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

[Posted: 9:30 AM EDT]

After a wild day yesterday, markets are rather quiet.  The FOMC meeting starts today, the new Saudi energy minister is conducting his first press conference at 1:15, and Israel is holding elections.  Here is what we are watching this morning:

The aftermath of the Saudi strikes:  Here are three items we are following in the wake of the missile and drone attack on Saudi oil facilities:

1. The retaliation issue—although President Trump suggested the U.S. was “locked and loaded,” it appears he is not in a hurry to escalate the situation. Although the president says it “appears” Iran was behind the attack, he also indicates he does not want war.  In addition, the White House seems to be suggesting the U.S. is going to be led by Saudi Arabia’s decision on Iran.  Part of the reluctance is probably due to the lack of attractive alternatives.  It is hard to see how the U.S. could find additional economic sanctions (Iran is heavily sanctioned already), and mere sanctions would look like a weak response to a historic attack.  A blockade against Iran is an option, but how one determines when “victory” is achieved is difficult.  In other words, what would have to occur to lift the blockade?  Additionally, a blockade could put U.S. Navy vessels in harm’s way.  Limited airstrikes against the Iranian defense industry (to weaken its capacity to build missiles and drones) is probably the most likely response, but that action could escalate.  The president doesn’t want a war this close to an election that could spike oil prices and undermine his reelection chances.  Also, like his predecessors, he would really prefer less involvement in the Middle East.  However, as we noted yesterday, doing nothing or something less than a proportional retaliation runs the risk of ending the Carter Doctrine.
2. The negotiations issue—the Ayatollah Khamenei has announced that there will be no talks on any level with the U.S. This decision effectively ends any chance of a diplomatic solution.
3. The “how did this happen” issue—one of the unanswered questions is how did the Saudis not have adequate defense against this attack? The KSA’s defense spending ranks third in the world with total defense spending and first relative to the GDP, at 8.8%.  We haven’t seen much written on this issue, other than Russia’s offer to sell the KSA the S-400 system.  In our estimation, there are two potential reasons why the kingdom was unable to protect these key facilities from a combined drone and missile strike.  First, pure incompetence.  The leadership was more concerned with a terrorist or ground attack and simply didn’t consider this sort of strike.  Thus, the defense that was purchased was inadequate.  Second, the defense system was adequate but was disarmed by a cyber-attack.  If the answer is the first reason, it’s inexcusable.  If it’s the second, it’s terrifying because it means that missile defense systems are vulnerable.  We don’t know the answer to this issue but will continue to watch for information.

What now?  OPEC and Russia appear to be using this event to drain global inventories.  OPEC and Russia’s output policy has been designed to slowly reduce global stockpiles; with the KSA partially offline, the cartel appears to be using this situation to accelerate the process.  If so, this should keep a bid to oil prices.  We note that the KSA has already signaled to customers that October oil loadings will be delayed.  The risk of much higher prices is tied to the U.S. response to this attack.  At this juncture, the White House is exhibiting caution, which reduces the odds of a spike.

Venezuela heats up:  The situation in Venezuela has become a stalemate in recent weeks.  The U.S. has mostly exhausted economic sanctions and the Venezuelan economy is moribund, so additional measures probably won’t have much of an impact.  The U.S. has no interest in a military response.  However, we are seeing tensions rise between Colombia and Venezuela.  The former is accusing the Maduro regime of harboring guerrillas, and of planning bombings against Colombia’s capital, Bogota.  Leaders in the region are calling for the activation of the 1947 Rio Treaty, a mutual defense treaty among Latin American countries.  We will be watching to see if a group of nations in the region will build a military force to remove the Maduro regime.  Although Venezuela’s oil production has declined precipitously, Colombia does produce 0.9 mbpd and a conflict could reduce supplies in an already tight world.

Islamic State:  Secretive ISIL leader Abu Bakr al-Baghdadi issued an audio message urging his followers to redouble their fight against nonbelievers, and their efforts to build an Islamic caliphate, in spite of the group’s severe weakening and loss of territory.  The message is a reminder that ISIL hasn’t been completely destroyed, and that it will probably continue to pose a terrorism threat in the near term.

Trade:  Liao Min, China’s vice-minister of finance, is in route to Washington to begin preliminary trade talks.  USTR Lighthizer remains committed to a comprehensive trade agreement with China, something that China does not appear to want.  Again, this issue underscores the differences within the Trump administration on trade; the Lighthizer/Navarro wing want a broad agreement that will encompass not only trade but intellectual property and security, while the Mnuchin/Kudlow wing want a narrow agreement that only affects trade.  The president vacillates between the two camps.  In general, we watch Lighthizer; if he does not get his way, we would expect him to resign and if he does, we will get a narrow deal.  If he stays, we doubt China will agree to anything before the elections.  Meanwhile, the U.S. and Japan appear to be near a trade agreement.

Hong Kong:  Illustrating the negative impact of the continued anti-Chinese political protests, and the threat of a violent Chinese crackdown, private investors are reportedly pulling millions of dollars of gold out of Hong Kong.  The pullout not only reflects concerns that China could restrict capital outflow from the city, but also that protests at the municipal airport and other facilities could impede shipments.

Italian politics:  Just after the center-left and populist-left formed a government, former Italian PM Matteo Renzi announced he is leaving the center-left Democratic Party to create a new centrist group similar to what Macron has created in France.  His decision will weaken the current coalition, and could end up bringing down the government.  We are seeing a backup in Italian sovereign yields this morning.

Russia:  Another powerful Russian has floated the idea of amending the country’s constitution to allow President Putin to stay in power after his current term ends in 2024.  Sources close to the Russian leadership say Putin currently thinks he and his United Russia Party are strong enough that they don’t need to worry about the future yet.  However, the Russian oligarchs and others who have profited from the Putin regime are worried about losing their favored positions, so they’re laying the groundwork for legal changes that could keep Putin in power.

