February 26, 2019
There are formidable storm clouds on the horizon concerning Brexit. The deadline for Britain leaving the European Union (EU) is just over 30 days away, on March 29th. This date is shaping up to be a disaster!
Already, Britain appears to be slipping into a recession over the Brexit mess. For example, Land Rover Jaguar announced 4,500 layoffs and is short of capital. Honda announced that it will close its plant in Swindon, England, employing 3,500 workers, in 2021. Some EU automotive companies, like Porsche, have warned its British customers that a 10% surcharge may be added after March 29th since there is no agreement between Britain and the EU on vehicle tariffs. Economies hate uncertainty, since businesses and consumers tend to postpone purchases, which causes the “velocity of money” to grind to a halt.
Britain is supposed to pay the EU a multi-billion-pound exit fee to leave, but Prime Minister Theresa May has not been able to get the House of Commons or Parliament to approve any exit fee. As a result, chaos reigns and both the British pound and euro are expected to remain weak due to all this Brexit chaos.
Meanwhile, continental Europe may be slipping into a recession. Italy is already in an official recession after two consecutive negative GDP quarters and rising unemployment. France is still dealing with the aftermath of its yellow vest protests, but these EU problems have been overlooked due to the Brexit news.
Ironically, neither the Bank of England nor the European Central Bank (ECB) can cut interest rates enough to fix their ailing economies, so more quantitative easing (QE) may be their only option. The only problem with QE is that it further weakens currencies and sparks inflation, as prices on imports rise.
Essentially, the chaos surrounding Brexit has caused money to flow into the U.S. and suppress our Treasury yields. This international capital flight is expected to persist through March and possibly beyond, depending on the ongoing infighting within Europe. The insults from the EU bureaucrats regarding Britain’s decision to leave the EU without a transition plan exposed just how bitter the EU is about Brexit. Specifically, European Council President Donald Tusk made some provocative comments that there is “a special place in hell” for the British officials pushing for Brexit. That was his parting jab at the failure of EU officials in Brussels to extract any significant exit payment from Britain.
Interestingly, The Wall Street Journal on Tuesday reported that, based on their two-year government bonds, Finland, France, Germany, and Austria all have negative yields due to ebbing confidence. Although money is gravitating to what is perceived to be stable EU countries, as the amount of negative government yield grows, that money is looking elsewhere, and the U.S. is unquestionably the oasis.
U.S. Energy Production Aids in Policing Venezuela and Other Dictators
Thanks to all-time record crude oil production, the U.S. is now driving world economic growth. U.S. control over worldwide energy prices should eventually lead to political changes in Venezuela and possibly Iran as their respective economies collapse. Like China has successfully done, the U.S. is now using its economic might to influence the world, with a special focus in our home hemisphere.
Speaking of U.S. economic might, President Trump last week in Miami delivered a scathing speech that warned Venezuela’s military authorities that they would “lose everything” if they remain loyal to President Nicolas Maduro and refuse to allow emergency humanitarian aid piling up on the Colombian border. The U.S. military continues to fly C-17 cargo planes to Colombia with nutritional supplements and hygiene kits. Venezuelan opposition leader, Juan Guaido, is demanding Venezuela’s military allow the humanitarian aid in. He has offered amnesty to military officers who violate Maduro’s blockade.
President Trump called Maduro a “Cuban puppet” and warned officials who keep Maduro in power that “the eyes of the entire world are upon you.” In his speech, President Trump said Cuba is reported to have sent 1,000 military and intelligence advisors to protect President Maduro. Complicating matters further are the approximately 400 Russian security personnel in Venezuela, ostensibly defending Maduro.
Finally, President Trump said, “The twilight hour of socialism has arrived in our hemisphere.” He concluded by saying, “The days of socialism and communism are numbered, not only in Venezuela, but in Nicaragua and in Cuba as well.” Obviously, by continuing to fly C-17 cargo planes to Colombia, the U.S. is planning to help with massive humanitarian aid to Venezuela. The best possible solution is for the Venezuelan military to end the humanitarian aid blockade and back opposition leader Juan Guaido.
This chaos in our hemisphere is actually helping financial markets, since international confidence in the U.S. is boosting the U.S. dollar and suppressing Treasury yields. Naturally, a stronger U.S. dollar lowers commodity prices and squelches inflation. Lower U.S. energy prices should boost consumer spending, while lower interest rates should eventually help the automotive and housing industries to recover.
The bottom line is the foundation under the U.S. economy remains strong, although we have seen an interruption in the normal flow of economic statistics. For instance, the Conference Board on Thursday announced that its leading economic index (LEI) declined 0.1% in January, but three of the 10 LEI components – building permits, new orders for capital goods, and new orders for consumer items – were not available due to the federal government shutdown, so there’s little value in these preliminary data.
Finally, the Fed released their Federal Open Market Committee (FOMC) minutes on Wednesday, revealing that they plan to stop shrinking their $4 trillion portfolio via asset sales later this year. Details will come later. The FOMC minutes said, “Such an announcement would provide more certainty about the process for completing the normalization of the size of the Federal Reserve’s balance sheet.”
This is big news, since the Fed has been systematically selling government securities and artificially keeping Treasury bond yields a bit higher than they might otherwise be. When the official announcement comes out that the Fed will stop selling $50 billion per month in government securities, I expect that Treasury bond yields will decline. The FOMC minutes also revealed that several Fed officials lowered their economic outlook due to (1) softer consumer and business sentiment, (2) downgrades in foreign economies’ growth outlooks, and (3) tighter financial conditions stemming from the year-end market swoon. Overall, the FOMC minutes were very revealing and very positive for both bonds and stocks.