Daily Comment (July 3, 2019)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

(NB: We will publish an abbreviated report on Friday.  Because of the all-important labor market data, we wanted to provide our coverage of that issue and the usual energy market update as well.  Additionally, the AAW will be updated.  But the headings in yellow on Friday will not be updated.)

There is a lot of central bank news today.  The media is abuzz over the July 4th parade.  U.S. and European equities are doing well this morning.  Here is what we are watching today:

The EU returns to the back room:  In the last election cycle, the EU built an open process for choosing new leaders, ending a backroom process where France and Germany would essentially make the selections.  The open process failed in this cycle to settle on new leaders and so the EU presidents and chancellors returned to the backrooms to make their picks.  Ursula von der Leyen, the German defense minister, was the selection for EU Commissioner.  She is a somewhat controversial pick and still requires MEP approval.  Chancellor Merkel abstained from voting for her; there is speculation that her coalition partner, the Social Democrats, were still smarting from the rejection of a socialist for the commissioner role.  However, it is also quite possible that Merkel is quietly cheering her selection because it removes a potential competitor for her role.  Although Merkel intends to leave office when her term ends, one can never be too sure.   At the same time, there are increasing concerns about the chancellor’s health, which may speed her exit from public life.

The other major announcement was that Christine Lagarde was named to replace Mario Draghi as president of the ECBLagarde has deep experience in managing financial crises—she was the French finance minister during the 2008 Great Financial Crisis.  In addition, she can clearly manage large public sector entities, as shown by her management of the IMF.  However, she isn’t an economist and thus we would not expect her to develop any new plans to what Draghi has already put in place.  Needless to say, the French are happy and policymakers are pleased that they won’t be dealing with a German hawk as ECB president.

Meanwhile, one thing Lagarde won’t have to deal with is a fiscal crisis in Italy.  A deal between Rome and Brussels was made today.

Fed Governors:  President Trump announced two candidates for the two open spots on the Fed’s Board of Governors.  Christopher Waller, the director of research for the St. Louis FRB and Judy Shelton, were named as candidates.  Waller is a more traditional pick; Jim Bullard, the President of the St. Louis FRB, was reportedly asked about a governor’s spot but he demurred.  Selecting Waller is probably the next best thing as we suspect Waller reflects the dovish views of his boss.  Shelton is much more controversial.  She has argued for a return to the gold standard as a way to prevent competitive devaluations.  The gold standard was part of the supply side economist toolbox, but it was never seriously considered for policy.  There are a plethora of reasons why the gold standard would be problematic, the biggest is that the gold standard failed when suffrage expanded after WWI. The gold standard requires the cost of policy adjustment to be borne by labor; when common people got to vote, they opposed such policies.  In addition, the gold standard tends to be a hawkish position, which seems to counter what the president wants from policymakers.  It is possible that President Trump believes Shelton will be politically reliable but there is no guarantee that is the case as she could prove to be an ideologue and a hawk.

We expect the Senate to easily approve Waller, adding a dove to the policy vote.  Shelton will likely have a more difficult time with her approval.   It should also be noted that the Senate probably takes around six months to approve Fed governor nominations and so by the time either or both would be approved, the easing might be done.

A Russian military accident:  A Russian submarine had a fire earlier this week, killing all on board.  It is unclear exactly what happened, and we will continue to monitor this situation.

Iran:  Tehran has announced it will expand its enrichment activities in the very near future.  Iran continues to evade sanctions but it is clear it’s economy is suffering.  For now, we expect Iran to stall on any potential negotiations until the 2020 elections; if Trump is reelected, we would expect talks to occur shortly thereafter.  If a Democrat wins, look for the JCOPA to return.

Japan:  Despite the general momentum toward a re-loosening of monetary policy around the world, it’s important to remember that there is also a significant subset of policymakers who want to delay or minimize any rate cuts.  For example, Bank of Japan board member Yukitoshi Funo said today that Japan doesn’t need to loosen policy right now because a moderate economic acceleration is expected later this year.  That comes as U.S. monetary policy officials like Cleveland Fed President Mester said this week that they’re still not yet convinced that rate cuts are necessary.  In other news from the Land of the Rising Sun, Japanese officials said they were considering making more products subject to restrictions on exports to South Korea beyond the high-tech goods announced earlier this week.  The move is in retaliation against South Korean demands for compensation for forced labor by the Japanese during World War II.

India:  Monsoon rains in the region around Mumbai have reached the highest level in more than a decade, leaving more than 80 people dead, partially closing the airport, raising concerns about crops, and putting pressure on Prime Minister Modi to improve infrastructure.

Brazil:  A special committee of Brazil’s Congress looks set to pass a watered down version of President Bolsonaro’s proposed pension reform, which would then allow the bill to be presented to the full chamber for a vote.  The amendments reduce the projected savings from the bill to approximately $245 billion over the next ten years, but that still is widely seen as insufficient to avert a fiscal crisis as the country’s pension costs continue to explode.  The proposed pension reform has been a key reason for the rise in Brazilian stocks since Bolsonaro’s election.

UAE/Yemen:  Western officials say the United Arab Emirates have been pulling tanks, attack helicopters, and other military assets out of Yemen, as it tries to extricate itself from the Saudi-led campaign against the country’s Iran-backed Houthi rebels.  The sources say one reason for the UAE’s action is fear that its continued participation in the campaign could spark retaliatory strikes from Iran.

Australia looks at tax cuts:  The conservative government is close to passing a major tax cut.  This cut might give the Australian markets a boost.

View the complete PDF