by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EDT] Markets across the world are rather quiet this morning. Oil remains the focus. Here is what we are watching:
Oil: Yesterday, the Trump administration announced that no more oil waivers will be granted on Iranian oil exports, which will tighten oil supplies. The U.S. has asked Saudi Arabia to lift production; the kingdom has responded cautiously, fearful of triggering another price collapse like we saw last autumn. We do expect Russia to lift output later this year.
What has spooked the oil markets are reports that Iran might retaliate to U.S. moves by closing the Strait of Hormuz. If Iran loses its ability to export oil, it has no incentive to keep the strait open. After all, its enemies in the region, primarily the Saudis, would be selling oil at higher prices at Iran’s expense. We examined this threat in a series of WGRs last year. Our analysis concluded that Iran could, at potentially great cost, shut down the strait for up to two months and even that action would not completely eliminate oil flows from the region due to the creation of alternative pipelines. However, the actions the U.S. would take to reopen the strait would represent a significant military escalation and might lead to a broader conflict. Thus, oil prices will tend to be supported due to the rising degree of uncertainty.
A funny guy wins in Ukraine: In the wake of Volodymyr Zelensky’s win, the hard part begins. It’s one thing to win an election, but it’s another to govern. Zelensky has no parliamentary party. He does not have a group of advisors. He faces a hostile power on his eastern border. Ukrainian voters are tired of ineffective government and widespread corruption, but electing someone without experience or political power probably won’t fix those problems. Ukraine’s elections highlight a broader problem in democracies—there is widespread distaste for political skill but it’s hard to get anything done without it. Therefore, there is immense temptation to elect new faces that make great promises but do not have the skills to make political change. As frustration builds, the temptation to jettison democracy altogether increases.
The Fed: Herman Cain has bowed out. We are a bit surprised that he gave up so quickly but when four GOP senators announced their opposition the White House apparently didn’t see a reason to burn political capital on his behalf. Stephen Moore remains a candidate and, so far, no senators have announced their opposition. So, despite widespread mainstream opposition, Moore remains in the mix. We will be watching to see who emerges as the next candidate; we would not be surprised to see Larry Kudlow get the nod.
Chinese naval parade: China will conduct its largest naval show this week as a flotilla of vessels will sail in the Asian region to showcase China’s rapid military expansion. Although China’s naval capacity is still dwarfed by the U.S., it is closing the gap and the parade will be closely watched by U.S. officials.
Brexit: Although there aren’t any looming deadlines, we note that PM May continues to negotiate with the Labour Party opposition to cobble together a coalition for her exit plan. It seems like a long shot. Meanwhile, Tory activists are pressing for a non-binding no-confidence vote to replace May with a more hardline Brexit supporter. Because May survived an official no-confidence vote in Parliament last December, based on party rules, she can’t face another official vote until December of this year. Party activists are trying to force a rule change so she can be ousted. Although we still don’t expect a hard break with the EU, the odds of the U.K. stumbling into that outcome are slowly increasing. In the short run, such an outcome would be devastating for the British economy. However, in the long run, the U.K. may simply “beat the rush” because, at some point, we expect the EU to unravel and being out during that event will probably be better than being in.