Authored by Michael Every via Rabobank,
Once again time to try to shine a light through the miasma of intellectual fog surrounding us (and my own personal brain fog at this stage of the week).
With US inflation at 8.5% y/y, Q1 GDP came in at -1.4% q/q annualised. There is a word for that many banks feel too impolite to mention starting with ‘s’ – “stagflation”. Actually, there are several words. Of course, the data were a very mixed pile, with business spending up 9.2% and consumer spending 2.7%. The drag was from lower federal spending, a draw-down on inventory, and a plunge in exports and surge in imports.
One immediate point to note is that this is why markets prefer US GDP data to Chinese: do we ever get this kind of surprise, market volatility, and relative numerical transparency from China? As such, those who expect Beijing’s release to one day be the true global benchmark for markets are presuming there won’t need to be any markets worth the name at that point. Which is kind of the political package now being offered.
While we do still have markets, the key question is if the Fed will look past the data or not. Is it wiser to focus on the business and consumer side and presume the government, inventory, and net exports mean revert, or to worry about a repeat of headline GDP in the current quarter? In the latter case, the Eccles Building will have started an aggressive hiking cycle with the US already in recession. The FOMC statement next week is going to be a doozy either way. Whisper it, but markets might even have to *read* it for once rather than just snapshot headline analysis. (I know, radical idea, right?)
The US dollar clearly takes the view that the Fed will look past GDP. with the broad DXY at 103.6, a two-decade high, and up 8.3% in 2022. It continues to defy claims of its imminent collapse and the emergence of a commodity-backed New World Order digital MacGuffin.
In particular, JPY just tested past 130 and EUR under 1.05. Neither is a surprise. The BOJ just doubled down on their bond buying in defence of a 0.25% 10-year JGB yield, which is seeing local market chatter of JPY at 135, 140, 145, and even 150: I find all believable if the Fed doesn’t find -1.4% GDP to be. In Europe, there is the usual push-me-pull-you of speculation over tiny ECB rate hikes ahead, but the real action will come when the Eurozone’s current account surplus unwinds as exports slump while commodity import costs stay high.
On that front, some in the EU are opening rouble bank accounts to buy Russian gas to heat their swimming pools to slightly lower temperatures in solidarity with Ukraine. As someone outside markets commented on Twitter last night, given European gas payments now have to be in roubles, and ONLY via Gazprombank, Russia can in theory set the EUR/RUB exchange rate wherever it wants for each counterparty, e.g., Germany could see a different *FX* price for gas, as well gas price, than Hungary – and wouldn’t that be unexpected for an apolitical and never coercing economy to do? The threat underlines again why Europe is over an (oil) barrel here due to decades of ‘bumble durch trundle’ policy.
However, that’s a powerful argument to never do business with Russia, or like-minded partners. As @fbermingham notes, "The Voice of German Industry" just adopted the “autocracies vs. democracies” meme and backed sanctions, saying, “The consequences are extremely severe for individual companies and sectors, but business is willing to bear these costs to defend the strength of the law." This is hardly a positive for a country totally reliant on Western technology chains even under Stalin. (Or, as just alluded to, for the Western businesses selling it to them “because bumble durch trundle”.) Yes, China could perhaps fill the gap – but at the cost of it losing the West like Russia.
Specifically on energy, the German government is suggesting it will now back an EU oil embargo: and, if applied aggressively, that could see Russian oil flows to *almost everyone* knee-capped for years, if not permanently. Of course, that would mean higher energy prices globally. Yet it shows one can be bullish oil, gas, and commodities without being bullish on the rouble, which nobody is *using* regardless of where a line on a screen sits.
The same argument holds true for net-commodity-importing Russian friend CNY, with offshore CNH sitting at the appropriately-devilish 6.66 level at one point yesterday -4.5% in just over a week, and CNY fixing today slashed 549 pips to 6.6177, the weakest since November 13, 2020, but actually stronger than the market had feared.
Relatedly, David Fickling today argues a point I was making in the middle of the previous decade. China may going all in on infrastructure spending to boost its headline growth rate *again* --despite the fact that one-party rule is already ‘winning’ against the US looking at Q1 GDP-- yet ‘More Infrastructure is the Last Thing China Needs’.
