By Michael Every of Rabobank
We've just seen huge market volatility. This week promises more given it’s month and quarter end with key positioning, portfolio reallocation, and short squeezes all in play. On top of that, the news continues to underline the central thesis: that the ‘one size fits all/one world for all’ neoliberal/liberal/’new normal’ system is collapsing.
Red v Blue
Friday’s US Supreme Court overruling of Roe v Wade was a shock despite having been flagged in an unprecedented leak. It was leading news on Bloomberg and the Financial Times because it exposes US fault-lines. Overturning a near-50 year constitutional precedent means we have US inflation and monetary policy which echoes the 1980s, a pre-Roe status of 1973, and polarization that echoes the 1960s, 1930s, 1880s, 1860s, and 1830s.
The optimistic view is that the US can work this out politically, as the rest of the West has. USA Today stresses: ‘The Supreme Court has now given millions of citizens rather than nine justices the power to decide.’ Tellingly, last week the Court reaffirmed the Second Amendment right to bear (concealed) arms and saw the first gun control legislation in decades too.
The pessimistic take is things get worse. Justice Thomas -- not the other five anti-Roe justices -- floated roll-backs of other constitutional rights, as did the dissenting Court minority. Twitter has (unbanned) calls for violence, burning down the Court, or killing justices, following the recent arrest for attempted murder of a man targeting Justice Kavanaugh. Some politicians say they will defy the Court, that it has no legitimacy, or they will now pack it. Some media echo this, and claim civil war looms. It’s likely hyperbole, but this is what one expects in an ‘winner takes all’ emerging market, not a constitutional liberal democracy claiming to lead a global struggle vs. autocracy.
It is unlikely markets are going to treat Treasuries or the US dollar as EM assets on the basis of what happened on Friday. Yet the long-run market impact could be significant. Justice Thomas, in an interview with The Federalist, stressed the importance of the Supreme Court pressing ahead to roll back “the administrative state” and Federal agencies, who:
“…have the executive power, the enforcement power, they have administrative judges to adjudicate, so they have all three. And the question for us is, where do they fit in the constitutional structure?... If we simply defer to the agencies,… aren’t we doing precisely what happened when it came to the royal courts of the pre-Revolutionary era?... You’ve got this creation that sits over here outside the Constitution, or beyond the Constitution. How does it fit within our constitutional structure?”
One wonders where the imperial Fed sits in this view.
We also risk a more polarized/balkanised US. Will population shifts from California and New York to Texas and Florida on economic grounds become two-way on culture? The DNC’s @DavidOAtkins points to fragmentation risks as, “…California is not going to follow Idaho's rules. We're just not. We don't have to and our people deserve better. And if we have to Constitutionally protect basic social rights and set up our independent EPA because the GOP destroyed the federal govt, we will.” Such splits can even hit firms. Kirkland & Ellis, which helped over-rule the challenge to the Second Amendment, told the two lawyers who did so for it to either end such defences or leave the firm. So, red and blue states, firms, products, and consumers?
Blue v Red
If Red v Blue is clear in US politics, so Blue v Red is in geopolitics. The US, Australia, Japan, New Zealand, and the UK just launched a Partners in the Blue Pacific scheme to counter China, and the G-7 a rival to China’s Belt and Road Initiative in its ‘Partnership for Global Infrastructure and Investment’. The US is promising $200bn in funding: *if* that is new money and *if* the rest match it we are talking about a serious global policy shift. Meanwhile, China warned a US spy-plane flying above international waters in the Taiwan Strait, which is seen as a dangerous escalation by both sides.
Belarus is being used as a base for more widespread Russian air attacks on Ukraine, including against Kyiv again, and Moscow says it will base nuclear weapons there aimed at Europe. Tensions also continue to mount near the critical Suwalki gap leading to Kaliningrad.
Ignoring that Iran plays for Team Red (as it just attempted to assassinate Israelis in Turkey) EU foreign policy chief Borrell is trying to resuscitate the Iran nuclear deal - just before US President Biden heads to the region to sign military agreements with states who don’t want it to happen. (Indeed, such anti-Iran regional co-ordination is already crystalizing.)
‘Black’ v Green
Meanwhile, Germany (and the EU) are forced to blink on green pledges: coal output is soaring; plans made for the risks of Nord Stream 1 closing, which could reportedly mean consumer gas prices doubling or tripling; it may appropriate parts of Nord Stream 2 to speed up new LNG pipelines; it and others, reportedly want to delay EU bans on the sale of new petrol and diesel cars from 2035 to 2040; it is pushing the G-7 to drop a pledge to stop financing fossil fuel projects; and French power firms are calling for immediate energy rationing.
Yet Europe won't help Africa --which has fossil fuels and minerals for EVs-- to develop its fertiliser capacity because of concerns over *EU* green targets; and the US is to proceed with production of biofuels despite the global food crisis.
