Daily Comment (December 17, 2019)
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EST]
Good morning from snowy St. Louis! It’s a relatively quiet morning, but there are some developments to note. It turns out the risk of a hard Brexit hasn’t entirely been eliminated, and French unions are threatening to play the Grinch for Christmas. Fortunately, fiscal policy and the financial markets look better here in North America. Here’s what we’re watching today:
United Kingdom: Reports say Prime Minister Johnson this week will propose legislation prohibiting any extension of the Brexit transition period beyond the end of 2020, even though the exit deal with the EU allows for such an extension if a new U.K.-EU trade deal isn’t finalized by then. Officials close to Johnson say the proposal merely encapsulates the prime minister’s promise to “get Brexit done.” However, it’s probably also aimed at boosting the U.K.’s leverage in its upcoming negotiations with the EU for a permanent trade deal – negotiations in which the much larger EU is likely to have the upper hand. The problem is that negotiating the new deal will be complex and time consuming. There’s no guarantee that a deal can be put into place by the end of 2020, so any law prohibiting an extension creates a new risk that U.K.-EU trade would suddenly revert to WTO rules, with the U.K. facing tariffs, quotas and other barriers to its Europe-bound exports. Both British stocks and sterling are therefore down sharply so far today.
France: Just as unions were preparing to launch today’s latest round of massive protests against President Macron’s proposed pension reform, his hand-picked pension commissioner in charge of the effort was forced to resign for not disclosing almost a dozen paid and unpaid roles in the private sector. Given the need for France to streamline its pension system, the news is likely to be negative for French assets today. It also appears the news has emboldened labor leaders, with the chief of one major union issuing a veiled threat to cause massive disruptions over the Christmas holiday next week.
U.S.-China Trade: Despite the euphoria over last week’s “phase one” U.S.-China trade deal, NAFTA update and U.K. election, it’s important to remember that we’re now in the period where people start focusing on the details and how things will actually play out. That will inevitably cause some second-guessing and reassessments, which will impact the markets. Today, for example, there are reports that one way China plans to show a boost in its U.S. imports is to lift its trade war tariff on fuels, and re-route some $10 billion in ethanol imports so they come directly to China, as opposed to being transshipped through Hong Kong.
U.S. Repo Market: In an important sign that the Fed may have gotten its hands around the issues in the short-term borrowing market, the overnight repo rate barely budged yesterday, even though it was the deadline for quarterly corporate tax payments, and settlement day for recent Treasury bond issues. When those issues last popped up in mid-September, overnight rates spiked to above 10%. The Fed responded by flooding the system with cash in the form of short-term loans, which has not only appeared to calm the market down, but will probably also provide a boost to the economy and the broader financial markets. Add that to the list of uncertainties that have been lifted in recent days (U.S.-China trade, the NAFTA update, and Brexit), and it should be no surprise that the equity markets performed so strongly yesterday.
U.S. Government Budget: Democratic and Republican leaders in Congress have agreed on a $1.3-trillion package of appropriations to fund the federal government through the rest of this fiscal year, which ends September 30. The bill would boost discretionary spending by almost $50 billion over last year’s level. Assuming Congress can soon get the appropriations passed into law as planned, that should avert the threat of a partial government shutdown starting on Friday, so the news is likely to be market friendly. We note that the legislation includes several other interesting provisions. For example, it would require IRA investors to start taking their minimum required distributions by the age of 72, rather than 70-1/2 currently. It would also raise the minimum age for purchasing tobacco products to 21.
Canadian Government Budget: Canadian Finance Minister Morneau issued updated economic and fiscal forecasts showing the government will tolerate much bigger deficits for the next four years. In part, the decision to loosen fiscal policy reflects the challenges of running a minority government that relies on the support of left-leaning parties. More broadly, the move provides additional evidence that governments around the world are warming to the idea of spending more to boost growth, especially now that loose fiscal policy is seen as becoming less effective. Bigger budgets may very well help goose growth and boost asset prices, though at the expense of higher debt levels later on.
United States-Mexico-Canada: In an effort to diffuse Mexico’s anger over a provision in the USMCA bill making its way through Congress, U.S. Trade Representative Lighthizer said labor disputes under the new trade deal will still be adjudicated by an independent panel, as agreed to by the United States, Mexico and Canada last week. According to Lighthizer, the U.S. labor attaches would merely offer “technical assistance” when disputes arise, rather than acting as independent inspectors. Mexican trade negotiator Jesús Seade said he was satisfied with the U.S. response. That should help ensure U.S. approval of the deal can happen this week, which should be positive for U.S., Mexican and Canadian equities.
Germany: Even though Chancellor Merkel’s open-door immigration policy at mid-decade generated intense popular pushback and helped spark the rise of populist leaders throughout Europe, continued economic growth and low unemployment could be reversing the tide. Against a backdrop of worsening labor shortages, even as growth slows, the Merkel government yesterday held a “skilled labor summit” to discuss ways to bring foreign workers to Germany from outside the EU. In spite of the political cost of the immigration policy in recent years, Merkel was sufficiently emboldened to say, “What is really important is that we are seen in third countries as a country that is open to the world and interested.” Just as notable, Finance Minister Scholz said, “We have accepted that we are a country of immigration.” It’s important to remember that Merkel is a lame duck, so such statements probably have limited political cost for her. All the same, it will be interesting to see if skilled worker shortages reduce anti-immigrant sentiment and the appeal of populists in Germany, or elsewhere.
Argentina: The new, leftist government of President Fernández proposed massive spending hikes and still more emergency taxes, including a 30% levy on all imports and a hike in personal wealth taxes. That’s on top of the big export tax hikes for farm goods announced last weekend. The moves, which appear to validate investor concerns about the government, are likely to be negative for Argentine stocks.
India: Prime Minister Modi issued a strong defense of his new citizenship law, which has sparked mass protests across India because of its perceived tying of citizenship to religious affiliation, and discrimination against Muslims. The statement did nothing to diffuse the protests. If they continue and grow, the demonstrations could become a headwind for Indian assets.