Rabobank: The Fed Must Act Because The US Is Losing The Dollar's Power As Global Collateral To Commodities
By Michael Every of Rabobank
Fed day - and what a Fed day! In the space of a few trading sessions the market has swung from expectations of a 50bps hike, eyebrow-raising a few weeks ago, to 75bps, a weapon last wheeled out in 1994, with some whispers of 100bps.
75bps was actually one of the smaller Volcker hikes, the largest being a staggering 525bps in March 1980. In short, the last time US inflation got out of control on the supply and demand side, it dwarfed present volatility.
In March 1980, Volcker hiked 500bps— zerohedge (@zerohedge) June 14, 2022
In April 1980, Volcker cut 850bps
In May 1981, Volcker hiked 400bps
In June 1981, Volcker cut 450bps https://t.co/lsAPrEm5fi
True, the US is not seeing a demand boom now even if the rich are in fine fettle, and some see a post-Covid carpe diem, borrow-and-live-now, pay-later attitudes. Yet supply is constrained, and higher oil output is not helped by suggestions of a 21% windfall tax on energy companies; or lower tariffs on Chinese bicycles, which President Biden apparently favours. Our Philip Marey also sees a wage-price spiral in place that will continue if policy is not tightened.
The irony is that if the Fed ‘only’ goes 50bps, we might get a relief rally. Yet what if we get 75bps and indications of more to come via the dot-plot? Is that already fully priced in?
As a run-up to today, markets tried to force an equity and bond bounce: both largely failed, as the S&P closed lower, and bond yields went higher. US Treasury 2s are now 3.42% when they stood at 2.82% three days ago; 10s are at 3.47% when they were 3.05%; and 30s at 3.42% versus 3.16%. Needless to say, DXY was higher at 105.2 at time of writing. In Europe, German 2s are 1.22%, up 39bps in three days, and 10s are 1.75%, up 33bps. Italian 2s are 2.12%, up 73bps(!), and 10s 4.17%, up 56bps. Equally needless to say, EUR/USD was lower. These are the kind of bond moves one might normally project over a year or two or three, not the same number of days.
As I was trying to argue last night, badly, through a head cold, and at the end of a 15-hour day, this is unprecedented for post-Volcker developed markets (DM). However, it’s standard fare for emerging markets (EM), which regularly see pick-ups in demand or supply shocks lead to balance of payments shortfalls, then synchronized sell-offs across asset classes. Is what we are seeing in DM just central-bank over-reaction, or that a deliberately supply-constrained world makes DM look either Volcker-ish or like EM?
It’s just a view: but if it’s right anyone punching said argument is going to end up like the chap in this Twitter meme picking on a ‘banana man’, not a strawman. Bloomberg are at least running from the on-rushing waters shouting ‘World’s Central Banks Got it Wrong, and Economies Pay the Price,’ over the shoulder.
DM are DM because they traditionally controlled supply chains. If EM made what they needed, they wouldn’t be EM. Yet if DM now don’t make what they need, how do they expect to stay DM – just by making the economic rules? What if others say no? Ask yourself that as Russia turns off the gas taps to Europe to try to force them to drop sanctions, as the US Freeport LNG terminal says it will be out for 90, not 21 days. So, EU gas prices soar; more inflation; more balance of payments deficits; and less room for ECB policy manoeuvre.
As a commentator noted this week, the post-1945 global institutions the West created, in all their double-standard glory, are not the source of Western power: Western power is the source of institutions with double-standard glory. Indeed, arguably the real difference between DM and EM is that: “Sovereign is he who decides on the exception,” as the DM UK argues to the EU while ironically doing a great impression of being an EM.
That concept matters more than markets want to see: why can some act and others not? “Because some markets”? There is open pushback against the global system from those providing key inputs into it. The West either pushes back or gets pushed off the stage.
The quote just mentioned actually originates from Carl Schmitt, chief jurisprudence source for the Nazis; and Wang Huning, one of the CCP’s most brilliant intellectuals, draws on Schmitt for how China should act. His fellow academic Jiang Shigong also argues:
“…we are living in an age of chaos, conflict, and massive change in which world empire 1.0 is in decline and trending toward collapse, while we are as yet unable to imagine world empire 2.0… We cannot deny that these ages of historical transition have also created the opportunity for each civilization to construct world empire 2.0… We see the reconstruction of Chinese civilization and the reconstruction of the world order as a mutually re-enforcing whole.”
This really isn’t about cheap bicycles.
Indeed, ‘Xi signs outlines that direct China’s military operations other than war’ active from today. This refers to disaster relief, humanitarian aid, maritime escorts, peacekeeping, counter-terrorism, anti-pirate and peacekeeping missions, preventing spillover effects of regional instabilities from affecting China, securing vital transport routes for strategic materials like oil, or safeguarding China’s overseas investments, projects and personnel. In short, much more of the PLA globally. Hopefully not a “special military operation” too.
(As an aside, we also see reports that after freezing $6 billion in deposits and seeing angry crowds trying to get their money back, banks in China’s Henan are stopping affected depositors from physically going in to branches by turning their Covid Health Code ‘red’, which bars them from public space. “Zero-Covid is just about public health.”)
Back to the Fed. When we looked at how Modern Monetary Theory works we flagged if an economy runs large trade and current account surpluses, or is the global hegemon and reserve FX, they are “sovereign”: if they don’t, they aren’t, they just get higher inflation and a weaker currency. Did we not just establish that fact in reality? Is China not demonstrating it with how they run their economy – albeit as they also want to break away from the Eurodollar somehow? DM are not immune to that iron logic: look at Japan ahead of this week’s BOJ meeting.
So far, the Fed has been immune to all of this. Yet on energy, or at least refined fuels, it no longer is. Neither is the US on many manufactured goods. All it has left is the rules set up by Western power that is no longer so powerful. So, act the Fed must, says the geopolitical logic: which is why while some are being swept away by this market tsunami, those thinking the US would have to choose the US dollar over the US economy or US markets have intellectually far drier feet. If the US loses the power of the dollar as global collateral to commodities as collateral, then its economy and markets will soon follow. Maybe that logic doesn’t hold: but a hawkish Fed today suggests it does.
To be blunt, there is real EM schadenfreude in current Western struggles. In 1997, and long before that in Latin America, EM crises were treated thus: raise rates; cut state spending; force recession; sell off state assets (to the West); and sell off private-sector assets at fire-sale prices (to the West). Yet when the West faced its own crisis in 2008, what did it do? Cut rates; do QE; and bail everyone guilty out. If the Fed now has to keep hiking in 75bps steps and can’t cut rates and do more QE without inflationary consequences, then West perhaps faces a 2008 redux without a safety net.
Unless the Fed does to commodities what they just did to crypto, where Coinbase is laying off 18% of its staff. The Bloomberg NFT index is also collapsing. Who knew that monkeys in sunglasses don’t provide much in the way of realpolitik sovereignty when push comes to shove?
Of course, you can’t eat schadenfreude, served hot or cold (or crypto). DM may hate the surge in commodity prices, the dollar, and Eurodollar rates, but for many EM it is an outright calamity.
If the Fed keeps tightening, we face global pain, most so in EM. If the Fed backs off “because markets”, we face global inflation. Either way today, après Fed, the deluge.