Daily Comment (April 2, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Markets are quiet after a strong rally yesterday.  Here is what we are watching this morning:

Turkey fallout: The stunning losses in local elections have put President Erdogan on notice—the economy is suffering and he needs to address the problem.  Addressing a weakening economy with rising inflation will be challenging.  The weak currency will help in the economy’s recovery but Turkey is probably looking at a year of falling real wages and stagnant growth.  The temptation to use temporary measures to lift growth will be high.[1]  Although the elections reflect economic turmoil, for the most part, it looks to us like the financial markets have mostly discounted the bad news; simply put, the elections are a lagging indicator.

Brexit: Parliament voted on four measures for Brexit and rejected all of them.[2]  It is becoming apparent that all of the ideas for leaving without disruption mean the U.K. will remain tied to the EU with less influence than it has now.  The customs union, which lost by a mere three votes, doesn’t really solve anything.  Such a union keeps the U.K. in the EU’s trade bloc on tariffs but not on product standards.  Thus, there would still be a border problem in Ireland.  Essentially, Britain is rapidly realizing that it must either (a) leave suddenly and completely, suffering an immediate economic shock in return for full independence, or (b) call the whole thing off.  There really isn’t any middle ground.

The other trend that is becoming apparent is that May can either (a) stop Brexit by cobbling together a coalition of Remain-supporting MPs in Parliament at the cost of marginalizing the Tory Party, or (b) hold the Tories together but suffer a hard Brexit.  We think she leans toward the second option.  Our position has been that no government wants a hard break, and that is probably true, but a hard break may be considered a better option than eternal Labour Party dominance.

Bouteflika out: The president of Algeria, Abdelaziz Bouteflika, will leave office on April 28.[3]  It is unclear who will replace him.  Although there is no evidence that Algerian energy production has been affected, the chances of a disruption are rising.

Fed conference: The Fed will hold a monetary policy conference in Chicago June 4-5; ideas about policy, including inflation targeting, policy transparency and employment, will be on the agenda.[4]  As we discussed recently,[5] the Fed is investigating its inflation target, considering if it should be trying to target a level or average change in inflation.  The Chicago meeting will likely overshadow the August Jackson Hole meeting this year.

September fiscal cliff? The Treasury will hit a hard debt limit by September.  At that point, the debt ceiling will need to be raised.  Congress has already begun work on a deal but both houses are closely watching the White House, which is making noise about a wholesale rewrite of recent budget deals.  Although it isn’t uncommon for these arrangements to go down to the wire, the looming election year will play a role.[6]  Thus, we will continue to monitor this issue but would not be surprised to see a crisis develop in late Q3.

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[1] https://www.ft.com/content/6ca1d484-546d-11e9-91f9-b6515a54c5b1?emailId=5ca2d4f0341b100004e47892&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[2] https://www.nytimes.com/2019/04/01/world/europe/uk-parliament-soft-brexit-may.html?emc=edit_fd_20190402&nl=&nlid=567726720190402&te=1

[3] https://www.bbc.com/news/world-africa-47776725?utm_source=POLITICO.EU&utm_campaign=647364b043-EMAIL_CAMPAIGN_2019_04_02_04_47&utm_medium=email&utm_term=0_10959edeb5-647364b043-190334489

[4] https://www.reuters.com/article/us-usa-fed-conference/fed-sets-agenda-for-chicago-framework-conference-in-june-idUSKCN1RD351

[5] See Confluence Asset Allocation Weekly (3/8/2019).

[6] https://www.politico.com/story/2019/04/02/congress-spending-budget-shutdown-1244283