Political problems at home…
“…history is returning with a vengeance. For most of the past 18 months, the markets have blithely ignored the Trump administration’s disruptive foreign policy…. To those who weren’t paying attention, or weren’t taking [Mr] Trump too seriously, which included many in debt and equity markets, now might be a good time to adjust your outlook. The period of easy money is coming to an end. The age of difficult politics can no longer be ignored.”
Edward Luce — ‘Swamp Notes’, Financial Times, 2 November 2018
In London last week, I spent a good deal of time talking to clients and policymakers. Even taking into account the inevitable concern there about Brexit (and, to a lesser extent, Italy), the number one topic on more or less everyone’s agenda was — entirely understandably — China/US relations and whether Xi Jinping and Donald Trump will strike a deal on trade at this weekend’s G20 summit.
In considering this question, it is essential, in my view, to keep four things firmly in mind.
First, at the risk of stating the obvious, whatever Mr Trump does — and says — from here on, be it domestically or on the world stage, will be driven more or less entirely by what he believes to be most helpful to his number one objective, ie winning a second term. Furthermore, we should be in no doubt that the President, who seems to be singulalry untroubled by self-doubt, has total confidence not only in his ability to do just that but also in the personal approach and policy priorities which brought him to the White House in the first place.
Looking at the imminent future, this certainly applies in the case of a possible government shutdown early next month over the federal budget. Few, if any, issues play more strongly with Mr Trump’s core support than the proposed wall along the border with Mexico and he may well judge it to his advantage to dig in on this, especially given the electorate-at-large’s dismal view of Congress. In the event of a shutdown, he may even be hoping it would last into the new Congress in January so that he can try to shift blame for the impasse firmly onto the Democrats' shoulders**.**
Second, Democratic Party control of the House of Representatives with effect from 3 January means that his chances of pushing through another major piece of legislation to bolster his approval ratings are very low indeed. Of course, in theory at least the Democrats ought to be supportive of a bill to boost infrastructure investment. Indeed, it would not surprise me if Nancy Pelosi (who looks increasingly likely to return as Speaker even though this may not be in her party’s best interests come the 2020 elections) manages to steer a Democrat-sponsored infrastructure bill through the House. However, I doubt very much such a bill would win majority support in the Senate even if the President himself were to back it (which is certainly not impossible).
This does not, of course, mean that Mr Trump’s domestic agenda is dead. To date, his pursuit of his policy objectives, perhaps most notably deregulation, through non-legislative means, eg executive orders, has been impressive by any standards (see here) and there is no reason to suppose that this is likely to change over the remaining two years of his current term. However, for high profile, headline grabbing initiatives he will inevitably — and in time-honoured fashion — now turn increasingly to the foreign policy agenda.
Third — and clearly, therefore, related — Tip O’Neill’s famous retort that “all politics is local” when asked about his views on foreign policy has probably never been more true than it is in ‘Trump-world’ today.
To be fair to Mr Trump, one could reasonably say that reelection has been the top priority of every occupant of the Oval Office at this stage in his presidency — and especially if his party has just taken something of a drubbing in the midterms. However, the huge differences between, on the one hand, the relatively benign principles of his Hamiltonian post-1945 predecessors and, on the other, Mr Trump’s nationalistic and unilateralist world view together with his clear propensity to pander to a relatively narrow electoral base at home point to an increasingly turbulent, if not downright dangerous, road ahead.
Fourth, headlines really matter to Mr Trump — and he is very good, as we have seen on several occasions in the past (perhaps most notably with the launch of steel and aluminium tariffs in March), at turning the news flow around in his favour. As I wrote on 19 November, irrespective of the fate of the Mueller investigation, Democrat control of the House means that Mr Trump is going to come under yet more pressure domestically in the coming weeks and months — even if (as I think they will) the Democrats can resist the temptation to launch an impeachment motion. (And note that since I wrote that article, mainly focusing on Mr Trump’s alleged links with Russia, the Democrats have made it clear that they are also determined to look into possible business ties with Saudi Arabia in the light of his staunch support for Crown Prince Mohammad bin Salman (MbS), more on which below.) Trade is not, of course, his only recourse when he is looking for favourable headlines (immigration being right up there too); but it remains, in my view, at or near the top of Mr Trump’s list as far as investor interest is concerned.
