Daily Comment (July 2, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s the first day of Q3!  So far, it’s not an auspicious start.  We did celebrate “Bobby Bonilla Day” yesterday, one of our favorite holidays.[1]  There is lots of news this morning.  Let’s dig in:

Mexican elections: As expected, Lopez Obrador, otherwise known as AMLO, easily won Sunday’s election, taking an estimated 53% of the vote.  All of his competitors have conceded defeat.  In addition, it appears he will have a majority in the legislature.  There is great fear among the business class in Mexico.  AMLO ran on an anti-corruption platform with a clear bias for the poor of Mexico.  In some respects, AMLO is a bit like President Obama; many in Mexico are pinning their hopes and dreams on the new president with expectations that are sure to disappoint.  We do expect him to negotiate a hardline with the Trump administration over NAFTA, but AMLO has not indicated he wants to end the free trade agreement.  The peso has weakened on the news.

Trade: First, on Friday, $34 bn of sanctions on Chinese goods are set to be implemented with expected retaliation.  Second, the president is expressing his disappointment with firms that have announced job shifts in response to the foreign retaliation.[2]  This is additional evidence that Trump’s trade policy is nationalist in design.  It’s all about jobs and economic activity here rather than elsewhere.  While that’s good for American jobs, it almost certainly won’t be good for American earnings.  Axios[3] is reporting the administration has drafted a bill that would essentially give complete trade authority to the White House.  In some respects, this leaked report is how this administration negotiates.  It starts with an outrageous position and retreats back to what it wanted all along.  By all accounts, the chance that this bill would get passed is nil.  However, given current conditions in Congress, it isn’t clear whether the leadership is up for taking on the social media attacks the president can make.

There are three takeaways from this report.  First, although this bill is unlikely to become law, the “dead on arrival” statements are probably incorrect.  Second, this bill is further evidence of the anti-globalist core of this administration.  Third, even if the bill fails, the president can run on it in 2020; there isn’t really much difference between the left- and right-wing populists regarding trade and this trade position could cause even broader splits within the Democrat Party.  So, even if the bill fails to gain traction, it may have political value.

As we noted last week, the president is already weakening the WTO by refusing to approve appellate judges who handle trade dispute appeals.  In September, an appellate judge is expected to retire and once he does so the body won’t have a quorum, therefore disputes cannot be appealed.[4]  So, by continuing to veto judges, the administration is effectively rendering the WTO into irrelevance.

Central bank notes: A couple of items here.  First, the Fed is finding that managing reserves while paying interest on them and removing them at the same time is causing some degree of turmoil in the short-term interest rate markets.[5]  This may lead the Fed to keep the balance sheet higher than expected and end the reduction of the balance sheet sooner than expected.  Second, the administration’s director of the National Economic Council, Larry Kudlow, made a statement[6] late last week suggesting the Fed shouldn’t raise rates too quickly because growth doesn’t cause inflation.  This positon is classic supply-side economics; this school assumes that supply will always expand to meet demand if conditions are right.  In other words, in a deregulated and globalized economy with low tax rates, supply will always increase to meet demand and therefore monetary policy should only tighten on clear evidence of overheating (which should be addressed with more supply expansion).  The important takeaway from his comment is that the administration is skirting close to breaking the “Rubin consensus” that administrations should not comment on monetary policy.  We believe a major risk factor is that the Trump administration could adopt the Nixon playbook of managing the Fed, which set the stage for the inflation of the 1970s.

Oil: President Trump has asked the Saudis to boost output to lower oil prices.  Over the weekend, we heard from relatives and neighbors asking us, “Why are gasoline prices so high?”  We indicated that the combination of strong demand, falling supply in Iran, Libya and Venezuela and the lack of adequate pipeline capacity in Texas are all conspiring to raise prices.  The response was that no one cared…they just want gasoline prices to decline.  So, the president is leaning on the kingdom to help.  Although there are some doubts as to whether the president really did ask,[7] we have no doubt that Trump, like nearly all American presidents (G.W. Bush was perhaps an exception), wants lower gasoline prices.

German drama:The head of the CSU and the government’s interior minister, Horst Seehofer, is threatening to resign.  He is expected to meet with the chancellor today to see if a compromise can be met.  If he does resign and the CSU pulls out of the government, it could fall, bringing new elections and probably the end of Merkel’s political career.  It is possible that Merkel could simply replace Seehofer, but a CSU exit will almost certainly trigger a crisis.  A fall of the Merkel government would be a bearish event for the EUR.

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[1] In 1999, after the Mets released Bonilla, they owed him $5.9 mm.  Rather than pay him the money, they negotiated a deal where he would be paid $1,193,248.20 per year, starting on July 1, 2011, with continuing payments each July 1st until 2035 (when Bonilla will be 72 years old).  That amount assumed an 8% return on investment on the original $5.9 mm.  However, the reason the Mets negotiated the deal was that the Wilpon family, the owners of the Mets, were investors with Bernie Madoff, who, at the time, was returning 12% to 15% per year with an eerie lack of volatility.  The owners figured they could put the money with Madoff and earn the spread over the 8%.  Of course, things didn’t work out that way but Bonilla still gets his money each year. http://www.espn.com/mlb/story/_/id/16650867/why-mets-pay-bobby-bonilla-119-million-today-every-july-1-2035

[2]  https://www.politico.com/story/2018/07/01/trump-harley-davidson-689614

[3] https://www.axios.com/trump-trade-war-leaked-bill-world-trade-organization-united-states-d51278d2-0516-4def-a4d3-ed676f4e0f83.html

[4] https://www.politico.eu/article/wto-donald-trump-protectionism-brussels-fears-trump-wants-the-wto-to-fail/

[5] https://www.wsj.com/articles/fed-faces-decisions-on-shrinking-its-huge-bond-portfolio-1530466910

[6] http://thehill.com/policy/finance/394810-kudlow-fed-should-move-very-slowly-on-rate-hikes

[7] http://fortune.com/2018/07/01/white-house-trump-tweet-saudi-arabia-oil/