Tuesday, April 24, 2018

Strategic Global Intelligence Brief for April 24, 2018

Short Items of Interest—U.S. Economy

What Does a 3% Yield Mean?
In some respects, it doesn’t really mean all that much as there is scant difference between yields of 2.9% and 3%. However, there is a psychological impact as far as breaking that 3% barrier. The implications of a higher yield for the 10-year Treasury bond are significant because this is the first time it has been at that level in the past four years. It is a sign of growing confidence among investors, but higher yields will also lead to higher borrowing costs. The rise in the Fed funds rate will impact mortgages and other credit, but often less than will the rise in bond yields. The hike is not going to radically change the financial environment overnight, but remember that it was a rise in the 10-year bond that spooked the markets a few months ago as it was thought to be a precursor to reductions in stock values.
                                                         
Good News in the Housing Market
The rate of new home sales rose for the second month in a row. There was a 4% increase that was quite a bit more than had been expected. The new home sector is a narrow part of the overall market, but the growth in existing home sales was also better than had been expected. The headwinds that analysts have been so worried about are still there, but they have not yet had the negative impact that was feared. The big concerns are that mortgage rates are headed higher and that the price of homes will continue to escalate as the stock of available housing remains very limited in many of the hottest markets. The latest inhibitor is an acute shortage of skilled workers to build the new homes in these booming communities.

NAFTA Reforms and Energy
All three NAFTA members are coordinated when it comes to opening up the energy sectors for all three nations. The power of global oil production has profoundly shifted to North America from the Middle East and all three are interested in accelerating that trend. There are reforms that would accelerate pipeline efforts across borders, making it easier for the U.S. to sell natural gas and for U.S. companies to explore for oil in Mexico. The one provision that distresses the energy companies as well as others is a removal of a rule that now gives U.S. companies some protection against government interference with their operations in Canada and Mexico. Energy companies are often vulnerable to expropriation and interference and they have relied on NAFTA for protection—something that Trump’s plan may end.

Short Items of Interest—Global Economy

Trade Deficits Changing
For the past couple of decades, the trade patterns have been the same. The developed world was buying a great deal more from the developing world than it was selling to them. The emerging markets were producing the cheaper manufactured goods that were in demand from the developed world consumers, but these countries didn’t have the economies to support the purchase of the higher-level goods from the developed world. That is changing fast. The level of surplus from the emerging markets has fallen to the lowest point since the 1990s. Many of these states will be running deficits in the next five years because they have more interest in the output from the developed world as well as a mounting appetite for the services that are supplied by the developed world.

Cautionary Note Regarding North Korea
In past years, there have been agreements with the North Koreans that involved providing food aid and other assistance. It was very common for all that aid to be diverted to military use in North Korea and for none of it to find its way to the supposed target.

Russian Sanctions
It is another altering of the tariff battle. The U.S. stated that tight sanctions would be imposed on Rusal—the world’s largest aluminum producer. Immediately, there were big price spikes, but now it seems these sanctions may not be imposed if one of the key Rusal investors is removed from his position. Oleg Deripaska was the target of the sanctions and if he sells his stake, the deal is that sanctions will be lifted. Subsequently, the price of aluminum has fallen a bit.

Can the U.S. Work with Europe?
The U.S. ostensibly has an alliance with Europe and counts many of the nations of the EU as long-time partners and supporters. It would be hard to look at current relations between the U.S. and Europe and assume that these alliances remain intact. The number of divisive issues seems to increase every day and tension between Trump and European leaders would be best described as that of enemies as opposed to long-standing friends. This will likely be a week of extreme contrasts when it comes to relations between the U.S. and Europe as there are scheduled visits from both Emmanuel Macron and Angela Merkel. Macron’s visit is extremely high profile because it is the first state visit that Trump has engaged in. Merkel will arrive later in the week with far less pomp and circumstance. Trump has an unusually close relationship with Macron, or so it is assumed at the moment, while the animosity between Trump and Merkel is intense and mutual.

