By Michael Every of Rabobank
Yesterday saw the Riksbank in Sweden cut rates by 25bp to 3.75% for the first time since 2016 (as Brazil cut 25bp to 10.50% as expected, yet the BoJ opened the door to another tiny June hike). Rate cuts, and a month before the ECB is expected to do the same! As Bloomberg put it, “their choice signals that the domestic situation, with subsiding inflation and a sputtering economy, takes precedence over any concern that moving ahead of bigger peers will lead to another bout of korona weakening that in turn would fuel import prices.” Or that cutting rates doesn’t see speculation and inflation return locally; and/or that the global backdrop doesn’t suddenly do anything (additionally) nasty that would complicate the inflation environment for everyone.
On that latter note, the headlines speak to a dynamic that risks exactly that kind of development, if not immediately then over time.
First, ‘Biden warns Israel he will halt US weapon supplies if it invades Rafah’. The US president doesn’t mean just the $260m of munitions already on hold despite Congressional approval, but most offensive weapons, even if defensive systems such as iron dome interceptors will still flow.
There are few topics less well understood and more passionately championed on both sides that the current conflict between Israel and Hamas, but these points hopefully underline why this US action has a key geopolitical, and potential market, impact.
- The US is trying to dictate Israel’s policy, but far too belatedly to please the anti-Israel crowd.
- It removes the only pressure-point left to force Hamas to release the remaining Israeli hostages which it holds (including dual US citizens), displeasing the pro-Israel crowd.
- This as a huge political win for Hamas. It leaves Israel with only the recent Hamas-penned deal that would see it hold hostages for longer, retake control of Gaza, and gain the release of high-profile Palestinian prisoners into the West Bank. That latter action would crush the popular standing of the Palestinian Authority, leading to a Hamasification that would undermine both US/Western hopes for Arab states helping rebuild Gaza under a reformed Palestinian Authority and a two-state solution.
- This US “offense things bad, defensive things good” strategy is a mirror image of what they have tried and failed with vs. Russia (re: Ukraine) and Iran (re: Israel), among others, so far.
- Saudi Arabia will be wondering if a defense alliance with the US is worth it when their future actions might be proscribed by a White House National Security Advisor who a week before 7 October proudly claimed that the Middle East was “the quietest it has been in years.” Other allies in other regions, from Europe to Asia, may also start to wonder how reliable the US is when push really comes to shove.
- Israel, seeing this as existential, could ignore the US, creating a rupture between key allies. Or it could pivot to attack Hezbollah in Lebanon, which would be a far more destructive, destabilising conflict: and any US refusal to supply ammunition for that would be a true geopolitical earthquake that would embolden all forces pushing back on the US and its allies further.
In market terms, this doesn’t mean anything for energy prices immediately: indeed, some may wrongly take it as a “de-escalation” signal. However, the underlying pressure on the geopolitical tectonic plates has increased enormously, and the risks of a fresh eruption of some kind --with an inflationary impact of various potential forms (i.e., look at the Houthis)-- has increased in tandem.
Second, the IMF’s Gopinath this week stated: “Consider a world divided into three blocs: a U.S. leaning bloc, a China leaning bloc, and a bloc of nonaligned countries.” Which is of course exactly what we did years ago, when almost nobody else in markets was talking about it seriously. While she stresses that “connector countries” like Mexico and Vietnam are key ‘middlemen’ between the US and China, she notes we are seeing signs of real embryonic geopolitical and geoeconomic rupture.
The currency composition of cross-border payments for US-leaning countries is unchanged, but for those China-leaning the CNY share has more than doubled, from around 4% to 8% - and this is not only Russia, but a broader upstream trade commodity finance shift I have flagged before. She notes China’s shift from SWIFT to its own CIPS; central banks’ increased gold purchases for FX reserves; and flags the potential risks of trade fragmentation like Brexit on steroids, financial fragmentation that will see capital flows shift, and even that “the global payment system could become fragmented along geopolitical lines with the emergence of new payment platforms with limited or no interoperability.” Which is what happened in the 1930s, as well as in the Cold War, and which I have flagged as a risk repeatedly for years – and I have stressed that the dollar still wins even in a fractured world order where we all lose.
In a mild scenario, the IMF thinks this could reduce world GDP by 0.2%; in an extreme scenario, losses could be 7%; and low-income countries could experience 4 times the GDP loss of other countries in the event of fragmentation of commodity markets into two blocs. Most of the losses would be due to trade restrictions of agricultural commodities, raising concerns about food security in poorer countries: you think cocoa is volatile now? Again, we did this geopolitical work on agri commodity flows years ago.
Fragmentation of trade in minerals for the green transition would also make the already vastly expensive energy transition even more costly, as these minerals are geographically concentrated and not easily substituted. Again, this is a point made here before.
Understandably, the IMF asks, “So, what can we do to prevent this?” Yet the answer is: “The ideal solution would be to preserve and strengthen the multilateral rules-based global trading system and the international monetary system… and making more progress on dealing with subsidies and national security trade restrictions and developing international rules and norms on… industrial polices… But given where we are today, the ideal may be difficult to achieve.”
So, all the IMF can offer is “to keep open the lines of communication and stay engaged,” and “work together on areas of common interest,” which means little, and “limit harmful unilateral policy actions, including industrial policies” – which are about to expand massively, even in Europe.
Third, US presidential candidate RFK, Junior says that he has a dead worm in his brain and, “I have cognitive problems, clearly. I have short-term memory loss, and I have longer-term memory loss that affects me.” But not to worry, because you have the alternative choice of Joe Biden. Or of Donald Trump.
That all says, “disinflation and rate cuts”, right? So, surely, it’s time to risk doing just that?
