by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] The second episode of the Confluence of Ideas podcast is available!

Happy employment Friday and All-Saints Day!  We cover the data in detail below, but the quick take is that we have a strong report.  Payrolls rose 128k compared to a forecast of 85k.  The unemployment rate ticks higher to 3.6%.  In other news, China’s data surprises to the upside.  The Fourth Plenum ends.  The problems of hegemony.  Christine Lagarde’s tenure at the ECB begins today.  Here are the details: 

China data:  Earlier this week, the government’s PMI series were weak, with manufacturing remaining under the 50-expansion line.  In addition to the government data, Caixin, a media company in China, also provides a survey of manufacturing which tends to include more small companies.  In a marked divergence from the government’s report,  , the highest level in two years.  It is not unusual for the two series to disagree but, in the past, the government data tended to be higher than the Caixin report.  Thus, the Caixin report was generally held to be more reliable.  It isn’t clear what this report is signaling; the strength does diverge from the broader array of data coming out of China.  It may be that large firms have been more adversely affected by the trade war compared to smaller firms, which may be more sensitive to the domestic economy.  Regardless of the reason, we did see a lift in global equities off this report which offers some hope for global growth.

The Fourth Plenum:  The CPC meeting ended yesterday with little news.  The lack of information isn’t a surprise; usually, whatever was decided is revealed in the weeks after the meeting.  It does appear Hong Kong was on the list of items for discussion.  The leadership has indicated it intends to “perfect” the selection of leaders for the former colony.  That likely means less democracy.

The headaches of hegemony:  As the U.S. removes itself from the Middle East, Iran and Russia are vying for regional dominance.  However, both nations are getting a taste of just how much “fun” it is to try to bring order to a disorderly region.  Iran has steadily increased its dominance of Iraq.  This makes sense.  Throughout history, Persian empires had to capture what is present-day Iraq to project power.  Recent unrest in Iraq is proving to be a real pain for Tehran. The Iranian leadership sent one of its most respected (and feared) operatives, Qassem Soleimani, the head of the Islamic Revolutionary Guard Corps, to Iraq to try to save its hand-picked prime minister, Abdel Abdul Mahdi.  The ploy apparently failed as Mahdi has resigned after he lost support of Iraqi powerbrokers.  Iraq’s president, Barham Salih, has indicated he will draft a new election law and hold new elections.  Meanwhile, protests in Lebanon are threatening Hezbollah’s influence in Beirut.  The civil turmoil has risen to the level where Iran’s supreme leader, Ayatollah Khamenei, has expressed alarm about the situation.  Meanwhile, Russia will have to deal with the rising possibility that Syria and Turkey could stumble into a war.  Turkish forces have reportedly captured 18 Syrian soldiers.  Complicating matters further, this time for China, unrest is rising in Pakistan as well.

United Kingdom-Brexit:  In a radio interview with Brexit Party leader Farage, President Trump claimed “certain aspects” of Prime Minister Johnson’s new Brexit agreement with the EU would prevent a future U.K.-U.S. trade deal.  It’s widely understood that the U.K. would suffer from limited leverage in any trade negotiations with the United States, but Trump’s statement seemed to go beyond that.  Farage is reportedly a friend of President Trump, so it could be that Trump is trying to tip the scale in favor of Farage in Britain’s December election.  Or, Trump could be calculating that Farage could draw pro-Brexit voters mostly from the Labour Party, clearing the way for a decisive win by Johnson and his Conservative Party.

Meanwhile, bringing his campaign for the December election to full gear, Labour Party leader Corbyn finally started to lay out details on how he would handle Brexit if elected.  First, he vowed he would “get Brexit sorted out within six months.”  More to the point, he also laid out three key actions he would take to do that: 1) Request another withdrawal deal extension, 2) renegotiate the latest withdrawal deal, and 3) hold a second Brexit referendum.

United States-Mexico-Canada:  House Speaker Pelosi yesterday said congressional Democrats and Trump administration officials are close to an agreement in which she would allow a vote on the updated NAFTA treaty in return for adjusting the treaty to toughen its labor and environmental standards.  That should provide modest support for U.S., Mexican and Canadian stocks.

United States-India:  The WTO said India broke global trade rules by providing some $7 billion in export subsidies to its pharmaceutical, textile, steel and information technology companies.  If India fails to end the subsidies within six months, the ruling would allow the United States to impose punitive tariffs.  The ruling should be negative for Indian stocks in at least the short term.