Fifth and finally (and, again, at the risk of stating the obvious), these same considerations will continue to drive Mr Trump to say and do things which do not necessarily appear to many of us to be consistent with achieving reelection. Indeed, as I hope to make clear later in this article, he is even very likely to pursue policies within this overarching electoral context which run counter to one another! A recipe, if ever there was one, for renewed volatility in equity markets, with all its inherent risks.
…and an increasingly unfavourable economic context
“Which gets me on to Trumpenomics. Last December’s tax cut injected roughly $1.5tn into the economy. But where is the growth going? Some of it is showing up in continued jobs creation, which is chugging along at roughly the same monthly rate as for most of the past five years. The majority of it is heading into higher asset prices. There is little sign of the new investment, overseas capital repatriation or middle-class income growth that the likes of [Messrs] Kudlow, Hassett and Trump are trumpeting. Next year the stimulative effects of the tax cut will wear off fairly quickly.”
Edward Luce — ‘Swamp Notes’, Financial Times, 21 September 2018
Regular readers may recall that I am a long-standing fan of the FT’s ‘Swamp Notes’ (subscriber access only); but I particularly liked the article from which the above quote is taken, saving it at that time with this current article very much in mind.
Just two months downstream, it appears that Mr Luce may have been a trifle optimistic as to how quickly some of the sheen would start to come off the economy — at least from an investors’ perspective if the recent performance of the stock market is anything to go by.
Let’s also keep in mind that Mr Trump has repeatedly singled out the previously impressive performance of the stock market under his stewardship as proof positive of his self-professed prowess at managing the economy. So, this does matter, especially in the sense that, in his search for scapegoats, the Federal Reserve is likely to continue to be targeted by the President despite the associated risk of further unsettling investors — witness his efforts yesterday to blame Fed Chair Jay Powell for the GM lay-offs.
[Note: For readers with access to the FT and interested in more on the political implications of GM’s decision, I recommend ‘Donald Trump faces fallout of stalling US car industry’ by Sam Fleming and Andrew Edgecliffe-Johnson, published on 27 November. Reflecting on my earlier observation to the effect that some of Mr Trump’s moves would run counter to his re-election ambitions and to other policy steps, I was particularly struck by this quote from it:
“Mr Trump’s tariffs on imports from China and other countries have been more clearly negative, inflating GM’s raw material costs by $1bn”.]
This being said, I have to acknowledge that it remains an open question how close we are to the end of the economic cycle. But I am still totally in agreement with Mr Luce’s conclusion to his 21 September article, as follows.
“This presents a spectre for [Mr] Trump’s 2020 re-election campaign. Unless he can find some other source of fiscal or monetary stimulus, the economy is unlikely to be his friend. Can he persuade a Democratic-run Congress to sign up to a big spending bill on infrastructure? In theory yes. In practice, I very much doubt it. A Democratic House will have its hands full burying the Trump administration in subpoenas, televised hearings and possibly impeachment proceedings. It would take a Herculean feat of compartmentalisation for [Mr] Trump to negotiate bipartisan legislation while fending off multiple inquisitions into his malfeasance. Might he secure China’s economic surrender? Again, that is doubtful. Xi Jinping has as much, if not more, at stake politically as [Mr] Trump. His presidency-for-life might not survive a cave-in. What, then, would be the basis of [Mr] Trump’s re-election campaign?”
No big deal?
“America is enjoying what I think is the tail-end of the tax cuts. But investors are looking ahead worriedly to what will be a long, existential conflict between the world’s top two economies.”
Rana Foroohar — ‘Swamp Notes’, Financial Times, 26 November 2018
The answer to Mr Luce’s question could all too easily turn out to be, in part at least, escalating the US’s trade war with China (ultimately counter-productive though this may be).
