Daily Comment (January 24, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Equities are rising modestly this morning.  Here is what we are watching:

Venezuela heats up: Venezuela has been a problem for a while.  Its economy and government have essentially stopped functioning.  Hyperinflation has set in.  There is a massive exodus of Venezuelans[1] to other parts of South and Central America (and, at some point, it is safe to assume they will come to the U.S. border).  The state oil company, PDVSA, has been gutted by replacing competent workers with lackeys loyal to the regime; oil production has declined to 1970s levels.  In fact, it is such a mess that the real mystery is why the current regime remains in power.  It appears this mystery may be getting resolved.  Protests in Venezuela have taken on a different tone.  For years, the Chavez/Maduro leadership was able to control the country due to loyalty from the working class.  Protests generally came from the middle and professional classes; the rich mostly live in Miami now.  What is new is that the working classes are turning on the government.  For a time, Chavez was able to funnel resources to the poor, which helped maintain support, but now the economy has become so weak that it can’t buy off the lower classes anymore.[2]

Juan Guaido, the president of the National Assembly, has declared himself interim president.  The Trump administration has recognized him as the new president of Venezuela[3] and, more importantly, the military and security services are not moving against him.  Regional governments have turned against Maduro, led by Brazil’s new leader, Jair Bolsonaro, but also with support from Argentina and Paraguay.[4]  Maduro responded by giving U.S. diplomats 72 hours to leave Venezuela.  SoS Pompeo, following the logic that Maduro is no longer president of Venezuela, indicated the diplomats would stay.[5]  As we noted yesterday, the Trump administration is considering oil sanctions on Venezuela[6]; if implemented, they would remove the last prop keeping the Venezuelan economy functioning (as badly as it is).  Meanwhile, Russia has warned the U.S. not to use military force against Maduro, which is, in a sense, an idle threat.  There is no way Russia could maintain a major military effort over such a long distance.  Instead, we would look for Russia to do its usual move in these sort of circumstances, which is to create pressure on U.S. interests where it can, e.g., Ukraine, Moldova, etc.[7]  Besides Russia, Maduro’s dwindling international support comes from Turkey, Cuba, Nicaragua, Bolivia and South Ossetia (a state only in the mind of Putin).

We suspect Maduro is finished.  What follows will be critical.  The most pressing issue is to restart the economy, which means getting oil flowing again.  The quickest way to accomplish this is to open the oil sector to foreign investment and allow foreign ownership of reserves.  We doubt a new government would go quite that far, but generous production-sharing agreements would likely be a minimum.  Still, it would probably take at least two or three years for output to return to the 3.0+ mbpd level it was before Chavez undermined PDVSA.  The second major issue is debt; Venezuela needs to restructure its debt and will almost certainly require an IMF bailout.  China and Russia, which have both become major creditors, are likely to be disadvantaged by a U.S.-supported regime.

Eventually, a renewed Venezuela will be bearish for oil prices; recovery would add 2.0 mbpd to global oil supplies.  However, that recovery will take at least a couple of years.  In the short run, turmoil could reduce Venezuela’s oil output even further and is thus supportive for crude.

ECB: The ECB, as expected, left policy rates unchanged.  However, the press conference comments were decidedly dovish.  The line from ECB President Draghi from H2 2018 was that prosperity was just around the corner.  In these prepared comments, he has finally admitted that the Eurozone economy has slumped and he indicated the ECB will keep policy easy until growth and inflation rise.  The EUR slumped on the news.

World growth: As we note below, flash PMI estimates from Asia and Europe were well below expectations.  Eurozone PMI is now hovering just above the 50 expansion line at 50.5.  Japan is sitting at 50.0, down from 52.6 in December.  By its mandate, the Federal Reserve does not act as the central bank of the world but, in reality, it is because of the dollar’s reserve status.  Thus, if the FOMC members are looking at a pause, world economic performance does offer an excuse for maintaining steady policy.

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[1] See WGRs, The Venezuelan Migration Crisis: Part I (9/17/2018) and Part II (9/24/2018).

[2] https://www.washingtonpost.com/opinions/2019/01/23/venezuelans-take-streets-again-could-democracy-be-won-this-time/?utm_term=.520b71843986&wpisrc=nl_todayworld&wpmm=1

[3] https://www.axios.com/venezuela-juan-guaido-nicolas-maduro-us-donald-trump-96db1b60-62e4-411b-bbe8-e03f27344821.html and https://www.ft.com/content/4ac66f4e-1f3b-11e9-b126-46fc3ad87c65?emailId=5c4952cdba3bc100043c5744&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[4] https://www.axios.com/trump-regime-change-venezuela-maduro-pence-video-b2a231d5-af89-4b49-bf68-dae2fc2a2f8e.html

[5] https://www.washingtonpost.com/world/the_americas/opposition-launches-protests-to-oust-maduro-as-us-venezuela-tensions-rise/2019/01/22/0416687a-1e4f-11e9-a759-2b8541bbbe20_story.html?utm_term=.437758d096b0

[6] https://www.reuters.com/article/us-venezuela-politics-usa/us-weighs-oil-sanctions-on-venezuela-as-it-steps-up-pressure-idUSKCN1PH22B

[7] https://www.reuters.com/article/us-venezuela-politics/as-world-looks-on-venezuelas-guaido-to-keep-up-pressure-on-maduro-idUSKCN1PI0CY?feedType=RSS&feedName=topNews