by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Although financial markets are quiet, there is a lot happening in the news.  Here is what we saw as important:

President Trump ready with two Fed governor nominations: The president, according to numerous media reports, is prepared to fill two of the current three vacancies on the FOMC.  Randal Quarles, a former Treasury official, is said to be the selection to replace Tarullo, who was acting as the governor with the regulation mandate.  His public statements suggest he would likely roll back regulations on the banks and his appointment would be welcomed by the financial services industry.  The other selection is Marvin Goodfriend, an economics professor at Carnegie Mellon; he has broad experience working as a researcher in monetary policy.  Media reports touted comments he has made critical of QE and his support of a “rules-based” policy for setting rates as evidence that he would be a hawkish “offset” to Yellen.  However, deeper research suggests this is a facile analysis of his broader work.  Goodfriend opposed QE mainly because he was much more supportive of negative interest rates.  Of course, the major problem with negative rates is that they create a positive return for cash.  Thus, negative rates should trigger massive cash hoarding if the rates become negative enough.  His solution to this problem would be to devalue cash by having the central bank no longer exchange 1:1 currency for reserves.  In other words, the value of cash held would be allowed to adjust as well.  We remain unsure how this would work in practice but suffice it to say that to suggest Goodfriend is a hawk is probably a misjudgment.  In fact, his views appear radical enough to suggest we may be installing the next Kocherlakota.

Terror attacks in London: Again, the U.K. was the target of another attack over the weekend.  IS has claimed responsibility but we don’t yet know how involved the group was in the attack.  It isn’t clear why London was the target unless terrorists groups want to undermine the May administration.  Although these attacks are clearly not on the scale of 9/11, they are effective insofar as they terrorize.  Thus far, these attacks have had little effect on financial markets and, in fact, the more often they occur, the more markets become inured to them.

Thursday is a big day: On Thursday, former FBI Director Comey is expected to testify before Congress, the British hold elections and the ECB holds its regular meetings.  The Comey testimony runs the risk of further distracting the administration from tax reform, health care, etc.  In the U.K., the polling spread remains in the single digits, with the latest poll showing the Conservatives holding a 7% lead, although some polling from late last week showed the race as a dead heat.  We still expect the Tories to win but a narrow victory would defeat May’s reason for calling snap elections, which was to build a larger mandate to negotiate Brexit.  Finally, the ECB may begin hinting about tapering and rate increases.  If so, the EUR may get a boost.

The PRI in Mexico squeaks out a win: A quick vote count in the state of Mexico gives the governorship to Alfredo del Mazo, the candidate of the ruling PRI.  The last count shows the PRI up 32.3% to 31.3%.  This election was seen as a harbinger for next year’s national elections.  The PRI has ruled the state of Mexico for 88 years and so a loss here would suggest that the leftists under Andres Manuel Lopez Obrador[1] might win the presidency.  We caution that this final vote hasn’t been tabulated so the PRI may still lose this state.

Qatar isolated: Bahrain, Saudi Arabia, Egypt and the UAE, among others, have severed diplomatic ties to Qatar.  Diplomats are being sent home.  The severing nations are angry with Qatar for their supposed ties to Iran and its support of the Muslim Brotherhood.  Less than two weeks after the president’s visit to Saudi Arabia, the anticipated coalition against Iran and terrorism appears to be fracturing.  We note the U.S. operates out of the Al Udild Air Base in Qatar; the base is used for air operations against IS.  So far, we don’t know if operations will be disrupted due to this diplomatic spat.  Religious authorities in Saudi Arabia are accusing the leadership of Qatar of religious illegitimacy.  Conspicuous in its absence is Pakistan.  The Pakistanis have been cool to the Saudis’ tensions with Iran and any sort of conflict with Iran would be problematic without Pakistan’s support.  Overall, we have seen such tensions before, although not to this degree; in fact, the actions being implemented are commonly part of war.  Thus, this is an issue that bears watching.

The Israelis do have “the bomb”: There was a report in the weekend NYT[2] that Israel was planning to detonate a demonstration nuke in the Sinai in 1967 if its forces were being overwhelmed.  This was to serve as a warning to the Arab states that the costs would be catastrophic if they tried to make good on their promise to “push Israel into the sea.”  The plan was never executed because the IDF won a quick victory in the 1967 Six-Day War.  On the 50-year anniversary of this conflict, the report reveals what Israel has refused to acknowledge, which is that it is a nuclear power.

The White House is pushing infrastructure: The White House seems to be preparing to unveil a plan to rebuild U.S. infrastructure this week.  It appears to rely heavily on local direction and money, with only modest federal involvement and funding.  Needless to say, state and local governments are less than impressed.  The idea of state and local government funding is a pre-1930s conception; it only works if the projects generate enough cash to service the debt drawn to pay for them.  Thus, toll roads and other service fees are required to build projects.  Although such constraints should lead to better projects, the public has gotten used to federal funding and it would be a shock to force car owners to rent or buy electronic pass units to drive around.  We note that the president is expected to unveil a partial privatization of the air traffic control system today.

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[1] See WGRs: The Rise of AMLO: Part I, 3/13/17, and Part II, 3/20/17

[2] https://www.nytimes.com/2017/06/03/world/middleeast/1967-arab-israeli-war-nuclear-warning.html?emc=edit_mbe_20170605&nl=morning-briefing-europe&nlid=5677267&te=1