by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] The overnight news was relatively light, but here are the events we’re keeping an eye on today:

Changes at the Fed: Yesterday, the FOMC decided to maintain interest rates at their current levels but hinted at a possible rate increase in December.  The Federal Reserve cited strong economic growth as the reason for further monetary tightening.  Currently, the upper bound fed funds rate is 1.25%, which is relatively low compared to the neutral rate of 3.0%.  As a result, we expect rate increases to continue into 2018.

In other Fed news, President Trump is expected to nominate Jerome Powell, a Federal Reserve governor, for the Federal Reserve chairman position.  If confirmed, Powell would be replacing Janet Yellen after her term ends in February.  He is not expected to have a tough time getting confirmed in the Senate as he has a good relationship with Republicans and Democrats alike.  In 2011, Powell made a name for himself for his contribution in brokering a deal between the Obama administration and Congressional Republicans to raise the debt ceiling.  Trump’s selection of Powell would be considered a relatively safe choice as Powell has close ties with the Republican establishment.  Powell’s colleagues describe him as being neither dovish nor hawkish, but moderate.  That being said, there are some Senate Republicans, including Vice President Mike Pence, who would prefer that President Trump select John Taylor, who is known to be hawkish.  Accordingly, it is widely believed that he would maintain Yellen’s approach of gradual interest rate rises.

Updates on tax reform: The tax reform package is expected to be revealed later today.  Reports suggest that the House is struggling to come up with legislation that is palatable to all factions of the GOP and the White House.  Recent attempts at proposal changes to make the bill more appealing have been complicated by the president’s doggedness over key reforms.  Trump has tweeted his disapproval of a possible phase-in period for corporate tax cuts, increased taxes on 401(k)s and retention of the Obamacare individual mandate.  There are fears that Congress might replicate the failure of their Obamacare repeal if they insist on meeting all of Trumps demands.  That being said, there have been a few concessions made as of late—it is believed the corporate tax rate will likely be temporary, the top individual tax rate will remain unchanged and mortgage rate deductions will be capped at $500,000.  As of right now, we are not confident that tax reform will be complete before the end of the year.  We will continue to monitor this situation.

Rate hikes in the U.K.: Today, in a 7-2 vote, the Bank of England decided to raise its benchmark interest rate for the first time in a decade, while still maintaining its asset-buying program.  The move is likely in response to elevated levels of inflation.  Core CPI is 2.5%, which is higher than the 2.0% target set by the central bank.  In addition, the BOE has signaled that it will likely raise interest rates two times before the year 2020.  Even though the rate rise was expected, BOE policymakers have expressed concern as to the effect it might have on GDP, which has been relatively weak compared to some of its European peers.

Energy recap: U.S. crude oil inventories fell 2.4 mb compared to market expectations of a 2.1 mb draw.

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 been declining.  In fact, inventories are now at their lowest level since mid-2015.  We also note that the SPR fell 0.8 mb, meaning total oil supplies fell 3.2 mb.

As the seasonal chart below shows, inventories are well into the autumn inventory build season but, so far, inventories have mostly been stable.  As refinery runs pick up, further declines are likely.  The real test will be in Q1 2018.  As the chart below shows, inventories usually rise.  Thus, oil prices could be well supported if inventories fail to increase.

Based on inventories alone, oil prices are overvalued with the fair value price of $54.23.  Meanwhile, the EUR/WTI model generates a fair value of $62.89.  Together (which is a more sound methodology), fair value is $59.60, meaning that current prices are below fair value.  Recent oil price strength has narrowed the degree of undervaluation.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Equity markets have been fairly strong following relatively strong earnings and expectations surrounding the FOMC meeting today.  The overnight news was relatively light, but below are a few topics that we are keeping an eye on today:

Return of the ban? Yesterday, a driver in a pickup truck hit and killed several pedestrians along a bike path near the Hudson River in Lower Manhattan.  Mayor Bill DiBlasio has since declared the event an act of terror.  Although there was a written letter in Arabic pledging allegiance to ISIS, authorities are not convinced that the driver had any affiliation with the terrorist group.  President Trump condemned the terrorist attack and pledged to take more action to deter further attacks from happening.  The president has not yet specified what measures he plans to take but, since the driver was from Uzbekistan, the president may revise his travel ban list to include more countries.  This event has not had an adverse effect on markets which suggests no perceived threat to U.S. national security.

