By Marc Chandler
This post was first published on Marc to Market
While the pundits are talking trade wars, Chinese officials are taking the latest US provocations in stride. Pressure on China’s trade practices are not new. The US has been complaining about intellectual property violations since Bill Clinton was President. China’s trade practices have also raised the ire or US and Europe, which has resulted in tens of dozens of anti-dumping actions.
China’s emergence on the world stage was always going to be disruptive. Even if it played by the rules, its sheer scale is daunting. By threatening the economic equivalent of “mutually assured destruction”, the Trump Administration will likely win Chinese concessions. It seems that many of the concessions, like a better defense

By Marc Chandler(This post originated at Marc to Market)
The idea that monetary and fiscal policy can and ought to be used to ameliorate the business cycle, to avoid the kind of boom/busts that lead to social instability and radical ideologies is a rather modern notion, and it remains somewhat controversial. Many now see it as hubris that policymakers can tame the business cycle. However, for those who subscribe, the general understanding is that policy ought to be counter-cyclical.
In a cyclical expansion, tax revenues are higher and social support funding, such as unemployment compensation, are lower.Budget deficits ought to fall, and even Keynes’ did not advocate a permanent deficit. Some policymakers in the UK even formally thought about the budget balance over the course of entire

By Marc Chandler
Originally published on Marc to Market
There is a general understanding of what happened last week. The 2.9% rise in average hourly earnings in the US reported, the fastest since 2009 spurred fears of rising inflation. The jump in US interest rates triggered equity sales and a spike in volatility, which in turn spurred the unwinding of low vol bets that had been paying off handsomely.
While this consensus narrative has much to recommend itself, there is a major discrepancy. The rise in US interest rates since both the end last year and since the January employment data appear to reflect mostly an increase in real rates and not the inflation premium.
This preliminary assessment is borne out by reviewing the change in nominal yields and the change in

By Marc Chandler
Originally published on Marc to Market
There is a general understanding of what happened last week. The 2.9% rise in average hourly earnings in the US reported, the fastest since 2009 spurred fears of rising inflation. The jump in US interest rates triggered equity sales and a spike in volatility, which in turn spurred the unwinding of low vol bets that had been paying off handsomely.
While this consensus narrative has much to recommend itself, there is a major discrepancy. The rise in US interest rates since both the end last year and since the January employment data appear to reflect mostly an increase in real rates and not the inflation premium.
This preliminary assessment is borne out by reviewing the change in nominal yields and the change in

By Marc Chandler
Originally posted at Marc to Market
The short-term solution reached last month to extend the US federal government’s funding expires on Thursday, February 8. Leaders from both parties say they want to avoid another partial closure. Last month, parts of the federal government were closed for three days, which is about par for the course (around half of the government’s 19 shutdowns since 1977 lasted three days).
The House of Representatives is planning to vote tomorrow on a continuing resolution to extended current spending plans through March 22. It is not clear at this juncture that it has the vote to pass the motion. The consensus among Republicans may be fraying.  Some of the fiscal hawks and the conservative Freedom Caucus are balking at what would be the fifth

By Marc Chandler
(This post first appeared at Marc to Market)
ECB President Draghi was unable to arrest the US dollar’s slide and euro’s surge.  But he did not try particularly hard. 
While many investors are a bit stumped by the pace and magnitude of the dollar’s slump, Draghi seemed to imply that it was perfectly understandable given the recovery of the eurozone economy.  The economy is the strongest it has been in more than a decade, but the US is no slouch.  The US reports the first official estimate of Q4 GDP tomorrow January 26 and it will likely be the third consecutive quarter of above 3% growth. 

How are growth impulses transmitted to the capital markets?  One channel is the demand for capital is expected to increase and this may increase real interest rates.  Another

By Marc Chandler
(this post originally appeared at Marc to Market)
Did US Treasury Secretary Mnuchin signal a change in the US dollar policy?  Probably not. As Mnuchin and President Trump have done before, a distinction was drawn between short- and longer-term perspectives.  In the short-term, a weaker dollar says Mnuchin, is good for US trade and “other opportunities”.  In the longer-term, Mnuchin explicitly acknowledged, “the strength of the dollar is a reflection of the strength of the US economy.”
The market chose to focus on the first part of the comment because it was already selling dollars and this offered justification at an important inflection point.  The dollar has strung together a 4-5 week slide despite macroeconomic conditions,  including strong growth, tax cuts, the

By Marc Chandler
(originally published at Marc to Market)
The US Treasury International Capital report for the month of November 2017 was released yesterday.  It showed that the two largest foreign holders of US Treasuries, China and Japan, were net sellers.  China sold about $12.6 bln and Japan sold about $9 bln of US Treasuries.  Foreign investors sold $6.4 bln of Treasuries, meaning that outside of China and Japan, other foreign investors were net small buyers of Treasuries.
The offshore centers, where some hedge funds may be located for tax purposes, of Bermuda and Cayman Islands were net unchanged on the month.  We know from more recent Commitment of Traders data that large speculators turned net short 10-year Treasury

