Strategic Global Intelligence Brief for October 4, 2018

Short Items of Interest—U.S. Economy

Jobless Claims Fall
Whenever there is a major natural disaster, the expectation is there will be a series of economic ripples. The first of these will be a surge in the number of people claiming unemployment since many will lose their jobs—either temporarily or permanently. The arrival of Hurricane Florence was supposed to wreak havoc all along the Carolina coast, but it was not quite as devastating as had been expected. Damage was indeed vast, but it was not the kind that shut companies down—instead they faced the prospect of cleaning up from the flood. That meant many people kept their jobs and engaged in the repair and recovery. The new claims numbers were down further than expected and the storm's impact on employment will be muted.

Even the Doves Want Higher Rates
Charles Evans from the Chicago branch of the Fed has a reputation for being a real dove on the subject of rates. Throughout the years of the economic recovery, he has been an advocate for lower and lower rates. He held that position even as many of his colleagues advocated for a tighter market. He has now joined the ranks of those who are worried more about inflation than growth and suggests the Fed is on the right track. He has long been a critic of speculative borrowing to invest in the market and favors making that kind of borrowing much harder to access.

Factory Orders Up—Thanks to Aerospace
This is another month where the factory data will have to be taken with a little grain of salt. The numbers are up by more than has been the case in the last 11 months. It is certainly adding to the good news coming from the U.S. industrial community. The only fly in the ointment is the fact that much of this growth has been attributed to the performance of the aerospace community. This has been one of those months for good airplane sales. That always causes this data to swell. The good news is there has been solid growth in the other industrial segments as well.

Short Items of Interest—Global Economy

IMF Warns Japan
Next year, the Japanese consumer is going to get hit with an expanded consumption tax. The International Monetary Fund (IMF) is warning this will likely result in slower economic growth at a point when Japan will be least able to support it. It is expected Japan's yen may be adversely affected by trade and tariff wars and the domestic economy will be counted upon more than ever. The country needs more cash in its coffers. It has had this tax hike planned for a while, but the IMF is suggesting it be offset to some degree by a spending hike. The problem is that spending more only worsens the budget problem the tax hike was supposed to address.

Russia Accused of Mass Cyber Attack
The Russians are vehemently denying the GRU [Russia's largest foreign intelligence agency]

had anything to do with the series of cyber attacks that hit targets all over the world earlier this week. In truth, these seemed somewhat random as they affected everything from the subway system in Kiev to the World Anti-Doping Agency and a small U.K. television station. The kink to the GRU was established by the methodology used and some of the identified origin. It seems to have been an experiment to determine just how vulnerable these targets really are. The conclusion is they are very vulnerable.

What Does African Infrastructure Need?
There are few government actions that relate as closely to the economy as infrastructure. Africa has an issue as do most areas of less development and it has to conjure up a plan to address it. The problem is actually worse in Africa as much of the existing network was never designed to help the domestic economy—it was just there to expedite the goods transfer from Africa to the west and colonial powers. Today, the continent needs a focused and multi-national commitment to build roads, railways and airports that really do connect the whole of the continent, but this will be a very complex undertaking to say the least.

Oil Companies Resist EU Efforts on Iran
When the U.S. decided to pull out of the nuclear deal with Iran, the majority of the European states that had been party to that deal were angry and vowed to find ways to subvert the U.S. action. They wanted to maintain the relations they had been establishing with the Iranians. After failing to convince the U.S. of the need to do so, there were plans hatched to allow business to continue. The problem is the big oil companies are not at all interested in cooperating with the EU as they do not want to run afoul of the U.S. and all the fines and punishments that have been promised.

Analysis: From the start, the motivations for an Iran deal have diverged. The U.S. looks at Iran as a major enemy and a threat to most of the aims for the U.S. in that region. The Iranians are hostile to close U.S. allies such as Israel and Saudi Arabia. The Iranian government has also been active in supporting movements the U.S. has been fighting. It backs the Hezbollah in Lebanon in its attacks on Israel, the regime of Bashar al-Assad and the Houthi fighting Saudi Arabia in Yemen. The list goes on and on. The U.S. has always made it clear it would like to see Iran play a far less hostile role in the region, but these requests and demands have fallen on deaf ears.

