Daily Comment (December 20, 2019)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EST]

N.B.  A couple of items.  First, the Daily Comment will go on hiatus from Dec. 23, 2019, to Jan. 1, 2020.  Publication will resume on Jan. 2, 2020.  Second, the fifth episode of the Confluence of Ideas podcast has been posted.  “Arriving at Decisions” examines the issues that surround making decisions under conditions of uncertainty.

Happy Friday!  In fact, it should be an especially happy day, as several important uncertainties are formally being removed.  The House has given its OK to the U.S.-Mexico-Canada trade deal, and the Senate has approved funding for the federal government for this fiscal year.  In the U.K., parliament is formally debating Brexit and is expected to pass the deal easily.  Here’s what we’re watching today:

United States-Mexico-Canada:  The House of Representatives yesterday voted 385-41 to approve the “USMCA” trade agreement.  The update to NAFTA will now need to be approved by the Senate, most likely early next year.  The Canadian parliament also still needs to approve the deal, but as of yet there is no set schedule for a vote in either of its chambers.  Only Mexico has approved the deal so far, but since the United States and Canada are both expected to follow suit, it appears that the uncertainty regarding North American trade is dissipating, which is probably one key reason for the ongoing rally in stocks.

U.S. Federal Budget:  The Senate has approved the two appropriations bills necessary to fund the federal government through the fiscal year ending September 30.  If President Trump signs the bills before the end of today, as expected, there will be no new government shutdown.  The news is likely to be positive for stocks as it removes yet another potential source of uncertainty.

United Kingdom:  Parliament today began debating Prime Minister Johnson’s Brexit withdrawal deal with the EU.  The bill is widely expected to pass with a comfortable majority, helping to remove a bit more uncertainty regarding Brexit.  That’s likely a positive for European stocks, although it’s important to remember that there is growing concern that Britain may not be able to secure attractive trade deals with the EU, or the United States in the coming year or so. Separately, the government announced that the new head of the Bank of England will be Andrew Bailey, a longstanding official at the central bank who is currently the head of its regulatory office.  The well-respected Bailey is considered a “safe pair of hands,” so the decision is likely to be positive for British assets.  All the same, it is still not clear where he will take British monetary policy when he officially assumes his post on March 15.

U.S.-China Trade:  Chinese leader Xi Jinping reportedly doesn’t plan to attend January’s World Economic Forum meetings in Davos, Switzerland.  That eliminates one potential venue for him to meet President Trump for a formal signing of the “phase one” U.S.-China trade deal.  However, China still plans to send its top trade negotiator to Washington in January so he can sign the deal.

European Union-China:  The new president of the European Council, Charles Michel, said he will push the EU to prioritize deeper economic ties with China while also protecting its own markets.  In doing so, he vowed that the EU’s international trade policies would not be dictated by the United States.  The statement amounts to pushback against U.S. efforts to re-set relations with China, but it also reflects the slow-growing EU’s reliance on exports.

India:  Thousands of Muslims and social activists today staged another round of protests against Prime Minister Modi’s new, Hindu-friendly citizenship law, in defiance of the government’s ban on public gatherings.  It still seems Modi will eventually get control over the protests (especially because of his clampdown on the internet and communication services yesterday).  That helps explain why Indian stocks have been able to push to new record highs this week.  However, today’s defiance against the public-meeting ban suggests he still has his work cut out for him.

Lebanon:  Christian, Sunni and Shiite political leaders (including Hezbollah) have agreed that the country’s new prime minister will be Hassan Diab, a former education minister who is now the vice president of Lebanon’s top university.  As described in our WGR from December 2, Lebanon’s “confessionalist” power-sharing system requires the prime minister to be a Sunni Muslim, but many parliamentary Sunnis refused to vote for Diab, suggesting the real winners in the negotiations were Hezbollah, the Maronite Christians and maybe even the youthful demonstrators that brought down the former prime minister two months ago.  Since the move helps reduce uncertainty regarding Lebanon, there is still no firm news on what Diab will do to address the country’s financial and debt crisis.

North Korea:  Thousands of North Korean laborers are streaming out of Russia ahead of a Sunday deadline to avoid UN sanctions.  The exodus will end one of North Korea’s last remaining sources of foreign funds.  It may therefore help stoke the country’s recent new provocations aimed at the United States.  Reports indicate U.S. intelligence is closely monitoring North Korea for a potential Christmas Day missile launch.

U.S. Junk Bond Market:  Moody has issued a report warning that this year’s rally in low-rated bonds has left them vulnerable to a significant fall in value next year.  As shown in the charts near the end of this article, U.S. high-yield bonds have provided a total return of 13.97% for the year through yesterday.  With the Fed’s 2019 interest-rate cuts, the recent improvement in some economic indicators and the new easing of global trade tensions, some of that strong return may well be justified.  However, according to Moody, “If the anticipated improvement in fundamentals governing corporate credit do not materialize, a significant widening of high-yield bond spreads is likely.”

View the complete PDF