Daily Comment (June 10, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Monday!  It’s a risk-on day, with equities higher, and gold and Treasury prices lower.  The U.S. and Mexico have a trade deal.  The G-20 Finance Ministers’ meeting (the pre-meeting for the leaders’ meeting) didn’t resolve much.  Here is what we are watching today:

The Mexico deal: The U.S. and Mexico arrived at a deal, avoiding tariffs.  Financial markets were leaning toward this outcome so we are higher this morning, but the rally actually began last week.  Here are the key takeaways:

  1. It isn’t completely clear that the U.S. got anything it didn’t already have.  According to reports, Mexico had already agreed to increase border security on its southern border.  The president has indicated there is more to the agreement but hasn’t detailed what additional concessions he received.  There have been reports that Mexico agreed to buy more U.S. agricultural goods.  However, that assertion has been denied by Mexico.  So, on its face, it doesn’t look like too much changed.
  2. Mexico is clearly relieved that the tariffs were averted.  The MXP rose on the news.  However, the tariff threat, now introduced, could return if the White House determines Mexico isn’t delivering.
  3. It still isn’t clear why the president reversed himself.  He may believe he did get something new from Mexico.  He may have concluded the economic damage from the tariffs would be too costly, thus retreated and declared a win.  If the first answer is right, then a return of the tariff threat is likely.  If it’s the second, we probably won’t hear of it again.  Unfortunately, we have no good insights as to which option is the correct one.
  4. One of the important policy items to note is that this administration, unlike its predecessors, is aggressively mixing trade and security policy.  This is a major departure from previous administrations and has created some divisions within the current administration.  For example, USTR Lighthizer has tried to keep technology policy and trade separate in his negotiations.  Although the president has been criticized for this mixing of policy, and Senate GOP leaders seemed to join this opposition, there is some logic to putting the two together.  American hegemony is partly built on trade policy.  The U.S. deliberately accepted the reserve currency role; once that role was in place, the need from foreign nations to acquire dollars allowed the U.S. to weaponize trade.  Whether or not this policy continues post-Trump is not clear.  However, we note that Sen. Warren has argued the U.S. should “actively manage” the dollar’s exchange rate to promote domestic manufacturing.  In many respects, exchange rate manipulation would be much more effective than tariffs but would end up at the same endpoint—weaponizing trade.  Thus, by design, trade and national security policy could become linked.  How? Because the reserve currency nation can use trade as a foreign policy tool.  Both Trump’s and Warren’s policies would cause economic volatility.
  5. Even after this outcome, the problem of Central American migration remains.  If anything, we expect it to become exponentially worse because, at some point, some of the four million Venezuelans that have fled their country will start heading north.  Interestingly enough, as Mexico and the U.S. become more hostile to these refugees, Europe is becoming a destination.
  6. For now, this agreement is good news for financial markets and should provide a lift to Mexican assets.

The G-20: The finance ministers from the G-20 nations met in Japan over the weekend to prepare the agenda for the leaders’ meeting at the end of June.  There didn’t appear to be much progress in easing tensions.  The group was critical of U.S. trade policy.  Treasury Secretary Mnuchin suggested that the U.S. and China would probably create a similar outcome to the Buenos Aires summit.  If so, it would imply that a deal won’t be finalized but a ceasefire might emerge.  It is interesting to note that Mnuchin suggested an advancement in trade talks could lead the U.S. to ease up on Huawei (002502, CNY 3.36); if so, it would confirm Chinese suspicions that the tech issue is merely being used for leverage and has less to do with national security.  However, as we note above, with this administration the two are more closely linked than in previous governments.  There was an agreement to create uniform tax rules; if put in place, it would be especially onerous for tech companies.

China and trade: We note that China’s May trade surplus widened due to an unexpected jump in exports, which rose 1.1% from last year.  Most likely, foreign buyers are stockpiling on worries about future trade impediments.  If so, the gains will not be sustained.  China has summoned U.S. tech firms to meet with officials and indicated that they should not cooperate with the U.S. restrictions on technology trade.  This action puts tech firms in a dilemma; either cooperate with the U.S. and lose business in China or break U.S. law.  China is planning export controls on “sensitive technology,” a retaliatory act against U.S. proposals.  Meanwhile, Vietnam is cracking down on firms re-exporting Chinese goods to avoid tariffs.  And, the U.S. is moving to undermine the ability of Chinese companies to list on American exchanges.  Finally, more Western newspapers are being blocked by the “great firewall.”

The Hong Kong protests: There were widespread protests against a new extradition law that would allow China to extradite people in Hong Kong to the mainland.  Fights broke out in the Hong Kong legislature over the measure.  Steadily, Beijing is expanding its control over Hong Kong despite treaty arrangements that were designed to protect the area from encroachment.  As this encroachment continues, Hong Kong will be seen as less independent from the mainland and therefore less attractive for investors and free thinkers alike.  As is its custom, Beijing blamed foreign influences for the unrest.

Middle East: The Pentagon is considering a request for a major troop buildup in the region.  This request will tend to run counter to the president’s desire to avoid being tied down to conflicts in the region.  The U.S. has given Turkey a deadline on the S-400 missile purchase from Russia.  If Turkey makes the purchase, the U.S. will cancel sales of the F-35 and end pilot training.  Saudi Arabia claims that OPEC is fully on board to maintain output cuts but Russia is still considering whether it will cooperate.  PM Abe of Japan is going to Iran to act as an intermediary between the U.S. and Iran.

Odds and ends: The leadership race begins in Britain today.  Speculation is rising that PM Abe will implement the consumption tax hike.

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