Yellen, Blinken, Shippen, And Prayen

By Michael Every of Rabobank

Let’s start by Yellen. US Treasury yields dropped after Treasury announced it expects to net borrow $760bn in Q1 vs. a previous prediction of $816bn. Markets hurrahed, but let’s be clear: first, there are quirks of timing in the financing calendar, long grass I don’t go into other, but others do; and second, there is no hike in tax rates nor reduction in public spending - all the ‘gain’ was due to higher nominal GDP growth/‘fiscal drag’, which reflect inflation. That’s bond bullish? Tomorrow’s Quarterly Refunding Announcement’s political trick will be how much bill issuance we see vs. bonds to fund that $760bn. The political gossip will be how much Yellen thinks bond yields are coming down vs. her deliberately issuing them to run-down the Fed’s Reverse Repurchase (RRP) facility given funds parked there can easily switch to higher yielding T-bills. And don’t forget that as RRP excess liquidity declines, that flow is a liquidity gain offsetting Fed QT; and once RRP is drained, some think QT may have to stop. Again, that’s bond bullish… while Treasury fiscal policy bullies the Fed and runs huge, inflationary deficits financed by T-bills!

Let’s then start Blinken - which is that the US is doing when the US Secretary of State states, “The response against Iran could be multi-levelled and come in stages and be sustained over time.” Operation Praying Mantis, where the US sank half the Iranian fleet in a day in the 1980s, it won’t be: Operation Praying Man, ‘tis. Because while the White House counts its dead, injured and loss of deterrence at the hands of Iran-backed forces --as Tehran says it didn’t do it-- it’s also counting the cost of a war that would not only not be over by the 2024 election, where higher oil prices would likely mean Biden loses, but might still be going on in 2028. Markets will therefore be relieved as Bloomberg, both accurately and ridiculously, says the US aims to find a way to bomb Iran just enough to show it’s angry without doing real damage - so ‘politesse’, not real politics. But risks remain: bomb too much – war; bomb too little – more Iran pushback until we trigger that same war; and it’s not clear if there is a sweet-spot between the two. Worse, markets don’t get the real backdrop is:  

• Si vis pacem, para bellum (If you want peace, prepare for war).
• Si vis packing, para bellum (The US wanting to exit a region will invite more conflict until it does).
• Si vis packing it in, para bellum (If the US becomes isolationist, it will be OK – but others sink fast).

On which, it’s time for ‘shippen’. As Freightwaves puts it, “The Red Sea crisis --and the Middle East situation in general-- is worsening. There’s growing conviction that shipping diversions around the Cape of Good Hope will increase in scope and last much longer than initially expected.” (By some!) Yes, listen to central bankers’ views on the Red Sea crisis. However, also listen to Red Sea ship captains’ views on inflation and rates – the latter have a more realistic view of the world!

While central bankers in warm offices look at PowerPoint slides prepared by wonks steeped in unworldly math and unrealistic theory that say “disinflation”...

... in the Red Sea, airstrikes vs. the Houthis aren’t working to stop Houthi attacks on shipping.

So, maybe the US has boots on the ground in Yemen. Are they visiting, or trying to find local allies to fight the Houthis to repeat Afghanistan-on-sea? And as more cargo shifts round Africa, Somali piracy is picking up in response. Where or what or who next? Don’t be surprised when something ‘unexpected’ happens again.

In the broader region, we should be prayen. US policy is being made by National Security Advisor Sullivan, who in September 2023 noted, “The Middle East Region is quieter today than it has been for two decades,” and by Secretary of State Blinken, who just stated, “We have not seen a situation as dangerous as the one we are facing across the region since at least 1973.” He seems to have forgotten those Iraqi ‘nuclear weapons’, and the Iran-Iraq War – but he’s not wrong that the current situation bears no relation to the idiotic assessment made just four months ago.

We also have the risk of the Israel-Hamas war expanding to Israel-Hezbollah. On the first front, Hamas just rejected another ceasefire in exchange for releasing its hostages, as demanded by the International Court of Justice, instead insisting the war has to stop. On the second, tensions are soaring on the Lebanese border. The Israeli defence minister just stated his troops will “very soon go into action” there soon, and the Free Press notes, “Take the current war with Hamas and multiply it by ten. That’s what war with Hezbollah would look like. And Israelis are not asking if it will begin, but when.” Spring, some feel.

Meanwhile, maritime maven John Konrad makes a key point across the bows of Yellen, Blinken, shippen, and prayen that markets fail to grasp: “the US Navy can either keep the world safe OR protect the large fleet of Danish, Swiss & German owned containerships. The hard truth is the US Navy simply does not have the capacity to do both.”

Understand what that means: would you like your cargo to arrive quickly and cheaply? OK, but then you can’t have geopolitical stability. Would you like geopolitical stability? OK, but then you can’t have your cargo cheaply and on time.

Right now, the US is trying, and failing, to protect global supply chains, and trying, and failing, to protect geopolitical stability. Whichever path it ultimately chooses will be disruptive and inflationary. Regardless of what wonks with PowerPoint show central bankers in warm offices, there looks to be no sustainable disinflation against this kind of worrying backdrop.

Indeed, out of sight of most in markets, we are seeing defence spending surge in the West, just as we are seeing US fiscal spending go through the roof in other areas. For the first time since 1944, Finland has activated Stage 1 of its procurement plans, activating wartime production reservation agreements; German arms factories which would have taken a decade to be built are now constructed within months, according to Rheinmetall (while complaining about a lack of German orders); and the UK and Australian press have both had headlines about conscription(!) Yet this is just a fraction of what will be required by their economies if the US Navy can no longer secure either global supply chains or geopolitical stability. How about a European navy that can protect its cargo, for example? We are talking vast sums of money.

Even New Zealand, which has contributed six (6!) sailors to the Red Sea efforts, and whose military is seen as not fit for purpose --because why would a country with a small population and very rich natural resources need defenses when it can export stuff to the peace-loving world?-- has just had the RBNZ chief economist say it has a “way to go” to get back to 2% CPI, dashing hopes of an earlier rate cut: up went the NZD as a result.

The US itself must also make huge ‘guns or butter’ choices that will have an equally huge impact on QRAs going forwards. This will be evident soon enough, even to those who opt to focus on the shallowest of headlines rather than the depths of the Red Sea and our problems