Risk level: ORANGE - HIGH

RED: Severe (+/- 4%) ORANGE: High (+/- 2%)  YELLOW: Elevated (+/- 1%)  BLUE: Guarded (+/- ½%)

THE BOOSTER SHOT

•             China targeting U.S. oil and LNG hits Trump where it hurts

•             The systemic link between policy and power tell us to expect strategic mistakes

•             The U.S. trade gap could be telling for revisions in second quarter GPD

The Chinese government on Friday hit the Trump administration where it hurts by proposing tariffs on U.S. liquefied natural gas and crude oil. Capping off what was a relatively quiet week in geopolitical affairs, Beijing has now struck at the heart of Trump's quest for energy dominance. China's response followed claims by U.S. Trade Representative Robert Lighthizer that Beijing was skirting the law with its retaliatory trade policies. U.S. Secretary of State Mike Pompeo, meanwhile, griped that the Trump administration wasn't treated fairly by the Chinese, stressing it was an inherited trade regime that stacked the deck against the United States. All this followed second quarter gains in U.S. gross domestic product of 4.1 percent. A growing trade deficit, compounded by a recent increase in U.S. oil imports, could nevertheless undermine gains in the U.S. economy and lend support to sentiments that second quarter GDP was attributable to one-off factors. We're expecting economics and trade to dominate the narrative in the coming week. While those are more on the fundamental side of the market equation, those issues are indicative of broader dynamics in global power. With trade and second quarter earnings driving the market, we were within range of our scale with a Yellow alert last week as Brent lost 1.45 percent to close the week at $73.21 per barrel. That's now an impressive five weeks in a row for a spot-on call about the week ahead in the price of oil.

China and the United States spent the last few days in a blame-game over trade policies. Earlier in the week, China said it wouldn't respond to U.S. "blackmail" on trade and on Friday, its Customs Tariff Commission of the State Council said unilateral measures from the Trump administration breached multiple trade rules to the detriment of free trade. Speaking in Singapore on Saturday, Pompeo said it was China that was breaking the law. The Trump administration, he said, "desperately" wants a free and open trade relationship with its international partners.

"All the work that we’re doing in the trade arena is designed exactly for that purpose," he said. "President Trump inherited an unfair trade regime where American workers and American companies were not treated reciprocally or fairly by the Chinese, and the efforts of the Trump administration are to right that, to correct that, to adjust that."

Pompeo's remarks echo those from Trade Representative Lighthizer, who said President Trump was now proposing a 25 percent duty on $200 billion worth of Chinese goods because Beijing had "illegally retaliated" against the U.S. economy.

The trade tensions provide a backdrop for emerging economic and national power trends. An increase in crude oil prices in June and declines in the exports from the U.S. automotive sector drove the U.S. trade deficit to its highest level since November 2016, two months before Trump took office. That could impact later revisions to second quarter GDP growth, which stands at 4.1 percent so far. In its latest revision, real GDP growth reflected positive contributions from personal spending and exports. The Commerce Department reported on Friday that June exports, however, were $1.5 billion less than the previous month.

Joseph Nye, the former dean of the Harvard Kennedy School of Government, in a 2014 lecture on American leadership commented on the "rise of the rest" as a challenge to the U.S. position on the international stage. With IMF projections of a U.S. decline in the share of global production, Nye said the United States wasn't so much losing as other countries were doing more. On the possibility of China overtaking the United States in terms of power and economic potential, Nye said the real danger to the international system wasn't the shift in the poles of leadership, but in systemic entropy "leading to an inability to collect actions together and get things done." Charles F. Doran at the John Hopkins School of International Studies, meanwhile, united geopolitical history and economics into a single dynamic to explain state behavior. Plotting a general cycle of maturation and decline, Doran said changes in power lead states to struggle with their conception of reality and make misstates. The ingredients necessary for rational choice, he said, are absent and strategies become flawed.

These theories would suggest more mistakes are possible as both sides of the emerging trade war react to their positions of power, perceived or otherwise. Recall that last week, we noted that Sen. Bob Corker, R.-Tenn., the chairman of the Senate Foreign Relations Committee, wondered if there was any real strategy in the Trump White House. Or is it, he wondered, that the president – to borrow from Nye – is in a position to undermine the institutions to "get things done." Forced to search for new foreign policy roles, a nation struggling with direction will feel threatened and more likely to over-react.  This, in turn, could undermine national power and, if we follow Doran's single dynamic, economic growth as well.

We would expect the tit-for-tat on trade to continue in the coming week. The increase in trade shots across the bows of the world's leading economies has sparked concerns about global growth, a concern that's likely to diminish demand. Meanwhile, the latest OPEC survey from S&P Global Platts shows production from Saudi Arabia and other regional producers is more than enough to offset the real and potential loss in output from Iran, Libya and Venezuela. And on Saturday, restrictions on the flow of oil were eased when Saudi Aramco announced shipments through Bab-el-Mandeb Strait near Yemen will resume "with immediate effect."

With its healthy appetite for oil, China targeting Trump's strategy of energy dominance will open a new phase in the brewing trade war. We're also mindful of the steady drums of war in the Persian Gulf as Iran stands pat on its determination to protect its interests and the nuclear deal that lets its oil flow. The week ahead may be a little quiet, though keep watching for clues in second quarter earnings. With tariffs and trade taking the headlines, we're pointing out Tuesday's earnings report from Plains All American Pipeline. On Thursday, Japan releases its annualized GDP and on Friday, we got a look at the U.S. Consumer Price Index.

For the week of March 21, when Trump announced a plan to impose tariffs on $50 billion worth of Chinese goods, the price for Brent crude oil lost 2.6 percent. Based on that, we're issuing an Orange alert for this week, but think it may be a bit on the pale side as oil seems rather range bound still. Expect tailwinds if U.S. inventory reports show a draw on crude and headwinds should the trade war escalate further.