***JAPAN WATCH

Today: Flat car sales = steep production declines in Q4; U.S. exports in a down trend; China slows further; oil; Japan; U.S. politics.

According to Ward’s: vehicle production is now scheduled to decline in Q4 at a -13.1% QoQ a.r., down from the -6.3% previously scheduled.

U.S. Trade Gap Widens The U.S. trade gap widened in September as exports fell to a five-month low, a sign of how a stronger dollar and slower growth overseas could weaken demand for American-made goods and weigh on the broader economy.

Exports decreased 1.5% from August while imports were nearly unchanged. Exports were down 0.3% in Q3 with an accelerating slide. In September, exports to China swung from a 3% increase in August to a 2% drop. In Europe, exports swung from a 4.6% increase in August to a 7% drop in September.

What Falling Exports Mean for U.S. Economic Growth

The unexpectedly large widening in the September U.S. trade deficit has economists thinking  the Commerce Department will make a steep downward revision to third-quarter gross domestic product growth from the initially reported 3.5% annual rate. Commerce will release its second reading of summer GDP on Nov. 25.

In its Oct. 30 report, Commerce said the net exports deficit for all of the third quarter narrowed sharply from its second-quarter level, contributing 1.32 percentage points to GDP growth. But Commerce had estimated the September trade deficit would be little changed from its August level. Instead, the nominal gap widened from $43.0 billion in September from $40.0 billion. The widening reflects the decoupling of economies: Faster U.S. growth is drawing in more nonpetroleum imports, while the global slowdown helped to reduce U.S. exports by a large 1.5%.

In response to Tuesday’s trade report (in addition to weak construction and factory orders data), economists are reducing the estimates for third-quarter real GDP growth. Economists at BNP Paribas now track third-quarter GDP at 2.8% and J.P. Morgan forecasters think the rate will be revised to 2.9%, while the econ shops at Goldman Sachs, Royal Bank of Scotland and Capital Economics think the rate will fall to about 3%.

Economists are split on what the trade situation means for fourth-quarter growth now expected at 3.0%, according to forecasters surveyed by the Wall Street Journal.  The J.P. Morgan economists think the drag from net exports could continue into the fourth quarter. But Paul Ashworth, chief U.S. economist at Capital Economics argues the collapse in crude oil prices means that the trade deficit will narrow again. He writes in a research note, “By the end of the year, the lower cost of imported oil should push the trade deficit well below $40.0 [billion].”

CHINA: SLOW AND SLOWER

IP Sees Lower Growth than Chinese Official Figures

Carol Roberts, chief financial officer of International Paper Co.IP +3.91%, sees economic growth in China that is lower than official government figures.

China reported its gross domestic product grew of 7.3% during the third quarter, but Ms. Roberts has seen virtually no growth in its corrugated packaging business there.

“China is much weaker than what the headlines will tell you,” she told CFO Journal. “We look at those numbers and scratch our heads a bit.” (……

She said that political and economic uncertainty in Russia has depressed demand in the country, as well as in Ukraine.

China Puts the Brakes on Car Makers Auto Sales Grew 7% in First Nine Months of the Year, Down from 13% a Year Ago

Global car makers sounded new warnings that demand in China, the auto market’s strongest growth engine in recent years, is cooling further and clouding prospects after several reported disappointing October sales in the country.

On Tuesday, Honda Motor Co. and Nissan Motor Co. cut their sales projections in the country for this year, and the chief executive of luxury-car maker BMW AG said flatly the nation’s “high double-digit growth rates are over.”

