Daily Comment (April 2, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] We are seeing a mixed market this morning—U.S. equity futures are lower as are Treasury prices, while commodities are higher.  Much of Europe is closed today for Easter Monday.  Here is what we are watching this morning:

China retaliates…sort of: China slapped tariffs on 125 items, mostly foodstuffs.  Steel and aluminum were targeted, a direct action against U.S. tariffs on those two metals.  Frozen pork was included, as were tree nuts, including almonds.  Between 2012 and 2017, about 75% of China’s almond market came from the U.S.[1]  However, we do note that soybeans were specifically excluded from the list, suggesting China is taking a measured approach to trade tensions.  A potential trend we are watching is that China may be implementing trade actions against products in “blue” states; putting tariffs on soybeans harms the Midwest, which is generally supportive of the GOP.  Assigning tariffs that harm California, on the other hand, probably won’t trigger an aggressive response from the White House.

NAFTA threat: There are reports that “caravans” of Central American migrants are moving through Mexico to the U.S.  The president tweeted that if Mexico doesn’t stop these flows then he will end NAFTA.  Trade and immigration policy are complicated.  The agriculture and hospitality industries often need seasonal workers and the local markets are simply unable to provide enough labor.[2]  Completely restricting immigration will adversely affect some industries; therefore, reform needs border control but also rules to allow needed workers in some industries.  Meanwhile, U.S., Canadian and Mexican trade negotiators are working to reform the NAFTA agreement, but the statements we saw on Easter from the White House complicate those discussions.  There is no doubt that the U.S. will be less affected than other nations in a trade war.  However, there will be significant costs to the U.S.; for investors, a trade war means higher inflation, which lifts nominal interest rates and contracts P/Es.

A threat to Putin?  Although President Putin has faced widespread protests in the past, they have obviously failed to remove him from office or prevent him from executing his preferred policies.  However, last week there was a fire at a shopping mall in Kemerovo, a small city in south-central Russia, killing 64 people, 41 of which were children.  A zoo and its animals also perished.  Protests have broken out; corruption is being blamed for the deaths as emergency services and normal precautions were clearly inadequate.  Local leaders have been astoundingly tone deaf—one official noted that children die every day and thus dismissed the protesters as trying to court the media.  As anger has increased, Putin has followed his usual script, which is a staged photo op of him showing concern.  Protests have begun to spread, with large demonstrations noted in 20 cities.  The governor of the Kemerovo Province, Aman Tuleev, resigned over the weekend.  History suggests that these protests will eventually die out but the fact that they have not only lasted this long but also spread does suggest that Putin’s power may be under pressure.

The NY FRB spat: John Williams, the current president of the San Francisco FRB, is the leading candidate to fill the president vacancy at the NY FRB.  Its current occupant, Bill Dudley, is expected to retire by summer.  Williams is an accomplished economist and is qualified for the position.  However, two problems have emerged; first, diversity advocates would prefer someone other than a white male for the job, and second, there are concerns about his regulatory history.  Here is what we find interesting about this debate.  During the late 1960s into the early 1980s, central banks in the West were often compromised by political influence.  This was true at the Federal Reserve, which became legally independent of the Treasury under Truman.  Nixon pushed out Fed Chair William Martin in the late 1960s and then undermined his successor, Arthur Burns, forcing him into inappropriate policy accommodation in the early 1970s to support Nixon’s re-election campaign.  Central banks in much of the West were beholden to finance ministries to “coordinate” monetary policy with fiscal policy.  In fact, standard Keynesian economics argues that monetary and fiscal policy should be coordinated.  In a non-political world, this idea is uncontroversial.  In the real political world, it’s a recipe for inflation because the political class usually opposes austerity.  So, in the deregulatory revolution of the 1980s, central bank independence became common.  Since the 1980s, the Federal Reserve has mostly operated with minimal congressional oversight (governors require congressional approval while regional bank presidents only require approval from the Board of Governors).  Some on the right, notably the Pauls (Ron Paul was a Texas congressman and Rand Paul is the current junior senator from Kentucky), have been calling for “Fed audits” which are really policy audits.  Their goal is to force a monetary policy that mimics a gold standard.  However, if we see monetary policy politicized, the most likely outcome would be inflation.  The current uproar over John Williams likely portends a bigger shift to reinjecting political oversight into monetary policy.  We have been expecting policy reflation to steadily develop over the next decade.  This potential interference into the policy process is one part of that expected development.

View the complete PDF

[1] http://www.chinadaily.com.cn/business/2017-05/24/content_29471108.htm

[2] http://www.ky3.com/content/news/Branson-want-permanent-job-recruiting-relationship-with-Puerto-Rico–464249763.html