by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EDT] Good morning! It was a quiet overnight session with some modest recovery in risk assets after the recent sell-off. The U.S. released a plethora of data this morning, which we cover in detail below. Most of Europe is closed for Ascension Thursday. Here is what we are watching:
The eastern front of the trade war: EU Trade Commissioner Malmström warned officials that the U.S. is preparing to level “billions” of EUR in tariffs this summer. The tariff threat comes from the subsidies that the WTO has determined Europe gives to Airbus (EADSY, 31.86). Car tariffs remain the most significant threat. If the U.S. moves forward with tariffs on Europe, the most likely response would be a weaker EUR.
The dollar threat: We tend to take a relaxed position on the dollar’s reserve currency status. Although it does confer benefits to the U.S. economy, it also brings significant costs. Essentially, the U.S. economy has foreign savings thrust upon it (that’s the inverse of the trade deficit), which causes either higher levels of unemployment or debt, depending on how the foreign savings is allocated into the U.S. economy. At the same time, U.S. consumers benefit from a broad array of goods and services and low prices. Furthermore, because these foreign savings must touch the U.S. financial system, it gives policymakers enormous power to coerce other nations into accepting U.S. foreign policy goals. If they don’t, the U.S. can deny access to its financial system and deny them the use of the dollar for global transactions. This power is being observed with the Iran nuclear deal. Europe wants to keep the deal together even without U.S. participation. But, to do that, European companies would have to continue to do business with Iran in violation of American sanctions. As long as these companies don’t use dollars in the transaction and don’t contact the U.S. financial system, this is possible. Good luck with that! To facilitate this trade, Europe has created a special vehicle that would, in theory, allow trade with Iran to occur and hide the transactions from the U.S. financial system. India is reportedly setting up a separate but similar system to trade with Iran. It is unlikely that these programs will completely isolate Europe from U.S. financial rules. These alternative payment systems could undermine the dollar’s reserve status and reduce American power. But, they come at a cost; to really be effective, the EU must start running large trade deficits and accept foreign saving, something that would be an anathema to Germany. These alternative payment systems represent a threat to U.S. hegemony, but it will not be a serious threat until other nations are willing to accept the whole cost of the reserve role, which, to date, none have been willing to bear.
The EU and Italy: The EU is threatening to sanction Italy for its fiscal spending. Italy, at least according to Ambrose Evans-Pritchard, is considering issuing micro sovereign bills, a type of tax anticipatory notes that could act as a parallel currency. Although the EU will probably manage Brexit and survive, a rupture with Italy would be a serious threat to the Eurozone and may fracture the single currency.
Brexit: Labour leader Corbyn suggested today that another referendum would not be merely about staying or going, but other alternatives as well. Although British leaders continue to indicate that the EU will renegotiate the May agreement, there is no evidence to suggest the EU will budge. U.K. voters in the EU elections showed a clear preference for parties that wanted to either (a) leave with or without a deal, or (b) stay in the EU. The problem for the political classes is that they are trying to find a middle ground between these two positions when one probably doesn’t exist. If they were to hold 50 referendums, they would probably find that, like the coin flip experiment done in entry level statistics, the outcome to stay or leave would likely be about equal. The inability to craft a middle ground increases the odds of a hard Brexit. It’s a bit like when there is a review of a call in Major League Baseball; when the review is inconclusive, the call on the field stands. The fact that Article 50 has been invoked means the call leans to a hard Brexit. Avoiding this outcome would likely require a general election and, in the current political environment, it isn’t obvious that any party in Britain can achieve a majority.
Venezuela: In a completely unexpected move, the central bank of Venezuela published several spreadsheets detailing its economic performance. The country hasn’t officially published this data since 2015 so the fact that the information was even being gathered is a bit of a surprise. It isn’t clear why this data was released; it is quite possible that it was a rogue operation because it’s hard to see how this data burnishes Maduro’s position. Nevertheless, there were some interesting highlights. In Q3 2018, GDP fell 22.5% on a yearly basis. Inflation in 2018 was 130,000%. GDP has contracted every quarter since 2014. Everyone thought conditions in Venezuela were bad, but now we have some data to back up that perception.
A positive for nuclear power: The IEA warned this week that nations should reconsider closing aging nuclear power plants because nearly all the alternatives will boost greenhouse gases and increase costs to consumers.
Odds and ends: Benjamin Netanyahu was unable to form a government, so new elections will be held in Israel. It appears Russia is violating the nuclear test ban. Turkey is threatening to put missiles on the Mediterranean; most likely this is to threaten Cyprus. Turkey is in a dispute with Cyprus over offshore hydrocarbon assets that both nations claim.