A new leader for Islamic State:  IS has a new leader.  The group acknowledged the death of al-Baghdadi and the “nation’s” spokesman, Abu Hassan al-Mahajir, and announced a new leader, Abu Ibrahim al-Hashemi al-Qurayshi.  At this point, no one seems to have any idea who this person is, or even if he really exists.  It is likely that this name is a nom de guerre, so analysis will need to go behind the new name to find out who has adopted it.

Odds and ends:  The Trump administration is backing away from plans to freeze auto emissions targets, creating a middle ground between Obama-era plans and a complete reversal.  South Africa is seeing financial turmoil, with the SAR falling 3% over the past two days.  Moody’s is expected to issue a review today.  Japan has issued a warning over China’s growing military power.  The U.S. has added sanctions on four products that could be used to aid Iran’s military.  Sixteen nations are meeting in Bangkok at the China-led Regional Comprehensive Economic Partnership (RCEP) meetings.  The RCEP was China’s response to TPP.  The Basel Committee is starting to look at crypto assets and banking.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

The second episode of the Confluence of Ideas podcast is available!

Happy Halloween!  Not to scare, but today’s report is a long one as there is a lot of news to cover.  We have a deep dive on the Fed meeting.  China trade is good for the short term, not so good long term; the news is pressuring equities this morning.  We also have an update on Chinese economic data and our weekly energy update.  The Nationals win the World Series.  Here are the details:

Fed recap: As expected, the Fed did deliver a 25-bps rate cut.  The Fed’s statement and the press conference signaled that the U.S. central bank is likely to pause its recent rate reductions.  They did leave room to ease further if conditions warrant but, in the absence of weakness, cuts are complete for now.  The bank acknowledged weak investment but also noted that consumption remains robust.  In fact, yesterday’s GDP data showed that consumption pretty much dictated growth; the other three components of GDP, investment, net exports and government, broadly offset each other.  Thus, as long as consumption holds up, the economy will too.

There were two hawkish dissents, KC FRB’s Esther George and Boston FRB’s Eric Rosengren.  In our assessment, these two members are opposing cuts for different reasons.  George is a hawkish Phillips Curve adherent and likely opposes cuts on fears that they will be inflationary.  Rosengren is a “finance-sensitive” voter, and probably opposes the cut on fears that they will lead to overvalued equity markets.  Unlike the last two cuts, St. Louis FRB’s James Bullard did not want a more aggressive cut.  The lack of a dovish dissent suggests the voters believe they are not reacting to prevent a recession but are adjusting the policy rate to more closely match economic conditions.  In a recession, we would expect a return to ZIRP, so Bullard accepting this statement tends to support the notion of a “mid-course correction.”

This chart shows the implied three-month LIBOR rate from the Eurodollar futures market along with the fed funds target.  The spread between the two rates is the upper line.  Inversions are shown by vertical lines.  In 1995, the Greenspan Fed abruptly ended a tightening cycle as the spread inverted and generally guided rates based on the behavior of the implied LIBOR rate.  The current spread, post the rate cut, is -10 bps.  Pausing at this level is defensible in the absence of recession.

 

Market reaction was interesting.  As the press conference wore on, we saw sentiment shift from hawkish to dovish.  The chart below is yesterday’s intraday price action in gold.  Note the “V” bottom; the initial reaction to the statement was bearish for gold, but there was a decided shift in sentiment.

When Powell suggested that the Fed was not likely to raise rates anytime soon, it was a tacit admission that the last three rate hikes were a mistake.  Here is the relevant comment from the presser:

     Q: You have prepared this rate cutting cycle to the insurance cuts in the ’90s. The Greenspan fed took those cuts back after awhile. They raised rates again fairly quickly. I am curious what the onus is for doing that in this cycle. What would you make you guys decide it is appropriate to raise interest rates again?

A: So the reason why we raised interest rates is because generally is because we see inflation as moving up or in danger of moving significantly. We  don’t see that now. Inflation moved down in the first quarter of this year. We thought that that was due to some extent to transient factors. That turns out to have been the case. It has moved back up. But it seems to be settling in below 2%. So we really don’t see that risk. And inflation expectations have also kind of moved down and sideways both surveys and market based over the course of this– of really the recent months. And, you know, we think that inflation expectations are very important in driving actual inflation and we are strongly committed to achieving our 2% I inflation objective. So we are not thinking about raising rates right now…What we are thinking now is that our current stance of policy is appropriate.  Will remain so as long as the outlook is keeping with the expectations.

