Daily Comment (September 4, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Back in session!  Summer’s over.  Today is all about the dollar, EM and oil.  Here is what we are watching:

Emerging markets: Emerging equities were mixed overnight, with China doing well but others not so much.  It’s looking like concerns are breaking into two broad categories.  The first is the fragile group.  These are nations that have borrowed in dollars and are vulnerable to dollar strength and rising U.S. interest rates.  Argentina and Turkey are the prime examples of countries that will struggle to avoid default or restructuring.  The second category includes those nations that are dependent on the U.S.-supported global trade structure; China and India are two examples of this group.  The first group is most vulnerable to tightening monetary conditions in the U.S.  The second group is being influenced by the Trump administration’s trade policies.  If this analysis is correct, the first group will remain under pressure until we see signs that the FOMC is nearly finished with tightening.  The second group may benefit if there is a change of control in Congress in November.  For the time being, there doesn’t appear to be immediate relief on the horizon.  The administration is poised to implement $200 bn of sanctions on Chinese goods by Thursday.  Recent trade actions are already affecting global supply chains.[1]  Argentina has released an austerity program.[2]  We view it as a first step in stabilizing the currency.  Turkey is also hinting at raising rates.[3]

The dollar: Continued trade friction and Fed tightening are boosting the dollar this morning.[4]  The U.S. and Canada were unable to agree on a renegotiation of NAFTA last week but talks do continue.[5]  President Trump, in an interview with Bloomberg, made off-the-record comments that made their way into Canadian media.  Essentially, the president indicated that Canada would have no choice but to accept the agreement made with Mexico.  As we noted last week, this puts PM Trudeau in an impossible position and, predictably, the Canadians balked.  The problem for the White House is that NAFTA is a treaty and Congress has input.  Already, we are hearing that Congress may force negotiators to keep Canada in the agreement.  U.S. labor leaders are pushing to maintain the pact in its current form.[6]  Simply put, Congress may trim the degree of changes the White House can make to the treaty and get it passed.  Dollar strength is weighing on most commodities this morning, including gold.  Oil, as noted below, has bucked the trend.

Oil and Gordon: As noted below, TS Gordon has formed and is moving into the Gulf of Mexico.  Oil rigs have been evacuated,[7] although some production will be maintained as many of the facilities have automated systems that will keep oil flowing until wind speeds reach certain levels.  Such storms will disrupt imports and thus could lead to a reduction in inventory levels over the next couple of weeks.  In addition to Gordon, expectations of tightening sanctions are already affecting Iranian oil flows.  Concerns over Iran have been supportive for oil prices and the tropical storm has simply added to supply concerns.

Pound down:Worries about a hard Brexit are hitting the GBP.  PM May has tried to weave a policy that will meet the goals of the “leavers” but keep enough ties to the EU so as not to harm the economy.  Unfortunately, this policy has managed to please neither side and is raising worries that the May government won’t be able to recommend a coherent policy for leaving.[8]  If no plan emerges, we will likely see further weakness in the U.K. currency.

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[1] https://www.ft.com/content/03e4f016-aa9a-11e8-94bd-cba20d67390c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[2] https://www.ft.com/content/402a9d1a-af80-11e8-8d14-6f049d06439c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56

[3] https://www.ft.com/content/50dbd284-af47-11e8-8d14-6f049d06439c

[4] https://www.reuters.com/article/us-global-forex/trade-and-emerging-market-worries-keep-dollar-near-one-week-high-idUSKCN1LJ02Z

[5] https://www.nytimes.com/2018/08/31/business/us-canada-nafta.html?rref=collection/sectioncollection/business&action=click&contentCollection=business&region=rank&module=package&version=highlights&contentPlacement=5&pgtype=sectionfront

[6] https://www.politico.com/story/2018/09/03/trump-nafta-labor-unions-806291 and https://www.politico.com/story/2018/09/02/trumka-trump-union-labor-day-806115 and https://www.wsj.com/articles/union-leader-says-a-new-nafta-wont-work-without-canada-1535903570

[7] https://www.reuters.com/article/us-global-oil/u-s-oil-prices-rise-as-gulf-platforms-shut-ahead-of-hurricane-idUSKCN1LK028

[8] https://www.ft.com/content/1f3a606c-af6d-11e8-8d14-6f049d06439c?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56