Daily Comment (October 9, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s another risk-off day; we did see U.S. equities recover yesterday into the close but the futures are indicating a lower opening.  Here is what we are following:

China: There has been speculation that President Trump and Chairman Xi would meet at next month’s G-20 summit, but the White House has indicated the U.S. won’t engage with China unless it brings a detailed list of concessions.[1]  China has responded by saying it does have a list but won’t present it without assurance of a “stable political climate in Washington,”[2] which we take to mean as a single voice on Chinese trade policy.  There have been multiple voices on trade policy, from the relatively dovish positions of Treasury Secretary Mnuchin to the more hardline positions of Lighthizer and Navarro.  But, what has likely spawned the condition for a single point person was a recent speech by VP Pence which seemed to signal a break point in relations.  Up until now, American presidents tolerated unhelpful behavior from China (e.g., forced technology transfers, large current account surpluses, informal trade impediments) with the belief that, eventually, China would follow the path of other Asian authoritarian regimes and democratize.  The Pence speech seems to suggest that this isn’t going to happen and the U.S. is prepared to treat China as a hostile power.[3]

We are rapidly breaking new ground here at a time when MSCI is considering boosting China’s weighting in the emerging market indices.[4]  If tensions continue to rise, index investing could become a problem.  We do note that China is taking steps to offset these tensions.  Yesterday, we noted the reduction in bank reserve requirements.  There are reports in China’s media today calling for strong stimulus measures to boost growth.[5]  Overall, we have two significant cross-currents—U.S. pressure and domestic stimulus.  In the short run, the latter is probably more important.  Increased Chinese stimulus could boost commodity demand but only if the CNY doesn’t markedly weaken.

IMF downgrade: The IMF, in its biannual update on the world economy, lowered its global GDP growth projections by 0.2% to 3.7% for this year and next.[6]  The body cites tariff concerns and emerging market weakness as reasons for the downgrade.[7]  The IMF did say it would boost its forecast if the trade dispute between the U.S. and China is resolved.

Oil prices:Oil prices have lifted as Hurricane Michael has evolved into a rather significant storm.  Energy companies have been evacuating staff from offshore oil platforms, which will reduce U.S. production by 0.3 mbpd (out of 11.1 mbpd).  Perhaps more importantly, although the key energy region between Houston and the Mississippi Delta will be mostly spared, the storm will disrupt oil imports.  The Louisiana Offshore Oil Port (LOOP) should not be directly affected by the storm but tankers will probably not be able to access the LOOP for a couple of days simply due to the presence of the storm.

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[1] https://www.ft.com/content/6f1bd226-cb67-11e8-b276-b9069bde0956

[2] ibid

[3] https://www.wsj.com/articles/the-deeper-meaning-of-pences-china-broadside-1539010010

[4] https://www.bloomberg.com/news/articles/2018-09-25/msci-considers-boosting-china-a-share-weighting-adding-chinext

[5] https://www.reuters.com/article/us-china-economy-policies/china-must-take-strong-stimulus-measures-to-support-growth-state-media-idUSKCN1MJ07H

[6] https://www.ft.com/content/9d03bef0-cb0e-11e8-b276-b9069bde0956?emailId=5bbc31cd953e44000494e4a2&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[7] https://www.reuters.com/article/us-imf-worldbank-outlook/imf-cuts-world-economic-growth-forecasts-as-import-tariffs-emerging-market-issues-bite-idUSKCN1MJ025