Tax reform: Last night, the House GOP decided to delay the rollout of their much-anticipated tax reform bill.  It is currently being held in the House Ways and Means Committee.  It is believed that the bill as it is currently written still does not have enough support.  Yesterday, Bloomberg reported there was a proposal to let the corporate tax rate gradually decline over a five-year period, which would put the corporate tax rate at 20% in 2022.  The president has since come out against that proposal.[1]  In addition, there is growing speculation as to whether the Senate GOP will be able to form a coalition without seeking the help of Democrats; the GOP can only afford to lose two votes in the Senate, and Senators Rand Paul[2] and Susan Collins[3] have expressed their hesitancy for the bill as it is currently constructed.  There is growing speculation that the GOP will not be able to pass tax reform before President Trumps’ Christmas deadline.

Asylum for Catalan separatists? In Spain, Spanish authorities have threatened to issue a European arrest warrant if ousted Catalan President Carles Puigdemont fails to show up to his court hearing.  Earlier this week, Carles Puigdemont and several of his advisers fled to Belgium in order to avoid charges related to the October 1st referendum.  Puigdemont has since stated that he will not return to Spain until he receives “guarantee of a fair trial.”  It has been widely speculated that Puigdemont and his advisers could seek political asylum in Belgium.  In order for Belgium to grant political asylum, it would need to start judicial proceedings to denounce the Spanish government’s crackdown of the referendum, which could be politically tricky given Belgium’s separatist past.  Belgium Prime Minister Charles Michel has claimed that he did not invite the former Catalan leader and would treat him as any other EU citizen.  If Spain were to issue the arrest warrant, Belgium would have up to 60 days after the warrant issuance date to grant asylum.  We will continue to monitor this situation.

FOMC rate decision: The Federal Reserve is expected to maintain current interest rate levels, although there is growing speculation that the Fed could raise rates in December.  Despite weakening inflation, the Fed is likely to point to strong GDP growth numbers as a reason to continue monetary tightening.  Fed chair front-runner Jerome Powell, a supporter of Yellen’s gradual interest rate approach, is expected to adopt a similar interest rate policy if chosen to become the next Fed chair.

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[1] http://www.reuters.com/article/us-usa-tax-trump/trump-says-he-is-not-looking-to-phase-in-corporate-tax-cut-idUSKBN1D02AC

[2] https://www.cnbc.com/2017/10/18/trump-tax-plan-hits-bump-in-senate-as-rand-paul-weighs-no-vote.html

[3] https://www.axios.com/collins-opposes-estate-tax-repeal-cut-to-top-tax-rate-2504006556.html?xrs=RebelMouse_fb&utm_source=facebook&utm_medium=fbsocialshare&utm_campaign=organic

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Happy Halloween!

Financial and commodity markets are quiet this morning, awaiting the president’s pick for Fed chair (Powell is the consensus selection), the president’s trip to Asia and Friday’s employment report.  Here is what we are watching this morning:

The indictments: Although the indictments dominated the news flow yesterday, we still view this as a long process.  The primary concern is that the issue will become a larger distraction for the White House and make tax cuts more difficult.  The tax changes are already quite difficult.  Yesterday, we saw a trial balloon of phasing in corporate tax changes over five years.  That landed with a “thud” and was probably behind the Treasury rally seen yesterday.  Tax writers are fiddling with such ideas because it is becoming difficult to even come close to neutrality.  If the president moves to fire Mueller, it may trigger a constitutional crisis and that could have a detrimental impact on equity markets.  We don’t expect that outcome but the odds are rising from a low level.  The House is expected to offer a tax bill perhaps as early as tomorrow.

South Korea and China make up: When the U.S. put the THAAD anti-missile system in South Korea, China went “ballistic”[1] and pulled diplomats from Seoul.  Apparently, China has decided that the system isn’t that big of a threat after all.  We suspect that the threat has nothing to do with it.  Instead, China is probably trying to woo South Korea away from the U.S. by giving in on this missile system.  If a conflict is going to occur in North Korea, the U.S. will base some operations in South Korea.  If the Moon government, who leans dovish anyway, wants to avoid war on the peninsula, getting China to pressure Pyongyang makes sense.  And, if China wants to reduce the chances of war, influencing South Korea to oppose U.S. military actions would make sense.  We note that the U.S. will have three carrier strike groups in the area soon and, for the first time, has sent a squadron of 12 F-35A fighters to the Kadena AFB in Japan.  Although we haven’t seen the strongest precursor for war (removing American civilians from South Korea would be the clearest signal of an imminent attack), the U.S. is clearly moving military assets into place for a conflict.

