Daily Comment (April 7, 2017)

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

[Posted: 9:30 AM EDT] Happy Employment Data Day!  We cover the data in detail below but the payroll data, showing only a 98k rise, was quite disappointing.  We suspect seasonal factors played a role as February weather was unusually mild while March was colder.  It should also be noted that the unemployment rate fell to 4.5% (-0.2%), which is actually bullish.  Initial market reaction has been bullish bonds and bearish equities and the dollar.  However, we see lots of noise in the numbers so reversals throughout the day would not be a surprise.

At the same time, we have had heavy news flow over the past 24 hours.  Here’s what we see going on:

The U.S. bombs Syria: President Trump ordered a moderately sized cruise missile strike on an airbase in Syria in response to the Assad government’s use of nerve gas against rebels with high levels of civilian casualties.  Since the 2013 deal with Syria was thought to have ended Syria’s chemical weapons program, it is disappointing to see the regime use these weapons.  It is unclear if they hid these weapons during the period when they were supposed to have eliminated them or if they have reconstituted their WMD industry.  The U.S. response was limited but it is possible that escalation could follow.

Market reactions: Markets acted as one would expect—equities fell, gold and Treasuries rallied and oil prices jumped.  Although Syria is a minor oil producer, the attack involves three major oil producers, the U.S., Russia and Iran.  Thus, any escalation could affect oil prices; the most likely catalyst would have been if Iranian or Russian security personnel were killed in the attack.  Given that Russia was warned of the strike, the odds were lessened that such an action would happen.  We expect this attack to be limited and thus the overnight trends will likely reverse over time.

International and domestic reactions: European governments were supportive.  China’s reaction was mostly neutral while Russia reacted harshly, as one would expect, calling the action a “significant blow” to U.S./Russian relations.  However, if this is a one-off attack, which we believe it is, the Russians won’t escalate the situation.  Russia can’t afford to go to war with the U.S.  On the other hand, if the Kremlin thought it had its man on Pennsylvania Avenue, this attack undermines that position.  Within the U.S., the reactions were interesting.  Establishment figures across the aisle praised the attack; populists, especially on the right, were rather critical of the missile strikes.

Takeaways: We expect Trump to be mercurial and this action is clear evidence of this characteristic.  It has been less than a week since the administration indicated that regime change in Syria was no longer a goal of the U.S.  What it shows about Trump is consistent with the behavior of Jacksonians; besmirching honor guarantees a response.[1]  It’s clear that Trump took the attacks personally.  Assad engages in war atrocities often but usually with conventional weapons.  Thus, indiscriminate bombing of civilians is tolerated but the use of chemical weapons isn’t.  And, the fact that the images of gassed children were broadcast worldwide appears to be a major factor behind the response.  So, the lesson to the world isn’t that attacks on civilians won’t be tolerated; it’s that high-profile attacks using banned weapons will not be allowed.  We don’t see a change in U.S. policy in Syria.  We seriously doubt we will see a large U.S. ground troop presence in the country anytime soon or an escalation of U.S. military activity in the region.  For nations under threat, such as North Korea, this missile strike is a warning of sorts and may raise tensions even further.  At the same time, Pyongyang should also note that it’s the public dishonor that gets one into trouble; acting badly in secret is probably ok.

The Mar-a-Lago meetings: Thus far, not too much has come out of the talks between Chairman Xi and President Trump.  The Syrian attack will act as a distraction.  North Korea, trade and the level of U.S. influence in the Far East are all issues but we doubt they will be solved in this meeting.  Xi needs a smooth runway into CPC meetings in October that will allow him to pick his own team for his second term.  Thus, low-key meetings are his goal.

The Senate goes nuclear: The Democrats are prepared to filibuster Neil Gorsuch and so the GOP will change the rules and allow Supreme Court justices to be appointed by a simple majority vote.  Although legislation is still subject to filibuster, it’s just a matter of time in our opinion until this changes as well.  The Senate has traditionally acted as a governor on policy, preventing it from moving too far or too fast in either direction.  Once we go to simple majorities, there isn’t much use for having the Senate around.  It probably should become like the House of Lords in the U.K.

Why is this happening?  The nation has become deeply divided on partisan lines and thus sees anything the other side wants as prima fascia evil.  Both will claim “the other side started it” and both are credible.  At root, however, is that we get the government we send to Washington and when the country becomes partisan and divided, we want the other side vanquished.  Since the divisions are more or less equal, it’s hard to get a large enough majority to force one’s will on the other.

(Source: Voteviewblog.com, Rosenthal and Poole)

This chart shows the degree of partisanship in the House and Senate; the higher the number, the more partisan the body.  The House is the most divided it’s been since the data series began in 1879; the Senate is approaching the highs it set in the late 1890s.  We suspect partisanship was probably higher around the Civil War but that shouldn’t offer us comfort.  This level of partisanship makes it difficult to govern and probably impossible to maintain the superpower role.  It’s worth noting that the trend for bipartisanship began to accelerate after WWI when the U.S. was beginning to realize that it was going to have to take a more global role.  We remained remarkably bipartisan through the Cold War, although the degree of agreement began to unwind as the Cold War ended.  We don’t know how this will play out for sure but there are a couple of observations that can be made.  First, if the Senate eventually ends the filibuster rule, policy shifts will become more pronounced and violent with new parties in power.  Political risk for financial markets will escalate.  Second, we are probably in an era of major coalition changes within the established parties.  Third, America’s superpower status will almost certainly be unsustainable with this degree of domestic political division.

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[1] For background, see WGR, 4/4/16, The Archetypes of American Foreign Policy: A Reprise.