‘Good Luck Out There’: Full Week Ahead Preview

Ok, well barring some kind of Trump-related disaster overnight, the first thing to watch this week will be Catalonia.

As a reminder, Puigdemont has until 10:00 (08:00 GMT) on Monday to “clarify” exactly what the hell he has “declared” or not “declared.” Assuming he has indeed “declared” something, he’ll have until Thursday to “un-declare” it or else Madrid might simply suspend Catalonia’s autonomy.

“Catalan President Carles Puigdemont will avoid giving a clear response to the Madrid government over whether he declared independence last week,” La Vanguardia reported on Sunday evening. Madrid has apparently “reminded” him that his reply needs to be “clear and simple” where that means either he has declared independence or not.

According to a member of the regional government who spoke to La Sexta, Puigdemont has his response ready. For his part, Jordi Sanchez, leader of separatist group Catalan National Assembly, says Puigdemont’s reply to Rajoy “will be dignified and clear with no surprises.” He added that the Catalan government will not renounce the mandate given by the referendum. Who knows.

Here’s Barclays with a little color:

The conflict could escalate: At this point, it appears more likely than not that Article 155 will be triggered; demonstrations and disruptions by the more radical separatists could follow (even without Article 155 being triggered). It is not clear how Article 155 would be applied; how much control the central government would and could exercise or for how long. On the positive side, the offer by PP, PSOE and Ciudadanos to reform the Constitution — they have the majority required — could help to meet some demands of the moderate nationalist groups in Catalonia. Art 155 might be avoided by calling regional elections.

Fiscal control: The central government has the institutions and legal framework to take fiscal control. In fact, Catalonia has been under the tight budgetary control of the central administration since the financial crisis. On the funding side, as of Q2 17, Catalonia received €52.5bn, or 68% of Catalonia’s €77bn public debt through the central government funding facility, and it is also by far the biggest user of it, representing 33% of its total lending.


While Spanish law contains a no-bailout rule for the regions, in our baseline scenario we expect that the central government will continue to provide the necessary funding to Catalonia so that it can continue to meet its financial obligations.

The Spanish news wire Efe said on its website that the Catalonia government believes the region would continue within the European Union and euro zone if it declared independence, which would necessitate a Catalan central bank. So that’s fun.

Obviously, Spanish equities and periphery spreads are at risk here, but if the past couple of weeks are any indication, the bar is pretty high in terms of something going “wrong” enough to trigger any meaningful moves in the euro. Liquidity is of course ample and the idea that Draghi would let this spiral out of control without resorting to aggressive jawboning seems very slim – especially with the October ECB meeting right around the corner.

Also in focus will be the Japanese election, which is just a week away. Here’s Barclays’ summary of where things stand on that:

Japan’s general election on 22 October will play a critical role in shaping Japan’s economic policy and market outlook. Recent election surveys indicate declining support for Abe’s opposition — namely, the Party of Hope — and most Japanese investors expect ruling parties (LDP-KP) to win the majority, but retain less than the two-thirds of seats needed for a constitutional amendment. Under such an outcome, volatility may pick up in the near term with uncertainty about government formation, but expected policy continuity under Abe leadership, where the BoJ remains firmly committed to YCC, should leave the USDJPY outlook again dependent on external developments, such as broad USD trends and global risk sentiment.

As you’re probably aware, this is a gambit by Abe. He’s aiming to capitalize politically off North Korea’s belligerence by seizing the moment and solidifying power. As The New York Times notes, it looks like the gamble is set to pay off, but with a price for Japan as a whole. To wit:

Last month, when Prime Minister Shinzo Abe of Japan dissolved Parliament and called a snap election for Oct. 22, he seemed to be making the decision from a position of strength. The opposition was in disarray, and his popularity ratings were picking up again, his hawkishness apparently vindicated by North Korea’s mounting belligerence.

In fact, the decision was a sign of weakness – of Mr. Abe’s political weakness and also, more problematically for the country, of a crisis of representativeness in Japanese politics. Whatever the outcome of the election on Sunday, a gap is growing between voters’ policy preferences and the new conservative two-party system that seems to be emerging as the liberal-left opposition is shoved aside.


Ms. Koike claims to have created the Party of Hope in order to “reset Japan.” It’s a conveniently vague slogan – and reminiscent of the Liberal Democratic Party’s own, “Take Japan Back.” The Party of Hope rests on a policy platform of catchy but vague sound bites – it is against nuclear energy, overhead power cables and hay fever, among other things – some fundamentally at odds with Ms. Koike’s avowedly conservative positions.

She hardly is an ideological foe of Mr. Abe’s: She served in his first government, including as defense minister in 2007. Which is one reason that when Ms. Koike decided not to run in the upcoming Diet race, it suddenly seemed as though she had never intended to take on Mr. Abe but rather had been positioning herself to strike a deal with him after the election.


