Daily Comment (September 18, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Good morning and G’mar Hatima Tova this Yom Kippur, the Day of Atonement.  Equities are ticking higher this morning and oil is up strongly.  Here is what we are watching today:

Trade: As expected, the White House did put new tariffs in place on China.  The initial act affects $200 bn of goods[1] at a 10% rate.  If nothing changes, that rate will rise to 25% at year’s end.  China has just announced that it will apply new tariffs to $60 bn of U.S. goods—we have no details at this time.  That puts China’s tariffs at $120 bn of U.S imports, which is 92% of U.S. exports to China.  Equity markets are taking this news in stride; there are a couple of reasons for the lack of reaction.  First, this move was well telegraphed, and it should be noted that the announcement was not as draconian as it could have been.  For example, various goods were excluded, including child safety devices and some consumer electronics.  This shows some degree of sensitivity from Washington.  And, starting at 10% offers hope that this announcement is an opening of negotiations.  Now that China has sanctioned just about all U.S. imports, we will be watching for additional measures.  There is some speculation that China may try to affect supply chains[2] along with other measures.[3]  If China were to take these steps, it would represent a major escalation of the trade conflict.  It is still difficult to tell whether the president is really just trying to bring Xi to negotiations and is creating conditions to improve the U.S. position or if this is really all about containing China and there is nothing to discuss.  If the latter is the real goal, conditions will deteriorate.  But, if the former is the goal, the situation will improve.  Currently, the financial markets seem to be leaning toward the former outcome.

Good news and bad news from Syria: In a recent WGR,[4] we discussed the situation in Idlib, the current focus of the conflict in Syria.  There have been a couple of important new developments.  First, Russia and Turkey have announced the creation of a demilitarized zone (DMZ) in Idlib.[5]  Details are sketchy at this point.  It isn’t exactly clear what area the DMZ will cover and there is no evidence that Assad has agreed to the proposal.  But, the mere fact that Russia and Turkey are trying to prevent a catastrophe is a welcome development.  Second, the bad news is that a Russian reconnaissance plane, an Il-20, was accidently shot down by Syrian anti-aircraft defenses (supplied, ironically, by Russia, an S-200[6] system).  The Syrians were under attack by Israeli air assets and were responding when the incident occurred.[7]  Although there are always concerns of escalation after incidents such as these, we doubt the Russians will intensify the issue with Israel.  Russia, in attempting to play the superpower role in the region, is trying to balance the interests of Syria, Turkey, Israel and Iran.  Even casual observation makes it clear that managing these interests will be next to impossible (welcome to our world, Vlad!).  We suspect Russia’s solution will look much like America’s, which was to simply keep the groups separate.  However, now that borders in the region have become fluid, this may be impossible.  Unfortunately, Russia does not have the military or economic means to actually pacify the region.  And, the U.S. can play the role of spoiler by supporting Israel’s power projection.  Still, at least for today, the good news is probably more important than the bad.

The Kingdom undermines Trump: Saudi Arabia indicated today that it is “comfortable”[8] with oil prices higher than $80 for Brent, signaling to traders that breaking this level won’t trigger higher oil flows.  President Trump has been critical of OPEC and the Saudis for lifting oil prices, calling for lower oil prices and greater supply.  Although the president has plenty of distractions, we will be watching for a response, which could include an SPR withdrawal.  In addition, there is growing evidence that the proposed sanctions on Iran are reducing Iran’s oil flows.[9]  Despite lots of rhetoric about avoiding sanctions and jettisoning the dollar, in the end, the dollar’s reserve role remains in place and most nations are either ending or reducing oil imports from Iran.  The Saudi comments and Iran’s reduced flows are boosting oil this morning.

Japan war games:Japan conducted naval exercises[10] last week and what is notable is that it involved a submarine along with three destroyers.  The vessels were practicing anti-submarine tactics and conducted the games in the South China Sea before making a port of call at Cam Ranh Bay in Vietnam.  China’s response, thus far, has been unusually mild, which may reflect the fact that China and Japan have been holding high-level talks in light of concerns from both nations about U.S. trade policy.  Japan’s military action does suggest that the Abe government does not feel secure with regard to China’s territorial ambitions and is sending a signal that, despite a pacifist constitution, it is actually a potent military power.

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[1] https://www.politico.eu/article/trump-to-slap-tariffs-on-200b-more-chinese-goods/?utm_source=POLITICO.EU&utm_campaign=2094c1a441-EMAIL_CAMPAIGN_2018_09_18_04_42&utm_medium=email&utm_term=0_10959edeb5-2094c1a441-190334489 ; https://www.nytimes.com/2018/09/17/us/politics/trump-china-tariffs-trade.html?emc=edit_mbe_20180918&nl=morning-briefing-europe&nlid=567726720180918&te=1 ; and https://www.ft.com/content/a88cec7e-babf-11e8-94b2-17176fbf93f5?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[2] https://www.cnbc.com/2018/09/17/the-associated-press-chinese-official-beijing-should-target-goods-needed-by-us.html?wpisrc=nl_todayworld&wpmm=1

[3] https://www.ft.com/content/4bacf050-7396-11e8-aa31-31da4279a601

[4] See WGR, The Battle for Idlib (9/10/18).

[5] https://www.nytimes.com/2018/09/17/world/middleeast/idlib-syria-russia-turkey.html?emc=edit_mbe_20180918&nl=morning-briefing-europe&nlid=567726720180918&te=1 and https://www.washingtonpost.com/world/turkey-and-russia-agree-on-de-militarized-zone-in-syrias-last-rebel-held-enclave/2018/09/17/f37e76dc-b6ad-11e8-ae4f-2c1439c96d79_story.html?utm_term=.bd38b52c1d51&wpisrc=nl_todayworld&wpmm=1

[6] https://missilethreat.csis.org/defsys/s-200-sa-5-gammon/

[7] https://www.bloomberg.com/news/articles/2018-09-18/russia-says-military-plane-lost-during-israeli-attack-on-syria

[8] https://www.marketwatch.com/story/oil-rallies-as-saudi-arabia-said-to-grow-comfortable-with-crude-above-80-a-barrel-2018-09-18

[9] https://www.livemint.com/Politics/ctuzaEXF5PrAAfAufnFmDK/In-big-win-for-Trump-US-sanctions-cripple-Iranian-oil-expor.html

[10] https://www.ft.com/content/708a5af8-ba62-11e8-94b2-17176fbf93f5?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56