Daily Comment (November 26, 2019)

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

[Posted: 9:30 AM EST]

It’s very quiet this morning.  (N.B.  The Wednesday report will be the last one for this week; have a great Thanksgiving.)  Chair Powell gave an upbeat speech.  Trade negotiations continue.  Chairman Xi is having a rough time lately.   There was a major art heist in Germany.  Here are the details:

Powell speaks:  Chair Powell gave a speech to the Providence Rhode Island Chamber of Commerce yesterday.  The content was generally upbeat. Although he did hint that the central bank had overestimated the strength of the economy earlier in the year, the recent cuts are designed to extend the current expansion.  He also noted that the Fed was committed to bringing 2% core PCE inflation, which would require continued easy policy.  Overall, there wasn’t a whole lot of new information in the speech, but it does confirm that the bias of policy is to lower rates but, for now, policy should remain stable.

Trade:  Although we remain somewhat doubtful that a material deal will be struck with China, the two sides are continuing to talkChina is signaling it thinks an agreement will be reached.  Why our doubts?  First, both sides seem to continue to believe the other side needs a deal more, a condition conducive to miscalculation.  Second, the underlying positions are hardening.  Liu He, China’s lead trade negotiator, said earlier this week that the Xi government wants a “stronger, better and bigger” state economy.  The influence of the state on China’s economy is one of the primary concerns of the U.S.  Subsidies from the state are seen as unfair competition.  On the U.S. side, the Voice of America and Radio Free Asia have joined forces to create a new service called “Global Mandarin,” a development that will likely not sit well with Beijing.  We may get an interim arrangement.  It may temporarily slow the deterioration of relations.  However, over time, the strategic competition will continue to fester.

In other trade news, there is apparently progress on USMCA.  Global trade data from the CPB World Trade Monitor indicate that activity fell 1.3% in September from August.  A recent economic paper concludes that the incidence of the China/U.S. tariffs is mostly falling on company profit margins.  China’s CNY depreciation didn’t offset the tariffs and companies have not shifted the costs of the tariffs to retail.  The key unknown is if this condition will continue indefinitely.

Chairman Xi’s, no good, very bad week:  As we noted yesterday, local elections in Hong Kong were a landslide victory for pro-democracy parties.  The fallout from this political event is now starting to develop.  First, Beijing was certain that the vote would support its favored candidates, so much so that reports suggest they already had their “victory” narratives in place and didn’t even consider a loss.  This is one of the problems with elections for authoritarian regimes; sometimes, voters surprise the leadership.  Beijing seemed to believe that the silent majority of Hong Kong citizens viewed the protestors as destructive and thus would vote for stability.  Most likely, this was the message Carrie Lam was telling her minders.  Now, Chairman Xi has a dilemma.  If he wants conditions to calm in Hong Kong, he likely needs to give the pro-democracy movement a “bone”; he needs to give some level of political reform.  However, allowing a vote on leaders is not the direction the CPC wants to go, and we expect Beijing to reject such a notion.  There are reports the CPC has set up a new monitoring body for Hong Kong, evading the established liaison office.  This new body is likely in response to what Beijing sees as the official group’s inability to send reliable information to the CPC leadership.  Reliable information is always a problem for authoritarian regimes; local officials have an incentive to spin positive narratives and thus, surprises such as the Hong Kong protests can emerge.  One of the features of democracy is that the vote becomes a form of reliable information.  Of course, the leadership has to be open to hearing it; the current narrative out of the CPC is that foreign intervention is the cause for the unrest.

The Hong Kong vote isn’t the only headache affecting Chairman Xi.  There are reports a Chinese spy has defected to Australian authorities, and is telling tales of interference in Hong Kong and Taiwan.  The CPC is attempting to discredit the alleged spy, but the defection is a problem for China.

In other China news, the PBOC issued a warning that rising household debt is creating economic risks and will demand a policy response.  Investors are already skittish about China’s corporate and local-government debt, so they won’t want to hear about another debt problem.  They also won’t want to hear about a potential clampdown on mortgage, or consumption lending when the Chinese economy is already in a secular slowdown and is struggling with the U.S.-China trade war to boot.  The news is therefore negative for Chinese stocks.

Russia-Ukraine-European Union:  Russian President Putin and Ukrainian President Zelensky talked by telephone yesterday to discuss a new deal allowing Russian natural gas to pass through Ukrainian pipelines for delivery to the EU.  The current deal expires January 1, and EU-mediated talks for a new contract are expected to start next week.  The aim of the talks is to avoid disruptive gas shortages like those caused by Russian-Ukrainian disputes in 2006 and 2009.

Odds and ends:  The U.S. and Australia are working together to build supplies of non-Chinese rare earths.  Although climate change remains a divisive political topic, there is one area where there appears to be little doubt of its occurrence, the insurance industry.   Property insurers are lifting premiums for areas subject to specific weather events, e.g., tornadoes on the central plains, but are also simply refusing to ensure areas prone to wildfires.  China issued $6.0 bn of sovereign bonds denominated in dollars; the auction was oversubscribed by more than 3x and the amount was a new record for China’s dollar issuance.

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