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

[Posted: 9:30 AM EDT]

It’s Fed week, but the big news is that financial and oil markets are roiled by an attack on Saudi Arabia’s (KSA) oil infrastructure.  Here is what we are watching this morning:

The attack of the Houthis?  Houthis in Yemen have claimed a massive attack on Saudi Arabia’s oil infrastructure.  Here are the key points:

1. Initial reports indicated that 5.7 mbpd of crude production was lost, or about 58% of the KSA current output. Saudi officials have indicated that they expected to bring about a third of that production back early this week. However, recent reports suggest that outlook may have been overly optimistic.
2. The attacks appear to be strategically sophisticated as 19 different points of impact were reported. First, the processing facility at Abqaiq was struck.  This facility processes 7.2 mbpd of oil; therefore, even if Saudi fields continue to pump oil it can’t be exported until this facility is restored.  Second, 1.2 mbpd of the Khurais oil field was also damaged.  About 18% of the KSA’s natural gas production is offline, as is 50% of its NGLs that were affected.
3. Although the Houthis have claimed responsibility for the attack, there is a great deal of skepticism about this claim. Secretary of State Pompeo blamed Iran shortly after the attack.  Iran has categorically denied this claim.  Regional media sources claim the attacks came from Iraqi soil, which the Iraqis have denied.  The White House has released photos that suggest the attack came from the north or northwest, which are casting doubt on the Houthis’ claim.  In fact, the attack appears to be sophisticated enough that it probably exceeds the Houthis’ capability.  This factor alone increases the odds that this either came from Iran or from a close proxy.
4. We now will watch closely to see how the administration responds. President Trump indicated he was “locked and loaded.”  Iran may have misjudged the president, exhibiting a classic mistake that foreign nations have historically made about the U.S.  The Jacksonian streak that runs through American foreign policy has befuddled foreign adversaries before.  The Jacksonians appear to be isolationists and thus can be taken advantage of; the president’s decision to back away from an earlier missile attack may have emboldened Iran into thinking that it could get away with the escalation.  However, Jacksonians will defend their honor, thus a military response is likely if the president concludes that this act besmirches America honor.  As we note below, we still believe the president wants to avoid a military confrontation, but if he feels he is personally being challenged then all bets are off.
   1. At a minimum, this attack will end any chance of talks, at least in the near term.
   2. If Iran is implicated, it will be hard for Europe to continue to maintain the Iranian nuclear deal.
5. Here is our “back of the envelope” analysis of the oil situation. OPEC has been producing around 29.9 mbpd; its total capacity is about 34.6 mbpd.  Thus, at first glance, this problem appears manageable.  The loss of Saudi production is 5.7 mbpd but excess capacity is 4.6 mbpd.  Thus, the world only needs 1.1 mbpd, which could easily be filled from the OECD’s SPRs around the world.  However, it isn’t that simple:
   11. Although the KSA’s capacity is thought to be 11.5 mbpd, it is still likely that much of that oil would still need to flow through Abqaiq. Thus, a conservative estimate would have to assume that the KSA’s current full production is probably closer to 4.1 mbpd, at least initially.  We would expect some of that capacity to be restored in the near term, although full recovery may take months.
   12. If our back of the envelope analysis is correct, this action against the KSA cuts OPEC excess capacity by 7.4 mbpd.
   13. In addition, 1.6 mbpd of the cartel’s excess capacity resides in Iran. It is unlikely the U.S. will lift sanctions on Iran now as excess capacity is down 9.0 mbpd.
   14. Taking this all into account, a rough estimate is that OPEC can now produce around 26.6 mbpd. That means the world must find 4.4 mbpd of lost production.
   15. Essentially, the world oil market is now running without any buffer. For most of the history of the oil market, some producers have held production off the market to stabilize prices.  This offline capacity has acted to dampen price spikes when events occur.  The world mostly relies on the KSA for maintaining this buffer.  For the time being, that buffer is missing which means price volatility will rise.
6. The loss of a buffer turns our attention to the Strategic Reserves (SPR). The estimated operational drawdown capacity of the U.S. SPR is 4 mbpd.  It takes about 13 days from the time a presidential order is made until oil begins to reach the market.  The SPR has never had a sustained drawdown of this magnitude and thus, we don’t know for sure if it will work.  At the same time, given high U.S. production and rather elevated levels of commercial inventory, the likelihood of an extended supply shock is rather small…if consumers act rationally.  However, that is a heroic assumption.  The reason the OECD, through the auspices of the IEA, created the SPR system was to prevent hoarding.  In theory, in the case of a global supply shock, the IEA “coordinates” the SPR response.  Since the SPR system has never been tested on a drop of this magnitude, it is unclear if the IEA members will actually allow the IEA to coordinate the national SPRs.  In theory, the IEA could direct the U.S. to sell SPR oil to Paraguay to relieve a shortage there.  The idea that U.S. taxpayers would not have access to the oil they paid for so that Paraguay could avoid a price spike is politically unlikely.  The economic reasoning behind coordinating the SPRs is to discourage hoarding, but if the SPRs become mere national stockpiles, hoarding behavior is likely and the price spike could have legs.
7. This attack is a potential test of the Carter Doctrine. The Carter Doctrine states that the U.S. is prepared to use military force to defend its interests in the Persian Gulf, originally a response to the Soviet Union’s invasion of Afghanistan in 1979.  The U.S. response to Iraq’s invasion of Kuwait in 1990.[1]  It has even been claimed that the Carter Doctrine was used to justify the 2003 Iraq War.  If SoS Pompeo’s allegation that Iran was responsible for this attack, the Carter Doctrine would seem to argue that a military response against Iran is warranted.  It is certainly possible that the Houthis did launch the attack, but even so they likely procured the drones from Iran.  So, we could end up with one of two scenarios:
   1. The Carter Doctrine is enforced and we see military action against Iran—at least airstrikes against Iran’s defense industry, the part that makes drones, would be possible. A military strike would increase uncertainty surrounding oil supplies, at least in the short run, lifting the odds of escalation and pushing prices higher.
   2. The Carter Doctrine is not enforced—this would mean the doctrine is probably no longer operational and would signal a major change in U.S. policy. This decision would lower oil prices in the short run but increase the “normal” level of geopolitical risk in the market, putting a higher premium into oil prices.
8. Our expectation is that the White House, notwithstanding Pompeo’s claim and the president’s comment about “locked and loaded,” would prefer to avoid military action against Iran. Once engaged, it may be hard to contain the escalation and a sustained spike in oil prices could tip a slowing U.S. economy into recession.  Although the Trump administration is facing a decision on the Carter Doctrine, it has been on shaky ground for some time.  The Obama administration’s “pivot to Asia” was a clear signal that the U.S. just wasn’t as concerned about the Middle East.  The shale revolution reduced the need for the doctrine.  Still, it is important when a superpower pulls back from a stated policy.  Clear points of departure force other nations to change policy.  At a minimum, if the Carter Doctrine is defunct, Middle East oil supply becomes less secure.
9. The KSA is no longer a reliable swing producer. To some extent, this attack is “the big one.”  Anyone who has analyzed oil markets has always acknowledged the possibility of an attack on the KSA oil facilities.  Even after repairs and the return of production, forevermore, we will know that these facilities are not completely safe.
10. The timing of this attack was inauspicious. There are two problems.  First, CP Salman had just fired the leadership of the energy ministry and Saudi Aramco.  That means this crisis will be handled by the new, untested leadership.  This crisis would have challenged a seasoned staff, but the odds of a mistake are elevated with an untested group.  Second, the IPO of Saudi Aramco is in doubt; a company that faces these sorts of threats will face a significant discount.
11. Finally, a sustained spike in oil prices will further undermine global economic growth.

