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

[Posted: 9:30 AM EDT]

Note: After a long hiatus, we have resumed podcasting.  Our new series, titled The Confluence of Ideas, begins with an overview of “Hegemonic Stability Theory” (the program title links to our podcast page).  Our plan is to record a new episode about every 10 days, or three per month.  We hope you enjoy them—let us know what you think!

Happy Monday!  An update on Brexit, and our thoughts on the drug cartels in Mexico.  Unrest is springing up all over the world and so are elections.  Here are the details:

Brexit: The anticipated vote didn’t happen on Saturday.  Instead, Parliament passed a measure that forces PM Johnson to ask for an extension.  He sent an unsigned letter to Donald Tusk asking for the action.  Initially, this vote looked like a major blow for Johnson but, in reality, it appears the vote was to ensure that a hard Brexit won’t occur on Halloween.  Johnson intends to bring his bill up again this week and estimates of votes suggest he will get the 320 needed to pass.[1]  In other words, a slim majority has decided this is the best deal they are going to get and favor Johnson’s plan; they didn’t vote for it on Saturday, opting for the other measure, in order to prevent a hard Brexit.

That being said, there is still a good bit of uncertainty.  Labour may attach a call for a second referendum, this time on Johnson’s bill.  This position might gain favor even if Johnson’s bill passes if the majority is narrow.  If a second referendum is held, there is a rising possibility that the U.K. stays in the EU.  Why?  Because of demographics.  Older voters support Brexit; younger voters don’t.  Over the past 30 months since Brexit started, older voters have died and more young people have become eligible to vote.  The GBP continues to swing based on sentiment toward Brexit; as the odds of a hard Brexit fade, the currency has been appreciating.

Mexico: Last week, in the city of Culiacan, there was a firefight between Mexican troops and gunmen associated with Joaquin Guzman, the son of “El Chapo,” the notorious drug lord.  After capturing the young Guzman, authorities returned him to his “associates” following the cartel’s threats to assassinate Federal officers in their control.  This situation is quite disturbing.  Harkening back to Thomas Hobbes, we give the state a monopoly on violence to protect us from lawlessness.  A monopoly on violence, according to Max Weber, is one of the hallmarks of a nation.  The fact that drug cartels control much of Mexico weakens the government’s claim on sovereignty.  Although this doesn’t necessarily prevent investors from considering Mexico as a destination for funds, the tenuous nature of state control does have to be taken into account.

Unrest spreading: We are seeing civil unrest spreading around the world.  There was another round of protests in Hong Kong on Sunday.  Protestors across the political spectrum came out against corruption in Lebanon.  Meanwhile, in Chile, protests against a fare hike for public transportation are expanding rapidly.  The Pinera government has rescinded the hike but unrest has continued, enough to trigger state-of-emergency declarations.  Eight people have reportedly been killed in the rioting.  Protests have emerged in other South American nations, including Argentina and Ecuador.  The common themes in these protests are opposition to corruption and a reaction against austerity.  We are continuing to monitor Hong Kong, although we suspect that, in the end, Beijing will bring things under control.  The unrest in Chile is escalating and the government’s reaction has been rather harsh.  Chile has been one of the most stable nations in the region, so civil disorder there does raise concerns.  Lebanon is divided, therefore small protests can spin into big ones relatively quickly.

Elections: The Swiss held elections over the weekend, in which the Greens had the best showing.  The center-right will continue to dominate the government.  Vote counting continues in Bolivia.  It appears the vote will be inconclusive and a run-off will be necessary, although the fact that election officials stopped updating results has raised concerns of a “fix.”  Canadians go to the polls today in a race that is too close to call.  Argentina will hold its elections next week.

Germany: The Bundesbank said the country’s economy may have contracted in the third quarter.  If so, it would mean Germany has entered its first recession in six years.  That confirms the view of most analysts, and it suggests continued weakness in the overall Eurozone economy and strong headwinds for Eurozone stocks.

