Daily Comment (January 23, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] After all the news from yesterday, markets are fairly quiet this morning.  This is what we are watching today:

The shutdown ends: And it ends with mostly a whimper.  Democrat Party leaders essentially ended the shutdown with a promise for a vote on DACA and an extension of CHIP.  The populist wing of the party is furious; the GOP is spiking the football.  However, it’s not as dire as it looks for the Democrats or as great for the Republicans.  First, funding was only extended until February 8.  We can then do this all over again.  On DACA, the Senate might pass a bill that offers a path to citizenship but it isn’t obvious if the House will pass something and it’s anyone’s guess if the president would sign it.  Second, this was only a battle; the real war is the debt ceiling issue, which will likely come up by early April.  That could lead to a more serious crisis.  The trade that would avert a crisis is DACA in return for more defense spending, but the GOP now believes the Democrats will cave on DACA so they will be less likely to negotiate.  If the left-wing populists push establishment Democrats hard enough, we may have a debt ceiling impasse in a couple of months.

So, what are our takeaways from the shutdown?  First, Democrats really can’t do government shutdowns because, at heart, they like government and view it as a force for good.  Republicans view government as a necessary evil, a testament to the fallen nature of humans.  For Democrats, shutting down the government is a repudiation of something they hold dear; for Republicans, it’s “time off.”  Second, although there is great handwringing about immigrants, in reality, neither party is willing to deplete significant political capital for them.  Remember, President Obama could have done something about immigration in his first two years when he had a veto-proof majority in the Senate.  Instead, he used his political capital on the ACA.  The Democratic leadership knows they will still carry the majority of Latino voters in November and beyond.  Thus, the leadership isn’t compelled to move heaven and earth for their issues.  Third, for markets, the takeaway is to mostly ignore Washington.  That could make April an issue.

President to Davos: With the shutdown ended, we expect the president to make his way to Switzerland later in the week.  Expect an “America First” speech and some comments about trade (see next).

Trade action: After running as a protectionist and promising to take steps to reduce the trade deficit, the Trump administration finally acted yesterday by putting tariffs on solar panels and washing machines.  Solar panels and cells will face a 30% tariff and washing machines could face up to a 50% duty.  The actual impact will be complicated.  For manufacturers in the U.S., this action is a cause for celebration.  However, this only works if foreign manufacturers don’t cut prices further.  In the past, when the U.S. has put temporary duties on imports, foreign manufacturers have usually responded in two ways.  First, they cut prices further.  Since the duties were put in place to offset foreign government subsidies, the government could simply give more support.  It’s important to remember that for foreign governments the exports are designed to boost employment and gain foreign reserves.  The companies involved may not actually care about profits.  Second, if additional government support isn’t likely and the firm wants to maintain profit margins, it may simply move the production to another nation—that approach may not work in this case (it appears the duties are not specific to a country but to the product).  What is also missing is that manufacturing, especially for solar panels, is only part of the business.  There are an estimated 260k jobs in the solar electricity industry; about 40k are in manufacturing, with the bulk in sales, support and installation.  Overall, the solar industry views the final outcome as better than expected; a 35% duty was the consensus and 50% was possible.  And, the duties decline every year for the next four years.  Thus, as trade actions go, this was not overly punitive.  However, given the specificity of this action, it may not be indicative of future trade policies.

Yield action: BOJ Governor Kuroda indicated this morning that his central bank is not abandoning QE or policy accommodation.  In the wake of his comments, global long-duration sovereign yields declined.  We didn’t really expect Kuroda to say anything different but there has been growing speculation that the BOJ was going to follow the ECB in tightening policy.  We note that over $14 trillion of global government bonds carried a negative yield in early 2016.  That number has fallen to $9.6 trillion.

The lesson of UKIP:  The U.K. papers[1] are carrying reports about the steady decline of the U.K. Independence Party, the party of Nigel Farage, who was a driving force behind Brexit.  Farage stepped down from party leadership last year and his successor is failing to hold the party together.  Essentially, movements usually don’t last; their ideas are co-opted by mainstream parties and shift the political discussion.  In one sense, UKIP was successful beyond all measure; whole groups of people in the country that had been ignored by the two main political parties found a voice in UKIP.  But, now that these citizens have found their voice, they will have more power by being part of the Tories or Labour.

A troubling decline: The U.N. reports that foreign direct investment (FDI) fell 16% in 2017, the second consecutive year of decline.  The “Greenfield” project, investment that creates new plant and equipment, fell 32% to $571 bn, a 14-year low.  It’s hard to tell if the drop was due to fears of increased protectionism, government interference or part of an overall decline in investment activity, but falling FDI does suggest globalization is in retreat and could eventually lead to higher inflation.

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[1] https://www.ft.com/content/cff64e3c-ff84-11e7-9650-9c0ad2d7c5b5?emailId=5a66a827f3e8d400040bd1d0&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22