Overall, the attack is a new, significant risk factor for not just the oil markets but for the world economy.  It will take a few weeks to determine the significance of this weekend’s activities.

The problem of easing:  As we noted last week, ECB President Draghi’s easing plans were not universally supported.  It appears that at least nine members had some level of misgivings.  This week, Chair Powell has his turn to try to convince the voting members that a rate cut is necessary.  Although we have little doubt that a 25-bps cut is coming, we would not be surprised to see a hint of uncertainty surrounding future cuts.  The financial markets have reduced their expectations of future rate reductions; we might see more if the statement is balanced and does not lean toward further easing.

The chart on the left shows the implied three-month LIBOR rate, two years into the future; the implied rate comes from the Eurodollar futures market. The chart on the left shows the implied rate and the fed funds target on the lower lines with the spread on the upper line.  In general, the Fed tends to ease when the spread inverts.  We have seen a deep inversion recently but the backup in the implied rate would suggest that up to two rate cuts of 25 bps have been withdrawn from the markets.  Still, the implied LIBOR rate suggests that at least three more cuts are still coming.

Perhaps Powell’s biggest hurdle will be convincing the Phillip’s Curve adherents that they should cut rates.  To visualize Powell’s problem, we use the Mankiw Rule, a derivation of the Taylor Rule.  The Taylor Rule is designed to calculate the neutral policy rate given core inflation and the measure of slack in the economy.  John Taylor measured slack using the difference between actual GDP and potential GDP.  The Taylor Rule assumes that the Fed should have an inflation target in its policy and should try to generate enough economic activity to maintain an economy near full utilization.  The rule will generate an estimate of the neutral policy rate; in theory, if the current fed funds target is below the calculated rate, the central bank should raise rates.  Greg Mankiw, a former chairman of the Council of Economic Advisors in the Bush White House and current Harvard professor, developed a similar measure that substitutes the unemployment rate for the difficult-to-observe potential GDP measure.

We have taken the original Mankiw rule and created three other variations.  Specifically, our model uses core CPI and either the unemployment rate, the employment/population ratio, involuntary part-time employment and yearly wage growth for non-supervisory workers.  All four variations compare inflation and some measure of slack.   Here is the most recent data:

This month, all the variations’ estimated target rates rose substantially, a product of rising inflation and tighter labor markets.  All the models now suggest the Fed is too easy, although the employment/population variation is just above the current midpoint implied by the target.  Essentially, even the most easy variation would argue for steady policy.  Powell, likely on momentum alone, will be able to get a rate cut at the meeting but further cuts will likely require more persuasion.

The divergence of opinion about monetary policy is coming from two sides.  The first is the idea that the economy isn’t in all that bad of shape and cutting rates is not justified.  This is the usual problem with monetary policy and the business cycle.  Financial markets give the longest lead but tend to trigger false positives; waiting for the economic data to show a downturn in place usually means policymakers cannot move quickly enough to avoid a recession.  However, the fear is that easing when labor markets are tight might trigger inflation and thus the desire to hold steady will be notable.  The second idea is that monetary policy is exhausted and further stimulation must come from fiscal policy.  We are more sympathetic to this argument, but the problem is that the Western world’s legislatures are deeply polarized and (a) getting a fiscal package passed will be hard, and (b) getting a package passed that is actually effective may simply be impossible.

On a related note, the BOJ is considering further easing, which would require negative nominal interest rates.

On strike:  The United Auto Workers (UAW) is calling a strike against General Motors (GM, 38.86).  The union has instructed some 46k workers to walk off the job, the first action of this magnitude since 2007, when a UAW strike idled 73k workers.  The union is striking over the usual things, benefits and pay, but is also wanted to force the automaker to follow earlier contracts that forbid closing the plants except in an emergency.  Work stoppages have become increasingly rare since the 1980s.  Last year, nearly 500k workers were involved in stoppages.  Including this recent action against GM, the workers involved year to date is 372k.

The increase in labor actions is likely due to the long expansion.  We suspect the UAW leadership wants to make a deal now when the economy is still expanding because it will be much more difficult to press for higher wages in a recession.  In addition, UAW officials are facing investigations from the DOJ; a successful strike could keep the rank in file aligned with the current leadership.

Chinese economy:  The Chinese economy is slowing rapidly.  Industrial production growth fell to the lowest level since the Great Financial Crisis.

Fixed asset investment rose 5.5%, which was weaker than forecast, and retail sales growth eased as well.

All this suggests that China needs further stimulus to avoid additional economic weakness.  There is little doubt that the trade war is adversely affecting China’s economy more than the American economy; however, the issue isn’t so much the level of pain but rather the tolerance for it.  It is our position that Chairman Xi believes China has a higher pain tolerance and that Washington will blink first.

An interesting side note is that Chinese firms are divesting foreign assets, including those in the U.S.  It is unclear what is driving this divestment.  Some of it is likely coming from government pressure to reduce exposure abroad.  There is a desire from Beijing to curb capital flight.  Restrictions on investment are increasing and the change in the investing climate might be encouraging divestment.  But the bigger worry is that firms in China may be facing a cash crunch and they are divesting to build liquidity.  If the latter is the reason, it bodes ill for global growth.

United States-Japan:  In a joint statement that President Trump and Prime Minister Abe will release after their meeting in New York next week, the U.S. will promise not to hike tariffs on Japanese autos.  The leaders will also sign a new bilateral trade agreement.  Up until now, President Trump hasn’t definitively ruled out new tariffs against Japanese auto imports, so the move is a significant sign that the trade tensions weighing on so many other U.S. relationships probably won’t be a problem for Japan in the near future.

