By Michael Every of Rabobank
Have you got the energy?
Yesterday, Bloomberg noted ‘Fears of 5% Yields Are Back, Thanks to Oil’s Surge’. We are over a quarter into a year in which we were promised rapid, wall-to-wall rate cuts, but so far only the Swiss have proved punctual: now we are threatened with higher long yields to boot?
Yes, the Fed’s Daly underlined she still sees 3 cuts this year, even if “a projection is not a promise,” and the same tone has been struck by almost all central banks. Yet Mester raised her long-run Fed Funds forecast from a “long-time” view of 2.5% to 3.0% (and ruled out cutting in May, which the market wasn’t thinking about as odds of a June cut start to fall back).
In the US, we have persistently strong labour market data (for all the questions over it); sticky core CPI trending higher, not lower; PPI doing the same; and financial conditions that say ‘buy all the things’; and now ISM manufacturing back above 50, with new orders and prices paid not backing goods deflation. Let’s see what the services ISM employment index says today.
European and UK data are less ebullient, even if stocks aren’t, but today’s Eurozone CPI data will underline both goods deflation and services inflation far above the 2% CPI target level. How will the latter come down absent an economic downturn more dramatic than one requiring just a few rate cuts, which themselves should logically push it back up again?
Now back to Bloomberg’s “5%” headline as Brent sits at $89 this morning, the highest level since last October: is it really all about energy at the end of the day? There’s a scientific and philosophical case to be made that it is, even if it fuels resistance from everyone paid to look at everything but energy. However, it’s complicated. The Financial Times underlines that solar panels are now so cheap they are being used as fences in Europe… because the cost of labor has gone through the roof, so installing panels them there is uneconomic. In short, you have cheap energy *and* high inflation.
You don’t need to be an energy expert to see a cyclical manufacturing upturn would mean energy demand moves higher, while supply is being deliberately limited by OPEC+.
You don’t need to be a Middle-East expert to see geopolitical risks are high: and as that region sadly often proves, things can still get much worse.
You don’t need to be a Russia-Ukraine expert to see geopolitical risks are high: and, as we predicted, Ukraine has continued to use drone attacks against Russian oil refineries. The latest took out Russia’s third-largest facility 800km away in Tatarstan. While Russia says it doesn’t need to reduce diesel exports for now, how many more refineries need to be struck before that happens? Because, logistically and logically, refineries are going to keep being struck.
You don’t need to be a China expert to see the read-between-the-lines-out of the latest telephone call between Xi and Biden was focused on Taiwan, which is another geopolitical flashpoint (and a physical one given the earthquake and tsunami warning we just saw there). And is there is a link between that Xi-Biden call and US Treasury Secretary Yellen suddenly announcing she will be in China from April 4-9? Perhaps she’s just looking for more ‘shrooms?
Have you got the energy to keep tracking what you should be tracking in order to track what you think you should be tracking?
Next to Godleyness
Meanwhile, Bloomberg echoes our Fed Watcher Philip Marey in saying a 60% Trump China tariff and a 10% universal tariff could reduce US GDP by 0.5% and push the PCE deflator to 3.7% by end-2025. That should wake a few people in markets up.
Yet their static neoclassical model doesn’t consider Trump might also cut taxes on production to zero and introduce a federal sales tax, which could imply a very different dynamic outcome. Combined, that combination could theoretically shift the US economy away from imported consumption towards domestic production; and even if the US household consumption share of GDP goes down, GDP itself could go up by more as we see a domestic productive investment boom, so US consumers are still better off overall. In short, that would be inflationary growth for the US, and deflationary no-growth for exporters to it.
In short, these Godley balance-sheet ramifications matter as much as energy for markets. However, traditional economic analysis does not consider this approach, so keeps ending up in an unGodley mess that is now pushing us to conflated structural inflection points as the global system breaks down.
What’s the Fed supposed to do, if these Trump tariffs and tax cuts happen? And do other central banks celebrate their neoclassical deflation ‘win’? I don’t think so.
QE and negative rates were a first, doomed-to-fail response to our global problems, as Kalecki had said they would be in 1943. Now we may see the next logical step, flagged here in 2015: reflation behind trade barriers, with all the concomitant volatility and geopolitical tensions.
Indeed, please read ‘Car dealers will decide America’s future: The nation's gentry could finish Trump's revolution’. It underlines how the US political economy might work from the grassroots up to link back to the themes most only look at in silos: populism, trade imbalances, EVs/green, US-China relations, asset prices, and the US dollar’s role in our current and any new global paradigm.
If you thought QE moved markets, wait and see what happens if and when structural global imbalances built up over decades start to unwind. The best way to keep clean hands through that mess is to stand close to Godleyness.
