by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] We are seeing further equity weakness this morning; interestingly, too, Treasury yields are rising.  The asset market weakness doesn’t appear to have a single cause, but rather a mix of factors has weakened investor sentiment.  Here is what we are watching:

Who knew tax reform would be so hard?  Although analysts persistently warned that tax reform would be difficult, investors seemed to be quite sanguine about the potential for change.  The House and Senate have issued their bills and it’s hard to see a path to compromise.  The Senate wants to delay implementing the corporate tax changes for a year, which will infuriate the White House.  After all, no president has an interest in boosting future growth which may only benefit a successor.  In addition to that major discrepancy, the marginal rate structure is vastly different.  And, the Senate bill does less to “broaden the base” by reducing tax expenditures.  Given the political situation, the Senate bill will tend to be the blueprint because it will be much more difficult to move the bill through that body than the House.  We have had strong doubts that a tax reform bill would get passed during this administration.  Our position remains the same.  It should also be noted that there will be winners and losers if a bill does get passed.  Those hurt may be exactly the kind of households that would usually support Republicans.[1]

The populist president: President Trump gave an anti-trade speech in Asia overnight, bookended by President Xi offering a robust defense of globalization.  The cover of this week’s Economist is all about the U.S. stepping back from the world.  This is a situation we have been discussing (and warning about) for the past eight years.  Although there are lots of brave voices suggesting globalization can continue without the U.S., if it does, it won’t look like the last century’s globalization with the U.S. providing global security and the reserve currency for “free” to the world.  Instead, we expect either an 18^th century sort of colonization (the Eurozone as Germany’s commonwealth, the “one belt, one road” as China’s colonial drive) or a regionalization of power with no global power in place.  At some point, financial markets will realize that a deglobalized world will not be good for business.  Although we doubt this is the precise moment, the financial markets have mostly been ignoring the anti-trade, anti-immigrant policies of this administration.  Perhaps some of that is being priced in.

The Roy Moore situation: Although we doubt the travails of Mr. Moore are significant to today’s weakness, we see one important takeaway.  The scandal and the reaction show, in bright lines, the split within the GOP.  When the Senate majority leader calls on a candidate to withdraw from a race in a solid Republican state, it begs the question…what kind of relationship will the party leadership have with him if he wins the special election?  The election will be held on December 12.  Given the polarized nature of the electorate, unless further evidence emerges, we expect Moore to win.  Predictit still gives him a 55% chance of winning; that is down from 60% but still looks rather safe.  But, for McConnell, how reliable of a vote will Moore be going forward?  Our position is that the underlying coalitions of both parties are in flux but they become much more apparent for the party in power because it has to govern.  The ACA debacle and now the issue with tax reform are laying bare these divisions with the GOP.  The Roy Moore situation does, too.

Junk takes a hit: High yield bonds have come under pressure in the past few days, mostly on disappointing earnings from firms that issue these instruments.  Spreads have been narrowing for some time.

This chart shows the spread of high yield to the five-year Treasury.  Note that the spread is in the lower range of history.

The rise in yields is seen at the right side of the graph.  Will this continue?  A move toward 6% would not be a shock, but to sustain rates higher than that level would require a rise in financial stress.  So far, there isn’t much evidence that stress is rising.

Don’t forget December 8!  On December 8, the borrowing capacity of the Treasury will be exhausted and a new debt limit will be required.  Given that tax legislation is dominating the debate, Congress will scramble to make a deal to lift the debt ceiling; look for Democrat Party leaders to leverage this moment for their goals.

And, on other items:

China opens: In a surprise move, China announced today it will allow foreigners to purchase a majority stake in Chinese financial firms.  This is a shocker, although in reality it will have less impact than it should.  While there may be some interest from foreign firms in directly accessing the Chinese financial system, there is no consistent rule of law in China.  A foreign firm could find itself the majority owner of a bank that the government forces to do things it doesn’t want to do.  So, optically, this is a big deal, but it won’t have much effect if it isn’t accompanied by a consistent regulatory environment.