Hong Kong:  For the 15^th straight weekend, anti-Chinese protestors launched demonstrations and mass vandalism, underlining their view that Chief Executive Carrie Lam’s withdrawal of her controversial extradition bill was “too little, too late.”  In what may be a new tack by Beijing to fight the protestors and split the pro-democracy movement, editorials in three Chinese state-owned media outlets accused Hong Kong’s property tycoons of hoarding land and driving up real estate prices.  With tensions remaining, the risk of a crackdown by China is likely to continue weighing on Hong Kong’s economy and asset markets.

United States-European Union:  In the longstanding dispute over EU aerospace industry subsidies, the World Trade Organization approved a U.S. request to impose punitive tariffs against some European goods.  If implemented, the new U.S. tariffs could widen the trade war and further undermine confidence and investment in the EU.

Italy:  The new governing coalition of the populist, left-wing Five Star Movement and the center-left Democratic Party has filled out its cabinet positions, putting the traditionalist Democrats in an unexpectedly strong position.  For example, Roberto Gualtieri, a Democratic Party veteran and EU insider, has gotten the post of finance minister.  The new government is widely expected to loosen fiscal policy in an effort to boost the economy, just as the previous coalition between Five Star and the right-wing League sought to do, but the new government is likely to get substantially more leeway from the EU, which should help calm some of the volatility in Italian assets that was common over the last couple of years.  To illustrate how the new coalition might be more different in tone than in substance, the government allowed a charity ship with 82 rescued African migrants to dock in Italy over the weekend, but only after requiring it to first wait six days at sea while it negotiated with other EU countries to take some of the refugees.

United Kingdom:  Prime Minister Johnson today holds his first face-to-face talks on Brexit with the outgoing European Commission president, Jean-Claude Juncker, and the EU’s chief Brexit negotiator, Michel Barnier.  Johnson is not expected to present a detailed proposal for a new exit deal, but he may float some trial balloons, especially related to his thoughts on keeping Northern Ireland in a customs union with the EU.  There also seems to be some disagreement within Johnson’s cabinet as to whether a Brexit delay might be countenanced.

Tunisia:  Exit polls show outsiders won the first round of the country’s presidential election yesterday.  The top vote gatherers were apparently Kais Saied, a constitutional law professor unaffiliated with any party, and Nabil Karoui, a television tycoon imprisoned for tax evasion shortly before the balloting.  The current prime minister and other mainstream politicians were punished for their inability to improve economic growth and cut corruption since the country launched the “Arab Spring” reform movement in 2011.  If the results are confirmed, Saied and Karoui will face off in the final round of the election on October 13.

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[1] Klare, Michael. (2004). Blood and Oil: The Dangers and Consequences of America’s Growing Dependency on Imported Petroleum. New York, NY: Henry Holt and Company.

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

[Posted: 9:30 AM EDT]

Happy Friday!  It’s a quiet morning with equities continuing to lift on trade hopes.  Should we be worried about inflation?  The day after the ECB.  Here is what we are watching this morning:

Trade:  It looks like an “off ramp” may be emerging, an interim trade deal with China.  As we noted yesterday, the U.S. will delay increasing tariffs on Chinese goods by two weeks to avoid applying the hike on a major anniversary day for the PRC.  President Trump is signaling he might be ok with an interim deal.  Yesterday, we had dueling reports, with Bloomberg indicating that White House sources had said the U.S. was considering a rollback of tariffs and a potential trade peace deal with Beijing.  CNBC ran a report from the White House denying this was true.  China is softening its stance on importing agricultural goods.  If China begins significant purchases, and some buying has apparently commenced, we could see tensions ease.  There is growing talk that negotiators could focus more on the trade deficit, but leave the more contentious issues for later.

This vacillating of tensions is a reflection of internal disputes within the administration.  The Navarro/Lighthizer wing wants significant reforms forced on China.  The Mnuchin/Kudlow wing wants a more modest deal where everyone is declared a winner, which would be welcomed by the financial markets.  The key, of course, is where the president sits, and he tends to swing between the two camps.  The past few months have shown that when financial markets panic, the president reduces the tension.  But, fearing he will be seen as weak on China, he tends to then revert back to a hardline position.  China does appear to want a deal, but only one that would disappoint the Navarro/Lighthizer wing.  It is possible that re-election concerns could push the president toward the Mnuchin/Kudlow wing; however, the president does believe that the trade war with China is a political winner and therefore does not necessarily see the hardline position as a problem.  Our take?  We will probably get more of the same—the cycle we have been seeing will likely continue.

In other trade news, there is a concerted effort from the business sector to get USMCA through Congress.  There is still a high level of opposition in Congress to passing the trade treaty, but progress is being made.

ECB:  Market reaction to the ECB was rather interesting.  The first reaction was that the easing was less than expected—the EUR rallied, bond yields rose and European bank stocks rallied.  Then, traders decided that it was, in fact, a significant easing, and the EUR depreciated, bond yields fell and European banks stocks fell.  After a while, these positions reversed again.  So, what exactly happened?  Draghi did get some significant measures adopted.  But, opposition was strong, especially from the northern Europeans.  This opposition prevented a larger rate cut and higher levels of QE.[1]  German opposition to further easing will likely be formidable.  So, the market’s take is that this latest package may be the last of its kind for a while, and although Draghi was able to get some open-ended elements into the program, Christine Legarde will likely need time in her new office before she can build consensus to do more.  When markets believe a policy has been exhausted, there is often a reversal in trend; the trend in place may need a steady diet of whatever caused it and the trend begins to reverse if that diet becomes restricted.  Essentially, the verdict from the financial markets is that this package is it and thus further weakness in the EUR is less likely.

What about inflation?  The rise in core CPI has raised concerns that inflation may be brewing.  Although the fear isn’t baseless, we don’t expect a major inflation problem to develop.  If one looks at core CPI relative to the ISM Manufacturing Index, the rise we are seeing in the core rate is normal.

Since the turn of the century, the ISM Manufacturing Index tends to lead core CPI by about two years.  The rise we are seeing is “right on time” and we will likely see a rise to 2.5% into next year.  However, about a year from now, inflation should begin to decelerate and fall back below 2% into 2021.  Nevertheless, this rise in the core rate may slow the pace of easing. 

