Daily Comment (January 11, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST]

Chinese pullback in Treasuries: Yesterday, citing an anonymous source, Bloomberg News reported that China is considering reducing or halting its purchases of U.S. Treasuries; China has since denounced the report as “fake news.”  Initially, U.S. Treasuries, the dollar and U.S. equities fell on the news, but have since rebounded.  The report is interesting for two reasons: 1) it shows that China’s use of soft power to reduce U.S. influence around the world also extends to delegitimizing the U.S. media; and 2) this report could be China’s way of signaling to President Trump that it will not back down in the event of a trade war.  China reducing its purchases of U.S. Treasuries could have a negative impact on the U.S. economy as the U.S. is currently under pressure to find alternative sources of financing in order to replace the loss in government revenue due to passage of the tax bill.  A decrease in demand for U.S. Treasuries may lead to higher interest rates which could also make it more expensive for households and corporations to borrow.  However, as long as China continues to run an enormous trade surplus with the U.S., its only alternative to buying Treasuries is to sell the dollars it accumulates.  This would have the effect of appreciating its currency relative to the dollar, not likely China’s desired outcome.  Hence, we tend to discount the validity of the report.

NAFTA exit imminent: Reuters reported this morning that Canadian officials expect President Trump to announce U.S. withdrawal from NAFTA later this month.  Mexico has already announced it would also leave NAFTA upon the U.S.’s exit.  Canada, on the other hand, is exploring other options and we suspect it may reconsider joining TPP.  If this report is true, President Trump would likely face staunch opposition in Congress, especially among establishment Republicans.  A U.S. departure from NAFTA would likely be bearish for U.S. equities, especially for automakers who rely on supply-chains set up throughout the three countries.  All things considered, Canada probably leaked this report in order to gain leverage in the next round of meetings in Montreal on January 23-28.  We will continue to monitor this situation.

Trump open to talking with North Korea: In a phone call to South Korean President Moon Jae-in, President Trump stated he would be open to setting up talks with Kim Jung-un under the right conditions.  At the moment, it is unclear what conditions the president would be willing to accept, but in the past he has stated that North Korea would have to abandon its nuclear program before discussions can begin.  Despite President Trump’s apparent willingness to hold talks with North Korea, there are also reports suggesting the president is considering punitive airstrikes.  This carrot-and-stick approach has been a signature negotiating style of this administration; therefore, we have not put much weight on the latter issue and expect tensions between the two countries to simmer down.

Uncertainty in Catalonia: The Catalan parliament is due to hold its first meeting at the end of the month but it is unclear who will be the next leader.  According to Catalan bylaws, the leader of parliament needs to be present in order to present the government program.  Given that the presumed two possible leaders are either in jail or in exile, it is unclear who will lead the parliament.  There have been discussions that Carles Puigdemont could present the government program via Skype, but skeptics claim that will be challenged in court as they would argue that he needs to be there physically.  Puigdemont’s second in command, Oriol Junqueras, is currently in jail.  Current Catalan President Carmen Forcadell has announced that she will not continue her duties as president in the upcoming parliament.

Possible second Brexit referendum?  The prospect of a second referendum on Brexit is currently gaining steam as Brexit campaigner Nigel Farage admitted earlier today that he is warming to the idea.  British Prime Minister Theresa May has come out against the notion of holding a second referendum as it would surely undermine the U.K.’s leverage with the EU during Brexit negotiations.  Since the U.K. announced its intention to leave the EU in March of last year, Theresa May has struggled to gain support for a cohesive Brexit strategy going into negotiations with EU officials.

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