Daily Comment (November 12, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s Monday and a bank holiday.  Since Veteran’s Day fell on a weekend, the banking system is partially closed today, which means the cash Treasury market is closed.  This is what we are watching this morning:

OPEC and oil: President Trump has been critical of OPEC and high oil prices, and the Saudis have been sensitive to his complaints.  However, now that the midterms are over, it appears the kingdom is pressing for higher prices.  The Saudi energy minister, Khalid al-Falih, suggested yesterday that the oil markets have overcorrected and prices should move higher.[1]  In addition, the kingdom is officially pushing for a 1.0 mbpd cut by December.[2]  Although Russia isn’t necessarily warm to the idea, it hasn’t shot it down either.[3]  Oil prices have suffered a significant decline recently, mostly due to seasonal factors and rising U.S. output.  The OPEC news may arrest the decline, but a reversal will need inventory reduction; a bit of dollar weakness would be helpful, too.

MbS: This week’s Weekly Geopolitical Report concludes our two-part series on the Saudi crown prince.  We note a couple of articles today.  First, the NYT reports that the crown prince was considering an assassination campaign against his and the kingdom’s enemies.[4]  Second, as we note in our report, it is likely the other princes will try to rein in MbS.[5]  His unstable decision-making is becoming a problem and could bring instability to a nation that strives for stability.

Brexit: Earlier this month, there was optimism that PM May would be able to strike a deal with the EU on Brexit.  Although the substance of an agreement appeared to be lacking, hopes were high.  It appears these hopes are fading rapidly.  The EU has rejected a key compromise point[6] on the Ireland/Northern Ireland border.  Negotiations have been intense but both sides can’t seem to come up with an agreement that will work for both parties.[7]  The British prime minister is facing political broadsides from both Remainers and Leavers; May has been trying to weave a path that would give each side enough to accept a Brexit deal that would not leave the U.K. economy completely outside the EU.  However, she has not been able to craft a compromise; in fact, such an arrangement may not be possible.  The GBP has declined on the lack of progress.  It should be noted that most EU deals don’t occur until the deadlines, mostly because there are so many parties involved that getting to an early answer is impossible.  Thus, one should not conclude that a deal isn’t coming.  However, if a plan isn’t in place by the end of November, it will be virtually impossible for the remaining members of the EU to agree in time for the March 29th deadline.  A “hard” Brexit, which simply pushes the U.K. out of the EU and forces trade to WTO rules, would be a hard shock to the U.K. economy.  Already, there are calls for government bailouts if such an event occurs.[8]

Chinese tensions rise: Chinese authorities have been cracking down against labor protests that have been springing up recently.  These follow student activism at Peking University, where students, acting as good Marxists, supported a unionization movement for workers at the school.[9] Another issue facing the leadership is growing financial problems.  China has been using financial repression against households for years; it is how it creates saving for investment.  Households were generally only allowed to put their savings in banks that offered low interest rates, usually below the rate of inflation.  Financial firms have sprung up over the years offering higher interest rates; however, these firms are loosely regulated and, occasionally, default, causing localized unrest.  Peer-to-peer lending has been one of these industries.  Now, it appears a major one, Ezubao, has failed and depositors are demanding the government bail them out.[10]  We saw similar issues with wealth management products.  There is a solution—allow banks to raise interest rates to market levels which would undermine these unregulated financial products.  But, that would undermine the development model China has used since the late 1970s and, more importantly, reduce the wealth of powerful figures in the CPC.  Finally, the PBOC is signaling that it will act to prevent the CNY from depreciating significantly.[11]  Although the central bank may be successful in its goals, it should be noted that if the Trump administration does follow through on additional tariffs then CNY weakness is a nearly inevitable response.

Navarro reacts: Senior trade advisor Peter Navarro accused major Wall Street firms of being “unpaid foreign agents”[12] for meeting with Chinese officials earlier this month.  These strong words should be seen in the context of the divisions within not only the administration but the political system as well.  Populist wings have emerged on both the left and the right and Navarro, along with Robert Lighthizer, represent the right-wing version, at least on trade.  Populists of both stripes oppose globalization.  However, it is a bit jarring for a GOP administration to label Wall Street as unpaid foreign agents.

North Korea lurks: Although the Hermit Kingdom has been off the front pages for a while, we note that the Kim government has been continuing to work on its weapons of mass destruction.  According to the Washington Post,[13] the regime is working on its ballistic missile program at new “secret” bases.  Kim Jong-un, like his father and grandfather, won’t be ignored indefinitely and the lack of progress on improving relations could mean new tensions in 2019.

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[1] https://www.cnbc.com/2018/11/11/oil-prices-saudi-arabia-says-markets-are-getting-it-wrong-again.html

[2] https://www.ft.com/content/1e3639a6-e5e7-11e8-8a85-04b8afea6ea3?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[3] https://www.wsj.com/articles/opec-edges-closer-to-production-cut-as-saudis-russia-signal-intent-1541956957

[4] https://www.nytimes.com/2018/11/11/world/middleeast/saudi-iran-assassinations-mohammed-bin-salman.html?emc=edit_mbe_20181112&nl=morning-briefing-europe&nlid=567726720181112&te=1

[5] https://www.ft.com/content/2f853996-e5d3-11e8-8a85-04b8afea6ea3?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[6] https://www.thetimes.co.uk/edition/news/may-s-brexit-deal-crashes-as-eu-turns-off-life-support-fg02wktsp

[7] https://www.theguardian.com/politics/2018/nov/12/may-has-little-room-for-manoeuvre-brexit-german-minister-warns

[8] https://www.politico.eu/article/business-will-need-state-bail-outs-in-no-deal-brexit/?utm_source=POLITICO.EU&utm_campaign=f80619b654-EMAIL_CAMPAIGN_2018_11_12_05_40&utm_medium=email&utm_term=0_10959edeb5-f80619b654-190334489

[9] https://www.ft.com/content/cbecd5d8-e627-11e8-8a85-04b8afea6ea3?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[10] https://www.ft.com/content/c71eea4a-c198-11e8-84cd-9e601db069b8?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[11] https://www.bloomberg.com/news/articles/2018-11-12/china-signals-tougher-yuan-management-at-expense-of-market-role

[12] https://www.wsj.com/articles/peter-navarro-blasts-china-and-wall-street-globalists-1541787254

[13] https://www.nytimes.com/2018/11/12/us/politics/north-korea-missile-bases.html