Brexit:  There is a chance that Hungarian PM Orban could come to Boris Johnson’s aid by refusing to agree with an Article 50 extension.  EU decisions require unanimity; a single vote of opposition can kill a deal.  If Orban decides to oppose an extension, Brexit will occur on Halloween.  Meanwhile, it is starting to look like the solution to the Irish problem is to put the EU/U.K. trade border at the Irish Sea, leaving Northern Ireland in the customs union.  The only way this can occur is with new elections; currently, the minority government is still aligned with the Northern Ireland Unionists.  But, if Johnson wins the next election without needing the Unionists, he will be free to deal with them as he sees fit.

Johnson and the outgoing European Commission president, Jean-Claude Juncker, will meet in Luxembourg on Monday.  The meeting marks their first face-to-face talk on Brexit, and with Johnson’s hint this week that he could be open to keeping Northern Ireland in a customs union with the EU, there is probably some chance of a breakthrough.  However, Johnson would have more leverage by dragging negotiations out further, and Juncker is merely a lame duck.  Therefore, the more likely result of the meeting may simply be that it will provide Johnson the opportunity to float more details on his Northern Ireland thinking and sound out Juncker for the EU’s likely reaction.

Meanwhile, Labour is holding party meetings and the Brexit issue is dividing their party as well.  So far, Corbyn has not put out a clear position on Brexit.  If he chooses to champion Remain, he will lose a large share of traditional union voters to the Tories.  If he opts for Leave, he will lose the young urban supporters to the Liberal Democrats.  At some point he will have to choose, but he clearly doesn’t relish having to do so.

France:  Transport workers are on a massive strike today in order to protest President Macron’s proposed pension reforms.  Public transport in Paris is reportedly at a standstill.

Argentina:  The International Monetary Fund is reportedly getting cold feet about releasing a $5.4 billion tranche of its bailout package for Argentina that is due this month.  In part, that’s because of President Macri’s call for creditors to “voluntarily” accept delayed repayment on more than $100 billion of the country’s debt.  In addition, officials worry that the likely winner in next month’s presidential election, Alberto Fernández of the populist Peronist Party, may take an even more radical step toward debt repudiation.  Sources say IMF officials may therefore postpone the disbursal until after the election.

South Korea:  Moody’s has warned that more than a dozen major South Korean exporting firms could have their debt ratings cut in the coming months because of a deterioration in their earnings amidst the U.S.-China trade war.  The companies are mostly in the technology and chemicals sectors.

Japan:  Sources say officials at the Bank of Japan are becoming more open to the idea of cutting the benchmark interest rate even further into negative territory, especially after yesterday’s decision by the European Central Bank to do just that and to launch a new round of bond buying.  The sources say the BOJ would try to focus any further cuts on shorter maturities in order to maintain an upward-sloping yield curve and help ease the pain for financial firms.  That would be especially important amid reports that banks are already considering imposing account maintenance fees on consumer deposits.  In its policy statement last month, the BOJ said it wouldn’t hesitate to take new easing measures if needed.  The earliest it would make such a move would be at its meeting in late October, since officials want to gauge the impact of a planned hike in Japan’s value-added tax on October 1.

Econ 101:  California is moving to deal with its lack of real estate supply by implementing rent control.  Discussing the likely outcome would be a good weekend assignment for someone taking intro economics.

Long bonds?  The Treasury is considering 50-year and maybe even 100-year bonds.  They should, in our opinion.  Yields are low and extending funding would be prudent.  Should investors buy such bonds?  That’s a different story…

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[1] However, another constraint to QE is the fact the ECB is running out of sovereign bonds to buy.  To expand QE further, other instruments will need to be available for purchase, e.g., bank loans, corporate debt, perhaps equities.

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

[Posted: 9:30 AM EDT]

The ECB delivers.  The U.S. is delaying tariffs on China.  Here is what we are watching this morning:

The ECB:  In the statement, the ECB restarted QE to the tune of €20 billion per month and cut deposit rates to -50 bps.  The benchmark rate was left unchanged, meaning negative rates won’t be applied to retail investors.  Forward guidance is now open-ended and results targeted; in other words, stimulus is no longer guided by the calendar (this is similar to how QE3 was managed in the U.S.).  Two new changes were implemented that give this package power.  The first is that negative rate tiering will be introduced.  This is potentially a very powerful tool.  Essentially, even under conditions of negative interest rates, tiering can introduce a profitable lending spread for banks.  For example, if the ECB offers loans to banks at -100 bps, even if banks lend at -50 bps, they are still earning a positive spread.  Using tiering, there is no limit to how low negative rates could go.  The second change is that term lending will be repriced and expanded.

In the press conference, in his prepared statement, Draghi (in his swan song press conference) lowered inflation and growth forecasts, blaming trade tensions between China and the U.S. for lower inflation and growth.  The tweet response from President Trump was noted (see below), but he continues to hew the line that monetary policy in Europe is not designed to guide the exchange rate.  That has been the official line of the G-7 central banks for years, allowing the dollar to weaken during U.S. QE and the weaker EUR and JPY under unconventional stimulus by those nations’ central banks.  Central banks argued that they were conducting policy for domestic reasons only.  Although this line is part of the old regime of policy, under President Trump, the argument probably doesn’t hold.  Next week’s WGR discusses the currency issue in detail.

Market reaction was interesting.  At first, the EUR and rates rose, likely because there wasn’t a cut in the deposit rate and QE was less than expected.  European bank stocks initially rose.  However, as the broader ramifications of the package were realized, bank stocks fell, interest rates plunged and the EUR fell sharply.  The decline in the currency caught the attention of the commander in chief, who remains sharply critical of the Fed.  The decline in the EUR may be the most problematic element of the ECB policy; we would expect the U.S. to refocus on EU trade negotiations, and what looks like a deliberate attempt to weaken the currency will likely trigger a more hostile position from U.S. trade negotiators.

We are seeing a similar reaction in U.S. markets.  Gold prices jumped, Treasury yields fell and equities rose.

Tariff delay:  To avoid applying a tariff hike on the 70^th anniversary of the CPC’s capture of mainland China, the White House has delayed implementation for two weeks, making them effective on October 15.  According to reports, the delay was a direct request from top Chinese trade negotiator Liu He.  Thus, it has the air of a favor.  In response, the Chinese Ministry of Commerce welcomed the move and claimed Chinese buyers were already making inquiries about buying more U.S. agriculture goods.  The apparent baby steps toward reconciliation are welcomed as U.S. and Chinese negotiators prepare for another round of trade talks in the coming weeks.  Hopes of an early end to the trade war are providing a small boost to risk assets so far today.  However, the moves over the last day still seem quite modest to us.  There is still no assurance that the two sides can reach an amicable agreement.