Global fiscal policy: At the annual meetings of the IMF and World Bank over the last week, multiple finance ministers and central bankers suggested the threat of further slowing in the global economy calls for increased fiscal stimulus.  The officials specifically noted that easy monetary policy is now probably at the limit of what it can do to support the economy.

China trade: There was some optimism expressed by China on the progress of trade talks.  However, there were no details offered.  The optimism is helping equities this morning.

Syria: U.S. troops are decamping for western Iraq, although the administration is considering leaving a small contingent in Syria.  Kurdish forces have withdrawn from the border as part of the ceasefire agreement.

Odds and ends: JP Morgan (JPM, 120.56) is announcing a new plan to reintroduce those with criminal backgrounds into the workforce.  Some of this is likely part of recent announcements by the Business Roundtable to move beyond mere shareholder interest in setting policy, but it is also possible that tight labor markets are prompting the move.  Although fears have eased, there are still worries about financial market liquidity.  One of the characteristics of cyberwar is that it can be difficult to determine the source of the attack.  Russia has taken this a step further, instigating attacks and making it appear that Iran was behind them.  It’s getting so hard to find financing in the shale oil patch that some firms are turning to directly securitizing wells.  This action effectively turns ownership of the well over to a special purpose vehicle which pays out production revenue to bondholders.  These bonds could have some interesting characteristics; rising oil prices might actually boost the value.  At the same time, it would shift a number of risks to bondholders, including faster decline rates and regulatory changes.  Mario Draghi presides over his last ECB meeting on Thursday.

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[1] Although there are 650 seats in Parliament, the Commons Speaker and his three deputies don’t vote.  And, Sinn Fein has seven seats in Parliament but refuses to sit in the House of Commons.  That means there are effectively 639 seats, so 320 will pass a measure.

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

[Posted: 9:30 AM EDT]

Note: After a long hiatus, we have resumed podcasting.  Our new series, titled The Confluence of Ideas, begins with an overview of “Hegemonic Stability Theory” (the program title links to our podcast page).  Our plan is to record a new episode about every 10 days, or three per month.  We hope you enjoy them—let us know what you think!

Happy Friday!  China GDP growth eases.  Ceasefire in Turkey.  Here are the details:

China:  Third quarter GDP was up just 6.0% year-over-year, compared with annual increases of 6.2% in the second quarter, and 6.4% in each of the two quarters before that.  The growth rate in the third quarter was not only weaker than expected, but it was also the slowest expansion in some 30 years.  The slowdown stemmed primarily from the U.S.-China trade war, cooling manufacturing investment and weaker income growth; along with the simple fact that the economy is much bigger, and more mature than it was during its peak growth period in the early 2000s.  Of course, China’s true growth rates are widely considered to be even weaker than the official data indicates.  The really intriguing thing about today’s report is that the government was willing to release such a weak number.  Along with its generally limited stimulus measures in recent months, this could reflect a deliberate decision to signal that slower growth is now acceptable and won’t necessarily lead to new fiscal, or monetary policy responses that might worsen the country’s debt load.  The data has therefore weighed heavily on Chinese stocks today, driving them sharply lower.

U.S.-China Trade:  Right before the latest round of U.S.-China trade talks early this month, National Economic Council Director Kudlow arranged for a group of outside economists to meet with President Trump and explain how trade uncertainty is hurting the economy.  Tellingly, Trump reportedly pushed back, blaming the Federal Reserve for not doing enough to boost the economy.  All the same, it is possible that the economists’ message helped convince the president to strike the partial deal with the Chinese.  The question is whether the message will stick long enough to prevent a reversion to Trump’s tough tactics against China.

Ceasefire:  Turkey has agreed to a five-day ceasefire on the southern border, which eases the threat of U.S. sanctions.  However, there are reports that suggest the agreement is already being violated as shelling and drone strikes have apparently occurred.  It appears to us that it is unlikely Turkey will “take its foot off the gas pedal” in this fight, so even this limited ceasefire probably won’t be strictly followed.

