Politics may Continue to Overshadow Economics

The new monthly cycle of high frequency economic data has
begun. 
The manufacturing PMI shows
the synchronized global recovery is continuing.  The service sector and
composite PMI will be reported in the week ahead.  They are unlikely altering the general expectation
for robust growth in Q4.  
Even the disappointing US
auto sales  (17.35 mln seasonally-adjusted annual pace vs. expectations
for 17.5 mln and 18.0 mln in October), the US economy appears to be
accelerating.
  The
Atlanta Fed GDPNow points to 3.5% Q4 GDP.  The New York Fed GDP trackers see a 3.9% pace. 
The November jobs report
takes center state in the week ahead.
  Although the month-to-month report
can move around, the averages are quite stable.  Last year, the non-farm
payrolls rose an average of 187k a month.  Through August, before the
storms’ havoc,  the US created 176k jobs a month.  The median
expectation in the Bloomberg survey that the economy created net new 200k jobs in November.  
Barring a significant
surprise, the focus is on average hourly earnings more than the number of jobs
created or the headline-grabbing
unemployment rate.
 
In the current debate, we find ourselves in the camp that expects inflation is accelerating next year. 
However, the November report may exaggerate the rise, which the median
forecasts call for a 2.7% year-over-year
pace from 2.4%.  The base effect is less
favorable this month.  
There is little doubt the
market, encouraged by commentary from Fed officials, continues to expect a Fed
hike on December 13.
 
We estimated fair value for the December Fed funds futures contract, assuming the hike, is 1.295% and it finished last
week at 1.29%.  The implied yield of the January 2019 futures contract has
been fairly steady around 1.84%.  This
is consistent with a full hike and around 2/3 of a second hike
discounted.  
European economic activity
is finishing the year on a strong note.
  Last week’s news that core inflation was unchanged at 0.9%
in November disappointed the otherwise favorable economic momentum.  This
week, the disappointment may be delivered
by weakness in retail sales, which have
unwound October’s 0.7% increase.  The year-over-year rate will fall back to 1.6%, which is where it was at the end
of last year.  
The UK offers a full slate
of data, including PMI, industrial
production, manufacturing output, house prices, and trade.
  On balance, it appears the UK
economy is stabilizing at the quarterly growth rate of 0.3%-0.4%. 
 The balance of opinion favors the
BOE being on hold next year.  
Japanese trade highlights
include a possible small upward revision to Q3 GDP from 1.4% to 1.5%. 
 Japan’s October current account and
trade balance is a useful reminder of the significance of earnings stream
generated from foreign investment.  The repatriation of yield, dividend,
royalty, and licensing income outstrip the trade balance by a two-to-one
margin. 
The economic data may pose
headline risks, but the stronger impetus will come from political developments
in the week ahead. 
 Investors
got a taste for what could be in store at the end of last week as the two main
political issues–the Russian investigation and tax reform–erupted at the same
time.  
That Flynn admitted to lying
to the FBI about contact with Russia
during the transition period is puzzling. 
 It was not illegal, so why the deception?  That Flynn plead guilty to a
minor crime compared with other charges that could have been made, seems to suggest Flynn not only will
cooperate with the investigation but can
provide significant information. 
Flynn is the fourth person
indicted by the Special Investigator, Mueller.
  The risk is that what appear to be distraction
tactics themselves disrupt the news stream, like seen last week.  There
may be some speculation that President Trump may think again about firing
Mueller, but this is not the most likely scenario.  Given the number of people indicted, firing Mueller would strength argument the the President was obstructing justice.  It is a powerful charge, an d obstructing justice was the first charge in the draft of the articles of
impeachment against Nixon.  Although some of the event markets show
that the “betting” that Trump will be impeached
has increased, we think it is far premature to take seriously.  
The Senate version of the
tax reform was fluid until the very end,
and it finally passed early Saturday morning. 
 The next step, which will begin in the coming days is to reconcile the House and Senate versions.  There are several
significant differences.  There are some issues where the differences
cannot be split.  The last-minute gymnastics that were needed to balance the contradictory
interests speaks to the delicate balance struck, which is put into jeopardy during the reconciliation process.    Over the weekend, President Trump seemed to have suggested willingness to compromise on the corporate tax cut.  
One may be forgiven for thinking that because
Republicans will control the reconciliation process that an agreement will be
easy. 
 The main
reason behind the inaction by the legislative branch has been difficulty in
reconciling competing interests within the Republican Party.  After the
reconciliation committee hammers out whole cloth from the remnants, both the
House and Senate will vote on the bill again before it goes to the
President.  The declared goal is to have this done before Christmas. 
 