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[1] https://www.washingtonpost.com/business/economy/i-dont-feel-wealthy-the-upper-middle-class-is-worried-about-paying-for-the-tax-overhaul/2017/11/09/a5cf1acc-c55e-11e7-aae0-cb18a8c29c65_story.html?utm_term=.dfb78c5a42bd&wpisrc=nl_todayworld&wpmm=1

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] We are seeing some equity weakness this morning.  There isn’t anything specific weighing on the market other than what looks like profit taking.  Here’s the news we are watching this morning:

President Trump in China: The president received $250 bn in trade deals and promised investments.  He will call this a win.  China, on the other hand, made no promises of structural change in the trade relationship that would be necessary for a sustained decline in the trade account.  China has created a situation of persistent oversaving; this was done to build China’s investment base.  Although this investment-led development was successful (and has been used at some point by every nation that has achieved developed status), a point is reached where the investment infrastructure is adequate and restructuring the economy away from suppressing consumption is necessary.  We actually think that process is already underway.  The aggressive consolidation of power in China by Chairman Xi will give him the wherewithal to restructure the economy.  How will that look?  One way, and, in our opinion, the best way, would be to sell off part of the state-owned enterprises to households at discount prices.  This would boost household wealth and lift spending.  Another way would be to put in social safety nets, like social security and deposit insurance.  But, doing this will directly harm the wealthy and powerful in China; that’s why Xi had to implement the purges he did in his first term.  If Xi makes these moves, the Chinese external accounts will move from surplus to at least balanced, if not deficit.  However, Xi cannot be seen as doing this because of demands by the U.S.  And so, in place of real reform, which may be coming, Xi gave “baubles” to President Trump so Xi can reform at his own pace.

China and North Korea: There’s not much new here.  U.S. policy continues to hold that North Korea is China’s problem to solve when China has no interest in solving it.  China would be more worried if the U.S. engaged in direct negotiations with Pyongyang.  As we noted recently,[1] China and North Korea are not really allies.  A North Korea aligned with the U.S. would give Beijing its worst nightmare—a hostile power on its border.

More trouble for May: PM May has lost her second minister in a week.  Priti Patel, May’s international development secretary, resigned after it was revealed she held up to a dozen unauthorized meetings with Israeli officials during a summer vacation.  This follows on the heels of the resignation of May’s defense minister, Michael Fallon, on charges of “inappropriate conduct.”  The GBP has been struggling on fears that May’s government will fall and new elections will be held.  The weakness of May’s position has undermined her ability to negotiate Brexit, which has also pressured the currency.

Saudi crackdown continues: Bloomberg[2] is reporting that the wealthy in Saudi Arabia are fearful of additional asset freezes and are trying to move money out of the country.  Although bitcoin reportedly jumped yesterday after a plan was shelved that would have created an offshoot of the popular cryptocurrency,[3] we suspect Saudi capital flight might be behind the rally and may support further upside to bitcoin.  Cryptocurrencies have proven effective in evading capital controls and bitcoin could have another leg up if Saudi subjects begin to use the tool to move money away from the kingdom.

This is a year-to-date chart on the XBT/USD exchange rate.

Venezuela may avoid default…for now: Russia has apparently agreed to restructure $3.0 bn of Venezuelan debt it holds.  This isn’t anything new; over the past three years, Moscow has given the country $10 bn of assistance.  In return, Rosneft (MCX: ROSN 334.10) was given 49% of CITGO, which is PDVSA’s refining arm in the U.S.  Russia is using Caracas’s woes to gain further control of Venezuela and will likely try to use this foothold in the Western Hemisphere to weaken U.S. influence in the region.  Still, it appears highly unlikely that Venezuela will avoid restructuring its debt.

Merkel is struggling: Chancellor Merkel has been trying to cobble together a coalition after her party’s weak showing in the September elections.  She has attempted a “Jamaica” coalition, consisting of her conservative CDU/CSU party, the Free Democrats, a libertarian-leaning party, and the Greens, the environmental party (the party colors are green for the Greens, yellow for the Free Democrats and black for the CDU/CSU, the Jamaican flag colors).  These parties are not natural allies, but political leaders fear that another election may lead to further gains for the AfD.  This weakness in Germany comes at a time of a growing global power vacuum and raises the dangers for further drift in Europe.  At the same time, distraction in Germany may lead Merkel to be soft on Brexit negotiations, which would benefit the U.K.