In other words, unlike the 1995 mid-course correction, it is unlikely these cuts will be reversed anytime soon.  That led to the bounce in gold, a lift in equities and a rally in fixed income.  The lack of fear from a Fed mistake could boost equities into the usual Q4 rally, assuming that there are no issues emerging from trade.

China trade: A new wrinkle emerged on the trade talks.  Chile’s President Pinera, due to persistent unrest, has cancelled the APEC leader’s summit that was scheduled for November 16-17.  Without this meeting, Presidents Xi and Trump will have to set up a specific meeting of the two leaders  There are reports that China is pushing back against large grain purchases, and is unhappy with human rights talks.  Despite the cancellation, negotiations continue and some sort of trade arrangement, a small deal, is likely.  However, what has reversed equity futures this morning are reports from China that indicate a long-term deal with the U.S. on trade probably isn’t possible.  If a major deal isn’t possible, a steady deterioration of relations between the world’s two largest economies is likely.

China economic data: Although we cover the data itself below, we note that the official PMI data came in soft.  The government’s official purchasing managers index fell to a seasonally-adjusted 49.3, short of expectations that it would hold steady at the 49.8 reached in September.  The index has now been under the 50 level that indicates expansion for six straight months, reflecting both China’s secular slowdown, and the U.S.-China trade war.  That bodes poorly for Chinese equities.

The services index fell to a three year low of 52.8.   In manufacturing, new orders and exports orders both declined.  There are reports that in the face of falling growth, Chinese manufacturing firms are using cash to purchase wealth management products.  Similar behavior was seen in Japan in the late 1980s.  One interesting sidelight; U.S. poultry equities are rising on reports China has lifted a four-year ban on U.S. chicken imports.

Perhaps even more unsettling is Hong Kong’s GDP; preliminary data shows the city-state’s GDP plunged 3.2% in the third quarter, far worse than both the expected decline of 0.5% and the second-quarter fall of 0.6%.  By conventional reckoning, that means the economy is now in recession, reflecting the negative impact from continued anti-China political protests, the U.S.-China trade war and capital flight.

Responding to the Fed’s cut in U.S. interest rates yesterday, the Hong Kong Monetary Authority today cut its benchmark interest rate to 2% from 2.25% previously.

A signal of change: The House voted 405-11, in a non-binding resolution, to say the U.S. government should no longer associate itself with the denial of the Armenian genocide that occurred from 1915-23.   Turkey vehemently disputes this allegation, and the U.S. has generally avoided taking a position on this issue, especially after WWII, to maintain favorable relations with Ankara.  The fact that this resolution passed is a signal of how far relations have deteriorated.   Erdogan’s response was rather muted, suggesting the U.S. has “no right to give lessons to Turkey.”

United Kingdom: Labour Party leader Corbyn launched his campaign for the December election by vowing to change the country’s “corrupt” economic system and bring down the “privileged” rich.  To make his proposals as concrete as possible, he specifically named multiple high-profile individuals that he would target, including the Duke of Westminster and other landlords that he accused of hiking rents and tearing down economical apartments to build luxury high rises.

Eurozone: Eurostat today said Eurozone GDP continued to rise tepidly in the third quarter, posting an annualized growth rate of just 0.8% after stripping out seasonal and price effects.  That matched the second-quarter growth rate, but it was significantly lower than the 1.7% growth rate in the first quarter.

India-North Korea: The Nuclear Power Corporation of India has confirmed that malware was surreptitiously installed on the computer system of its newest nuclear plant.  Even worse, cybersecurity firms have already traced a large data extraction from the plant to the Lazarus Group of North Korean hackers.  The hack highlights the continuing risk that rogue states or groups could launch a sudden, unexpected cyberattack on critical facilities around the world.

Odds and ends: The U.S. has renewed waivers on Iran, allowing foreign companies to continue work at Iranian nuclear facilities.  This renewal might be a good faith gesture by the U.S. and could support talks.   Senate and House negotiators are continuing to work to avoid a budget led government shutdown, but conflicts over the border wall may still lead to a closure.  Farm bankruptcies are up 24% since 2011, as low prices and trade wars push farmers to the brink.  North Korea has launched missiles into the seas around the peninsula.  The new ECB president called on Germany and the Netherlands to boost fiscal spending.  Brazil’s president lashed out at the media on reports he is connected to the murder of a prominent opposition leader.  The UAW has a tentative deal with Ford (F, 8.54); if the rank and file approve, a strike will be avoided.  The EU will be officially between leaders starting tomorrow. The Islamic State is said to be issuing a statement soon, perhaps naming a new leader.  The BOJ left rates unchanged.