Lower expectations for the world’s largest automobile market come when car makers are confronting economic and currency weakness in South America and Russia, increased regulatory costs in the U.S. and weakening economic data in Europe that could threaten sales momentum heading into 2015. (…)

Honda on Tuesday lowered its sales target for China by more than 10% this year. (…)

Nissan said that it has lowered its 2014 sales target for China to 1.27 million vehicles from 1.4 million, citing slowing Chinese economic growth and increased competition. In the first 10 months of this year, Nissan reported a modest 3.5% increase in its motor vehicle sales in China, to 983,500 units. (…) Nissan’s new forecast calls for flat sales in the country. It sold 1.27 million motor vehicles in China last year, up 17% from a year earlier. (…)

OIL

Oil-Glut Move Spurs Further Losses

U.S. oil futures fell $1.59, or 2%, to $77.19 a barrel, a fresh three-year low, and Brent crude, the global benchmark, slid $1.96, or 2.3%, to $82.82 a barrel, a new four-year low.

Judging by gasoline futures, retail gasoline prices are likely to decline to $2.77 over the next six weeks, a potentially significant positive for Holiday Sales.

Oil market’s focus on Saudi formula is undue

(…) On Monday, the kingdom’s decision to lower official selling prices (OSPs) for US customers in December triggered a violent sell-off after commentators said it signalled the start of a battle for market share.

Ironically the same thing happened last month: only then it was a reduction in Saudi OSPs to Asia – the biggest buyer of Saudi crude – which sparked talk of a price war and weakness in oil prices.

So what are OSPs? And why is the market becoming obsessed with them?

Saudi Arabia sells its crude oil via Saudi Aramco, its state-owned company. Most of its oil is sold on annual contracts, which are priced with reference to regional benchmarks – the Dubai/Oman average in Asia, Argus Sour Crude Index (ASCI) in the US and the weighted average of Brent (BWAVE) in Europe.

What Aramco decides each month are the price differentials for its various grades of crude. These range from super light, typically a premium product, to heavy crude oil, which usually fetches a lower price.

At the start of each month Aramco’s marketing arm informs the holders of the contracts what the differential, or adjustment factor, relative to the benchmark will be for loading in the following month.

Crucially, these differentials are calculated from oil product prices, according to Standard Chartered. This ensures crude oil is competitively marketed to refiners. This is known as netback pricing and links the revenue of the producer to the final market price for refined petroleum products.

For December US loadings, Arab Light was priced at a $1.60 premium to ASCI, a 45 cents reduction on the previous month, and Arab Heavy at a $2.20 discount, also down 45 cents.

To put these price cuts in context, the Arab Light differential was at a record premium in summer while Arab Heavy recorded its narrowest discount ever. Unsurprisingly, these differentials affected demand for Saudi crude, which dropped 337,000 barrels a day in August to 894,000 barrels a day – the lowest since December 2009.

To reverse some of those losses, Aramco has cut its US differentials to make its oil more attractive to refiners, say analysts and consultants.

Now, that is a long way from starting a price war – although it will indirectly increase the competitive pressure on US shale producers. Moreover, Saudi Arabia actually increased its December OSPs for Asia, laying to rest the idea that it had started a fight for market share in its most important market.

So why has the market interpreted things so differently?

Partly it is a lack of understanding. A very technical and commercially driven adjustment mechanism has been misinterpreted by investors looking anxiously for clues about Saudi oil policy.

“We see a clear lack of understanding of an OSP’s purpose,” says Morgan Stanley analyst Adam Longson.

But other factors are at work. One is negative confirmation bias. There are a lot investors betting on lower oil prices because of weak demand growth and rising supplies and they are seizing on any data that support their position.

Gold Falls to 4½-Year Low

Russia withdraws support for the rouble

Russia’s central bank on Wednesday abandoned its policy of unlimited foreign currency interventions to support the rouble, accelerating moves towards floating the Russian currency following recent steep falls.