Europe has far less at stake with these issues. Israel is not held in such high esteem by Europe as there is considerably more sympathy for the Palestinians. The Europeans are not as engaged with Saudi Arabia and oppose what the Saudi Kingdom has been trying to accomplish in Yemen. The Europeans have been more interested in stopping the development of a conflict that could end with nuclear weapons exchanges. They believe the Iranians when they assert they have interest in nuclear weapons simply to deter attacks from Israel. The U.S. doesn't believe or accept that rationale and insists that Iran has aggressive tendencies.

Most importantly, the Europeans want access to Iranian oil and have already invested billions in the Iranian economy. The U.S. policy of sanctions against Iran jeopardizes these business relationships and gives the Europeans more reason to want to undercut the U.S. policy. The threat from the U.S. ranges from fines to prohibiting business relations with any company that works with Iran and U.S. contacts. The major oil companies and others are refusing to engage with the activity suggested by Europe and will pull out of Iran as quickly as possible.

This all infuriates the European authorities. They have all but accused the U.S. of engaging in blackmail. The U.S. has been unmoved and continues to assert that Iran has the ability to end this economic pressure by simply agreeing to curtail support for insurgencies and terror organizations. The U.S., for its part, maintains the Europeans are naïve and have allowed themselves to be manipulated by the Iranians. If the oil companies do not elect to challenge the U.S. on this issue, the European attempt to break the sanctions policy will fail pretty completely.

U.S. Moves to Counter Chinese Influence
The U.S. has just managed to overcome the usual bipartisan rancor to pass a $60 billion development package aimed at providing development funds for other nations. This is highly unusual and unexpected given the kind of rhetoric that has been emanating from the U.S. of late. It has been a constant in President Trump's speeches that only America matters and most of the foreign aid efforts have been ridiculed as a waste. This has been the position taken by many in Congress as well. That begs the question as to why this attitude should change now. The fact is that $60 billion is not an enormous sum and will not alter the path of the developing world all that much, but it is a gesture, and one that may be repeated.

Analysis: The motivation for this $60 billion is not altruism or a sudden interest in the plight of the poor. This is a move to counter the growing influence of China in the developing world. It is obvious that priority will be those nations courted by China or likely to be. If these nations are clever about all this, they will be able to play the game that regimes played during the Cold War when they played the U.S. and USSR against one another—getting both nations to spend far more than they originally intended to. The U.S. is likely to put much of this cash to work in Africa as this has been where China has been making inroads and where the countries of Africa have experience in playing one donor off against the other. The fact is that money alone will not create the kind of development these nations seek.

Investors Back on a Roll
The bond markets went on a tear yesterday and showed gains not seen since 2011. It was as if a lid had been removed from a boiling pot. The rally is expected to continue into the week. The sense is that all the watched indicators are behaving in a generally positive manner and more good news is expected in the weeks to come. The latest set of encouraging news came from an area that had been causing the most concern—trade. Prior to this week, it seemed that President Trump was bound and determined to start trade wars with friends and foes alike. It was one thing to be irritated with the behavior of the Chinese, but it has been hard to reconcile the belligerent attitude towards longtime allies such as Canada, Mexico and the nations of the European community. Not that the U.S. has never had cross words for these allies in the past, but the disagreements were those that take place between friends. The mood under President Trump has been hostile and, in many cases, these allied nations were coming under more pressure than states that have been clear enemies of the U.S. in the past and which remain enemies in many ways today. The deal to rework NAFTA into the USMCA has been taken as a sign of what can really be expected from the Trump White House once all the social media bombast is stripped away.

Analysis: The ebullient investor mood seems connected to three factors—at least for the time being. The first and probably the most secure is the sense that consumers will be ready, willing and able to play their traditional role in the U.S. economy for the remainder of this year and into next. The jobs data to be released tomorrow will show unemployment still remains at a record low, confidence in the job sector is still high and wages are still starting to rise a little as employers are compelled to pay more to find new employees and keep the ones they have. The really good news is the low rates of joblessness have not been all that inflationary (although there are some signs this will not be true much longer). The latest data from the Purchasing Managers' Index reinforced this notion of renewed consumer enthusiasm with the data showing spectacular growth in the service sector—the place where 80% of Americans work. By most accounts, the consumer is in the mood to spend at a decent rate in this holiday season.