China is attempting to separate trade talks from national security issues, hoping that by separating the issues it can more easily reach a trade agreement.  Separating the issues may prove to be difficult; we note the Pentagon has issued a list of military-linked Chinese companies that the U.S. and allies are expected to avoid for security issues.  Compliance with this list will, by design, affect trade.

Brexit:  It is becoming clear that if a Brexit deal is going to be reached, it will be resolved over the Ireland border issue.  If Johnson gets an election and wins a majority, he would no longer need the DUP.  In that case, we would not be surprised to see him put the trade border in the Irish Sea and put Northern Ireland within the EU, for purposes of trade.  If this happens, it will likely accelerate the eventual unification of Ireland.  Although this document was leaked earlier, the government’s worst case for a hard Brexit is dire.  The Brexit camp argues, with some degree of credibility, that the Remain camp has engaged in “project fear” to scare voters into voting to remain. This document suggests that without planning, a hard Brexit could be disastrous, at least in the short run.

Germany:  The respected Ifo Institute cut its forecast for German economic growth to just 1.2% in 2020 and 1.4% in 2021 as it warns that the continued pullback in the country’s manufacturing will spread to the services sector and push up unemployment.  The slowdown in Germany’s factory sector is by now well recognized, but the idea that it could spread to other sectors has gotten less attention.  As manufacturing also slows in the U.S., a key question is whether that slowdown will eventually start to undermine U.S. services and employment.

Japan:  Prime Minister Abe has named Shinjiro Koizumi, the son of former Prime Minister Junichiro Koizumi, as his new minister for the environment.  Although the younger Koizumi is only 38 years old, and while this is his first cabinet position, the fact that he inherits a political base from his popular father is being taken as a sign that he has a bright future in politics and could even be a possible successor to Abe.

Japan-South Korea:  As part of his cabinet reshuffles, Abe also named Isshu Sugawara as his new international trade chief, and Sugawara has already vowed that Japan won’t back down in the Japan-South Korea dispute over Tokyo’s behavior in Korea before and during World War II.  Reflecting the U.S. pullback from its traditional hegemonic role in geopolitics, Japan and South Korea continue to slap trade restrictions on each other because of the dispute.  In addition, Seoul today formally requested that the International Olympic Committee ban Japan’s “rising sun” flag at next summer’s Tokyo games, claiming the flag is a symbol of Japan’s brutal imperialism in the past.

Space, the Final Frontier:  In other news from South Korea, the government announced it would postpone the launch of its lunar orbiter until July 2022.  That disappointment follows the apparent crash landing of India’s lunar lander on the moon’s south pole last weekend.  Despite the failures, the big trend that many investors aren’t paying attention to is that with advancing technologies and falling costs, multiple countries are stampeding into space exploration.  Significant lunar and deep-space projects are now being conducted not only by the U.S., Russia and China, but also by countries like Israel, India and South Korea.  The efforts often involve both public and private entities.  This often unrecognized “megatrend” could potentially have significant investment implications in the future.

Energy update:  Crude oil inventories fell 6.9 mb compared to an expected draw of 2.8 mb.

In the details, U.S. crude oil production was unchanged at 12.4 mbpd.  Exports rose 0.2 mbpd, while imports fell 0.2 mbpd.  Refinery operations rose 0.3%.  The drop in stockpiles was the combination of steady output, higher refinery demand, a rise in exports and a fall in imports.

This chart shows the annual seasonal pattern for crude oil inventories.  As we approach the end of the spring/summer inventory withdrawal season, we are starting the autumn rebuild period at a sizeable deficit.  Without aggressive increases in stockpiles, we will likely continue to lag seasonal patterns which, on its own, is bullish.

Based on our oil inventory/price model, fair value is $68.61; using the euro/price model, fair value is $47.97.  The combined model, a broader analysis of the oil price, generates a fair value of $54.46.  We are seeing a clear divergence between the impact of the dollar and oil inventories.  Given that we are nearing the end of the summer driving season, the bullish impact of inventories will likely diminish in the coming weeks; a sideways to lower price path is the most likely outcome.

We have seen two divergent geopolitical trends.  The first being the change in command in the Saudi oil ministry to a member of the Salman family is considered bullish for oil as the royal family wants higher oil prices to support the IPO of Saudi Aramco.  We note that Russia and Saudi Arabia are calling for better compliance on output cuts.  The ousting of John Bolton increases the odds of negotiations with Iran.  So far, the two have mostly balanced themselves, but if talks open up with Iran, prices will likely fall further.  We also note that the IEA is warning that slowing demand in 2020 will likely lead to higher stockpiles and lower prices.

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

[Posted: 9:30 AM EDT]

It is 9/11, the 18^th anniversary of the terrorist attack on New York and Washington.  Equity markets are mostly steady this morning.  We are rotating in equities.  China gives in (a little) on trade.  Bolton’s out.  Here is what we are watching this morning:

China trade:  China announced it will exempt a range of goods from the 25% extra tariffs that were implemented last year.  However, notably, corn, soybeans and pork failed to make the list.   Drugs, non-grain animal feed and lubricants were exempted.  Although the action does suggest that China may be making a good faith effort to improve the environment for negotiations, the move itself is quite limited.  Still, any sign of hope will be welcomed.

China market news:  There were a couple items of note on China and its impact on markets.  First, China has removed quota limits on foreign investment.  This action would suggest China is interested in attracting foreign investment; we note that the previous quotas had not been fully utilized, so this action probably won’t trigger a major influx of new funds.  Second, although China’s foreign reserves held steady in August, Hong Kong’s fell 3.5%, or about $15.6 bn.  This drop suggests that capital flight is probably starting to develop.  Third, China’s car sales fell for the 14^th consecutive month.  There are growing concerns about China’s economy and its impact on the U.S. and global growth.

Bolton:  John Bolton either resigned or was fired yesterday.  There were reports that he was signed by the Patriots, but those have not been confirmed.  Usually, the removal of a national security director isn’t a market event.  When Trump’s two previous directors departed, H.R. McMaster and Michael Flynn, they weren’t market-moving events.  However, Bolton’s departure did have a dramatic effect on the oil markets, which fell sharply on the news.

