Daily Comment (January 8, 2020)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EST]

After a wild overnight session, risk assets are rising this morning.  Here are the details:

About last night:  As we were watching the Blues dispatch the Sharks, Iran launched a series of missile strikes against two bases in Iraq.  Market reaction was swift—equity futures plunged, oil and gold prices soared.  However, comments from Iran suggest that an “off ramp” might be in place that would allow both sides to de-escalate current tensions.  Tweets from Javad Zarif, Iran’s foreign minister, suggested that the attack might be all that Iran intends to do IF the U.S. doesn’t retaliate.   Tweets from President Trump seemed to suggest that he might be satisfied with not retaliating, especially since there were no apparent casualties.  As these messages of moderation entered into the market, risk assets recovered and safety assets retreated.

There are two unknowns; first, does last night really represent all that Iran plans on doing in retaliation?  Second, will President Trump take the off ramp and not react to yesterday’s missile strike?  Let’s take the second part first.  It would fit the president’s past patterns to not react to the missile attack.  No Americans died in the event which appears to be one of his red lines.  If a pinprick missile strike is considered to be enough to compensate for the killing of Soleimani, it seems like that outcome is favorable to the U.S.  Which leads us to the first question.  We have serious doubts that Iran believes it has fully retaliated.  However, direct military confrontation is not the usual path Iran takes in projecting power.  The missile strikes buy the regime time; it can tell its citizens it acted, and we suspect the Iranian media will play up the attack to make it appear more damaging than it was.  Still, we doubt yesterday’s response will be the final retaliation; though, it may take months before we see the next action and, in the meantime, financial markets will likely show less concern over this issue…assuming our assessment of the second question is accurate.

Venezuela:  Juan Guaido isn’t done yet.  After President Maduro tried to oust Guaido as the head of the National Assembly, Guaido and his supporters stormed the building, pushing past security personnel to give Guaido the opportunity to take the oath of office and return as head of the legislature.  So, for now, Venezuela remains divided.

Libya:  Forces led by General Khalifa Hifter have taken control of Surt, a city on the central coast of Libya.  Hifter is generally considered a secular leader and controls most of eastern Libya.  The U.N. backed government, which has Islamist group support, is centered in Tripoli but has been struggling to hold territory against Hifter’s forces.  The Libyan civil war is attracting outside influence; Russia and Egypt have generally been supporting Hifter while Turkey recently sent troops to support the Tripoli government.

Taiwan:  Voters on the island go to the polls on Saturday in an election that is being framed as a choice between freedom, or dominance by Beijing.  Events in Hong Kong loom largely over this election.  China has aggressively intervened to swing the vote to the KMT candidate.  The incumbent, President Tsai Ing-wen, the DPP candidate, was trailing in the polls in the spring but has seen her fortunes improve while the KMT’s candidate, Han Kuo-yu, has slipped badly in the polls.  Hong Kong is the primary reason.  Taiwanese politics tend to swing based on attitudes towards China.  The KMT, which represents the Nationalists from the mainland who lost to Mao in 1949, tend to favor closer ties to the PRC, whereas the DPP tends to favor looser ties.  The crackdown in Hong Kong undermines the “one country, two systems” formula that emerged in the transfer of Hong Kong to PRC control in 1997.  If Tsai wins, as it appears she will, tensions between Taipei and Beijing will likely increase.

Silicon Valley strikes back: Once staunch opponents of trade protectionism, U.S. tech giants are now backing tariffs against French goods. The reversal comes on the heels of a controversial French digital services tax that hit firms such as Facebook (FB,213.06), Amazon (AMZN,1906.86) and Alphabet (GOOG, 1393.34). As the world moves away from global free-trade toward more regional free-trade, it is likely that Big Tech will come under pressure from other countries due to an increase in both scrutiny and competition.  Therefore, we are not confident that the signing of the “phase one” trade deal with China will lower global trade tensions as much as the financial markets expect. That said, it is also becoming more likely that the traditionally left-leaning Silicon Valley are becoming more open to forming an alliance with moderate leaning conservatives.

Brussels vs UK: On Wednesday, European Commission President Ursula von der Leyen warned the UK that it must adhere to a “level playing field” of rules to protect European companies from unfair competition.  The warning comes as both sides prepare to restart negotiations on a Brexit agreement, following PM Boris Johnson’s decisive victory in December. The posturing by the European Union, highlights the growing uneasiness that the bloc has about the UK’s departure. On Tuesday, PM Johnson revealed his “fast-track” trade deal, in which he stated that the UK should have the right to diverge from certain EU rules. Officials from the EU fear that the condition laid out by PM Johnson, could lead to a creation of a hard border, which could potentially disrupt supply chains. Given ongoing geopolitical risks, we are not confident that the bickering between the UK and the EU will have much of an impact on equities in the short-term, however, there may be long-term ramifications if a deal is not reached by the end of the month.

Cyber-attacks in Texas: On Tuesday, Texas Governor Greg Abbott announced that the state saw a surge in infiltration attempts by foreign operatives; 10,000 attempts per minute in the last two days. Although Iran was implicated, it is believed that other countries have also attempted to gain access to the Texas network. At this time, the state reports that is has been able to block all attempts to gain entry, but has not elaborated on where the attacks are targeting. Despite Texas’s success in preventing attacks, hackers were able to successfully hack into the U.S. Depository Library Program earlier this week. As we have mentioned in prior comments, warfare is much more likely to happen with computer viruses than with bombs. Hence, we do not expect Texas to be the only state affected going forward.

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