"One Wonders What Markets Will Learn The Hard Way Over The Next 12 Months"
By Michael Every of Rabobank
A year ago today, the war in Ukraine started. This shocked market analysts, who were certain that massing hundreds of thousands of men, tanks, and helicopters on the border, as Russian social media shared plans for a Russia with even larger borders, in no way suggested that a war was imminent. True, this was not their area of specialism. However, the risk was not hard to spot if one looked, and it threatened to directly impact the markets being myopically focused on. By contrast, we had predicted a month before the war began that it looked far more probable than markets were pricing, and it would trigger a ‘metacrisis’ if it started. (True, not every forecast made played out as we expected due to second order effects, but it was a far better call than ‘peace now’!)
Seven weeks ago, the same analysts implied the war was winding down via their 2023 forecasts. Today, all the signs are that it is about to escalate. In short, a year of experience has seen no improvement in the market’s collective inability to understand the realpolitik outside its siloed, bean-counting expertise.
Moscow media just announced the ‘training of thousands of volunteers from Afghanistan’ to be sent to fight in Ukraine alongside newly-mobilised Russian troops (and all the Syrians who never turned up): that may scare ‘The Living Daylights’ out of the West. There are also worrying signals from Moldova and its Russian-backed secessionist statelet, Transnistria, which Russia is accusing Ukraine of planning a false-flag operation to invade. “The armed forces of the Russian Federation will adequately respond to the impending provocation of the Ukrainian side,” Moscow warns. That comes weeks after foreign minister Lavrov stated Moldova might share Ukraine's fate if it tries to unite with cousin Romania, joining both the EU and NATO.
Today sees China’s peace plan for Ukraine: read it carefully for de-escalation and any ‘escalate to deescalate’. Relatedly, the White House will shortly put “constraints” on Chinese companies believed to be “active in evading sanctions” related to the war. Meanwhile, the Chinese embassy in D.C. emailed journalists a five-chapter pamphlet on "US Hegemony and Its Perils" - in January, markets were lapping up reports that China’s ‘wolf warrior’ diplomacy was over. Then again, a new ex-Mastercard, US-backed boss of the World Bank? That will do nicely… to underline how hegemonic the US still is within flailing legacy global institutions.
If you want to see what some are doing against this backdrop, look at Poland. It is rearming at an incredible pace, up to 4% of GDP, with $100bn being plowed into a new military.
If you want to see what some are not doing, look at Germany. The Washington Post notes, ‘Germany pledged a military revamp when Ukraine war began. Now it’s worse off’, and that Chancellor Scholz “raised expectations that he would revitalize Germany’s beleaguered armed forces, announcing a dramatic shift in defence policy and a special fund of €100bn. Instead, German donations to Ukraine have further diminished supplies of its long-neglected armed forces…. As months have passed, more than 10% of the €100bn… has been lost to inflation and interest payments. And even a Bundeswehr wish list derived from before the war remains unfulfilled.” The promise to dedicate at least 2% of GDP to defence “now, year after year,” in Scholz’s words, has stalled. Berlin now aims to meet the 2% target in the next “few years.” So, after the war is over?
If you want to see what some are doing to get round what some are doing, look at three recent headlines:
‘EU checks growth of exports to Russia's neighbouring countries due to suspicions of sanctions evasion’. Those running the EU and G7 are even more myopic than markets to only just have spotted this.
‘Russian warlord passed UK money laundering checks with mother’s utility bill’. Those running the UK are more myopic still, or large piles of money obscured their vision.
‘Europe’s energy war with Russia is not over, says IEA chief’. Markets are saying otherwise, while counting beans and fantasy rate cuts.
One wonders what Germany, and markets, will learn the hard way over the next 12 months, if anything. I have my own guesses.
On markets, today the next BOJ Governor Ueda testified to parliament on how he sees things. If those of us who follow geopolitics pointed to a systemic break looming, with Ukraine the trigger, the same holds true for monetary and fiscal policy via the BOJ. We see that massive fiscal deficits, massive QE, and massive yield curve control is not compatible with a country running trade deficits if it wants bond market and FX stability: one will give. What happens in Japan matters for all of us in that the geopolitical backdrop is one in which massive fiscal expansion is necessary, at least on the military. (Good luck trying to sell an angry voting public on the need for guns not butter: though the Germans seem to be smothering themselves in the latter to become so slippery that they don’t have to do anything on the former.)
With Japanese CPI today at 4.3% y-o-y headline and 4.2% ex-food, up from 4.0%, and 3.2% y-o-y core, up from 3.0%, Ueda noted that the current BOJ easing was still appropriate, but that it may need to normalise policy if the outlook for prices improves. In other words, if CPI hits 2% sustainably, no more QE – but they are not there yet in his opinion. The real problems will start if they ever do hit their target. But if a trade deficit stays in place, so may higher inflation - for all the wrong reasons.
Staying in political central banking, the Wall Street Journal reports ‘China to Shake Up Financial System as Xi Jinping Installs Key Associates’. In short, two Xi men are now leading candidates for top positions at the PBOC, and a Communist Party body to tighten political control over financial affairs may be revived. I am sure the market analysts who can’t see tanks on the border, and who underline how important it is to have independent central banks while also being bullish on China --or who display the ability to do basic math, in a vacuum, to argue “the next China is China”-- will be equally shocked.
Today the major focus will be US personal consumption expenditure and savings data from which the Fed draws its favourite measures of inflation, the headline and core PCE deflators. Income is seen up 1.0% m-o-m and spending 1.4%, with a headline PCE deflator of 0.5% m-o-m and 5.0% y-o-y, and core PCE 0.4% m-o-m and 4.3% y-o-y. The latter in no way argues for a rate pivot, even if it would be down from 4.4% in December. However, expect siloed bean-counters to zero in on any decimal-place rounding down as a risk on signal – even as the calendar points to how wrong such big picture calls have been for a year now, both on geopolitics and on the Fed.
Happy Friday, even if it is a very unhappy --first-- anniversary.
