Daily Comment (December 21, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] 

[N.B.  The Daily Comment will go on holiday from December 24 to January 2.  From all of us at Confluence, but especially Thomas and me, thanks for reading and have a Merry Christmas and Happy New Year!]

On Friday, December 14, we published our 2019 Outlook: Red Sky at Morning report.  If you missed it, you can find the report linked here or on our website.

Happy Winter Solstice!  It’s another risk-off day—Washington unrest is the catalyst.  Here is what we are watching this morning:

Washington unrest: Although spending any time watching cable news could lead one to think that Washington is always in crisis, what is going on now is actually chaotic.  Here is the rundown:

Shutdown: It appeared the White House and Congress had a deal.  In fact, a large number of senators headed home after voting for a spending bill, thinking the issue was resolved.  The president, however, changed his mind and demanded border wall funding.  The House did vote for the measure but it has no chance in the Senate.  And so, we are heading into a partial shutdown.  Usually, financial markets pay little mind when we have a shutdown outside of a debt ceiling issue.  However, the sudden shift from an agreement to no deal has undermined investor confidence, which is already fragile.  The president indicated that the shutdown could last a long time; that outcome could eventually start delaying data releases, which would further unsettle conditions (imagine no employment data for a month, or relying on the API for energy data).

Mattis: General Mattis was the last constituent of the “committee to save America,”[1] members of the administration representing the establishment who saw themselves as the primary barrier preventing the president’s populist instincts from running rampant.  Since the president’s election, we have noted the continued battle between the establishment and the populists within his administration.  The establishment pushes for business and market-friendly policies, such as tax cuts and deregulation.  It opposes the populist goal of deglobalization, which includes trade impediments and immigration restrictions.  The president has tended to straddle these divisions; the establishment has clearly benefited from tax cuts and deregulation, but the populists cheer the tariffs, tough talk on the border and anti-immigration stance of the White House.

In terms of foreign policy, populists want to reduce the American superpower role while the establishment supports continued American hegemony.  That means continuing to freeze the three conflict zones,[2] which include the Middle East.  This policy goal has been coming under pressure well before Trump took office.  The Middle East became unstable after Bush removed Saddam Hussein from power and led Iraq into civil war.  President Obama’s support for the Arab Spring led to civil conflict in Syria.  The decision not to enforce the “red line” against Assad for using chemical weapons further weakened the U.S. position in the region.  The power vacuum led to the rise of IS and prompted the U.S. to insert troops in the region to weaken this group.  Russia has reasserted itself in the region.  Iran is attempting to expand its influence.  Saudi Arabia has been courting the U.S. to undermine the Obama-era policy of normalizing relations with Iran.

So, it’s not like President Trump inherited a well-functioning policy.  However, removing U.S. troops from Syria ensures the U.S. will have even less influence in the region.[3]  Secretary Mattis opposed removing the troops, but the president exercised his prerogative and ordered the withdrawal of the 2,000 American troops in the area.  Mattis apparently saw this as his red line and resigned.  And, he didn’t just resign—his exit letter lacked any of the usual expressions of gratitude to the president and instead offered a stinging rebuke.[4]  In the letter, Mattis defended the Liberal World Order of free trade and support for allies—in other words, the policy the U.S. has followed since the end of WWII.  Essentially, Mattis is indicating that, in his view, the president doesn’t support that policy, while Mattis does, and it is probably better for the president to have a defense secretary who has views consistent with his own.[5]  Already, U.S. allies are viewing the resignation with trepidation.[6]

This exit isn’t just the normal flow in and out of an administration.  Mattis is signaling to the GOP establishment that Trump is turning populist and the members of the establishment have to start considering their options.  And, we are seeing some pushback.  Sen. Ben Sasse, who has been critical of the president, was critical on this issue, too.[7]  Sen. Lindsey Graham, who has had an on and off relationship with the president, is in a full-on Twitter feud with the White House.[8]  However, perhaps the most unexpected response came from Sen. Mitch McConnell, who has generally been supportive of the president; he was actually rather critical of the decision that led Mattis to resign.[9]  Mattis represented, to some degree, a member of the administration that the establishment could look to for comfort.  That is now gone.