A couple of thoughts about the PCE data: In reviewing the personal consumption data, a couple of concerns emerged.  First, the saving rate is rolling over.

We have also seen a stall in deleveraging at the household level.  This is a “good news, bad news” situation.  The good news is that, at least in the short run, households are feeling more confident and are willing to spend down saving to make purchases.  We may be reaching the limits on how much more saving can fund consumption, and if consumption is going to rise in the absence of wage growth then debt will need to rise.  Taking on leverage with debt at current levels is probably self-limiting as well.

Second, we are seeing inflation-adjusted per capita income stall.

This chart shows real per capita income against trend.  It peaked in May and fell below trend in August.  The downtrend accelerated in September.  Although this number isn’t necessarily a good indicator of the business cycle, it should affect consumption.  Both these numbers suggest that the 3% GDP growth we are seeing is probably not sustainable.

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[1] See what we did there?

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It was a heavy weekend of news.  Let’s dig in:

Manafort, Gates indicted: Paul Manafort and his former business associate, Rick Gates, were indicted this morning and told to surrender to the FBI.  Latest reports indicate that Manafort and his former partner will face charges related to tax law, money laundering and disclosure of foreign lobbying.  The media over the weekend was frothy over who might get indicted, but Manafort has been on the special council’s radar for months.  The fact that we didn’t see anything beyond these two does suggest, at least for now, that the scope of the probe remains relatively narrow.  Gates remained with the Trump campaign until after the election, but Manafort was relieved months before November.  Because the indictments were narrow in scope, we doubt this news will have significant market impact, at least in the short run.

Realtor and home builders revolt!  The National Association of Home Builders and the National Association of Realtors have officially come out in opposition to the GOP tax plan despite the fact that the deduction for state and local property taxes was retained in the proposed tax bill.  The two groups wanted a homeowner tax credit in the bill as well, but bill writers scrapped the proposal.  Losing these two groups weakens the possibility of passing a tax bill; there is a realtor in nearly every congressional district and they will flood the airwaves with critical ads in the coming weeks.  It looks to us that if a bill is going to make it through the Senate, it will need to cut rates AND keep most deductions, meaning it will be a deficit builder.   In the coming weeks, we will have more to say about the impact of a larger deficit on the economy and financial markets.  In general, the risk of larger deficits is that it leads to higher inflation, but the effects are actually rather complicated.  This chart offers one clue.

This chart shows that since the late 1980s, the fiscal account scaled to GDP tracks the dollar and leads the forex rate by two years.  The correlation isn’t perfect but it does suggest that if we are right and the deficit does widen then the dollar could be vulnerable to a broader decline, but not until 2019-20.

The Fed chair this week: The money is on Powell.

The betting site Predictit.org is indicating a more than 80% chance that Jerome Powell will be the next Fed chair.  Again, we warn that the president is prone to change his mind and we may see a surprise.  We also want to reiterate the message of this week’s Asset Allocation Weekly (see below); the FOMC will be unusually hawkish next year regardless of who is chair.

Madrid takes control: Spain’s public prosecutor has accused the entire former government of Catalonia of rebellion, sedition and embezzlement and the deposed Catalan leader, Carles Puigdemont, is calling for civil disobedience.  The polling data doesn’t really favor independence.  In fact, there was a large anti-independence demonstration over the weekend in Barcelona.  The risk is that Rajoy’s crackdown will build sympathy for the independence movement and independence-supporting candidates will win when new elections are held in December.  Again, if Rajoy wants to look at a successful playbook, the way Ottawa has dealt with Quebec Separatists is perhaps the best.

Barzani resigns: A few weeks ago, Iraqi Kurds voted for independence.  Now, the man who led that vote, Masoud Barzani, has resigned as the Kurdish region’s president.  The move has clearly backfired as Iran, Turkey and Baghdad have moved to quash Kurdish independence.  The U.S. has negotiated a ceasefire, but we are hearing that oil flows from the region have been halted.

China breaks up plot to assassinate Kim Han-sol: [1] Kim Han-sol is the son of Kim Jong-nam, the older brother of Kim Jong-un.  Earlier this year, the “Young General” apparently had his older brother assassinated.[2]  According to reports, two agents of the DPRK are in custody in Beijing and are being interrogated.  Kim Jong-un is likely worried that China might consider overthrowing him and put a relative in place to maintain the dynasty.  Thus, the current DPRK leader has an incentive to kill any potential claimants to the throne.