Brexit:  There isn’t a whole lot more to say on this topic.  The vote will occur at 4:00 pm (11:00 am EDT), on Saturday.   The law needs the vote of 325 MPs.  So far, Johnson has 287 with certainty.  The DUP’s 10 MPs have already indicated they won’t support the measure, and Johnson pushed 23 former Tories out of his party.  It is expected that a majority of these 23 (not included in the 287) will likely support the measure.  Thus, to push this through, he needs some Labour support.  The FT’s current estimate suggests neither side has this locked up; their headcount is 321 against, 318 for.  That means that Johnson must woo seven of the remaining 11 undecided MPs to pass his plan.  The prediction markets still have the measure failing, 40% to 60%.  However, the odds have improved over the past 24 hours, from a 26% chance of passage.  If the measure fails, the Benn Act requires that Johnson ask for an extension from the EU; we do expect it to be granted, but there is no guarantee it will be.  BREAKING:  FRENCH PRESIDENT MACRON INDICATES HE WILL REJECT AN EXTENSION.   If one of the remaining 27 nations in the EU votes against an extension, a hard Brexit on Halloween would be looming.  Our take?  The chances of more Labour defections is elevated and the chances of passage with a close vote may be higher than it looks, while the possibility of a hard Brexit may move some votes to Johnson’s side.

Japan:  Prime Minister Abe’s cabinet has approved draft legislation that would require foreigners to advise the government before buying more than 1% of Japanese defense-sector stocks.  The move shows how protectionism is moving beyond trade and into the realm of international investment.  As we’ve been discussing recently, similar moves are afoot in the U.S. Congress, with the potential to seriously alter the makeup of the U.S. bond and stock markets as well as the prospects for the dollar.

Japan:  Defense Minister Kono said Japan will send naval ships and patrol planes to the Gulf of Oman to help protect oil shipments through the area.  However, reflecting Japan’s growing confidence in its large and capable navy, the Japanese forces will operate independently rather than joining the U.S.-led coalition being formed to help with that task.

The strike:  Although negotiations between General Motors (GM, 36.19) and the UAW have reached a tentative agreement, the union has decided to maintain the walkout.  This is a bit unusual; normally, once a deal is reached, the union calls off the strike on the assumption that the rank and file will approve.  The agreement, from our reading, doesn’t appear to be all that firm on future jobs; there was no detail released on future investment, and no guarantees on bringing jobs back from Mexico.  Thus, even though there is more money for workers in the proposed contract, passage isn’t certain.

Odds and ends:  Bolivians go to the polls on Sunday to decide if Evo Morales will get a fourth term (a violation of the constitution).   Germany expresses concern over a U.S./EU trade conflict.  China has acquired a lease to the entire island of Tulagi, a major potential threat to Australia and New Zealand.   After the Senate failed to overturn a veto on wall funding, a budget battle looms that could shut down the government next month.  Saudi Arabia has delayed the Saudi Aramco IPO.  Protests against the jailing of Catalan-independence leaders continues to worsen, including violent clashes with police in Barcelona and elsewhere in the region.  However, the violence is starting to cause cleavages in the independence movement.  It is also further weakening the ruling Socialist Party ahead of the elections on November 10.

Energy update:  Crude oil inventories rose 9.3 mb compared to an expected build of 3.1 mb.

In the details, U.S. crude oil production was unchanged at 12.6 mbpd.  Exports fell 0.2 mbpd while imports rose 0.1 mbpd.  The rise in stockpiles was mostly due to continued declines in refinery demand (see below).

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.

The most important information from this week’s data is that we are now well into the autumn refinery maintenance season.

The drop in refinery utilization should end with this week’s data.  However, the decline refining is well more than normal and is having a bearish effect on oil prices.

