By Michael Every of Rabobank
Close But No Cigar
After Treasury Secretary Yellen spoke of “an unprecedented economic and financial storm” if the US hits its debt ceiling, we might be close to a deal. President Biden cancelled trips to Australia and Papua New Guinea to shore up the Quad and sign a key defense pact after the G7 in Japan this week in order to fly back to D.C. to negotiate. Yet close is still not time for a cigar. Not when the White House says it’s optimistic on a deal by week end but McCarthy says he isn’t; and not when we are talking about the four horsemen of the financial apocalypse.
Relatedly, the Fed’s Barkin just said he isn’t convinced inflation is defeated and would be “comfortable” with more hikes; Mester thinks rates aren’t sufficiently restrictive; Logan added a slower pace doesn’t reflect a lack of commitment to reaching the CPI target; Goolsbee said services inflation is more persistent than previously thought, and he wasn’t sure if the Fed had restrained the economy sufficiently yet; and Bostic added if unemployment rises and inflation remains sticky, the Fed will face enormous pressure but must maintain its commitment to fighting inflation. Only Williams was in any way dovish, projecting CPI to be down towards 3% by year end. So close to a rates peak, perhaps, but nowhere near the rate cuts the market wants to match the cigar already in its mouth.
Indeed, yesterday’s US retail sales data showed ex-autos and gas 0.6% m-o-m vs. 0.2% expected with upwards revisions to the previous month’s data, and the control group 0.7% vs. 0.4%. Moreover, industrial production was 0.5% in April vs. a flat expectation, manufacturing 1.0% vs. 0.1%, and the NAHB housing survey up from 45 to 50 vs. no change expected. Even Japanese GDP got in on the act, with Q1 at 1.6% q-o-q annualised vs. 0.8% consensus. The Q1 Aussie wage price index was also up 0.8% q-o-q vs. 0.9% consensus but 3.7% y-o-y vs. 3.6%: that’s too high for comfort, and was led by the public sector. Sometimes, to paraphrase Freud, when you think you see an imminent recession, a cigar is just a cigar.
However, things are closer to getting lit globally. This week’s G7 will focus on Russia and China. On the former, the Financial Times warns ‘Russia’s economic war with the West moves to a new frontline’, and Western firms risk losing their assets there with little or no compensation. What makes them think the same wouldn’t be repeated in China should sanctions be rolled out for it?
Indeed, Bloomberg says ‘Wall Street’s Biggest Banks Face a Harsh Reality Check in China’, and that they are: “scaling back ambitious expansion plans and profit goals as a deteriorating geopolitical climate and President Xi Jinping’s willingness to sacrifice economic priorities for security concerns rock the private sector and throttle dealmaking… there’s now a realization that they need a fundamental rethink on the world’s No. 2 economy because the business climate has weakened significantly and the best opportunities for making outsized profits in the country are over, according to the senior executives… Publicly, everyone’s saying the same thing: China is still a massive opportunity and they have no plans to pull out, especially since so much money has already been spent. Privately, Wall Street executives are saying it’s difficult to maintain good standing with both sides as tensions repeatedly flare” The article adds China is no longer a top-three investment priority for a majority of US firms, according to an American Chamber of Commerce survey; and China is also now closing down cross-border broker trading apps to prevent capital outflows.
If only these Masters of the Universe had read political-economy, economic history, or Marxism-Leninism: or read someone who had – recall we were warning of this outcome as far back as 2017.
Yet this is just the economic war that markets now pretend isn’t happening or think doesn’t require anything beyond waving flags at the Eurovision Song Contest. In the actual war, the UK is already providing Ukraine long range Storm Shadow missiles and France is to send SCALP-EG cruise missiles. Now we see the ‘UK and Netherlands agree ‘international coalition’ to help Ukraine procure F-16 jets’, as the AFR notes ‘Australia has 45 FA-18 Hornets it could give to Kyiv’. That’s further escalation to which Russia will respond in kind or, maybe, in the ‘grey zone’: internet cables and key EU gas pipelines could ‘fall off a yacht’. In short, anyone thinking this war is close to an end in terms of its market impact gets no cigar, just a rocket. Especially when the EBRD says Ukraine will require $250bn to rebuild: so double that, and add it to the list of multi-trillion dollar commitments being made by Western governments.
Lastly, some good news, unless you are from Sunderland. My hometown, Luton, won 2-0 last night to make it to ‘Wemberleee’ to play either Middlesborough or Coventry in the Championship play-off for promotion to the Premier League. Yes, that Premier League. Yes, that Luton. For those who follow Wrexham under Ryan Reynolds and Rob McElhenney, imagine if in 2032 they are one game away from playing against Manchester United, Liverpool, Arsenal, and Chelsea, etc. That’s the journey here, and without any trace of Hollywood money or glamour. A town which a childhood friend recently tried to enthuse to me was “not as stabby as it used to be,” which fans of Manchester United, Liverpool, Arsenal, and Chelsea, etc., may soon have to test for themselves, knows all too well that close is no cigar. But to be able to imagine what one might be like in a place where they are never seen is already something special.