Daily Comment (June 22, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] We made it to Friday!  Markets are rather quiet this morning as immigration has overshadowed trade concerns.  We are seeing a bit of “risk-on” today after a rather rough week.  Here is what we are watching this morning:

OPEC: We have a deal. The cartel agreed to a 1.0 mbpd increase in quotas but not in production.  Since many of the members lack excess capacity, the real increase is about 0.6 to 0.8 mbpd.  That is a bullish outcome.  We are still waiting to see the Russian reaction but our expectation is that Russia will increase production to take market share from the formal cartel.  But, overall, this is a bullish result relative to fears of a much larger rise in output.  At the same time, we think Saudi Arabia is trying to guide prices modestly lower (low $60s to high $50s) in response to President Trump’s persistent criticism of high oil prices.  The president wants lower oil (and gasoline) prices going into the mid-terms.  Thus, don’t be surprised to see bearish comments from the Saudis in a bid to cool today’s early price spike.

Turkish elections: Most recent polls show Erdogan’s party coming in at 51.6%; if accurate, he would win Sunday’s election outright.  On the other hand, if he fails to achieve 50%, he would face a run-off election.  It should be noted that the most recent polls are illegal; Turkish electoral law indicates that no polls should occur 10 days before the election.  Thus, the veracity of the most recent polls is questionable.  The last legal polls showed Erdogan with 45.8% support.  The second place party is the Kermalist CHP; the policy platform of this party isn’t remarkably different than Erdogan’s except that the CHP leadership is campaigning on the goal of improving global relations.  We expect a close election and wouldn’t be surprised by a run-off.  But, in the end, we expect Erdogan to eke out a narrow victory.

Greek deal: After eight years, the Greek bailout is finally complete.[1]  Greece did not get a debt write-off but it did receive a 10-year extension of the loan terms and a decade deferral on interest and amortization.  Although this buffer will likely give Greece enough financial space to be able to tap the financial markets for loans, its government debt/GDP ratio remains at 180% and terms of the deal require austerity to remain in place.  In our opinion, this is another “can kicking” solution but, given that Greece has essentially more than a decade to build cash reserves, we shouldn’t see Greece affecting financial markets for a while.  Greece will be making mere token payments on its debt unit 2030.

German/French EU reform hits opposition: France and Germany reached an agreement on EU reforms.  The agreement was not all that ambitious but it is facing rather strong opposition from a number of EU nations, including the Netherlands, Finland and Austria, which are questioning the need for any Eurozone fiscal capacity.[2]  The economic theory of currency unions usually requires some sort of fiscal unity to address growth divergences within the union.  The Eurozone lacks this feature; instead, the Germans tried to use strict fiscal spending limits to address this problem.  What has developed instead is wide growth divergences.  The natural split in the Eurozone is between the north and south.  The opposition to France’s plan is mostly coming from the north.  Thus, we have doubts that anything of substance will come from Germany and France’s plan.

European immigration problems: The U.S. isn’t the only part of the world with immigration turmoil.  Chancellor Merkel is facing a breakup of one of the most durable coalitions in European political history, the CSU/CDU union.  Differences on immigration policy are threatening this long-standing arrangement.  The CSU, based solely in Bavaria, wants to block refugees from entering Germany.  Since Bavaria sits on Germany’s southern border, this action is essentially a national policy.  Merkel opposes this policy.  She is trying to work out a compromise but Italy scuttled her plans by rejecting a proposal that would have allowed refugees in Germany to be returned to their nation of entry which, in most cases, is Italy for migrants coming from Africa.[3]  It is possible that the Merkel government could fall over this issue.  German media is reporting that the other party in Merkel’s grand coalition, the SPD, is planning for snap elections.[4]  New elections would likely boost the AfD and lead Germany in a more populist direction, which would likely be bearish for the EUR.

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[1] https://www.ft.com/content/b1cba7c4-75a2-11e8-a8c4-408cfba4327c

[2] https://www.ft.com/content/19eba02a-75fd-11e8-b326-75a27d27ea5f

[3] https://www.ft.com/content/6d2a2c3c-7564-11e8-aa31-31da4279a601?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[4] https://www.forexlive.com/news/!/germanys-spd-is-said-to-prepare-for-new-elections-report-20180622