Based on our oil inventory/price model, fair value is $62.41; using the euro/price model, fair value is $47.31.  The combined model, a broader analysis of the oil price, generates a fair value of $51.74.   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] The EU and the PM Johnson have a deal.  Trade news continues.  Interesting items emerging from the financial markets.  Here are the details:

Brexit:  In the wee small hours of the morning (at least in the U.S.), EU and U.K. negotiators made a deal on Brexit.  Here are the key points:

1. The deal is mostly what PM May delivered with one key difference. The May deal forced the entirety of the U.K. to remain in the EU customs union.  Under Johnson, only Northern Ireland is still in the customs union.  In effect, there is a trade barrier between the British Isles and the Irish Sea.  As we suggested earlier, there was a clear chance that Johnson would sell out the DUP to get a deal.  It looks like he did.  The U.K. will now be able to negotiate new trade agreements with other nations, but Northern Ireland won’t be included in whatever arrangement emerges.
2. The DUP has already come out in opposition. This is to be expected.  However, it should be noted that of the 18 seats in Northern Ireland, seven lean republican (support union with Ireland) and so those seven will likely support the deal.  After all, Northern Ireland’s economic position is enhanced; it will be a member of both the U.K. and EU customs unions and there won’t be a hard border with the Republic of Ireland.  However, for the Unionists this deal is terrifying because it does separate, at least in economic terms, Northern Ireland from the U.K.  That is a step toward unification, although it may be a minor one.
3. At the same time, the DUP rejection will have an effect on hardline Brexit supporters within the Tories. When the DUP rejected May’s proposal, this group (the “European Study Group”) also rejected her plan.  Johnson has to sway this faction without DUP support—not impossible, but not easy either.
4. Johnson agreed to language of “maintaining a level playing field” with EU regulations. In theory, this agreement would prevent the U.K. from becoming the “Singapore on the Thames,” a U.K. that is deregulated and thus a threat to the cozy regulated world of the EU.  However, this promise is in the political section and is non-binding.  Elements of Labour that want Brexit, but want to avoid deregulation might take comfort in this agreement and vote for the deal.  Elements of the Conservatives (and the Brexit party) that want the “Singapore” option will have to trust Johnson, and believe these are simple “weasel words.”
5. The EU will need to accept this deal. All 27.  We suspect they will, but nothing is guaranteed.
6. Johnson wants the EU to signal it won’t give the U.K. an extension, thus framing this weekend’s vote in Parliament as either “Johnson’s deal or hard Brexit.” So far, the EU has not supported this position.  We would not expect them to, but if Juncker does deliver this for Johnson, it would give him tremendous leverage.
7. The GBP initially rallied on news of a deal but has fallen rather sharply on fears thar Parliament will, like it did with May, ultimately reject it. Or, Parliament will require amendments, e.g., approval only after a referendum.  So, there is still risk that this could all fall apart.  Johnson needs 320 votes.  He may not be able to pull this off.   He will likely need Labour votes to win and if Johnson’s deal is passed, he will almost certainly win new elections.  However, if Johnson can get the EU to make this vote on Saturday either by deal or hard Brexit, he might just pull it off.

European Union:  Illustrating how the Brexit deal will affect EU politics, German Chancellor Merkel said Britain’s exit from the union will leave her country with an “excessive burden.”  She therefore demanded that Germany get a rebate from the EU budget.  Given that Germany’s relative weight in the EU will rise after Britain leaves, she may well get what she demands.

European Central Bank:  In a speech yesterday, Bundesbank Chief Weidmann warned against a broadened stimulus policy that many think incoming ECB Chief Lagarde may consider, i.e., buying government bonds in return for infrastructure, or climate change investment.  That adds to similar pushback from French, Dutch and Austrian central bankers.

United States:  The United Auto Workers and General Motors (GM, 36.65) have reached a tentative deal on a new labor contract, although the ongoing strike could continue for as long as two weeks until union leaders approve it.  Whatever the final outlines of the deal, we think the union’s ability to hold out for a full month is a signal of rebounding power for organized labor.  If that rebound continues and broadens, it could eventually become a significant headwind for corporate margins, playing into the environment of greater regulation and increased inflation pressure that we think will evolve over time.

