Daily Comment (March 15, 2019)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Ides of March Friday!  The National Party Congress (NPC) ended in China and New Zealand is reeling from a mass shooting.  U.S. equity futures are higher.  Here is what we are watching this morning:

The National Party Congress: Unlike previous events, this one was relatively quiet.  Three items emerged.  First, China will return to stimulus, with an increase of 0.8% of GDP in off-budget bond issuance for infrastructure spending.  Although tax cuts have captured the headlines, they are mostly a head fake as spending cuts elsewhere in the budget will tend to offset them.  There could also be some easing of bank reserve requirements.[1]  The stimulus is not all that great but should be enough to stabilize growth.  Second, there was much talk about changes in industrial policy, including little mention of the Belt and Road Initiative or China 2025.  But, the policies still remain in place.  Second, a leveling of the playing field for foreign firms was announced to great fanfare[2] but, in reality, such laws are not terribly meaningful in a nation where “rule of law” really means “do what the Party says.”  The law is mostly there to help bring a trade deal with the U.S.  Third, although there has been some easing of property controls in cities, the national level policy remains restrained.  There had been hopes for change.  Overall, the NPC will support China’s economic growth and likely increase the odds of a trade deal with the U.S., but it won’t lead to an economic boom.

Fed next week: The FOMC will meet next week.  Although no action on rates is expected, we will be watching for two signals.  First, it is quite possible that the FOMC will indicate it will be on hold for most of this year.  Although the usual commentary on data dependency should remain, financial markets are signaling to policymakers that the fed funds should not increase this year.  We will be watching to see if the dots plot reflects this.  Second, the markets will be looking to see if the FOMC signals anything on the balance sheet.  There is growing speculation that the Fed will target a level between $3.8 trillion to $3.5 trillion.[3]  If the FOMC does signal no rate hikes this year and a higher terminal number for the balance sheet, then equities will take this news as supportive.

North Korea: In the aftermath of the recent summit, it appears North Korea may be moving back to a more hostile stance.[4]  Relations between the U.S. and North Korea are complicated.  It appears to us that Kim Jong-un thought he could get a lot from the U.S. and give up little; President Trump clearly figured this out and walked out of talks.  Pyongyang probably wants to pull the U.S. back into talks and thus is using threats to accomplish this outcome.  However, we note the recent comments about restarting warhead and missile tests didn’t come from Kim but from other officials.  We would expect Kim to write another letter or two to Trump to try to get another round of talks.  In addition, a turn toward hostility would be a help to China, who may offer to help out for some easing of trade tensions.

Tehran to Baghdad: Iranian President Rouhani visited Iraq this week, his first state visit to his neighbor.  The visit appears to be designed to undermine U.S. sanctions.[5]  Given the degree of influence that Iran has in Iraq, we expect Iraq to offer a “leaky border” for smuggling.  What was interesting about Rouhani’s visit was that the Iranian president was given a rare audience with Iraq’s leading religious authority, the Grand Ayatollah Ali Sistani.[6] Sistani has always been a political moderate; he does not ascribe to Iran’s “rule of the clerics” model developed by Ayatollah Khomeini, preferring the traditional quietist[7] position of the Shiites.  Sistani opposes Iran’s paramilitary influence in Iraq and apparently noted this in his conversation with Rouhani.  The meeting will lift Rouhani’s position in Iran among moderates and will likely tighten relations between the two governments.

Brexit: So, now what?  The next step is yet another vote on PM May’s exit plan.  Although this seems like a futile exercise[8] to have another vote after the plan has failed miserably twice, it may actually pass on a third turn.[9]  First, May’s minority partner, the DUP in Northern Ireland, is coming under significant pressure from the Northern Irish business community to avoid a hard border and that may mean accepting the backstop and May’s plan.[10]  Second, the EU is indicating that the only way it will agree to an extension is if there is a second referendum.  The Brexiteers are uncomfortable taking a chance on another vote, which might end up with a return to the EU.[11]  Third, it appears that the European Research Group, the collection of Tory MPs who support Brexit, is splitting.  The group, which numbers around 90, only has a core of about 20 MPs.  There are reports that the pragmatists in the group are having second thoughts about careening into a hard Brexit and may end up favoring May’s deal.[12]  And, finally, Labour is facing dissention in its own ranks[13] and may actually lose an election, based on recent polling.[14]  Labour leader Jeremy Corbyn has been pining to bring down the government and have an election, but if Corbyn can’t hold his party together then they might simply vote for May’s plan to avoid another referendum or a hard Brexit.  If May’s plan passes, look for the GBP to rally.

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[1] https://uk.reuters.com/article/us-china-parliament-economy/china-premier-says-can-use-interest-rates-other-policy-steps-to-help-economy-idUKKCN1QW09Y

[2] https://www.scmp.com/economy/china-economy/article/3001780/china-approves-new-foreign-investment-law-designed-level

[3] https://www.reuters.com/article/us-funds-pimco/fed-could-soon-announce-plan-to-stop-shrinking-balance-sheet-pimco-idUSKCN1QV2WB

[4] https://www.reuters.com/article/us-northkorea-usa/north-korea-may-suspend-nuclear-talks-with-gangster-like-u-s-diplomat-idUSKCN1QW0C9?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top

[5] https://www.washingtonpost.com/world/irans-rouhani-in-iraq-for-historic-visit-to-offset-us-sanctions/2019/03/11/24c6e88b-eb40-4da1-b091-c4eb64c0fce3_story.html?utm_term=.a056337ce629&wpisrc=nl_todayworld&wpmm=1

[6] https://www.washingtonpost.com/world/by-granting-rare-audience-iraqs-grand-ayatollah-sends-message-to-washington-and-tehran/2019/03/13/9a624870-4506-11e9-94ab-d2dda3c0df52_story.html?utm_term=.329425d52887&wpisrc=nl_todayworld&wpmm=1

[7] https://en.wikipedia.org/wiki/Political_quietism_in_Islam

[8] https://www.youtube.com/watch?v=UijhbHvxWrA

[9] https://www.youtube.com/watch?v=zMRrNY0pxfM

[10] https://www.ft.com/content/43ec8b9e-466a-11e9-a965-23d669740bfb?utm_source=POLITICO.EU&utm_campaign=154de0543d-EMAIL_CAMPAIGN_2019_03_15_06_44&utm_medium=email&utm_term=0_10959edeb5-154de0543d-190334489

[11] https://www.thetimes.co.uk/edition/news/eu-will-agree-to-extra-time-if-there-is-a-second-brexit-referendum-z6td8nvd7?utm_source=POLITICO.EU&utm_campaign=154de0543d-EMAIL_CAMPAIGN_2019_03_15_06_44&utm_medium=email&utm_term=0_10959edeb5-154de0543d-190334489

[12] https://www.ft.com/content/300a59e4-465b-11e9-b168-96a37d002cd3?emailId=5c8aeeb0cc534f000485fbec&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[13] https://www.telegraph.co.uk/politics/2019/03/14/mps-reject-second-referendum-labour-frontbencher-quits-partys/

[14] https://www.theguardian.com/politics/2019/feb/02/labour-slumps-in-polls-as-tories-open-biggest-lead-since-general-election