Notes From Underground: U.S. foreign and economic policy are operating in unison (2+2=5)

I want to direct our readers to a post to last weeks piece by one of our readers, Newt Canute. It is a piece about our views on China and the U.S. response to recent Chinese  statements and actions. Newt cites a piece from Stratfor, a global political economy analyst group, and we read its work when it’s in the accessible to the public domain. While we don’t always agree with Stratfor, we will note that its analysis is some of the best out there. Better on the politics than the economic predictions. Read the post for it will fit nicely with where we are heading in today’s piece.

It was reported on Friday that Chinese Premier Hu Jintao had decided to attend Barack Obama’s nuclear security summit in Washington on April 12. This was a victory for the Obama administration as the Chinese were needed if this summit was to gain the international traction that the foreign policy team was hoping for. It is important to note that with healthcare completed, the Obama team needs something positive to happen in foreign policy for up to this point all their efforts have been for nil. Efforts in the Mideast, Copenhagen, Qatar, Iran, China and even relations with Japan have not gone well. Yes, we know that there was an arms agreement with the Russians, but we will hold our applause until we see further results. The Chinese are coming to the summit and that is a short-term success for Obama.

Following the Chinese announcement, Treasury Secretary Tim Geithner issued a release that said the Treasury Department would hold off from the April 15 announcement the Chinese’s status as a registered currency manipulator. Geithner agreed to hold off on targeting China in order to see if there is a change in China’s currency policy during the next three months when several strategic G20 meetings are scheduled.

What outcome is the carrot and stick approach of currency manipulator trying to effect?

All of our analysis points to some type of action on Iran. The US is either opting for “severe” sanctions with real bite on the Iranian regime, or planning some type of military action against the nuclear abilities of Iran. But they want to have the entire UN security council on board. We think sanctions with real bite are in play as Obama wants to prove to the Israelis that he is serious about preventing Iran from going nuclear. China may have been worried that the US was going to enforce some type of tariffs and was finally willing to negotiate away Iran for the short term. Interestingly, Geithner’s release on currency manipulation has a time table that sits well with the democrats playing for the Congressional elections in November.

Also tying trade and global politics together was the meeting Obama held with the French President Sarkozy. In a meeting at the White House in which Sarkozy and Obama discussed the nuclear summit and Iran, the French leader let it be known that he was unhappy that the European consortium, EADS, was not given a fair shot at the Air Force order for fueling tankers. Boeing had seemingly walked away with the contract, but EADS had complained that it was an unfair bidding process. President Obama promised to reopen the process so we will see if French support for Obama’s nuclear initiative and Iran sanctions will get EADS a piece of the tanker plane production. The politics of trade is also a slippery slope and it will even get more so now.

Late Thursday we got word of a Fed meeting for April 5. The Fed meets twice monthly. Some meetings are designated as open and some closed–the Fed’s Web site details the differences. It appears that the meeting on April 5 is designated as closed, prompting some to suggest that the FED will raise the discount rate to 1.25% and restore the fairly traditional difference between the funds and discount rate to 100 basis points. We think the market has anticipated this so we will not be surprised, but it may give the market a further sense that the FED is getting comfortable with the growth story.

Speaking of DEBT markets, it was interesting that the 10-year swap market traded lower than the 10-year Treasury market during the previous weeks and that helped sustain the S&Ps and equity rally. Some analysts are making much of this as a statement about the U.S. Treasury going the way of Greece and other stressed sovereign debt. At this juncture we are not in that camp but view it as an outcome of what Richard Koo has termed the balance sheet recession. U.S. corporates are sitting on mountains of cash as they have also paid down a great deal of DEBT and want to be sure that they don’t get into a bad debt situation until all of the debt issues are resolved and banks begin lending again. The freeze up of short-term lending facilities that followed the Lehman bankruptcy scared corporate treasurers into making sure they had ample cash on hand. This is why we think the credit markets have been hit by this very rare event that has taken place in the treasuries and swap markets.

On Friday,with the release of the unemployment report, the long end of the Treasury market sold off, but the equity markets rallied in the small window of time that they traded. Monday will see if that reallocation continues to take place as money moves from bond funds to equities. As we have suggested many times before, keep watching Blackstone (BX) and Ochs-Ziff (OZM) for further indication that the thaw in the credit markets are giving rise to further strength in the Equity markets. Just as an aside, the unemployment report was as expected but the good news was that the private sector job growth was broad-based and better than expected. The private sector news is what gave reason for equities to rally and the DOLLAR to get a bid. The DOLLAR will also like the movement by the Chinese and Geithner backing off for the moment so we should see some short-term DOLLAR buying.

Tags: Dollar, Fed, S&P