The Bank of Russia said it would dramatically reduce support for the rouble and spend no more than $350m a day to intervene in the domestic foreign exchange market. Previously, there was no set limit for such interventions, and the bank had been selling up to $2.5bn a day in recent weeks to support the Russian currency. (…)

Dollar rally puts focus on Beijing Worries about competitiveness as renminbi surges against euro and yen

Some analysts warn that the current slide in the yen and the euro is raising pressure on China to boost competitiveness by weakening the renminbi, something that would send shockwaves across the global economy. (…)

On a trade-weighted basis, the renminbi has risen more than 15 per cent since the start of 2013, according to an index compiled by JPMorgan. Excluding Hong Kong, the eurozone is China’s largest trading partner while Japan is number three.

Though not a widely held view, Lombard Street Research estimates that the renminbi is now 15-25 per cent overvalued, and will depreciate as China looks to shift its economic model away from fixed-asset investment. (…)

The yen and the euro have appeared locked in a race to the bottom, with each dropping 10 per cent against the dollar in the past six months. Against the renminbi, those declines are even greater, with each losing 12 per cent. (…)

“If the dollar continues to strengthen, the pressure on the PBoC to engineer another short and sharp mini-devaluation and once again shock expectations will rapidly escalate,” writes BNP Paribas economist Richard Iley in a report. (…)

However, many analysts believe the most likely course is for the renminbi to be held steady against the dollar, rather than for a significant devaluation. Sacha Tihanyi, FX strategist at Scotia Bank, says stability is more important than the exchange rate in achieving China’s goal of economic transition.

“The last thing you want to do is disrupt financial markets and prompt capital outflows, which is what a policy of devaluation would do,” says Mr Tihanyi. “It wouldn’t be consistent with China’s policy preference.”

There are also questions over how effective currency policy is in boosting exports, as shown by previous misplaced beliefs at the onset of Japan’s Abenomics project.

Back then, many analysts feared South Korea would suffer as a weaker yen would cause a switch towards Japanese goods.

Experience has proved otherwise, with many Japanese exporters choosing to maintain prices in dollars and book the extra yen as profit, or having long shifted manufacturing overseas. While the won has risen by a third against the yen in the past two years, South Korean exports have proved resilient.

JAPAN WATCH

Japan Wages Rise Most in 6 Years as Abe Seeks Price Gains

Average monthly salaries excluding bonuses and overtime payments rose 0.5 percent in September from a year earlier to 242,211 yen ($2,124), the largest increase since February 2008, the labor ministry said in Tokyo today. The total cash earnings including bonuses and overtime payments advanced for a seventh month and summer bonuses were the biggest in six years.

While the labor market is tightening, earnings adjusted for inflation still fell 2.9 percent, a 15th straight monthly drop, underscoring the challenge that remains for Abe in stoking the economy. The job-to-applicants ratio reached the highest level in more than 20 years in recent months, encouraging companies to boost wages to attract workers.

Consumer prices excluding fresh food increased 3.0 percent in September from a year earlier. Stripped of the effect of an April sales-tax bump, this core measure of inflation was 1.0 percent.

The total cash earnings including bonuses and overtime payments rose 0.8 percent in September to 266,595 yen while summer bonuses this year rose to 370,550 yen.

Kuroda’s Reagan Moment: A “Stay the Course” Plea In his first public comments since the Bank of Japan’s controversial big new easing Friday, Gov. Haruhiko Kuroda took an unusual detour from his standard economic assessment to nod to — and try and quell — rising political opposition to his all-out war on deflation.

(…) “To completely overcome the chronic disease of deflation, medicine should be taken until the end. A half-baked medical treatment will only worsen the symptoms.”

Mr. Kuroda’s remarkable plea for patience follows a razor-thin 5-to-4 vote on his own policy board in support of the additional easing, showing skepticism growing even from within his institution. Small businesses around the country complain that the weakening yen has pushed up their costs, while they fail to enjoy the offsetting gain in profits reaped by Japan’s larger companies with overseas operations. Wages, while rising, have so far failed to keep up with the rising inflation Mr. Kuroda has pursued, especially when combined with last spring’s sales tax hike. (…)

Mr. Kuroda didn’t invoke Mr. Reagan Wednesday, but he and aides have made clear that they’ve studied closely the Volcker experience — noting the serious short-term pain it inflicted, and the resulting political backlash, as well as the long-term benefits attributed to it. They see their whatever-it-takes crusade to break deflationary expectations as the flipside of Mr. Volcker’s determination to crush the rampant inflation expectations of the late 1970s.

