period leading up to the FOMC meeting on September 20-21.  The speech was generally viewed as dovish, especially in contrast to Boston FRB President Rosengren’s speech last week, which was taken as hawkish and increased the likelihood of a rate hike to 60% for December.  Following Brainard’s speech, the December rate increase probability fell to 54% but remains higher than it has been all summer.

Brainard indicated that the economy is making gradual progress toward the central bank’s goals, although a preemptive hike is less compelling in an environment where labor markets have improved but inflation pressures remain mild.  Specifically, she pointed to five areas that should warrant caution.

1. Inflation has been less responsive to labor market improvements than in the past, making the Phillips Curve a less reliable indicator.  We have noted before that there is an ideological divide amongst the Fed board and FRB presidents over the importance of the unemployment/inflation relationship posited by the Phillips Curve.  Brainard belongs to the group that does not believe the Phillips Curve is as dependable of an indicator in the present environment as it was during the 1970s and 1980s.
2. Labor market slack has been greater than anticipated, with the unemployment rate improving but other labor market indicators only showing mild improvement.  She specifically pointed to the low participation rate, higher percentage of workers in part-time positions for economic reasons and lackluster wage growth.
3. There are risks presented by foreign market uncertainty.  Brainard discussed risks from today’s interrelated global markets, especially as the spread of disinflation is a worry in developed countries and weak international demand is likely to pressure domestic growth.
4. The neutral interest rate will likely remain low for an extended period of time and will be much lower than the pre-crisis neutral rate.  Brainard argues that the new normal economic growth environment also warrants a corresponding lower neutral rate.
5. Policy options remain asymmetrical as the low rate allows for the Fed to more easily respond to faster than expected growth, while options for responding to lower growth remain limited.  This is the argument that some Fed officials have made for hiking rates now as they would have the ability to loosen policy if growth slows.  The argument is somewhat controversial because a premature rate hike could add to conditions conducive for a recession in the current low-growth environment.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] Although Friday’s sell-off in equities was impressive, the financial chatter over the weekend was almost non-existent.  U.S. equity markets have been extended for some time and, so far, investors took Friday in stride.  The proximate cause for the drop was a renewed fear of Fed tightening.  Boston FRB President Rosengren, previously a reliable dove, said on Friday that a rate hike is “justified” due to the growing tightness of the labor market.  We have said much over the past few years on the issue of the labor market.  This chart, which should be familiar to our readers, is probably the best way to show the uncertainty.

This chart shows the difference between the unemployment rate and the employment/population ratio.  The two series tracked each other closely from 1980 into the financial crisis.  Since then, they have diverged significantly.  Some of the weakness in the employment/population ratio is due to demographics; as the baby boom generation heads to retirement, the ratio should ease.

However, there are two problems with this explanation.  First, the millennial generation, which is also large, is entering its working years and should offset some of the retirements.  Second, the baby boomers are working longer.

The markets correctly worry that the Fed might tighten into an economy with ample slack and clearly low inflation.  Thus a hike may be a mistake.

There may be a bigger issue, however.  This most recent weakness has hit both long-duration bonds and stocks and seemed to follow after the ECB made no policy adjustments.  There is a worry that central banks may be concluding that there isn’t much more they can do to boost economic growth without participation from fiscal policy.  And, since the odds of expanding fiscal policy are remote, we may be moving to a market situation where further monetary stimulus isn’t coming.  A case can be made that monetary policy has been majorly supportive for equity markets.

The good news is that it’s doubtful the Fed will be contracting its balance sheet anytime soon.  The bad news is that we may be moving back to mid-range, which, from this point, will be a notable pullback in equity values.  The chart below shows an S&P index model, using the Fed’s balance sheet as the explanatory variable.  The last time we had a market this expensive to the model was in 2012 when the market was anticipating QE.  Fair value for this model is 2030 on the S&P.  Although a drop to that level would not be catastrophic, it would represent about an 8% decline from current levels.

Governor Brainard, a reliable dove, is expected to speak early this afternoon.  She may ease fears of policy tightening.  Currently, the fed funds futures market places only about a 15% chance of a rate hike on the 21^st of this month but the odds are around 60% for December.

There were three other news items from the weekend that caught our attention.

What is the state of Sen. Clinton’s health?  For the most part, these discussions have been only held among right-wing pundits and bloggers.  The mainstream media has either ignored the controversy or ridiculed it.  That stance may have changed after Sen. Clinton was removed from a 9/11 ceremony complaining of light-headedness.  The video of her entourage taking her away did not look good.  Later in the day, the campaign admitted the senator had pneumonia but mainstream commentators were sounding concern.  This election season has been one of the oddest in our memory.  The weekend events simply added to the controversy.  So far, financial markets have not been affected but we would not be surprised to see some volatility tied to the election as we get closer to November.