Energy update: Crude oil inventories rose 5.7 mb compared to an expected build of 0.5 mb.

In the details, U.S. crude oil production was unchanged at 12.6 mbpd.  Exports fell 0.4 mbpd while imports jumped 0.58 mbpd.  The unexpected rise in stockpiles was mostly due to rising imports which offset improved refinery demand.

This chart shows the annual seasonal pattern for crude oil inventories.  We are now into the autumn build season which usually lasts into early December.  This week’s rise is normal. We continue to monitor the autumn refinery maintenance season.

(Sources: DOE, CIM)This week’s recovery in utilization recovered “on schedule”.  WE would expect refinery operations to rise steadily into year’s end.

Based our oil inventory/price model, fair value is $61.13; using the euro/price model, fair value is $48.79.  The combined model, a broader analysis of the oil price, generates a fair value of $52.27.   We are seeing a clear divergence between the impact of the dollar and oil inventories.  Given that we are into the maintenance season, we would normally expect inventories to continue to rise.  Prices will remain sensitive to Saudi output and tensions in the Middle East.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

It’s Fed day!  We discussed the FOMC meeting in detail yesterday; there’s a quick summary below.  It’s also GDP day (see the Economic Releases section below for details).  At long last, there will be elections in the U.K., and we also update news from China.  Here are the details:

The second episode of the Confluence of Ideas podcast is available!

FOMC day: As we noted yesterday, a rate cut today would shrink the spread between the implied yield from the two-year deferred Eurodollar futures and fed funds to near zero.  If the Fed is using the 1995 mid-course correction as an analog, there is a chance of one more rate cut, but a pause would not be out of the question.  Given the divisions on the FOMC, squeaking out one more cut is probably about all that Powell can muster.  How will the markets take a pause signal?  Not well unless the statement suggests the Fed will continue to support the expansion.  That language will likely remain, so we don’t expect a bearish surprise there.  Finally, it is worth noting that Powell’s press conferences have had a tendency to be hawkish.

Before one decides to engage in a short-day trade, a word of caution—Powell has been learning as he goes along and thus this chart may more reflect his learning curve rather than a hawkish bias.  We will recap the meeting tomorrow.

China: Although the fourth plenum is continuing, there is little information emerging from the meetings, as is the custom.  In other China news, the regime claims to have eliminated all restrictions on foreign investment and will “neither explicitly nor implicitly” force foreign investors or companies to transfer technologies.  However, this new “directive” does not include investments or foreign firms on “negative lists,” which means industries that are barred from foreign involvement.  At first glance, this appears to be a major breakthrough.  However, it isn’t clear whether this directive has the force of law.  Nevertheless, this may be as much as the Trump administration can get and, in reality, even if a law is passed, enforcing such a law may not occur anyway.  If the U.S. takes this as a win, it is possible that progress on trade can occur.  At the same time, there are conflicting reports about a deal being ready for the November APEC meeting.

In another noteworthy development, Chairman Xi has apparently supported the development of a Chinese blockchain to ostensibly eliminate the need for the S.W.I.F.T. network.  That network facilitates money and information transfer between banks.  It has been used by the U.S. to enforce sanctions and China would like to undermine that power.  The Chinese version of a cryptocurrency would be one managed and monitored by the state.

Brexit: At long last, we will have an election.  On December 12, U.K. voters will go to the polls.  If a Tory government emerges, Johnson’s plan will likely be the structure of a Brexit deal.  If Labour can team up with the SNP, a second referendum will be held.  And, if the Liberal-Democrats win, Article 50 will be scrapped.  The wild card for the Tories is Nigel Farage’s Brexit Party.  He will argue that Johnson has failed to deliver Brexit; if a voter wants out of the EU, the Brexit Party is the only sure way to deliver that outcome.  For Labour, the problem is that the party has never fully defined its position on Brexit.  And so, there is a chance that working class older Labour supporters will drift to the Tories or the Brexit Party.  The Liberal-Democrats may be able to capture younger Remain voters from Labour as well.  Labour will try to make the election about anything but Brexit.  That might simply not be possible.

So, overall, the new election is a risky maneuver for all involved.  Current polls show the Conservatives with a sizeable margin; however, as the last election showed, the British electorate is fluid.  It does appear that the odds of crashing out of the EU are nearly zero and the choice is either a staged exit or remain.  Accordingly, we are seeing the GBP lift on the news.

