Daily Comment (January 9, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST]

Crypto problems: The major cryptocurrencies fell sharply yesterday after wide price divergences on South Korean exchanges led the exchanges to limit data on pricing.  South Korea, worried about excessive speculation in the cryptocurrencies, has been cracking down recently which is leading to growing concern about the stability and liquidity in this market.  We don’t have any strong feelings about this market nor do we recommend any positions, but we do warn investors this is a very immature market that is unstable and prone to illiquidity.  In other words, caveat emptor!

A rethink on policy structure: The FOMC has used the Phillips Curve as its guide to policy for years.  The concept of NAIRU (non-accelerating inflation rate of unemployment) has been the primary tool for policymakers.  In general, the idea is that there is a level of unemployment that will tend to lift inflation and policymakers expect to raise the policy rate if that level is breeched.  Chair Yellen has generally maintained that policy despite the fact that we have seen a steady drop in unemployment without a commensurate rise in price levels.  A growing number of FOMC members[1] are calling for incoming Chair Powell to consider other policy guidance frameworks.  These frameworks could include a target for price levels as opposed to the rate of change or a nominal GDP target.  Either method would probably lead the Fed to slow its pace of rate hikes; if this call gains traction, we would consider it bearish for the dollar and bullish for equities and the short end of the yield curve.

North Korea in the Olympics: Yesterday, North Korea agreed to send a delegation to participate in the Winter Olympics next month in Pyeongchang, South Korea.  South Korea has been seeking to reduce tensions with its northern neighbor to ensure a peaceful environment during the Winter Olympic Games.  In 1987, when South Korea was preparing for the 1988 Olympic Games, North Korea was accused of having terrorists hijack and crash a Korean Air Passenger plane in retaliation for a breakdown in discussions between the two countries to co-host the event.  North Korea’s participation is believed to be a forerunner for future military discussions to reduce tensions on the Korean Peninsula.  Skeptics claim that North Korea may be using the possibility of warmer relations in order to drive a wedge between South Korea and the U.S.; after all, this would not be the first time North Korea has agreed to hold discussions and then later reneged.  However, South Korean President Moon Jae-in remains optimistic about future discussions.  While campaigning to become president, Moon promoted dialogue with North Korea as opposed to seeking U.S. involvement and criticized the prior administration’s decision to prematurely deploy a U.S. anti-missile system.[2]  Furthermore, President Trump has also expressed optimism, stating that North Korea’s decision to hold discussions with South Korea is a sign that sanctions are working.  We will continue to monitor this situation.

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[1] https://www.reuters.com/article/usa-fed-policy-analysis/in-test-for-powell-internal-groundswell-grows-to-rethink-feds-inflation-approach-idUSKBN1EU24U

[2] https://www.reuters.com/article/us-southkorea-politics/south-korea-presidential-hopeful-u-s-missile-defense-should-wait-idUSKBN1440QJ