Wednesday, September 12, 2018

September-October 2018 Outlook: Deadlines September-October 2018 Outlook: Deadlines
Tue, 11 Sep 2018 20:49 PM EST

The next few months will see the culmination of a number of geopolitical issues that have been building a ‘wall of worry’ for the financial markets. A cluster of hard and soft deadlines will hit from now through the end of the year that will realign the global political and economic landscape for years to come. From the impending US Congressional election, to the due date for a Brexit deal, to looming ultimatums on trade deals, these deadline will mark binary moments that could either give markets the footholds to keep climbing or cause the first stumble toward the next recession. These key unresolved risks along with the historical trend for the September-October period to be especially volatile are a recipe for some unnerving gyrations during the next couple of months. If progress is demonstrated on these time-sensitive issues, then equity markets may continue to melt up on the strength of corporate earnings reports amid stronger fiscal stimulus and what is still a highly accommodative interest rate environment globally.

The D.C. Political Calendar

In the US, the growing intensity of the political divide between Democrats and Trump’s Republican Party may hit a crescendo in the next few months. With control of Congress the President has been able to shape an agenda of lower taxes, increased military spending, and cutting regulation. But Trump’s chaotic personality has maybe made these victories harder than they should have been and has contributed to consistently low poll numbers for the President outside of his core supporters. The installation of another conservative jurist on the Supreme Court this fall may be his last victory in a while as all indications are the Democrats should retake the House in the mid-term elections (November 6).

While a Democrat-controlled House may provide the President with a foil to grouse about obstructionism, it will effectively stall any further legislative planks in his agenda. Assuming a Democratic win, the new Congress will not be taking up additional tax cuts or discussing funding for a border wall. Democratic committee leaders will also seek more oversight of Executive activities and may even be emboldened to start impeachment proceedings (even if it’s a lost cause without a supermajority in the Senate).

The other political shoe that could drop in the next few months is the conclusion of Robert Mueller’s investigation of election meddling by Russia. With a handful of Trump associates already facing jail time it has yet to be seen if Mueller or federal prosecutors will net any bigger fish. The timeframe on when the investigation will close remains murky, but the pressure is growing with Trump’s lawyers threatening to cry foul if Mueller makes any major announcements in the two months leading up to the election, and the President himself saying since June that “he may get involved” in the FBI probe.

It should be noted that as part of his electioneering the President is also threatening another government shutdown if he does not get the border wall funding he desires. Current funding expires at the end of September, so if the Trump holds fast there could be a temporary disruption of some government services. Democrats will pounce on this as material for political ads, while the President will hope that it burnishes his reputation as a tough negotiator who is ready to shutdown “the swamp.”

Countdown to Trade War

Trump’s best hope at improving chances for the GOP in November would be to cobble together one or more significant trade deals. US trade negotiators reached a handshake deal with Mexico, but are having a harder time integrating Canada into the accord. Canada seeks a win-win-win agreement, but has said that no NAFTA is better than a bad agreement. PM Trudeau has stated outright that Canada wants to keep the dispute resolution mechanism (‘Chapter 19’) and that his country will not give in to US demands that it abandon dairy supply management (which results in high tariffs on US dairy products). Negotiators have given the impression that they are making slow progress, and if they can overcome these two points of contention it seems possible a deal could be reached by the end of September.

Markets have not reacted much to the Trump Administration’s tough talk on trade, largely on the belief that no one wants a trade war and that all sides will come to terms in the months ahead. That conviction may be tested if the US moves forward with $200 billion in additional tariffs on China that are now cleared and ready to go at any moment. President Trump appears to be holding the new tariffs in reserve as leverage to get some movement out of Beijing, and he recently threatened that another $267 billion could be teed up rapidly, which would effectively be putting duties on just about all Chinese imports.

All of this gamesmanship with tariffs does not appear to be benefitting anyone. Even though US metals manufacturers made upbeat comments about the trade restrictions, shares of US Steel have dropped 40% from the moment the metals tariffs were officially announced.

China is definitely feeling the pinch: the China Securities Journal recently forecast that export growth in the second half of 2018 may decline to 2% (after reporting July exports rising 12.2% y/y), and the Shanghai Composite Index and Hang Seng have tumbled into a bear market. Amid these circumstances, China has shown patience and has thus far given signals that it does not intend to use currency as a weapon in the trade war. Nor has there been any sign of either side giving concessions, and by all reports there is currently minimal high-level contact between Beijing and Washington.

