Daily Comment (November 22, 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 Friday! It’s a slow news day this morning. Financial markets are rather calm. We cover the global PMI data in the foreign section. Here is what caught our attention this morning:
Watching Corbyn: For the upcoming U.K. elections, Labour leader Corbyn unveiled his party’s policy manifesto. The policy proposals are a clear rejection of Tony Blair (and Bill Clinton’s) “third way” of center-left politics. Instead, it is being billed as a return to the 1970s; we would suggest that characterization isn’t radical enough. It would be more like the massive shift in the U.K. economy that occurred after WWII, with sweeping nationalization and much higher taxes on upper income earners. Sometimes the U.K. acts as a leading, or perhaps coincident, indicator of U.S. political trends; for example, Margaret Thatcher preceded Ronald Reagan by about a year and Tony Blair was a contemporary of Bill Clinton. The Brexit issue reflects rising populism in the U.S. One of the key questions for the 2020 election is whether a center-left or a populist-left candidate represents stronger opposition to a right-wing populist incumbent. If Corbyn does poorly in next month’s election, the Democratic Party leadership might conclude that the populist wing isn’t the right path to take. Thus, there may be an imbedded lesson for our election in the upcoming British poll.
China trade: We are hearing both Presidents Xi and Trump saying that a trade deal remains possible. Given the length of time that this phase one deal has taken, we are worried that we may see a “buy rumor, sell fact” action in the markets even if a deal is made.
A cautionary tale: Although the U.S. health care system is littered with flaws, the tort bar, for all its extremes, does act as a threat to poor medical practices. Under a single payer system, we doubt the government would tolerate such annoyances. A report from the U.K. suggests that a single payer system has its own issues as well.
The EU trade issue: The U.S. has quietly allowed the auto tariff deadline to pass. This has led to speculation that the Europeans are out of the woods. Apparently, that’s not the case. The White House is apparently considering a broader case against the EU. If the U.S. decides to pursue this path, we could see continued financial market turmoil; such a move would be negative for risk assets.
Hong Kong: The territory will hold local council elections on Sunday. These are usually minor affairs with the focus on local issues (noise control, rubbish pickup, etc.) Currently, these seats are dominated by mainstream supporters of the mainland. However, the pro-democracy movement is fielding a large number of candidates, turning the vote into a referendum of sorts on the protest movement. The president has not signed the recent Hong Kong bill. Tokyo and Singapore are trying to lure Hong Kong’s finance industry away from China.
ECB: Christine Legarde gave her first policy speech yesterday and pressed governments to boost investment spending. In some respects, this is an old tune. Finding profitable public, or private investment is difficult. It may be harder to find public investments in a developed economy that actually lifts productivity. However, there is an important embedded signal in this speech; monetary policy may be exhausted and if further stimulus is going to occur, it probably has to come from the fiscal side. Moving the Eurozone this direction will take all of Legarde’s ample political skills. Germany continues to view balanced budgets as a moral imperative and until this view changes, getting increased fiscal spending will be next to impossible.
A tariff twist: There has been much written about who pays the tariffs. The economic term for who pays the tax is called “incidence.” Often, it’s not as simple as it seems. For example, most people believe the payroll tax is shared between the worker and the firm but that’s not usually the case. Most of the time, the worker pays both sides, not just what he sees on his pay stub, because the firm reduces his pay for part, or all the employer portion of the tax depending on labor market conditions. In other words, in the absence of the payroll tax, wages would likely be higher. For tariffs, the incidence is even more difficult to discern. If the foreign firm is determined to maintain market share and faces a price inelastic demand curve, the foreign firm reduces the tariffed item’s price to offset the tax. However, if the foreign firm faces a price elastic demand curve, the tariff may be absorbed by domestic producers, or in higher prices to consumers.
There is anecdotal evidence that some firms are using market power to force the tariff adjustment on smaller firms. Larger firms are informing suppliers that they won’t tolerate a price increase and thus the smaller supplier is forced to absorb the incidence of the tariff.
Central bank independence: Judy Shelton, a nominee for Fed Governor, is suggesting that central bank independence isn’t sacrosanct. Although this stance is a reversal from commonly held beliefs since the 1970s, in fact, central bank independence does ebb and flow. During the 1930s into the early 1950s, the Fed got its rate policy from the Treasury to facilitate the latter’s borrowing program. If we are heading into a period of reflation, weakening central bank independence is an element to that project. So, Shelton’s nomination to the Fed should not come as a surprise.
Global financial markets: Managers at the massive hedge fund Bridgewater Associates have reportedly bought $1.5 billion worth of puts on the S&P 500 and Euro Stoxx 50, in a bet that the U.S. and/or European markets could fall significantly by next March. Our analysis suggests there is indeed a heightened risk of recession later in 2020. If so, we think that would imply the equity markets might start falling around mid-year.
Colombia: Hundreds of thousands of demonstrators marched through Bogotá and other cities yesterday to protest corruption, insecurity, and inequality, but it appears the government was able to keep them better controlled and less violent than the protests in places like Hong Kong and Chile. The youthful protests around the world are acting like a contagion, with activity in one country inspiring demonstrations elsewhere, but Colombia’s experience suggests governments could minimize the impact through good preparation and tightened security ahead of the protests. For example, the Colombian government mobilized 170,000 military and police personnel ahead of the demonstrations, shut its border, and imposed a curfew in at least one major city.
Bolivia: To end the political violence since former President Morales was forced from office for allegedly rigging his October 20 reelection, interim President Añez presented a draft law to annul that vote, call a new election, and name a new electoral board to oversee it. The actual date of the new election would depend on when the bill is passed into law.
Odds and ends: Speaker Pelosi is indicating that it is unlikely the North American trade deal will make it through Congress this year, although talks are continuing. Part of the problem is that there are other items (impeachment, budget) that are distracting from this issue. Speaking of the budget, the Senate passed the House spending bill which should avert a near term budget problem. However, this issue will return next month. In an abrupt about face, South Korea has decided it will continue to share intelligence with the U.S. and Japan. Increasing tensions between Japan and South Korea raised doubts the intelligence sharing would continue.