Daily Comment (July 1, 2019)

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

[Posted: 9:30 AM EDT] Global equity markets are sharply higher in a relief rally from the G-20 meeting.  Oil is up on OPEC+ news.  Although it’s not exactly official yet, we are unofficially enjoying the longest economic expansion in U.S. history.[1]  Here is what we are watching today:

The G-20: We pretty much got what we expected from the G-20.  Presidents Trump and Xi agreed to a set of items that were mostly anticipated.  Huawei (002502, CNY 3.59) got a modest reprieve; it will be allowed to trade with the U.S., although there will be restrictions.  The U.S. agreed to not implement another round of tariffs.  China agreed to buy some soybeans.  All this was anticipated but, despite the expectations, we are seeing a strong risk-on rally today.  Equities and the dollar are higher, while gold and Treasury prices are lower.  On the one hand, not much was resolved.  On the other hand, it clearly could have been much worse.

The G-20 did manage to agree on a communiqué but only because it didn’t promise much.

One of the benefits of the G-20, despite its unwieldy nature, is that side meetings can occur among leaders.  EU leaders looked like they had put together a plan to end the leadership fight over the European Commission.  Chancellor Merkel agreed to give up the commissioner job to Frans Timmerman, a Dutch center-left socialist.  Manfred Weber would get the European Parliament presidency as a consolation prize.  A Frenchmen would get the ECB presidency; a dark horse candidate could be Christine Legarde, the current managing director of the IMF.  However, it appears the deal fell apart on opposition from the smaller EU nations.

Since I was in the neighborhood: In a bold move, President Trump made history yesterday by being the first sitting president to cross into the demilitarized zone separating North and South Korea.  He met Kim Jong-un and promised to restart nuclear talks.  There is a proposal that would halt new weapons but allow the current arsenal to remain in place.  Perhaps the most telling item from this visit is that National Security Director Bolton was apparently in Mongolia.  Bolton has been a target of Pyongyang’s ire, so the optics of sending him to exile are significant.

Historic trade deal: The EU and Mercosur, the South American trading bloc, has reached a trade agreement.  Mercosur is a trading zone made up of Argentina, Brazil, Paraguay and Uruguay.  Something that should give the U.K. pause is that negotiations for this deal have been going on for two decades.  If the British think the EU will make a trade deal with them quickly they are probably mistaken.  A lesser free trade deal was also finalized with Vietnam.

OPEC+: Russia and Saudi Arabia have reached an agreement to extend the current output restrictions for another six months.  Although it is possible the rest of OPEC might balk, it isn’t likely.  Iran will probably complain but it has little influence on the final decision since its exports have collapsed.

Iran: Friday’s talks with the EU were not enough to forestall Iran from increasing uranium enrichment.  We expect tensions to continue to rise.

Something to watch: President Trump indicated that he wants to change the U.S./Japan security agreement, a plan that was crafted after WWII.  Under that plan, Japan agreed to not project offensive military power and only have forces for self-defense, and the U.S. agreed to guarantee its external security.  The point of the plan was two-fold; Japan, a leading industrial power, had almost no natural resources and is heavily dependent on secure sea lanes for raw materials.  The rest of Asia was always worried about Japan’s power projection to secure these resources.  By taking over Japan’s security, it no longer needed to worry about being cut off from raw materials and other Asian nations no longer had to fear Japan’s power.  The arrangement has prevented a mass industrialized war from occurring in Asia.[2]  Changing this arrangement could open the door to pre-WWII conditions that would likely destabilize Asia.

Venezuela: There were two items of note.  First, the U.S. has extended sanctions to the son of Maduro.  Second, the number of Venezuelans fleeing the country continues to increase; the Organization of American States warns that the total number of Venezuelan refugees could reach as high as 8.2 mm by the end of 2020.  That volume would make the Venezuelan refugee crisis larger than the Syrian crisis.  So far, the U.S. hasn’t seen a major influx of Venezuelans.  It is hard to imagine that we won’t at some point.

Hong Kong protests: Protests have developed on the 22nd anniversary of the handover of Hong Kong from the British to China.  The protests have become violent; if they continue, we will be watching closely for Beijing’s reaction.  You can follow along here.

Protests in Sudan: Protests have also developed in Khartoum against the provisional military government in Sudan.  The potential for a crackdown is high.

A spat with Switzerland: Until today, Swiss equities could be traded on EU exchanges due to a process called equivalency.  But, the agreement has expired and now such stocks can only be exchanged on the Swiss bourse.  The same shares cannot be traded on European exchanges.  The root of the problem is a dispute between the EU and Switzerland over political ties.  So far, the shares are trading without incident but the issue could emerge later this year if we get a hard Brexit.  If hard Brexit occurs, British companies may not be able to trade on EU exchanges after Halloween.

Fed talk: Although we have no additional speakers today, Vice Chair Clarida did talk early this morning in Finland.  As expected, he suggested the Fed would “act as appropriate.”  Richmond FRB President Barkin cooled expectations for a rate cut, suggesting such a move might be premature.

Turkey and Libya: Turkey has accused forces allied with Khalifa Hifter of detaining six Turkish nationals.  In addition, these same Libyan forces claimed to have destroyed a Turkish drone parked on the tarmac of Tripoli’s airport.  Outside forces have been turning Libya into a proxy conflict.  Turkey has been siding with Islamist forces in the western part of the state, while the UAE and others have been supporting Hifter.

Odds and ends: Taiwan’s president is scheduled to visit the U.S. later this month, an event certain to upset Beijing.  African Swine Fever may be killing much faster than reported.

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[1] There are two caveats.  First, the NBER, which dates the business cycle, doesn’t establish when recessions start for months after one begins.  Thus, if a downturn starts soon, the NBER could decide that a recession started in June, meaning we are not at a record.  Second, the dating of cycles didn’t begin until 1850, so, strictly speaking, a longer expansion may have occurred at some point between 1789 and 1850.

[2] The Vietnam War, though significant, was not a mass industrial war similar to WWI and WWII.