Every president “learns on the job.”  There really is no position that prepares one to be president of the U.S., although a governor may be the best learning experience.  However, what we usually see is that a new president starts with a deep team of notables, especially if the new president’s party has been out of office.  There are a lot of people who have been waiting to take a role in a new administration.  However, over time, presidents begin to figure out the job and want to be around people who will execute the policy of the president, not try to shape it.  Bolton and Trump were not of the same mindset.  Using Mead’s taxonomy,  Bolton was a mix of Wilsonian and Jacksonian archetypes, but leaned mostly to the former.  Thus, he was more of a neoconservative, wanting to use force against a myriad of enemies.  President Trump, on the other hand, is nearly a pure Jacksonian.  This archetype tends to be isolationist unless provoked.  Thus, we would expect Trump to attack Iran if it would engage in an action that killed an American but not use force as a matter of policy goals.  Bolton, on the other hand, wanted to use force against Iran as a matter of policy.

As presidents begin to shape their own administrations, they tend to remove those who have been trying to shape the president.  Those who follow the initial group of aides and cabinet members tend to be less notable but more willing to execute the president’s wishes.  Although the media will act as if what we are seeing is completely unique to this administration, the shifting is normal, although it may be happening faster with this one.

SoS Pompeo is the remaining member of the national security and foreign policy staff.  Although he is probably a similar archetype to Bolton, he has a better personal relationship with the president and seems more willing to execute policy.  What we expect to see going forward is more of a Trumpian foreign policy with less interference.

This probably means the odds of negotiations with North Korea and Iran are likely.  We may even see some thaw with Venezuela.  President Trump likes face-to-face meetings with leaders to solve what have been intractable problems.  Bolton opposed such meetings, as does Pompeo, but he will go along (at least for now).  Additionally, we do not expect Pompeo to stick around, either.  He seems to be considering a Senate run.  What is most interesting about President Trump’s foreign policy is how it is shifting the GOP from a Hamiltonian/Wilsonian stance to a Jacksonian one.  We will be watching to see if this shift becomes permanent or ends when Trump leaves office.  A Jacksonian foreign policy probably isn’t conducive for hegemony; America seems okay with ending that role, but the rest of the world is still dealing with the shock.

EU news:  Margrethe Vestager, the EU commissioner who has gone after the large tech firms, has been given a rare reappointment.  Usually, new EU leaders select an entirely new slate.  This is unwelcome news for the U.S. tech giants.  Political negotiations in Spain have failed and new elections are likely.  German economic think tanks are forecasting a recession for Germany.  Although the new government in Italy is less confrontational than the previous one, in terms of fiscal policy, the trend is the same.  Italy’s current proposed budget will violate EU guidelines.  We will be watching to see if this new government is given some “wiggle room” to support non-populist governments.

Turkey:  President Erdogan has a plan for Syrian refugees.  Either the U.S. and Turkey create and secure territory in Syria for over one million refugees or Turkey will release these refugees into Europe.  Turkey has an estimated 3.6 mm Syrian refugees, but the EU has an arrangement with Turkey.  Over the past four years, Europe has given Turkey $6.7 billion to keep these refugees from coming into Europe.  Erdogan is indicating this isn’t enough.  The Turkish president has wanted a buffer zone in Syria to (a) gain territory in Syria, and (b) create an area it controls to push Kurds further away from his border.  Although the U.S. has agreed in principle to establish this zone, it seems unlikely that President Trump will support a major U.S. effort to put in troops to secure this zone and create a buffer that undermines an American ally in the region, the Kurds.  Erdogan is accusing the U.S. of backing away from the deal.  If the agreement falls through, another European refugee crisis is in the offing, which could be bearish for the EUR and European equities.

The rotation:  In the past few days, we have seen an impressive rotation in equities, with value and non-momentum stocks gaining, while growth and momentum have taken a hit.

Along with the momentum/value reversal, Treasury rates have jumped, and the yield curve has steepened.  There is no doubt that the momentum/growth areas had become “crowded” and value was due for a bounce.  The issue now is whether this is the beginning of a broader trend or a mere correction.  If it’s going to be more than just a correction, we will likely need to see long-duration Treasury rates continue to rise, and for that to occur we would need to see a significant reversal of easing expectations.  In general, shifts in value to growth usually require P/E contraction.  Although long-term interest rates are not the sole determinant of P/Es, they are important.  Thus, what we are seeing is probably not a reversal in trend but a correction.

Brexit news:  Boris Johnson’s decision to prorogue Parliament was ruled “unlawful by the Scottish court.”  The ruling sets up a possible showdown in the Supreme Court.  In response, the ruling members of Parliament have asked to be summoned back to debate the issues surrounding Brexit, which Johnson is likely to deny.  The Supreme Court is expected to take up the issue next week.

In addition to the ruling, PM Johnson received flak from members of the rivaling Labour Party for not making enough progress in Brexit negotiations.  With seven weeks left until Brexit, it is believed that PM Johnson has not made substantial progress in securing a deal.  One of the primary hurdles to negotiations is the Irish backstop.  PM Johnson has asked for it to be removed from the deal completely but has not offered an alternative to the backstop.  There are rumors that he is exploring building a bridge that would link Scotland and Northern Ireland, but nothing has been formerly proposed.  One of the major risks to the proposal is that there are believed to be undetonated WWII bombs located in the water.

As the Brexit deadline looms closer, it is becoming clear that PM Johnson may not be able to come up with a Brexit deal; therefore, assuming elections are not called, the likelihood of a no-deal Brexit is really elevated.  Countries within the EU such as Spain and France have begun preparing for the worst.  This morning, Spanish PM Pedro Sanchez asked Spanish businesses with commercial ties to the U.K. to evaluate their exposure, and create contingency plans in the event of a no-deal Brexit.  France, which gave its businesses the same directive last week, also began testing a smart border in Calias, which is where a lot of French goods are transported to the U.K.  We expect a frantic adjustment if a no-deal Brexit happens, as it will be unclear how the U.K. and European countries will cope with the sudden withdrawal.

