by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EDT] We are seeing stronger equities, weaker bond prices and a stable dollar this morning. Here’s the news we are following:
The FOMC: The Fed statement didn’t offer too many surprises. It did admit that inflation is running below target but didn’t elaborate about the future path of inflation. As expected, rates were left unchanged and the Fed indicated that balance sheet reduction would begin “relatively soon.” Fed funds futures have now removed any more rate hikes this year, essentially indicating that balance sheet reduction will become the path of tighter policy. The biggest market reaction came from the dollar, which fell sharply in the wake of the statement. The greenback has stabilized this morning.
A new Sino-Indian War? China and India fought a border war in the Himalayas in the early 1960s and the dispute has mostly been simmering ever since. Although China and India really don’t want a war, partly because the ability to fight a war at the elevations involved is a deterrent, we are seeing a rise in tensions. The issue is China’s decision to extend a gravel road in the disputed region between China, Bhutan and India, which has led India to boost troop strength in the area. Under normal circumstances, we would expect mostly a war of shouting and then negotiations. However, conditions have changed. Chairman Xi is preparing for important party meetings in late October that will install new members of the Standing Committee of the Politburo. This is his chance to surround himself with a “cabinet” aligned with his interests. Looking weak will undermine Xi’s ability to select his own supporters. Meanwhile, Indian MP Modi has been pushing a nationalist agenda and cannot be seen backing down. Finally, this conflict is escalating at a time when U.S. influence is waning and thus the ability for the U.S. to step in and stop the squabble has lessened. As a result, what should normally be a local problem could become something more troublesome. If a war breaks out, it would be bearish for risk assets of both China and India.
The end of LIBOR: The London Interbank Offering Rate (LIBOR), the benchmark for some $350 trillion of financial products, will be phased out by 2021. U.K. regulators are moving to scrap the current system, which is based on a rate set by a survey of large British banks in London. The rate-setting process has been proven to be prone to manipulation and thus regulators want to change the current system. In the U.S., LIBOR is really the overnight interbank rate and we expect some similar rate to replace the current LIBOR quote. However, there may be some confusion until a new benchmark develops.
 In China’s political structure, the first term of a new president is usually hampered by a Standing Committee that is packed with allies of former presidents. In the second term, the sitting president gets to select more of his own allies. Thus, unlike what we usually see in the West, a Chinese leader can become more powerful in the second term than in the first.