The dollar can’t lose

Outlook: There is nothing out there in the financial environment that is dollar unfavorable. There are plenty of political things that don’t favor the dollar, but not financial things. That is the universal consensus—the dollar is the top safe-haven and while some other havens may also benefit, the dollar can’t lose. Let’s just note that by the time an opinion/outlook is universal, it’s wrong.

We continue to get projections of all the terrible outcomes of the trade war with China. Just one from the WSJ reports direct foreign investment from China already “fell to $5 billion last year, a seven-year low, from $29 billion in 2017, according to a report Wednesday by Rhodium Group. That is because China clamped down on capital outflows and more of the U.S. became off limits. The firm estimates $2.5 billion in Chinese acquisitions were abandoned because of concerns raised by the Committee on Foreign Investment in the U.S., a secretive Treasury-led panel that vets foreign investment for security risks.”

Then there are all the estimates of the cost to households--$600-800 per year each—when tariffs on about 25% of the 6000 items start hitting. That includes $11.3 billion in furniture, $9.2 billion in auto parts and $6.6 billion in luggage (NYT). You can see the full list of 11,609 items in lurid detail at https://www.nbcnews.com/business/economy/just-how-much-250-billion-tariffs-n903231.

Inside a ton of inflation data from Friday is this chart, from Goldman via The Daily Shot. Consumer prices are indeed going up because of tariffs. No kidding, Sherlock. But another factor is real average hourly wages outpacing the CPI, too.

A last-gasp hope lies in Trump meeting Xi at G20 in June, where the two authoritarians could decide to make a deal regardless of details. Over the weekend, the WSJ reports, the official People’s Daily newspaper said the text of any trade agreement “must be balanced and expressed in a way that is acceptable to the Chinese people and does not undermine the country’s sovereignty and dignity.” Trump understands pride; it’s not clear he understands dignity.

Not to downplay the awful outcomes of the trade war—many of which are still unknown—but in the US, the loss of jobs related to exports to China is about 300,000, easily digested.  The farm sector is going to get subsidies. And we Americans are dedicated, devoted consumers. Nothing is going to stop us shopping. This is not to be snide about materialism, but rather to express faith in American resilience. Seafood imported from China gets too expensive? Substitute from Japan and Thailand, maybe even the more fashionable seaweed. That one may seem a little silly and of course there are plenty of things for which there is simply no substitute, but on the whole, the sky is not falling. 

Well, not yet. We have about a month to go before the sky falls—the US adds everything to the tariff list and China retaliates. ANZ Bank says there’s a 60% chance that China and US won’t reach a deal, according to Bloomberg. The Bank of Singapore feels the same way. “We are increasingly skeptical that any meaningful agreement or even progress will be made in the near future…Bonds have not really priced-in the complete collapse of U.S.-Sino trade talks.”

Another Bloomberg report from an Asia hand also predicts no resolution any time soon. Today Trump again accused China of reneging (which China denies)—stalemate. China had demanded the US remove the 10% tariffs or no deal, and the US never put that on the table. Now, of course, the size has gone up from 10% to 25%. Trump wrote today “I say openly to President Xi & all of my many friends in China that China will be hurt very badly if you don’t make a deal because companies will be forced to leave China for other countries,. You had a great deal, almost completed, & you backed out!” Trump also tweeted “China should not retaliate -- will only get worse!”

It’s not clear whether Trump’s tweets reach the public in China, where censors work overtime to keep out whatever news they don’t like. This surely qualifies. For its part, China is pretending the USis the one that reneged, going back on its word to remove the tariffs. Normally we don’t believe Lyin-Donnie, but all the reports we saw leading up to the debacle said the 10% tariffs were not up for discussion—the US was always going to keep them.

That means it’s not really a breakdown in communication. It does seem as though the failure is China’s fault—it was never going to change the laws as the US demanded. According to Bloomberg, today we get details on how the US is going to raise the tariff to 25% on all the remaining imports from China, about $300 billion. We still await China’s retaliation.

To shift gears: The US economy and the mood of both businesses and consumers relies more on where the Fed is going than on the trade story. We have at least three Fed speakers today. We are impressed by an article in the newsletter WolfStreet by Wolf Richter that a twist in policy is on its way. Instead of rates lower to the point of QE, we could be getting rate pegging (which is what Japan is doing).

Fed Gov Brainard may have let the cat out of the bag heralding a shift in how to handle a crisis. Let’s say short-term rates go to zero. Unlike other central banks, the Fed refuses to contemplate zero. So, it could “announce a target for slightly longer-dated interest rates, such as one-year rates…  And it would buy just enough securities with those maturities, to bring the one-year yield down to the target range. And if more stimulus is needed, it might target two-year rates, she said:

“Under this policy, the Federal Reserve would stand ready to use its balance sheet to hit the targeted interest rate, but unlike the asset purchases that were undertaken in the recent recession, there would be no specific commitments with regard to purchases of Treasury securities…. The Fed would announce that it wants the one-year yield to be at 1%, for example, and if the Fed is credible in its announcement, it might not have to buy many securities to get the one-year yield to target.”

Pegging is what the Fed did during WWII. “The interest-rate peg became effective in July 1942 and lasted through June 1947. The Reserve Banks reduced their discount rate to 1 percent and created a preferential rate of one-half percent for loans secured by short-term government obligations, substantially below the 3 to 7 percent that had been common during the 1920s.”

A few years ago, former Fed chairman Bernanke illustrated how a peg works: “… suppose that the overnight interest rate were at zero and the two-year Treasury rate were at 2 percent. The Fed could announce that it intends to hold the two-year rate at one percent or less and enforce this ceiling by standing ready to buy any Treasury security maturing up to two years at a price that corresponds to a return of one percent. Since the price of a bond is inversely related to its yield, the Fed would effectively be offering to pay more than the initial market value. Think of it as price support for two-year government debt.” An appealing feature is that once the paper matures, the Fed has an automatic exit and the balance sheet is unchanged.

Wolf notes “This rate-peg approach to QE would not be designed to inflate asset prices, unlike classic QE which was specifically designed to inflate all asset prices in order to create the ‘wealth effect.’ Instead, a rate peg of this type is designed to make borrowing cheaper along certain parts of the yield curve, while minimizing the amount of securities the Fed would have to buy to do this. And with the “automatic exit” feature, it would not cause the lingering issues classic QE is now causing. Wall Street hype artists and assorted QE-mongers that have been calling for QE for months would be deeply disappointed with this rate peg approach instead of proper tried-and-true QE.”

This has the smell and feel of authenticity.

We are going to be see-sawing back and forth between China trade and Fed policy for some weeks to come. What else? Emerging market contagion might be possible. The US stock market can actually tank (but see below). Keep an eye peeled for unknown unknowns.

Tidbit: The S&P shows either a head and shoulders or a triple top (see the Chart Package). The world’s forecast pattern guy, Tom Bulkowski, say it’s neither, and he ought to know. See his signals. As of last Thursday, the target for the S&P is 2975 if the bull run continues, or 2800 by Wednesday if it corrects.

Tidbit 2: The lengthy election in India is not over yet but it looks like Mr. Modi will not only win, but win with the biggest voter turnout since independence in 1947, according to The Independent newspaper. Critics (like Jimmy Rogers) who adore India but are disappointed in Modi point out that he has done lots of good small things. Now he needs to do some good Big Things. India is a potential big winner in the US-China trade war.

Tidbit 3: Australia holds elections this week. The effect on the AUD, if any, will be minor. China counts more.

 

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