Is Kim Jong-un crazy?  The general consensus is no.  If one looks at it from the viewpoint of the dynasty, acquiring nuclear weapons is completely rational.  For most of the Cold War, North Korea was protected by the Soviet Union and its economy was mostly on par with the South.  But, its economy lost its funding from the U.S.S.R. with the fall of the Soviet Union, and South Korea’s economy was booming during the late Cold War years, clearly overtaking the North.  The Kims found themselves isolated.  They also could not help but notice that the U.S. had overturned various regimes in nations such as Libya, Iraq and Afghanistan, and President Bush had included North Korea in his “axis of evil.”  So, how does a state keep from getting invaded?  Get a nuclear weapon.  Dictators around the world believe that Muammar Gaddafi made a strategic error by ending Libya’s nuclear program.  It should be noted that getting a nuke won’t improve North Korea’s economy or allow it to take over the South.  All nuclear powers realize that the bomb is only a defensive weapon; even if North Korea attacked the U.S., it would face certain annihilation.  It doesn’t appear that is what the Kims have in mind.  Thus, we suspect North Korea will become a nuclear power that can deliver a warhead.  The U.S. won’t like it but there isn’t much we can do about it.  In fact, only one power on Earth can, and that’s China.  Until China decides North Korea is too big of a liability it will refrain from acting against the regime.  This morning, Chinese officials criticized the U.S. for “creating” the situation on the Korean peninsula.  After all, the U.S. is the global hegemon.  It has a duty to fix such things.  The only way China may conclude it has to curb the Kim regime is if South Korea and Japan decide to build their own nuclear deterrents.  The U.S. has worked to prevent that from occurring, but that doesn’t mean we can continue to prevent it.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] There were two big news items overnight.  First, North Korea detonated a nuclear device overnight, its fifth such test.  Early reports suggest the blast was in the 20 to 30 kiloton range, not a big bomb (by comparison, the standard American warhead, W-88, is 475 kilotons), but it does appear the North Koreans are mastering the nuclear cycle.  We know they are working on moving from devices to warheads, and if they reach that level of development then they will have a capable nuclear deterrent.  It also looks like the Kim regime believes such a deterrent is necessary.

Although there was general condemnation of the act, the nation with the greatest influence over the Kim regime, China, is less focused on North Korea and is most upset with South Korea for deploying anti-missile defense systems from the U.S.  It is highly likely that North Korea decided to detonate this device because it felt that China would allow it.

The other interesting news item is that the Fed has recommended to Congress that financial holding companies be denied the ability to invest in non-financial companies.  This rule was part of the initial Glass-Steagall Act and was clarified further in the 1956 Bank Holding Company Act.  But, when deregulation ended these restrictions in the late 1990s, bank holding companies could engage in this activity.  In addition, the Fed also recommended that banks no longer be able to directly hold physical commodities.  This may affect commodity ETFs that hold physical products instead of futures contracts.  This wouldn’t mean these products will go away, but that banks couldn’t sponsor them.

This action represents a further step in re-regulating the financial system.  Although these merchant bank activities have become less important since the financial crisis, these new rules will prevent banks from returning to them if they become lucrative again.  The action also sends a signal that regulators are steadily returning banks to a more traditional role, which will probably make them less risky but also reduce their profitability.

U.S. crude oil inventories plunged 14.5 mb compared to market expectations of a 0.6 mb build.

This chart shows current crude oil inventories, both over the long term and the last decade.  The drop this week was huge, but likely temporary.  Imports last week fell by 1.8 mbpd due to disruptions caused by tropical storms.  Usually, importers furiously rebuild stocks in the weeks following such an event.  Thus, over the next two weeks, we would expect much of this 14.5 mb draw to be replaced.

The unexpected drop in storage has put inventories below the normal seasonal trend.  Again, we would expect that drop to be reversed in the coming weeks.

Based on inventories alone, oil prices are profoundly overvalued with the fair value price of $40.87.  Meanwhile, the EUR/WTI model generates a fair value of $49.22.  Together (which is a more sound methodology), fair value is $44.55, meaning that current prices are a bit rich.  Although the market has put great hope on an OPEC deal next month, the plan looks to be more like jawboning the market higher.  Recent comments from various OPEC members suggest that they would like stable prices, which we could argue they are getting, but none of the major producers seem ready to actually cut production at this point.  In fact, there are reports that the cartel wants prices no higher than $60 per barrel, fearful that prices above that level will spur a rise in shale production in the U.S.   For most of the history of oil prices, stability has been the norm, which is common with cartel markets.  Thus, we would expect the Saudis to gravitate toward a $50 price with a range of $5 per barrel around that point.  Using the aforementioned combined model, and assuming a €/$ of 1.1300, a U.S. crude inventory level of 482 mb would put fair value just above $50 per barrel.  Current inventories are 511.4 mb, or about 29 mb above this level.

