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Strategic Global Intelligence Brief for July 26, 2018

Short Items of Interest—U.S. Economy


GDP Revisions Lowered as Newest Data Disappoints
The next GDP report doesn't come out until July 27 and already there has been some second guessing. A few weeks ago, there was some consensus around the notion that growth would be at least as high as 4.5% and perhaps 5.5%. This was slated to be the most robust quarter seen in the years since the recession started. Now, these optimistic assessments are falling by the wayside as the last-minute data is showing weakness. The estimates fell by an average of .5. That reduced the range from 3.5% to 4.5% as opposed to 3.8% to 4.9%. The bottom is not falling out of the economy, but it was supposed to be more impressive than this with the tax cuts pushing more growth. Part of what made analysts reconsider was weakness in terms of exports and global business as a whole.

Stutters in Housing Market
There was a substantial reduction in the pace of new home sales last month, the worst performance in eight months. The decline from the month before was 5.3%, but this has yet to create a lot of concern. The market seems to be cooling a little, but given that it was on the verge of overheating, this may be a good thing. The most pressing issue as far as new homes are concerned remains the labor shortage. In many of the hotter markets, there would have been more sales but for the fact that nobody can be found to actually build these homes. The labor shortage is acute in some areas but generally a problem everywhere. Most assume that numbers will improve through the summer, but this is getting close to the end of the best time of year for home purchasing. The housing market tends to slump at the point that kids go back to school as people want to be settled in their new homes before that happens.

A Few More Layoffs
First-time recipients of unemployment compensation rose just slightly in the last month, but this has been seen as seasonal activity and not reflective of what has been taking place in the greater labor market. Summer is when the auto sector closes plants for retooling and idled workers are temporarily laid off. There is also the flux that comes with the end of the school year, the start of all the summer breaks and the impact these have on kids who work summer jobs.

Short Items of Interest—Global Economy

Good News We Think, Maybe, Perhaps
The reversal of direction manifested by President Trump in his meeting with the President of the European Commission Jean-Claude Juncker has Europe heaving a sigh of relief, but this has been tempered by the fact that nobody had time to prepare any specifics. What is the timetable for agreeing on these new trade rules? When tariffs might be applied and what would provoke them? What does President Trump want the Europeans to do as far as opposing China? Presumably there will be time for the U.S. and EU to work all this out before another bombshell is dropped.

Profits Reappear in the Oil Sector
The average per barrel price jumped by more than $25 in the last several months. Now, that is showing up in the statements from the oil companies. They are not seeing record profits by any stretch, but they are up substantially from what they were earlier in the year. That is good news for those that sell into this sector as well as for communities that are tied to the oil and gas industries. 


Reforming the WTO
Commentary on this was almost lost in the discussion between Trump and Juncker. There was agreement on trying to reform the World Trade Organization (WTO) as opposed to just abandoning it as Trump had suggested. The issue now is to try to get back to rules-based trading to avoid the accusations the WTO is biased. The level playing field alarm has been sounded all year. This may be a first attempt to move the dialogue. 


Trump and Junckers Meeting
Here is an example of how fast-moving and confusing all this can be. As this article was being completed, the meeting between Trump and Junckers of the EU had not taken place, but nobody was expecting anything other than a reiteration of the positions both men had already staked out. Suddenly, everything changed and the trade war that everyone had expected was postponed. Maybe for a day or maybe permanently—nobody really knows. The challenge is that it remains a little tricky to decipher the strategy. 


The real target for the U.S. is China. There is more than a little justification for that position. China maintains a huge trade surplus as far as goods are concerned. They routinely steal intellectual property, manipulate the system to favor their exports and throw up many barriers to U.S. trade. China is the nation that should be attracting global attention, but they often get away with their actions as too many states do not want to risk losing this market. If one reads the comments by Juncker and Trump, there seems to be a method to some of this latest madness. 


It looks as if this is what the U.S. had been seeking from the Europeans all along. There have been references to this in the past as well. When the steel and aluminum tariffs were put in place, there were hints that Europe could avoid them if they would back the U.S. in its efforts to address China. It seems that Juncker and the EU may finally be prepared to link with the U.S. to put additional pressure on China. 


