Daily Macro: Widodo, PDI-P Lead / Siregar to DC / Tobin Tax Unlikely / KPK Bomb Scare / Industry Minister Eyed and more

In this briefing:

1. Widodo, PDI-P Lead / Siregar to DC / Tobin Tax Unlikely / KPK Bomb Scare / Industry Minister Eyed
2. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy
3. Fed Policy Credibility: Markets and President Trump Pile on the Pressure
4. Seismic Shift in Fed’s View Driven by Anaemic M2, Implying US$-Weakness and an EM-Positive Year
5. UK Politics: Swerve, Crash or Stop (55:30:15)

1. Widodo, PDI-P Lead / Siregar to DC / Tobin Tax Unlikely / KPK Bomb Scare / Industry Minister Eyed

Widodo maintains his 20 point lead in a late December poll, while PDI-P looks poised to control over 40% of the next parliament — rendering the recalcitrant Party Chair Megawati an unconstructive power broker.  Uno is pressing salient points about inflation and jobs, but Prabowo strikes discordant tunes.  KPK members suffered bomb threats at their homes.  The Riau-1 case increasingly implicates the industry minister, Golkar Chair Airlangga Hartarto.  The new ambassador to the US is a competent economist. 

Politics: Megawati delivered a high‑profile address to party members and dignitaries, including President Joko Widodo, that showed no inkling of embracing economic or governance reforms, despite their clear urgency.  Widodo lavished praise on the chair of the party to which he belongs; the hyperbole merely underscored his awkwardness with the powerful and imperious party chair (Page 2).  Vice Presidential Nominee Sandiaga Uno reiterated the importance of prices and jobs to voters, and downplayed the benefits derived by the poor from infrastructure works.  He is honing his messaging, but he still lacks solutions and Prabowo Subianto strikes discordant tones (p. 3).  The Solidarity Party (PSI) gained notice by issuing ‘Falsehood Awards’ to Prabowo, Uno and Partai Demokrat’s Andi Arief.  But the inspired party is languishing with negligible popular support (p. 4). 

Surveys: President Joko Widodo still had a 20 percentage point lead over Prabowo Subianto as of late December, according to the survey firm Indikator Politik.  The poll also found that only 15 percent of respondents believe that Prabowo abducted pro‑democracy activists in 1997‑98, even though he himself has admitted to doing so (he denies having abducted those that never returned) (p. 5).  The Survey Network (LSI) noted continued strong support for Megawati’s PDI‑Perjuangan, while parties such as the National Democrat (Nasdem) Party, the National Mandate Party (Pan) and Hanura could suffer exclusion from the next parliament.  Islamic-oriented parties appear poised to lose a third of their seats – but it remains to be seen if Gerindra, which is expanding, embraces elements of an Islamic agenda.  Dominance by PDI‑P in the next parliament would bode ill for economic and institutional reform (p. 7).   

Justice: Although unharmed, two Anti-Corruption Commission (KPK) members were targets of attacks on their homes by unknown assailants.  Two Molotov cocktails hit Laode Syarif’s home and a fake pipe bomb was found at KPK Chair Agus Rahardjo’s (p. 9). 

Policy News: A former finance minister suggested a reverse Tobin tax on portfolio funds, but the current minister, Sri Mulyani Indrawati, pointed out its costliness (p. 10).  The information minister promised a long‑awaited ride‑sharing regulation soon (p. 13).

Appointments: A prominent macro‑economic policymaker of the Yudhoyono‑era, Mahendra Siregar, received induction as ambassador to the US, after having served for two years as the government’s chief advocate for the palm oil industry (p. 13). 

2. Extraordinary Fiscal and Monetary Policies Have Disrupted the Global Economy

In their public presentations, central banks seem to be contemplating the use of neutral interest rates (r*) in addition to unemployment/inflation theories. R* has the advantage of appearing to be subject to mathematical precision, yet it’s unobservable, and so unfalsifiable. Thus, it permits central banks to present any policy conclusion they want without fear of verifiable contradiction. R* is the policy rate that would equate the future supply of and demand for loans. It rises and falls as an economy strengthens and weakens. Long-term observation during the non-inflationary gold standard, period indicated that r* in an average economy was 2% plus, which would become 4% plus with today’s 2% inflation target. The Fed may soon end this tightening cycle with the fed funds rate at or near 2¾%, which would be r* if the rate of lending and borrowing in America remained stable thereafter. Rising (falling) lending would indicate a higher (lower) r*. 

3. Fed Policy Credibility: Markets and President Trump Pile on the Pressure

Financial markets and President Trump have raised the ante on Fed policy conduct, but the clash with the Administration was inevitable given the tighter monetary policy offset to last year’s easing of fiscal policy.

President Trump’s attack on the Fed may indicate broader issues and concerns about the performance of his economic team, notably Treasury Secretary Mnuchin.

Uncertainty about the Administration’s future relations with both the Fed and House of Representatives will remain elevated during 2019, thereby increasing the pressure on the Federal Open Market Committee (FOMC) to assume a greater leadership role in the realm of economic management.

Financial markets have become excessively reliant on crystal-clear guidance from the FOMC since the financial crisis, but policy communication in 2019 will be reset to incorporate flexibility and patience in the realm of future conduct.

US equities have other adverse factors to consider in 2019 apart from Fed policy, but lower valuations suggest reduced investor complacency, as well as offering some downside protection.

Recession risks in the US are still manageable due to low inflation and the FOMC’s ability to lower the federal funds due to its past policy actions.

4. Seismic Shift in Fed’s View Driven by Anaemic M2, Implying US$-Weakness and an EM-Positive Year

Fed chairman Jay Powell’s extraordinary flip-flops over the past 3 months have left his communication strategy in tatters (unsurprising, given that he has no economics training, as we warned at his appointment: Trump Now Has a Clear Path to Damage the Fed, Even as He Loses Political Ground). Nothing in the US growth numbers or core inflation could justify the seismic shifts in the Fed chair’s language. However, M2 money supply moderated sharply to 3.8% YoY growth in October, and didn’t materially improve in November or December, suggesting that the money multiplier is not rebounding quickly enough to offset the sharp contraction in the monetary base. In our view, this is the indicator that the FOMC and market need to pay more attention to in 2019.  

While the stock market has predicted “nine of the last five recessions” (to use Paul Samuelson’s famous phrase), an inverted UST yield curve (specifically a negative 2-10 year Treasury spread) has predicted each of the last seven recessions. The 1980 recession began 18 months after the yield curve first inverted, but the lag has been shorter (about 12 months) for the subsequent four recessions. The yield curve has not yet inverted, but is inexorably trending toward negative territory. We expect the US to enter recession no later than mid-2020, bang in the middle of the next US presidential election cycle.  

A weak US$ is likely to remain the last reflationary factor for the US in 2019. But, like in 2017, US$-weakness will be positive for Emerging Markets (EMs). We expect China’s debt and growth challenges to come to a head this year, but they would have imploded a lot sooner and more drastically had this been another year of US$ strength. 

5. UK Politics: Swerve, Crash or Stop (55:30:15)

• The UK parliament continues to show its opposition to everything, including a no deal Brexit. Recent amendments are more signalling than substance, though.
• A political swerve to approve a deal based on the existing one remains the most likely scenario, in my view (55%). Brinkmanship leaves a crash out with no deal as a significant risk (30%), though, as it is the default outcome despite opposition.
• Stopping the exit from the single market and customs union (15%) is appealing to many commentators, but it still looks more like hope over reality, in my view.