Mr. Volcker’s “aggressive monetary tightening… laid a sound foundation for prosperity of the U.S. economy…,” Mr. Kuroda noted in a speech late last year. He’s now waging a full-throated political campaign to try and convince the public, and his own policy board, that he can do the same for Japan.

POLITICS

A Shellacking for Obama

The Republicans on Tuesday defeated at least four incumbents to take control of the Senate and are adding to their majority in the House. Add the GOP sweep of most of the close races for Governor, including in states Mr. Obama won twice, and the vote is a major repudiation of the President’s governance. (…)

The GOP also added to their House ranks, with a chance to have the largest Republican majority since the 1950s, and maybe the 1920s (if they hit 247 with a gain of 14 or more). That would be a cushion against potential losses in 2016 and give Speaker John Boehner more policy running room. After losing 63 seats in 2010, Mr. Obama appears to have lost more House seats for his party in midterm elections than any President since Eisenhower, who lost 66 in 1954 (18) and 1958 (48). (…)

The liberals who have cheered on Mr. Obama as he drove his party into this ditch are now advising that he should double down on partisanship. Veto everything. Rule by regulation, including a vast immigration diktat that would poison any chance of bipartisan and thus politically durable reform. Demonize Republicans at every opportunity to elect Hillary Clinton in 2016.

If we judge by Mr. Obama’s six-year record, that is what he will probably do. But there is a better way that would do more for the country and his own legacy. Start by recognizing that many Republicans want to do more than merely oppose him. They know their own political brand needs burnishing, and that even their most intense partisans want some results from electing Republicans.

Above all that should mean focusing on measures to lift the economy out of the 2% growth trap of the Obama years. We offered this same advice in 2012, pointing to the way rapid growth had helped Bill Clinton and Ronald Reagan survive the traumas of their second terms. (…) (WSJ)

In Control of Congress, GOP Looks to Set Agenda

For Businesses, Signs of Hope Businesses are hoping the dust will settle from Tuesday’s election with new attention on corporate taxes, immigration, trade and energy, top priorities that have eluded breakthroughs in recent years.

Can Obama, GOP Leaders Work Together?

Washington gridlock cannot get much worse

(…) When Republicans had only partial control of Congress, it was rational, if cynical, for them to behave as if anything good that happened strengthened Mr Obama’s hand. A weak economy, even if worsened by a debt-ceiling crisis they instigated, was ultimately the president’s problem, not theirs.

But Republican incentives will be different in the days ahead. Co-operation with Mr Obama – at least on selective matters of mutual concern – may make more sense than unflinching obstruction.

The first argument for conciliation is that Republicans will soon bear an equal share of responsibility for what happens in Washington. They will have the power to pass bills on their own. Passing only legislation that Mr Obama is certain to veto, like overturning the Affordable Care Act, will not win them much credit with voters.

Conversely, vetoing any legislation whatsoever that Republicans are able to pass will consign Mr Obama to premature irrelevance.

This is a version of the logic that took hold after Republicans captured both houses of Congress in the 1994 election. Despite the bitter conflict that resulted in multiple government shutdowns, Bill Clinton and the Republicans managed to find common ground around a major welfare reform bill, a balanced budget and numerous smaller issues. (…)

A second reason that co-operation may increase in 2015 is the changing dynamic within the GOP. Until this year, the biggest hazard to Republican incumbents came from more extreme Tea Party conservatives.