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[1] https://www.bloomberg.com/news/articles/2017-10-30/china-breaks-up-plot-to-kill-kim-jong-un-s-nephew-report-says

[2] https://www.confluenceinvestment.com/wp-content/uploads/weekly_geopolitical_report_3_6_2017.pdf

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] As we detail below, Q3 GDP came in stronger than forecast.  And, yesterday’s spate of tech company earnings were quite solid.  Equities and the dollar continue to rally and interest rates are grinding higher.  Here is what we are watching:

A budget passes the House: As expected, the House passed a budget but the measure made it by a mere four votes.  The measure failed to attract any Democrat Party votes and GOP members from high income tax states tended to oppose the measure as well.  A tax bill could make it through the House over the next two weeks, but the Senate will be a different story.  If a deal does get passed (and we put the likelihood at a coin flip, at present), it won’t happen until probably late Q1 or early Q2 2018.  As the bill is developed, opposition will grow as lobbyists will try to preserve tax breaks.  At this juncture, the most controversial issue is the ending of State and Local Tax (SALT) deductions.  If this measure does pass, it could further polarize the nation politically and geographically.

Will repatriation occur?  One of the expected benefits of corporate tax reform is that money held overseas (which isn’t taxed under current law until it’s repatriated) will come flowing in, funding new projects and boosting the dollar.  Although a deal could bring the former, don’t count on the latter.  Brookings[1] notes that much of this money is already in the U.S.  Under American tax law, the earnings held overseas can be repatriated without triggering a tax event if it isn’t used for dividends, buying companies, loan collateral or making investments.  In other words, the money is already in the banking system but it is affecting the economy through bank lending, not through direct action by firms.  Thus, a deal to “bring back” the money will help stocks (we expect it to be used mostly for dividends and stock repurchases) but it won’t boost wages, investment (at current low interest rates, there is no legitimate investment project that isn’t already being made) or the dollar.

Catalonia: Catalan President Puigdemont was unable to convince his regional parliament to organize new elections and has moved to declare independence.  PM Rajoy will now almost certainly move to depose the Catalan government and take direct control of the province.  New elections will likely come in the next six months.  So far, the financial markets are taking all this tumult in stride.  Eurozone equities are higher this morning, although Draghi’s policy changes being taken as dovish and the weakness in the EUR are probably more than offsetting anything happening in Spain.  However, this drive to self-determination and the withdrawal from the center across Europe is a broader problem that will need to be managed in the future.

Will Venezuela default?  PDVSA, the Venezuelan state oil company, will need to make $985 mm in debt service payments today, and another $1.2 bn by next Thursday.  Although the country has used its 30-day grace period on some loans, these bonds don’t have this vehicle and so the money is due.  Default is looming if they fail to pay; if the debt is restructured, it would be one of the largest in history.  It is also possible that creditors will attempt to seize assets, including the Citgo refineries here in the U.S. (there are three, representing about 750 kbpd of capacity).  Although official reserves are $9.9 bn, it isn’t clear how much of that has already been pledged as collateral.  Credit default swaps put the odds of an official default at 75% over the next year.

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[1] https://www.brookings.edu/blog/up-front/2017/10/25/repatriated-earnings-wont-help-american-workers-but-taxing-those-earnings-can/

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s a news-heavy morning.  Here is what we are tracking:

Yellen out?  Politico is reporting that the president has narrowed the field for Fed chair, eliminating Gary Cohn yesterday and also Yellen.  Although the source from Politico, Ben White, is generally reliable, in the same report, a source suggests that the president changes his mind often and so no one may really be out.  Still, Senate Republicans would like to have a Fed dominated by GOP members and therefore would prefer someone other than Yellen.  It is worth noting that the president recently visited with Senate Republicans and thus may have been swayed.  For the most part, we have seen this as a Powell/Taylor race for a while and, from our perspective, it’s really about who gets what seat.  Powell would be expected to be a continuation candidate; Taylor would likely be much more hawkish.  We note that some have argued that, theoretically, Taylor could be dovish.  The official Taylor Rule (different from the Mankiw Rule, which we detail often) is based on a formula that compares inflation to a target and GDP compared to potential GDP.  If Taylor were to conclude that the Trump administration’s deregulation and fiscal policies increase potential GDP, he could be dovish.  This was the argument Greenspan made in the 1990s; he believed that the tech revolution would boost productivity enough to offset rising wages.  Still, the Taylor Rule is widely calculated and if he were to manipulate the formula to justify current policy, the dream of “rules-based monetary policy” would be lost.  Thus, it seems reasonable to expect that if Taylor is chair, he will be hawkish.  The dollar rallied on the news.

