Daily Comment (July 15, 2019)

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

[Posted: 9:30 AM EDT] Happy Monday!  China’s GDP came in on expectations but the trend is clearly showing that growth is slowing.  The EU Commission vote is this week.  Global debt is growing.  Tropical Storm Barry is now moving into Missouri.  Here is what we are watching today:

China’s GDP: China Q2 GDP came in on expectations at 6.2%.  China’s GDP almost always comes in on forecast because the government can set the growth rate by taking on more debt.  But, the fact that the Xi regime accepted growth this low does suggest the government is trying to slowly reduce the glide path of growth.  The reading in Q2 is the slowest growth in nearly three decades.  Weaker exports were partly to blame for the slowdown.  In general, China can probably only grow at around 3.5% to avoid adding to debt.  We believe Xi has the power to reduce growth to that level but he wants to get there slowly in order to avoid an abrupt drop in output.  Given that he has the ability to stay in power indefinitely, he may be around long enough to lower China’s growth to a sustainable pace without something that looks like a recession.

Hong Kong: Knowledgeable officials in Hong Kong say the territory’s chief executive, Carrie Lam, offered to resign several times in recent weeks in the midst of massive protests against her proposed bill to allow extraditions from Hong Kong to China.  However, the officials say Beijing refused to accept the resignation, telling Lam to stay in her post “and clean up the mess she created.”  Meanwhile, protestors continue to agitate against the extradition bill and other grievances, including a near-riot in a luxury shopping mall last night.  While Lam remains in charge, the incident confirms that her days are numbered and that the political situation in Hong Kong is likely to remain unstable for the foreseeable future.

Global Monetary Policy: The acting head of the International Monetary Fund (IMF), David Lipton, offered his backing for looser monetary policy by the major central banks, such as the Federal Reserve and the European Central Bank.  In an interview with the Financial Times, Lipton said, “If the economy needs support, you provide support . . . It’s more important than it’s been in a long time to avoid a recession, to be careful about any actions that might trigger a downturn.”  We already believe more loosening is on the way – including a likely interest rate cut by the Federal Reserve at the end of the month – but Lipton’s statement will help give monetary authorities political cover to proceed with the moves in spite of skepticism among some policymakers.

United States-Turkey: Officials from the State Department, Pentagon and National Security Council have drawn up a list of proposed sanctions against Turkey for its purchase of Russia’s S-400 air defense system, the first deliveries of which began on Friday.  The proposed sanctions would have to be approved by President Trump, but officials say the United States won’t make a public reaction to the S-400 deliveries until sometime after today.  Sanctions would likely ratchet up tensions between the countries and present further headwinds for the Turkish lira and Turkish assets.  Another problem for Turkey is that there are rising tensions over natural gas drilling in waters off of Cyprus.  The island is divided between Turkey and the EU and the former is drilling off waters that it claims, which are not globally recognized.  The EU is threatening to cut funding for Turkey.

Russia-Ukraine: In a sign of at least some thawing of relations between Russia and Ukraine, an official at the Russian Ministry of Foreign Affairs said the two governments are discussing the return of two dozen Ukrainian sailors who were seized by Russia last year.  The development comes after the new Ukrainian leader last week suggested multilateral talks on Russian-Ukrainian peace, and President Putin said he would be open to the idea under certain conditions.

Mexico: On the other hand, Mexico’s economy appears to be falling into recession.  Clearly, the trade conflict with the U.S. is having an adverse effect on investor sentiment in Mexico.  However, another factor could be AMLO’s policy of cutting government spending on the bureaucracy.  One of AMLO’s campaign promises was to move spending away from the bureaucracy to the poor.  However, this has led to the reduction of some basic services, such as firefighting.  Although there is an element of AMLO’s austerity that is going to be popular, it is going to be difficult to determine what activities are wasteful and unnecessary and what are critical.  While no one would argue that police services are needed, there may be questions on whether new cruisers are necessary.  Once public investments are questioned, over time, such investments decline and eventually public workers won’t have the tools necessary to do their jobs.  It is possible that the cuts to government spending have occurred before the spending was shifted to the poor; if that’s the case, then the government sector will be a drag on the economy.

U.K. makes an offer: The U.K. has offered to release the tanker it holds if Iran doesn’t deliver the oil to Syria.  It isn’t clear what kind of guarantees Tehran can offer to satisfy the British but it does look like both sides are trying to ease tensions.

Debt: The Institute for International Finance (IIF) is a bank-owned body that conducts research on international financial matters.  One of the tasks the IIF performs is to monitor global debt levels. The IIF reports that global debt rose $3.0 trillion in Q1 to $246.5 trillion.  With global GDP estimated to be around $85 trillion, world debt/GDP is around 290%.  Emerging market debt has hit a record high.  One side effect of low interest rates is that they encourage the expansion of debt levels, making the global economy vulnerable to rising interest rates.

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