By Michael Every of Rabobank
I am assuming my post-FOMC Chair testimony headline above is the only one which refers to a cheesy 1980’s (and far worse 2022 Netflix rebooted) cartoon. However, I do so deliberately.
What we got in Congress yesterday WAS reminiscent of the 1980’s, with Powell refusing to take a 100bps hike off the table as if he were a muscled-up He-Man. Yet while another 75bps in July and more mighty blows were promised, Powell also suggested nobody was going to get really hurt. Ignore what Larry Summers just said about millions of people needing to lose their jobs for years, because a recession is “not inevitable,” says Powell: Oh yes it is, says Philip Marey.
Markets agree with Philip, not the guardian of Fedternia. Indeed, we are finally seeing a logically consistent movement: lower stocks, as US stocks head for the worst H1 since 1932, lower bond yields, lower commodities, and a slightly lower US dollar.
Real-economy indicators are looking ugly. US data are obvious. Europe can delude itself that there isn’t going to be a recession ahead, but the IEA is warning it to prepare for a total cessation of Russian gas flows, and Germany is listening, and that would feel like a depression. China keeps promising stimulus that doesn’t arrive, and its consumers won’t spend, or its banks productively lend. The strike-laden UK just saw another high inflation print driven by food and energy prices, driving gloom, while two by-election defeats today would suggest doom for the government.
Moreover, Korean 20-day export data this week were -10% m-o-m and -3.4% y-o-y. Hong Kong is seeing massive intervention to keep the HK$ pegged to the US$. Sri Lanka is asking civil servants to work a four-day week so they can grow their own food on Fridays. Broader financial stress indicators are also picking up.
So, the market now accepts recession is a risk, having been in total denial. Rightly so: we can't expect energy or commodity prices to stay low if demand picks up; and we can't bring new supply online for years.
Yet this still does not make the open and shut case for the Fed to pivot as the rapid resolution of a seemingly intractable problem, as in any good 1980’s cartoon. Indeed, the more the market heard ‘By the Powell of Greyskull; I have the power!... but no recession!’, the more stocks and oil actually came off their intra-day lows (before stocks dipped again). The market is pricing in less Fed tightening and earlier Fed cuts than before Powell held aloft his sword.
Much more of this, and oil and stocks will both be going up even as bond yields go down, and we will be back to logically inconsistent market moves that will force the Fed to keep punching harder. Yes, Powell repeated he can’t do anything about rising food and energy prices to Congress: but isn’t it amazing that at just the same time as 75bps got wheeled out, both food and energy are (temporarily) falling back?
Yesterday’s testimony also took place against the backdrop of a ‘Masters of the Universe’ struggle for global power: it got very little airtime compared to Powell, but the BRICS (Brazil, Russia, India, China, South Africa) summit is now underway. Russia’s President Putin just used the forum to stress: (1) Russia is selling more oil to India and China - who are refining it, and selling it to Europe; and (2) BRICS are developing an alternative global reserve currency backed by commodities, and an international payments system, to reduce their use of USD and EUR.
China’s Xi Jinping also backed Russia’s world view that NATO was most responsible for the war in Ukraine, and called it “a wake-up call,” warning against “expanding military alliances and seeking one’s own security at the expense of other countries’ security.” Because China has never done that.
For those who haven’t been paying attention to geopolitics, this might be a shock: it is, however, exactly what I was flagging in my (largely unread) report, ‘Why ‘Bretton Woods 3’ Won’t Work’.
Let me repeat again that this proposed BRICS system is unlikely to work. For a start, India and China are at geopolitical loggerheads, which makes it BRI/C/S in reality. Worse, there is no history, trade data, or logic to suggest you can just staple together a few big net commodity exporters, with huge linkages to the West, to a massive net commodity importer, with huge linkages to the West, and expect this to work – or to retain those linkages to the West.
There was a story this week about a Chinese property developer taking payment in garlic and wheat: you want an alternative global economy and financial system based on that? More importantly, the West will react strongly to any BRICS movement towards breaking US$ global hegemony.
Most of the global financial system is based on credit, based on collateral, and so on the US dollar / Eurodollar. That digital green paper sits behind up to $50 trillion in ex-US annual trade-flow and financial liabilities, and vastly more including derivatives. That is backed by only $7 trillion in US$ FX reserves, $3 trillion of which sit in China to back/prop up CNY. It’s a bad, unstable, unfair, bubble-creating system backed by an increasingly dysfunctional hegemon. But it works, in its own way, and it has the all the benefits of the incumbent network effect.
A BRICS alternative is that global shadow banking, actual banking, and real trade flows should all start to accept credit based on a new digital FX with commodities as collateral instead. Which also implies people won’t be able to repay their Eurodollar commitments.
There are lots of ways the West can respond to this.
Hedge fund billionaires and Wall Street can say ‘We want in!’, which is possible given Western financial systems operate like mercenaries rather than an army (which is why there are no countries around today that operate their national defence on that basis.) If that happens, some rich Westerners get richer, but the West loses its global pre-eminence and the geopolitical power to act on issues like Ukraine and Taiwan.
Or the Fed can say anyone using a BRICS currency loses access to the US financial system. That would bifurcate the world. As we already see with sanctions against Russia, it would also mean the West, and third parties, doesn’t get the commodities (or industrial goods) that the BRICS produce. That means massive inflation in some places, deflation in others, and global depression, not recession. I wouldn’t rule it out, but the end-game is clear.
Or the Fed can keep raising rates to force commodity prices down, raising the collateral attractiveness of the US$ and reducing that of its new rival. That would mean recession – and it already does. It would imply a massive blow-up for those leveraged long commodities - as with crypto. It would also make getting hold of US$ even harder - but that’s what Fed swap-lines, for friends, would be for. This is obviously not what the markets think will happen, and I understand why. (“Because markets.”) However, it’s not cartoonish. It’s just taking monetary policy into the geopolitical dimension, where it always sits, and most so when potential monetary rivals appear.
Today we can listen to see if we get any more details from the BRICS. Then we don’t have to wait long for the rival G7 meeting, where we have very few He-Men or Men-at-Arms. The leaders of France, Germany, Italy, the US, UK, and Canada are all struggling, and only Japan’s PM Kishida is showing real confidence to plough ahead - as Jane Foley talks about the possibility of USD/JPY ploughing a fresh low of 140.
Then we get the NATO summit next week, as Estonia’s PM warns of the risk of the country being “wiped from the map”, and where we may see exactly what Xi was warning about in terms of expanded alliances and shifts of focus towards China. In short, a paper tiger may turn into a true BattleCat - although it will need the financial Powell of Greyskull to get there.
Or tell yourself none of this matters and that we have a happy ending ahead due to Fed rate cuts and more QE. Just recall He-Man’s sister She-Ra rode a unicorn: perhaps it excreted the M&Ms you are eating.