The second motivator for the investment community seems to be the progress made in terms of trade deals and relationships. The prospect of the U.S. breaking ties with its major trading partners had been filling analysts and investors with dread. The deal struck with Mexico a few weeks ago had many expecting a rapid rework of NAFTA, but then it got bogged down. Now that the deal is done and the changes are minor, there is renewed hope other trade disagreements will be similarly worked out. China is the most challenging of these, but there is general acceptance that China has been getting away with market manipulation for some time and needed to be challenged. The markets will really start to boom when there is a pact signed with Europe. Now, that seems possible.

The third factor motivating the investor is the absence of the immediate threats that were thought to have manifested by this time. The inflation issue is still out there, however. Few expect the problems to go away, but the issue is not yet imminent. The expected wage inflation is not appearing yet, but neither are the big commodity-based gains. Oil prices have gone up by around 24% since the start of the year, but this has yet to be crippling as far as the price at the pump. Steel and aluminum prices have risen by over 40% due to the 25% tariffs imposed on imported metal, but these costs have not been passed on. All of these price hikes are still coming, however, and consumer reaction will likely manifest later this year or early next.

Did President Trump Back Down?
The assessment of the USMCA is now in full swing. As with most agreements between various nations, there are different interpretations—who are the winners and who are the losers. Trump's approach to trade and global business has been decidedly hostile—at least as far as the rhetoric has been concerned. This has been the administration of "America First." That implied no deals would be allowed to stand that did not overtly favor the U.S. This new pact is not the dream agreement from the perspective of the committed free trade advocate, but it is not a protectionist success either. It is a compromise as all of these deals are. The countries that sign on to any trade deal are looking to get the most they can from it without giving up too much.

Analysis: The U.S. did what it has always done—set priorities around which to bargain and negotiate. The most important part of the agreement was that which dealt with the auto sector. President Trump made lots of promises to the auto workers; some of these needed to be kept. The Canadians were somewhat amenable to those auto sector changes as most of them would affect Mexico more than Canada, but the key demand for them was dispute resolution. Canada has been furious over the capricious attacks Trump launches. It refused to give up the system that allowed these plans to be challenged. Canada was protective of their dairy sector, but it found wiggle room at the end.

The fact is trade agreements are the fruit of negotiation. This is something President Trump claims as an area of expertise. His approach is far more belligerent than those who have gone before, but that doesn't make it any less effective in many situations. It is a stick and carrot policy or maybe a stick and a bigger stick. In the end, there was a carrot or two for Mexico and Canada. Both were also eager to avoid the stick. The deal done here seems to set up future deals with Europe and a variety of other trading partners, but it is not yet clear what this means to the Chinese.

And Then There Were Four
She was a funny little barn cat that was living at my stepson's place. It seemed like she had been put together by a committee. Her back legs looked like rabbit legs and were too long for her—she could never quite sit normally. Her face was tiny and she kept that kitten look all her life. It appeared she was deaf as a post and her momma cat never let her out of sight as she tried to keep her close to the house. My stepson was worried about her surviving and convinced us to take her. Once we got her to the vet, we learned her hearing issues were temporary. The vet dug a big wad of cow dung out of each ear—she was apparently in a very wrong place at a very wrong time. After that, she had the selective hearing all cats seem to possess. She remained very petite and fit her name as she was just a "snip" of a thing. Most of the time, we called her Snippy.

She was the first cat to greet and accept any newcomers to the household. She was always very curious about the new cats and liked checking out new people as well. Over the years, there were health scares but she always fought her way back from these issues—losing most of her teeth in the process. The last year has been tough as she was slowly starting to fade, but throughout she remained a cuddle buddy. Yesterday, she just reached the end. We did what all human cat companions are called upon to do. It was a very sad day. Now, she has joined her much loved predecessors in the little pet cemetery (Smudge, Squeak, Scamp and now Snip). The remaining four are getting a lot of attention as we remember to treasure every moment we have with these fascinating creatures.