Daily Comment (June 21, 2019)

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

[Posted: 9:30 AM EDT]

NB:  Our strategy team is expanding!  Patrick Fearon-Hernandez has joined our firm as Market Strategist.  He comes to us from a broad and interesting career, including a stint at A.G. Edwards and the Central Intelligence Agency.  You will be seeing his work in the coming weeks and we are excited to have him aboard. 

Happy Friday!  It’s the summer solstice today. In the news, an operation against Iran was about to start but was called off by the president.  There are elections in Istanbul over the weekend and the G-20 meets.  Additionally, the global ISM data was mostly steady to better than expected.  Here is what we are watching today:

Iran: As we noted yesterday, Iran has downed a U.S. drone.  President Trump warned Iran against such actions.   According to reports, the U.S. was about to conduct an air operation against Iranian targets but President Trump called off the action.  According to reports, the action was designed to target radar facilities that use missile or artillery against Persian Gulf shipping or aircraft (hence a response to the aforementioned drone attack).   It isn’t clear as to why the action was rescinded.   However, we do note that there is a key divergence within the administration, between hawks, such as Bolton and Pompeo, and the president himself, on such matters.  President Trump was to avoid deep involvements in the Middle East—and other areas too.  That isn’t how a superpower usually acts and is certainly not how the U.S. has behaved since the end of communism.  However, populists in the GOP oppose foreign interventions, while the establishment tends to support them.

So, where does this leave us?  Clearly, the potential for escalation is still in place.  Although, it also shows great reluctance to dive into a conflict.  We now await to see what sort of response we get from Tehran.  At the same time, we don’t know why the action was halted.  Was it due to something as simple as “cold feet?”  Did President Trump get information, perhaps from a foreign source, that led him to rethink the action?  We may never know but for now, the mere threat of a conflict will tend to support risk assets, such as oil, gold and the yen.

Trade talks: There isn’t too much new on the trade front.  China appears to be framing the discussion between Presidents Trump and Xi as occurring because the U.S. is asking for talks.  The trade teams have resumed negotiations.  The best outcome is the two leaders not only restart talks but make progress in a compromise deal.  The worst outcome is both leaders walk away from discussions and end trade talks.  The most likely outcome?  A freeze on new tariffs and a promise to return to negotiations in earnest.  The problem for both the U.S. and China is the easy parts have been discussed and fleshed out, while the remainder gets to core issues that will determine the direction of relations going forward.  Those issues are very difficult.  The other issued we are concerned with is both leaders may be overestimating the strength of their positions and thus feel no need to compromise.  We are assuming a neutral outcome, but the chances of a hard break are not insignificant.

Brexit: It’s now down to two candidates, Boris Johnson and Jeremy Hunt.  This outcome, in a sense, is already a win for Johnson, who likely didn’t want to face the formidable Michael Gove in the final vote.  There were rumors of “tactical voting” where Johnson supporters voted for Hunt to prevent Gove from winning second place; the outcome for second was close, with Hunt besting Gove by a mere two votes.  From here, the Tory party members will vote for a new PM.  We expect Johnson to win this vote on July 22.

EU woes:  The EU is in turmoil after being unable to agree on a new leader to replace Juncker.  In some respects, the leadership vote in the EU is in flux because the establishment is losing its grip on the union.  At the same time, the viciousness of the vote reminds us of an old line from Henry Kissinger, who once noted that “academic politics are so vicious precisely because the stakes are so small.”

Italy:  Deputy PM Salvini is threatening to resign if he doesn’t get his way for budget conflicts with the EU.  Salvini is trying to push through a tax cut that will lift the deficit and threaten to break EU budget rules.

Hong Kong:  Although the extradition bill has been postponed the city is preparing for another weekend of protestsApparently, protests are already underway.  With President Xi focusing on the G-20 and North Korea, the protestors likely have another weekend to act.  However, when Xi gets back to normal business, we will be watching to see how long he tolerates this behavior.  Investors will be taking notice as well. 

View the complete PDF