Energy recap: U.S. crude oil inventories rose 2.2 mb compared to market expectations of a 2.5 mb rise.

This chart shows current crude oil inventories, both over the long term and the last decade.  We have added the estimated level of lease stocks to maintain the consistency of the data.  As the chart shows, inventories remain historically high but have declined significantly this year.  We also note the SPR fell by 0.7 mb, meaning the net build was 1.5 mb.

As the seasonal chart below shows, inventories rose modestly this week.  It appears that we are “skipping” the usual autumn inventory rebuild period.  Usually, inventories would peak in two weeks.  After that, stockpiles would decline into year’s end and then start their largest build from early January into early April.

Refinery operations continued to rise last week, in line with seasonal norms.  If this continues, and we expect it will, it should be bullish for oil prices.

Based on inventories alone, oil prices are undervalued with the fair value price of $53.22.  Meanwhile, the EUR/WTI model generates a fair value of $59.70.  Together (which is a more sound methodology), fair value is $56.99, meaning that current prices are very close to fair value.  Dollar strength and the rise in oil prices have mostly addressed the recent undervaluation.  Oil prices should continue to benefit from turmoil in the Middle East, but we would look for a period of consolidation in prices unless geopolitical conditions deteriorate significantly.

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[1] See WGRs: North Korea and China: A Difficult History, Part I (10/16/17); Part 2 (10/23/17); and Part III (10/30/17).

[2] https://www.bloomberg.com/news/articles/2017-11-09/saudi-billionaires-are-said-to-move-funds-to-escape-asset-freeze

[3] https://www.bloomberg.com/news/articles/2017-11-08/bitcoin-surges-to-record-on-speculation-possible-split-avoided

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] There was a good bit of news overnight.  Here is what we are watching:

The message from the voters: Governor and downstate elections were held in Virginia and New Jersey yesterday.  Although small sample size projections are the lifeblood of political punditry, we see three legitimate takeaways.  First, polarizing figures seem to boost voter participation.  In 2016, an element of voters opted for Donald Trump simply because he wasn’t Hillary Clinton.  Sec. Clinton was a polarizing figure, which led Republicans and disaffected Democrats (Berniecrats and others) to vote for Trump.  Now, the president has become a polarizing figure and that seemed to boost Democrat Party turnout yesterday.  It should be noted that polls were favoring the governor winners, although they did outperform the polling.  Second, the establishment/populist divide remains in place.  There is a tendency to simply look at the winners and losers but neither party has really embraced the populist mantel.  The president claims he has but if that were true his order of execution of his legislative agenda would have been infrastructure, trade restrictions and immigration restrictions.  Only immigration has been implemented and that’s because it doesn’t need legislative action.  Trade action has been limited to killing TPP but that may have been dead already.  NAFTA remains in place and actual targeted tariffs against China and other large deficit nations haven’t occurred.  Tax changes and ACA adjustments would have been far down the list.  The order of execution suggests that he isn’t fully committed to a populist agenda.  However, we are not seeing anything coming out of the Democrat Party that suggests an embrace of populism either.  Thus, the continued realignment of the underlying coalitions of the two parties will continue.  Third, the midterms very well could put the GOP majority at risk next year.  This highlights a point we have been making for over a year—political capital is limited and perishable.  Much of it was burned over the ACA repeal and now it’s being torched on tax changes.  By next spring, the president’s political capital will mostly be exhausted and he will be in the maintenance period for the rest of his presidency.

The president moves on to China: The president ended his visit to South Korea with a rather straightforward speech, avoiding bombastic threats but making it clear the U.S. would defend its allies.  China, so far, is using the Abe playbook, flattering President Trump and showing him a good time.  However, back in Washington, China is facing a significant sanctions threat.  The Senate banking committee approved the Otto Warmbier Banking Restrictions Involving North Korea Act, or BRINK Act; the bill would increase sanctions on firms doing business with North Korea, specifically targeting major Chinese banks.  Up until now, sanctions have only affected small Chinese firms and banks and therefore haven’t had a significant effect on curtailing China’s economic support of North Korea.  We note that President Trump did soften his rhetoric against North Korea earlier in this trip, calling on Kim to make a deal.  This bill may represent the “stick” and talks are the “carrot.”