And so even before any ballot is cast on Sunday, one outcome already seems clear: The election will spell the demise of Japan’s liberal left. A conservative two-party system without real checks and balances is emerging in Japan, and the gap keeps widening between the country’s politics and the people’s preferences.

So that’s some useful context on the political ramifications.

“The latest opinion polls suggest LDP’s potential strength heading into the election [and] the risk is to higher Japan equities,” BofAML notes, adding that “even if Koike advances, her policies are not so different from the LDP and she has suggested a possibility of grand coalition.” Here’s a chart that gives you some historical context for the Nikkei around elections:


Of course we’re already sitting a 21-year-highs, so why not, right?


And then there’s the NAFTA negotiations, which aren’t going well because, you know, because Donald Trump. Here’s Reuters:

Some downcast participants said [Trump’s] demands, unveiled this week in line with the President’s “America First” agenda, have increased the odds of NAFTA’s demise. At the very least, they could make it impossible to reach a deal renewing the treaty before a year-end deadline.

“The atmosphere is complicated,” one trade official told reporters, adding that his fears about some “pretty harsh, pretty horrible” demands from the U.S. side of the negotiating table were coming true.

Speaking on condition of anonymity because the talks are confidential, the official added the U.S. stance “has a clear protectionist bias, a bias that is trying to eradicate, minimize, eliminate the mechanisms that existed in NAFTA in the last 20 years.”

Barclays doesn’t sound too upbeat. “After three rounds of talks, the US continues to take an aggressive stance aimed at reducing the current trade deficit with Mexico using NAFTA as a policy tool,” the bank writes, before noting that they believe “there is a significant possibility that Mexico will withdraw from current negotiations.” The peso has fallen for four straight weeks, the longest stretch since January.  In the event NAFTA falls completely apart, USD/MXN could climb ~10% and trade above 20.50, Citi says.

Moving right along, there’s also the 19th Party Congress this week in China. Let’s go to Goldman for the preview:

Although Xi Jinping will keep his position in this interim congress–coming midway through the traditional ten-year tenure of the general secretary–a major reshuffle will still occur within the CCP’s highest governing bodies. Specifically, five of seven seats on the Politburo Standing Committee (PSC)–the senior-most CCP leadership–are expected to turn over, as is about half of the Politburo, the 25-member decision-making body that sits just below the PSC.


Key to watch in this process will be whether Xi Jinping–who is already widely regarded as the most powerful leader of China since Mao Zedong–can use the reshuffle to further consolidate power. And, perhaps more importantly, any indication of what he intends to do with it–pursue economic reforms more aggressively or maintain the status quo.

To explore these issues, we sat down with two experts on Chinese politics, David Shambaugh of the George Washington University and Willy Lam of the Chinese University of Hong Kong. Both anticipate the Congress will cement Xi Jinping’s absolute authority over the CCP and the country. And both raise the possibility that Xi could be paving the way to stay in power beyond two terms, in a break with historical norms.

However, Shambaugh and Lam view Xi as a visionary, not a reformist. They believe his overriding goal is to strengthen and perpetuate CCP rule, with no tolerance for policies that could destabilize the political order. (Lam argues, for example, that Xi is determined to avoid the political self-criticism that he believes brought down the USSR.) As such, both experts see only limited prospects for economic reform. But one possibility to watch: a potential reshuffling involving the role of premier that might signal a more aggressive reform stance.

All that said, our own view is that a more consolidated power base could increase the odds of structural reforms in Xi’s second term. GS Senior China Economist MK Tang and Chief China Equity Strategist Kinger Lau argue that such a shift looks more likely than in the recent past because growth led by fixed investment and easy monetary policy has become increasingly untenable. Although any reform strategy is most likely to remain selective and targeted, the potential result may be more sustainable, but slower, economic growth.

Such a slowdown may be all but unavoidable according to Andrew Tilton, GS Chief Asia-Pacific Economist, given the debt build-up that China’s new leadership will have to address. Tilton digs into the potential implications of the eye-popping increase in China’s debt-to-GDP ratio since the Global Financial Crisis (from 154% in 2008 to over 260% today), concluding that while an acute crisis is unlikely in the near term, growth will eventually have to slow as policymakers rein in credit expansion.

Meanwhile, back at the Ponderosa, we’ll invariably get the usual circus from Trump, who is coming off what was easily his worst week yet – and that is some damn feat considering how bad his weeks have been since taking office. The fallout with continue from his decision to scrap Obamacare subsidies while bewildered lawmakers will try to figure out where to start on somehow negotiating tax reform, the next steps on Iran, and the fate of DACA all before a December deadline that comes just ahead of the Fed meeting.

And speaking of the Fed, we’re still waiting to hear from Trump on that. Powell seems to be the favorite at this point although there’s always an outside chance Trump could nominate Chester Cheetah or maybe Krusty the Clown.


Good luck out there.

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