Daily Comment (September 21, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT]  Happy Friday!  Equities are up as the dollar softens and Treasury yields are higher.  Here is what we are watching today:

More on Brexit: Well, that was ugly…the British press is describing the Salzburg conference as a “humiliation” and a “disaster.”[1]  In a somewhat unexpected move, the EU forcefully told PM May that her Chequers plan was a non-starter.  Instead, the EU leadership has given May an ultimatum—either come up with a plan for the Irish border or talks are over.  To reiterate, the Irish problem is this: without a deal, a hard border will form on the Ireland/Northern Ireland frontier.[2]  A hard border will undermine the peace deal between the two nations that has been in place for years now and has been very successful.  The EU plan was to keep Northern Ireland within the EU trade platform and put the border, effectively, in the Irish Sea.  May has rejected that plan, rightfully arguing that such an outcome would essentially mean losing sovereignty over Northern Ireland.  May was ultimately angling for the same trade rules for Northern Ireland to be applied to all of the U.K.  If the Northern Ireland border remained open and in the EU trading platform, and the U.K. remained as well, then Britain would get all the benefits of EU membership without the costs, such as free movement within the EU.  Not surprisingly, this outcome, as we see today, wasn’t acceptable to the EU.[3]  The EU leadership has given May four weeks to come up with a new plan.[4]  Of course, complicating this situation is that the Tories hold their party conference from September 30 to October 3 and, given the debacle in Salzburg, May looks weak and vulnerable.  On the other hand, a collapse of May’s government could lead to new elections in the U.K. and the potential for a Labour government led by Jeremy Corbyn.   However, it should be noted that another solution may be developing.  If May is unable to deliver a deal there could be a second referendum[5] which might lead to a reversal of Brexit.  No deal would be profoundly bearish for the GBP, while a decision to remain would likely lead to a strong rally in the currency.  Roughly, a no-deal outcome would likely lead to $1.100 and a new vote to stay would take us to parity at $1.650.  We note the GBP is coming under pressure this morning in the wake of these developments.

Turkey: Turkey has offered a new plan to support the lira.[6]  The primary component is an austerity program which will cut spending by $10 bn.  Although the plan was welcomed, the general belief was that it didn’t go far enough to show how the financial system will be supported as the country tries to deal with rising debt service costs.  Still, this plan is evidence that the Erdogan government is aware it has a problem and is trying to stabilize the situation.

OPEC meeting: OPEC is meeting this weekend in Algeria, but there is little chance the cartel will agree to a production increase.[7]  Iran has already indicated it will veto any plan to boost supplies.  To some extent, OPEC is becoming moot; the oil market is now being controlled by supply decisions in the U.S., Russia and Saudi Arabia.  We don’t expect sharp supply increases from the major producers so oil should remain well supported.

No NAFTA deal yet:[8]Although negotiations continue between the U.S. and Canada, no agreement has been reached.  The key sticking point is auto tariffs; Canada wants guarantees that the U.S. won’t put tariffs on cars.  The U.S. essentially wants Canada to simply accept the deal the U.S. has already made with Mexico.  We still think odds favor a deal, but the longer negotiations extend, the less confidence one should have in that assessment.

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[1] https://www.theguardian.com/politics/2018/sep/21/humiliation-and-disaster-how-uk-press-covered-theresa-may-salzburg-ordeal

[2] https://www.ft.com/content/f18fda2e-bc0b-11e8-94b2-17176fbf93f5

[3] https://www.ft.com/content/e9077124-bcf0-11e8-94b2-17176fbf93f5?emailId=5ba47c4dd8eae600046ed7c5&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[4] https://www.ft.com/content/95466282-bcde-11e8-8274-55b72926558f?emailId=5ba47c4dd8eae600046ed7c5&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22

[5] https://www.ft.com/content/84b953d2-bccc-11e8-94b2-17176fbf93f5?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[6] https://www.ft.com/content/172f23cc-bcb4-11e8-8274-55b72926558f?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[7] https://www.reuters.com/article/us-oil-opec-algeria/opec-unlikely-to-agree-official-output-increase-in-algeria-but-pressure-mounts-idUSKCN1M01Q7

[8] https://www.reuters.com/article/us-trade-nafta/nafta-deal-not-yet-in-sight-canada-stands-firm-on-auto-tariffs-idUSKCN1M030Z?feedType=RSS&feedName=topNews