Daily Comment (January 22, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] The media is focused on the government shutdown but, if the markets are a guide, there isn’t much to see.  This is what we are watching this morning:

BREAKING: The IMF has boosted its estimate for global GDP to 3.9%, up 0.2%, in part due to the U.S. tax cut.  This would be the fastest growth in seven years.

The shutdown: The shutdown continues this morning with little signs of reconciliation.  For this to end, one side has to concede to the other and the primary impetus would be negative polling.  That’s why both sides are desperately spinning blame on the other side.  Although reliable and timely polling remains scarce, it appears to us that partisans are convinced the other side is responsible and will suffer the most damage.  Until it becomes obvious that one side is clearly being blamed, this shutdown could go on for a while.  Currently, the decision markets are putting the odds at 50/50 for an end to the shutdown by Thursday.  We would not be surprised to see this go into the weekend.

What are the potential effects?  First, if the shutdown does last into the weekend, the president probably won’t go to Davos.  Second, more parts of the government will begin to shut down and other services will slow.  The economic effect will be modest, perhaps 0.1% to GDP.  Third, the most important market effect would occur if economic data starts to be delayed.  For example, we may see initial claims delayed if this shutdown lasts a week.  The weekly crude oil inventory report could be affected, although the latest news from the EIA is that the data will be released on time.  As this shutdown continues, even if the data has been collected there may not be workers in place who can sort and publish it.  The longer this goes on, the more markets will be “flying blind.”  Overall, this shutdown isn’t likely to be a big deal.  The focus from the financial markets has been on tax reform and since that bill was passed expectations for 2018 were rather low anyway.  Thus, we view it as a media event but nothing more.

Turkey invades: Turkish troops have crossed the border into Syria to attack a Kurdish rebel group that has gained control of the area.  The U.S. has been supporting the Kurdish Syrian Democratic Forces who have been attacking what remains of Islamic State.  Ankara’s action is provocative; Syrian leader Assad has opposed the move and Russia is struggling to remain neutral.  And, the U.S. opposes Turkey’s invasion.  President Erdogan has promised the operation will be swift; no leader wants to find himself bogged down in an insurgency war in a foreign country.  At the same time, the borders of Syria and Iraq are borders in name only in various parts, and Turkey may decide that controlling a part of what was once Syria to prevent the Kurds from gaining control is an attractive position.

The Brazil problem: Brazil is holding presidential elections in October.  The two leading candidates are Luiz Inácio Lula da Silva and Jair Bolsonaro.  The former, known as “Lula,” was president from 2003 to 2011.  He is considered a hard leftist, although one could argue he governed as a center-left president.  Lula is the leading candidate and will probably win in the fall, except…an appeals court this week could uphold his earlier conviction for corruption and money laundering.  If the court upholds the conviction, Lula can’t run (and could go to jail).   Bolsonaro is a hard-right candidate who has allegedly made disparaging comments about women, Africans and gays.  As we are seeing in many parts of the world, the center isn’t holding support and radical candidates are doing well in polls.  If Lula’s conviction is upheld, we may see Brazilian financial markets suffer.

Merkel wins (the first step): The SDP did agree to open formal coalition talks with the CDU/CSU this weekend.  The vote was close, as these things go—only 56% of the SDP party leadership was on board with beginning discussions.  Usually, these decisions are executed with a voice vote but it was too close for that procedure.  The next step is for the parties to decide on mandates—which party controls various ministries.  Once that is done, the SDP membership must approve the actual coalition.  Although joining another grand coalition is not very popular with SDP members, the alternative of another election is even more troubling. Thus, we think the grand coalition will be formed and Chancellor Merkel will continue to govern Germany.

Iranian banks: We recently discussed Iran’s protests in a WGR.[1]  The weekend NYT[2] reported that a factor in the protests was a series of bank failures that caused the loss of depositors’ money.  In the West, such concerns have been ameliorated through deposit insurance.  Prior to the 1930s, bank failures would often cause depositor losses.  Iran shows no signs of adopting deposit insurance and the general tone of the article suggests the authorities are blaming depositors for their losses.  Iranian political leaders should be careful with such claims.  Bank balance sheets are always a bit opaque because it is hard to determine the value of bank assets (mostly loans); a healthy bank can become a troubled one with a few defaults.  It appears that in Iran, the politically well-connected were able to secure favorable loans that they defaulted on and the costs are being born by depositors.  Losing deposits tends to adversely affect the middle class who have less liquidity to diversify into other asset classes.

OPEC: Russia and OPEC members are hinting they may continue to cooperate even after the current agreement expires.  We doubt Russia will be joining OPEC or cooperating all that much in the future.  But, as we noted last week, Russia’s Reserve Fund is exhausted and falling oil prices would be deadly for its economy.  Thus, this “jawboning” to keep oil prices elevated is a costless way to keep revenues strong.

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[1] See WGR, The Iranian Protests, 1/8/2018.

[2] https://www.nytimes.com/2018/01/20/world/middleeast/iran-protests-corruption-banks.html?emc=edit_mbe_20180122&nl=morning-briefing-europe&nlid=5677267&te=1