By Marc Chandler
(this post first appeared on Marc to Market)
There is nothing quite like a falling dollar to spur take of the erosion of the greenback’s reserve status.  There has been talk for several months that China is preparing in yuan-denominated oil contract (with an embedded gold option).  It has not been launched yet, but some observers see it as a blow to the dollar’s role.
We are skeptical.  In the mid-1970s, when OPEC agreed to use the dollar as the benchmark for setting prices, it may have been significant.  However, we argue that the liberalization of the capital markets has changed this assessment.  The key to the dollar’s reserve role is not that most commodities are priced in dollars or that trade, even when

By Marc Chandler (originally posted at Marc to Market)
The investment climate is being shaped by two powerful forces.  First is the very accommodative policy stance. This includes the United States, where despite delivering the fifth rate hike in the cycle, adjusted by headline CPI, remains negative. As the balance sheet has begun being reduced, financial conditions in the US are easier now than a year ago.
The ECB’s bond purchase program, which has been cut in half to 30 bln euro a month starting now, is only the most visible part of its extraordinary monetary policy.  Other elements include the minus 40 bp deposit rate, the full allotment of fixed rate refi operations, and the quality of the assets and collateral.
There are

By Marc Chandler (originally published at Marc to Market)
Germany does not have a government, though the election was more than three months ago.  Spain, Portugal, and Ireland have minority government.  Austria is the first government since the financial crisis to include the populist right.  The EU is trying to press Visegrad group of central European countries to conform to the values of Western European members.  And yet it is Italian politics and the election on March 4 that is drawing attention.
Investors do not seem to care much about political developments provided they are local and do not pose systemic risk.  Italy may pose such risk, the argument goes, because the largest parties want to ditch the euro.  Perhaps

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Political Economy » The Importance of China’s New VAT

By Marc Chandler
Yesterday, China announced one of the most important tax reforms of the past twenty years.  It is replacing a business tax on gross revenue for non-manufacturing companies with a VAT.   Manufacturing companies have been subject to a VAT approach for a few years.  The reform extends it from manufacturing and a few services in a pilot program to industry-wide application. It will now cover construction, real estate, finance and consumer services.
The shift to the VAT is expected to reduce the service sector’s tax bill by CNY500 bln (~$77 bln) or 0.7% of GDP.  A report indicated that businesses will pay 11% VAT compared with the previous 5.5% business tax.  While the rate is higher, the base is considerably smaller.  The break is consistent with the government’s modest stimulative measures.  It denies the government of revenue,but it was already built into this year’s budget and incorporated in the deficit projection of 3% of GDP.
The shift to a VAT for services will help facilitate the economic transition from manufacturing to services as the economy matures.  The manufacturing sector has benefited from the lower tax rate of the VAT and now services and small businesses will as well.
The VAT has other implications.

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Political Economy » Britain, Brexit, and sovereignty

By Marc Chandler
originally posted at Marc’s blog, Marc to Market
As the European Union grew, the unanimity in decision-making increasingly gave way to qualified majority voting.  This development took away an important weapon the UK deployed to pursue its national interest.  It use often to frustrate the collectivist decision-making in Brussels and exert its will for a broad union that preserved national sovereignty.
National sovereignty is at the crux of the matter now.  This is the bedrock upon which those who want the UK to leave the EU are basing their case.   The EU rules that encroach upon nearly every aspect of business.  It threatens to become a super-state.
Even if one believes that Prime Minister Cameron identified the right reforms to safeguard the UK’s interest, which not everyone does, no agreement would have or could have appeased those seeking greater independence.   Those advocating a UK exit have been making a forceful case, and the European Commission’s bungling of the immigration issue provides timely fodder.
Those that favor the UK remaining in the EU could not vigorously make their case during Cameron’s negotiations.   Only now will this case be articulated.

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By Marc Chandler
Through the venomous comments and erosion of trust, the broad framework of what couple prove to be a workable compromise over Greece’s financial crisis may be emerging.   This is not to suggest that the eurozone finance ministers meeting will reach any important decision.
Indeed, the Greek Prime Minister has already reduced his finance minister’s role in the negotiations, and it appears Merkel has done something vaguely similar.  Schaeuble did not favor the second aid package to Greece.  Instead, he reportedly argued to use the time and funds to facilitate a non-disruptive exit for Greece.  Merkel eventually went the other way.  Even now she seems more committed to keeping Greece in than is her finance minister, but Germany, no less than Greece, is willing to repeat Draghi’s pledge to do whatever is necessary.
Part of what is necessary is to change the language.  Many may scoff at the dropping of the use of “Troika” but symbols are very important in this context.  Greek officials have indicated a willingness to reform the pension system and VAT.  They do not agree on foisting more austerity through cutting current benefits or hiking the VAT.  The reforms could generate additional savings over time.