The lack of progress on US/China trade talks is also hampering negotiations with North Korea. President Trump effectively stopped the countdown clock on the ‘denuclearization’ of the Korean peninsula, canceling his Secretary of State’s visit on the grounds that China is no longer helping the cause. The implication is that North Korea will be put on the back burner until the Sino-American trade dispute is resolved.

The US also continues to tangle with Europe and emerging market countries on tariffs, with a large focus on the automobile and steel industries. The US and EU announced a temporary ceasefire in late July with an agreement to discuss WTO reforms and to work toward zero tariffs on non-auto industrial goods. The two sides agreed to resist implementing any new tariffs while talks are ongoing. Trade representatives from both sides will meet again at the end of September with the goal of finalizing agreements on at least some areas of trade by November.

Emerging markets are struggling with US trade pressures coupled with the strong dollar, which have exacerbated already difficult local conditions in places like Turkey and Argentina. Elections in Brazil (first round October 7, runoff October 28) will be a chance to stabilize Latin America’s biggest economy, maybe providing footing for the emerging markets. After years of the political establishment being overrun by corruption, this election could be a seen as a break with the past, though markets participants are not that keen on the expected victory by one of the more left-leaning candidates.

World leaders will have several opportunities to hash out their differences (or clash further) in the coming months. The UN General Assembly in New York, scheduled for September 25, is often used by politicians as a platform for policy speeches and a chance for bilateral meetings, and leaders will gather again in Buenos Aires on November 30 and December 1 for the G20 summit.

Brexit Deadlines Loom

The clock is running out on Brexit talks, which appear to be moving along in fits and starts, with some recent headlines indicating that EU and the UK have eased some of their redlines in hopes of getting closer to a deal. The days ahead will come down to whether the EU accepts the ‘Chequers’ proposal formulated by UK PM May as a compromise. If Chequers can be used as a framework, then an exit arrangement may still be reached by the legislative deadline that has reportedly already been pushed out a month to mid-November. If all goes well, an EU summit could be held in that timeframe to seal the deal.

Things get much more complicated, however, if the EU explicitly rejects the Chequers proposal. The BOE’s chief economist Haldane recently noted the markets are putting chances of a ‘no deal’ Brexit at about one-in-four, but that may rise dramatically if the EU says ‘no’ to Chequers.

Should Chequers be spurned, pro-Brexit ministers are urging the PM to take a harder tack, endorsing an agreement framed on the EU’s trade agreement with Canada. The “Canada-plus” model envisions allowing nearly all goods to be traded without tariffs, but, just as with the Chequers plan, this new idea does not solve the most nettlesome issue in the talks: a resolution for the Irish border that prevents the reintroduction of fixed customs checks at the border that would undermine Ireland’s Good Friday Agreement. Unless UK and EU negotiators find an answer to avoid a hard border in Northern Ireland soon, they may not be able to get a withdrawal agreement in place by March.

In recent days the EU’s chief Brexit negotiator Barnier stated that he sees a realistic possibility of reaching an agreement in the next 6-8 weeks. That comes on the heels of reports that the EU was instructing Barnier to get a deal done to avoid a ‘hard Brexit.’ An informal meeting of the EU 27 in Salzburg on September 19 may be the first indicator that this timeframe is on track. Current expectations are that the Salzburg meeting could report more Brexit progress and confirm plans for a formal leaders’ summit on Brexit, likely on November 13…if all goes well.

End of an Era

All of the short term deadlines of the next few months described above are coming due in the context of the end of an era of extremely accommodative monetary policy. The global economy is starting to hum again, but it is not clear how long that will continue once the unprecedented central bank accommodation is withdrawn.

Most major central banks have now made minor adjustments to edge away from ultra-easy policy, but rates largely remain stuck near zero. The BOE is only planning one more rate hike between now and 2020, the ECB is not expected to start raising rates until September 2019, and the BOJ may not raise rates for years.

Meanwhile, the Federal Reserve will extend its divergence from other global central banks with another 25 basis point rate hike at the September 26 FOMC meeting. That will take the key rate to over 2.00% for the first time since 2008, and bring it closer to the ‘neutral’ rate which is being estimated somewhere in the 2.50-3.00% range. The September hike is locked in, but there is still some dove/hawk debate over a fourth 2018 rate hike in December. The Fed appears to be ignoring President Trump’s gripes about rates rising too fast, and that may even stiffen the Fed’s resolve to move higher again in December to demonstrate the central bank’s independence.