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

[Posted: 9:30 AM EDT]

Good morning!  Equity markets are a bit lower this morning, although there is a huge amount of rotation in the sectors.  Chinese inflation data was mixed.  Parliament is prorogued.  Here is what we are watching this morning:

Is the ECB set to disappoint?  Mario Draghi leaves the ECB on Halloween and he is trying to deliver one last burst of stimulus.  Talk of new rate cuts, tiered negative rates and new QE have been offered but there is growing concern that Draghi, a lame duck, won’t be able to deliver.   Growing opposition among the members of the ECB centers on the idea that things aren’t all that bad, at least not bad enough to warrant such aggressive actions.  This situation is important, because if Draghi can’t implement these measures, it’s unlikely his successor, Christine Legarde, will be able to push measures through, at least immediately.  Legarde is not considered an economic heavyweight and thus probably won’t be able to sway the members on the strength of her arguments.  Instead, she will likely need time to build a consensus on the committee to bring any changes into place.  If the ECB falls short, look for a further rise in long-term rates, weaker gold prices and a stronger EUR.  We don’t view these market reactions as the beginning of a long-term trend.  The European economy is still struggling and will need additional stimulus.  Although there is a glimmer of hope for fiscal loosening (see below) if economic conditions don’t improve, we will likely see the ECB eventually adopt what Draghi is proposing.  But, in the short run, we think the odds of disappointment are elevated with the aforementioned results.

A fiscal expansion in Germany?  German officials are starting to make noise about a fiscal expansion and there is growing speculation that policymakers are working on ways to get around the balanced budget rules.  To some extent, this is a “no duh” moment; Germany has ample fiscal capacity (negative yielding sovereign debt is a clear indication of its existence).  Europe, and, for that matter, the world, needs Germany to shrink its current account surplus and fiscal expansion could do the trick.  However, despite the obvious need, Germany has a deep-seated aversion to fiscal expansion and inflation.  Actual deficit spending probably doesn’t occur without a full-blown recession in place.  Nevertheless, if the policy mechanisms are in place, fiscal expansion could be implemented quickly.

Brexit:  Prime Minister Johnson has lost a second vote on having a snap election, as the Labour Party and other opposition groups refused to allow the ballot in order to ensure that Johnson asks the EU for a delay with Brexit, as now required by law.  Since parliament is now on leave for the next five weeks, the earliest an election can take place is November.  Recent polling shows Johnson is still the most popular British politician, with much higher support than Labour Party leader Jeremy Corbyn.  However, he doesn’t necessarily have a majority, and he continues to lose support from traditional Conservative Party stalwarts who reject his drive toward a no-deal Brexit.  In the House of Lords, the Duke of Wellington announced he would quit the party to protest Johnson’s program.  As Johnson becomes increasingly hemmed in, there are some signs that he may be shifting his position.  In talks yesterday with Prime Minister Varadkar of Ireland, Johnson said Northern Ireland and the Republic of Ireland could trade agricultural and food products under EU rules, although that idea would be strongly resisted by British nationalists on grounds that it would weaken the status of Northern Ireland in the United Kingdom.

We may see the GBP drift higher as positions are squared in front of the return of Parliament in mid-October.

Chinese inflation:  China released PPI and CPI for August.  The data told two stories.  On the CPI data, it’s all about pork.

Overall, CPI rose 2.8%, while core CPI rose by only 1.7%.  Food prices jumped 10.2%, led by a 47% rise in pork prices caused by the African Swine Fever pandemic.  There are rising concerns about the political impact of the pork issue.  However, despite the spike in prices, there has been no movement by China to increase its buying from the U.S.  This may occur if conditions continue to deteriorate, but probably not before the CPC meetings in early October.  Meanwhile, the PPI data shows evidence of renewed deflation

Tech troubles:  Tech firms are facing two threats.  First, more than 40 state attorney generals have joined a bipartisan probe into large tech firms, including Facebook (FB, 188.76) and Alphabet (GOOG, 1204.41), in a broad anti-competitive probe.  Perhaps the greatest threat to the large tech platforms is regulation and the fact that this is state-level, broad and bipartisan will make fending off this action through lobbying very difficult.  Second, California is about to pass new labor laws that will force companies that rely on “gig workers” to reclassify them as employees.  Many of these platforms struggle to attain profitability even with the 1099 structure; the regulatory burden of making their workers W-2 employees will either (a) destroy the model, or (b) require much higher prices.

European Commission:  Incoming European Commission President Ursula von der Leyen is naming her top lieutenants today, and perhaps the most important news is that current Competition Chief Margrethe Vestager will continue in her role.  Vestager has aggressively pursued anti-trust actions against a number of major U.S. and foreign technology firms, including assessing huge fines.  This aggressive approach to enforcing market competition rules will now likely continue, which will add some measure of risk to international firms doing business in Europe.  In a nomination that has implications for Brexit, the EU’s trade chief will be Phil Hogan of Ireland.  The new economic policy leader will be Paolo Gentiloni of Italy, and the responsibility for defense, the single market and industrial policy will be in the hands of Sylvie Gouland of France.  The nominees will face questioning by the European Parliament later this month, after which the legislators could reject them as a team or pressure von der Leyen to give them different jobs.

Iran:  Although it isn’t catching the attention of the media, tensions in the Middle East surrounding Iran and its proxies are heating up again.  First, Iran is trying to pressure Europe into breaking U.S. sanctions by steadily violating the nuclear deal through increased uranium enrichment.  With the U.S. exit from the agreement and the reimplementation of sanctions, Iran is arguing that it is no longer bound to the deal.  However, it had initially complied (sort of) to try to encourage Europe to violate American sanctions.  Nonetheless, despite efforts to create a method of evading the U.S. financial system, in practice, the Europeans are not buying enough Iranian goods to support the Iranian economy.  In addition, it does appear that one of the fears of opponents of the nuclear deal, the fear that Iran might cheat, may have been realized.  Israel has been arguing that Iran violated the arrangement by illegally stockpiling fissile material.  The IAEA reports that it has  found traces of nuclear material in a warehouse.  Finally, Hezbollah has downed an Israeli drone as tensions rise in the region.  All of this is bullish for oil prices, which have been bolstered by the change of leadership in the Saudi oil industry.

Spain:  An advisor to the European Court of Justice warned today that Spanish banks may have violated consumer protection laws by the way they explained a widely used mortgage price index to borrowers.  As might be expected, the potential for lawsuits and fines is weighing on Spanish bank stocks today.

North Korea:  First Vice Minister Choe Son Hui was quoted in state-run media today as saying Pyongyang is ready to restart denuclearization talks with the United States later this month.  At the same time, however, the country launched two more short-range missiles, likely as a warning that Washington needs to get back to the bargaining table.

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