The Street and Brexit: The FT[1] reports today that large U.S. financial firms have informed the Trump administration that if progress on Brexit doesn’t improve soon they will be forced to begin moving operations out of London.  Interestingly enough, it was also mentioned that the U.K. run by a Corbyn-led Labour Party would be viewed as very negative.  Initial job losses are pegged at 10k but could eventually rise to over 70k if the U.K. government is unable to execute Brexit and maintain trade relations with the EU.  The GBP fell on this report.

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[1] https://www.ft.com/content/2dec32be-c3e3-11e7-b2bb-322b2cb39656?emailId=5a021eb88a3fa4000439a9cb&segmentId=ce31c7f5-c2de-09db-abdc-f2fd624da608 (paywall)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] The overnight news was less active than the weekend but there’s still a lot going on.  Here’s what we are watching:

Saudi Arabia: We see two items of note this morning.  First, the king has ordered banks to freeze the accounts of numerous Saudi nationals who are not formally under arrest.  We suspect this was done for two reasons.  First, the purge may be widening and the king wants to remove the capabilities of these people from leaving the country.  Second, it may be designed to prevent capital flight.  Although the people affected by the account freeze may not be involved in corruption, fears of political instability will lead people with assets to try to secure them outside the country.[1]  The drain can adversely affect local financial markets, so freezing the accounts prevents them or their money from fleeing.  Second, Saudi Arabia has accused Iran of an “act of war”[2] after a missile was launched from Yemen into Riyadh.  War would raise tensions and increase the odds of a supply disruption.  Oil prices jumped yesterday and are modestly lower this morning.  The kingdom also accused Lebanon of declaring war on Saudi Arabia due to the actions of Hezbollah.  Tensions in the region are clearly rising.  We note that in a series of tweets the president praised King Salman and his son for their actions.

Trump in South Korea: President Trump has left Japan for Seoul today.  In a speech, he struck a conciliatory tone with North Korea, imploring its leader to “make a deal.”  The president noted that there has been “a lot of progress” in negotiations with the Hermit Kingdom.[3]  He also noted that the U.S. has three carrier strike groups in the region and unexpectedly informed his audience that a nuclear-powered submarine is also in theater, which may have been a surprise to his guests.  The president has consistently downplayed the likelihood of a negotiated settlement to the North Korean situation, but these comments raise hopes that a diplomatic solution is possible.

Trump goes to China next: President Trump will meet with President and General Secretary Xi later this week.  We expect that China will offer a series of inconsequential trade concessions that will allow President Trump to gain a “win.”  Whether the president sees through the ruse will be the focus of our attention.

The return of Wang: Comments from former graft-buster Wang Qishan suggested that there are “plots to grab power” in China,[4] and vigilance against corruption is critical.  Wang recently stepped down from the Standing Committee of the Politburo due to age but there are rumors he may be selected for vice president,[5] a state office rather than a CPC office.  Wang is one of Xi’s most trusted associates so finding a place for him makes sense.

China’s debt ploy: It is no secret that leverage in China is excessive.  PBOC Governor Zhou Xiaochuan has been ranting on this problem for the past few months.  Bloomberg[6] reports that under Chinese law firms can swap debt for “perpetuals,” which appear to be similar to the old British consuls, which were bonds that paid interest but were never amortized nor returned principal.  By making this swap, firms can count perpetuals as equity and not debt, “instantly” reducing leverage.  Of course, they still must service at least the interest, which tends to be a bit higher for perpetuals.  Interestingly enough, Zhou has apparently discovered this tactic and has begun to criticize it as masking the degree of leverage in the Chinese financial system.

Quarles to speak: As noted below, Governor Quarles will talk today at The Clearing House’s annual conference in New York.  This looks like the first public speech since he was sworn in yesterday as governor and vice chair for supervision.  We will be looking to see if he gives any hint on policy.

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[1] This is one of the attractive features of cryptocurrencies—they facilitate capital flight.

