By Michael Every of Rabobank
Too much math, not enough polymath
We start, of course, with Ukraine. Despite talk of more G7 sanctions on Russia today, there is growing recognition that they cannot prevent Russia pivoting its fight towards eastern Ukraine, the West will instead need to supply far more, and far more powerful armaments than it has so far. In other words, escalation. Moreover, a far longer war than many had been hoping, which will have larger consequences for markets.
Pakistan, Sri Lanka, Peru, and Lebanon are all also seeing various states of instability, and the EU is to cut off billions of euros in funding to Hungary in response to the recent election victory of populist Orban, perhaps by the end of the year. The US is floating new permanent military bases in Romania, Poland, and the Baltics, even if there will not be permanent US troop deployments. To repeat, this is a long-run crisis.
Even EU foreign affairs chief Josep Borrell is now a hawk, stating to the European Parliament tonight that last week's EU-China Summit: "…was not exactly a dialogue, maybe a dialogue of the deaf... we could not talk about Ukraine a lot, and we did not agree on anything else. China… didn't want to talk about Ukraine,… human rights and other stuff and instead focus on positive things. The European side make clear that this... compartmentalisation isn't feasible... for us Ukraine is the defining moment on whether we live in a world governed by rules or by force. We condemn Russian aggression against Ukraine and support this country's sovereignty, democracy, not because we follow the US blindly, as sometimes China's suggests, but because it is our position... China cannot pretend to be a responsible great power but close its eyes or cover its ears when it comes to a conflict that obviously makes it uncomfortable... because it knows very well who the aggressor is, although for political reasons, refuses to name them."
On commodities, Wall Street is stepping back from metals trading, hardly a surprise given the volatility. There are also suggestions the EU could form a single entity to buy its gas to lower costs and prevent countries being played off against each other. Put that together with China’s plans for one national board to buy iron ore and it points to what has been flagged here before: more politicised, more national-security focused, more price-controlled or barter-based global commodity trade and trading. Where does that leave the global trading houses? And imagine if, as I doubt, we then move to a world of commodity-backed currencies.
Indeed, all global(ization) institutions are struggling to define their new roles. The US just stated it does not see Russia being kicked off the US Security Council(!) Yet that doesn’t mean the UNSC can function in a polarized world: we’ve been here before, both with the UN and its predecessor, the League of Nations. Likewise, who listens to the WHO? How about the WTO? Or the IMF? And, as sabres are rattling and hotdogs everywhere threaten to cost nearly as much as they did at the last in-person Davos, the WEF tweets: ‘Venus was once Earth-like, but climate change made it uninhabitable. #Space #ClimateChange’. Is this science or science fiction? One thing it isn’t is relevant for a realpolitik geopolitical world.
That isn’t a charge one can level US Trade Representative (USTR) Tai, who is misrepresented by Bloomberg as saying, ‘US Isn’t Seeking a ‘Divorce’ From China’. She said that; but also that she has given up on China ever shifting from its mercantilist model that damages the US; and she is going to push for policies to rebalance trade on US terms and rebuild its industrial base. Unstated was that the only logical ways to do so are more tariffs, industrial policy, and/or capital controls. So ignore the headline disingenuously implying that trade wars are over in an era of Cold War and hot war for the algos that decide what stocks are worth. The opposite is true.
Central banks have little grasp of what is unfolding around them, from inequality to populism, inflation to war, and linked shifts in the financial architecture. It’s ironic given they were set up specifically to finance wars, and the industrial development to allow countries to win them. It’s hard to see how their roles will stay the same ahead: but they are trying hard to pretend that they will.
The RBA just gave a hint it might have to raise rates from 0.1% in the face of global inflation, booming Aussie commodity exports, and such ridiculous building approvals and house-price data that either the economy is on fire, or the credibility of the Australian Bureau of Statistics is in tatters. (And both can be true at once.) The Aussie 10-year yield now stands at 2.93%, up from 0.61% back in 2020, while 2s, nearer to the lifeblood of the Aussie economy, mortgage debt, is at 2.04%, again nearly all the way back to the 2018 levels prevailing before the RBA started to cut rates.
The PBOC might be under pressure to ease after China’s services PMI came in at 42.0 vs. the ridiculously optimistic 49.7 consensus. However, it is constrained by the US policy direction given it wants to keep CNY stable to keep inflation under control.
The Fed is yelling it is going to tighten: uber-dove Brainard not only backed hikes, but a rapid QT, so Fed balance sheet reduction. The US yield curve leaped higher on that news, US 2-year yields up 12bp from their intraday low, and another 3bp higher in Asia this morning to 2.56%, while 10s were up 18bp from their low, and were at 2.59% at time of writing. So, the curve disinverted - and yet the US 30-year fixed mortgage rate just went above 5% for the first time since 2011, which will hit housing and the economy hard. Indeed, the irony is just as the Fed has the policy bit between its teeth, the logistics industry that called higher inflation last year now says consumer demand is crumbling due to higher prices. In short, steepening won’t last long: but you won’t like the flattening.
As The Hill reminds us ‘Nobel economists were dead wrong on inflation: Don’t expect an apology’, and: “Last September, as the Build Back Better legislation was being considered in Congress, many members worried about the inflationary pressure of injecting an additional $2.4 trillion into the economy on top of the $4.1 trillion committed to the American Rescue Plan and the Cares Act. When it looked like the Democratic majority might include enough deficit hawks to scuttle the bill, Nobel Laureate economist Joseph Stiglitz rounded up another 16 of the 36 living American Nobel Prize economists to declare, in an open letter, that whatever upward pressure on prices all this new money might bring there was no threat of inflation.”
Inflation hawks are now saying destroying final demand is the only way to deal with supply-side inflation that acts as de facto taxation. Notably, neither the Stiglitzians nor the hawks say structural supply-side inflation can only be addressed by the structural arguments of the USTR.
A few market strategists are now trying to pivot from central bank plumbing to geopolitical supply chains to explain what is going on. However, that territory is a far steeper (learning) curve than the ones they are used to, and most are sticking to their models – and exactly the same market calls. Equally, we don’t have polymath economists who understand realpolitik and war at central banks due to institutional inertia. Hence they will be guided wrongly.
Today’s Fed minutes are likely to confirm that view.