I can understand why some to whom I spoke last week are among those who believe that Xi Jinping and Mr Trump will come to some sort of agreement when they meet in the margins of the G20 this coming weekend. After all, the former has enough problems at home just now (slowing growth, student and labour unrest, Uighurs etc) without having to cope with the potentially deeply damaging escalation of tariffs in January which Mr Trump is threatening. As for Mr Trump, even if he is oblivious of the damage escalation stands to do to the US economy and his re-election prospects (or believes that China would genuinely throw in the towel in time for him to effect a recovery), his love of ‘the deal’ may yet prove decisive this weekend.
In other words, I do not rule out a deal (and associated headlines which would certainly trigger an immediate uptick in investor sentiment). But if deal there is I am pretty confident, given Xi Jinping's limited room for manoeuvre politically, that it would be about as substantive, at best, as Mr Trump’s 12 June ‘deal’ with North Korea's Kim Jong-un. In other words, a temporary truce which leaves the current tariffs in place while postponing the threatened escalation pending further talks. Anything more than would be a major (upside) surprise.
Furthermore, I see no reason to believe that a truce would hold for very long. After all, we have seen agreements struck by the likes of Treasury Secretary Steve Mnuchin and Commerce Secretary Wilbur Ross only for them to fall foul of USTR Robert Lighthizer, a genuine trade expert and an uber-hawk on China. For my money, Mr Lighthizer is the real power in the White House when it comes to trade policy. Furthermore — and critically given that trade and national security have become irrevocably intertwined in ‘Trump-world’ — at least when it comes to China he appears to enjoy the full support of Secretary of State Mike Pompeo and National Security Advisor John Bolton plus a sizeable portion of the Pentagon ‘establishment’.
As if this were not enough, whether or not he has a second summit with Kim Jong-un I expect Mr Trump to become increasingly frustrated with what I see as an inevitable lack of progress with his North Korea agenda (which will not, in my view, prevent closer North/South relations as President Moon Jae-in continues to pursue his own agenda despite the risk of a backlash from Washington — see also 29 November addendum below). Equally inevitably, Mr Trump will look for a scapegoat here too — with Beijing fitting the bill nicely for its ‘failure’ to deliver Pyongyang.
Expert international relations commentator Gideon Rachman offered an incisive assessment of prospects for the summit in the 19 November edition of the FT (subscriber access only). He began by stating (correctly, in my view) that a Marxist would expect business interests to prevail and a meaningful agreement to be reached this weekend by the two presidents. Certainly, the business lobby in the US is pushing towards that end as another FT article — this one by Tom Mitchell and James Politi published on 26 November — spells out in some detail. However, he ultimately dismisses such an outcome in favour of what he refers to as the “realist” school of history’s likely conclusions, as follows.
“Strategic tensions have increased, alongside the trade rivalry. American military strategists fear that China’s programme of building military bases in the South China Sea has changed the balance of power in the region….
To demonstrate that the US has not tacitly accepted Chinese dominance of these waters, the US has stepped up naval patrols, with ships from the two navies recently coming dangerously close to a collision. Some Washington hawks also want the US to persuade its allies — in particular Japan and South Korea — to allow America to deploy short-range nuclear missiles in the region. In theory, this would be to deter North Korea; in reality, the message would be directed at China.
These military tensions make the US-China trade dispute much harder to settle than the Trump administration’s trade arguments with Mexico and Canada, neither of which are strategic rivals to the US.
It is this geopolitical dispute — rather than the economics — that make me think that the ‘realist’ assessment of US-China rivalry is most likely to be vindicated. So even if the G20 summit sees Mr Trump agreeing to defer his plans to increase tariffs on China, a trade truce may not last for long given this backdrop of growing superpower rivalry.”
I concur — and especially if I also throw Taiwan, about which I wrote again only yesterday, into the mix. To put it another way, I stand by the assessment set out in my 3 April article that the ‘best case’ scenario for China/US relations for the foreseeable future may prove to be one in which trade becomes the 21st century equivalent ofThucydides’s trap.
