Daily Comment (December 20, 2016)

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

[Posted: 9:30 AM EST] There wasn’t much on the economic front overnight.  The BOJ, as expected, left policy unchanged.  There had been some rumblings about the Japanese central bank allowing bond yields to rise in line with rates in the U.S.  To recount, the BOJ has fixed its 10-year JGB yield at zero and will adjust its balance sheet to maintain that price.  This policy was changed earlier this year away from a set level of buying.  We see little reason for the BOJ to change policy now; in fact, it now becomes more powerful as U.S. rates rise because it supports a weaker JPY.  And, that is what we saw in the aftermath of the meeting.

In the press conference, BOJ Governor Kuroda made it clear that policy will remain in place.  He indicated that inflation still remains too low and the current JPY weakness is mostly due “to a strong dollar, not a weak yen.”  If the BOJ maintains its current policy, we would expect the JPY to continue to weaken.

There were two geopolitical events yesterday.  First, a truck struck pedestrians in a crowded market in Berlin in an apparent terrorist attack.  According to reports, the man arrested was a 23-year-old Pakistani refugee who entered Germany at the end of last year.  This attack will increase pressure on Chancellor Merkel who has come under heavy criticism for her open refugee policy.  The chancellor is a consummate politician; given the growing wave of populism, we would expect her to shift her stance away from refugee support to maintain power.  However, if she does make this change, Europe will become closed to Middle Eastern refugees and problems in the latter region will worsen.

The other event was the assassination of Russia’s ambassador to Turkey who was killed by one of his security guards, a Turkish policeman.  Peter Zeihan, a geopolitical analyst we follow, made an interesting observation about Russia’s elite.  In the U.S., there is a surprisingly wide road to influence.  A university education, the right internship, a stint in the military, powerful friends, state and local government, a place in the bureaucracy, business success and connections, etc. can be paths to positions of power.  In Russia, there is really only one path to national leadership, which runs through the intelligence agencies.  The FSU and GRU are the only real roads to positions of influence.  Thus, in the U.S., approximately 2.0 mm people have some degree of influence.  More importantly, they become a pool of talent that people in power can tap.  That number in Russia, according to Zeihan, may be around 200.  Thus, losing a figure like Ambassador Andrei Karlov may be quite a blow.  He was multi-lingual and savvy.  Before going to Turkey he represented Russia in North Korea.  Thus, Karlov was no mere functionary but a rare talent.  It is important to note that Karlov managed the 2015 incident when Turkey downed a Russia warplane.  Karlov was apparently instrumental in helping Erdogan deescalate the situation and maintain Russian/Turkish relations.  If anything, they have improved since the event.

Who Putin puts in Turkey will be important.  As IS collapses, Turkey, Iran, the Kurds and Syria will be trying to grab territory and influence in the region.  If Russia can’t replace Karlov with someone of equal stature, the potential increases for larger conflicts.

View the complete PDF