[2] https://www.ft.com/content/eaf5b226-c38f-11e7-a1d2-6786f39ef675 (paywall)

[3] https://www.washingtonpost.com/news/post-politics/wp/2017/11/07/trump-arrives-in-seoul-tours-camp-humphreys-military-base-on-eve-of-north-korea-speech/?utm_term=.096975fcf465

[4] http://www.reuters.com/article/us-china-corruption/chinas-former-top-graft-buster-warns-of-plots-to-seize-power-idUSKBN1D70HR

[5] https://www.axios.com/potential-next-act-for-trusted-xi-adviser-2505606876.html

[6] https://www.bloomberg.com/news/articles/2017-11-06/china-s-firms-have-found-a-way-to-cut-debt-at-least-on-paper

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST] Oh my, it was a very busy weekend for news.  Let’s dig in.

Saudi Arabia: The Kingdom of Saudi Arabia (KSA) was a hub of activity.  There were a few items of note.

1. It appears that Crown Prince Muhammad bin Salman (MbS) has engineered a massive purge, arresting at least 17 prominent members of the Saudi security apparatus and important business figures.[1]  Among the most important is Prince Miteb bin Abdullah, the son of the late King Abdullah and, until yesterday, the head of the Saudi National Guard.  There are three major military/security agencies in the KSA.  The regular military, the interior ministry and the National Guard.  King Salman is generally in control of the first two, but the latter was under the authority of Prince Miteb.  The National Guard has been in the Abdullah family for years; arresting Abdullah, along with other military leaders, consolidates MbS’s power in the kingdom.  Prince Waleed bin Ibrahim al-Ibrahim was also detained; a major global investor, he is often referred to as the “Buffett of Saudi Arabia.”  Major media leaders were arrested as were numerous military figures.  This is a major action by MbS to consolidate power.  The unknown here is whether this was a purge or a counter-coup.  MbS has been moving quickly to consolidate power and this action is threatening lots of powerful people in the KSA.  It would not be a surprise if there are plots to overthrow the king.  However, whether there was nothing afoot or something brewing, the outcome is the same—King Salman has eliminated most of his rivals and can now smoothly abdicate for his son and crown prince, MbS.  The official discussion was that the arrests were over “corruption” and were the actions of a newly created anti-corruption body.  However, the fact that they could react this quickly does suggest that it’s a cover for a purge.  That’s not to say there isn’t corruption in the KSA; Transparency International[2] ranks the KSA at 62^nd on its corruption scale out of 176 nations.  That’s in the “neighborhood” of Italy and Montenegro, meaning it’s fairly corrupt but not all that bad for the region.  Still, as we noted above, this appears to be more of a purge and anti-corruption is a tool.
2. A missile reportedly launched from Yemen was aimed at the Saudi Airport but was shot down by an anti-missile defense system, a Patriot.  At first glance, this isn’t a story that would be a huge shock.  After all, the KSA is involved in a conflict in Yemen.  On the other hand, it does appear to be a significant upgrade to the Houthi’s arsenal.  However, in light of the rest of the news, there is some speculation that this may have been a “false flag” operation.  In other words, given that the Houthis are thought to be aligned with Iran, this launch could be casus belli for a conflict with Iran.
3. Lebanon’s PM, Saad al-Hariri, abruptly resigned while visiting the KSA.  Lebanon’s political system is delicately balanced.  There have always been constant tensions between Sunni, Shiites and Christians.  As populations have changed, the country has been forced to adjust.  The long civil war during the 1970s was in part due to the difficulties in adjusting to changes in socio-ethnic-religious allocations of power.  At present, the Shiites are the most dominant group and Hezbollah the most potent military force.  For the past few years, Hezbollah has been focused on the war in Syria.  This has given Hariri political space to pass important legislation, including rules on oil and gas exploration.  The fact that Hariri resigned in Riyadh (apparently after an assassination attempt) suggests the Saudis want a leader in Lebanon who will more strongly oppose Hezbollah.  We note that Hezbollah’s leader, Hassan Nasrallah, indicated that his group did not push for Hariri’s removal and that the decision had been imposed by Riyadh.  Hariri’s departure will likely increase instability in Lebanon; Israel has, for the most part, been able to avoid the regional turmoil as Syria and Iraq deal with devolution.  However, if tensions in Lebanon rise and Hezbollah tries to dominate, Israel may find itself pulled into a widening conflict.
4. There was a helicopter crash that reportedly killed Prince Mansour bin Muqrin, the deputy governor of the Asir province.  He was the son of former Crown Prince Muqrin bin Abdulaziz, the last “king worthy” son of Ibn Saud, the founder of the KSA.  According to reports, Prince Mansour was returning from an inspection tour of his province when his helicopter crashed.  The cause of the crash has not been determined.[3]

