Daily Comment (July 16, 2019)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] It’s July!  The trading deadline looms in baseball and a few deals (two involving our beloved cross-state team) have already occurred.  Markets, on the other hand, are very quiet.  Here is what we are watching today:

The EU vote: The EU Commission presidency vote happens late today and the current candidate, German Defense Minister Ursula von der Leyen, is talking to various groups trying to cobble together enough votes to take office.  She needs 374 votes to win, but anything less than 400 will tend to reduce her mandate.  The vote is expected to be very close.  In her last speech before the vote, Ms. von der Leyen pledged to push through a new EU carbon tax and achieve carbon neutrality for the EU by 2050.  She also backed EU-wide unemployment insurance and promised to punish international technology firms that “play” the EU tax system.  Ms. von der Leyen is expected to win with the support of Europe’s mainstream parties, though she has gotten significant pushback from many in the center-left, especially the German SPD.  She has shunned giving the Greens any specific role in government.  If she loses, it will plunge the EU governance into uncharted waters.  It is unclear if there is any consensus on another candidate.  If she is rejected, it may put downward pressure on the EUR

While the legislators will also soon be voting on a new leader of the European Central Bank (former International Monetary Fund Chief Christine Lagarde), it’s important to remember that none of the new leaders will have carte blanche in their roles.  As an example of that, Banque de France Governor François Villeroy de Galhau said at a conference today that monetary policy shouldn’t be dependent on market expectations.  The statement was seen as pushing back against expectations that the ECB will loosen policy at its upcoming meeting.

Libra: We have had concerns about the rise of cryptocurrencies for some time.  Although the coins might have some worth as a store of value asset and do help citizens evade capital controls, they are also useful for transactions in the black market.  Ransomware threats often require payment in cryptocurrencies.  However, what has surprised us is how governments have generally not reacted to the potential sovereignty threat that cryptocurrencies represent.  One of the important roles of government is the creation of currency; giving that up to the cryptocurrency market opens up the possibility of private money and the loss of state power.  Facebook’s (FB, 203.91) proposed foray into the cryptocurrency market appears to have caught the attention of Washington.  The SEC is considering if it should regulate Libra, essentially deciding if Libra is a security.  The Treasury is also expressing concern, with the Treasury secretary warning that Libra may be a “national security issue.”  There is even talk of banning tech firms from offering any financial services.  Regulation may not kill Libra but making it palatable to regulators will likely undermine the attractiveness of cryptocurrencies, in general, which comes from their anonymous nature.

Central bank weapons: Central bankers around the world are quietly preparing for the next downturn.  Since interest rates are already low, unconventional policies will likely be necessary to stimulate growth.  The ECB is considering adding unsecured bank debt to the assets it will buy in a downturn.  The Fed is considering the launch of a repo facility that would allow the central bank to accept Treasuries as collateral if money market rates rise a certain level above the policy rate.  The fact that such measures are under consideration suggests the developed world central banks are concerned that conventional monetary policy will not function well in the next downturn.

Brexit: Both candidates for leadership of the Tories are pushing for no backstop in Northern Ireland.  It might be possible to put a trade border inside Ireland to allow the physical border to be open between the U.K. and Ireland, but the problem is that such an action would effectively move the border of the U.K. further into what is now the Republic of Ireland.  We don’t see the EU giving that to Britain.

Meanwhile, here’s a new word to watch—proroguing—which is when the executive closes Parliament, ostensibly to implement policies favored by the executive but opposed by the legislature.  This idea has been circulating among Brexit supporters as a way to prevent Parliament from preventing the country from leaving the EU.  Proroguing outside of normal recesses is constitutionally tricky.  Essentially, it requires the Queen to shut down Parliament at the request of the PM.  We have doubts Queen Elizabeth would take this action.  After all, such a move would rekindle republicanism, which wants to end the royals altogether.  As the chances of a hard Brexit increase, the pound continues to weaken today to its lowest level since April 2017.

Greece: In a sign of improved investor sentiment toward Greece and its new center-right government, the government is planning to sell a new seven-year bond at a yield of just 2.1%, a modest 2.6% spread above comparable German debt and barely more than the U.S. Treasuries of the same maturity.  That comes as loosening monetary policy has driven yields to below-zero in a range of emerging markets.  All the same, in spite of those signs of positive sentiment, there are reasons to maintain caution regarding the emerging markets, especially considering the evolving global backdrop of trade protectionism and a reversal of globalization, policy turmoil in places like Turkey and Mexico, and the recent strength in the dollar.

Bulgaria: Interior Minister Mladen Marinov said Bulgaria is undergoing a massive hacker attack from a Russian website, including the release of millions of emails with stolen personal financial data and statements calling for Bulgarian Finance Minister Vladislav Goranov to resign.  According to Marinov, the attack suggests Russian revenge for Bulgaria’s recent decision to buy F-16 fighter jets from the United States.

China: The Chinese government pushed back against comments from President Trump, who argued that the 6.2% GDP growth in Q2 is evidence that the Chinese economy is suffering and that Beijing would be wanting to make a trade deal with the U.S.  China’s fiscal spending in H1 rose 10.7% as the government moves to bolster growth.  The government yesterday issued a new policy prohibiting both central and local agencies from providing subsidies or loans to support state-owned companies that otherwise wouldn’t be financially viable, i.e., “zombie enterprises.”  The communiqué said the policy aims to make it easier to close down such zombies and better allocate resources, but China will probably also tout it in order to diffuse U.S. criticism about unfair subsidies for state-owned exporters.  The problem is that local governments will still be the ones deciding whether or not firms are viable, and they’ll still have an incentive to keep the zombies alive.  Top-level trade negotiators from the United States and China plan to talk by phone again this week, with U.S. officials expressing optimism that the conversation will lead to new face-to-face negotiations, but China’s hardline Commerce Minister Zhong Shan warned that China will “stand firm in defending the interests of our country.”

North Korea: In spite of positive atmospherics arising from the meeting between President Trump and North Korean leader Kim Jong-un after the G-20 summit last month, North Korean state media today warned that a joint U.S.-South Korean military exercise next month would reduce the justification for it to pursue denuclearization and better international relations.  The article said North Korea might consider renewed long-range missile tests if the exercise goes forward.

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