None of this has been explicit however. These threatened tariffs could be back in play tomorrow, but for now, the crisis with Europe has at least been delayed. Most of the analysts are chalking this up as a European victory, and with some justification. The fears had been widespread and global markets were reeling over the prospect of U.S. tariffs on a wide range of European products such as cars, food and industrial machinery. Europe was not sure how to react. There were diverging strategies with some taking a very hard-line position (Chancellor Merkel and President Macron) while others were trying to be cooperative to some degree (the new regimes in Spain and Italy). There are few that have any real sense of how to manage President Trump—Macron tried to play up the personal card and has been rejected every time, while Merkel has been stern and implacable. 


Analysis: One thing has started to become clear about President Trump. Everything is in play all the time. Every statement is only good for the moment and can be reversed as quickly as it developed. The rhetoric and angry accusations have next to nothing to do with the actual deal making—he means that bombast for his core supporters and then reverses course if that seems appropriate. Twenty-four hours prior to the meeting with Juncker, he had been in front of a very pro-Trump audience thundering on about the unfair deals with Europe and his determination to set it right. Then, he abandons that whole effort in exchange for some vague promises to work on reducing trade barriers for U.S. goods coming to Europe and European goods coming to the U.S. The important point to gather from all this is that he knows his supporters very well. They cheered wildly when he attacked Europe. Now that he has made nice with Europe without gaining a single concession, they are cheering that wildly as well. 


This is not how this diplomatic game has been played in the past. His style most definitely rubs people the wrong way, but it also must be pointed out that many of these positions have been ossified for years. The EU has been making supportive noises about allowing more U.S. access, but not much other than happy little conferences with smiles and no commitments happens. President Trump shocked the EU to its core and suddenly there appears to be progress. Granted, the EU has not given anything tangible yet and they may not. But it seems likely that some continued attempt to mollify Trump will be made just to avoid the kind of disruptive brinkmanship that has dominated the last several months. 


What Is at Stake for China and How Will They React?
The prospect of a combined effort from the U.S. and Europe to alter China's behavior is causing concern for China, although there hasn't been much formal reaction from Chinese officials suggesting they are worried about this. There have been similar threats against China for many years. In the end, the market opportunities beckon and trade takes place anyway. What is likely to be different this time? 


Analysis: Part of the change is that China has never dealt with someone quite like President Trump. He has been a real bull in their China shop and has made these trade issues personal. He has been willing to undertake a lot of risk to pressure the Chinese. It has now become a matter of who has the most leverage. The tariffs that China has declared on U.S. farm output are usually enough to get the U.S. to back down as this group of farmers and affiliated industries have considerable political clout. This time, there have been defensive reactions that may allow the U.S. to stay the course—bailouts for the farmer this year to the tune of $12 billion. Now there is the arrangement with the EU and the assertion that they will be buying a lot more farm output from the U.S. than in the past. If they really do follow through with that promise, the U.S. farmer will not feel the impact of the China tariff attack to the same degree. 


China needs the technology and industrial sophistication of either the Americans or the Europeans. In the past, they have played the two off against one another. If they are now working in concert, the impact on China will be significant. They may well start to seek ways to accommodate the desires of both of these trading partners. 


Imran Khan Finally Gets His Chance
One way or the other, Pakistan is headed for a new era unlike anything it has seen for years. Whether that era will be successful remains to be seen, but for the first time, the country will not be led by one of the two dominant political families of the country (Sharifs and Bhuttos). Imran Khan has been trying to reach this position for many years. In the last election, he finished a distant third and was thought to be leaving politics altogether. He has always been far and away the most charismatic of candidates as the country's former champion cricket player. But he never seemed to be able to move past his fame and personal appeal. This time, he focused on building alliances with important factions within Pakistan. That included the still very powerful military. However, he has denied that he is close to the security services. They have tried to soft-peddle their support, but there were reports that elements of the military had been pressuring voters to support him at the polls. 


