Daily Comment (July 14, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] The CPI data came in weaker than expected, sending the dollar and Treasury yields lower.  We examine the data in the context of policy using our Mankiw model variations below.  Outside the inflation numbers, here are some of the other news issues we are tracking this morning:

More trouble for Donald Jr.:  It appears that there were other persons that met with Donald Trump, Jr., Paul Manafort and Jared Kushner.  Reports this morning suggest that there was also a lobbyist who was a former Soviet counterintelligence officer with suspected ties to Russian intelligence.  Whether this additional person is important or not isn’t really the problem.  The problem is that as new information continues to drip out, the administration is forced to deal with the Russian problem constantly and this is burning political capital that isn’t being used for other policy goals, e.g., deregulation, tax cuts, infrastructure rebuilding, etc.

Abe’s support declines to critical levels:  A new poll shows that Japan’s PM Abe’s favorable ratings have dropped to 29.9%, the lowest since he took power for a second time in 2012.  He has been hit be a couple of scandals.  Although Abe’s term won’t expire until September 2018, such low ratings will tend to undermine his ability to push through policy changes.  If Abe falls, it is probably bullish for the JPY, as it will appear that Abenomics has failed and the experiment of aggressive BOJ QE, fiscal spending and deregulation didn’t resolve Japan’s problem and thus, nothing will work.  That would likely lead to expectations that the BOJ will have to lift its extremely accommodative monetary policies because they will appear to have failed.

The debt ceiling:  While the Senate continues to work through its vacation on health care, the debt ceiling clock continues to tick closer to “midnight.”  Bloomberg[1] is carrying a report today suggesting that the Treasury is dusting off old Obama administration procedures to deal with potential default, including a program to prioritize paying interest on Treasuries while delaying other spending.  The Obama plan would pay interest on the Treasury debt, Social Security, veterans benefits and entitlements, roughly in that order.  All other spending would likely be delayed and the longer the crisis extends a higher probability some entitlement payments might be delayed as well.  The markets seem to be comfortable that nothing bad will happen; credit default swap prices for 5-year T-notes is running around 22 bps.  At the peak of the last debt ceiling crisis in 2011, they almost hit 70 bps.  Although there is probably no good reason for this issue to become a crisis, the constant distractions in the White House may lead to the U.S. stumbling into a problem here due simple management failure.  We will report on the 5-year CDS periodically for signs of concern.

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[1] https://www.bloomberg.com/news/articles/2017-07-14/trump-may-have-to-use-obama-s-secret-debt-plan-worrying-markets