China:  Even if a truce is reached in the U.S.-China trade war, the Chinese government will struggle to reignite growth with fiscal or monetary stimulus measures.  At a conference of local-government development funds this week, officials complained that even if they were given more money, they are running out of attractive infrastructure projects to invest in.  That serves as a reminder that China’s economic slowdown doesn’t just reflect the trade war; it also reflects the fact that the economy is maturing and now has fewer attractive investment opportunities than before.

China:  Based on a survey across 18 cities, Cushman & Wakefield estimates China’s commercial real estate vacancies stood at 20.0% in the third quarter, up from 16.7% in the third quarter of 2018.  The consultancy said the rise in vacancies came not from excess building, but from weaker demand amid the continuing U.S.-China trade war and economic slowdown.

Saudi Arabia:  Confirming our view that the successful missile and drone attacks on Saudi oil facilities last month reflect incompetence, U.S. officials revealed they have struggled to convince the Saudis to upgrade their air defense systems.  According to one official, “We’ve told them their defense system was not up to speed.  But their defense apparatus [and] their central command lack competence.”  Even though the attacks failed to give a lasting boost to oil prices, systemic vulnerabilities in the Saudi air defense network and Iran’s desire to cause pain suggests we may see an even bigger attack from Iran in the future, which could have a larger, more lasting impact on the oil markets.

Odds and ends:  Scotch distillers, facing a tariff jump, are air freighting their precious liquid to the U.S. to beat the deadline.  There has been some rather interesting market action recently.  First, there has been a slew of profitable large option trades that have benefited from policy statements made by the Trump administration.  There are probably three potential reasons (a) insider leaks, (b) really good algorithms, and (c) there have been a number of these positions that haven’t worked but we don’t hear about those.  We reserve judgement for now.  Second, Eurodollar futures options traders are placing bets on negative interest rates.  We doubt these will be profitable, but the fact they are being made is newsworthy.

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

[Posted: 9:30 AM EDT] The IMF gives details on weakening global growth.  Brexit is at a crossroads.  Trade tensions with China remain.  Update on Syria.  The National League has its pennant winner; the Cardinals, meanwhile, have much in common with private equity.  The latter spent billions on alleged unicorns that turned out to be donkeys wearing traffic cones on their heads; the Cardinals spent millions on alleged hitters…anyway, here are the details:

Global growth:  As we went to the deadline yesterday, the IMF had just released its updated global economic forecast for 2019 and 2020.  The details are sobering.  The body described the world’s economic situation as “precarious” and reduced growth rates for this year to 3.0%, down from 3.3% in its April forecast.  That would be the slowest growth since 2009.  Next year’s growth is forecast for modestly better, at 3.4%.  The IMF blamed the trade wars and slow monetary policy responses for the downgrade.  World trade is forecast to fall to a 2.5% growth rate, with 90% of the world’s nations looking for slower growth.   The U.S. saw its forecast rise to 2.1% from below 2% in April.  China is forecast to see growth fall below 6% this year.

If trade tensions were to ease, growth would likely recover.  However, such a shift isn’t likely, or expected.   For most of the postwar period, a weaker U.S. economy could drag the rest of the world into lower growth, but the reverse wasn’t necessarily true.  However, due to increased global integration, there is a higher probability that a slower world economy will adversely affect the U.S.

