Some thoughts on the week I just missed

I am back after a week away from the site. Politically, it was a pretty eventful week. On the economy and market side, it wasn’t as dramatic. But I do have a few thoughts to start the week on what’s relevant.

1. Sentiment shift on Mueller investigation of Trump

I think the Cohen guilty plea was a big deal in the Trump – Russia investigation. It’s been five days now but I think my initial reaction about the plea deal is right. It won’t have any bearing on the economy. And it won’t have any bearing on the market. People overestimate how much politics impacts the economy. This is mostly political.

But, on the political front, it’s big news. Basically, Michael Cohen was the Trojan horse to investigating Trump’s entire business empire. We see that now, with the immunity deal Trump CFO Allen Weisselberg received from federal prosecutors in the Southern District of New York. And here we’re not talking about Trump – Russia or even Special Counsel Robert Mueller. We’re talking about multiple different legal inquiries into Trump’s dodgy pre-politics business practices. I think Adam Davidson really gets the broad strokes down in his latest piece at the New Yorker.

Donald Trump played fast and loose with his real estate business. And given the lax environment for white collar crime, he got away with it for decades. But, now under scrutiny as the President, he can’t get away with it. All of the dirty laundry will come out. And likely we will see multiple criminal acts, particularly money laundering I suspect. Will Trump be forced out of office as a result? I think it could happen. But given the midterm elections coming up, how the public reacts is important. The last I saw, favorability for Mueller’s investigation was up 11 percentage points to 59% even before the Cohen guilty plea.

The wildcard economically is what Trump does to deflect from the investigations. Some of these things – like a first strike on North Korea, for example – could have economic ramifications. This is where the danger lies. And, from a markets perspective, there’s no way of hedging that. That’s why we see no reaction from the stock market.

2. The flattening yield curve

I intend to write a separate markets piece for the markets subscribers, but I think of the flattening yield curve as also an economic signal. The US Treasury curve now shows less than 20 basis points difference between the 10-year and 2-year Treasury. Last month, I told you Treasury futures were telling us to expect 15 basis points by year end. And at that time, I said I expected the curve to be even flatter. I still hold to that sentiment.

What a flattening curve says is that the Fed’s policy is tightening. It says that the Fed has less scope for more rate hikes in the near future because it has already tightened so much.  It doesn’t mean recession. And it’s not a harbinger of recession.

However, when the curve inverts, then it says that the tightening has gone so far that the Fed must eventually reverse course. Lower long rates are a signal that bond markets expect the Fed to be forced to cut rates in the medium term. And that only happens when the macro outlook deteriorates. We are 15 basis points from that happening. And unless long rates increase from here, two rate hikes in September and December or September and March get us to inversion.

I am going to leave it there. More coming in a markets post later.

3. Tesla CEO Musk did not have funding secured

It’s no secret that the tweets from Tesla CEO Elon Musk about going private were ill-conceived. The problem now is that Tesla called off its look into going private late on Friday night after quickly ramping up its research into that option. This is in stark contrast to the market moving tweets done in the middle of trading hours for the stock. It smacks of misleading information and market manipulation. The question is whether the SEC will see it that way.

To my eyes, Elon Musk is more akin to Travis Kalanick, the former CEO of Uber, than he is to Michael Dell, who went private, or to Amazon CEO Jeff Bezos, who, almost 2 decades ago during the tech bust, was able to shake off his own cash flow problems under the threat of convertible bonds coming due. Eventually, the Tesla board may need to part ways with Musk unless he settles in.

It’s interesting that Uber is trying to go public right now and the talk is of them raising more money. I highly recommend the FT article by Shannon Bond on Uber’s recent strategy shift. It tells you things at Uber after Kalanick’s departure are still quite unsettled.

For Tesla, the same strategic questions are in play, especially if the board is forced to sack Musk. In that context, I recommend a Wall Street Journal article on how two decisions in 2016 by Musk put Tesla in the financial trouble it’s now in. It was the merger with Solar City and the hype behind the Model 3 that loaded the balance sheet with debt and restricted Tesla’s options.

As I write this, Tesla is trading at about $315 in the pre-market. That’s well below where it was when Musk talked about going public at $420 a share.

