Daily Comment (November 18, 2019)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EST] Episode #3 of our Confluence of Ideas podcast is now available.

Happy Monday!  U.S. equity futures are modestly higher this morning on hopeful trade talk.  PBOC eases. Hong Kong unrest intensifies.  Iran also facing unrest.  Lebanon flirting with banking crisis.  Here are all the details and more:

Trade talks:  USTR Lighthizer and Treasury Secretary Mnuchin conducted a phone conversation with Vice-Premier Liu yesterday.  We have seen a spate of positive comments recently.  For example, the U.S. is expected to grant Huawei (002502, CNY 3.48) a 90-day license extension.   However, one fact remains—China wants a tariff rollback and it isn’t clear that President Trump will agree.  Equity markets continue to ride on optimism surrounding a trade agreement.  If trade hopes are dashed, we could see a sharp reversal in the near term.

PBOC eases:  It wasn’t much of an ease, a mere 5 bps; the PBOC cut its 7 day repo rate to 2.50% from 2.55%.  However, it was the first cut in this easing cycle.  This rate peaked in March 2018.  Although the cut was small, it is expected that there is more to come.  Reports suggesting problems for China’s smaller banks continue to circulate.

Hong Kong:  Violence in Hong Kong was elevated all of last week and it intensified over the weekend.  On Saturday morning, PLA troops entered Hong Kong, armed with brooms to clean up after the previous night’s unrest.  Although the actual action was non-threatening, the symbolism was not lost; the next time, they could be armed.  Yesterday, the focus was on the Hong Kong Polytechnic University, which had been taken over by protestors.  Security forces surrounded the school and were arresting anyone who tried to escape.  The police did try to storm the university, but were rebuffed by students firing arrows, bricks and gasoline bombs.  Unnamed officials in the White House have condemned the use of force.  A bill in the U.S. Congress to support Hong Kong protestors has been fast tracked by the Senate; it isn’t obvious if the White House will sign it.  If passed, it would seriously undermine trade talks.  Despite the violence and weak economic data, Hong Kong equities did lift overnight; it’s not obvious as why this occurred but may be related to the PBOC cut.

Iran unrest:  As is common among OPEC nations, Iran heavily subsidies gasoline.  An Iranian was paying 10k riyals, or about 32 cents per gallon; the new price is 15k riyals, or about 50% increase.  In addition, if a household purchases more than 16 gallons in a month, the price doubles againConsumers didn’t take the hike lightly.  Supreme Leader Khamenei tried to ease fears, and at the same time warned demonstrators against violence.  There is clear concern about the anger; Iran has blocked internet access which would be critical in organizing opposition.  We have seen protests around the world over price increases, or reduced subsidies on government supplied goods.  Iran does appear worried.  Although U.S. sanctions have not led to new talks with Tehran, or stopped Iran’s meddling in the Middle East, the Iranian economy has clearly suffered.  The decision to raise gasoline prices smacks of either desperation, or foolhardiness.  We lean toward the former.

A leak:  Yesterday, the NYT ran a long report of what appears to be leaked internal CPC documents regarding the crackdown in Xinjiang.  The information does appear consistent with China’s actions in the region.  To a great extent, the extensive leak gives more details on China’s suppression.  At the same time, we saw few surprises in the report.  The bigger story is who leaked it and why.  It is possible that it is someone looking to undermine Chairman Xi; or perhaps a hardliner that wants to scuttle the trade deal.

Netherlands:  Because of the country’s strict pension funding rules, exacerbated by the ECB’s ultra-low interest rates, some two million Dutch pensioners are facing benefit cuts beginning next year.  Parliament is therefore set to start debating a solution this week, with unions threatening mass protests if relief isn’t provided.  Given that the United States and many other countries face similar pension pressures as a result of population aging, longer life expectancies, and low interest rates, it could be especially instructive to see how the Dutch political process deals with the issue.  Of key importance will be the relative weight put on higher required contributions, benefit cuts, or government support.

Lebanon banks:  Lebanon’s financial system is essentially a dual currency system; USD and the Lebanese pound.  Either specie is used in transactions.  For this system to work the Bank of Lebanon has to maintain a stable exchange rate; most of the time, it trades around 1475 to 1525, pound to dollar.  However, there is a problem with this system; the central bank can only print one of these currencies.  So, to maintain the exchange rate, the central bank either needs to maintain a steady ratio of supply between the two currencies, or the country must have a steady inflow of dollars, mostly through tourism.  Recently, banks have stopped allowing dollar depositors access to their money, leading to panic hoarding of dollars.  To increase the supply of dollars, Lebanon must implement austerity to run a current account surplus; needless to say, the current level of unrest suggests this will be very difficult to manage.

Saudi Aramco:  It does appear the kingdom isn’t going to get the valuation it sought.  The best it can get is $1.7 trillion; the crown prince wanted $2.0 trillion.  At this price, the IPO will raise nearly $26 bn.  Dealers expect the stock to be available on Dec. 12th.  The kingdom is focusing its selling effort on wealthy Saudis and sovereign wealth funds, including China and Russia.

Korea:  The U.S. and South Korea have postponed military drills in hopes of encouraging Pyongyang to enter talks.  It is not clear if this will be enough.

Brexit:  PM Johnson claims that all the current Tory candidates for MP back his exit plan.  He has also announced new corporate tax cuts.

Global Trade Flows:  The WTO said its September leading indicator of global trade flows improved slightly but still pointed to below-average growth, as improvements in export orders, container shipping and auto shipments were offset by weaker air freight and shipments of raw materials and electronic components.  The news is probably a slight positive for global stocks.

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