ECB: The ECB generally did as expected; although rates remain unchanged, QE will be reduced from €60 bn per month to €30 bn per month, starting in January.  It will be extended to September.  In addition, the ECB will continue to reinvest maturing bonds, thus keeping the balance sheet level after QE ends.  Although this outcome was in line with expectations, European bond yields fell and the EUR dropped.  The ECB is intending to reduce accommodation but at a very slow pace.

Interest rates: We have seen interest rates rise recently.  It appears to us that the primary driver of this change has been expectations of tighter U.S. monetary policy.  This is coming from two sources.  First, the market is discounting that a new Fed chair will be more hawkish than Yellen.  Second, even if Yellen remains, the roster of next year’s FOMC will be decidedly more hawkish based on the policy stance of the regional presidents; this is the topic of tomorrow’s Asset Allocation Weekly.  We are seeing the deferred Eurodollar futures market implied yield rise to near-cycle highs.

If Yellen is reappointed, which would be a modest surprise, we would look for a retreat in the above yield but probably not below this year’s lows set in early September.  This would put some downward pressure on the dollar and probably lower 10-year Treasury yields.

Catalonia to hold elections?  The regional Catalan government is set to call elections in a bid to stall a takeover by Madrid.  If calling elections doesn’t placate Madrid, PM Rajoy will likely invoke Article 155 of the Spanish constitution, which allows the central government to take control of a province to maintain the governmental integrity of Spain.  Tensions remain high but Rajoy should probably allow an election to go forward because there is a good chance voters will want to stay in Spain.  This is the message that comes from Scotland and Quebec; areas may want autonomy but actually leaving is usually a minority idea in a region.

Energy recap: U.S. crude oil inventories rose 0.8 mb compared to market expectations of a 3.0 mb decline.

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.  The impact of Hurricane Harvey is diminishing as refinery operations recover.  We also note the SPR fell by 0.3 mb, meaning the net build was 0.5 mb.

As the seasonal chart below shows, inventories rose modestly this week.  It appears that we are “skipping” the usual autumn inventory rebuild period.  We did see a strong recovery in production after a short hurricane disruption the previous week.  Oil imports rebounded as well.   Still, we usually see much higher inventory accumulation this time of year and so it should be supportive for prices if it remains slow.

Refinery operations rebounded 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 $53.76.  Meanwhile, the EUR/WTI model generates a fair value of $63.42.  Together (which is a more sound methodology), fair value is $59.80, meaning that current prices remain below fair value.  For the past few months, the oil market has not fully accounted for dollar weakness.  However, now the markets are not even taking tightening inventories into account.  In general, without the expected seasonal lift in crude oil inventories, oil prices at current levels are attractive.

In other oil news, Saudi Arabia and Russia appear poised to extend output constraints through 2018.  The official meeting is held on November 30.  The kingdom has been vacillating on where, when and if on the IPO of Saudi Aramco.  The leadership’s concern appears to be tied to the disclosure rules that New York and London would require.  The Royal Family essentially owns the state oil company and uses its revenue as the funding arm of the government.  Going public wouldn’t necessarily end that role but it would make the diversion public.  The FT reports this morning that the Saudi Stock Exchange, the Tadawul, may be the sole listing venue for Saudi Aramco.  We would assume that reporting requirements would be minimal.  However, listing exclusively on the Tadawul would likely reduce the value of the firm due to the expected lack of transparency.  On the other hand, it will allow the kingdom to raise funds in a manner it can control.

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by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are a bit weaker this morning—equities are signaling a softer opening while Treasuries are continuing to take on water.  There is a lot going on; this morning we are focused on the following issues.

