Daily Comment (June 25, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s Monday.  This morning, it’s trade, Turkey and OPEC.  Here are the headlines:

Trade: The Trump administration is preparing to put capital controls against Chinese investment in a variety of U.S. industries deemed critical for security.  The industries are mostly in the technology sector.  The president is using emergency powers granted to him to protect national and economic security.[1]  In addition, the U.S. will begin implementing tariffs on China by July 6th unless some action is taken to delay the move.  And, the president is threatening even more trade sanctions on additional countries.[2]  It appears the Navarro/Lighthizer wing of Trump’s inner circle has overwhelmed the establishment Mnuchin/Kudlow wing.  Worries about an escalating trade war sent emerging markets lower.  Treasuries and the yen rose.  Equities, in general, are weaker as well, although the risk-off trade has weakened throughout the morning.

Turkey: As we noted last week, illegal polls in Turkey were suggesting that President Erdogan would win a first round victory.  Because polls are not supposed to be conducted 10 days before an election we were unsure if the surveys were accurate.  Turns out they were.  Although results are not official, opposition candidates have conceded and it appears Erdogan took 52.5% of the vote.[3]  In addition, combined with his coalition partner, the Nationalist Movement Party, Erdogan will enjoy a majority in parliament.  Recent changes to the constitution will give the incoming president very strong powers.  The lira initially rose on the news but has turned lower.

OPEC: On Friday, oil prices soared on the idea that OPEC would not increase oil supply as much as initially feared.  Over the weekend, Saudi Arabia suggested that supplies would rise enough to ensure ample supply, which probably means the kingdom could expand output to meet the 1.0 mbpd increase in quota even if it produces over its individual country quota.  The news led oil prices lower this morning.  Most likely, we are seeing an evolution to price stability.  OPEC doesn’t want a return to the low $50s for oil prices, but the Saudis are facing political pressure from the U.S. and Riyadh wants to improve relations with the Trump administration after the deterioration under President Obama.  One of the truisms of oil is that rapidly changing prices attract attention but the cartel can get away with high, but stable, prices.  That is mostly OPEC’s goal, which means we are probably heading to a period of very low oil price volatility.

PBOC: The Chinese central bank lowered reserve requirements by $100 bn in order to protect the economy from the negative effects of tariffs and other trade actions.[4]  What is important from this action is that it took the CNY lower.  Currency depreciation is one way China could counteract the Trump administration’s trade actions.  So far, President Trump remains opposed to weakening the dollar to address trade, so as long as this avenue is open we look for more nations to take advantage of this policy and use a weaker currency to offset trade restrictions.

Merkel’s problem:A weekend meeting[5] didn’t resolve the chancellor’s problems.  Merkel faces an internal rebellion in her coalition that wants to restrict acceptance of immigrants.  To quell the rebellion, Merkel wanted to send refugees back to the country where they initially entered the EU (the “Dublin Principle”), which is current policy.  Clearly, this policy adversely affects countries like Greece and Italy, where many of the refugees first land.  Italy decided against helping Chancellor Merkel, demanding the first landing policy be abandoned.[6]  If Merkel can’t come to some sort of compromise, her government is in trouble and we may see new elections in Germany before year’s end.  That outcome would probably be bearish for the euro.

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[1] https://www.politico.com/story/2018/06/24/trump-china-export-controls-647091 ; https://www.ft.com/content/c002dadc-766b-11e8-b326-75a27d27ea5f?emailId=5b306e2f18cc4a00043573ad&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 ; https://www.wsj.com/articles/trump-plans-new-curbs-on-chinese-investment-tech-exports-to-china-1529883988

[2] https://apnews.com/c5a7fdde33b84ca9b100a8862326d6d4/Trump-lobs-new-threats-against-countries-trading-with-the-US

[3] https://www.ft.com/content/9ab2404e-7786-11e8-bc55-50daf11b720d?emailId=5b306e2f18cc4a00043573ad&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[4] https://www.ft.com/content/ae641456-77c1-11e8-bc55-50daf11b720d?emailId=5b306e2f18cc4a00043573ad&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.washingtonpost.com/world/europe/european-leaders-talk-migration-as-germanys-merkel-tries-to-save-political-future/2018/06/24/89a23266-764e-11e8-bda1-18e53a448a14_story.html?noredirect=on&utm_term=.bb30ec9ef264&wpisrc=nl_todayworld&wpmm=1

[6] https://www.ft.com/content/bc42c746-77c3-11e8-bc55-50daf11b720d?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56 ; https://www.nytimes.com/2018/06/24/world/europe/eu-migration-dublin-regulation.html?emc=edit_mbe_20180625&nl=morning-briefing-europe&nlid=567726720180625&te=1