Rabobank: This Will Be Shocking To Hear

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by Tyler Durden
Friday, Mar 04, 2022 - 03:00 PM

By Michael Every of Rabobank

The war in Ukraine is, as feared, seeing an increasing level of Russian artillery violence against citizens. Footage of attacks on Kharkhiv is now joined by images of greater devastation in many cities and towns. President Macron says Putin told him he is going to finish what he started – so things are about to get even worse. Humanitarian aid corridors are to be put in place, and a US-Russian military hotline set up to prevent ‘misunderstandings’, but expect a further crisis of death, destruction, millions of refugees - and deeper international opprobrium at, and isolation of, Russia and Belarus.

Indeed, just before publication Ukraine was alleging Russia was firing on the Zaporizhzhia nuclear power station in Enerhodar, which the mayor claims is already on fire. I won’t explore this any further as it was unconfirmed, and the station should *hopefully* have the necessary emergency protocols to shut down safely in such circumstances. However, this event underlines the kinds of fat tail risks that war brings daily far beyond Ukraine.

The full impact of this is dawning on markets: commodities were having their best week for 50 years as of Wednesday. Obviously, inflation is going to rise. Our Eurozone team argues we are about to see the largest supply shock since the aftermath of the Yom Kippur War in 1973. That, and US spending on the Vietnam War forcing the dollar off gold in 1971, combined to collapse the post-WW2 Bretton Woods architecture. Here we are again as Freight Waves, the global supply chain magazine, states “The second Cold War is here — and supply chains will be the front lines”:

We are witnessing the remaking of the world order in front of our eyes - and this will impact global supply chains in unforeseen ways. We are about to experience the most dramatic and unpredictable supply chain map we’ve experienced since WW2. If the Russia-Ukraine conflict’s international ramifications keep spreading, we face a real possibility of a bifurcating global economy, in which geopolitical alliances, energy and food flows, currency systems, and trade lanes could split.

During the first Cold War, the world was anything but flat. There were two worlds - the East and the West. That world is being recreated as we speak, and with it, Western companies will start to shift sourcing away from the East and more toward Western and neutral states. North American economic integration will become a new priority. Surface transportation across the Eurasian continent will become more complex, and possibly contested.

Entire supply chains will be rewritten, with new sources and partners - all in the interest of corporate and national security. This will create massive volatility and unpredictability. Companies will prioritize vendors that can provide consistent and dependable supplies, likely paying a premium. In the end, those costs will be passed on to consumers in the form of higher prices.

While prices will become an important consideration for consumers, brands that offer a consistently and predictably available set of choices will enjoy pricing power. The future market winners will be the corporations that make the investments in supply chain infrastructure and reliable, Western-friendly production locations.

Supply chain analyst roles will become the hottest jobs of the next decade, prized by corporations, consulting and even Wall Street for the ability to interpret, analyse and predict disruptions and risks in a new world order. Those same analysts will find themselves recruited heavily by national security, intelligence and defence organizations - as future conflicts will largely rise out of a desire to control materials and production.

New investments in supply chain technologies and automation will be accelerated, as will preference for near-shoring and domestic sourcing. Historical data models, based on following freight market trends, will become less relevant in the future. Companies with dynamic supply chains will require fresh data and forecasting that is constantly updated as new information and datasets become available.

The Ukraine crisis is perhaps the end of the preamble to a long history of geopolitical, economic and military conflict between the East and West in the second Cold War. Now the plot is thickening. State actors like Russia and China are choosing regional hegemony over global integration - we will see this play out further in the Baltics and the South China Sea, not to mention the Middle East and the greater Pacific.

WTO-led globalization took decades but accelerated when China entered in 2000. Global decoupling --if it comes to that-- and tighter regional socioeconomic integration will also take decades, and the pace of change will vary, sometimes fast and sometimes imperceptibly.”