Lebanon: We have been reporting about rising unrest around the world; Hong Kong, Bolivia, Chile and Lebanon have all been scenes of civil disorder.  In Lebanon, PM Hariri has given up and resigned.  Lebanese politics are finely balanced; Shiites, Christians, Sunnis and Druze all hold various parts of the government.  Protestors oppose this arrangement, seeing it as an impediment to progress.  However, it is unclear what will occur if the current arrangement unravels.  In the 1970s, the result was a bloody civil war.  Hezbollah, the Shiite group that is arguably the most powerful body in the country, has shown no interest in resigning from the government or participating in a reshuffle.

USMCA: There are fears that the impeachment proceedings will delay a vote on the North American trade deal.  However, another issue has emerged; the Trump administration wants to dictate where auto companies can make cars and parts, and receive duty-free treatment under USMCA.  This is a remarkable degree of interference into the sourcing and investment decisions of companies, but is a further signal of a swing toward an equality cycle.

The new subprime? Years after the financial crisis it appears that consumer installment loans have replaced the controversial sub-prime mortgage as debt vehicle of choice for borrowers with both low credit and savings. As opposed to a credit card, installment loans allow consumers to borrow money for specific purchases. Because rising wages have stagnated for workers, corporations have offered installment loans in order to boost profits and meet consumer demands. That said, the practice of issuing installment loans has come under increased scrutiny as some lenders have begun to take advantage of the lack oversight and have issued loans with interest rates well into the triple digits. The usage of these installment loans is a cause of concern as the economy debt burdens weigh on consumers’ willingness to spend. In addition, increased scrutiny of these instalment loans provides further evidence that economy policy is likely shifting away from favoring efficiency, and more toward favoring equality. Earlier this month, California passed a bill that would effectively limit the amount of interest charged on installments loans to 36% plus the fed funds rate for loans between $2,500 and $10,000.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

The S&P 500 hit a new record yesterday.[1] There is growing hope of a trade deal.  The FOMC meeting begins today.  Brexit continues.  Here are the details:

China trade:  Contours of a trade deal, or ceasefire, are slowly emerging.  There are reports that the U.S. will offer to extend tariff delays of 25% on $34 bn of Chinese consumer electronics.  These tariffs were initially set for July 2018 but granted exclusions that ran through December 28^th of this year.  The USTR is said to be considering extending these by another year.   This seems like a rather small offer; we haven’t heard anything from the Chinese side most likely because they are holding CPC meetings.  Peter Navarro is said to be opposed to the trend of negotiations but, unlike in earlier talks, he and Lighthizer are not together in opposition.  From our perspective, a modest extension of tariff exclusions and an offer to buy soybeans seems like a rather small agreement.  However, we do note that China is allowing the CNY to appreciate, which may be a signal it is willing to make an arrangement.  However, a simple delay in trade hostilities is probably enough to cool market worries and give stocks a boost.

FOMC:  Market expectations are calling for a 25 bp rate cut at this week’s meeting, which will end tomorrow.  This is a meeting without “dots” so all we will have to work with is the statement and the press conference.  What we will be watching for is how the financial markets react to a signal of a pause.  Chair Powell still has a large contingent of Phillips Curve adherents who will be less that keen on further cuts in the face of low unemployment.  And, equities hitting new highs will weaken the resolve of the few members who worry about financial market froth.  If Powell is using the mid-1990s soft landing as a policy guide, we are getting close to a pause point.

This chart shows the implied three-month LIBOR rate from the Eurodollar futures market along with the fed funds target.  The spread is the upper line.  Inversions are shown by vertical lines.  In 1995, the Greenspan Fed abruptly ended a tightening cycle as the spread inverted and generally guided rates based on the behavior of the implied LIBOR rate.  The current spread is -40 bps; another 25 bps cut will get us close to a positive spread.  It would not surprise us to see the Fed pause if we get a cut tomorrow.

In light of new highs in equity indices, the question then becomes how will equity markets react if the Fed pauses?  Most likely, without a steady diet of accommodation, equity markets will probably stall.  However, through all of the recent strength, retail money market levels continue to rise.

If investor sentiment swings to euphoria, there is ample fuel for a major rally in equities.  For that to occur, we would probably need more than a ceasefire in the trade situation.  Nevertheless, the rally in equities while cash levels are increasing is impressive.

Brexit:  The saga continues.  After seeing an election bill fail, PM Johnson is trying another tactic, this time a simple bill that would allow for an election without a two-thirds majority.  So far, the GBP is holding up through these machinations.  U.K. betting sites are leaning toward a hung election, where no party wins a governing majority.  In the details, at least one major bookie says there are even odds that no party will win an outright majority, while two others put the odds of that outcome at 11/10 (52.4%).  All three major bookies put the odds of the Conservative Party winning an outright majority at 10/11 (47.6%), while they put the odds of Labor winning a majority at between 23/1 (4.2%) and 16/1 (5.9%).

