Daily Comment (March 19, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Monday!  We are seeing weaker equity markets and rising Treasury yields this morning.  There is a lot going on—let’s dig in:

A Brexit deal: Negotiators for the U.K. and EU have announced they mostly have an agreement in place.  Although some problems remain unresolved, mostly the Ireland/Northern Ireland frontier, both sides have made significant progress on an exit agreement.  The GBP jumped on the news and is holding its gains as further details become available.  The currency market reaction does suggest this outcome was not expected.

Mueller worries: Financial markets, for the most part, have ignored the personnel news out of the White House.  There have been one-day blips surrounding significant departures, such as Gary Cohn, but they generally haven’t started a trend.  Overnight, we saw another downward drop, seemingly tied to a series of Twitter quotes suggesting the president may dismiss Robert Mueller.  This area may be a red line.  The AG can fire Mueller[1] but the president, at least directly, cannot.  This is dangerous ground for the president.  Firing Mueller will raise the “taint” of scandal even if one doesn’t exist.  If Mueller is forced out, it could trigger a constitutional crisis that would likely affect investor sentiment.  As we note in this week’s Asset Allocation Weekly Comment (see below), the “misery index” P/E model suggests the S&P is fairly valued and equities should do better if earnings continue on their current path.  However, P/Es are always vulnerable to sentiment shocks and such a crisis might trigger one.  It does appear the White House is trying to ease tensions as recent tweets suggest no action will be taken against Mueller, but that hasn’t lifted equities yet.

A new PBOC Chief: After 15 years as governor of the People’s Bank of China, Zhou Xiaochuan has retired, passing on the position to Yi Gang.  Yi is a Western-educated economist with 20 years of central banking experience.  He should be considered a continuity candidate.  Yi is committed to financial reform and, like his predecessor, wants to see debt levels reduced.  However, the PBOC, like nearly everything in China, is not independent of the CPC.  Although there is broad agreement between the CPC and PBOC on the need to delever, the former always loses its nerve when it becomes apparent that such actions will slow economic growth.  We see no reason for this to change in the near term, although Chairman Xi has amassed enough power to press for this significant change.  In fact, if he fails to bring lower debt growth, it begs the question as to why he bothered to gather such control.

Problems at Facebook: In this report, we don’t comment on individual companies unless the news surrounding them has macro implications.  Facebook (FB, 185.09) is down sharply in the pre-market trade after several articles in the U.S. and Britain suggested the company was either duped or willfully negligent during the 2016 election.  Cambridge Analytica was able to gain access to personal data for the social media firm’s users and the company used this information to directly target potential voters.  Using technology to receive news from political organizations is nothing new.  However, if the data was gained without authorization, it likely violates privacy rights of users and is a potential risk for the company.  Given that “big tech” has been a major support to the equity markets, a large decline in one of these companies will tend to have outsized effects on the overall equity market, which is why this issue bears watching.[2]

Putin wins!  In a weekend of historic upsets, one outcome was never in doubt—Vladimir Putin won another six-year term as president.  What he intends to do with this power is uncertain but, in a clearly rigged election (there were no real alternatives in the election), the real issue was turnout.  It looks like about 65% of eligible voters cast ballots, which isn’t bad but not the 70% Putin was hoping for.

OECD boosts growth forecasts: The G-20 meets this week.  This group has become so unwieldy that it doesn’t really function as a policy group.  However, the OECD does put out forecasts before the meetings and it lifted its global GDP growth forecast to 3.9% for this year and next year, the highest growth forecast since 2011.  The group did warn that trade restrictions would weigh on growth if they become widespread.

A shutdown on Friday?  Congress is preparing to send a budget to the president this week.  He needs to sign it by Friday or the government will shut down.  The bill, introduced last month, will increase spending and not necessarily meet the goals of the administration on all spending priorities.  Will the president, who has become increasingly mercurial lately, simply refuse to sign the measure?  Although this outcome isn’t on investors’ radar screens, there is a chance that we won’t have an agreement and a shutdown will occur.  If this occurs, expect some weakness in equities and a decline in Treasury yields.

The Fed: The FOMC also meets this week.  Fed funds futures put the likelihood of a 25 bps hike at 99.3%, with a 0.7% chance of 50 bps.  We will have more on this tomorrow but policy concerns are likely weighing on financial markets today.

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[1] This is true under normal circumstances.  However, the sitting AG has recused himself from the Russian investigation, meaning one of his deputies would actually have to fire Mueller.  Nixon faced the same problem when he wanted to fire Archibald Cox.  Two officials resigned before Robert Bork did the firing. See: https://en.wikipedia.org/wiki/Saturday_Night_Massacre

[2] Here are some relevant articles: https://www.cnbc.com/2018/03/18/facebook-failing-zuckerberg-and-sandberg-absent-commentary.html?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top-stories ; https://www.nytimes.com/2018/03/17/us/politics/cambridge-analytica-trump-campaign.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-column-region&region=top-news&WT.nav=top-news ; https://www.bloomberg.com/news/articles/2018-03-19/facebook-s-zuckerberg-under-pressure-to-answer-for-data-breach?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top-stories ; https://www.cnbc.com/2018/03/18/whistleblower-christopher-wylie-says-hes-now-been-blocked-by-facebook.html ; https://www.ft.com/content/7ed1572c-2aa4-11e8-a34a-7e7563b0b0f4?emailId=5aaf3a4f92ba4800049585ec&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22 ; https://www.theguardian.com/news/2018/mar/17/data-war-whistleblower-christopher-wylie-faceook-nix-bannon-trump?CMP=share_btn_tw&wpisrc=nl_todayworld&wpmm=1 ; https://www.nytimes.com/2018/03/18/us/cambridge-analytica-facebook-privacy-data.html?emc=edit_mbe_20180319&nl=morning-briefing-europe&nlid=5677267&te=1