Daily Comment (June 24, 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 Monday!  Erdogan loses big in the Istanbul “do over,” protests emerge in the Czech Republic and the markets are digesting the Iran situation.  Here is what we are watching today:

Istanbul: After his party suffered a narrow loss three months ago in mayoral elections, President Erdogan claimed there were irregularities and this led to a second vote, which was held over the weekend.  In a rather stunning development, the opposition candidate, Ekrem Immoglu, won in a landslide, taking 54% of the vote compared to 45% for the AK Party’s candidate.  This loss is a blow to the Turkish president.  He was once the mayor of the city and considers it a base of operations.  In an equally interesting development, financial markets cheered the outcome, with Turkish equities and the lira rallying on the news.  We suspect financial markets would like to see Erdogan’s power lessened so as to achieve less erratic policy.

Trouble in Prague: An estimated 250k protestors flooded Prague in Wenceslas Square, the same place where the Velvet Revolution started which led to the overthrow of communism.  The protests were calling for PM Andrej Babis to resign on corruption issues.  He appointed a crony to justice minister, which has raised fears that she won’t prosecute the PM for his alleged criminal activity.

Iran: In the aftermath of the president’s decision to scrub a bombing mission, here is what we are seeing:

  1. The U.S. is opting for new sanctions and cyberattacks in lieu of limited airstrikes.  The president also indicated he is open to talks with Iran on its nuclear program and sanctions.  It is clear that President Trump wants to avoid escalation with Iran.
  2. The decision to scrub the mission appeared to be due to a couple of factors.  First, the president was concerned that the action was “disproportionate.”  Although shooting down the drone was clearly a hostile act, no Americans died in the incident; that would not have been the case with U.S. action.  Second, there are reports, not fully confirmed, that the missile strike on the drone may have been ordered by a lower ranking military officer in Iran and the Mullahs were not happy about the result.
  3. The unknown factor is how Iran views U.S. behavior.  If the Iranian leadership views this event as evidence that President Trump has no interest in a war but intends to keep sanctions in place, they may simply keep “upping the ante” until a military strike occurs.  We would expect the U.S. to signal, through backchannels, that such a response would be a mistake.  Nevertheless, it would not be unreasonable for Iran to take this position.
  4. Iran has a myriad of ways to respond to sanctions. The two we are most concerned about would be a cyberattack on the U.S. and its allies, and/or actions in the Persian Gulf that would cause a rapid rise in oil prices.  The first option is problematic because it may be very difficult to determine the source which would make it hard to retaliate.  The second option can be managed through SPR releases, but the world economy is already fragile and a spike in oil prices might be enough to put the world economy into recession.
  5. Another interesting facet of the Iran issue is that much of the rest of the world is looking at the 2020 elections and making the decision to stall and hope for a new resident in the White House.  The EU appears to be doing just that with trade policy.  However, in Iran’s case, it isn’t obvious if a new administration would make much of a difference.  The Iran nuclear deal wasn’t a treaty because there was no way Congress would approve it.  Going back to the old agreement will be a trick because why would Iran trust any American government?
  6. Our market take is that recent events are bullish for crude oil and risk-on assets.  The opportunity cost of aborting the bombing mission is that it may simply embolden Iran to act rashly and get away with it.  We think this is a misread of Trump’s Jacksonian nature but, as noted in point #3, it would not be an unreasonable position to take.

Trade talks: There isn’t too much new on the trade front, although there is activity in front of the G-20 meeting this weekend.  Our expectation is that we will see a promise to continue talking but a full deal probably isn’t possible.

Brexit: Boris Johnson had a tough weekend.  There were reports of a domestic disturbance and Steve Bannon has apparently been consulting with the PM hopeful.  Although we still expect Johnson to win, he isn’t really running on policy but on personality, so these reports are a problem for him.  The vote of the Tory party members will occur on July 22.  It appears the next PM will get to choose the new BOE Governor.

Italy gets a reprieve (of sorts): The EU has decided to delay any disciplinary actions against Italy to give more time for the Italian government to address its fiscal budget issues.

Odds and ends: Congress is looking at making social media firms show how valuable your information is to them.  Global financial markets continue to deal with falling bond yields.  Truckers are noting growth deceleration.  FedEx (FDX, 165.35) has been accused of diverting another package destined for the Huawei (002502, CNY 3.62) headquarters.

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