Daily Comment (April 3, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a “risk-on” morning. Equities are up around the world. It’s also the 70^th anniversary of NATO.[1] Here is what we are watching this morning:

A trade deal with China: Reports suggest the U.S. and China are nearing an agreement on trade.[2] The two sides are still hashing out enforcement issues and the path of implementation, but most of the longstanding differences have apparently been ironed out. Meetings in Washington are scheduled for this week.[3] Optimism about a trade agreement is boosting equities this morning.

Brexit: After a difficult cabinet meeting, PM May has reached out to opposition leader Corbyn to work out a Brexit deal.[4] Up until now, May has tried to manage Brexit within the Tory Party but has apparently decided that continuing on that path will lead to a hard Brexit, which she wants to avoid.[5] Corbyn has avoided a direct outreach because his ultimate goal is to become PM; rescuing May tends to undermine that objective. However, if Corbyn can work with May and deliver a workable exit that doesn’t lead to a sudden economic shock, then he can claim the mantle of statesman and enhance his future chances. Needless to say, hardline Tories are angry.[6] The hardliners are perfectly fine with a hard Brexit, assuming that forecasts of an economic crisis are simply scare tactics. May’s decision to work with Corbyn runs the risk of splitting the Tory Party and rendering the Conservatives to minority status for years.

So, May and Corbyn will work on a common plan. If they come up with one, both leaders will present it to Parliament and a vote will be held. If it passes, the U.K. will petition the EU for an extension of Article 50.[7] If they don’t come up with a common plan, May will likely ask for an even longer extension.

The White House and the Fed: There is more reporting suggesting that President Trump is profoundly unhappy with Chair Powell, apparently viewing his appointment as one of the bigger mistakes of his presidency.[8] According to reports, the president has indicated to Powell that he is “stuck” with the current chair. He has also criticized Treasury Secretary Mnuchin for pushing Powell’s nomination, and reportedly preferred Kevin Warsh for the job.[9] Warsh was not considered to be a strong choice for the role.[10] At the same time, the president may have believed that Warsh would be more open to the White House’s position on rates. We would not be surprised to see Warsh resurface for one of the two open governor positions on the FOMC, especially if Trump can get Moore through the nomination process.

Gold’s quiet supporters: Gold is apparently making a comeback among central bankers concerned about the long-term stability of the dollar.[11] Given low interest rates around the world, the opportunity cost of holding gold has fallen. What we find interesting about this action by central bankers is that they don’t view other currencies as an attractive alternative to the dollar. At the same time, the gold market is rather small so there will be limits to the banks’ abilities to shift reserves to the yellow metal.

A couple of taxing ideas: The Center for American Progress[12] has published a report calling for a tax on monopoly power.[13] Such a tax fits well within the MMT framework of taxing “bads” to achieve a different result. Market power is coming under deeper scrutiny on fears that monopolies and oligopolies are causing unusually high profit margins. By taxing market concentration, the incentive to merge and buy competitors will likely be diminished. Of course, regulation tends to cut in the opposite direction; increased regulatory costs tend to encourage concentration as businesses attempt to spread the regulatory costs over more units.

A tax on unrealized capital gains has been floated by Sen. Ron Wyden.[14] Along with equalizing the difference between income and capital gains taxes, the law attempts to tax gains before they are taken. Although such a tax is possible, it would be quite complicated; for example, one would expect the cost basis on an asset to be adjusted each tax year. In addition, unrealized capital losses would also need to be recognized. And, the tax should also include residential real estate. We doubt Wyden’s bill will get any traction but the fact that it has even been written suggests we are in a new, more populist, era.

Oil news: Three of the eight nations that were granted waivers on Iranian oil have indicated they are no longer importing crude oil from that nation.[15] Falling Iranian supply is bullish for crude oil.

As we noted last week, Saudi Aramco issued bonds to buy a Saudi petrochemical firm. As part of the bond issue, the Saudi state oil company released public financial numbers for the first time in four decades. It was revealed in the report that the giant Ghawar oil field, for years the world’s largest, can only produce 3.8 mbpd, which is 2.0 mbpd less than generally estimated. That means the Permian basin is now the world’s largest producing area at 4.1 mbpd. The kingdom still indicates it can produce 12.0 mbpd, although that number may be called into question in light of this most recent news. The bottom line here is that there may be less oil capacity available than we think which is bullish for oil prices.

Closing the southern border? The White House has backed away from this threat[16] after aides apparently convinced the president that doing so would cause significant economic dislocation.[17]

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