Trade War, Commodity Prices and Inflation, N. Korea…Now Italy, Mid-Year Noise?

“Politics is the art of preventing people from taking part in affairs which properly concern them.”            Paul Valery  (French poet, essayist and philosopher)

Lots of Noise out there, it’s keeping us on edge and frightens us not to pay attention as loud as it is, but perhaps we should not pay attention. The noise started in 2016 on the political front after a surge of refugees hit Europe in 2015. Fears grew that the Dutch would vote overwhelmingly populist, it didn’t, then Macron had a sweeping victory over the National Front in France to much relief, and the big surprise was Brexit where the populists came through and not to forget the unexpected Trump victory. Now we have Italy as well as Poland, Hungary and Austria. Italexit is the buzzword and yet one can only imagine that even the Italians know that leaving Europe would be far worse than the collapse of Lehman Brothers on international markets and economies and livelihoods. Italy has hardly recovered from this crisis. So noise?

This post was started March/April when commodity prices were roaring and trade disagreements and new tariffs were implying trade wars developing. Inflation seems to reflect more commodity prices rather than increase of wages. Commodity volatility can imply that inflation will remain elusive. Maybe we have to be careful what we wish for–inflation-wise–costs rising more than incomes can cause more discontent than trying to minimize debt exposure. Worse of all, esp. for those sitting in Germany, is the speculation that the Euro and even the EU are failing experiments. It has kept the peace which is a fantastic achievement!

So with all this noise, speculation on Italexit, new governments in Spain and Italy, the ever-reliable Merkel being challenged at home and abroad. It seems Merkel and the European governments will have to come up with a stricter, yet humanitarian policy for the scores of refugees in order to further and maintain peace.

Let’s re-visit the 2018 Unimaginables from December 2017. So far most of the ideas have remained unimaginable and outright wrong, but how much longer?

Now what can happen in 2018 that most cannot imagine (published December 2017):

Unimaginable #1: More of the Same – Business as Usual — Markets continue to rally including the bond market. 

2018 has introduced volatility into the equation, but it has not really changed the longer term picture. Synchronized global growth was the excitement at the turn of the year. That has diminished as politics take the drivers seat and challenge the status quo of doing lucrative business in the USA without any offers of reciprocity.

TRADE WAR:

On May 31, 2018, www.supchina.com: Trade War or Trade Mission (Navarro)? South Seas Navigation free? On May 30, 2018, www.supchina.com put it nicely in their daily:

“Low Signal, High Noise is a description of media and market indications of low signal-high noise situations. The descriptions goes as follows:

“The signal-to-noise ratio is a scientific measure that compares the level of a desired signal with the level of background noise. Engineers use this ratio for electrical signals, but in the time of Kim Jong-un and Donald Trump, the concept is very important for the news business. U.S.-China trade tensions and whatever you call the developments on the Korean Peninsula are two of the biggest news stories of the year, and both are generating a din, a hubbub, a clamor, a racket, and a commotion. But that’s really all we have. The parties involved are making a fuss, but nothing has really changed. America’s economic ties to China are much as they were last year, while Kim Jong-un still has his nukes and his gulags.” www.supchina.com, 30May2018

 

Business as usual? I think many would say that America’s economic ties to China are increasingly volatile and will remain so until America is convinced China is paying the really true value for American goods, services and know-how.

NAFTA

NAFTA is on the verge of breaking down, it seems like the initial lack of noise coming from Mexico and Canada was perhaps frustration, but was it also a bluffing exercise? Now retaliation measures are being announced from Mexico and Canada. The uncertainty will keep the markets on edge for now.

VOLATILITY: HIGHER THIS YEAR, BUT TRENDING LOWER — “BUSINESS AS USUAL?”

Volatility in the EuroStoxx is higher than last year due to the Italian scare, but is trending downwards! The VIX is heading for those 2017 lows…
Source: WSJ-The Daily Shot (May 29, 2018)

Market volatility is gradually abating despite the lingering macro risks- S&P500 (June 4)

Source: WSJ-The Daily Shot (June 5)

Unimaginable #2: Inflation remains elusive such that rates stay low and bonds continue to rally AND economies compete to lower taxes! 

