Daily Comment (May 4, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Employment Day! We cover the data in detail below but the quick take is that it was weaker than expected. Although the unemployment rate fell to a new cycle low, it appears to be due to people leaving the workforce. The other major issue is that wage growth still remains subdued. Here is what we are watching this morning

Changes to Iran deal? In an attempt to salvage the Iran deal, the EU settled on a supplementary agreement that would allow the U.S. to impose sanctions on Iran if it attempts to develop an ICBM. The arrangement was made in response to criticism from President Trump that the Iran deal is too lax. There has been growing speculation that President Trump may not renew the sanction waivers on May 12 unless there are drastic changes to the deal. Global powers seemed to be on edge regarding his decision because if this deal were to fail a second one will be much harder to secure. Hawks in both Iran and the U.S. have expressed an unwillingness to compromise in the event of new negotiations. We will continue to monitor this situation.

Argentina default? A combination of rising inflation and weakness of the Argentine peso has called into question Argentina’s debt quality. Argentina’s central bank has struggled to meet its annual inflation target of 15%, with the latest annualized CPI reading at 25.4%. The central bank has responded by raising rates aggressively, hiking rates by 300 bps two times this week and again this morning by 675 bps; currently its benchmark interest rate is 40.0%. Meanwhile, the Argentine peso has weakened against the dollar as markets prepare for the FOMC to raise rates in June. As a result, Argentine Century Bond, which are U.S.-dollar denominated, have tumbled. The chart below shows the historical price—at the time of this publication, Argentine Century Bonds were trading at a discount of $86.15.

(Source: Bloomberg)

China negotiations: Earlier this morning, the U.S. trade delegation demanded that China lower its trade deficit with the U.S. by $200 bn by 2020. Last year, the U.S. trade deficit with China was $337 bn. In addition, the U.S. asked China to eliminate all subsidies linked with its “Made in China 2025” initiative and lower import tariffs to levels similar to the U.S. This appears to be the opening offer from the U.S. and therefore probably will not resemble the final deal. That said, China has expressed a willingness to lower its trade deficit with the U.S. — as it tries to make a switch from an export-based economy to a consumption-based economy — but wants to do so on its own terms. China will be reluctant to accept any deal that will make it look weak to its public and will likely keep its hand close to its chest. Yesterday, it was announced that China’s largest news outlets were banned from reporting on the negotiations.[1] We will continue to monitor this situation.

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[1] https://www.bloomberg.com/news/articles/2018-05-03/china-is-said-to-order-reporting-ban-on-mnuchin-led-trade-talks