Analysis: There are at least three major issues that divide the U.S. from Europe at the moment. These are just the big ones as there are more specific concerns with select members of the European Union. The first is the imminent expiration of the exemption granted to the EU when it comes to steel and aluminum tariffs, which expires in about a week. Europe wants these tariff exemptions made permanent and there does not appear to be any room for maneuver here. The fact the U.S. imposed these tariffs on Europe in the first place angered the EU and they have taken this as an insult from the very start. The U.S. has demanded that Europe join with the U.S. to pressure China as a precondition for granting any kind of permanent exemption. It is not that Europe objects to putting pressure on China as they have much the same issue with the behavior of the Chinese as does the U.S. Instead, it is the manner in which the U.S. has gone about enlisting their support.

A second major issue is the nuclear weapons deal that was negotiated with Iran. This is seen as vital to European interests and was negotiated primarily by Germany, France and the U.K. The inspectors, who have been examining the Iranians since the pact was signed, acknowledge that Iran has fully complied with the deal and that is sufficient for the Europeans at this point. The U.S. has been frustrated by the agreement since it doesn’t go far enough. Iran continues to develop its missile technology, allowing it to threaten U.S. allies, such as Israel and Saudi Arabia, with conventional warheads. Iran also continues to support and bankroll many of the bad actors in the region that the U.S. has long opposed: Hamas in Palestinian territory, Hezbollah in Lebanon, Shiite militias in Iraq and the Shiite insurgents that are at war with Saudi allies in Yemen. The U.S. wants an agreement that covers these issues, not just the nuclear deal. Europe asserts that stopping the development of nuclear weapons is the first step and enough for now, but Trump and his more hawkish foreign policy team is not supportive.

The third major issue revolves around Russia. The U.S. has been ramping up sanctions on Russia and this is in marked contrast to how the Trump regime started. The rapprochement that seemed to be part of the Trump plan has been abandoned wholesale as the U.S. has reacted to issues of Russian interference in U.S. elections, attempted assassinations, oil politics and a host of other concerns. The EU has also been upset with Russia but has been reluctant to go as far as the U.S. Russia is a far more important trade partner to the EU than to the U.S.—it is the fourth largest for the EU and the EU is the number one trade partner for the Russians. It is not that Europe seeks to let Russia off the hook, but they do not want to be as aggressive as the U.S. has become.

What is at Stake for Macron and Trump?
State visits are big deals. There has not been one so far in the Trump term and that is unusual. By this point in the presidency, other presidents have generally had a few already. These are meetings that are extremely high profile and all about putting on an immense show. France has already done one of these for Trump last July. This is when it was asserted that somehow Macron and Trump had developed a good relationship and it would not be inaccurate to assert that Macron is Trump’s best friend in Europe. That this is the presumed case is more than unusual given the deep policy differences. Macron is a committed globalist and seeks to strengthen the EU, while Trump is a populist and nationalist who doesn’t trust globalization. Macron defeated the populist who Trump had tacitly supported in the French elections and there are many policy differences on issues large and small.

Analysis: On the other hand, they have things in common as well. Both were outsiders who upset the norm as they defeated all the candidates who were supposed to win handily. Both have very personal styles of leadership and have been criticized for their lack of diplomacy and tolerance of those who fail to support them. Macron is convinced that he can bring Trump around to ways of thinking that will temper the “America First” approach. He will need to get some kind of concession from Trump this week if this visit is to play well in France. Trump is not popular at all in France or anywhere else in Europe. Macron has been fighting his own sagging popularity, so coming back from the U.S. with nothing to show for the visit will be damaging.

There is little chance Trump will back down on Iran or Russia at this point, so all eyes will be on the tariff talks. If Macron gets significant concessions on the steel and aluminum tariffs that satisfy EU demands to some degree, the trip will be a success and he will get credit for being the European who can work with Trump. It also boosts Macron as the new power in Europe, as it will further eclipse the role of Germany’s Angela Merkel because she will no longer be a factor as far as the tariff argument is concerned.

The Pollen Attack Bringing Japan to its Knees
There is all manner of modern maladies that can compromise economic growth in a given nation. There are concerns over water quality and air quality, pesticide use and so on. The industrial advances never seem to come without some less-than-appealing aspect, but Japan has a rather unique problem. It is one sufficient to be called the “national disease” and it is one that affects the country every spring. Hay fever is not unique to Japan by any means, but the outbreak is so severe that Japan suffers economic slowdown at this time every year. The arrival of spring means the arrival of massive amounts of tree pollen produced by the millions of trees that were planted decades ago, which replaced those lost during war and overdevelopment. The problem now is that there are far too many of these heavy pollen-producing trees and they produce enough to send half the working population into serious hay fever attacks. These attacks either force people to stay home or compromise their work abilities.