In that I have described this as the likely 'best case' it is at least implicit that, even if I see it as a low probability, I do not rule out something more serious up to and including military clashes of some sort between China and the US. Or, as Mr Rachman puts it in turning to his third school of history:
“But the personality and impulses of the US president make all firm predictions dangerous. If there ever was a walking, talking embodiment of the ‘accident theory’ of history, it is Mr Trump.”
All this being said, amid all the focus on China please keep in mind that it may not be alone in being targeted by Mr Trump on trade imminently. His seemingly visceral dislike of the European Union has always made it likely, in my view, that he will slap tariffs on vehicles imported from Europe at some stage (and I have never had much faith in the deal he struck with the President of the European Commission, Jean-Claude Juncker, in July). He has probably only been persuaded (by Mr Lighthizer primarily) to stay his hand thus far out of a desire for support from the EU and Japan dealing with China, not least at the upcoming G20 summit. Nevertheless, and irrespective of whatever transpires this weekend, GM’s recent announcement almost certainly increases the probability of Mr Trump acting against auto imports from Europe — and, quite possibly, Japan and South Korea.
Where war is more likely
“President Trump told me that if Iran does anything at all to the negative, they will pay a price like few countries have ever paid before.”
John Bolton (on Twitter), 23 July 2018
On several occasions earlier this year I have written about what I have referred to as “the POTUS premium”, ie Mr Trump’s unintentional elevating of the oil price thanks to his hawkish stance on Iran. Having over-estimated lately the probable impact of this, I now have to give the President some credit for his success in getting the oil price down again. He has, after all, persuaded Saudi Arabia not to cut production as the price has fallen — at least, for now; and his partial exemptions for some procurers of Iranian oil from the US sanctions brought in on 5 November have also helped. On the other hand, I don’t think he should take credit for lowering expectations for global economic growth and therefore demand for oil by starting a trade war with China!
Herein though lies another of possible Trump action which would run counter to one of his stated objectives, ie if he were to strike any sort of deal with Xi Jinping this weekend it would likely lead to at least a modest immediate uptick in the price of oil rather than the still lower price for which he is calling.
Nevertheless, even if the China/US trade war escalates further, I find it hard to believe that the oil price will not recover somewhat early in 2019. Consider.
First and foremost, the current price of Brent crude of around USD60pb falls significantly short of the USD70pb which is widely considered to be the minimum Saudi Arabia needs to balance its budget. Even if (as some believe), there has been a behind-closed-doors oil-related deal between the Trump Administration and the Saudi regime to try to protect MbS over the murder of Jamal Khashoggi, Riyadh is only likely to put its own interests first (rather than Mr Trump’s) and is more than wise enough to realise that the President’s ability to prevent Congress from sanctioning Saudi Arabia over the murder is very limited. Indeed, as Andrew Roos Sorkin points out in a recent article in The New York Times, Mr Trump’s very public support for MbS may actually run counter to Saudi Arabia’s overall economic interests.
Second, although I am confident that MbS and Mr Trump will meet in the margins of the G20 — and that oil will be on the agenda — it now appears less likely in the wake of the Kerch Strait clash between Russia and Ukraine that the latter will meet President Vladimir Putin. But we may be very confident that the Russian leader will meet with MbS and that they will, as they have in the past, look to pre-cook Opec’s next move before the cartel meets on 6 December. Russia certainly has no interest in a lower oil price; and I can’t see at this stage that Mr Putin believes that he has anything to gain by accommodating Mr Trump in any case.
Third, although the future of the current exemptions on procuring Iranian oil is, overall, unclear, it does appear very likely that the number of countries with waivers will shrink from eight to five at the end of the year. Furthermore, I find it hard to believe that the squeeze on Iran won’t be tightened still further as we move into 2019.
Fourth, although Mr Trump is undoubtedly correct to see a lower oil price as a boost to ‘middle America’, it may not be a good think for the US economy overall. At the risk of testing readers’ patience by yet again citing the ‘subscriber access only’ FT, a 27 November article by Brendan Greeley is well worth reading in this respect and is neatly summed up by the following quote:
“Cheap oil is still great for American drivers. But it also discourages American oil firms from drilling new wells in West Texas shale. What Mr Trump does not seem to have grasped is that the country doesn’t respond to the price of oil the way it did even a decade ago. Sad drillers now have a bigger effect than happy motorists.”