For many, this will be shocking to hear. For us, not at all. In 2015 we flagged ‘FX Wars’ as the first stage of a global economic battle; in 2016 --pre-Brexit, pre-Trump-- we said the global system was on ‘Thin Ice’; in 2017 we warned of a new ‘Great Game of Global Trade’ and a looming ‘New Cold War’; in January 2021 we argued the ‘Roaring 20s’ analogy was only true if you could ‘Count to 30s’; in summer last year we emphasized we were ‘In Deep Ship’ as global logistics were geopolitical; and in January this year we said 2022 threatened ‘Unravelling’. And to Freight Wave’s point that supply chain analyst roles will become the hottest jobs of the next decade, I refer back to yesterday’s Daily: ‘*You* can’t trade geopolitics’ – but you’d better start doing so fast.

Example #1. Bloomberg reports Wall Street has already “been purchasing beaten-down company bonds tied to Russia in recent days, as hedge funds that specialize in buying cheap credit look to load up on the assets… Finding ways to wager on distressed securities is standard fare on Wall Street. But doing so in the wake of Russia’s widely condemned invasion of Ukraine brings unique risks. World leaders are seeking to punish Russian companies and cut the country off from the global financial system, and any firm perceived as working against those interests faces potential reputational damage, market watchers say.” Quite. We all know capital knows no country, but even for The Street this takes some beating – and someone may take a serious beating over it. That’s how it was under the last Bretton Woods architecture.

Example #2. If wheat prices continue to rise --and the longer war lasts, the more they will-- then a growing chorus will point to the risks of a potential re-run of the Arab Spring in the Middle East and parts of Africa. You think we have chaos now? Throw in some new wars/civil wars there.

Example #3. Oil markets soared on bipartisan US support for further sanctions on Russian energy yesterday, but the White House and Berlin pushed back. They then fell on rumors the Iran nuclear deal is about to get over the finishing line. But think about this in the full context. The deal’s terms, according to someone who quit in disgust seeing it hatched out, is driven by Russia, which, along with China, is helping Iran evade sanctions. It will allegedly include removing sanctions on human rights abusers and designated terror groups such as the Iranian Revolutionary Guards Council (IRGC); allow Iran to buy tens of billions of dollars of Russian weaponry; to develop ballistic missiles; and offers no tougher controls on nuclear development; so, in 2031 --if not sooner given it reportedly already has 60% of the processed uranium needed for a bomb-- Iran will be a nuclear break-out state able to get one when it wants.

Look at the reaction from US-friendly UAE, under attack from Iranian proxies, at the UN Security Council; from US-friendly Saudi Arabia, under attack from Iranian proxies, via an interview with its de facto ruler Prince MBS in The Atlantic where he threatens to stop investment in the US and do more in China (Does Joe Biden misunderstand something about him? “Simply, I do not care,” MBS replied. “It’s up to him to think about the interests of America.” He gave a shrug. “Go for it.”); and from US ally Israel, under attack from Iranian proxies, which states it will ignore any deal and act as needed. The risks are that rather than lowering oil prices and *preventing* war --against an Iran whose economy has been flattened by sanctions the US is now imposing on Russia: so do they work or not?-- a new nuclear deal is more likely to *lead* to war and see oil soar to new record highs.

The deal also suggests the risk of the US losing critical allies at a time when sides are being taken. On which, Russia is to hold the first “International Anti-Fascist Congress”(!) in August this year, inviting the Saudis, China, Uzbekistan, Pakistan, Iran and other stalwart defenders of democracy and human rights, as a mirror image of the recent US Summit of Democracies. India has been invited to both; and while the US and India collaborate on the Quad against China, yesterday saw US diplomats suggest D.C. may sanction New Delhi for buying Russian weapons; and we got this 2-minute clip on Indian TV summarising the passions and confusion. You know when I said ‘*You* can’t trade geopolitics’? I wasn’t just talking to the market, it sadly seems.

Against all this, markets are already seeing extraordinary price action. As Bloomberg notes, liquidity is now altered such that trades of decent size in almost anything see outsized price moves. In short, the bid-offer spread is as far apart as Putin and any leader he talks to at his big table; or Russia and the rest of the world. Expect those spreads to get wider and wider until something breaks. Which won’t be helped by the Fed, which Powell says will plow on while everything not under its remit crumbles.

Of course, despite the global architecture collapsing in the 70s, the US still managed to emerge even stronger and more central. Will that be the case this time round? The fundamentals still say yes, much as many don’t want to hear that message. Yet even if that is the case, the journey ahead is going to be as shocking as Freight Waves implies.

Happy Friday.