Daily Comment (April 10, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a very quiet morning in front of some important news today. Brexit, the ECB meeting and Fed minutes are all on tap this morning. Here is what we are watching:

ECB: The ECB has pushed the first rate hike into next year (and it will be unlikely even then). Other than that, everything else remains unchanged. The ECB is in a difficult spot. The EU economy is clearly slowing, but with its policy rate already negative it’s not clear if additional cuts will help. And, new aggressive actions might have a “whiff of panic.” In the press conference, ECB President Draghi intimated that the central bank has policy tools to ease further; the markets are taking his comments as dovish as the EUR has weakened.

Brexit: PM May has met with French President Macron and German Chancellor Merkel. The EU intends to offer a long extension, to perhaps the end of the year or the end of Q1 2020, with the option of leaving before the deadline if a deal is reached.[1] The EU wants a longer deadline because it doesn’t want another year of monthly cliffhangers. This is a nightmare outcome for the Brexit crowd; the longer the break is delayed, the more likely it is that the U.K. never leaves. At the same time, it’s hard to see how PM May can stick around with such a long deadline. However, she is nothing if not tenacious and because she has already won a leadership vote the Tories are sort of stuck with her until December.

Fed minutes: There will be great interest in seeing any comments on how policy reversed, but given the sanitized nature of this report we doubt any real insight will emerge. We will have to wait until 2024 when the actual transcripts are released to hear what really happened. The other item of interest is the FOMC’s adjustment of its inflation target policy. Vice Chair Clarida suggested in discussions yesterday that the Fed might allow inflation to run above target for a period if it had been below target previously.[2] This policy change would allow the Fed to be more dovish and signal to markets that breaking the 2% target would not necessarily mean an immediate move to tighten. In early June, the Fed will hold a conference in Chicago on the inflation targeting issue.

China/EU summit: By all accounts, China caved to EU demands.[3] The agreement[4] pretty much gave the EU everything it asked for, including meetings on human rights, reductions in industrial subsidies[5] and reduced technology transfers.[6] Although diplomats are lauding the meeting as a “win-win,” in reality, the EU was prepared to exit the meeting due to the lack of progress.[7] China could not afford a two-front war on trade and thus the EU likely benefited from the difficult U.S./China trade negotiations.

The IMF and trade: Yesterday, we noted that the IMF had lowered global growth estimates. The fund noted that one of the uncertainties surrounding the forecast was trade policy. What the world is struggling to understand is that the U.S. is fundamentally changing its trade policy. This may be the biggest change in U.S. trade policy since Nixon closed the gold window and ended the Bretton Woods system. The Nixon administration faced an external accounts problem. By closing the gold window and floating the dollar, Nixon forced the adjustment on foreign nations. However, the cost was inflation. Under Reagan and his successors, the U.S. position was shifted to open trade to weaken inflation. Thus, globalization was supported to contain prices. Trump is shifting this policy to reduce the external balance but, unlike Nixon, he is mostly using tariffs[8] instead of dollar weakness (Nixon also used tariffs but mostly relied on currency depreciation). However, we expect the current administration to eventually seek dollar weakness. A significant way to weaken the dollar is to undermine the perception of Fed independence; the proposals to add Herman Cain and Stephen Moore could be related to this goal.[9] Nixon also undermined Fed independence in a public campaign to embarrass Fed Chair Burns. Even if Cain and Moore are not appointed,[10] the die has already been cast. If the president gives up on both, he can more easily appoint conventional doves (current Fed Presidents Bullard and Kashkari would be my recommendation) to the open governor positions. This outcome would not meet Trump’s aim of loyalty, but it would give him the same outcome without the drama.

Oil news: Uncertainty surrounding Libya remains elevated as General Hifter continues to move on Tripoli.[11] While we would not be surprised to see Hifter gain control of the capital, his actions will probably not stabilize oil production as militia groups continue to operate despite Hifter’s march on the western parts of Libya. Meanwhile, Iraqi oil output unexpectedly fell[12] and Venezuelan output plunged 0.5 mbpd in March to 960 kbpd. All this news is supportive for oil prices.

Israel elections: Although the two major right-wing party groups each won 35 seats in the Knesset,[13] it appears PM Netanyahu will be able to put together a government.[14] This will make him the longest serving PM in Israel’s history.

A conflict with Italy? Italy has raised its deficit/GDP projections on forecasts of weaker economic growth.[15] The EU is apparently not taking this news well and is making noise about rejecting Rome’s spending plans.[16] We don’t expect the EU to follow through but a conflict with Italy will further boost populism in Europe. In addition, fiscal expansion is exactly what the EU needs so punishing Italy is counterproductive.

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