Politics is Economics in the Week Ahead

Many people assume that politics and economics are separate spheres.  We find ourselves often harkening back to the even older tradition of referring to "political economy". After all it was Harold Laswell, who is regarded as the father of modern political science, that famously defined politics as who gets what, when and how. Isn't that the role of the price mechanism and the market economy?  

The highlight of the holiday-shortened week (Japan Monday, US Thursday) ahead are two official meetings.  The EU and OPEC.  There are three issues at the EU meeting that will be important for investors.    First, the new European Commission will assess the 2015 budgets.  Although the outgoing commission let France and Italy slide with some financial sleight of hand to improve from their initial offering,  the two countries still stopped shy of the previously agreed up targets.   If there is truly a new sheriff in town(and we are not convinced there is), France may be subject to a fine up to 4 bln euros or 0.2% of national income for breaching the fiscal rules.   

To be clear, this is not a defense of the austerity fetish, rather it is a recognition of the untenable situation.  Despite its violations, France has not made a clear break of the ordo-liberal diktat, nor does it enact strong measures to boost aggregate demand.    France is neither fish nor fowl, but its goose is cooked as the political elite is intellectually bankrupt, and National Front are the only ones promising change.  

Second, EC President Juncker is expected to unveil a new three-year 300 bln euro infrastructure program of the European Investment Bank that will be administered by local governments. Preliminary reports suggest that the funds will be used to facilitate private investment, but is mostly funds already earmarked.  Less than a third is can be considered what the Japanese call "real water".   While we are sympathetic to the idea that what ails Europe is not something that monetary policy alone can fix, the program is far too small of a scale to make much of a difference.  It is not even 1% of GDP per annum. 

It is also too small given the capacity.  With the EIB, European officials have a rare opportunity. Specifically, bonds issued by the EIB,  do not count toward any country's deficit/debt levels.  It appears to be a financial black hole.  Moreover, as the ECB looks for other assets it can buy to expand its balance sheet, we have suggested that EIB bonds have much to recommend themselves. ECB purchases of supra-national bonds, which include EU, EIB, EFSF, and ESM bonds, would be far less controversial that a sovereign bond purchase program.  It would also be  much easier to administer than a corporate bond purchase program, which has been floated as well. 

Third, Juncker himself has been called upon to resign.  The far left tried to censure Juncker following the revelations that Luxembourg helped facilitate large-scale tax avoidance while he was prime minister and finance minister.  However, the Far Left could not sufficient signatures of it motion to force a vote (10% of the members 751 members of the European Parliament).  Then the populist right, led by UKIP and France's National Front managed to get the signatures, and a censure motion will be voted o probably at mid-week.  

For his part, Juncker denies wrong-doing.  He claims not to have been the architect of Luxembourg's tax regime.  It was out of his hands.  Yet, besides rigorous investigative journalism, the reform thrust of Luxembourg's new finance minister helped shed light on the Lux-Leaks.  

To succeed in forcing Juncker's resignation, a two-thirds majority is needed, which seems unlikely. The center-right Christian Democrats and center-left Socialists have stood by Juncker, and the far left refuses to support a motion brought by the populist right. In Germany, Merkel was initially reluctant to support Juncker's candidacy, and Finance Minister Schaeuble has made some not-too-thinly veiled criticism. Germany may choose to continue to support Juncker and avoid the risk of a new crisis.  

There may be some further fallout, even if the motion does not carry.  By joining forces with France's National Front, which it said it would not do, the UKIP may be vulnerable to a backlash.  It might not have shown in last week's by-election that was forced when a Tory MP Reckless (his name, not a judgment) decided to switch to UKIP.   He was re-elected.  Second, even if Juncker survives, his credibility may have been undermined, and this may weaken the EC as an institution at that moment in time when strong leadership is essential.  Third, the EU Parliament, perhaps emboldened by delivering the Council of Ministers (heads of state) a fait accompli by running presidential candidates, is likely to make its voice and will heard.  