Markets have taken higher US rates in stride and that may continue as the Fed works its way back to the ‘neutral’ rate. As this process continues, there seems to be little discomfort with the flattening yield curve, perhaps in part because Japanese and German bonds are holding down the long end of the curve. The theory goes that the 2-10 year curve may not be as good a signal for recession as in the past because of extraordinary global rate accommodation over the last decade. However, it is possible that a yield curve inversion could still trigger a stock market reversal, becoming a self-fulfilling prophecy as traders who are trained to watch for the inversion react to it.

It appears that US economic outperformance and the strong dollar will be the dominant themes in the global economy for the rest of the year. America’s economic strength has allowed the Fed to get far ahead of other central banks in policy normalization, and now the market perspective may be shifting toward predictions of how high rates will go. Fed Chairman Powell has signaled that, with inflation looking very stable, once rates get to ‘neutral’ the Fed will be more cautious about taking rates higher from that point, even if the economy remains very strong. Barring any new shocks developing from missing one of the geopolitical ‘deadlines’ described earlier, that should give comfort to the markets that the next recession is not due any time soon.

3: UK Manufacturing PMI; US ISM Manufacturing PMI
4: UK Construction PMI
5: UK Services PMI; US ISM Non-Manufacturing PMI
6: China Trade Balance
7: US Payrolls & Unemployment

9: China CPI
10: UK Q2 GDP; UK Manufacturing Production
11: UK Goods Trade Balance
12: UK Claimant Count & Unemployment; US PPI
13: BOE Policy Statement; ECB Policy Statement & Press Conference; US CPI; China Industrial Production
14: US Retail Sales; Preliminary Univ. of Michigan Consumer Sentiment

17: EU Final CPI; Empire State Manufacturing Index
18: UK CPI & PPI; German ZEW Economic Sentiment; BOJ Policy Statement
19: US Housing Starts & Building Permits; EU 27 meeting in Salzburg
20: UK Retail Sales; Philadelphia Fed Manufacturing Index; US Existing Home Sales

24: Various EU Flash Manufacturing & Services PMIs; German Ifo Business Climate
25: US Conference Board Consumer Confidence; UN General Assembly in NYC
26: FOMC Policy Statement & Press Conference
27: German CPI; US Final Q2 GDP; US Durable Goods Orders
28: German Retail Sales; UK Current Account; UK Final Q2 GDP; EU Flash CPI; US Personal Income & Spending; Chicago PMI
29: China Manufacturing & Non-Manufacturing PMIs
1: UK Manufacturing PMI; US ISM Manufacturing PMI
2: UK Construction PMI
3: UK Services PMI; US ISM Non-Manufacturing PMI
5: US Payrolls & Unemployment

7: Brazil election (1st round)
8: China Trade Balance
10: UK Q3 GDP; UK Trade Balance; US PPI
11: UK Manufacturing Production; ECB Minutes; US CPI
12: Preliminary Univ. of Michigan Consumer Sentiment

15: US Retail Sales; Empire Manufacturing; China Q3 GDP; China CPI; China Industrial Production
16: UK CPI & PPI; German ZEW Economic Sentiment
17: UK Claimant Count & Unemployment; EU Final CPI; US Housing Starts & Building Permits; FOMC Minutes
18: UK Retail Sales; Philadelphia Fed Manufacturing Index
19: US Existing Home Sales

24: Various EU Manufacturing & Services PMIs
25: German Ifo Business Climate; ECB Policy Statement & Press Conference; US Durable Goods Orders; UN General Assembly in NYC
26: US Advance Q3 GDP

28: Brazil election (2nd round)
29: German Retail Sales; US Personal Income & Spending
30: German Preliminary CPI; EU Flash Q3 GDP; US Conference Board Consumer Confidence; BOJ Policy Statement & Outlook Report
31: EU Flash CPI; Chicago PMI; China Manufacturing & Non-Manufacturing PMIs
1: UK Manufacturing PMI; BOE Policy Decision & Inflation Report; US ISM Manufacturing PMI
2: UK Construction PMI; US Payrolls & Unemployment

6: US Midterm Election