Daily Comment (April 16, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s relief Monday!  There was an attack on Syria but it was quite limited.  Equities have moved higher, Treasury yields have lifted, oil prices have dipped and the dollar is lower.  This is what we are watching this morning:

Parsing Syria: Late Friday, the U.S., U.K. and France launched a missile and bombing raid on three suspected chemical weapons sites in Syria.  Although it appears damage to the facilities was extensive, there was no leakage or any reports of casualties.  This suggests that Syria fully anticipated what targets would be hit and evacuated the facilities.  Russia was essentially warned to ensure no Russian personnel would be harmed.  The strikes were calculated to show American resolve against chemical weapons without expanding the conflict or threatening the Assad regime.  Although B-1 bombers did use the Qatar facilities in the attack, there was no evidence of direct Gulf State participation.

What can we take away from this action?  First, we think Trump’s recent comments about leaving Syria are where his preference lies.  The reaction of some right-wing populist commentators was interesting as there was strong condemnation of the attacks.  Right-wing populists are opposed to American hegemony and want an end to the inconsequential wars that accompany that position.   This group represents the president’s core supporters and he will be conscious of their opposition.  Thus, we would not be surprised to hear him return to the withdrawal position soon.  Second, the action will not deter Assad from his goal, which is to retake all the territory lost.  He may stop using chemical weapons to achieve this aim but attacking Syria for using chemical weapons but allowing his military to use indiscriminate bombing, i.e., attacking civilian areas and hospitals, is just as bad.  Why does the U.S. tolerate the latter but respond to the former?  There are probably a couple of reasons: (a) chemical weapons are weapons of mass destruction and the U.S. wants to restrict other nations from having them because they reduce America’s ability to project power, and (b) President Obama didn’t enforce the red line on this issue and President Trump is something of the “anti-Obama” in terms of policy.  In other words, he perceives that his base reviles Obama and thus does not want to do anything that smacks of a similar policy.

Additionally, the president really does want to end American hegemony.  We believe this process began with the last administration and continues with this one.  The majority of Americans appear to have tired of the role and don’t see any reason, in light of the end of the Cold War, to maintain America’s superpower role.  A recent Washington Post article[1] notes the president wanted Europe to “handle the Ukraine problem.”  Actually, the policy of demilitarizing Europe and taking over its security was deliberate—Europeans don’t get along (just look at how they handled the Greek debt problem) and have been the fount of two world wars.  Letting Europeans handle security problems will lead to a rearming of Europe and, a generation from now, an environment for conflict.  President Obama concluded that the U.S. could not afford to maintain stability in three regions (Europe, Middle East and Far East) and therefore prepared to remove American influence in the Middle East by allowing Iran to become the regional hegemon.  Trump’s election put that plan aside but its replacement is a free-for-all.  Leaving the Middle East may be necessary but the fallout could be difficult.  The refugee crisis in Europe is partly due to this withdrawal and, at some point, we would expect a disruption of oil flows.

The U.S. has announced further sanctions on Russian firms, those involved in Syria’s chemical weapons industry.  Expect much consternation but no real change in circumstances.

So, the worst outcome for the markets, which would have been Russian casualties, Iranian attacks on Gulf State oil facilities and a wider conflict, did not and probably will not occur.  The result has led to weaker oil prices, higher Treasury yields, dollar weakness and stronger equities.  The good news is that a broader war with deep U.S. involvement isn’t likely.  The bad news is that the Middle East will devolve, bringing further instability.

The currency dog: Sherlock Holmes, in the short story Silver Blaze, talked about the absence of an expected outcome.  In the story, there was a house abduction and the “dog didn’t bark.”  One of the oddities of the Trump administration has to do with the dollar.  At Davos, Treasury Secretary Mnuchin noted that a weaker dollar would support America’s trade policy aims.  The president quickly scotched the idea of dollar weakness for that goal.  However, pressing dollar weakness looks like a policy that a president intent on reducing the trade deficit should support.  Over the weekend, we learned that the Treasury won’t name several nations,[2] including China, as “currency manipulators.”  Naming China with this designation was part of Trump’s campaign, so the reluctance is something of a surprise.

We suspect the president, always conscious of the visibility of his actions, wants tariffs for the dramatic effect.  That way he can show his base something clear he is doing to punish trade miscreants in ways they can see.  On the other hand, the border adjustment tax, which was part of the tax reform discussion but jettisoned, and a weaker dollar would have likely been more effective than tariffs in reducing the trade deficit.  However, using these tools to affect trade is complicated and takes time.  The president appears to have made the decision that visibility is worth more than potential effectiveness.

Nevertheless, we note with interest a tweet from the president this morning that said, “Russia and China are playing the Currency Devaluation game as the U.S. keeps raising interest rates.  Not acceptable!”  Two issues are contained in this statement.  First, the president seems to have discovered that a weaker currency can offset the effects of tariffs, and second, this may be a shot across the bow to the Powell Fed that the White House is becoming uncomfortable with tighter monetary policy.  Will the president soon discover the benefits of a weaker dollar?  We will be watching to see if more comes of this; if it does, the dollar will likely weaken.

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[1] https://www.washingtonpost.com/world/national-security/trump-a-reluctant-hawk-has-battled-his-top-aides-on-russia-and-lost/2018/04/15/a91e850a-3f1b-11e8-974f-aacd97698cef_story.html?utm_term=.dcfd4031c578&wpisrc=nl_politics&wpmm=1

[2] https://www.nytimes.com/2018/04/13/us/politics/trump-china-currency-manipulator.html