Daily Comment (March 12, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Monday!  We switched to daylight savings time on Sunday (a rather barbaric practice).  Here is what we are watching this morning:

Scrambling on Korea talks: Weekend reporting made it clear that the president agreed to talks on his own without consulting staff.  The normal protocol is for advisors to the president to meet with officials of the other nation, hammer out a deal or at least topics for leader discussion and then the leaders meet.  That way, the odds of a successful meeting are high.  This meeting is in reverse; the president agreed to a meeting but it is unclear exactly what will be discussed.  Yes, both the U.S. and North Korea have long-standing goals—North Korea wants a peace treaty and security guarantees, while the U.S. wants denuclearization—but there hasn’t been any real discussion about how to achieve these measures.  For example, North Korea probably wants a peace treaty that will include the removal of U.S. troops from the peninsula.  Denuclearization without inspections isn’t realistic.  Thus, we currently have talks promised without an agenda.  More to come, obviously…

NEC Chair: Shahira Knight has signaled she doesn’t want the job.  Chris Liddell has emerged as the front-runner.  He is a former Microsoft (MSFT, 96.54) and General Motors (GM, 37.84) executive who has close ties to Jared Kushner.  Kevin Warsh, the former Fed governor, has also been mentioned and Peter Navarro is also offering his services.  It should be noted the WSJ editorial board is critical of Liddell, suggesting he isn’t high profile enough or strong on free trade.[1]  Expect more drama on this appointment; however, financial markets probably won’t care all that much unless Navarro is selected—that decision would be taken as bearish.

Iran nuclear deal in trouble?  Axios[2] is reporting that the president indicated to Israeli PM Netanyahu that the U.S. will pull out of the Iranian nuclear deal if major changes are not made.  According to this report, the U.S. has told European negotiators they have until May 12 to fix the deal or face U.S. withdrawal.  If the deal falls apart, look for Iran to make a dash for a bomb.  At worst, this leads to a U.S. or Israeli air campaign against Iranian nuclear sites.  At best, it sets off a nuclear arms race in the Middle East.  The Iran nuclear deal is far from perfect but it does appear to have frozen Iran’s nuclear program.  Given that Iran hasn’t really seen any improvement in its economy since the agreement, Tehran may conclude it is better off without a deal.  If the deal fails, we view it as bullish for oil prices.

Saudi IPO postponed: According to the FT,[3] the Saudi Aramco IPO won’t come to market this year but in 2019 at the earliest.  Apparently, the delay is due to the fact that CP Salman wants a $2.0 trillion valuation and company executives are struggling to achieve this number.  In a related report, the WSJ[4] is reporting there is a pricing policy difference between Saudi Arabia and Iran.  The former wants oil prices in excess of $70 per barrel (Brent), while Iran wants a price closer to $60.  This is an interesting role reversal; historically, Iran has been a price hawk, wanting to maximize revenue, while Saudi Arabia has been a moderating force, worried that high prices induce demand destruction.  We believe Saudi Arabia needs that higher price to (a) balance its fiscal budget, and (b) improve the valuation for the Saudi Aramco IPO.  We remain bullish oil until the Saudi IPO prices; after that, we will need to see if Saudi Arabia’s market share policy changes.

Trade talk: The president continues to make trade threats, this time targeting German luxury automakers.[5]  Interestingly enough, both BMW (EUR 85.46) and Mercedes-Benz (EUR 68.33) have extensive U.S. production and thus may not be all that affected by the tariff.  So far, financial markets are taking the stance that the talk is more aggressive than the reality.  Still, we view trade impediments as a serious threat to the financial markets because they would raise structural inflation, which would tend to depress P/Es and raise interest rates by boosting inflation fears.

Abe scandal: In February 2017, Moritomo Gakuen, an ultra-nationalist school developer, acquired land in Osaka for ¥134 mm, about 10% of its appraised value.  Gakuen’s schools reportedly use texts from the Imperial era as part of the curriculum, a practice outlawed by the U.S. during occupation.  Although the administration has denied the reports, the principal of the school has indicated that the PM’s wife gave him a gift of ¥1.0 mm.  By itself, the donation isn’t illegal but Abe could be in trouble if he is found to have misled parliament.  Further investigations have revealed that 14 alterations were made to documents by the finance ministry surrounding the aforementioned land sales and are threatening to engulf Taro Aso, the finance minister.  The LDP is holding leadership meetings this autumn and Abe may not be able to hold his position if the scandal continues.  If Abe is ousted, Abenomics goes with him and we would expect the JPY to appreciate.

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[1] https://www.wsj.com/articles/a-not-so-liddell-problem-1520802951

[2] https://www.axios.com/trump-said-us-will-leave-iran-deal-netanyahu-d9672407-6d18-4978-a08b-3051484b1486.html

[3] https://www.ft.com/content/62fa88b0-21f4-11e8-9a70-08f715791301

[4] https://www.wsj.com/articles/opec-divided-on-the-right-price-for-oil-1520769600?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosgenerate&stream=top-stories

[5] https://www.ft.com/content/6bbd9e74-2546-11e8-b27e-cc62a39d57a0?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56