Daily Comment (January 8, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] Happy Monday!  We may be on a path to the first down day of the year for equities, although it is obviously early.  Here is what we are noting this morning:

Abandoning the Palestinians: We have always believed that the Palestinian cause was more for show than reality among the Arab governments.  In other words, it was expected that Arab leaders would support the cause of the Palestinians against Israel.  In reality, however, none of the Arab states were willing to do a whole lot to push for an actual two-state solution.  In fact, not having a separate Palestinian state worked in their favor because the messy realities of governing become a problem once a state is born.  A report in the weekend NYT[1] discussed how an Egyptian intelligence officer placed phone calls to influential talk show hosts asking them to publically denounce the U.S. move of its embassy to Jerusalem but persuade their viewers to accept it.  Essentially, the article indicates that the building of a Sunni bloc to oppose the rising Shiite bloc, led by Iran, requires the Sunnis to have good relations with Israel.  It was noted that King Salman denounced the move but has “quietly signaled…tacit approval for the Israeli claim to Jerusalem.”  This shows that support for the Palestinians in opposition to Israel is a luxury the Arab states can’t afford in light of the Iranian threat.

German coalition talks: Chancellor Merkel and SDP leaders are meeting to try to build a new grand coalition.  There are numerous sticking points.  Two big ones are over the EU and immigration.  The SDP is the party of a “United States of Europe,” which is becoming increasingly unpopular in Europe; in fact, this stance has probably been one of the key factors in the overall demise of the center-left across Europe.  The SDP supports French President Macron’s call for a unified Eurozone budget and an EU finance minister.  German conservatives blanch at this goal because they fear the rest of Europe will try to expand fiscally at the expense of German taxpayers (which is probably true).  In addition, the SDP wants open immigration, another policy that appears out of step with the direction of policy across Europe.  Talks are expected to continue until Thursday; at that point, either the SDP and CDU/CSU will begin formal negotiations on forming a government (deciding which party gets what ministries) or end discussions.  If talks end, then Merkel must either (a) form a minority government, which she opposes, or (b) call snap elections.  Both the SDP and CDU/CSU are uncomfortable with another round of elections, fearing their unpopularity will lead to even greater political fracture.  At the same time, Merkel has mostly ruled out a minority government, fearing it would be unworkable.  No such arrangement has occurred in the postwar period.

May reshuffle: PM May announced she will reshuffle her cabinet, which has been rocked by recent resignations.  Most of the changes will likely be to non-core ministries and we expect the PM to name younger ministers to these roles.  It is possible, but not likely, that May will shift or fire some of her rivals, e.g., Boris Johnson.  We would not expect it, but it might happen.  If it does, it would suggest May feels emboldened.

Cohn pushes back: With SALT deductions limited in the tax bill, high tax states are considering other ways to maintain revenue and deductibility.  One idea being floated is to shift the income tax to a payroll tax paid by employers, which remain deductible.  Another is to establish a donation fund that citizens can contribute to in lieu of taxes.  Cohn suggested the administration would fight such moves as it would reduce Federal tax revenue.

2018 policy: Trump administration officials met over the weekend to begin the process of policy priorities in the new year.  Usually, these are outlined in the State of the Union address.  There is growing concern that the president will push for trade restrictions; this is where the GOP establishment will try to thwart the president’s agenda.  An increase in trade restrictions will almost certainly raise inflation and interest rates and put the current equity bull market at risk.

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[1] https://www.nytimes.com/2018/01/06/world/middleeast/egypt-jerusalem-talk-shows.html?emc=edit_mbe_20180108&nl=morning-briefing-europe&nlid=5677267&src=twr&te=1