He notes, “As of 2019 --before the past two years of infrastructure splurges-- China’s stock of public capital was already about $21,400 per person - a greater sum than in Australia, Belgium, Israel, Portugal, Spain or the UK, and comparable to that in Germany, Ireland, and Italy. That’s particularly striking when you consider that GDP per person (and thus, ultimately, China’s ability to pay off such colossal investments) is still less than half of developed countries.
On measure after measure, the scale of building now exceeds far richer economies, even after accounting for China’s vast population and geographic scale. The country’s 37,607km of high speed rail operating or under construction amounts to 57% of the world’s total. Per person, it’s above Italy, Taiwan or the UK, and only modestly behind Japan and South Korea.
Its electricity grid has more km of distribution wires per person than most of western Europe, even though dense cities might necessitate less. The 1.3m km of electricity transmission lines could stretch to the moon and back three times, and reach further than those in the US, Russia, Brazil, Canada, Australia and Saudi Arabia --put together. China already consumes more electricity per person than Italy, Spain and the UK-- and demand is still rising faster than in almost every other major economy.
Chinese demand for industrial commodities remains insatiable. More than half of the world’s steel is consumed there, along with a similar share of nearly all industrial metals. One oft-quoted statistic is that China used more cement between 2011 and 2013 than the US during the entire 20th century. That still understates things. Taking the past decade as a whole, it’s used five times as much as America between 1901 and 2000.”
Alongside a Russia that is being cut-off from Western technology and markets, this vast, fiat, not green ‘Great Leap Forward’ is the other proposed foundation for a commodity-backed New World Order digital MacGuffin: ‘Produce commodities to build bridges to nowhere and empty apartments. Systemic stability will be maintained by capital controls and exports to deadly-rival, indebted, fiat Western consumer markets’. What an improvement over what we have now (which also sucks, but has incumbency)! Where do I sign up?
If the US dollar is going down, not up, and I mean *down* down, then we are all going down with that ship.
All of this was clear years ago, and is just as clear today. However, from the China is magic side to the magical thinking about the New World Order, a collective intellectual fog seems to have settled.
Is it naked, auto-lobotomising self-interest? A ‘Year Zero’ ADHD generation who have the entire sum of human knowledge at their fingertips but think the world was created in 2015? A post-modern miasma which no longer understands what basic principles such as capitalism, socialism, Marxism, fascism, mercantilism, or imperialism actually mean; and one where we just meme, because we are ‘too busy’ on TikTok, or Bloomberg, to be autodidacts and *learn* what they no longer teach us to memorise by rote?
Try to peer through the fog for a moment. How easy would it be for the West to spend more on infrastructure and productive capital investment, with a hard military edge? And how much harder is it for an economy entirely built on over-investment (and increased militarisation) to do less when its other pillar of its growth is net exports to a geopolitical rival? Does this geopolitical disconnect end in a peaceful takeover like Elon Musk and Twitter, which offered no blood, little sweat, and Progressive tears?
As a case in point, the US Congress just agreed a WW2-style Lend-Lease support package for Ukraine, which was last used to help the USSR fight the Nazis. President Biden is proposing $33bn in aid, and $20bn for weapons, ammunition, and other military assistance. That’s almost three weeks; worth of EU gas payments into Russia’s coffers. And comes right after Russia warned of a “lightning response” to those who help what it sees as “Ukrainian Nazis”, with an implied nuclear threat.
Renowned geostrategist Harald Malmgren again warns he fears the Russian response could be the use of a tactical nuclear weapon against Ukraine, which the West is not prepared for. Moreover, he says the current White House team has no experts in nuclear strategy to hand: it keeps trying to deescalate on the nuclear front, which can be seen as weakness rather than strength, while simultaneously trying to show strength not weakness in conventional arms and sanctions. The risks of that strategic mismatch should be clear.
No fog here. The logic going forwards is the same binary I have argued since this started: constant escalation until one side blinks – and then a divided world economy; or a long, painful grind – leading to a divided world economy.
If you think that backdrop, two-way economic war, and risks of wider hot war than we are seeing now allows us to make confident predictions about “peak inflation” or interest rates --let alone subscriber numbers for streaming services(!)-- then you are opting to cloak yourself not just in intellectual fog, but in smoke and mirrors.
There is now a fog of war over *all* forecasts and presumed models of ‘how things work’.