In fact, the most bullish scenario for oil may have little to do with oil stockpiles and more to do with the dollar.  Yesterday, ECB President Draghi offered no new stimulus and the EUR rallied.   Assuming no change in U.S. stockpiles, a €/$ of 1.1556 would generate a fair value of $50.  Our calculation of purchasing power parity for the exchange rate is around 1.3000; again, assuming stable inventories, the fair value for oil at that exchange rate is $73.35 per barrel.  If the ECB is finished with policy stimulus and the FOMC hits its terminal rate with only a couple of rate hikes, a weaker dollar could develop.  This probably won’t occur this year, but might be a 2017 event.  On the other hand, there are some major political concerns in Europe.  Brexit still has to be executed, Italy has a key referendum next month, Spain will likely require new elections and Portugal may need a bailout.  These worries will likely offset, at least for 2016, any hawkishness from the ECB.

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by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] This morning’s big news is the ECB’s decision to leave policy unchanged.  The EUR rallied, Treasuries dipped and Eurozone yields rose as well.  We are well into Draghi’s press conference at the time of this writing and it is evident that the ECB did nothing at this meeting.  Draghi did indicate that the ECB is ready to act and has the capacity to do so if necessary, but did not believe it was necessary at this meeting.  We suspect, and think this is the market’s take as well, that Draghi could not convince the rest of the committee to take steps to add new accommodation.  With QE set to end in March 2017 (although the ECB has indicated it could extend the program), there are worries that ECB stimulus may be coming to a close.  Equity markets have turned lower in Europe and U.S. equity futures have also moved modestly lower.

One of the lesser followed indicators we monitor is the National Credit Managers Index.  The index measures the health of corporate credit—everything from the demand for borrowing to the recoveries on bad debt.  The group noted that sales fell 6.3 points, from 60.0 to 53.7, consistent with the weak data seen in the PMI data.

This chart shows the composite index.  It should be read like the PMI data; 50 is the expansion/contraction line.  The current reading is the lowest since 2009 and it has been falling since Q2.  Note that in 2008, the index hovered around 50 only to plunge under 50 as the financial crisis emerged.  Although the data does not have a long history, the trend we are seeing is a worry.

We haven’t commented on the tax situation between the EU, Ireland and Apple (AAPL, 108.36), although we are gathering information on the issue.  However, we do note that Sen. Elizabeth Warren (D-MA) has an editorial in today’s NYT in which she is critical of the tech giant and of corporate tax policy, in general.  Economists tend to believe that corporate taxes are a bad idea—the incidence of the tax tends to fall on households anyway through higher product prices.  Clearly, the more competitive the industry, the less those firms can pass the tax on to their products.  But, for unique products and concentrated industries, the tax incidence tends to fall on households.  However, that knowledge doesn’t stop Warren from calling for higher taxes on corporations.  That she would take that position isn’t really news.  What is interesting to us is the target of her wrath, Apple.  Her party has received significant support from the tech sector and most of the commentary we have seen from Washington has been critical of the EU.  This is the second time we have noted that Warren has attacked the tech sector, suggesting that the Sanders/Warren wing of the party holds significantly different positions from the current leadership of the Democratic Party.

Although Portugal has fallen from the headlines, today’s FT notes that structural adjustments have not been addressed in the 30 months since the last crisis.  There are growing worries that a second bailout may be necessary.  The current Socialist government holds a minority and remains in office only due to the tacit support of hard-left parties.  If the current government falls, and creditors become nervous, a credit crisis originating in Portugal is possible.  If it coincides with the upcoming Italian referendum next month, the potential for another Eurozone crisis will rise.

We want to update comments we made earlier this week regarding Venezuela.  We noted earlier that Citibank (C, 47.48) had resigned as pay agent for PDVSA bonds.  We speculated that if no other bank took the role, it might increase the likelihood of default.  Our report that Citibank has resigned from its role is true.  However, according to the terms of the agreement, Citibank can resign but cannot stop performing the role until another pay agent is appointed.  Thus, PDVSA will have a pay agent for the foreseeable future and it will be Citibank, because it is highly unlikely that anyone else will want the job.

Russian President Putin withdrew support for a batch of new security laws, called the “Spring Package.”  The new rules are very strict, essentially ending free speech, severely restricting foreign NGOs and curtailing social media.  With parliamentary elections on September 18^th and presidential elections in March 2018, Putin is caught between worries about unrest stemming from a weak economy, prompting the new security rules, and growing unpopularity due to the security measures themselves.

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