Brexit:  Talks between the U.K. and EU continue, but the problems that bedeviled Theresa May’s Brexit plan have resurfaced for Boris Johnson.   The EU’s red line is no hard border on the Ireland/Northern Ireland frontier.  Johnson seems amenable to that outcome, but has to craft a plan that effectively jettison’s Northern Ireland without the Unionists discovering it.  So far, Johnson also hasn’t managed that hurdle, although the DUP in his government have not rejected the proposal out of hand.  In fact, the DUP may be swayed, in the end by money; there are reports that the Unionists are asking for “billions, not millions” to secure their votes.  Johnson’s problem, like May before him, is all about votes. His plan isn’t attractive enough to bring in votes from outside the Tories, so he needs the Unionists to pass the plan.  Another issue has emerged; Johnson’s vision of the U.K. after Brexit is far different than May’s.  The latter saw Britain apart, but similar to Europe; the former sees the post-Brexit U.K. as a low tax, low regulation alternative to Europe, an outcome that gives EU leadership the willies.  Additionally, there is another complication—Labour is warming to the idea that it might support Johnson’s plan, but only if it includes a second referendum; in other words, the Johnson plan would get tentative approval but only after the public confirms it.  The GBP has eased from yesterday’s strong rally on worries over talks.

China and trade:  The House has passed the Hong Kong Human Rights and Democracy Act; if passed, it would require the executive branch to determine whether political developments in Hong Kong justify its special treatment as a separate trade area.  Beijing, not surprisingly, isn’t happy with this development, threatening unspecified retaliation if it becomes law.  As we noted yesterday, Beijing is pressing the U.S. to rollback $ 50 bn of existing tariffs before agreeing to buy U.S. agricultural products.  Increasingly, there are doubts China will buy all these products anyway.

The Turkish incursion:  The White House continues to take criticism from both wings of the establishment, with strong exception being taken about the impact of sanctions.   VP Pence and SoS Pompeo are in route to Ankara to try and sell Turkish President Erdogan on a ceasefire.  We doubt the U.S. delegation will have much success.  The real worry is whether Russia and Turkey will end up in a direct conflict.  If that were to occur, it would involve a NATO member and the question is, if Article 5 were invoked, would the rest of NATO come to Turkey’s aid?  If NATO demurred, it would seriously question the security guarantee that NATO membership provides, and give Putin something he has desired all along; to break up NATO and give Russia the opportunity to retake eastern Europe.

Repo Rebellion: Following the Federal Reserve’s decision to expand its balance sheets, money market funds, who are among the largest holders of US treasury, have expressed resistance to the measure. Because money market funds are only able to buy assets with no more than 13 months of maturity, it would be more profitable for them to hold on to the US treasuries as opposed to selling its share of treasuries to the Fed and then going back into the market to buy debt with potentially lower yields. The resistance from money market funds will likely add to the angst of the Federal Reserve, as attempts are made to get cooperation from financial institutions to resolve the liquidity concerns in the repo market.

Odds and ends:  France has given a non to Albanian and Northern Macedonian bids to join the EU.  There are an increasing number of areas where a $100k income isn’t enough to buy a home.   Kim Jong un mounted a strong steed as a show to highlight the anger of the North Koreans over continued sanctions.  North and South Korea played to a 0-0 draw in a World Cup qualifying match in Pyongyang in front of an empty stadium.  Apparently, the North Korean leadership was uncomfortable with the potential loss to its southern rival so it implemented a news blackout and didn’t allow spectators.  In the Democratic Party debates last night, the tech sector was a prime target.   There are reports that confirm the U.S. responded to the Iranian attack on Saudi Arabia with a cyber strike.

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[1] We know, “dog bites man,” right?

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

[Posted: 9:30 AM EDT] Commercial bankers come back to work today.  The Middle East is a mess, but oil prices haven’t budged.  There was little progress on Brexit, but hope remains.  The Chinese trade deal continues to hit snags; China also released a batch of economic data.  Here are the details:

BREAKING:  IMF LOWERS GLOBAL GROWTH FORECAST TO 3%, LOWEST SINCE THE GREAT FINANCIAL CRISIS. 

Middle East:  The Turkey/Syria situation is devolving at great speed.  As we noted yesterday, Syria and Russia have become the Kurds new ally against Turkey.  The likely cost to the Kurds?  Living again under Assad’s control.  The U.S. imposed sanctions but they were less onerous than feared, and the TRY rallied on the news.  A Saudi diplomat called the U.S. action in Syria a “disaster.”   Russia is working to fill the power vacuum– Alexander Lavrentiev, Russia’s special envoy to Syria, said Turkey’s invasion of northern Syria is unacceptable and was not agreed with President Putin in advance.