Global Investment Flows:  In a sign that anti-globalism political leaders aren’t just rolling back trade, the OECD has issued a report showing international investment flows are also dropping.  In the first half of 2019, the data shows foreign direct investment across the globe was down some 20% from the second half of 2018.  FDI into the United States was down more than 25%.

Japan-South Korea:  Media reports yesterday said Japanese and South Korean officials are working on a deal to resolve their dispute over Japan’s behavior in Korea before and during World War II.  The deal would focus on compensating Koreans who were subject to forced labor by the Japanese, potentially via an “economic cooperation” fund to be financed by Japanese companies.  As we discussed in our WGR of September 30 and October 7, the Japanese government insists that it owes nothing under the 1965 treaty that normalized relations between the countries, while recent South Korean court decisions have allowed Koreans to sue Japanese firms for redress.  The proposed deal would allow compensation to be paid in all but name.  Today, Japanese officials denied any such deal is in the works, but that could just be political posturing.  If such a deal is completed, it would remove a significant cloud over Japanese-South Korean trade, so it would likely be a modest positive for Asian equities.

Hong Kong:  Pro-democracy activist Joshua Wong was officially disqualified from running in next month’s local elections, on grounds that his political group has called for Hong Kong to have self-determination.  Meanwhile, municipal Chief Executive Carrie Lam denied that Chinese leaders in Beijing are planning to oust her for her failure to control the city’s continuing and increasingly violent anti-China protests.  Together, the developments are likely to add more fuel to the protests, and further weigh on the Hong Kong economy and financial markets.

Russia:  As a reminder that various Russian organizations continue to push back against President Putin’s narrative of a Great Power Russia where all is well, activists in Moscow today publicly read the names of 40,000 fellow citizens executed by Stalin in 1937-38.  The ceremony took place in Lubyanka Square, directly in front of the former KGB headquarters, which is now the headquarters for the KGB’s main successor agency, the Federal Security Service (FSB).  Similar readings took place in some 35 cities across the country.

Saudi Arabia:  The government opens its third annual Future Investment Initiative conference today, featuring at least five presidents and the chiefs of several major multinational corporations.  Given the high-level attendees, the “Davos in the Desert” meeting will have the potential to produce policy or corporate news – and potential mischief by Saudi rival Iran.

Odds and ends:  As impeachment accelerates, there is concern that the other business of Congress is getting sidelined.  For example, we might see a government shutdown or USMCA may be put at risk.  One of the side benefits of the raid that killed al-Baghdadi is that intelligence is gathered from the leader’s compound.  Something similar occurred after the raid on bin Laden’s compound.  We note that an IS spokesman was killed in an airstrike yesterday.

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[1] It’s the 90^th anniversary of “Black Tuesday.” The Dow Jones Industrials lost nearly 25% over two days on October 28^th and 29^th and volume on the 29^th reached a record that held for nearly 40 years.

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

Good morning and happy Monday!  It was a busy weekend in front of a busy week.  Here are the details:

Baghdadi dead: The leader of Islamic State (IS), Abu Bakr al-Baghdadi, died over the weekend, killing himself with a suicide vest while his compound was raided by U.S. Special Forces.  Killing the leaders of such movements, such as the operation against Osama bin Laden, are important psychological events.  In the case of al Qaeda, the group continues to operate but the profile of the new leadership is significantly lower, which probably makes sense because having a high profile makes one a high-value target.  Although we expect IS to continue, its form will likely be far different than what we saw a few years ago.  It more likely will look like al Qaeda; IS will be something akin to a franchise name for similar movements around the world.  We strongly doubt it will, in the short run, control enough undisputed territory to be considered a caliphate.  At the same time, as the U.S. withdraws from the Middle East and other parts of the world, the ability of IS and fellow travelers to operate will be fostered.  So far, the market impact of this event was minimal; if anything, it might be modestly bearish for crude oil.