Analysis: The Japanese would like to remove a significant number of these trees in order to replace them with varieties that produce less pollen, but this is far easier said than done. The trees are generally hard to get to since they were planted on steep slopes in part to control erosion. There is also very little profit in lumbering in Japan because imports are far cheaper and readily available. The pace of construction has been languid at best and that further reduces the incentive to harvest. The governor of Tokyo made a pledge to do something about the hay fever issue, but nobody really has a suggestion as to what that would be.

This brings up a problem that affects a lot of societies and vexes many leaders. The environment is hard to manage and there is never really enough money to throw at any given issue. China is coping with industrial air pollution that chokes major cities, like Beijing and Guangzhou, due to the existence of inversion. The agricultural areas are always subject to drought one year and flooding the next and there are always new and exciting scourges from insects and disease. It is not that coping mechanisms do not exist, but the plans always require money and there is simply never enough to go around.

For the time being, Japan will be limited to what it has always done during the spring weeks. Everyone will be wearing masks and the majority of the population will spend as little time outdoors as possible. The business community will simply have to adjust to being short staffed for the duration and retailers will have to wait for the customers to brave the pollen and shop.

AMLO Holds on to His Lead in Mexico
The televised debate between the candidates for presidency was thought to have been won by the man who is in second place in the polls at the moment. But, Andres Manuel Lopez Obrador (AMLO) continues to hold a commanding lead over his challengers. Thus far, AMLO is playing what many have referred to as the “Lula” card. The former president of Brazil had been cut from the same mold as AMLO. He was the far-left leader of the Worker’s Party. He never was able to capture more than around 20% of the vote until he shifted gears and abandoned the fatigued-look of Fidel Castro and adopted a semi-centrist position. AMLO has done the same thing and has expanded his base of support from the left leaning to those who would be termed center-left and moderate. His focus has been on three things: an end to corruption and crime with an emphasis on dealing with the drug gangs, addressing the broad income inequality in Mexico by focusing on development in poorer areas and rural communities, and facing down threats from the Trump administration. The most important factor moving the needle in polls has been Trump. Every time he lashes out at Mexican immigration or NAFTA, the poll numbers jump again in favor of AMLO.

Analysis: Ricardo Anaya Cortes is starting to emerge as the only candidate that might be able to slow AMLO. He is also something of an outsider and represents the center-right and business community to a degree. His popularity is highest in the northern states of Mexico, where the PAN started. He is in the tradition of former PAN leader Vicente Fox, an outsider who comes from the business community and not from traditional politics. He has avoided falling into the trap that claimed Felipe Calderon by also focusing on issues that matter to the poorer southern states. The candidate of the PRI stumbled in the debate and seems essentially finished as far as a viable run.

The U.S. has remained silent as to preference and that is good news for Cortes. The hostility toward the U.S. is high and any attempt to indicate a favorite would backfire. Cortes has been just as critical of Trump as AMLO and, in some ways, more intense as he does not want even a hint of that connection. The election is just a few months away, however, and AMLO holds a lead over Cortes of 42.7% to 28.8%.

Stuff
When one does what I do for a living, one is exposed to lots of stuff. Every meeting has tables of those obligatory objects emblazoned with the logos and names of companies and organizations. It is hoped that you grab a handful of these useful things and then subsequently remember the group or company that provided you with the pen, glasses cleaner or stress ball. There are things that really defy description, such as the device that was designed to amplify one’s cell phone ringer. A demonstration made it clear that you could be in another state and hear that phone ring. I was cleaning out my desk the other day and realized that almost every pen I own has somebody’s name on it.

There are fads as well. For a long time, it was flash drives and I still have dozens of these. Today, it seems that cell phone chargers, ear buds and other musical enhancers are big. I just donated about a dozen portfolios and pads to charity and for this, I am sure to go straight to Hades. Every once in a while, there is something truly clever and appreciated (by me in any case). There was a group that gave away a reading light that could be attached to a book or worn with a head band and I have used that on many an airplane. Another favorite of mine was a tiny screwdriver set that nested in itself and had several heads small enough to do those little repairs on glasses and laptops.