That Don't Repress Me Much
By Benjamin Picton, Senior Market Strategist at Rabobank
US equity indices gained yesterday as oil prices pulled back from recent highs and bond yields followed suit. The S&P 500 closed 0.46% higher while the Dow Jones was up 0.56% and the NASDAQ Composite Index lifted 0.45%. The Bank of Canada kept rates at a low, low 2.25% yesterday for a seventh-consecutive meeting. Governor Tiff Macklem struck a more hawkish tone, but RaboResearch’s Christian Lawrence and Molly Schwartz write that they wouldn’t be surprised to see the BOC on hold for another seven, despite the market pricing hikes.
The slight fall in oil prices followed Donald Trump responding “I don’t think too long” when questioned by journalists about how long the renewed bombing campaign against Iran is likely to last. On the flip side, the President also indicated that the US is prepared to carry out further strikes. The recent adoption of a ‘tanker for tanker’ policy whereby the US has targeted Iranian ships in response to Iranian attacks on allied ships transiting Hormuz presents fertile ground for ongoing flashpoints.
New data released by the Energy Information Administration yesterday showed commercial crude inventories fell by 4.5m barrels last week while the Strategic Petroleum Reserve saw a draw of just over 3m barrels. The EIA reports that US refineries are working at 98% capacity. This is likely because the supply of products have been severely constrained by shipping interruptions in the Strait of Hormuz and Ukrainian attacks on Russian refining infrastructure. These converging factors have seen refining margins blow out to multi-decade highs.
Nevertheless, capacity remains insufficient to meet requirements, causing gasoline inventories to fall by 1.2m barrels and prices to remain above $4/gallon throughout the course of August. Distillate inventories posted a small build, but diesel prices are at their highest levels since April.
So, the world is short hydrocarbons and that is contributing to higher prices for all kinds of goods and services as commodity shocks work their way through supply chains. China and the United States have both taken steps to address energy vulnerabilities: the US through its recent deal to take control of a large share of Venezuelan crude reserves and China through the mass adoption of alternative energy sources and electric vehicles. The US strategy does nothing to solve the pressures on refined product supply chains in the near term: reserves are one thing, but you need to be able to get them out of the ground and put them through a refinery somewhere to convert them to usable fuel.
China’s approach reduces the need for liquid fuels and also reduces China’s dependence on imports and international supply chains where the US Navy can still put its foot on the hosepipe. Installed solar generation capacity just overtook coal in China for the first time, and the huge excess capacity in electric vehicle manufacturing is seeing Chinese marques overtaking established brands wherever they still enjoy market access. Jeremy Clarkson is in the Times reviewing the Jaecoo 7, saying “four years ago this car company didn’t exist. Now it is the third bestselling car in the UK”. Scott Bessent, meanwhile, recently remarked that a Chinese BYD is “the best $70,000 car that $35,000 can buy”. No wonder the European auto sector is worried.
Bessent has accused China of engaging in financial repression to ensure that returns to savers and borrowing costs for industry were held artificially low and the value of the CNY artificially weak. PBOC Chief Pan Gongsheng dissented against Bessent’s characterization by saying that China does not deliberately pursue a trade surplus and is committed to boosting domestic demand. He also pointed the finger back to countries running trade deficits, saying that they should be cutting fiscal deficits and raising domestic savings rates to address structural imbalances. He might have a point on that score.
Financial repression has gathered more interest in recent times. The FT recently published a piece saying “the risk of a new age of financial repression is rising” while the Times yesterday claimed that the “world economy faces a new phase of financial repression”. If we define financial repression as government dragooning the private sector into helping hold borrowing costs low we could easily argue that it has been ongoing in the developed world for some time. Perhaps that is the signal from the ~400% increase in gold prices since the GFC, as the Dutch central bank shifts more than 78 tonnes of its bullion reserves from New York to London due to a perceived increase in geopolitical risk.
Policy rates were set miles below nominal GDP growth rates throughout the 2010s as a narrow definition of inflation remained blind to enormous asset price inflation, banks were told that they must buy greater quantities of government paper, quantitative easing was normalized, pension funds have increasingly been directed to invest more of members’ savings according to national priorities rather than blindly pursuing maximum returns. Now we see the US Treasury engaging in exactly the sort of behavior that China is accused of, which is kind of the point: the US believes it is fighting fire with fire by copying the Chinese neo-mercantilist model.
At the crux of this shift is the imperative to eliminate structural trade imbalances to rebuild American production (July US factory order figures reported yesterday were strong), because production underpins national security. Perhaps what is not widely appreciated is that if you are re-orienting your economy away from consumption, and especially consumption of artificially cheap imports with your artificially-strong dollar, you are going to have to do less consuming. In the absence of explosive productivity growth, the American plan is for lower living standards.
No wonder the President is saying that failure to embrace AI will make countries “backward and poor” while the Treasury Secretary tells data center operators that they need to do a much better job of securing their social license.