Daily Comment (July 5, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Welcome back!  Here is what we are watching this morning:

On trade, it’s good news and bad news:  The good news first…German automakers met with Richard Grenell, the U.S. Ambassador to Germany, and reaffirmed their support for zero tariffs on EU/U.S. auto trade.[1]  The German automakers also indicated they would maintain their investments in the U.S. if tariff increases were averted.   The EU, as expected, is following Germany’s lead.[2]  This change in Europe’s stance does suggest that U.S. pressure might lead to policy changes, which is the political establishment’s hope.  In light of U.S. trade pressure, China is wooing Europe to join an anti-U.S. alliance on trade.  Thankfully, so far, the EU sees the folly of China’s offer and has demurred.[3]  The news on auto trade has lifted risk assets this morning. Now, the bad news…at midnight, the U.S. is planning to implement tariffs on $34 bn of Chinese goods.  China is expected to retaliate in kind.[4]  At worst, the Chinese tariffs could be the opening salvo in a significant trade war.

Oil talk:  Over the holiday, President Trump reiterated his call for OPEC (read:  Saudi Arabia) to increase oil production in an effort to lower oil prices.  In fact, the tweet was blunt—we are paying for your defense so bring down gasoline prices.[5]  In reality, there isn’t a whole lot more OPEC can do to lower oil prices.  Falling production in Libya, Venezuela and Nigeria are curtailing supply.  The U.S. sanctions on Iran will simply exacerbate the problem.  The U.S. might be expected to fill the global gap and is working to do so.  But, pipeline constraints in west Texas are limiting the supply that can be made available for export.  That pipeline problem won’t be resolved for about a year.  The president correctly understands that rising gasoline prices will be unpopular with his populist base.  The key unknown is this—are the tweets simply jawboning, so even if prices stay high, voters will still credit him for trying to bring down prices?  Or, do voters really want lower prices or else?  If it’s the latter, the president may have only one tool left, which is an SPR release.  However, the risk is that if the SPR release fails to lower prices, there are no other policies available to lower prices in the short run.  In other words, the threat of an SPR release might be more powerful than the actual announcement.  After all, if the market believes that shortages do exist, adding oil from the SPR could very likely trigger hoarding, leading to a condition where inventories rise at the commercial level but prices rise as well.  For the most part, the greatest threat for higher oil prices is in the summer.  When demand falls after Labor Day, price pressures will likely ease.

Iran:  Iran has threatened to reduce its cooperation with the IAEA, the body that determines if Iran is meeting its obligations with the nuclear deal.[6]  Reducing cooperation would likely end the treaty because without inspections, the fear that Iran is secretly enriching uranium would undermine trust.  The commander of the al Quds Force of the Iranian Revolutionary Guard Corps, the infamous Qassem Solaimani, indicated that his nation would block the Strait of Hormuz if the U.S. stops Iranian oil sales.[7]   This is a serious threat; casual calculation suggests that about 30% of world oil exports pass through this chokepoint.  Most of the oil goes to the Far East.  The U.S. can prevent Iran from blocking the strait permanently, but it would involve military action.  It should be noted that Gulf producers, cognizant of this threat, have increased pipeline capacity to avoid the strait.  Still, a blockade, or a serious threat of one, will lead to oil hoarding and drive prices higher.

ECB:  Hawks on the ECB indicated today that interest rates may rise sooner than President Draghi suggested in the bank’s last meeting.  Although we doubt that the ECB will move rates higher anytime soon, the report has boosted the EUR this morning.

Novichok returns:  Two British citizens, Charlie Rowley and Dawn Sturgess, have reportedly been stricken by Novichok, the nerve agent used against a former Russia spy four months ago.[8]  It is possible that this poisoning was accidental; the couple had visited a botanical garden that the Russian spy and his daughter had visited during the previous attack.  It doesn’t appear that Rowley and Strugess are spies, so what this event may prove is that it is difficult to decontaminate an area after Novichok is used.

[1] https://www.ft.com/content/77d1671c-7fa6-11e8-bc55-50daf11b720d

[2] https://www.ft.com/content/87bf0aa0-7ed2-11e8-8e67-1e1a0846c475

[3] https://www.reuters.com/article/us-usa-trade-china-eu-exclusive/exclusive-china-presses-europe-for-anti-us-alliance-on-trade-idUSKBN1JT1KT

[4] https://www.wsj.com/articles/u-s-will-shoot-itself-in-the-foot-if-it-pulls-the-tariff-trigger-china-says-1530767200

[5] https://www.ft.com/content/6168aae0-7fd2-11e8-8e67-1e1a0846c475

[6] https://www.reuters.com/article/us-iran-oil-sanctions/iran-threatens-to-cut-cooperation-with-nuclear-body-after-trump-move-idUSKBN1JU1E9

[7] https://gulfnews.com/news/mena/iran/iran-threatens-to-block-strait-of-hormuz-1.2246857

[8] https://www.nytimes.com/2018/07/04/world/europe/salisbury-poison-skripal-amesbury.html?emc=edit_mbe_20180705&nl=morning-briefing-europe&nlid=567726720180705&te=1

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