Daily Comment (January 8, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] U.S. equity futures are higher this morning as the recovery continues.  Here is what we are watching today:

Fed news: Atlanta FRB President Bostic suggested that the policy rate may be near neutral and perhaps only one more increase is needed.[1]  Bostic has made it clear he would not support a hike that would invert the yield curve, so based on that position alone his comments were consistent with that stance.  Cleveland FRB President Mester, who we rate as a “2” on the 1-5 hawk/dove scale (1 being most hawkish, 5 most dovish), told the WSJ that she thought the central bank has some “flexibility,” which we interpret as suggesting the Fed could hold rates steady for a while.[2]  This implies we probably won’t see rate hikes in the near future, if at all.  Bostic was a voter in 2018; Mester isn’t a voter this year.

Meanwhile, FRB economist Nellie Liang has withdrawn[3] from potential nomination for an open Fed governor seat.  It isn’t clear why she withdrew as it doesn’t appear the White House wanted her to quit.  Her stated reason was discomfort with the “limbo” of the nomination process.  We will be watching closely to see if the president takes a direct hand in the next nomination.  It appears to us that Treasury Secretary Mnuchin has been the primary source of governor nominations but, given the president’s desire for a dovish Fed, we would not be surprised to see him select someone much more radical to the position.  One possibility would be to appoint one of the dovish Fed presidents, e.g., Neel Kashkari or James Bullard, to the position.  Both would be reliable doves.  In fact, the president actually has two governor vacancies he could fill since Marvin Goodfriend’s nomination has been stalled for months.  Both these current regional bank presidents could likely be confirmed since they clearly have experience.

Trade talks: Trade talks between China and the U.S. continue in Beijing today.  Although nothing concrete has emerged, sentiment surrounding the talks is positive.  According to reports, the U.S. side is pressing China for verifiable goals as China has a tendency to offer vague promises that are difficult to check.[4]  We expect these talks to end shortly but resume in Washington in the near term.  Both sides need a short-term deal and we expect such an outcome.

Shutdown woes: The government shutdown continues.  So far, we haven’t said much about it because it hasn’t affected financial markets significantly.  However, we are now starting to reach a point where it might as critical government functions could be affected soon.  There are reports that the IRS is struggling to make refunds (although they apparently can take your tax dollars without issue), and food stamps may be delayed.  There are scattered reports that TSA officers are taking sick days in response to working without pay, causing airport delays.  And, there are also reports that farmers are finding their trade relief checks delayed due to the shutdown.  In addition, crop loans could be affected soon.[5]  The president is going on television for a primetime address tonight and there are rumors he may try to declare a national emergency to fund his border wall proposal.  The National Emergency Act of 1976[6] gives the president broad powers and could conceivably be used for this goal, although it would almost certainly face court challenges.  House Democrats are preparing partial funding bills that would fund various parts of the government.  This tactic is rather standard in shutdowns; the bills fund popular parts of government (e.g., national parks) that would likely find some GOP support in Congress.  The goal would be to fund everything but wall building.  Of course, the president could veto these bills, but then he is seen as preventing Americans from going to Yellowstone or receiving welfare.  As noted above, so far, the impact on financial markets has been modest but that may change the longer this shutdown continues.

OPEC and oil prices: The Saudis are apparently considering new plans to further cut oil exports with a goal of lifting Brent prices to at least $80 per barrel.  The need for increased government spending is behind the policy.[7]  Meanwhile, Iran is hoping nations that currently have waivers from U.S. sanctions will apply to extend them,[8] which does undermine the Saudis’ goal of higher oil prices.  Although the hawks in the administration (Bolton and Pompeo) will likely try to curtail waivers, the president does appear attuned to the price of oil and may be open to waiver extensions.

Syrian policy update: As we noted yesterday, John Bolton effectively reversed the president’s Syrian withdrawal policy by setting preconditions that will likely not be met for a generation.   Turkish President Erdogan was not pleased.  Bolton was in Turkey apparently to meet with Erdogan, but the Turkish president snubbed Bolton, leaving the American national security director to enjoy a two-hour meeting with Erdogan’s spokesman.  Turkey was quite pleased with President Trump’s announcement of the U.S. troop withdrawal because it would give Ankara a nearly free hand in dealing with the Kurds.  We will be watching to see if Bolton and Pompeo prevail or if the president orders the withdrawal over the objections of these members of the administration.  If Bolton and Pompeo lose on this one, it may also impact the aforementioned Iranian oil embargo waivers.

Brexit:The Irish PM Leo Varadkar offered PM May an olive branch of sorts, suggesting the EU could offer some moderating language on the Ireland/Northern Ireland border issue.[9]  The “backstop” has become the most contentious issue of Brexit.  Essentially, if a hard Brexit occurs, a border is erected on the Ireland/Northern Ireland frontier.  The worry is that the open border has lowered sectarian tensions in Northern Ireland and closing the border will bring the troubles back.  The U.K. is quite uncomfortable with a return of sectarian tensions because it will almost certainly require British troops to return to the area for security.  So, the backstop is about keeping the Ireland/Northern Ireland border within the EU to prevent a hard border.  However, this also means the U.K. would remain tied to the EU, but not in it, thus preventing Britain from negotiating new trade deals.  Hard Brexiteers worry the backstop will become permanent, putting Britain into some sort of trade limbo where it isn’t really part of the EU but not really separate.   PM May wants assurances from the EU that the backstop won’t last forever, but it isn’t really obvious how a hard border can be avoided.  There was consideration given to putting the EU/U.K. trade border at the Irish Sea, effectively putting Northern Ireland in the EU; this possibility horrifies the Unionists in Northern Ireland because it would separate Northern Ireland from the U.K. and eventually lead to unification with Ireland.  Varadkar’s comments are welcome but lack substance as there really is no good solution to the Northern Ireland border issue.  The noted article does suggest that the deadline for leaving could be extended but, as we noted yesterday, that would likely require full EU approval and getting the entire group to agree on anything is hard, which is why the deal in place probably can’t be adjusted.  As we stated yesterday, the longer Brexit goes on, the odds of a hard separation are rising.

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[1] https://www.cnbc.com/2019/01/07/feds-bostic-sees-one-interest-rate-increase-for-2019.html

[2] https://www.wsj.com/articles/cleveland-feds-mester-expects-higher-rates-but-sees-no-urgency-11546896645

[3] https://www.cnbc.com/2019/01/08/nellie-liang-withdraws-her-nomination-to-federal-reserve-board.html

[4] https://www.wsj.com/articles/u-s-pushes-china-to-follow-through-on-trade-promises-11546869147

[5] https://www.jsonline.com/story/money/2019/01/04/government-shutdown-makes-already-rough-farm-markets-even-rougher/2475446002/?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top

[6] https://en.wikipedia.org/wiki/National_Emergencies_Act

[7] https://www.wsj.com/articles/saudis-plan-to-cut-crude-exports-to-7-1-million-barrels-a-day-say-opec-officials-11546877089

[8] https://www.reuters.com/article/us-india-iran-oil/iran-hopes-india-will-seek-fresh-waiver-from-u-s-sanctions-deputy-foreign-min-idUSKCN1P20MX

[9] https://www.ft.com/content/49c33f0e-1320-11e9-a581-4ff78404524e