The G-7 is also considering imposing a price cap on Russian oil by withholding its monopoly on shipping insurance on any global importer which refuses to adhere to it. That’s a very high risk game of geopolitical brinksmanship which will either see Russian energy income slashed, or will alienate the rest of the world and humiliate the West – and see even higher energy prices.
All v All
*Finally*, the West grasps it's in an economic war: but it doesn't see where all the fronts are. For example, G-7 gold trade with Russia is to be cut off by sanctions too. However, everyone else can still buy it and sell it on, like Russian oil. The G-7 needs to win global hearts and minds to win.
That means noticing the FT warning the food crisis is biting in Africa; that up to 345m people --4.4% of humanity-- are at risk; that the Economist says ‘A Wave of Unrest is Coming’; and that Bloomberg predicts ‘Hunger and Blackouts are Just the Start of an Emerging Economy Crisis’. Indeed, Spain just saw an incursion into its enclave in Morocco in which 23 people died, Peru has joined Sri Lanka and Ecuador in economic chaos, and China has had to bail out Pakistan with a $2.3bn loan.
Yet the response so far is for the better off to subsidise their own food and energy, which forces the ultimate cost onto the world’s very poorest and makes things worse: California is talking about giving households $1,050; Spain is to spend another EUR9.5bn on tax breaks and commodity subsidies; and even middle-income Malaysia will spend $18bn this year on subsidies, almost 5% of its GDP(!) The risks of a global all v all are rising, as are internal red v blue pressures in many places.
Indeed, as the ECB struggles for its own "anti-fragmentation" strategy, the Dutch Prime Minister states it is up to Italy to deal with the problem itself via reforms, which will surely only make the ECB’s immediate task harder(?); the UK deeply-unpopular PM Johnson say he wants to stay in office until the mid-2030s(!), as Scotland would like to leave by 20:30, and Northern Ireland could potentially follow; and even in China, an ultra-hardliner Xi loyalist was also just appointed the new Minister of Public Security ahead of the expected schedule – surely not for no reason at all.
The answer must be for supply to increase: yes, it must be sustainable, but so must the current global population, or else politics, geopolitics, and markets can’t be. However, that new supply is itself going to break up the global system, as part of ‘sustainable’ means not relying on others in a pinch so we don’t end up here again. Relatedly, in her latest note ‘Time to Get Real’, geostrategist Dr Pippa Malmgren underlines, “Food is now a national security issue that warrants spending from the defence budget… It’s time to get real. That means a world where capital and talent get on their bikes and start making hard stuff.” Which is hard, and inflationary before it is deflationary.
Green v Red
Despite this mess, markets think the Fed is going to tighten less than feared just days ago. That was helped by Friday’s revisions to the final Michigan consumer sentiment survey: the headline fell to a 50-year low, but more ‘important’ was that longer-term inflation expectations dropped 0.2ppts to 3.1% y-o-y. Despite massive uncertainty from respondents, this was because a sub-set felt long-term inflation would be very low. Do they all work for the fixed income market or pension funds? Nobody on Main Street is thinking “deflation”!
As evidence, look at rents. According to CoreLogic, they just surged 41% y-o-y in Miami, 26% in Orlando, 18% in Phoenix, 17% in San Diego and LA, and 8% in New York, D.C., St Louis, Philadelphia, and Honolulu: that’s quite the ‘forecast err-OER’ in a series the BLS says is rising much more slowly.
Nonetheless, the Wall Street end-month/end-quarter/short-squeeze/’new normal’/Fed put crowd got their win last week, and they may get another this week too. They just didn’t notice that oil leaped on Friday day too, despite many speculative longs having been reversed, which rains on the deflation premise and yells ‘stagflation’ or ‘incession’. And ‘soaring global unrest’.
If the Fed can’t step up now, it never can. Indeed, the BIS just warned that leading economies risk tipping into a high inflation where rapid price increases are normal, dominate daily life, and are difficult to quell. It is openly calling for key rates to be raised "quickly and decisively" in H2 2022, even if “some pain will be inevitable,” because falling behind the curve risks far worse than that. Are the Fed going to ignore that call?
Bloomberg says that ‘Fed Chair Jerome Powell's path to 2% inflation needs luck, or failing that, pain’. That overlooks the unlucky geopolitical backdrop it faces. If the *supply* side is not fixed, even if the Fed pivots, it will have to flip back, with no credibility, if inflation gets worse. They had better be hoping the G-7 plan works: or *help* the G-7 plan work, which might mean telling other people to help others globally. After all, the Director of the Institute for Financial Transparency correctly tweets, “Few realize Volcker's high rate plan appears successful only because of luck. Had OPEC continued to raise prices, his plan would have been an abysmal failure.”
Zooming in, such a view suggests ‘red’ will win against ‘green’ even if this week sees the opposite. Indeed, 3% on the US 10-year Treasury once seemed a ‘new normal’ ceiling: if said new normal is falling apart, it now looks to be a floor.