By Michael Every of Rabobank
The Pause That Didn't Refresh
Eagle-eyed readers may notice I haven’t written the Global Daily since May 23. That’s quite the pause, but with Covid pneumonia responsible, it wasn’t one that refreshed. Ironically, ‘The Pause That Doesn’t Refresh’ was my 2023 outlook title, which mocked the market view that early rate cuts loomed, and spoke about the risks of sticky services spending and core inflation, supply destruction in commodities, escalating geopolitical shocks, low unemployment and lingering Covid effects for some (Amen!); larger fiscal deficits; a drive for reindustrialisation; and that when we were expected to have rate cuts (i.e., now, as some said in January) we would still be looking at the risk of further rate hikes – just alongside central-bank policy acronyms to keep things stable. Not a bad take, I think one can say.
In the 11 weeks since May 23, the US S&P is +9.0%, the broad US dollar index is lower, and the Hamburg World Commodity Index +5.7% and +4.5% in July alone. US 2-year yields were 4.26% and are now 4.76% (+50bps), 10s were 3.70% and are now 4.09% (+39bps); in German Bunds, it’s 2.81% vs. 2.96% (+15bps) and 2.46% vs. 2.59% (+13bps); in Australia, 3.52% vs. 3.96% (2s +44bps) and 3.66% vs. 4.19% (10s +53bps); in the UK 4.14% vs. 4.95% (2s +81bps) and 4.14% vs. 4.53% (10s +39bps); and in Japan -0.07% vs 0.02% (2s +9bps) and 0.38% vs. 0.63% (10s +15bps). The focus is now on curve steepening, and whether this will be of the bull (deflation/rate cuts) or bear (no cuts or more hikes/stagflation) variety. As in January and May, most are taking the optimistic view, which is buoying other assets.
However, the only place where that bad is good view is ‘justified’ right now is China, so if you want a pre-2020 lower-for-longer economy, look there. Its 2-year yield has dropped from 2.23% to 2.14% and its 10-year from 2.69% to 2.65%; the Financial Times quotes an auto analyst saying it now produces 40m cars a year, but can only consume 20-25m; trade data today are expected to show imports declining by 5.6% y-o-y, so China ‘boosting global growth’ is factually incorrect, and export growth is seen -13.2%; and tomorrow’s CPI and PPI are both set to print more deeply negative y-o-y. In theory, Western analysts baying for deflation and rate cuts should like this, but they don’t. Talk of a ‘Zombie Economy’ isn’t welcome because said author notes, “a web of Wall Street bankers and corporate executives had reason to suppress more sceptical analyses, as they continued to profit off luring investors into China. The illusion of limitless high-speed growth thus ruled the day at the very moment when the economy entered its most serious crisis since the outset of the market reform era." Beijing has more understandably also banned negative commentary in its economic, financial media, including the word "deflation".
Meanwhile, Western central banks are pausing to assess contradictory data, but it remains to be seen if they can truly halt or, more importantly, reverse to previous rate lows. After all, we see:
An ageing workforce and ultra-low unemployment. The UAW is now demanding a 46% pay deal over four years, airlines face massive labor shortages and pay demands too (‘America’s Truckers, Cargo Pilots and Package Carriers Are Fed Up’), and FedEx pilots are demanding a 30% pay rise. That’s got the decimal place in the wrong place for inflation hawks.
The US Department of Labor is proposing to today restore the New Deal-era Davis-Bacon Act that sets a wage floor for construction workers on public-works projects, reversing its 1979 gutting by President Carter, and potentially one of the most significant changes to pay in decades. Of course, that means higher, not lower wages. There is an election in 2024 you know!
There is a need for massive defense spending --percentage points of GDP, not tenths of one percent-- in the US, UK, Australia, and even New Zealand, while Canada, like Europe ex-France and Poland, lags dangerously far behind.
A resulting onshoring/reshoring boom lies beyond the current inventory down-leg of the bullwhip effect is over – look at the surge in US manufacturing construction spending.
Huge government bond issuance hence comes along with, not a replacement for, private demand for capital.
The Economist warns ‘The West’s de-risking strategy towards China will fail’: but that means more decoupling and supply shocks than we are being sold by politicians, not less. On friend-shoring, the WSJ warns ‘The Era of Ultracheap Stuff Is Under Threat’ because Asian factories can’t find enough young workers either.
The US trade and tech war with China is about to become an investment war, with a long-awaited executive order to limit US outbound capital flows likely to be introduced this week. When that starts to happen in both directions, the global architecture will change even more.
Supply destruction in commodities is underway via war in the Black Sea, possibly West Africa, and always potentially the Middle East; that is as the SCMP reports ‘Mainland China airs documentary signalling military preparation for Taiwan attack and willingness to sacrifice’.
Supply is also constrained by trade restrictions in oil from Saudi; rice from India; uranium from Niger; nickel from Indonesia and the Philippines; and rare earths from China. More will follow.
The FT (‘Inconvenient truths about the green transition’) points out that Western green production ex-China will take six years to develop and cost twice as much as it does today, when the bill was already astronomical.
Entrenched global oligopolies and monopolies most economists refuse to recognize will raise prices whenever they can get away with it – i.e., in times like these.