So, what do we make of all this?  The context of these events goes back to the end of WWII, when Franklin Roosevelt and Ibn Saud created a friendship agreement between the U.S. and the KSA.  The U.S. didn’t want Saudi oil falling into the hands of the British or the Soviets, and thus established relations with what is essentially a medieval kingdom.  American policymakers knew that the states created by colonial powers in the Middle East were inherently unstable, where minority groups were given power in many cases to force the local leaders to rely on the colonial powers for support.  When the colonialists departed, these nations devolved into authoritarian states often run by despots; although such leaders were antithetical to America’s views on government, the U.S. maintained the borders in the region to prevent instability.  That’s why President George H.W. Bush built a coalition to remove Iraqi forces from Kuwait but didn’t pursue these forces back to Baghdad or attempt to overthrow the Hussein regime.  However, every president after Bush has undermined stability.  President Clinton implemented harsh sanctions on Iraq and steadily weakened its economy.  President George W. Bush invaded Iraq and removed its leader, but was unable to build a working government to replace the tyrant.  President Obama wanted to “pivot to Asia” which implied a “pivot from the Middle East.”  Adding to tensions was his support for the “Arab Spring” which has proven, in almost all cases, to lead to chaos.  Because Obama wanted to reduce U.S. influence in the Middle East, he had to elevate a new regional hegemon.  He chose Iran; the Iranian nuclear deal was, in part, a starting point to Iranian ascendency.[4]  That decision, while defensible, was destined to be politically unpopular and President Obama lacked the political finesse to execute what would have been a difficult political feat.  President Trump has returned to the American position of hostility toward Iran that occurred after the 1979 Iranian Revolution and hostage crisis.  Current U.S. policy appears to support the ascendency of Saudi Arabia as the regional hegemon.  And so, the events of this weekend should be seen in the context of the KSA taking steps to assume the regional hegemonic role.  We doubt the KSA has the ability to execute this role but consolidating power, reforming the economy and modernizing social life in Saudi Arabia are probably necessary if MbS can transform the KSA into the dominant regional power.

The problem is that if the KSA can’t perform the role, Iran, which views itself as the regional dominant power, will aggressively take steps to undermine the KSA in the region.  The U.S. will need to decide if it will commit resources to the region when it faces a rapidly rising China in the Far East and a devolving EU in Europe.  We fear the U.S. doesn’t have the resources or the will to deal with a three-front world.  The most likely outcome is that the U.S. allows the Middle East to devolve and focuses on Europe and the Far East (the Obama pivot).  That means, at some point, a disruption of Middle East oil supplies and higher oil prices.  In the past, fears of this outcome would have determined U.S. policy.  However, shale oil and improving efficiency can allow the U.S. to focus outside the region.

Paradise Papers: We have links to the enormous data dump that exposed governments and individuals who have used offshore accounts to shelter wealth and income from taxes.[5]  But, the key takeaway from the breadth of those revealed (the Queen? Really?! And Bono?) is that the populists have a point.  Leaders across the establishment, whether center-left or center-right, have availed themselves of questionable to illegal means to avoid taxes.  It smacks of Leona Helmsley’s infamous line, “We don’t pay taxes; only the little people pay taxes.”  Populist leaders around the world now have new fodder with which to attack the establishment.

Dudley to retire: NY FRB President Bill Dudley announced he plans to retire about mid-year 2018; he was scheduled to leave at year-end.  The NY FRB president has unique powers on the FOMC.  As true of all regional bank presidents, he is appointed by the board of directors of said bank.  However, unlike other regional FRB presidents, the NY FRB president is a permanent voter on the FOMC.  In other words, he has the voting power of a governor without the Congressional appointment.  This power is given to the NY FRB because of New York’s predominant role in the U.S. financial system.  Although Dudley has historically been a moderate (we rate him a “3” on our hawk/dove scale), he has evolved into a “Minskyist.”  We break the FOMC into three groups—Phillips Curve Disciples, Phillips Curve Heretics, and Minskyists.  The disciples believe in the Phillips Curve and believe that tight labor markets require higher rates.  The heretics believe the curve is no longer functional and believe the FOMC shouldn’t raise rates until inflation exceeds the target.  The Minskyists believe that lower rates trigger financial market distortions and thus call for higher rates to prevent asset bubbles.  Thus, Dudley has become rather hawkish recently.  The odds favor that Dudley will be replaced by a disciple simply because there are more of them around.  That outcome may mean a somewhat less hawkish stance from the NY FRB.

