Daily Comment (July 21, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Friday!  Here are the items we are following this morning:

Pardon me:  Numerous media reports indicate that the Trump administration is exploring pardoning options and ways to ring fence Special Counsel Mueller’s investigation.  There are overtones of Nixon in these comments.  First, seeking pardons when no one has reportedly done anything wrong suggests that there is fear that something illegal will be found.  Second, Special Investigators have wide latitude once an investigation gets underway.  Trying to restrict an investigation (or for that matter, pardoning protocol) gets into legal gray areas over the boundaries of presidential powers.  Of course, our concern remains focused on financial markets.  One of the patterns we have seen recently is that equities tend to maintain strength while other financial areas seem to be reacting to these issues.  For example, we have seen Treasuries strengthen in recent sessions after yields had backed up earlier in the month.  Our position on the dollar is that the greenback is overvalued because the forex markets rapidly discounted tightening Fed policy (see the Asset Allocation Weekly below for details).  However, it is possible that recent dollar weakness is also a reaction to the growing turmoil in Washington. The fact that the dollar appreciated yesterday despite a rather dovish press conference and statement from ECB’s Draghi suggests that factors other than monetary policy are underpinning dollar weakness.  Simply put, the political issues in Washington are not adversely affecting equities yet, but that doesn’t mean that other financial markets are not reacting to these events.

Brexit concerns:  The May government appears deeply divided over how to execute Brexit, reflecting Tory divisions that are similar to issues within the GOP here.  The populists want a “hard” Brexit that will restrict the ability of foreigners to work in the U.K. and loath to pay the EU “exit fee” for leaving.  The business wing of the Tories wants a “soft” Brexit that will maintain London’s financial pre-eminence which means that Brexit really isn’t much of a break with the EU.  Unfortunately for Britain, there are elements within the EU that see opportunity from Brexit and are goading the Tory negotiators toward a hard Brexit so as to bring much of London’s financial business to the continent.  Given PM May’s poor election performance, we suspect that her government is likely to face a no confidence vote at some point; the confusion we are seeing in negotiations may simply reflect the lack of an electoral mandate.

China v. India:  China and India fought over disputed parts of their border in the Himalayas in 1962.  Currently, the two states are facing off in the Doklam plateau, which is at the trisection of India, China and Bhutan.  China is building a road in an area claimed by Bhutan and the latter is asking for Indian assistance in enforcing its claim.  This border dispute is part of rising tensions between the two countries.  India has quietly opposed China’s “one belt, one road” initiative and has recently joined naval exercises with Japan and the U.S.  As the U.S. profile declines in the region, tensions between India and China are likely to increase as both powers jockey for regional influence.

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