We will be watching how far this establishment rebellion goes.  Already we are seeing Sen. Grassley push back on steel and aluminum tariffs as part of USMCA.[10]  The shutdown will likely anger Senate Republicans.  At the same time, the president seems to be moving into an increasingly populist stance this year.  The trade conflict began in earnest in February.  The removal of troops is classic Jacksonian policy, who like to fight wars with overwhelming force and clear endings.  The president is planning on drawing down troops in Afghanistan,[11] likely opening up the country for the return of the Taliban.

Our view is that President Trump has been attempting to placate both the populists and the establishment but he is steadily being forced to choose.  If he decides to go populist, he will lose support in the Senate which may hurt him if impeachment occurs.  At the same time, his victory was mostly due to populist support.  The president has a difficult political path to hew.  It may be difficult to pull off.  But, the more he leans populist the greater the risk to equity markets.  It would make sense to delay this conflict as long as possible but it appears that option may not be available.  Thus, we will continue to closely watch how this situation evolves.

China: The U.S. has accused two Chinese nationals of a series of cyberattacks on the U.S.[12]  Other nations have made similar accusations.  So far, the U.S. and China have kept trade talks separate from security issues.  But, that condition may not last.  China has announced further measures to boost the economy, which has slowed due to earlier deleveraging and trade issues.[13]  Although China has been buying more American soybeans, thus far it has not purchased U.S. crude oil.[14]  That fact has likely added to recent crude oil weakness.

Brexit: According to reports, PM May is building options in case her Brexit proposal fails.  This may include delaying the exit,[15] a new referendum or new elections.[16]  Given that deadlines didn’t improve the chances of her plan, it probably makes sense to consider other options.  We still expect another referendum with the increased chance that Brexit may be rescinded.

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[1] https://www.axios.com/the-committee-to-save-america-1513304754-2e4002e8-5720-422a-a668-8db4210785fb.html

[2] For a more in-depth discussion, see our WGR, The Mid-Year Geopolitical Outlook (6/25/18).

[3] https://www.nytimes.com/2018/12/20/world/middleeast/syria-us-withdrawal-iran.html?emc=edit_mbe_20181221&nl=morning-briefing-europe&nlid=567726720181221&te=1

[4] https://www.politico.com/story/2018/12/20/mattis-to-retire-in-february-trump-says-1072150

[5] https://www.bloomberg.com/opinion/articles/2018-12-21/mattis-resigns-and-puts-trump-s-presidency-in-peril?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top

[6] https://www.nytimes.com/2018/12/20/world/asia/mattis-resign-afghanistan-withdrawal-trump.html?emc=edit_mbe_20181221&nl=morning-briefing-europe&nlid=567726720181221&te=1

[7] https://www.sasse.senate.gov/public/index.cfm/press-releases?ID=A6A8DA56-49E5-44B3-8E76-25CD20A2D182&utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top

[8] https://www.postandcourier.com/politics/lindsey-graham-and-president-trump-are-feuding-on-twitter-and/article_a1e66484-0490-11e9-baee-df7f0ecc2475.html


[10] https://www.axios.com/chuck-grassley-trump-tariffs-section-232-national-security-613bb759-acac-4a36-9703-9a2ee1958f28.html

[11] https://www.nytimes.com/2018/12/20/us/politics/afghanistan-troop-withdrawal.html?emc=edit_mbe_20181221&nl=morning-briefing-europe&nlid=567726720181221&te=1

[12] https://www.nytimes.com/2018/12/20/us/politics/us-and-other-nations-to-announce-china-crackdown.html?emc=edit_mbe_20181221&nl=morning-briefing-europe&nlid=567726720181221&te=1 and https://www.ft.com/content/f5f0b42c-046c-11e9-99df-6183d3002ee1?emailId=5c1c6e9b0e56a1000466bc18&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[13] https://www.bloomberg.com/news/articles/2018-12-21/china-says-more-tax-cuts-coming-signals-easier-monetary-policy?utm_source=google&utm_medium=bd&cmpId=google

[14] https://www.reuters.com/article/us-usa-trade-china-oil/crude-refusal-china-shuns-u-s-oil-despite-trade-war-truce-idUSKCN1OK0FG

[15] https://www.ft.com/content/e8d70ba8-03a7-11e9-99df-6183d3002ee1?emailId=5c1c6e9b0e56a1000466bc18&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[16] https://www.bloomberg.com/news/articles/2018-12-20/u-k-s-may-is-hatching-secret-brexit-plan-b-to-avoid-armageddon