OPEC meets on November 27.  The price of oil is off by nearly a third over the past five months. The price is not below the cost of production, but it is below levels that were assumed in this year's budgets.  The key issue for investors is whether OPEC can agree on a substantial cut in output to stabilize prices.  The operative word is substantial.  In October, OPEC's data indicate the cartel produced about 30.25 mln barrels a day.  This is above 250k barrels a day above their production agreement.  

Iranian oil is also a wild card.  Monday, November 24 is the deadline for an agreement on Iran's nuclear capability.  Last minute negotiations were being held over the weekend. There have been some optimistic noises, and although a short extension may be needed, a deal may be at hand.  This would end the sanction regime that has curtailed Iran's oil sales.  

Daniel Yergin warns that OPEC underestimated the resilience of the US shale producers.  He notes that the lion's share (80%) of the new output next year would be profitable at $50-$69 a barrel. In the first week in November, the US produced 9.06 mln barrels a day.  This is the most since the early 1980s when this time series began. Although the drop in prices has seen 1) some rigs shut, 2) a hit energy issues in the high yield bond market, 3) some cuts in planned capital expenditures, the US industry, which is experiencing falling direct costs, appears in a better position to cope with lower prices than OPEC, despite its vast reserves and sovereign wealth funds.  

In terms of economic data, the flash eurozone harmonized CPI may be the most important, given the upcoming ECB meeting.  Draghi's comments last week renewed speculation that a new initiative will be taken at the December 4 meeting.  Speculation in some quarters that a sovereign bond purchase scheme is imminent and inevitable seems misplaced.  There are many other assets that are less politically, legally, and operationally less complicated than purchasing sovereign bonds.  

New record low benchmark 10-year rates were seen last week for France, Italy, and Spain. Germany's 10-year yield is within a basis point of the spike low to the record low of 75 bp on October 15.  Five EMU governments have negative yields on two-year obligations (Germany, Finland, Belgium, Netherlands, and Austria), while France pays half a basis point annualized.   EONIA itself is negative.  It is not clear, the efficacy of pushing sovereign bond yields lower.  

The UK and US also offer revisions to Q3 GDP estimates.  Economists do not expect a revision from the UK earlier estimate of 0.7% quarter-over-quarter and 3.0% year-over-year.  Investors may pay more attention to the details that may shed light on the future trajectory.  A big shift has already taken place in terms of pushing out interest rate expectations from the spring 2015 to late-2015, and some economists are pushing their call out into 2016.  

The 3.5% estimate for Q3 US GDP is subject to downward revisions, stemming from construction spending and trade figures.  The Bloomberg consensus calls for a revision to 3.3%.   We would not be surprised with a somewhat deeper revision.  The US will also report personal income and consumption data, including the Fed's preferred inflation measure, the core PCE deflator. The core rate of inflation is expected to have remained steady at 1.5%.  

Japan reports a host of data, including employment, retail sales, and inflation.  The BOJ has preempted the data.  However, just like the unexpected contraction in Q3 GDP put the BOJ aggressive measures in a better light, so too will the expected further easing of price pressures.  When adjusted for the sales tax increase, the key rate of inflation for the BOJ may slip further, possibly below 1.0%.  

Lastly, turning to China, investors will be closely monitoring the impact of the unexpected interest rare cut before the weekend.  It would seem to hurt banks over the shadow banking activity.  It might be aimed to help support the housing market in which prices have continued to fall.  It will also be a big week in China for initial public offerings.  The CNY1.6 trillion worth of shares being brought to market is reportedly the most of the year.  The anticipation has tied up liquidity and had lifted money market and repo rates in recent days.  Finally, we note that HK-Shanghai equity link did not produce the big bang that many anticipated.  It suggests that the missing element, at least at the moment, is desire not access.  The Shanghai Composite rose to a 3-year high on November 17, finished the week a mere 0.3% higher.