Of course, it may be some time before the oil and gas lobby and the likes of National Economic Council Director Larry Kudlow (who ducked a question on oil prices at a press conference earlier this week — which Mr Bolton then also avoided!) can persuade Mr Trump of the error of his ways (if at all). But even if the President persists in his present stance, I am very doubtful that he will get his way even if Iran and the US manage to avoid a direct military clash.
I want to be absolutely clear that such a clash is not my base case. But I am very mindful of Mr Bolton’s (and Mr Pompeo’s) hawkishness on Iran — despite his rowing back somewhat on earlier calls for forced regime change — and on Mr Rachman’s assessment of Mr Trump relative to the ‘accident theory’ of history. It was, therefore, with considerable interest that I read an article earlier today from The New Yorker, forwarded to me by a friend, in which Seth Harp reports on the extent of the US military build-up in eastern Syria and reflects on the possibility that this may have far more to do with Iran than the greatly diminished threat now posed by Islamic State.
Most importantly — and to come around full circle — as I opined in my 23 October article, bashing Iran resonates powerfully with Mr Trump’s critically important white evangelical support. Despite the obvious risks around the oil price, Iran therefore remains top of my list should the President decide to resort, in his quest for re-election, to a ‘wag the dog’-type action.
Armageddon vs Volmageddon
“Financial crises always start the same way. Loose monetary policy leads to an increase in debt and a rise in risk-taking. Over-confident financiers, lax regulators and politicians desperate to please voters operate in this toxic environment until a bubble eventually bursts, taking the financial system down with it.”
Rana Foroohar, Financial Times, 20 May 2018
There is no shortage of political risk looming on the near horizon — the aforementioned Brexit, Italy (and, related, the European Parliament elections) and Russia/Ukraine as well as, possibly, the Korean peninsula; general elections in Argentina, Belgium, Canada, Greece, India, Indonesia, Ireland, Israel, Portugal and Ukraine; important local elections in Turkey; and, needless to say, a highly volatile Middle East irrespective of Iran.
However, barring the proverbial ‘black swan’, the ‘big two’ will remain:
- China/US relations plus Mr Trump’s broader trade agenda; and
This is, in fact, much as things stood when I wrote the following in a report for one of my clients back in mid-February:
“The turbulence which we saw in financial markets in late January/early February could not reasonably be attributed to political drivers except insofar as the successful passage in the US at the end of 2017 of the tax bill contributed to market sentiment over the likely trajectory of interest rates this year. It was, nevertheless, a (timely, in my view) warning that the near-consensus ‘Goldilocks’ scenario for the global economy as a whole for this year…is by no means a ‘slam-dunk’.”
With just five weeks of the year remaining I guess one could say 'so far, not so bad'. But we do now appear to be much closer to a potential crunch point in one or other (or, possibly, even both). And at a time when, I think it would be fair to say that ‘Goldilocks’ is nevertheless on life support with scant hope of a recovery.
With all due respect to the Federal Reserve (whose task over the coming months promises to be nothing short of daunting), it is Mr Trump’s political agenda, not US monetary policy, which is, in my view, most likely to kill her off completely.
Addendum: 28 November
Fed Chair Jay Powell spoke at the Economic Club of New York a few hours after my article was first published. Investor reaction to his measured words demonstrated (to my mind at least) the extent to which markets are vulnerable to headline-driven shifts in sentiment. My personal view is that his speech is not really a reflection of a firm decision by the Fed to trim back on interest rate rises so much as a measure of the politically driven uncertainty with which it is grappling.
Addendum: 29 November
Having only briefly touched on the Korean peninsula and Moon Jae-in's pursuit of an agenda which is not entirely in tune with that of the US Administration's I subsequently came across this article in The Atlantic by Uri Friedman which explores this in some depth.
Image credit: 'Goldilocks R.I.P. (Part 1)' www.zerohedge.com