Daily Comment (June 5, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Good morning!  The risk-on rally that began yesterday is continuing this morning.  The ADP employment data was very weak (see below) and is prompting a strong rally in fixed income.  Here is what we are watching today:

What prompted the rally?  Much of the lift seen yesterday into today has been credited to Chair Powell, who suggested in a speech yesterday that the Fed could cut rates, especially if the trade issues weaken economic growth.  The attribution seems to suffer from a common malady seen among editors in the financial media, the post hoc, ergo proctor hoc[1] fallacy.  After all, the financial markets have been convincingly signaling that the Fed should be cutting rates aggressively and soon.  So, the only way Powell could have been bearish is if he had signaled that the FOMC is not inclined to cut rates, which would contradict what several members of the committee have been signaling for weeks.  A better case could be made that the market had fallen too far, too fast and that, perhaps more importantly, the current levels in equities have likely discounted the impact of recent trade news in the absence of recession.  So, how far will the rally carry?  Probably not to new highs, but we wouldn’t be shocked to see a move toward the upper end of the recent range, or around 2900 on the S&P.

World growth forecasts cut: The World Bank has cut its global growth forecast from 2.9% to 2.6%, and has reduced its forecast for global trade as well.  The IMF has reduced its forecast for China’s GDP to 6.0% from 6.2%.

Trouble in Africa: We are watching developments in three nations.  First, in Sudan, protests earlier this year ousted President Omar Hassan al-Bashir.  The military and the protestors were uncomfortable allies in the effort to remove the strongman from his three-decade grip on the country.  Now, the military has moved against the protestors.  It is unclear who is in charge as the military isn’t unified and various factions are trying to take control.  Civilians continue to oppose military control.  Although Sudan isn’t the oil producer it once was since the creation of South Sudan, it remains a significant transit point for oil so unrest there could reduce oil flows.  In Libya, fighting continues and has intensified.  General Khalifa Hifter, who controls the eastern part of Libya, is trying to invade the western part but has faced fierce resistance as the conflict is becoming a proxy war, with Hifter getting support from Egypt, the UAE, Saudi Arabia, France and Russia, while Qatar and Turkey are aiding the various groups aligned against Hifter.  Libya is a member of OPEC and the war has threatened to reduce oil supplies.  In Algeria, protests continue but the military government has been slow to accede to civilian demands.

The future U.K./U.S. trade deal: Brexiteers have argued all along that if the U.K. were to exit the EU it would have the freedom to make new trade agreements that would be more suited to its economy and improve the island nation’s prospects.  Perhaps.  But, the other side of being able to make new deals is that the U.K. outside the EU will have much less leverage in negotiations.  President Trump, perhaps inadvertently, gave the Brits an insight into what it will look like when negotiating with the U.S. from a position of weakness.  Yesterday, the president suggested that the hallowed National Health Service might be part of trade negotiations.  The backlash was swift and fierce and Trump did back away from the comment.  Although the president seemed to preserve the “sacred” nature of the NHS, in reality, the U.K. will be dealing with the U.S. from a deep position of weakness.  Not only will the NHS be in play, but so will agriculture and financial services.  President Trump did the British a favor by giving them a glimpse of what post-Brexit will look like.  Let’s see if they take the hint.

The Mexican tariffs: President Trump continues to insist that the tariffs will be applied.  Senate Republicans are showing a rare sign of opposition to the White House.  The FT highlights the states that would be most affected by the trade impediments.  There is a possibility that President Trump might accept some gesture by Mexico and delay implementation but, so far, it looks like a multi-level pile-up between Mexico, the White House, the Senate and American businesses.

Establishment versus the Populists: One theme we have regularly discussed is how the Trump presidency has been straddling both the establishment and the populists.  His tax cuts and deregulation are firmly establishment policies, whereas his immigration and trade policies are populist.  The establishment is starting to realize that the president isn’t always its ally and a pushback may be developing.  The aforementioned discussion of Senate opposition to the Mexican tariffs is one element of this counterattack.  Campaign funding may be another.  At the same time, this establishment versus populist divide is also playing out in the Democratic Party.  We note that Sen. Warren, one of the plethora of Democrats running for president, has offered an economic plan that fully skews toward job creation and against capital and efficiency.  The 2020 presidential election may not offer any candidate fully to the liking of the establishment.

Italy versus the EU: As we have noted in recent days, Italy is facing potential sanctions from the EU over fiscal deficits and government debt.  Although the Italian government continues to insist it will avoid a confrontation with the EU, Deputy PM Salvini (and the real power in the government) is warning that Italy might issue a parallel currency that could be used to pay government debt.  The issuance of a parallel currency would be a significant threat to the Eurozone as other indebted nations might take similar actions.

Continued trouble in the farm belt: Last weekend, I[2] took a trip through the middle of Illinois.  Nearly all the fields, which would usually have emerging corn plants, were fallow.  Cold weather and heavy rain have delayed planting in key parts of the Corn Belt at unprecedented levels.  We are very close to the point where corn planting becomes impossible, thus farmers may either move to soybeans or simply not plant.  At the same time, farmers are famous for moving aggressively once conditions improve.  So, we may still see a soybean crop this year.

Odds and ends: U.S. colleges and universities are watching with great concern as the flow of Chinese students to the U.S. is under threat.  Walmart (WMT, 102.56) is offering high school students free SAT prep and partial scholarships in a bid to find new employees, a sign of how tight the labor markets have become. 

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[1] “after this, therefore because of this”

[2] This is Bill talking…