It’s no surprise then that a market-implied inflation expectation measure, the US 5-year 5-year forward breakeven inflation rate, has again surged to its highest level in over a year at 2.53%, and isn’t far off its mid-2022 peak of 2.57%. More short term, US inflation is going to rise again y-o-y on a headline basis as soon as this Thursday, where CPI is already seen up from 3.0% to 3.3% with only a 0.2% m-o-m print; the base effects then get even less helpful even before higher energy and food prices hit again.
Yes, central banks can then opt to look at core CPI and ignore all of the above – but that is exactly the error they made in the 1970s, and how you move the market dial towards stagflation fears.
Of course, not cutting rates also comes with real risks. The Fed no longer sees a recession ahead, though our US team does, but Bloomberg argues ‘The Euro-Zone Economy Is Set for a Painful Reckoning: ECB rate hikes will trim 4% from economic output, research shows, a hit that will coincide with a return of restraints on public spending’. The German press also reports specialty chemicals group Lanxess plans to close two production plants by 2026 due to high electricity price, adding German industry has enormous disadvantages domestically, so companies are migrating: “De-industrialization begins,” said the Lanxess CEO. “This seriously jeopardizes German prosperity and social security for people in the medium and long term. The federal government had to wake up. We need an economic policy that deserves this name.“ For anyone thinking deindustrialisation is bullish Bunds, because lower growth, think again. Back in February we already conclusively showed what bad, stagflationary outcomes deindustrialization means for Germany. Berlin will no doubt be hoping that today sees Taiwan’s TSMC decide to proceed with a German chip plant, even if this creates frictions with China.
Yet our real problem is that this not just about inflation or rates, which are just painful symptoms, but rather a paradigmatic failure across the political-economy - which we are trying to resolve without addressing political-economy. The more we only write about inflation and rates, the deeper the hole we dig.
Likewise, appointing the Deputy Governor of the RBA, with an A$6m property portfolio, as Governor and holding fewer rate meetings per year is not going to shake the tree; neither is the BOE hiring Ben Bernanke to analyze why it made such large forecast errors – except in that it takes one to know one. These (in)decisions betray not so much a pause as a freeze: they show an establishment frozen like deer in a car’s headlights; or stuck like pigs in a large trough; or as just deeply unimaginative, overpaid civil servants unable to think outside the box.
On the missing political-economy note, the New York Times’ David Brooks just asked ‘What if We’re the Bad Guys Here?’, belatedly grasping the view that the Clinton and Obama Spamalot administrations allowed a new ‘technocratic’ elite to enjoy old Cantillon nest-feathering as others lost their nest-eggs, while still feeling morally superior about their gains because ‘they were the smart ones’; and then the backlash was the Sir-Mix-A-Lot Trump administration; and now Biden’s, which the Financial Times’s Gideon Rachman just called ‘the heir to Trump’. I’m not sure if Brooks knew he was echoing the British comedy duo Mitchell & Webb, who years ago played SS officers asking, “Are we the baddies?” Yet with real-life fears of the Far Right rising, what is Brooks suggesting *we do* specifically? We will be waiting a long time for that punchline, I suspect. However, if you think the answer is to cut rates and or taxes, let assets rip, and ‘allow nature to heal’, then when that punch does finally land, it will hurt all the more.
To make that point, consider ‘Last call for neoliberalism: What I saw at the party at the end of the world order’ from the Canada’s Globe and Mail, whose author notes of a recent glittering New York encounter:
“[The] end of neoliberalism – and the subsequent decay of democracy – were on my mind as Justin Trudeau entered the room at the consul-general’s soirée…. But even as this party was just beginning, everyone seemed to understand that the way things had been done for so long – that party was over.
The outlines of the new order that Mr. Biden’s national security adviser sketched out earlier that afternoon have since come into focus: protections for sensitive industries; de-risking from China; building up domestic capabilities. We need a new industrial strategy for the next century, Washington has made clear – one that recognized that a society was more than its economy, that workers were the lifeblood of democracy, and that foreign policy must ultimately improve the lives of ordinary citizens at home…
Later, I managed to speak with Mr. Trudeau; I gave him a copy of my book, in which he is featured. I also asked him: What could we thinkers and intellectuals do to reinforce democratic principles from outside the system?
Mr. Trudeau stepped back. I saw his eyes darting as he thought of how to respond. It was an honest question, asked in good faith.
Finally, he leaned in and said: “I think you shouldn’t be so cynical about people working on the inside.” Before I could reply, Mr. Trudeau glided away to another group of people.
All my life, I have repudiated cynicism: I had seen elite systems from within, and witnessed the kind of liberal-elite behaviour that had given people so much reason for pessimism. Yet I still retained my ability to hope. I did not think there was anything cynical about expecting leaders to live up to their own stated principles, or about acknowledging the reasons that others – including many young people – were becoming despondent about the state of the world. Indeed, it would be up to citizens on the inside and outside of government to ensure democracy was upheld and progress was shared. If the Prime Minister really thought my question was cynical, in this pivotal moment of transition – these dying days of neoliberalism – I am deeply worried about what comes next.”
And now I need a pause to recharge my fading battery, and I suspect many of you are feeling far from refreshed.
