Daily Comment (April 5, 2017)

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Yesterday, Richmond FRB President Lacker announced he was stepping down immediately after admitting he was involved in a leak of confidential information to an analyst with Medley Advisors, a well-connected Washington think tank.  In October 2012, Medley published details of Fed deliberations that were non-public.  In a conversation with that analyst, Lacker refused to comment on the information, which may have given the impression that he was confirming the report.  We doubt that Lacker was the source of the leak; the public information we have suggests he was not but, perhaps inadvertently, confirmed it for Medley.  Still, his abrupt resignation and acceptance of responsibility usually occurs as part of a deal to spare Lacker from further investigation.  We suspect the leaker has still not been found.[1]

In the short run, his departure isn’t a big deal.  First of all, he was leaving in October anyway.  Second, he wasn’t a voter this year.  The FOMC is losing one of its hawks; we rated Lacker as a one-star hawk, our most hawkish designation.  Usually, regional FRBs replace presidents with similar characteristics.  After all, it’s the bank board that appoints these presidents and there is some degree of continuity on these boards.  However, given the whiff of scandal that surrounds Lacker, the Richmond FRB may decide to go a different direction which may lead to a more centrist replacement.

It looks as if Syrian President Assad’s forces used chemical weapons in an area controlled by rebel forces.  We note that this attack closely follows comments from the administration’s ambassador to the U.N. suggesting that regime change is not the goal of the Trump government.  Although that is the de facto policy of this administration, some things are better left unsaid.  Confirming Assad’s position might have given him confidence that he could get away with using chemical weapons.  However, in all fairness, U.S. Syrian policy has been a mess for some time.  President Obama’s red line in Syria that was crossed and subsequently ignored was poorly managed.  Allowing the Russians to participate in Syria was a mistake as well.

We think the best way to examine U.S. Middle East policy is to consider it as part of the postwar order.  The U.S., in addition to containing communism, froze conflict zones in Europe and Asia by taking over the defense of Western Europe and Japan.  This gave confidence to other parties in the region who would have normally been traditional enemies that they had nothing to fear.  So, demilitarizing Germany (and, effectively, the rest of Europe) told Russia and the other European nations that the U.S. was the keeper of the peace and traditional regional rivalries were no longer a threat.  In the Far East, by taking over Japan’s defense, China knew it was protected from Japanese attack.  In the Middle East, the U.S. enforced the flawed existing borders, which meant living with the brutal autocrats in the region who were the only ones capable of maintaining order in states that were not created for natural stability but for the benefit of colonial powers.  In the Middle East, we can safely say that American postwar policy is no longer in existence.  By supporting the Arab Spring, the U.S. has unleashed tribalist and nationalist factors that will likely shape the region for the next three decades.  Richard Haass has suggested that conditions in the Middle East closely resemble Europe in the 17th century during the bloody Thirty Years War.  At this point, the Middle East is in turmoil and we don’t expect it to improve anytime soon.  For markets, so far, the conflicts haven’t affected oil production and so the impact hasn’t been significant.  However, continued conflict will raise the likelihood that, at some point, oil flows will be disrupted.

As Chairman Xi and President Trump gather together in Florida, the Young Marshal in Pyongyang launched an intermediate range ICBM.  The response from the White House was, “the clock has now run out and all options are on the table.”  It is unclear what exactly this means, but it does suggest that some options might include military activity.  It doesn’t appear that the financial markets are expecting such action; if they did, we would expect equity values to be declining sharply, with Treasury prices and the dollar rising as well.  We don’t expect military action by the U.S. either but our confidence in this position isn’t strong due to the nature of the Trump administration.  We continue to monitor conditions closely.

By all accounts, the French debate wasn’t good for Le Pen; her opponents attacked her position on the Eurozone and her responses were deemed weak.  European political systems tend to isolate populists as the establishment parties, who usually oppose each other, unite to prevent a populist victory.  We expect a similar outcome in France.  However, it will all come down to turnout.  It doesn’t appear to us that the other candidates foster strong feelings among supporters; at the same time, Le Pen supporters seem to be committed.  If voter participation is low, Le Pen has a better chance of winning than current polls suggest.  However, even a low turnout may not be enough to grant her a victory.

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[1] For a compilation of the report, see https://www.nytimes.com/2017/04/04/business/lacker-leak-fed.html?ref=business.