Analysis: There will be challenges to the vote as the opposition parties assert they were discriminated against at the polls. It would be unusual if there had not been this kind of meddling, but it doesn't appear to be any worse than has been the case in prior elections. Even the opposition admits they have little chance of succeeding in their appeal. The big loser in this campaign was Nawaz Sharif as he was forced to campaign from jail at times as he had been convicted of corruption. This was the issue that motivated the bulk of voters—a sense of being completely fed up with the rampant corruption. 


Now that Khan has the prize he has sought for these many years, he will face more than a few daunting tasks. The list of highest priorities is very long. He has to find a way to galvanize the weak economy and attract investment while coming to grips with the terrorism practiced by the Taliban and other Islamic radicals in the nation. The elections themselves were targets of several bombing campaigns that killed hundreds. This violence inhibits foreign investors and even forces the domestic businesses to look outside the country for expansion opportunity. Corruption is rife—he promised an end to it during the campaign. This has been the promise of every leader that has taken power over the years; however, none have been able to do much about it. It pervades the country from the bottom up. There are even those who are supporters of Khan who have been accused of being part of the problem.
There are also many issues with Pakistan's neighbors to contend with. There had been overtures between Sharif and Narendra Modi of India at the start of Modi's rule, but these faded. There is still a great deal of tension over the disposition of the Kashmir; Khan will be expected to weigh in very soon. The connection between Pakistan and Afghanistan is a complex one. The intelligence service in Pakistan has long backed the Taliban, which alienates the U.S. They see the Taliban as a buffer against the Indians. Then, there are the relations between Pakistan and China, as well as with the U.S. 


Pakistan is far too large and strategically significant to ever be labeled a failed state, but there are elements of this status that any new leader will have to contend with. Lurking behind the civilian leadership is always the threat of a military takeover as has happened many times in the past. The current situation favors Khan as he seems to have the backing of the army, but it is still tenuous. If there is some kind of security threat, the military can easily use that pretext as a reason to seize control. Khan can't appear to be subservient to the military, but they have to support him enough to continue to back him. 


Potential Impact From Tariff and Trade War Shows in Earnings Reports
There have been many comments regarding the real impact of trade wars and tariffs on the business community, but many have to be taken with a certain grain of salt as these have been meant to influence the debate to some degree. To get the full flavor of how a business looks at these issues, it helps to look at their most influential writings—their earnings reports. Most of those that have been issued in the last few weeks have been warning about reactions to the trade issues. They are anticipating serious disruptions to their supply chain. That will result in either trying to push cost increases down to their suppliers or perhaps trying to pass that hike on to the consumer. The latter step is the last resort. That means those suppliers will be getting the brunt of the impact. 


Analysis: It is abundantly clear that trade issues are starting to hit the forefront as far as strategy is concerned. The companies know full well that patterns will be disrupted and they will have to adjust. That adjustment will add cost. At some point, that will impact the wider economy as well as the consumer. 


Touring the World Is Easy
Yesterday was one of those days that remind me the world can be a pretty small place, and a diverse one. In the time it took to get from the Dallas Love airport to my hotel room, I was able to "visit" Nepal, India, Russia and Turkmenistan. My Uber driver was a guy from Nepal who had lived many years in India before arriving in the U.S. where he has also lived many places and started several businesses. He has operated a Motel 6 in Oakland, a restaurant in Wichita Falls and a transportation company in Dallas. We talked food and culture. He observed that Americans are far more diverse and tolerant than people back home in Nepal or India. 


When I got to the hotel, the young woman behind the desk was Russian and her compatriot was a young lady from Turkmenistan. Once again, we talked food and what brought them to Dallas. Both had married men who had been transferred to Texas. The Russian woman married an engineer from Dallas and the woman from Turkmenistan moved with her husband from their country to Texas to take a position in the oil fields. Guess what—we talked about food! Sense a theme here? It struck me that all three were still very excited and supportive of the new country where they lived. All echoed the same sentiment—this is a land of opportunity and few barriers. The Nepalese guy stated he would never have been able to start a business where he had come from as Indians are deeply hostile to those from outside the country, such as a Nepalese. Both of the women at the hotel desk were quite attractive and stated that back home they would have never have been allowed to be anything else. Here they were both training for careers in hospitality management and were no longer seen as just pretty faces. Both commented they were shocked at how polite everyone has been to them. Both have been here for almost eight years.

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