Inflation could remain elusive!  From Joe Weisenthal of Bloomberg (June 4):

“It’s been a cliché for awhile now, going into each month’s non-farm payrolls report, that the number to really watch was the average hourly earnings figure. The reasoning was that the economy was more or less at full employment, and so the only question was if and when that would translate into a major acceleration in wages. But after Friday’s excellent report, maybe it’s time to go back to just watching the headline job creation figure. The 223,000 positions added in May were well above the forecast of 190,000. Beyond that, economists have been saying for awhile now that even if growth momentum continues, it would be hard to sustain monthly job gains this large, on the theory that the U.S. is running out of available workers. But what if we’re not running out?223,000 new jobs don’t exactly suggest a shortage of people ready to go to work. So keep an eye on the headline number to test if one of the basic assumptions about the economy is correct. One other thing: While the average hourly wage number did beat estimates and pick up to 2.7 percent year-over-year growth, that’s only the best figure since January. There’s still no sign of some disorderly upward wage spiral that would suggest an extremely tight market.”

 

First US tax reform, now Italy!?! The new Italian government is getting ready to propose a 15pct Flat Tax. Will this create finally some tax receipts, but more importantly, economic growth?

Unimaginable #3: European growth outpaces the USA turning negative interest rates positive, narrowing the differential keeping the EURO strong with little volatility.

This Unimaginable actually looked imaginable at the peak in markets and economic indicators in January this year. Most headlines discuss now easing, but fail to emphasize how the PMI indicators stay above the 50pct mark, indicating continuing growth!

Is sentiment in the Eurozone stabilizing at current high levels? After the latest Italy-driven market swoon, confidence could deteriorate. (WSJ-The Daily Shot)

Top: Eurozone Consumer Confidence / Middle: Eurozone Business Climate / Bottom: Eurozone Economic Sentiment (Peak was January 2018)
Source: WSJ-The Daily Shot

You wonder if a flat tax in Italy will actually increase tax income and therefore investment? Unimaginable!

New Prime Minister Conté is taking a tough stance, seeking fairness across Europe.

Unimaginable #4: Consolidation across industries continues to drive the markets, ‘Mittelstand’ companies combine forces and get larger…

The ‘Mittelstand’ in Germany is closely looking at the Startup scene for digital leverage. Consolidation looks like it will actually be in European banks and US Tech!

(FT, 04June2018) SocGen and Unicredit looking to merge? (paywall)

Some speculate that once these two merge, Deutsche Bank will be the new bank’s next target?!?

(FT, 01June2018) Deutsche Bank’s systemic risk puts Italian lenders in the shade (paywall)

“The bigger picture: Banks are bulking up.(Finimize,June 4, 2018)
According to reports in May, British bank Barclays was considering an approach for rival Standard Chartered. Then on Monday, the UK’s Clydesdale and Yorkshire Bank Group improved its acquisition offer to shareholders of Virgin Money. Some European banks are under pressure to get bigger via mergers or acquisitions in a bid to be more competitive on the global stage – a number have struggled to grow profits while their US competitors have made hay in areas like trading stocks and bonds.”

Microsoft acquires GitHub  for $7.5bn (business insider)

Unimaginable #5: Oil prices approach $35! (2017 repeat)  – I remain a lonely oil bear…

Here is a chart of the US crude oil production going back to 1920.


Source: @JKempEnergy / WSJ.The Daily Shot

and Energy Efficiency Gains since 1990 (Demand)

Source: Oxford Economics

May 3

In a bearish sign for oil, US crude stockpiles jumped last week (we should be seeing declines this time of the year). One month later, they were down again…

Source: US Energy Information Administration (May 3) / WSJ-The Daily Shot /Source: @EIAgov; Read full article

…and demand? Can or will China keep up strong demand? (WSJ)

OPEC is now forecasting that the non-OPEC production increases (mostly from the US) will outstrip the demand.

Unimaginable #6:  Green Technology shares will be the big movers in 2018 (#5 and #6 may appear to contradict one another which makes the combination unimaginable)

The Tesla story comes immediately to mind as it struggles with mass producing the Tesla 3 and some controversial deaths and a weak balance sheet. Investors question how much longer will Tesla fans continue to back it. It is the most shorted stock.

 

Electric car production will significantly boost demand for copper, nickel, lithium, and cobalt.

Source: Moody’s Investors Service / WSJ-The Daily Shot

Who is driving the growth in solar capacity in the US?

Source: WSJ.com, h/t Paul Menestrier; Read full article

Unimaginable #7: 2018 is an election year, will the Republicans keep their majorities? A surprise 3rd party (!?!)–USA gets a “Macron Effect!”

