by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are generally quiet this morning.  Here are the news items we are watching:

The German elections reverberate: Although Merkel remains chancellor, the German political landscape is shifting radically.  If the ruling coalition is made up of the CDU/CSU, FDP and the Greens, it will be the first three-party government in postwar German history.  And, even putting this coalition together is problematic.  The FDP would probably prefer to be in the opposition.  How the Greens will operate in a conservative government will be interesting.  The CDU/CSU is generally considered one party but it isn’t; the CSU, mostly representing Bavaria, has more of a Catholic Church influence.  Thus, it is more socially conservative than the CDU and tends to support social spending.  The rise of the socially conservative AfD is putting pressure on the more conservative CSU to break with the CDU.  If this were to occur, new elections would be difficult to avoid.  The uncertainty surrounding the German government is putting pressure on the EUR this morning for the second consecutive day.

The Kurds vote: We won’t get the official results from the Kurdish vote for a few days, but it seems highly improbable that the vote will not support independence.  Neighboring nations are threatening the Kurds; Iraq and Turkey are holding military exercises near the Kurdish region and Iran has been making threatening comments.  Turkey has also threatened to cut off Kurdish oil exports, which is one of the reasons oil prices have lifted.  The Kurds want independence but it is obvious that the only way they can get it is to gain the protection of a local power.  The more likely candidates would be Turkey or Iran.  Usually, Turkey would oppose Kurdish statehood but having a state dependent on Turkey might be attractive.

A declaration of war: Financial markets were rattled by comments from North Korea’s Foreign Minister Ri Su Yong, who indicated that President Trump’s recent statements to the UN were a “declaration of war” and North Korea reserves the right to shoot down any foreign warplanes that venture near the country, even if they are over international airspace.  Reuters is reporting that North Korea has boosted its air defenses on its eastern border.[1]  This sort of talk is unsettling but it should be remembered that North Korea has a long history of provocations.  These include the sinking of the ROKS Cheonan in 2010, the boarding and capture of the U.S.S. Pueblo in 1968 and the 1976 “Axe Murder Incident” where North Korean troops attacked an American and South Korean tree trimming operation in the Demilitarized Zone, killing two U.S. soldiers.  North Korea also downed a civilian aircraft, Korean Air Flight 858, in 1987.  After the U.S. sanctioned Kim Jong-un in July 2016, the official news agency declared it as “an act of war.”  The same occurred after South Korea withdrew from a joint industrial complex in February 2016.  The key point here is that provocative statements and actions are standard course for the DPRK; how the U.S. reacts is important, but North Korea declaring war isn’t unusual.

Yellen speaks: As noted below, Chair Yellen speaks today.  We will be watching to see if she adheres to the generally hawkish tone of the statement or if her own position is more dovish.  We expect her to hold to the hawkish line, which may be dollar supportive.

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[1] http://www.reuters.com/article/us-northkorea-missiles/north-korea-bolsters-defenses-after-flight-by-u-s-bombers-as-rhetoric-escalates-idUSKCN1C026A?il=0