"Markets Are Overlooking How Much Worse This Can Get, How Inflationary It Could Prove"

By Michael Every of Rabobank

Waller Way to Behave

Points of order today. First, we need to underline the major disconnect between market pricing for aggressive 2024 Fed rate cuts -- including new hedges that the Fed cuts by 50bp in March-- and how the actual economy is still performing. Second, we have to ponder what drove the Fed to make the dovish statements in late 2023 that drove, and still drive, that kind of wild pricing. Third, we have to deal with the Fed, and others, walking it all back just weeks later.

That’s what Waller became the latest central banker to do yesterday. He started off saying, “For a macroeconomist, this is almost as good as it gets. But will it last?”, then argued only far more time than between now and the March meeting will tell. As a result, bonds, stocks, and just about everything except the US dollar sold off.

For the few who read Waller’s speech in full -- and people who price for six or seven Fed cuts, and 50bp cuts in March, when core inflation is well above target likely don’t read anything fully -- he added he’s more confident the economy can still move towards immaculate disinflation, that financial conditions remain restrictive (despite the Pavlovian response since Powell’s dovish turn), and that we can still get three rate cuts later in 2024 if inflation behaves, including next month’s revisions to CPI methodology. Indeed, what will be hedonically adjusted lower this time?

Yet all around us we see misbehaviour. Maybe the White House and Congress just found another $70bn down the back of the sofa to throw at voters; maybe President Biden will cancel student loans less than $12,000, so more money to buy a sofa. It’s an election year where, “democracy is on the ballot,” or ‘the future of the country’ is. You really think we are going to get tight fiscal policy? The key question is if the Fed will play ball or hardball.

Waller also mentioned the Red Sea, where the behavior is truly worrying – but so was his take that there would only be a one-time price effect if the Suez Canal remains closed. He hasn’t learned from the last shipping supply-shock crisis, it seems.

Meanwhile, more Houthi attacks on commercial shipping have occurred; Japan’s NYK is avoiding Suez too; so are Shell’s tankers, joining Qatari and Russian LNG carriers; and maritime insurance rates have soared from 0.1% to 1% of cargo, with some insurers reportedly avoiding coverage of US and UK (and Israeli) merchant ships against war risks – and that includes their “interest” in a ship, a far more blanket term than just the registration of beneficial ownership. Note that’s because the US and UK carried out recent airstrikes on the Houthis to try to stop these shipping attacks, which the EU disassociated themselves from (in order to keep their insurance rates down).

I published on this unfolding crisis yesterday (Same Deep Ship, Different Day). It stresses that markets are overlooking how much worse this can get, how inflationary it could prove, how hard it will be to resolve, and how it will soon be everyone for himself in trying to protect their maritime trade.

Making my points for me less than 24 hours later:

1. As already shown, the crisis is getting worse.
2. We see the warning that a ‘tipping point’ Houthi attack that reduces all willingness to sail through Suez is not far away.
3. Inflation pressures already loom: (‘DP World sees Red Sea disruptions hurting European customers hardest: Cost of goods into Europe from Asia will be higher’).
4. Chevron is warning of a very real risk to oil prices: that would certainly be the case if the Houthis turn their fire on Saudi Arabia again.
5. Maersk says the crisis could last for months. That may actually be optimistic.
6. The US is already winding back expectations that airstrikes will stop Houthi attacks, as it is about to officially redesignate them as terrorists. Indeed there is no realistic military solution to “The Houthis hijacking the world economy,” in the words of US National Security Advisor Jake Sullivan, without massive ground forces, which nobody will provide given how often Yemen has given invaders a bloody nose in the past.
7. Moreover, there is no realistic political solution. Rather, there is agreement with our immediate post-10/7 analysis that this is not just about Israel/Hamas, problematic enough, but the geoeconomics/geopolitics of the proposed India-Middle-East Economic Corridor which bypasses Iran. (“If you don’t work through us and our North South Corridor…we will make sure that no shipping is safe between India-South Asia to the Red Sea and Europe.”) Indeed, note that the UN Security Council resolution condemning the Houthi attacks was not supported by either China or Russia.
8. EU Member States Back New Naval Mission in Red Sea to try and keep their own cargo flowing. Yet how will they succeed where the US Navy has failed, and do you know how much it will cost Europe to do that at scale, long term – and as Germany is insistent on balancing its budget? (On which, see our recent note on the hunt for EU strategic autonomy.)

In my best Cilla Black impression (for the few who will get that reference) “Waller way to behave!” And Deep Ship for most of us? You bet!