Daily Comment (September 20, 2019)
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT]
Global equity markets are generally higher this morning. The EuroStoxx 50 is up 0.4% from the last close. In Asia, the MSCI Asia Apex 50 closed up 0.1%. Chinese markets were higher, with the Shanghai composite up 0.2% and the Shenzhen index also up 0.2% from the prior close. U.S. equity index futures are signaling a higher open.
After a busy week, it’s been a quiet Friday so far. We wonder how history will deal with the end of Mayor de Blasio’s campaign. Here is what we are watching this morning:
Misjudging Trump: We have been getting questions from readers about U.S. Iran policy. So, here is our response. It is starting to look like Iran has concluded that President Trump is a bully who will back down when his bluff gets called. Yesterday, Iran’s foreign minister, Javad Zarif, suggested that a military attack on Iran would trigger “all-out war.” This is a clear and strong threat. Throughout its history since the Iranian Revolution, Iran has generally been cautious in foreign affairs. Although it underwrites audacious acts (e.g., bombing of U.S. troops in Beirut, Khobar Towers bombing in Saudi Arabia), these are usually carried out by proxies or in ways that provide plausible deniability. In the attack on the Saudi oil infrastructure, Iran tried to follow the same script, with the Houthis immediately taking responsibility. However, unless the Houthis are hanging out in southeastern Iran or southern Iraq, it probably wasn’t their doing and Iran had to know that it would be hard to maintain that ruse.
After the U.S. failed to respond militarily to the downing of a U.S. drone, the leadership of Iran appears to have concluded that the White House is reluctant to engage Iran militarily. The U.S. response to the attacks last weekend has done nothing to suggest this assumption is wrong. So far, the U.S. has responded to what is probably the most significant act against the Carter Doctrine since Iraq annexed Kuwait with sanctions and threats of a military buildup. This isn’t to say that sanctions haven’t been effective; they have had a major impact on the Iranian economy. But, between the harsh sanctions and the lack of a diplomatic path, Iran has decided to up the ante.
One of our “go-to” tools in analyzing foreign relations and the reactions of presidents is to use Mead’s Archetypes. Regular readers are familiar with the four major ones. We note that these are merely archetypes as no president is a pure reflection of any of the four but all lean toward one. So, here is how we think each archetype would react to last weekend’s events:
- Jeffersonian: A Jeffersonian president would be angry that the U.S. was still even in this part of the world, but since we are there we should talk to allies and formulate a response. Military action would be a reluctant and last resort. This president would not have responded to the drone downing.
- Wilsonian: The drone downing would have triggered a strong military response. This recent escalation would have led to an ordinance being already in the air. Although this type would try to avoid escalation, its actions usually end up leading to a broader conflict.
- Hamiltonian: Always a realist, a Hamiltonian president would be trying to pull out of the Middle East, concluding that China was the real issue and shale oil has made the extensive U.S. commitment to the region unnecessary. However, this president, faced with the problem at hand, would likely attempt to escalate carefully, bombing highly visible but mostly symbolic areas in Iran, e.g. old oil fields that are in decline, secondary industrial sites, etc. In other words, it would send a signal that the U.S. isn’t happy, but also trying to avoid hitting anything that would lead to escalation. This archetype would have attacked after the drone downing.
- Jacksonian: This response would have been identical to the Jeffersonian response. These two types are the most isolationist of the four. However, if honor is violated, the response is the most aggressive. So, what would this president react to? The spilling of American blood or the harming of innocents. The response to such events would likely be swift and disproportionate.
We characterize President Trump as Jacksonian. In WWII, Jacksonians were America First supporters…until Pearl Harbor. Then, they wanted to annihilate Japan and Germany. If Iran escalates further and an American is killed, or if Iran’s actions kill children, Trump will likely shift to aggression that is stronger than Tehran expects. However, as long as the escalation avoids these two outcomes, we expect Iran to increase its belligerence, and probably get away with it. As a result, oil markets are probably underestimating the level of risk.
Brexit: A thaw is developing. Although a deal is still a ways off, the two sides are clearly trying to come up with a way to reach an accommodation on the Irish border issue. We have seen the GBP rally on hopes of a deal. If an agreement is forged, we could see a much larger rally in the currency.
A deal of sorts with China: Our base position on China is that the U.S. has concluded Beijing is a strategic competitor that will not fold itself into the U.S.-led order. Because of this a slow decoupling and increased competition is in our future. However, that doesn’t mean an intermediate deal cannot be struck. We note the Trump administration has exempted a large number of Chinese goods from tariffs. U.S. agricultural interests are talking to China as well. These actions might lead to a limited deal that would improve market sentiment. At the same time, Michael Pillsbury, a Hudson Institute analyst and key informal advisor to President Trump, has warned the U.S. will dramatically ramp up pressure on China if a trade deal isn’t struck soon. Pillsbury characterized the current U.S. tariffs against China as “low” and warned they could go as high as 100%.
Monetary policy: The Fed has conducted open market operations for the fourth consecutive day. The PBOC cut its benchmark lending rate for the second straight month, but only by 5 bps to 4.20%. The BOJ, on the other hand, cut its purchases across the yield curve in an attempt to steepen it. We doubt the BOJ can continue this action for long without triggering a strengthening JPY.
India: Prime Minister Modi announced a surprise tax cut that will slash the effective corporate rate to 25.17% from the current 34.94%, putting it on par with many other fast-growing Asian countries. New manufacturing firms will face an even lower rate. Indian stocks are surging on the news, but Indian bonds are down on concerns about the fiscal deficit.
Russia: President Putin has again been forced to back down a bit with his political repression, as he faces strong public outcry over the police beating and jailing of aspiring actor Pavel Ustinov during a protest last month. The actor was released on bail today. Putin still has a strong grip on power, but popular discontent is rising and has the potential to destabilize the country.
Saudi Arabia: There are reports that the crown prince is “bullying” wealthy Saudi families into large purchases of the Aramco IPO to bolster the price. Such action is further evidence that the Salman family effectively is “taxing the rich.”