It seems like just a week ago, we were talking about synchronized global growth. Suddenly signs of deceleration are everywhere. And bond markets are feeling it. I don’t see the economy falling out of bed though, barring an exogenous shock. Some thoughts below
Trump is totally unpredictable now
In yesterday’s post-market commentary, I alluded to what I’m about to say here. But it was tangential so I didn’t go into any detail. I wrote: “The troubling aspect of Tillerson’s dismissal is how it was handled.” And what I meant by that is that it shows total unpredictability. The sacking didn’t come out of nowhere. Rumors had been flying for months. Yet, apparently the US Secretary of State was fired on Twitter. That’s what the most credible accounts on the timeline say.
To add to this freewheeling, fly by the seat of your pants narrative, there’s the Kudlow appointment. The Wall Street Journal is reporting that Trump decided on Gary Cohn’s replacement after his name flashed on CNBC as a likely National Economic Counsellor pick. Here is the exact quote:
Mr. Kudlow said the president called him earlier Wednesday, after CNBC flashed his picture and reported he was the president’s likely pick. “You’re on TV. You look very handsome,” he said the president told him.
What kind of vetting process is that? I understand they know each other. But there was no formal process here. Just an instinctive reaction to TV news. That’s very scary.
Axios is saying the White House is now total chaos.
A White House official tells Axios:
“This is the most toxic working environment on the planet. …There’s no leadership, no trust, no direction and this point there’s very little hope.” https://t.co/PXiy8WZzQR
— Axios (@axios) March 14, 2018
No one of any caliber would dare join a White House in that environment. And as I wrote yesterday, “there are one or two more shoes to drop.” People are talking about Chief of Staff Kelly and National Security Advisor McMaster as potential departures from the Trump Administration.
Trump has already consolidated power
My view from yesterday: “Trump is looking to consolidate power. He wants to be surrounded by ideological and loyal brethren on all fronts.”
Bloomberg is running a story with this same theme.
Now, as he fires top aides who were a moderating force and replaces them with loyalists who share his world view and won’t object to his most controversial impulses, his administration is fast becoming a presidency of one.
That accelerated with the ouster of Secretary of State Rex Tillerson on Tuesday and last week’s resignation of White House economic adviser Gary Cohn. The moves make clear that Trump has lost interest in hearing dissenting voices and are likely to fundamentally shift American diplomacy and economic strategy.
That’s it exactly. But let’s remember who Trump is – and the Tillerson and Kudlow moves show it. He’s a risk taker — and a nationalist. America First. We are going to see America First in a much more virulent way now. Look at how Trump blocked the Broadcom takeover of Qualcomm. That’s how it will play out from here on out. Trump will be much more aggressive. And Trump will use national security to justify every protectionist trade measure he can. Doing so gives him much more executive authority. This is where trade wars can happen.
Potential shock: Trade war
Now, the Trump White House is looking to slash the bilateral trade deficit with China by $100 billion. That’s huge. How do we get there without a massive move in currencies? And if the currencies move, what happens to other bilateral trade flows, say between Europe and China? I don’t see this happening without more tariffs, big tariffs. And those tariffs will be met with countervailing duties.
Trump could play the ‘Taiwan Card’. If you recall, he mentioned Taiwan early in 2017 right before he took office. Beijing said it was “non-negotiable”. But Secretary of State designee Mike Pompeo is much more hawkish on China than Rex Tillerson. As Central Intelligence Agency Director, Pompeo warned recently of a “Chinese threat” to American interests. And this was perhaps a major reason to block Broadcom.
The South China Morning Post is good on this. And it’s about Trump and trade more generally, not just about China:
Trump is no longer making empty threats, but turning hawkish rhetoric into actions.
In addition, the scope of his latest move is more far-reaching, with targets of the tariffs ranging from “strategic competitors” such as China and Russia, to traditional allies such as the EU, South Korea and Japan. Even though Canada and Mexico are initially exempted, Trump has threatened to claw them back in if they fail to treat the US “fairly” in future Nafta re-negotiations.
The fact that Trump is no longer picking a fight with just China, but the rest of the world, hints at rising risks of global retaliatory backlash. Threats from the EU for a tit-for-tat response are ominous signs of what could be laying ahead for global trade.
It is these worrying turns of events that, in our view, have led the market to reassess the chance of a global trade war.
Trade War rhetoric just as the global economy shows signs of fatigue
Economic data out today were underwhelming. European industrial production figures for January were down 1% from December vs a 0.4% expected drop. US retail sales were down 0.1% in February. And the Atlanta Fed GDPNow forecast for the quarter slipped below 2%. If you recall, I was thinking the above 5% reading in early February was a great sign.
I would call that signs of economic fatigue. This is the fatigue I pointed to this morning.
I’m not in the camp that says the economy will fall over a cliff here. However I do think we are seeing a modest deceleration in US and global growth. And this has induced yet more curve flattening today. The 10-year ended the day at 2.80% with the two-year stuck at 2.25%. That puts at 55 bps of steepness, nothing too alarming. That’s about where we were in the Fall, by the way.
Two questions remain on this one though. What happens to the economy and long-term rates going forward? And what does the Fed do?
If the economy decelerates further, we could see 10-year yields retrace the entire Fall kick-up. If we went back to September, that puts us at 2.06%. A rally in early November took yields down to about 2.30%. 2018 began at 2.40%. Any way you look at it, you have a pancake flat or an inverted curve if we retrace just three to six months.
The Fed is a lock to hike later this month. And then they are due for an additional hike in June. If they stay the course, 2-year yields will likely remain around 2.25%. And that becomes our bogey for inversion. Inversion means recession. But that inversion has to occur for a couple of months and the lag time would be 12-18 months.
Let’s assume an inversion in June or July, the timetable I set out at the beginning of the year for complete flattening. That gives us until mid- to late-2019 to worry about a recession. And of course, the Fed could reverse course in the interim. We know Bernanke hiked into inversion in 2006. But he waited a whole year to cut. Powell might invert the curve, but act more aggressively to cut afterward. We just don’t know.
But there is reason to be bullish on Treasuries, rather than bearish. I know Jeff Gundlach is still talking about 3% on the 10-year. That scenario will take time and has to mean re-acceleration of growth or inflation.
Last thought here. Bloomberg mentioned that not a single 10-Year Japanese Government Bond (JGB) traded on Tuesday. Not one. That’s the benchmark maturity. My response?
The Bank of Japan owns 40% of the market. If it wanted, it could own 100%. Think about it. https://t.co/YsqwQt2Nqs
— Edward Harrison (@edwardnh) March 14, 2018
Is it central planning? Yes, of course it is. Can they ‘get away with it’? Of course they can. It’s a fiat currency. The Japanese government creates yen. Inflation is the concern. But even then, the Bank of Japan can go for financial repression. And there’s nothing the bond market vigilantes can do about it.
Think about that if America suffered a crisis as Trump consolidates power.