Brexit extension: Last week, we noted the “catch-22” that was emerging on the Brexit extension.  The EU wanted more clarity before granting an extension, while the U.K. wanted an extension to build more clarity.  It appears the standoff is being resolved.  The EU appears ready to grant a flexible extension to the end of January 2020, with the potential to move sooner if the U.K. resolves its issues.  Parliament will vote at approximately 7:00 pm London time on PM Johnson’s plan for an election on December 12.  That plan also includes a new vote on Johnson’s U.K.-EU Brexit deal.  If this fails, the path may shift to an alternative.  The Scottish National Party (SNP) and the Liberal-Democrats have offered a bill that would trigger an election on December 9.  That would be too soon for the Tories to push their Brexit bill through Parliament; thus, the election would occur before the Brexit bill is passed.  PM Johnson has expressed interest in the bill, which could pass with a simple majority.  The risk for Johnson is that he might not be able to offset the Brexit Party without executing Brexit before the election.  A hung Parliament is a possible outcome.  On the other hand, an election will be necessary at some point so getting on with it makes sense.

One of the fallouts of Brexit is the loss of Britain’s contribution to the EU budget.  Germany is balking at a projected rise in its expected future contribution.  The potential fallout (see below) could be renewed momentum to German populists and nationalists.  In other words, even after Brexit is “put to bed,” the remnant EU is likely to struggle with the political fallout for years and will face internal tensions that are likely to be negative for the euro and European equities.

Peronists win: Although it was no surprise that Alberto Fernandez won yesterday’s election in Argentina, the final results were a bit tighter than expected.  For investors, the key unknown is how much power his running mate, former president and first lady Cristina Fernandez de Kirchner, will have in the new administration.  The more power she wields, the greater the likelihood of default and turmoil.

German regional elections: The state of Thuringia, which resides in the former East Germany, held elections over the weekend.  The AfD made a strong showing, seeing its vote share rise to 23.5% from 10.6% in the last election in 2014.  The hard-left Die Linke (the Left) party won the most votes, at 31%.  The CDU took 21.6%, down 12 points from 2014.  The key point of the results is that the center isn’t holding; the hard-left and hard-right now command a majority in this small state and it isn’t likely that any of the parties can form a government.  These sorts of outcomes weaken the ability to govern.

CPC plenary session: The CPC will meet this week to hammer out policy for the upcoming year.  Chairman Xi waited until the last possible moment to hold this session, which may reflect internal dissention.  Xi has come under pressure for deteriorating relations with the U.S. and weakening economic growth.  As a result, we will be watching for any signs that Xi may be forced to accommodate these pressures.  Look for a rush to get a trade deal with the U.S. or fiscal stimulus.  Meanwhile, China is trying to woo foreign firms on the back of new legislation that liberalizes foreign investment.  Additionally, the trade talk reports remain favorable.

Fires in California: Widespread fires have led to blackouts in an attempt to reduce the chances of further conflagrations.  It is unclear if these blackouts will hurt overall economic growth, but the longer they persist the better the chances are that the blackouts will have a negative effect.

Odds and ends: The National Association of Business Economists are projecting less than 2% growth next year.  Recent polls show that attitudes toward socialism and capitalism are age-dependent.  Under conditions of hyperinflation, it is not unusual to see an economy shift to barter, and there is growing evidence that this is occurring in Venezuela.  With the end of the recent UAW strike, the union is now planning to use its current deal as a pattern for other automakers.  Finally, the USDA reports that the stocks of frozen pork bellies, the uncured meat that, once cured, becomes bacon, are at their highest levels since 1971.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] Happy Friday!  Markets are trading quietly this morning.  We are watching Johnson’s attempt to bring elections, China/U.S. trade talks, Syria reports and Argentine elections.  And, the EU moves to standard time this weekend.  Here are the details:

Brexit: PM Johnson has called for elections on December 12.  Unfortunately for him, he doesn’t control the process.  Under rules passed in 2011, he needs 434 votes in Parliament to bring new elections.  There is no evidence to suggest he is even close to getting that number.  Comments from opposition party leaders suggest they won’t back new elections without passing the Halloween exit date.  They would like the EU to officially grant an extension; in a moment that would make Joseph Heller proud, the EU doesn’t want to establish the new extension date until the election issue is resolved.  There are some other ways an election could be called.  Johnson could, in a Kafka-like moment, bring a no-confidence motion against his own government.  That resolution would only need a simple majority to pass and the SNP would likely join the Tories against the Johnson government.  The risk from this outcome is that there would be a two-week period during which other parties could form a government, although the likelihood that Labour could cobble together a majority isn’t very high.  However, this approach requires the two-week period plus the minimum time to put an election together, and this maneuver would need to be done before next Thursday.  Finally, Johnson could bring a “one-line” bill to Parliament calling for an election; that would only need a simple majority but amendments (e.g., a referendum, lowering the voting age, etc.) could be added to it.

