Submitted by Michael Every of Rabobank
75 years ago, the Allies defeated Nazism. Today is VE (Victory in Europe) Day, and a Bank Holiday Friday for once in the UK. Following VE day and the subsequent VJ day a few months later, WW2 ended; the US rebuilt the West and established a new US-centric world order; a huge slice of Europe and the world went communist and was sealed off behind high walls and barbed wire; the Cold War lasted from 1947 to 1991, when the Soviet Union collapsed; America, the only global hyper-power, then pushed ahead with an accelerated version of financial globalisation; the US seemed invincible – and then stumbled, with China seemingly ascendant. Besides respecting the Greatest Generation, who can’t have the public parades they deserve today, it’s worth recalling all this history on VE Day.
First, because Europe has spent much of this week showing how deep its divisions are in politics and economics. Serious questions are being asked by serious people about how its North-South and West-East gaps can be resolved: the UK is discussing a trade deal with the US even as it half-heartedly discusses Brexit with the EU; Germany’s constitutional court sees itself superior to the European Court of Justice; the gap in economic vision between Germany and Italy --and France-- is widening; and EU member Hungary, according to Freedom House, is “no longer a democracy”. Meanwhile, the brave new “geopolitical” EU has just seen its 27 ambassadors to China allow a joint editorial written in China Daily to mark 45 years of EU-China diplomatic relations to be censored – and then the censored, not original, version to be shared on social media within the EU itself.
Second, because the US is deep into an America First policy and a new Cold War with China. True, USTR Lighthizer spoke with China’s Liu He on the phone yesterday and (so far only) the Chinese are reporting “both sides agreed that good progress is being made on creating the governmental infrastructures necessary to make the [phase one trade] agreement a success.” However, the overall direction in not just this presidential election campaign but in US politics and public opinion as a whole is abundantly clear: anti-China.
Of course, markets and US corporates will try to steer things, and the narrative, otherwise. Yet there is a growing movement within the Republican party, beyond Trump, to pushback against the post-WW2 in order to deal with China. Senator Rubio is one well-known voice. Another is Senator Hawley, who just Tweeted “Who is arguing for isolationism? I’m not. I’m arguing for American leadership to reform the global economic order to meet 21st c. American needs & security. Start by abandoning the WTO and replacing it.” This geopolitics flows back to local US politics, and so to markets, when conservative publications run articles about “The Building Blocks of a China Strategy” which conclude “the mantras of ‘free trade’ and ‘globalisation’ of the past three decades should no longer serve as an excuse for the business class to get rich at the expense of the citizenry; they are free to maximise their wealth provided they bring the citizenry with them.”
Meanwhile, the outright ‘success’ of the US post-Cold War economic strategy was exposed yet again as yesterday saw futures markets pricing in negative US rates by the end of 2020! Yes, US bills have briefly traded negative before but this is different – and hugely worrying. On one hand this speaks to obvious facts like the IMF downgrading its assessment of global growth: -3% is now too optimistic even if we don’t have a new figure yet. Yes, it also speaks to the fact that Texas just opened up, and while beaches and parks are rammed, shopping malls and restaurants are empty (or so says Reuters). However, the risk of the US upending of the global system, which is incredibly deflationary before it is inflationary, and of a Cold War with China we all get dragged into, which is incredibly expensive and requires the lowest-possible cost of funding, is arguably also part of the underlying narrative if one chooses to lift that particular stone. Many don’t.
Yet while the US is retreating from the global system, or set to reorder it, one post-WW2 legacy reigns supreme: the Eurodollar. Indeed, we can still ‘celebrate’ Victory in Eurodollar day even when the market is pricing negative US rates. How? Because if the US is in that much trouble, imagine how much trouble everyone else is in - and how many USD they are going to need and can’t get hold of.
Is it any wonder that EM FX, with a few exceptions like IDR, are plunging? As one key example, Piotr Matys covers the latest fall in TRY here and concludes “It is often difficult to admit when a wrong choice was made. But, the sooner it is done, the better as the damage will be less severe and recovery will be much faster. Persistently remaining on the wrong path is usually very damaging and costly, which leads to a much longer recuperation period.” I think Rubio and Hawley are trying to say the same thing.
Of course, there are other EM FX that are hardly faring better: BRL is at 5.84 as I write, for example, down 10.5% in a month and 45% YTD, and ARS is at 67.2, down 3.4% in a month and 12.2% YTD. Moreover, one can argue the more these two currencies in particular go down, the larger the total Eurodollar victory will then become. That’s because China is far more likely to want to buy Brazilian and Argentinean agri goods at low, low prices than from the more expensive US; hence the “phase one trade deal” is more likely to blow up – with dramatic consequences for CNY, which will flow back to other EM FX.
And AUD too – especially given today’s RBA Statement on Monetary Policy today underlined that the worst economic downturn in history is about to hit (likewise, the BoE yesterday showed they expect the worst UK recession since the early 18th century) and that even in their Aussie upside scenario it will be years before unemployment gets back to the 5% rate that was already high enough to prompt RBA rate cuts pre-Covid.
The Day Ahead
Of course, the main data focus today is US non-farm payrolls. The expectation is that 22 million people will lose their jobs and unemployment soar to 16%. What more can one add to that sentence? Merely to say that these are the kind of economic figures that led to the need for a VE Day in the first place.
Equity markets seem to think that the war is already over – but it’s barely begun.