But in this year’s primaries the Tea Party’s power began to wane, as money from wealthy donors flowed to old stalwarts such as Thad Cochran of Mississippi and Pat Roberts of Kansas who were better positioned to keep their strongholds out of Democratic hands.

This will be even more true in 2016, since turnout is far larger, and the electorate much more Democratic, in presidential election cycles.

If you are a Republican incumbent who feels that the greatest threat to your job comes from your right, then you take a big risk when you side with Mr Obama about anything.

If, on the other hand, your principal worry is losing to a Democrat, you have an increased incentive to strike deals with the opposition on issues where Democratic positions are more popular than Republican ones. (…)

In the end, the argument for more co-operation is a simple one. Washington gridlock cannot get much worse. So at some point, it will begin to get better.

GOP Senate Takeover Puts Fed on Hot Seat Republicans’ takeover of the U.S. Senate promises increased political turbulence for the Federal Reserve, which has already been under pressure from a GOP-controlled House.

(…) Under the Republican-led Senate, Alabama Sen. Richard Shelby would likely become the next chairman of the Senate Banking Committee, which oversees the Fed.

Mr. Shelby is no fan of the Fed. He has been sharply critical of its regulatory performance in the run-up to the crisis. As the top Republican on the banking panel after the crisis, he supported stripping the central bank of its bank-supervision authority when Congress was writing the 2010 Dodd-Frank financial-regulatory overhaul law. He voted against Janet Yellen to be Fed chief, citing her support for the Fed’s bond-buying programs and his concerns that they could spark runaway inflation and other economic problems. (…)

In a recent client note, Ms. Petrou warned that a Republican takeover in the Senate could intensify congressional pushback against the Fed’s use of a new tool, known as overnight reverse repurchase agreements, to raise short-term interest rates when the time comes to tighten policy. (…)

A desire to curb the power of the Fed is one of the few topics on which Mr. Shelby sees eye to eye with Rep. Jeb Hensarling (R., Texas), the chairman of the House Financial Services Committee, say industry lobbyists and analysts. That means the two might be able to find common ground on legislation.

Mr. Hensarling’s committee, which has jurisdiction over the Fed in the House, held 11 hearings in the past year examining various aspects of the Fed’s authority. The effort culminated in legislation proposing a multifaceted overhaul of the Fed that would, among other things, require the Fed to adopt a formal mathematical rule to guide its interest-rate decisions. Ms. Yellen opposes such a move. (…)

Another measure that could get more traction with Republicans in charge is Sen. Rand Paul ’s “Audit the Fed” legislation. The bill by the Kentucky Republican would open up the Fed’s core monetary-policy deliberations to congressional scrutiny.

Sen. Ted Cruz of Texas, a potential GOP presidential contender in 2016, recently identified passing Mr. Paul’s bill as one of 10 top priorities should his party take control of both chambers. Six out of 10 Republican members of the Senate Banking committee are among the bill’s 31 co-sponsors as is Senate Republican Leader Mitch McConnell, who is set to become majority leader with Republicans in the Senate majority.

Mr. Paul’s legislation would direct the Government Accountability Office, a nonpartisan arm of Congress, to conduct a “full audit” of the Fed’s activities, including its deliberations on interest-rate policy, and report back to Congress.

Currently, the GAO reviews the central bank’s financial operations, but not its policy decisions or agreements with foreign governments and central banks. An outside firm audits the Fed’s financial operations and its findings are published in the central bank’s annual report.

A companion measure passed the House in September, but Senate Majority Leader Harry Reid (D., Nev.) has kept it off the Senate floor. That could now change with Republicans in charge.

Fed officials, led by Ms. Yellen, oppose Mr. Paul’s bill because they believe it could compromise the central bank’s political independence.

“I would be very concerned about legislation that would subject the Federal Reserve to short-term political pressures that could interfere with that independence,” Ms. Yellen said during her November 2013 confirmation hearing. She also argued that the Fed is “one of the most transparent central banks in the world.”