Daily Comment (November 20, 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.

It’s a risk-off morning at mid-week.  There are three items of note in the overnight news.  First, the Senate has passed the Hong Kong democracy bill.  Second, the debate between Johnson and Corbyn was mostly a draw.  Third, the Fed minutes are out today.  Here are the details.

Gaming out the Hong Kong democracy bill:  The Senate, in a rare example of bipartisanship, voted unanimously to pass its version of the Hong Kong democracy bill.  The bill would require the secretary of state to annually certify that Hong Kong remained sufficiently independent to warrant its special status as a global financial hub.  It would also allow the president to place sanctions on individuals who have been deemed to have suppressed human rights in Hong Kong.  A similar set of legislation passed the House unanimously in October.  There are some differences between the two versions, but with such strong support in the legislature, it is highly likely that a single version will emerge soon from the conference committee.  China has already condemned the action and is urging the White House to veto the bill.

This legislation complicates the trade situation with China.  Even with a veto, given the strong support in both houses, the president would be forced to spend prodigious levels of political capital to prevent an override.  Although China might view a heroic but failed effort as good enough to maintain progress on trade, more likely the Xi regime will view the bill as an affront to its sovereignty and that would be enough to end negotiations.  In addition, the president has to be careful with overt support for China.  As we have noted before, Bill Clinton used the Bush administration’s reaction to Tiananmen Square against the president in the 1992 campaign.  Protecting China would be used against the president in the 2020 campaign.  On the other hand, if phase one of the trade deal fails, financial markets will not take it well and that will also be a negative for the upcoming election.  President Trump reiterated that he will raise tariffs if China doesn’t make a deal with the U.S., suggesting he believes his bargaining position is stronger than Beijing’s.  At the same time, China continues to press for a rollback in tariffs, which may signal that Beijing believes it holds the upper hand.  Equities have made new highs, in part, based on expectations of a modest trade agreement.  If the deal fails, it would be reasonable to expect at least a return to the low end of the channel the S&P has been trading in for nearly the past two years.

In other China news, Beijing is arguing that the recent Hong Kong court decision to overrule the government’s ban on protestor masks was illegal.  Essentially, the PRC is arguing that such decisions are for Beijing to make.  Such heavy handed responses make it difficult for the U.S. to argue that Hong Kong deserves its special status.

Brexit:  PM Johnson and Labour leader Corbyn squared off in a televised debate last night.  Overall, the debate was best characterized as a draw, which paradoxically was probably a bit better for Corbyn.  Although the Labour leader needed a big win to reverse his polling deficit, he did make a good showing and prevented Johnson from pressing his advantage.  At the same time, debates for front runners is always fraught with risk.  It gives a lagging opposition a chance.  Johnson avoided major gaffes (which he is prone to making), so overall, the debate probably doesn’t undermine his chances.  The election remains the key short-term risk to Britain’s financial markets, especially the GBP.

The Fed:  The Fed will release the minutes of its most recent meeting.  Although the notes are heavily sanitized, they should offer some insight into the level of dissention on the FOMC.  In 2024, we will get the full transcripts of this year’s meetings.  It will be fascinating to see just how divided this Fed is.  The higher the level of dissention, the greater the hurdle to future easing.

The PBOC:  China’s banks are following the PBOC’s lead; the latter cut the Loan Prime Rate earlier this week and banks are cutting lending rates by a similar amount.  All indications are that the PBOC will become more aggressive in the coming months to offset a decelerating economy.

The rise of MMT: As we have hinted in the past, it appears Modern Monetary Theory (MMT) is becoming the most relevant alternative to orthodox economic thinking. Later today two expert witnesses, Randall Wray and Olivier Blanchard, are expected to testify before the House Budget Committee. The focus of the discussion will be on whether widening budget deficits have an adverse impact on the economy; in which MMT would argue only if it leads to inflation.  The impact on these hearings reflects a growing desire to increase deficits to boost growth. Over the past ten years economic growth in the U.S. has averaged just a little over 2%. In addition, traditional theories that hold that widening deficits leads to higher inflation have been somewhat unfounded during this expansion. Currently, the fiscal deficit is approaching $1 trillion for the first time since the financial crisis, while inflation as determined by the Personal Consumption Expenditure (PCE) still remains well below the Federal Reserve’s inflation target of 2%. As plans such as Medicare-for-all and the Green New Deal become more prevalent in policy discussions, we expect MMTers to grow in prominence.[1]

Odds and ends:  Shinzo Abe is now, officially, the longest serving PM in Japanese history.  The House has passed a short-term spending bill, increasing the odds that a shutdown will be averted in the near term.  The U.S. has arrested one of the foremost authorities on money laundering on—wait for it—money laundering.

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[1] For a guide to MMT, see here, here, here and here.