Xi sets Standing Committee: The new Standing Committee of the Politburo is led by General Secretary Xi.  Only LI Keqiang was retained from the last committee.  The new members include Li Zhanshu, who was Xi’s chief of staff and a close ally.  He is considered an orthodox Marxist and will support Xi’s attempts to rekindle Marxist indoctrination.  Wang Yang is from the Youth League (the other main faction is represented by Xi—the “princelings,” or sons of the early revolutionaries) and was a target of discrimination by the disgraced Bo Xilai.  Wang Huning is a political theoretician who supports “neo-authoritarianism,” a platform that best exemplifies Xi’s governance.  Zhao Leji is perhaps the most obscure of the new members who has mostly had a competent, but uninspiring, career.  He replaces Xi loyalist Wang Qishan as head of the anti-corruption bureaucracy.  Han Zheng was a municipal administrator in Shanghai and rounds out the group.  Overall, there is no one on this roster who is a clear heir apparent for Xi, and none will be young enough in five years to serve a subsequent five years, a requirement for heir status.  As we noted earlier this week, Xi will be required to give up the presidency in five years due to term limit law.  However, he will very likely retain the position of general secretary.  We would view the group as mostly loyalists but all appear competent.  The fact that Xi didn’t pack the committee with diehard loyalists suggests he feels very confident in his power.

Ships at sea: Although they are not in position to conduct operations against North Korea, the U.S. is moving two carrier strike groups (CSG), the CSG Nimitz and CSG Theodore Roosevelt, into the western Pacific.  The Nimitz was in the Middle East (part of the U.S. 5^th Fleet) but will be joining the 7^th Fleet in the Pacific.  Although not entirely necessary, the U.S. usually prefers to have three carrier groups in a region if it is considering military operations because three can conduct round the clock sorties on a target.  We also note that North Korea has tested a solid fuel rocket engine; North Korea has tended to use liquid fuel missiles, which are easier to manage but are vulnerable to pre-emptive strikes during the fueling period.  Going to solid fuel allows North Korea to launch missiles with less preparation, reducing the chances of a “left of launch” strike.  Meanwhile, NBC[1] is reporting that Joseph Yun, the top U.S. diplomat to North Korea, is warning members of Congress that North Korea refuses to engage in talks, apparently upset by President Trump’s characterizations of Kim Jong-un.  Yun suggested that diplomatic efforts are on their “last legs” and told lawmakers the White House is unresponsive to his worries.  President Trump will make a visit to the region in early November, a 12-day trip.  He is creating something of a stir by refusing to attend the East Asia Summit on November 14^th; U.S. presidents usually attend such events as a show of Pacific leadership.  Although the attendees of the summit will be disappointed, the other parts of the president’s visit should indicate that the U.S. remains a Pacific power.  We monitor the region closely; bringing three carrier groups together is a worrying development that may simply be a show of force.  Nevertheless, having these assets in place does give the president a platform to launch a war with North Korea.

Iraqi Kurds: On the one hand, the Iraqi Kurdish government has offered to freeze progress toward independence in a bid to ease tensions.  At the same time, Kurdish and Iraqi forces clashed yesterday.  Both sides accused the other of an ambush, although it does appear the Kurds got the better of Iraqi forces.

Fed update: In a meeting with the GOP senators yesterday, the president had a show of hands for the Fed chair position.  It appears that John Taylor was the preferred candidate, although Jerome Powell also received some votes.  Yellen noticeably did not.  However, we do note that President Trump may be Chair Yellen’s strongest advocate,[2] if for no other reason than the equity markets would cheer the decision.  President Trump has pointed to the strong equity markets as confirmation of his successful administration; if picking Taylor were to trigger a sell-off (and it very well could), then Trump would probably want to avoid this.  We still think this is a race between Powell and Taylor, but reappointing Yellen does hold some positive features for the president.

GOP mutiny: Senators Flake and Corker have indicated they won’t run for re-election and have come out with harsh criticisms of the president.  Flake was almost certain to face defeat in the primary.  The GOP is turning populist and establishment Republicans are being forced, at a minimum, to acquiesce to the president.  For senators, especially, criticizing the president looks like a path to becoming a private citizen.  The key unknown is how these senators will vote on taxes.  Corker is a deficit hawk and Flake probably leans that way, and there is little chance the tax plan (it’s no longer being called reform) will be revenue neutral.  If Flake and Corker decide to vote against the plan, the GOP is at 50/50 in the Senate.  Losing any other senators will doom the process.  If tax cuts fail to materialize, the failure could have significantly adverse effects on the GOP at the mid-term elections.

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[1] https://www.nbcnews.com/news/north-korea/lack-talks-north-korea-sounds-alarms-capitol-hill-n813951?utm_source=Sailthru&utm_medium=email&utm_campaign=New%20Campaign&utm_term=%2ASituation%20Report

[2] https://www.bloomberg.com/news/articles/2017-10-24/yellen-is-said-to-find-unlikely-advocate-at-white-house-trump