As our most recent WGR notes, the Carter Doctrine has been in trouble since 9/11.  What we are seeing now is the logical conclusion of a path we have been on for nearly two decades.  What is happening in the Middle East is a foreshadowing of what will eventually occur in Europe and the Far East.  We suspect that two areas of the world are watching what is happening to the Kurds with great interest—the Baltic states and Taiwan.  They have to wonder if the U.S. will back them from Russian or Chinese aggression.

Chinese trade:  China still hasn’t called last week’s meeting a “deal.”  This reluctance is partly due to China’s concern that President Trump won’t adhere to any agreement.  Our suspicion of what is happening to the U.S./China relationship is strategic ambiguity isn’t working anymore.  For years, both China and the U.S. would say the same things, but mean something quite different; as long as the “bluffs were not called” this didn’t matter much.  Now, the U.S. is forcing clarity, something China isn’t used to.  A new example emerged today.  The U.S. believed that in return for delayed tariffs (that were set to begin yesterday), China was to buy $50 bn of U.S. agricultural products.  Today, China suggested that to be able to make these purchases, the U.S. will need to roll back some of the tariffs currently in place.  China has also indicated it wants more talks before signing any agreement.  Meanwhile, Treasury Secretary Mnuchin has indicated that if a deal isn’t signed next month at APEC, the U.S. could go ahead and implement tariffs announced for mid-December.  The problem with these negotiations is that both sides think they have the upper hand and can, at some point, dictate terms.  As long as this condition exists, getting a deal done will be difficult.

China economic data:  China’s CPI rose 3.0%, a bit more than forecast, driven mostly by an 11.4% jump in food prices.  Pork prices rose 69% from last year, a key factor in the rise of food prices.

Meanwhile, PPI is still deflating.

Total credit grew 12.5% from last year, in line with the past three months.

Overall, the data shows that China has a serious food inflation problem; the fact that it is trying to negotiate lower tariffs in the face of a nearly 70% rise in pork prices is remarkable.  At the same time, deflation at the producer level is a warning sign of weaker growth, and likely reflects problems tied to the trade conflict.

 

Brexit:  We are seeing conflicting messages coming from the EU.[1]  The Finnish PM Antti Rinne, currently the EU’s president (it rotates among members) said overnight that the talks “need more time.”  However, the EU’s chief Brexit negotiator, Michel Barnier, suggested that a withdrawal deal is still “possible.”  We continue to believe that if Johnson wants a deal before Halloween, he has to “lose” Northern Ireland; in other words, he has to put the trade border at the Irish Sea and leave Northern Ireland in the EU customs union.  His current plan is trying to finesse this outcome by leaving Northern Ireland in the U.K. trade zone but adopting EU trade rules depending on the destination of the export or import.  If Johnson doesn’t abandon the Unionists, he will face new elections with a viable Brexit party on his right flank.  We suspect that Johnson will eventually abandon the Unionists which would give him a strong position in upcoming elections.

 

Global Bond Markets:  In his first investment outlook since retiring in March, former PIMCO bond king Bill Gross said that with a global bond market dominated by negative-yielding bonds, investors should favor stocks with a secure dividend.  However, he also warned that future stock price gains are likely to be muted as the impact of falling interest rates fades.

 

Odds and ends:  Spain is in turmoil after a Spanish court jailed pro-independence Catalan leaders.  The decision will complicate November elections.  Although Poland’s populist PiS party won the weekend’s election, it failed to control the upper house, making its win less impressive.  Although we rarely comment on U.S. elections this early, we are closely monitoring developments.  Apparently, Mayor Bloomberg is noting that the establishment “lane” may be opening and is considering running for the Democratic Party nomination.  The 2020 election has the potential to be as divisive as the 1860 election due to stark divisions among American voters.

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[1] We know, “dog bites man,” right?