The UK faces what appears to
be a soft deadline of Prime Minister
May’s lunch with EC President Juncker Monday to indicate a serious proposition
to address the Irish border issue. 
 The circle cannot be squared as the political forces are currently configured.  
If the UK is out of the
single market, a customs border is
needed.
   The
EC and Ireland say it cannot be between
Ireland and Northern Ireland.  The Conservative government enjoys a
majority at the will of the Democrat Unionist Party (DUP) from Northern
Ireland, which insists that the customs border is not between Northern Ireland
and the rest of the UK.   Therein lies
the rub.   The irony is that if another election is forced, a Labour Government that could
result would be less sympathetic to the interests of the DUP.  
It is a soft deadline in the
sense that the ultimate decision about whether to proceed to the next stage of
talks will be made at the heads of state
summit in the middle of the month.  
It ought not
to press the patience of EU President Tusk, who makes a recommendation
to the summit.  There seems to be a sense of frustration among the EU
negotiators that the UK is still not demonstrating the sense of urgency that
may be required.  
This first phase of
negotiations should have been wrapped up by now.
  The previous deadline was missed.  The kind of trade agreement
that is hoped to emerge from the second phase often takes years to
negotiate.  The UK has a hard deadline, the end of March 2019.  It is
still going to require herculean efforts to make that deadline, and a potential
UK election also could slow negotiations.
Linkages between domestic
politics and diplomacy are evident in
another political drama that is playing out in Europe.
  The issue is who will replace
Dijsselbloem as the head of the important Eurogroup of EMU finance ministers. 
Two candidates have emerged,  Portugal’s Finance Minister Centeno and
Luxembourg’s Finance Minister Gramegna.   A secret ballot will be held Monday among the 19 finance ministers.
It may seem unusual that
Merkel supported Centeno from the Socialist government rather than Gramegna
from the liberal (pro-business) party.
  However, it may serve domestic purposes of the Chancellor
who is trying to convince the SPD to join her again (for the third time in four
governments) as the junior partner in her coalition government-a grand
coalition.  It has cost the SPD dearly, with its support in the last
election the lowest in modern times.  Its
fortunes could worsen if new elections were needed.  
By making a concession to a
peripheral country, and allowing the Eurogroup head to remain in the hands to
the center-left, Merkel is also making calculations for the horse-trading that
will take place over the next couple
years as many top posts will be open.
 This will include the
vice president of the ECB in the middle of next year.  That appointment is
important in its own right, but also for
the implications of Draghi’s successor, given the European sense of
balance.  
Lastly, the Reserve Bank of
Australia and the Bank of Canada hold policy meetings next Tuesday and
Wednesday respectively.
 
Neither is expected to change policy.  The RBA’s economic assessment is
known.  The reasonable growth (Q3 GDP is reported the next day, probably
0.6%-0.7%) is blunted by the concerns
about the household sector-weak wage growth, weak household consumption, high
debt.  
The Q3 rate hikes have
coincided with a sharp slowing of the Canadian economy. 
 Growth slowed to 1.7% at an annualized clip in Q3 down from a 4.3% pace
in Q2, which was reported before the
weekend.  However, Canada also reported an
unexpectedly strong employment report, accompanied by an acceleration in
wage growth (2.8% year-over-year average hourly wages), which spurred a nearly
1.7% rally in the Canadian dollar before the weekend,
its largest single-day advance this year.  While officials warn
that they anticipate the economy will require less stimulus over time, implying
a tightening bias, there is no hurry to
act.  

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