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

[Posted: 9:30 AM EST] One of the political factors we watch with a new president is the management of political capital.  Political capital is essentially the goodwill, the mandate, which comes from winning an election.  Although not a hard and fast figure, it does appear to exist, can be depleted and has a “sell-by date.”  In general, by the 18^th month of the first term, the capital is exhausted even if it isn’t spent.  By that time, Congress is gearing up for the midterm elections and the president’s goals and aspirations become secondary to the desire for reelection.

Essentially, it’s all about first understanding the strength of the mandate and “spending” it wisely.  In my recollection, no president is perfect in this area.  In the sweep of the moment, it’s easy for a president to think he can do more than he is actually able and to get distracted by side issues that consume more time, effort and political capital than the issues warrant.  It’s also critically important for a president to understand the environment.  All Democratic Party presidents pine for the expansion of health care; Republicans for entitlement changes.  Attempting to achieve these changes tends to consume a lot of political capital and it’s hard to get much else accomplished.

President Trump is something of an enigma.  It is difficult to measure how much political capital he has given the size of his popular vote.  At the same time, he is so unconventional that he may have more than normal.  However, history would suggest his capital isn’t infinite and it probably remains perishable.  This means that we have to closely watch the allocation of political capital to policy and personnel.

After the November election, both the right-wing populists and the center-right establishment had their wish lists and both seemed to believe most of their goals would be fulfilled.  Financial markets clearly believed that tax reform and rate reductions were coming and regulatory rollbacks were likely.  Equity markets rallied, interest rates rose and the dollar jumped.  At the same time, the right-wing populists were expecting immigration reform, infrastructure spending and trade restrictions.  Trump is clearly trying to satisfy both constituencies while also trying to fill positions to build an administration.  Our concern is that he is experiencing a significant “capital burn.”  At some point, he is going to have to start choosing his battles more carefully to conserve his political capital and accomplish his goals.  We suspect this is going to require some degree of discipline that, at this juncture, seems to be lacking.  Without discipline, he stands to disappoint both wings of his constituency due to ineffective management and opposition from Democrats.

Here is an indicator that may offer some insight into the concept of political capital.

This chart shows the implied yield from the Eurodollar futures contract, two years advanced.  Essentially, it’s the market’s estimate of what three-month LIBOR will be in two years.  Note that the yield soared after the election, jumping nearly 90 bps in the first few weeks after November 9.  We believe the rate jumped on expectations that Trump’s fiscal stimulus would boost the economy and lead to tighter monetary policy.  However, we are starting to see the implied rate pull back, suggesting the financial markets are reassessing just how much he will be able to accomplish.

If our analysis is correct, the implied rate should rise if Trump’s policy goals begin to accelerate.  This is especially true if tax cuts and fiscal spending are implemented.  That would also lift long-duration Treasury yields and the dollar.  However, if the implied yield continues to fall, it would suggest the financial markets are discounting less stimulus and slower policy tightening.  This could lead to lower long-duration Treasury yields and dollar weakness.

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

[Posted: 9:30 AM EST] There’s a lot going on this Groundhog Day,[1] so let’s get started:

The Fed: The FOMC meeting was a clear non-event.  Almost none of the language changed and the new committee didn’t give us any hints that it is prepared to raise rates any faster than what the market currently expects.  This suggests that, at least officially, the Fed is comfortable with its current views and positions on the economy and sees no reason to change its policy trajectory.  Informally, it probably means that Chair Yellen isn’t prepared to get the attention of the White House until she is really comfortable with her policy decision.  The lack of tightening signals led the dollar lower which has continued this morning.  Chair Yellen does give her semi-annual testimony to Congress on February 14-15 and that may offer better insights into the Fed’s thinking.

The BOE: The BOE also left policy unchanged even though inflation and growth have been improving in the U.K.  The bank appears worried about a drag on growth from Brexit and thus is keeping policy easy.  However, inflationary pressures coming from the weaker GBP may eventually lead the BOE to begin raising rates or reducing QE.

An Iranian “red line”?  National Security Advisor Flynn spoke to the press yesterday indicating that the administration is “officially putting Iran on notice” over its recent missile test.  According to reports, the administration is considering “a large number of options”; there was no indication whether military action is being considered or ruled out.  The test does not violate the nuclear deal which, by itself, does not include provisions on missile tests.  However, the test likely defies the U.N. Security Council Resolution 2231, which does not allow Iran to test any missile capable of transporting a nuclear warhead.  This recent test is at least the second; the last one was thought to have occurred in July.  The Trump administration is signaling it won’t be as tolerant as the Obama administration on these issues and the diplomatic agreements.  The key unknown is whether this issue will escalate.  If fears of a shooting war rise, gold, oil and Treasuries are the most likely beneficiaries.  Given the strong tone of the objection coming from the Trump administration, some sort of response is required.  Otherwise, it could fall into the same trap the previous administration found itself in with Syria when a “red line” was violated but the Obama government failed to respond.  This lack of response arguably reduced U.S. influence not only in the Middle East but in other areas as well.

Who is leaking these transcripts?  The comments from two seemingly contentious phone calls by President Trump, one to Australian PM Turnbull and the other to Mexican President Nieto, have turned up in the press.  In the former, the two leaders argued about a refugee agreement made between the Obama administration and Turnbull which would allow 1,250 refugees who are stuck on the islands of Nauru and Manus.  Many of these souls are from the seven nations subject to restrictions by the recent executive order.  President Trump was apparently upset by the deal and is indicating that these refugees will, at a minimum, be facing “extreme vetting.”  Second, a transcript from a call with Presidents Trump and Nieto seemed to imply that the former is considering sending U.S. troops into Mexico to attack “tough hombres.”  We wonder how these transcripts are being leaked.  Is this being done deliberately by the White House to signal potential policy actions?  Or does the administration have a “mole” trying to expose the new government?  This is an issue we will continue to monitor.

The French elections:  Wikileaks has dumped 3,630 documents from the conservative (center-right) candidate François Fillon.  So far, nothing too salacious has been uncovered but there are fears that the group, led by Julian Assange, is trying to affect the outcome of the French election.  As we noted earlier, Fillon could be facing an investigation over allegations that he paid his wife to work as an administrator when in fact she did nothing.  Nepotism is not illegal in France but paying people not to work apparently does violate the law.  There are growing calls for Fillon to step down and allow another conservative to run in his place.  His polling numbers are falling and, if the election were held today, there is a chance that the two largest vote winners would be the National Front’s Le Pen and Emmanuel Macron, who is running as an independent.  There are worries that such an outcome would favor Le Pen, since Macron would not have a party apparatus supporting his bid for the presidency.  The fear in France is that the Kremlin, through Assange, is trying to put another Russian-friendly leader in a major Western government.  Le Pen has been a supporter of Russia, suggesting the Russian annexation of the Crimea was “legal.”  Le Pen has indicated she would likely favor “Frexit” and would almost certainly try to leave the Eurozone.

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[1] Test your Groundhog Day movie skills with this quiz!  http://www.stltoday.com/news/multimedia/groundhog-day-movie-quiz/html_b728cd22-4db4-11e1-8e5c-001a4bcf6878.html