By Michael Every of Rabobank
As I was going to St Ives...
“As I was going to St. Ives, I met a man with (G)7 wives; Each wife had (G)7 sacks; Each sack had (G)7 cats; Each cat had (G)7 kits; Kits, cats, sacks, and wives, How many were there going to St. Ives?”
This old English riddle is appropriate today given G7 leaders’ (and wives, sacks, cats, and kits) are all in St Ives, Cornwall – and traffic is murder as a result. Don’t even think about trying to get a cream tea there.
The multiplicative element of the riddle also seems appropriate given inflation keeps running hot – and the market keeps saying not. Yesterday’s US CPI report surprised to the upside, with headline inflation up 0.6% m/m and 5.0% y/y, while even core CPI was up 0.7% m/m and 3.8% y/y. “Sic transit(ory) in incremento pretiorum mundi,” said the US Treasury market, with 10-year yields spiking 5bp to 1.53% - and then collapsing back to 1.43% again regardless. The riddle contained in *that* is perhaps answered by short-covering, and the market seeing this surge as still a re-opening related supply shock (used car prices, etc., etc.) with no wage response looming, and so it will end up as destructive of demand in the end. Moreover, the surge in US demand we are clearly seeing, until current stimulus runs out in a few months, and the ever-present monthly Fed QE largesse, is seeing exporters to the US make serious hay, and their FX reserve levels surge in tandem. Those dollars have to go somewhere other than meme-stonks and rude cryptos: welcome to the Treasury market!
That said, there might be more stimulus ahead than thought. Swing senator Manchin, and nine others, have proposed a new compromise infrastructure fiscal package of $1.0 trillion over 5 years, with no tax hikes. It’s not the $4 trillion first floated over 10 years, but it’s hardly chopped liver at $200bn a year with no off-setting tax hikes – that is around 1% of US GDP alone. Might this move the Treasury needle, or will it be soothed at the climb-down and presumption that even if this happens, none of it will be Made in America, as promised?
Meanwhile, back to the G7 and entourage. This is an important meeting: there is the 15% tax deal, and opt-outs; a global vaccine plan; the background chill over Northern Ireland and chilled meats; and some commentators see this as US President Biden’s last chance to get Canada and the EU to agree to side with him in what he calls ‘a struggle between democracies and autocracies’, which has the smell of Potsdam and Yalta to it. So, weighty matters.
Then again, this G7 are no FDR, Churchill, and Stalin. We have Biden, with his Cold War vision; Suga of Japan, ramping up defence spending “dramatically” with a more muscular foreign policy; Moon of South Korea, traditionally more cautious, but edging closer to the US in some key areas; Morrison of Australia, giving Cold War/Churchillian speeches; and Modi of India, via Zoom, clearly leaning US, but obviously focused on Covid-19. But it also means renowned geostrategist Trudeau of Canada; “Sausage wars” Johnson of the UK; just-slapped-in-the-face Macron of France, where a recent poll shows more than half of voters think their political system is “broken”; Draghi of Italy, seen by markets as his country’s last hope, so with his hands already full; and Merkel of obstinately non-geopolitical Germany, today celebrating a test-run of gas through the Nord Stream 2 gas pipeline, and continuing to back doing as much business as possible with China. As such, we should temper expectations: not so much Potsdam and storms in a tea pot?
Yet the suggestion is that if the EU cannot muster enthusiasm to back the US and ‘democracies vs. autocracies’ now, they never will; and while US-EU relations will not then fall to the floor, as under the Trump administration, there will also be a low effective ceiling going forwards – which will matter hugely on many fronts over time. There are many ways to define this Atlantic drift, but perhaps the simplest way is that the US thinks ‘freedom isn’t free’, while the EU clings to the view that freedom is both free and free-trade. Notably, however, the EU has joined the US in calling on China to allow “complete access” for an independent investigation into the origins of Covid-19, which backs it on one particular --and contentious-- front. So we shall have to watch the G7 for further developments.
Meanwhile, if anyone is thinking that curtains are coming down from only one side of a potential East-West divide, China yesterday passed a new law to push back against foreign sanctions. Legal countermeasures now available to it include "refusal to issue visas, denial of entry, deportation... and sealing, seizing, and freezing property of individuals or businesses that adhere to foreign sanctions against Chinese businesses or officials." In short, a Western bank or firm must comply with US sanctions or lose access to the US market – but now that bank or firm operating in China, and/or its employees, can be legally punished for doing so. This can even apply to family members, and legal experts say perhaps also to think-tanks or journalists, or those on social media, who directly or indirectly advocate for sanctions.
We may not see the trigger pulled on that law immediately, but it shows just how much potential decoupling is being stored up ahead. And such decoupling is both very inflationary in some places, who will see supply shift back to them before they are ready, and very deflationary in others, who will see excess supply and no demand. The markets and central banks don’t want to see this geopolitical truth any more than they do the risk that inflation might be anything less than “transitory”.
Which brings me back to the opening riddle.
How many people were coming from St Ives? It looks like it takes math to work out: and do you include all the wives, and animals, and the man? However, the most common answer is: one - only the narrator was GOING to St Ives, and the others were coming FROM it. Sometimes the simplest answer is right there in front of our faces - but we like to try and hide it with math, cod-philosophy, and “because markets”.