Daily Comment (September 27, 2016)

by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] The first presidential debate was held last night and Sen. Clinton won by nearly all accounts.  She was, as expected, well prepared.  Potentially dangerous areas for her, such as the ongoing e-mail scandal and the Clinton Foundation, were not heavily covered.  Much time was spent on Trump’s tax returns; it does make one wonder what could possibly be in them that he does not want the world to see, because the cost of keeping them hidden appears to be very high.  As is typical of Mr. Trump, he suggested there was something “faulty” with his microphone that accounted for his problems.  In our research on his personality, he usually either wins or there is an exogenous reason for his apparent loss.  In reality, it appeared to us that Mrs. Clinton was successfully able to bait Trump into spending much time on his tax returns and his treatment of women.  And, most of Mr. Trump’s responses seemed to be a strange mix of word association, the kind of responses that one notices when teaching and a student answers a question with generalities, hoping that he says enough of the right words to get a pass at a right answer.

His response to the nuclear policy of “first use” was a good example.  He started his answer by seeming to suggest he would never use nuclear weapons first, which would be a monumental change in U.S. nuclear weapons policy.  First use allows NATO and the U.S. to respond with nuclear weapons if faced with a conventional attack.  Giving up first use would essentially restrict the use of nuclear weapons to only a response against a similar attack.  Later in his answer, he signaled that he would always want to keep his options open.  About the only conclusion we could draw was that he didn’t really understand the policy of first use and so he was “winging it.”  If our analysis is correct, he was simply unprepared for this debate.  The New Yorker recently quoted Trump as saying, “The day I realized it can be smart to be shallow was, for me, a deep experience.”  In the same piece, Trump is quoted as saying that others “…are surprised by how quickly I make big decisions, but I’ve learned to trust my instincts and not to overthink things.”[1]  These characteristics were evident last night.

The markets’ verdict was clear—Mrs. Clinton won.  The Mexican peso (MXN) has been very sensitive to the likelihood of a Trump win, weakening as he has been rising in the polls.   The currency’s performance last night was clear.

(Source: Bloomberg)

This is a three-day chart of the MXN/USD exchange rate on an inverted scale.  As Trump stumbled in the debate, the currency rallied strongly.

At the same time, it’s important not to read too much into this.  The Brexit vote showed that the establishment is a minority and even if the educated top 30% of the income scale saw Trump as unfit for office, that doesn’t mean he didn’t reach the lower 70%.

It should be noted, however, that the debate may not be decisive.  For voters who support Trump, he said all the right things about trade and the opportunity for political disruption.  Those who support Clinton heard what they needed to hear as well.  Among the potential undecideds, we have always suggested that the key voters are the disaffected Sanders voters.  We believe that there was nothing in yesterday’s debate that probably changed their minds.  Clinton came across as the status quo candidate; voting for her is simply a continuation of the last eight years.  Trump probably did nothing to make this group of voters feel comfortable about voting for him.  Thus, disillusioned Sanders supporters are still stuck with (a) voting for a third-party candidate, or (b) staying home.  We still contend the election rests with the Sanders voters and nothing about that changed last night.  We will be watching the polls in the coming days to see if anything decisive emerges but we would not expect such a change.  Trump would have liked to perform better and he will likely be better prepared for the next debate.

In other news, the OPEC meeting looks doomed to fail.  Iran came out today and said it has no plans to freeze its output.  This seemed to us to be a long shot all along, but the Saudi proposal will at least allow them to blame Iran for the failure of talks.  We note that Saudi Arabia has announced it will cut government worker pay by at least 20%, reduce perks and limit overtime as well.  Housing stipends were cut by 15% and vacations were capped at 30 days.  A hiring freeze was announced.  This news will be a shock for a protected class of worker that should have influence as more than two-thirds of all employed Saudis work in civil service.  This is a very dangerous announcement for the House of Saud.  The social contract in the kingdom is that the people have no say in how the government is run and the government provides a cushy life for its citizens.  Drastic cuts in pay could raise calls for greater participation in government.  We will be surprised if King Salman can push through these changes without civil unrest.

Finally, Venezuela is floating the idea of a debt swap; around $5.0 bn of PDVSA debt is coming due over the next two months and an additional $2.0 bn over the next year.  The state oil company is in discussions with bond holders to suggest a bond swap, trading current bonds for ones that mature in 2020.  We note that S&P is suggesting it will probably treat such a swap as a default.  There is some concern that the new bonds will pledge the Citgo assets as collateral and these have been promised on other bonds already.  Venezuela is skidding toward full default and this might be the opening salvo toward that end.

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[1] Osnos, E. (2016, September 26). Letter From Washington: President Trump. The New Yorker.