By Michael Every of Rabobank
I have long made black humor comparisons between the structural malaise of the West and the late-stage Soviet economy. The latter could see things weren’t working even in the 1970s but drifted through a “novy normalny” of slower growth and rising shortages, with the easiest answer always to build yet another statue of Marx or Lenin, talk about the proletariat, and hope things somehow turned around. Today the easiest answer is always to build another high-end condo or business center, talk about the proletariat, and hope things somehow turn around. The USSR eventually opted for the shock of glasnost (openness) and perestroika (reform) – which led to total collapse. The Fed appears to have just opted for ‘Fedrestroika’, which is going to cause lots of apparatchiks to get nervozny.
After all, as @S_Mikhailovitch correctly sees on Twitter, “Today's Fed is our version of the 1980’s Soviet Politburo. They say and do whatever may help sustain the unsustainable. That's the game. There is no other.” As someone replied, “To paraphrase that old Soviet joke ‘They pretend to have inflation under control, and markets pretend to believe them.’”
Now our commissars are promising a series of rate hikes to try to save the system from itself - Chair Powell ironically adding “I think there’s quite a bit of room to raise interest rates without threatening the labor market.” They also released a document called ‘Principles for Reducing the Size of the Federal Reserve's Balance Sheet’ when we know that they cannot sustainably reduce the balance sheet. It doesn’t get any more Soviet sounding than that, and if you can’t see that you’ve been in said system too long, or a true apparatchik.
My fellow Fed refusenik Philip Marey thinks they will hike four times this year. He also thinks it’s a deep irony they opted to reaffirm the equally-Soviet ‘Statement on Longer-Run Goals and Monetary Policy Strategy’ --with the sentence “the Committee seeks to achieve inflation that averages 2% over time, and therefore judges that, following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” -- as the adoption of this strategy is why the Fed has fallen so far behind the curve in the first place. That and the need to build high-end condos or business centers, talk about the proletariat, and hope things somehow turn around.
The market reaction to Powell’s Q&A was huge: 2-year Treasury yields leaped from 1.02% to 1.15%, while 10s went from 1.77% to 1.86%, flattening the curve further when we won’t get the first hike until March; stocks gave up all the ‘party-insider’ gains of the day; and the dollar rallied.
So, can Fedrestroika last? As our Rates Strategy team sees it, the Fed belatedly realizes there is nothing they can do about the supply-chain shortages and high inflation that plague the economy. (Yes, the US could repress inflation by fixing prices, but that would just make its shelves look more Soviet if they don’t also move the means of production home.) As such, the Fed has two choices: do nothing and risk inflation really sinking in; or raise rates knowing that if markets collapse they can then pivot back to zero rates/QE, building high-end condos or business centres, talking about the proletariat, and hoping that things somehow turn around. They know how to do the latter. In fact, it’s all they know.
One wonders how long this dialectic can be peddled before the proletariat prefers a different kind of dictatorship: but that’s a matter for samizdat (or Twitter) rather than the market media and apparatchiks, who all want to keep their lovely dachas.
And ‘Back in the USSR’, both fog of war and diplomacy swirl in the air. A senior Russian politician says Moscow rejects US proposals responding to its security demands as “fantasies”, with their foreign minister threatening “retaliatory measures”. The press says the US response only covered arms controls rather than US support for Ukraine’s right to pursue NATO membership, the red line for Moscow. Some military strategists point out the number of Russian troops on the border is not enough for a full invasion; others that the amount of equipment is, and that the extra troops only need to arrive at the last minute. (With some then wondering if it would be before, during, or after the Beijing Olympics.) Moreover, two dozen Russian embassy staff were just told to leave D.C. Neither development bodes well.
While Russia’s goal may still be to divide Ukraine, with the huge market tail risks we have already covered, it is assuredly to divide the West, with equally large tail risks over time - and here it is already winning. As the New York Times puts it: “Putin’s goal is to split the Europeans, and then split Europe and the US. If the impression prevails that Germany is not fully committed to a strong NATO response, he will have succeeded in paralyzing Europe and dividing the alliance.” While Berlin has just agreed to sell 5,000 helmets to Ukraine, that is not getting any hat tips given what everyone else is doing. Indeed, Chancellor Scholz appeared physically uncomfortable and reticent at a recent press conference when discussing Russia’s actions and what he would be prepared to do about them, which hardly builds confidence.
Meanwhile, Germany is fighting a two-front surrender, as Politico reports Berlin is “working behind the scenes to undermine a common position against China”. Chancellor Scholz’s office allegedly fears the EU is becoming too aggressive in its defense of Lithuania against Beijing’s economic coercion, after France last week said Beijing had gone too far with its attacks on the single market, and is “calling everyone who speaks German in the Commission” to tone down the pressure on China - which is not coercion when Berlin does it. ‘Coincidentally’, Reuters reports Lithuania may now consider backing down over its Taiwan stance: Slovenia next? And isn’t it nice to be able to tell smaller eastern European countries what to do?
Clearly, something needs to change: the issue is what (or who)?
On which, Italy --also being wooed by Russia-- still does not have a president. Today sees round four of voting, and while a successful candidate needed a two-thirds majority in the first three rounds, today that threshold is lowered to an absolute majority. Then it reduces every day going forwards until by March it is the first person to put their hand up. I joke: see here for proper analysis from Marnix Arendshorst, which underlines the potential market impact.
Yet I am not joking that the best defense supporters of British PM BYO can muster against accusations of him having attended an illegal birthday party under lockdown are that the PM was “ambushed by a cake”: cue Twitter memes such as a line of cakes with the captions “Can you identify your attacker from this line-up, sir?” Also cue more letters of no confidence and a likely leadership challenge, and GBP volatility. The one-rule-for-me-and-another-for-you is again very Soviet. The fact that there was a cake to go with the alcohol isn’t. Future historians will note while Europe was close to being carved up, the UK was preoccupied by slices of cake; yet it still played a more proactive role than Brezhnevian Germany, which was trying to have its cake and eat it.