Simply put, the mess continues.  The odds of a hard Brexit have been diminished, but that’s about all the progress we have made.

China trade: U.S. and Chinese trade officials will talk today on the latter’s purchase of farm products.  Reports indicate that China will agree to buy these products only if the U.S. cancels at least some of the planned and existing tariffs.  The U.S. has already agreed to drop $250 bn of tariffs that were scheduled for October 15.  China reportedly wants the removal of a 15% tariff on $125 bn of goods that was implemented on September 1.  If accepted, that would reduce the tariffs to $250 bn of Chinese imports.  From our standpoint, this looks like a big “ask” from the Chinese side.  We suspect they will be willing to accept the current state of tariffs but will reduce planned purchases.

Meanwhile, VP Pence, playing the traditional role of an attacking VP, gave a highly critical speech of China as well as U.S. companies that accommodate China’s demands.  China strongly rebuffed the speech.  To some extent, Pence’s speech and the rebuttal may be simple politicking, rather obvious attempts to improve the negotiating positions.  However, it may also be a true reflection of the state of the relationship that may never return to status quo ante.

Syria: There are reports that Turkish troops and militias engaged Kurdish and Syrian forces, bringing Turkey and Syria into direct conflict.  This battle is, of course, a violation of the ceasefire.  Meanwhile, Russia continues to send military police from the previous battlefield of Chechnya into the Syrian-Turkish border area.  And, in another reversal, the U.S. is considering bringing some American forces back into the theater to protect Syria’s oil fields from capture by IS.  The Germans are floating a plan to put NATO troops into the buffer zone to separate Turkey from the Kurds; in an interesting development, Annegret Kramp-Karrenbauer, the heir apparent to Merkel and the current defense minister, has indicated that German troops might participate.  We doubt anything comes of this but the fact that it is even being considered is a significant change.  The power vacuum is being filled in a haphazard fashion and the eventual outcome remains in doubt.

Argentina’s elections: Argentines go to the polls on Sunday; it appears likely that the Peronists will return to power.  What is unknown is how the new government will actually govern.  There are two (unrelated) Fernandezes running; Alberto is running for president, while his running mate is the former president, Cristina.  Alberto is more center-left, whereas Cristina, both when she was president herself and when aligned with her late husband, is a populist.  We suspect Cristina will be the power behind the throne.  Financial markets have been betting on the latter for months, expecting another round of default and depreciation.

Things that gives us pause: With the backdrop of the World Series, Rob Drake, a MLB umpire (who, BTW, isn’t working the series), released a tweet suggesting he was armed for a “cival (sic) war” if impeachment takes place.  In the U.K., a survey showed that a majority of Leave voters believe that “violence toward MPs is a price worth paying for Brexit.”  A majority of Remain voters think that “protests in which members of the public are badly injured is a price worth paying to stop Brexit and remain in the EU.”  Even in Canada, divisions are becoming stark.  Within hours of the Canadian election on Monday, in which Prime Minister Trudeau retained power with strong support in the country’s east but very little in the west, activists in the western province of Alberta started calling for it to withdraw from Canada, in what they’re calling “Wexit.”  For now, Wexit still seems to be a fringe movement, but if it grows it would be a headwind for Canadian assets.  Political divisions are transforming into tribal ones, where compromise is becoming impossible and civil unrest is more likely.

United States-South Korea: Finance Minister Hong said South Korea will give up its WTO designation as a “developing country,” following up on U.S. complaints that countries like South Korea and Hong Kong don’t deserve the designation and the preferential treatment it provides in international trade.  The main negative impact is expected to be on South Korea’s farmers.

Greece: Parliament has approved a package of economic reforms aimed at boosting investment and accelerating economic growth.  The reforms include allowing firms to opt out of some collective bargaining deals and letting local governments outsource some services to private operators.  The new rules should add new impetus to Greece’s improving investment climate.

Saudi Arabia-Yemen: The Yemeni government signed a power-sharing deal with separatists in the country’s south, which should help limit the country’s civil war to the separatist Houthis in the north.  The deal strengthens the government’s position, but it doesn’t remove the Houthi and Iranian threats to oil facilities in allied Saudi Arabia.  The risk bid for oil is likely to remain.

Russia: The central bank today aggressively cut its benchmark interest rate to 6.5% from 7.0% previously, citing a sharp drop in inflation and weak economic growth.  The cut was Russia’s fourth this year, and it was twice as big as each of the previous three cuts.  The central bank also cut its 2019 inflation forecast to a range of 3.2% to 3.7%.

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