4. The refugee crisis in Europe

This morning I caught something on immigration on the Daily Mail, the right wing pro-Brexit British tabloid. The Mail is always making an issue about foreigners and Muslims in a way that can only increase xenophobia among its readers. But this piece was definitely one to read and watch. The title: ‘They’re heading for the all-inclusive’: Stunned tourists watch 50 migrants storm Spanish beach.

Holidaymakers watched open-mouthed as the semi-inflatable Zodiac carrying around 50 Moroccans – including about ten children – beached near a luxury hotel area on Spain’s Costa de la Luz.

Footage shows refugees sprinting up the popular Barrosa Beach at about 3.30pm on Sunday before attempting to scale cliffs.

The incident happened near a purpose-built residential and tourist resort called Sancti Petri which boasts shops, restaurants and several four and five-star hotels.

A tourist filming the scene could be heard saying in Spanish as the migrants leapt from their boat: ‘Look how they’re running towards the Sancti Petri Melia Hotel. They’re heading for the all-inclusive Melia Sancti Petri. Look, look, look.’

The Daily Mail explains that Spain has replaced Italy as the EU entry point of choice for migrants “after Italy’s new hardline Interior Minister Matteo Salvini introduced a blanket ban on migrant boats entering the country’s ports.”

Why this matters: The flow of migrants into Europe is not going to stop. So this is going to be a hot button issue for the EU. And it will also continue to impact thinking about the UK’s decision to leave the EU.

Deeper dive: This past Saturday, we had a dinner party where I met a young woman from the Ivory Coast who has been in the US for nine years now. She told me that she was studying here when a civil war broke out. And she was basically stranded in the US, a refugee from her home country. That’s how it is for millions of people in war-torn countries like Syria. And while many of them are displaced internally – i.e. within their own country, many are forced to flee to other countries too.

When you add the climate change migrants and economic migrants to this group, Europe becomes a target destination because of its proximity to so many places that where the economic gulf to Europe is huge. Nothing is going to stop that pull.

At the same time, you have this:

Italy’s interior minister, Matteo Salvini, will meet Hungarian prime minister, Viktor Orban, in Milan tomorrow to discuss proposals to block migrants from entering the EU. M5S claim it’s not an “official government meeting.” In reality, the meeting shows where power lies in Italy

— Alberto Nardelli (@AlbertoNardelli) August 27, 2018

I see this as a move to the right in Italy, due in large part to migrant flow. Spain and Greece are equally vulnerable, especially in an economic downturn. This issue – migration – will cause a lot of political turmoil in Europe in the months and years to come.

5. The crisis in Turkey isn’t over

The good thing about the week I was off is that nothing major happened in emerging markets. At the same time, the pressure does continue. In European trading this morning the Turkish lira dropped from just above the 6 lira/USD level to 6.16. Two hours ago, it was still dropping, down to the 6.24 level. It has stabilized at the 6.17 level. But this is the result of traders coming back from holiday and turning their attention back to Turkey. I think last week was a breather that won’t last.

6. The Fed will continue to hike

As you know, a lot of this is a strong US dollar. But the US dollar has come off the boil a tad, 2% from August 15th highs. Even so, Fed Chairman Jerome Powell’s comments at the KC Fed Symposium in Jackson Hole made clear that the US rate hikes will continue.

The two issues on the Fed’s mind are curve inversion and the so-called neutral rate. These are two potential markers for when the Fed should stop raising rates. The one could come as soon as the end of the year if the Fed hikes in September and then again in December. The other is completely theoretical (and I would say bogus). But this is how the Fed thinks. Right now, the Fed has said the neutral rate is 2.9%. Unless long rates rise, raising short rates to that level would not only mean an inversion from 2 to 1 years but one from overnight to 10 years.

Basically we are in a position where the Fed’s stated policy path puts it on a collision course with yield curve inversion. And the question is when they pause in order to prevent that inversion. Right now, it doesn’t look like there are any hard stops. In the near-term, that’s bad for emerging markets. In the medium-term, it’s bad for housing and commercial real estate, which is increasingly leveraged to multi-single family apartment units. In the medium-term, this is also bearish for the whole US economy.

Let’s leave it there for today. More to come later today and later in the week.

Happy Monday!