‘Noise’: One Bank’s Take On US Politics In 2019

The political landscape stateside is a bit fraught right now – maybe you noticed.

The US is mired in the longest government shutdown in modern history and the man sitting in the Oval Office is (literally) suspected of being a Russian asset.

Meanwhile, we’ve got a divided Congress with a House that’s hell-bent on putting President “Best Brain” through the wringer and the 2020 Democratic field is (already) shaping up to be an absolute melee with everyone from stalwarts like ‘Liz to controversial candidates like Tulsi Gabbard set to make a run at the White House. Here’s hoping Beto “clears” that situation up.

All of this complicates an already tenuous situation vis-à-vis trade and foreign policy. The administration is keen to project optimism on a prospective deal with China, but the danger in tilting at windmills (which is what Trump is doing with Beijing) is that eventually, the other side gets exhausted with the charade and digs in. If you ask me, one of the most underappreciated tail risks out there (of course all tail risks are “underappreciated”, that’s why they’re tail risks) is that Europe and China decide negotiating with Trump is an exercise in futility on the way to simply telling him to pound sand and hoping he’ll either be impeached or soundly trounced in 2020.

At the same time, the disconcerting headlines around the administration’s foreign policy continue to roll in. America’s allies (and the world more generally) took comfort last year in the fact that Jim Mattis and John Kelly were around to effectively veto John Bolton’s mustache, but now both generals are gone. On Sunday morning, America woke up to a headline in the Wall Street Journal that Bolton wanted to conduct an actual military strike on Iran in retaliation for a September incident during which three mortars landed in a diplomatic quarter in Baghdad, injuring nobody. Of course Iran-backed militias firing mortars in Iraq is hardly something to be “alarmed” about and it’s certainly not something that should be used as a pretext for starting a world war. Israel is about as aggressive as aggressive gets when it comes to Iran, but it’s hard to imagine the Israelis doing something like, say, feigning surprise that Hezbollah is acting out and using that as an excuse to go and literally drop bombs on Tehran. That’s insane and according to the Journal, the Pentagon was understandably alarmed at Bolton’s request.

In any event, Goldman is out with their 2019 US political outlook and while there’s nothing particularly “profound” about it, it’s characteristically decent (and when it comes to penning sweeping assessments of US politics, “decent” is actually an overt compliment).

We’re not going to endeavor to tackle the whole thing in any great detail here because, well, because we cover all of these dynamics in real time, but we did want to highlight a couple of short passages and visuals.

Goldman starts by noting that 2019 is going to be less about policy and more about friction, although they don’t use the word “friction.” “Unlike the past two years, in which financial markets were intensely focused on policy events in Washington, 2019 should bring fewer policy changes”, the bank writes, adding that “political ‘noise’ could increase even further in light of a divided Congress, investigations, and the start to the 2020 presidential election and the Democratic nomination process.” Here’s a possibly useful calendar.

(Goldman)

For Goldman, the slide in stocks and mounting concerns about the domestic economy (because let’s not pretend Trump cares about the global economy) reduce the odds of a further escalation with China on trade.

I don’t know if there’s much point in assigning subjective odds to what will or won’t happen after the March deadline for a comprehensive trade agreement, but for what it’s worth, Goldman puts the chances of Trump making good on his promise to more than double the tariff rate on the $200 billion in Chinese goods that were taxed at 10% from September 24 at 30%.

“Instead, we expect a further extension of the current 10% tariff rate as talks continue”, the bank says, adding that “over the course of the year, we believe a deal that reduces US and Chinese tariffs is possible, but the more likely outcome is a longer-term pause that leaves much of the recently imposed US tariffs in place.”

They do, however, expect “non-tariff” policies aimed at China to be ratcheted up and that underscores the point made above about the potential for Beijing to get fed up with this. Is it really realistic that Xi is going to let Trump drag him along for another year, postponing tariff hikes and negotiating in bad faith by saying one thing over dinner only to say and do things that betray a penchant for more aggression later? Eventually, you’ve got to wonder whether China will just kitchen-sink it (so to speak) with fiscal and monetary stimulus, let the yuan depreciate (or maybe let it go to ~7.10 or so and then if it gets out of hand, play defense with some combination of reserve liquidation, capital controls and the CCAF) and hope the U.S. economy/stocks tank forcing Trump to the table or, failing that, souring voters into 2020.

Who knows.

But what we do know (even if everyone has a tendency to forget) is that the dispute with Beijing isn’t the only trade ball in the air. Goldman says auto tariffs are likely to be in the cards and that’s a clear risk for markets. Specifically, the bank thinks Trump will try to use the Commerce Department’s report as leverage, but will ultimately stop short of pulling the trigger. To wit:

The Trump Administration looks likely to propose auto tariffs, but we believe the Administration will ultimately decide that the political and economic costs outweigh the benefits. We expect the report to find that imports have national security implications and to recommend tariffs. There appear to be a range of proposals under consideration, from across-the-board tariffs on all imported autos and parts, to a narrowly targeted tariff on advanced (e.g., electric or autonomous) vehicles only. Once the report is issued, the President has 90 days to announce a decision. We expect the White House to use the threat of tariffs to attempt to reach an agreement with the EU and Japan on more incremental measures. Ultimately, we think tariffs on auto imports from the EU and Japan are a clear risk but not the most likely scenario (40% probability).

Amusingly (and this speaks to how successful Trump has been in making his base care about things that aren’t actually problems versus things that actually matter), Goldman notes that immigration policy is likely to be emphasized by the administration more and more going forward for two reasons, one of which is that Republican voters care far more about immigration than they do about trade or the economy.

“Among voters who voted for President Trump in 2016, 31% currently cite immigration as the most important policy issue, roughly double the number who cite the next most important issue (the economy)”, the bank dryly notes.

On fiscal policy, the message is straightforward – the fiscal impulse is waning and the extent to which it becomes a headwind depends in part on how sentiment is affected by continual gridlock. To wit, from Goldman:

We believe fiscal policy poses downside risks, in two respects. First, we expect the roughly ¾ pp positive impulse to growth from fiscal policy in late 2018 to fade to neutral by the end of 2019, assuming congressional action to extend spending caps. If caps are not extended, the fiscal impulse would turn more meaningfully negative in 2020. Second, as the ongoing partial federal shutdown demonstrates, fiscal deadlines are likely to cause disruptions and hit sentiment, though recent rules changes suggest the next debt limit increase might be less disruptive than expected.

There’s (much) more, but you get the idea, and in case it’s unclear, the title of Goldman’s note is “more politics, less policy.”

Of course “policy” is what the market keyed on in the first three quarters of 2018, as the tax cuts and stimulus buoyed markets and insulated the domestic economy from international economic turmoil. In 2019, that policy cushion is gone, leaving markets to focus on political tensions which, as this weekend made abundantly clear, are set to rise materially going forward.

One last thing: we would note that a quick snapshot of the VIX versus the EPU index shows that the much ballyhooed “disconnect” that persisted in 2017 has largely closed although, as ever, this chart is controversial.

(Bloomberg)