Glimmers of Hope on Debt Ceiling, China Trade Talks
Author: Greg Valliere
July 19, 2019
LOST AMID THE FUROR over the chilling “send her back” chant are signs of genuine progress on setting 2020 spending levels, raising the debt ceiling, and resuming high-level trade talks with China.
DONALD TRUMP’S BASE is 90% behind him after this tumultuous week, which gives the president some flexibility to consider a budget deal and a China agreement that might not be popular with the right wing. Let’s start with the budget —
A CLASSIC WASHINGTON POWER STRUGGLE is emerging on a deal now emerging between Nancy Pelosi and Steve Mnuchin, who realize that a debt default — unlikely but not impossible — must be avoided at all costs. They’re close to agreement on a two-year deal that lifts rigid spending caps, and now Washington is waiting for the push-back from the House Freedom Caucus and their deficit hawks. The key will be Trump.
WHO HAS THE PRESIDENT’S EAR? Will Trump agree to a two-year deal that dramatically increases Pentagon spending and also boosts domestic outlays, or will he side with top aide Mick Mulvaney and the deficit hawks, rejecting any deal that has Pelosi’s fingerprints on it?
OUR BOTTOM LINE: We think there will be a debt ceiling/spending caps deal; the question is when. There are numerous loose ends to tie up — including the controversial issue of spending offsets to pay for new outlays, a non-starter for the Democrats. Getting a deal done before the House leaves town at the end of next week is a tall order, compounded by the radioactive political climate.
SINCE NOTHING GETS DONE HERE until a crisis becomes imminent, we’re skeptical that a final deal can get wrapped up in the next few days. Our best guess is that there will be an agreement in principle soon, with details hashed out during August — paving the way for a final deal in early September, as a debt ceiling crisis looms. Washington and Trump love drama, so why not ratchet up the suspense for a few more weeks?
EVENTUALLY THERE WILL BE A DEBT CEILING HIKE and new spending levels that maintain a stimulative fiscal policy, along with a market-friendly hike in defense spending. Trump will have to sell this to base, which doesn’t like more Washington spending, but his base has nowhere to go; they’re wedded to each other.
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GLIMMER OF HOPE ON TRADE TALKS: Our sense after talking with a trade expert last night is that talks between the U.S. and China are back on track after Mnuchin spoke with Chinese officials yesterday and then did not rule out a face-to-face meeting between high-level delegations later this summer. Several issues are unresolved but we continue to expect a deal by winter.
WE REITERATE OUR BELIEF that Trump is in no hurry to finalize a deal with China because the longer the tariff wars continue, the longer the Fed will have to stay accommodative. In fact, even more trade tension could erupt between the U.S. and Europe later this summer. Trump will get his way — a rate cut at the end of this month and probably another one in the fall, largely because Fed officials worry about the economic headwinds that he largely created because of the tariff uncertainty.
A 50 BASIS POINT CUT? The bond market got ahead of itself yesterday, over-reacting to comments from New York Fed President John Williams that seemed to indicate a 50 basis point cut is possible on July 31. A Fed official later clarified that Williams was not predicting an aggressive cut.
PROPONENTS OF A 50 BASIS POINT REDUCTION will encounter stiff resistance within the FOMC, where several members are reluctant to even cut by 25 basis points later this month; they question why the Fed should waste its ammunition when markets are close to all-time highs, the economy is growing moderately, inflation may be warming up, and the labor market is roaring. The Fed will take out an insurance policy, but three rate cuts in the second half — which many in the markets expect — looks unlikely to us.
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