By Michael Every of Rabobank
It was a tough call for me whether to go with the above title of the Daily today, or for ‘These are not serious people, and I refuse to take them seriously’.
Friday’s shocking US inflation came in well above expectations at 1.0% m-o-m / 8.6% y-o-y headline, and 0.6% m-o-m / 6.0% y-o-y core. That’s the highest y-o-y headline CPI since December 1981, even further back in time than the first ‘Top Gun’ movie. Indeed, in Tom Cruise terms, it’s back to his second-ever movie, ‘Taps’.
Over the past decade, US CPI averaged 1.6% y-o-y. Over the past 12 months, it was 6.9%. Food, energy, and services inflation is rampant, and while goods inflation is edging lower and inventories need to be cleared, there is still an implied manufacturing shock coming from the input side with a lag. Indeed, core inflation has only seen one monthly print lower than 0.5% (6% annualized) since October last year, the trend in energy is not going to stop, and neither will that in Owners’ Equivalent Rent given soaring mortgage rates force more people to rent.
There is now some talk of so-called “core-core” inflation excluding food and energy, and airfares, rents, vehicles, hotels, and health insurance, which shows inflation is ebbing. Logically, if we take out everything going up then inflation is zero. Likewise, the Fed and the White House told us there was no inflation; was going to be no inflation; if there was any inflation it was mild; and once it got high, that it would be transitory. These are not serious people, and I refuse to take them seriously.
Yet the Michigan consumer survey collapsing to a lower level than during the Global Financial Crisis should be, with 1-year ahead inflation seen at 5.4% and 5- to 10-year inflation up to 3.3%. Given it is estimated US households need over $430 more a month just to stand still vs. inflation, this is not a surprise. Indeed, what Philip Marey had already flagged the Financial Times’ today makes clear is now the widespread view: ‘US set for recession next year, economists predict’. Yet we were repeatedly told by the Fed, the White House, and many in markets that a US recession was not a risk. Likewise, RaboResearch flagged the energy-shock risks for Europe weeks ago, which the ECB still does not recognize. Even Australia is now seeing market calls for a 15% drop in house prices ahead, which is hardly GDP positive for an asset-addled economy.
In short, we can ignore ‘stagflation’ and can proceed to a new word shared by an incisive reader: “Incession” – inflation and recession. I repeat that we aren’t used to that concept in developed markets by any name, but emerging markets know the phenomenon all too well. Congratulations to the Western leadership of the past four decades, who have successfully turned our economies into something closer to emerging markets!
Markets are obviously far from happy. US 2-year yields leaped from 2.81% to 3.14% Friday, the kind of spike few see in a career. 5-years jumped from 3.07% to 3.31%. 10-years rose less, from 3.04% to 3.16%, so 2s-10s is close to inversion again, and 5s-10s already is. 30-years, despite wild swings, only rose 3bp at the close to 3.19%, so 5s-30s is also inverted and 2s-30s is close to it.
Stocks went down again despite the hordes of deeply unserious people telling you they only go up. We also saw the US dollar surge, with EUR back below 1.05 this morning in Asian trading, and JPY moving past 135, as the DXY sits close to 104.5. Moreover, commodities dropped back only a little, with Brent -1.4% to $120.3. Imagine how much more is needed to get oil back to $100.
So, what should the Fed do this week? The expectation is Wednesday’s meeting will still the pre-flagged 50bps move. However, we are starting to hear whispers of a 75bps hike, and this weekend saw the first suggestion of 100bps and the Fed opening the door to inter-meeting hikes of indeterminate size. A good emerging-market central bank would do exactly that in these kinds of circumstances. Of course, the author of the 100bps call made clear this will not happen,… because these are not serious people, who we should refuse to take seriously.
A far broader range of policies are needed to fight inflation. Back in the late 70s and early 80s, supply-side reform moved the West away from a fiscal Keynesianism unable to cope with higher oil prices and tight labor markets by moving manufacturing jobs to emerging markets. Today, the trend is moving back towards fiscal populism and away from manufacturing in key emerging markets. However, these policies aren’t joined up in the way they were in the 70s and 80s, either intellectually or practically.
On the fiscal side, UK PM BYO is promising tax cuts, which don’t help those who aren’t earning much suffering most from high inflation. On the production side, he is launching a scheme to grow more food in the UK,… while cutting subsidies to farmers, signing free trade deals with cheaper producers, closing off EU markets and cheap EU labour, and pushing ahead with green reforms that raise costs. As an anguished farmer notes in The Guardian in an article about “rural fury”, “We want to be eating more British and more local food but again I just ask how. It’s all very well to have words but it’s got to have really meaningful delivery and we aren’t seeing that yet.”
In France, President Macron is projected to probably scrape a narrow parliamentary majority but is only going to take around 25% of the vote share. That will make it more difficult for him to cut taxes and raise the retirement age from 62 to 65, as pledged. So, perhaps just the tax cut then?
In the US, the White House is talking about fighting inflation while doing little to expand domestic supply over imports, and winking at slashing student debt, which is a direct fiscal transfer (to the relatively better off).
Markets won’t like it, but if we get “incession”, we are also going to get such “unpopulism”.
So, back to the question of ‘what to do?’ On the UK front, there is a simple theoretical answer: shift away from ‘Brexit means Hard Brexit’ to re-join the European Free Trade Area (EFTA), or the so-called Norwegian Model. True, it would be politically impossible under present leadership, but it might perhaps happen after the next election under Labour.
Yet what is the EU to do about its own self-inflicted structural problems that are far more difficult to resolve than Brexit? Note that Ukraine will find out within a week or so if it is going to get the green light to begin the (slow) EU membership process or not. At the same time, Ukraine is running out of ammunition with which to fight Russia, so determining what the country that joins will physically look like. Many Western soliloquies have been delivered, but far fewer arms: and Russia wants ‘its’ land back.
