by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EDT] Although global equity markets are steady to lower this morning, there is a lot of action in the forex markets. The dollar is sliding on a combination of lower expectations for Fed policy tightening and the lack of policy progress from the Trump administration. Here are the news items we are tracking this morning:
GOP Senate healthcare dies: Senate Majority Leader McConnell’s efforts to craft a replacement bill for the ACA fell apart overnight as he could not round up 50 GOP votes to pass a bill. This is a deep blow to McConnell’s leadership. There are reports he will now move to a straight ACA repeal, but our sources indicate this vote can’t occur as part of the reconciliation process and thus needs 60 votes, ensuring defeat. If this is true, all the GOP senators would vote for it but the repeal will never reach the floor because the Democrats can filibuster it. Why is this important? It suggests the GOP can’t govern. This is actually a characteristic we are seeing across the U.S. political landscape. Two-party systems are forced coalitions. There are wide divergences in the positions among various groups within parties (we believe these divergences will eventually lead to a realignment of the parties in the coming years). When a party is out of power, these divergences tend to be papered over in the interests of returning to power. However, once in power, these different groups believe they are the “real Democrats” or the “real Republicans” and they push a narrow agenda that, shockingly, fails to gain a majority. The GOP is clearly divided and these divisions killed the healthcare effort. Now the worry is that these divisions will not only prevent tax reform and infrastructure spending, they may not even get the debt ceiling increase accomplished without drama. If the GOP can’t get legislation passed, it weakens the outlook for change. We believe that is showing up today in dollar weakness; after all, if fiscal spending isn’t coming and investor sentiment weakens, the Fed won’t raise rates as much as expected. On Friday, we will release our new Asset Allocation Weekly; its focus is on the dollar.
OPEC drama: Oil prices have jumped this morning on rumors the Saudis are planning to cut oil exports. We may actually see reductions but only because air conditioning demand in the Saudi summer is driving up consumption. On the downside, Ecuador announced it will no longer comply with its 26 kbpd pledged cut in output because is simply can’t afford the loss of revenue. Although Ecuador’s defection, by itself, won’t be a major factor in weakening prices, it may encourage other defections which would be a problem for the cartel. We still expect the Saudis to make strenuous efforts to prop up oil prices into next year’s Saudi Aramco IPO (expected now in Q4 2018) which should prevent a sustained price decline. In addition, dollar weakness is a major supporting factor for oil prices.
China crackdown continues: Chinese banking regulators have instructed some lenders to lower the rates they offer on wealth-management products (WMP), which have become alternative investment products due to low deposit rates As the PBOC tightened the money supply, lenders have raised the rates on WMP to a 17-month high in a scramble to acquire lendable funds. The PBOC tightened the money supply to support deleveraging. The banks are trying to offset the PBOC’s efforts via WMP funds. The risk for the banks is that lowering rates on WMP will deprive them of lendable funds which will slow lending and economic growth. And, households may again increase their attempts to move funds offshore in search of higher returns. For years, China has abused the household sector through financial repression; this has led to rising real estate prices and the search for higher returns in overseas markets. China has been trying to stem the currency outflow through a number of regulatory tactics but the best way to keep the money at home would be to offer higher domestic financial returns to the household sector. Unfortunately, the more the household sector earns, the less the banking and business sector earns. Policymakers have generally been captured by the business sector and thus have based their economy on household financial repression.
The RBA turns hawkish: Although the Reserve Bank of Australia didn’t move on rates, in the minutes from its July 4th policy meeting, the bankers suggested a policy goal of a “nominal neutral cash rate” of 3.5%, which would imply a 200 bps rise in rates is in the offing. It is unclear if policymakers are really intending to lift rates this aggressively, but in an environment of increasing dollar disappointment, even offhand comments that suggest potential tightening lead to currency strength. The AUD has jumped to its highest levels since May 2015 on this news.