Democrats are making inroads, but they may be too quiet. Noise continues to prevail and the conservative movement becomes contagious, hitting Europe…

Unimaginable #8: Britain capitulates on Brexit…NOT. Changed my mind on this one! 

It is a struggle for May, but the determination to see it through is still prevalent.

Unimaginable #9: Populists on the retreat? Not in Europe’s member countries who ironically benefit the most from being EU members! 

Populists in retreat, now looks like wishful thinking as Hungary, Poland, Austria and now Italy populists are in control.

Unimaginable #10: Women Disrupt! 2018 – The Year When Women Lead the Way!

Women are making fantastic inroads in business and science. The #metoo movement has been effective. Some fear too effective, some say it’s about time. Women make up a tremendous pool of talent that should get its earned recognition.

Black Swans?  Tensions arise between India and China, as well as deepening between Saudi Arabia and Iran…. but America maintains the peace and eventually comes to the rescue (unimaginable?) while deliberately or not isolates China with an Indo-Pacific and Quad Alliances (Japan, Australia, India, and the U.S.).

This has not yet been played out, but trade tensions between China and the USA could be the trigger. The Black Swan can also be North Korea and/or Iran, learn to expect the unexpected…

 

SUPPLEMENT ON COMMODITIES / FOOD FOR THOUGHT

From SupChina.com (19April2018):

“Sorghum wars update — massive food price inflation coming?

“Yesterday, we noted that China will require a 178.6 percent deposit on American sorghum imports in anticipation of anti-dumping tariffs, starting today. “Most U.S. sorghum is grown for the Chinese market,” according to the Washington Post, and I said that sorghum is used for animal feed and to brew baijiu 白酒 — strong Chinese liquor. The U.S. grows feed sorghum, which is a near 100 percent replacement for corn in animal feed. China had already disrupted U.S. sorghum imports last year by erecting a number of fictitious phytosanitary barriers, as they are wont to do, to help incentivize local feed producers to switch to more expensive locally grown Chinese corn. “The tariffs on U.S. sorghum exports are really meaningless, as that trade has already been long disrupted. “Soybeans were one of the few agricultural products the U.S. had left to export to China, as they have systematically shut off every other commodity from cotton to corn. U.S. soybeans are now not trading to China, and after the tariff announcement, Brazil became China’s only origin. This has caused Brazilian soybean prices to surge, locking out all other nations from purchasing soy from South America (given no one nation in the world can meet global demand). Soybean prices have now settled up a dollar per bushel higher than they were trading prior to China’s actions — this equates to a roughly $0.05 per gallon increase in the price of soy oil in China. “All that China has done is cause massive inflation in its food sector. U.S. farmers are worried about the long-term impact, so no one wants to be honest in admitting that this has actually helped, not hurt, the price farmers receive for their soybeans. “Things are never quite as they seem.” March 20, 2018 Is there a natural ceiling now for oil prices as well as long term yields? What does that mean for currencies?

 

From Rockefeller Treasury Services Daily, 20 March 2018 “And we have a tidbit from oil economist Jim Williams, who reports oil price variability is based in large part on worries about supply interruption. “…If Venezuelan exports are halted we can expect at least a $10 increase in oil prices until Saudi replacement crude bridges the gap. We believe the increase would be short lived and not show evenly in the futures market, which would become more backwardated.” (RTS): This suggests we have been dead wrong about the price of oil falling to $40-45 on belated acknowledgement of US output. Instead we could be getting a $10 increase, or $75. Is the Fed watching? A story like this buttresses the argument for imaginary inflation becoming a lot less fictitious. We don’t mind eating crow if our forecasts improve.”

From the WSJ-The Daily Shot on 22FEB: When oil prices collapsed in 2014, analysts weren’t sure what will be the net impact of large changes in energy prices on the US economy. Increasingly, economists see energy being such a big business for the US that higher prices boost economic growth despite rising fuel costs for companies and households.

Source: WSJ.com, h/t Paul Menestrier; Read full article

This chart shows the number of “drilled but uncompleted” (DUC) wells in the US. More drilling ahead outside of the Permian Basin?

Source: CIBC, h/t Paul Menestrier

The global oil demand is expected to peak in the next couple of decades.

Source: WSJ.com, h/t Paul Menestrier; Read full article

 

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