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[1] https://en.wikipedia.org/wiki/2017_Saudi_Arabian_anti-corruption_arrests

[2] https://www.transparency.org/news/feature/corruption_perceptions_index_2016

[3] http://www.geographicguide.com/asia/maps/saudi-arabia.htm

[4] Although Iran remains wildly unpopular in the U.S., there are regional specialists who have argued that Iran is best suited for this role.  The strongest argument is expressed by Robert Baer. Baer, R. (2008). The Devil We Know:  Dealing with the New Iranian Superpower. New York, NY: Crown Publishers.

[5] https://www.bloomberg.com/news/articles/2017-11-05/panama-papers-redux-may-show-how-firms-wealthy-skirt-taxes ; http://www.bbc.com/news/uk-41876942?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top-stories ; https://www.icij.org/investigations/paradise-papers/explore-politicians-paradise-papers/ ; https://www.nytimes.com/2017/11/05/world/paradise-papers.html?emc=edit_mbe_20171106&nl=morning-briefing-europe&nlid=5677267&te=1

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy employment data day!  We cover the release in detail below but the quick read is that the report is relatively weak; payrolls rebounded sharply but below expectations, the unemployment rate fell largely due to a drop in the labor force and wages remained unchanged.  Weather events did affect the data.  The dollar and Treasury yields fell on the news.  Here is what we are watching this morning:

Tax roll-out reception: The GOP tax proposal, also referred to as the “Tax Cuts and Jobs Act,” received mixed reviews following its release yesterday.  As is typically the case with all first iterations of a new tax bill, there are many proponents and detractors alike.  The bill is considered to be generally business-friendly but some notable lobbyist groups have expressed their opposition to it.  The most prominent opponents are small business lobbyists and realtors.  Common critiques of the bill are that it does not do enough to repatriate offshore earnings, hurts real estate prices and does not provide enough help for small businesses.  It is generally perceived to have broad support among the House GOP, but there are some rumblings within the Senate GOP about possible changes to the bill.  Senator Marco Rubio tweeted yesterday that the child tax credits included in the bill are not enough to support middle-class families, while Senator Susan Collins has expressed opposition to the proposed elimination of the estate tax.[1]  We will continue to monitor this issue closely.

Traveling in the Indo-Pacific: Today, the president will start his 10-day trip across Asia, with his first stop in Japan.  While on this tour, the president is expected to discuss matters relating to trade and North Korea’s missile program, the latter being the primary focus.

During the trip, the president will refer to the area as the “Indo-Pacific” as opposed to “Asia-Pacific.”  The term was used by National Security Advisor H.R. McMaster during yesterday’s White House press briefing, during which he previewed the president’s agenda for his trip to Asia.  The term is meant to emphasize that the U.S. commitment stretches beyond the economies of China and East Asia in order to include economies along the Indian Ocean as well.

Japan will likely ask the president for more assurances regarding his commitment to deterring North Korea from Japan and South Korea.  Tensions between the U.S. and North Korea continue to build as Pyongyang accused the U.S. of running a “nuclear strike drill” along the Korean peninsula.  Although the Pentagon has denied the accusation, claiming that the drills were routine, McMaster urged during the White House press briefing that time is running out to address the North Korean situation.

Venezuela debt restructure: Yesterday, Venezuelan President Nicholas Maduro stated that the country will seek to restructure and refinance its debt following a $1.1 billion principal payment to bondholders on Friday.  This move will likely make bondholders anxious as the country has recently struggled to make good on some of its ongoing debts.  Earlier this year, the United States imposed financial sanctions on Venezuela in response to its crackdown protests, which have made it harder for the country to seek other forms of financing.

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[1] https://www.axios.com/child-tax-credit-new-tax-plan-2505451140.html