That is also ammunition to those who dispute that a globalised, free-trade economy holds all the best answers to our existential economic questions. How many EU countries would find themselves in the same boat as Ukraine in a similar crisis, which cannot be ruled out? Arguably all of them expect France. They would end up relying on the US – as ever. And whom can the US rely on? Didn’t we just go through this with Covid? Despite that, and Ukraine, the West is still firing geopolitical/geoeconomic blanks.
The simple fact is that if you push your commodities and manufacturing to other countries to lower inflation, you let those countries push you back by withholding supply, raising inflation again. Imagine if the US or EU were major net exporters to Russia or China, and D.C./Brussels didn’t like what they were doing: wouldn’t they withhold key goods as an economic pressure point? (Assuming American or EU firms cared more about home than their own profits - but there is always legislation/sanctions to give them a shove in the right direction.)
Geopolitical logic says the West needs to increase supply. It needs to do it now. And it needs to reduce supply from those who threaten to withhold it. Yes, that is as “unpopulist” as the Fed hiking 75bps or 100bps to also reduce demand and refusing to spoon-feed pampered markets as to what happens next on rates to keep them on edge. However, it does not stop either being true. The fact that this is not happening only shows that those at the top are not serious people, and that we should refuse to take them seriously.
Bringing it back to inflation, we are close to the summer solstice: then it’s six months until the depths of winter. At that point, Europe says it won’t be buying any Russian oil. If global supply is then constricted and demand hasn’t fallen, US retail gasoline prices might be $6 or $7 a gallon, or higher. Is that a recession? Yes, a deep one. Is it an inflation crisis too? Yes, a large one. And, crucially, it is driven by the geopolitical backdrop.
Relatedly, at the Singapore Shangri-La Dialogue, the good news was that the US and China are talking again. The bad news was what they were saying to each other. The US stressed they aren’t looking to form an ‘Asian NATO’, but don’t want any forced changes in the region. China claimed the US is stirring up problems, smearing it, and Beijing is prepared to fight a war to the end to take Taiwan if it moves towards independence, while escalating claims to the South China Sea: the only stated route to de-escalation is the US acceding to Chinese demands.
Meanwhile, Japanese PM Kishida’s keynote speech noted, “I will seek to build a stable international order through dialogue, not confrontation. At the same time, however, we must be prepared for the emergence of an entity that tramples on the peace and security of other countries by force or threat without honoring the rules.” He was not referring to the US.
“This will be absolutely essential if Japan is to learn to survive in the new era and keep speaking out as a standard-bearer of peace. I am determined to… secure substantial increase of Japan’s defence budget... In doing so, we will not rule out any options, including so-called "counterstrike capabilities”, and will realistically consider what is necessary to protect the lives and livelihoods of our people.” He also spoke of the Quad offering $50bn in infrastructure funding to ASEAN over next 5 years, obviously as a counter-offer to Chinese capital.
In short, the Japanese warning is that we risk stumbling towards a conflict like Ukraine in the Indo-Pacific too: and yet the West are *still* not moving supply chains fast enough to avoid calamity if it were to happen.
So, what to do? Shift supply as if this were a war *now*. And raise rates as high as needed for as long as needed to stifle capital flowing into frivolous and vampiric asset-speculation over desperately-needed physical production. It’s an Austrian view; it’s a realpolitik view; and it’s a post-Keynesian MMT view on how to fund it. But we aren’t seeing any rapid movement in that direction because those at the top in D.C. thinktanks and key parts of the Pentagon are also not serious people - and we should also refuse to take them seriously.
As the Modern War Institute at West Point puts it in its op-ed ‘We’re Doing It Wrong’, “The US just lost two wars. How is it possible that the war colleges have educated more than twenty thousand “strategists” over the last two decades and have nothing to show for it but two strategic defeats?... Take, for instance, economics. Students need to understand how economics works in the real world, such as how markets, debt, or rapid currency moves influence strategic decisions.” Equally, the Fed, which bankrolls the fading military hegemon propping up the entire global financial system, needs to understand the Pentagon’s needs and geostrategy better – rather than how to get on the $250,000 after-dinner speech circuit. (Though those prices have surely risen with inflation.)
Hold that thought as former Marine Gen. John Allen, President of the thinktank The Brookings Institute, steps down under an FBI probe for being an unregistered foreign agent (for Qatar). According to those who look at this in depth, that is the merest tip of the iceberg across D.C. – and Qatar is hardly the prime suspect.
Which brings me back to 1981’s ‘Taps’, where the movie description is: “When an exclusive military school is threatened with demolition by a rapacious real-estate company, the students stage an uprising and siege control of the campus.” So, Wall Street triumphing over national security was a thing back in 1981 in Hollywood imaginations. Now it’s real life, and some are worried about playing Taps (a bugle call during flag ceremonies at military funerals by the US Armed Forces) for real.
Reversing that US drift, and reversing a 1981 level of US inflation, requires new policies that are joined at the hip: and serious people we could take seriously. But for now we will probably just get 50bps this week and strategic inaction; and so higher commodity prices; and so higher inflation; and so incession.
As a result, we will also get populist political distractions.
Today, the British government will release legislation that opens the door to tearing-up the Northern Ireland Protocol, so breaking international law. The CBI are warning the UK this will be a huge error, and the EU have made clear it will trigger a trade war. Nonetheless, sausage rolls, the need to distract from two seemingly-inevitable byelection defeats this week, and PM BYO’s desire to stay in office all suggest the UK will nonetheless go down this route. Just don’t think the EU and US are immune from their own forms of such “unpopulism”.