Daily Comment (July 20, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Equity markets continue their quiet rise to new records.  Here are the items we are watching this morning.

ECB, BOJ lean dovish:  The BOJ came out overnight with nothing that wasn’t unexpected.  It is clear the bank won’t reach its inflation targets anytime soon, so it extended its deadline, making it the sixth time this has occurred under Abe.  The JPY weakened a bit on the news but since it was mostly anticipated, the forex move was modest.  The ECB has released its statement, which is almost identical to its last one.  The statement was taken as dovish by the markets.  In the press conference, Draghi remained dovish, suggesting that the ECB hasn’t laid out any plans for QE tapering.  Even though his opening comments and answers to questions were clearly dovish, the EUR rallied, European stocks fell and European sovereign yields rose.  However, we have seen a reversal in these prices after Draghi reiterated that tapering hasn’t been discussed.  Market behavior suggests that traders are focused on ECB balance sheet management.  Draghi is clearly keeping his “cards close to the vest” on revealing when tapering will begin.  Our view on market action suggests that it might be impossible for the ECB to avoid a “taper tantrum” once ECB QE ends.  Perhaps the most interesting market action is the EUR; the currency weakened after the statement then rallied during the presser.  It appears to us that the currency markets have concluded the dollar is going down, most likely because the ECB will eventually act to reduce stimulus.

U.S./China trade talks stall:  Negotiators for both nations quickly reached an impasse at trade talks.  The Trump administration is taking the position that the bilateral trade deficit with China is a serious problem that can only occur due to unfair Chinese policies.  Commerce Secretary Ross said, “If this were just the natural product of free-market forces, we could understand it, but it’s not.  So, it’s time to rebalance in our trade…”  Evidence of the differences between the two parties emerged when the U.S. canceled a scheduled news conference which was set for the two parties to reveal concrete proposals on trade.  It appears to us that China has no intention of changing its trade policies and its plan to deal with this trade spat is endless negotiations.  That would have worked before; although previous administrations clearly didn’t like the bilateral trade deficit, they understood that the superpower role necessitated a U.S. trade deficit.  The Trump administration, in our analysis, is preparing to withdraw from that role which ends the need for persistent U.S. trade deficits.  Thus, implementing trade barriers and ignoring the WTO are consistent with this position.  America’s more isolationist trade policy is a significant threat to the Chinese economy. 

Poland’s judicial crisis:  The Polish government has already increased control over the media, restricted public meetings and taken other steps.  Now, it is taking direct aim against the independent judiciary.  The populist Law and Justice Party has introduced bills that would force all the judges to resign, save those appointed by the aforementioned party.  Other bills would give the government greater control in appointing judges.  The EU has indicated that the actions against the judiciary, coupled with other moves, may mean Poland would no longer be considered a “democracy” by Brussels.  If this determination were to be made, it could lead to Poland losing its vote in the EU Parliament.  In one sense, this isn’t a big deal; it isn’t clear how much sovereign impact the EU Parliament has anyway.  However, calling Poland a non-democracy might trigger the decision to leave the EU, leading to Polexit.  Although there isn’t much discussion of Poland leaving the EU, the party in power will strongly oppose outside pressures and may conclude that being outside the EU will strengthen Poland’s sovereignty.  Another nation leaving the EU would seriously undermine the union.

The naming of a new Saudi Crown Prince looks like a coup:  Major U.S. media[1] are publishing reports that detail how the former Crown Prince Nayef resigned from the post and was replaced by his cousin, the former Deputy Crown Prince Salman.  We will have much more to say on this in future WGRs but we mention it here because it shows that the potential for leadership instability is rising in Saudi Arabia.  If instability rises, we would expect oil prices to rise.

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[1] https://www.nytimes.com/2017/07/18/world/middleeast/saudi-arabia-mohammed-bin-nayef-mohammed-bin-salman.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-column-region&region=top-news&WT.nav=top-news&_r=1