By Michael Every of Rabobank
Happy Chinese New Year! Kung Hei Fat Choi/Gong Xi Fa Cai/Sing Zia Ju-i!
The Year of the Rabbit 2023 is associated with longevity, peace, prosperity, and fecundity. All would be welcome after the Year of the Tiger, which was correctly associated with competition, challenges, rebellion, short-temperedness, unpredictability, and an official decline in the Chinese population. Markets started 2023 off rabbit-like, and while the ‘buy stocks’ trade may be fading, the ‘buy bonds’ trade is still going strong, as is ‘sell US, buy anything else’, assuming there are now no tigers to sink their teeth into defenceless, fluffy things like Europe.
If only we could rely on astrology and Wall Street projections!
“Tanks for nothing”; parallel unparalleleds
A new Russian offensive in Ukraine looms but Berlin won’t send German tanks. However, it might finally allow others with German-made tanks to send them. Yet geopolitics experts agree that while Germany doesn’t want Russia to win, it doesn’t really want Ukraine to win either, as that would decouple from Russia permanently, create a new Poland/Balts/Scandies/Central Europe/Ukraine bloc, and EU gas would flow from the south via Italy, not from the east via Germany, shifting intra-EU power dynamics. The German press says its defence industry fears every Deutsche tank will be replaced by an American, entrenching US market position. In short, the risks are still of an extended war, not rabbit-like peace, and the damage to peaceful Germany's reputation within the EU and US, not just as an arms dealer, is not to be taken lightly.
Bloomberg also reports ‘Germany and France Push for Huge Spending to Compete With US’, meaning its Inflation Reduction Act (IRA). The Franco-German view is that “European businesses will need to unleash investments on a nearly unparalleled scale to keep from falling behind US and Chinese firms as countries revamp their economies to make them more climate friendly.” Except smaller EU member states are vexed again because, as with unparalleled EU energy subsidies, it is the Big Two who can most afford to prop up their industries. (Even as the unparalleled German defence spending promised to keep smaller EU members, and industry, safe is not happening.)
France and Germany insist the whole EU must get the same US trade treatment as Canada and Mexico under the IRA. However, they aren’t likely to get it when German tanks are “out” yet Berlin and Paris stress China must be “in” any trade loop just as the US Congress looks to introduce legislation to create an ‘inverse CFIUS’ to limit US private capital flows to China.
Rabbit lovers should also note that the unparalleled increase in the EU fiscal deficit now being floated to subsidize French and German businesses, on top of unparalleled energy subsidies (and maybe unparalleled defence spending), will mean a larger Eurozone current-account deficit and higher inflation. Doesn’t that imply unparalleled higher ECB rates? Or perhaps there won’t be any investment, or defense spending, or energy subsidies – but then we get the unparalleled sucking sound of investment moving from Europe to the US and/or China. Doesn’t that also imply a long-run current-account deficit and higher interest rates?
China’s new year holiday will show if ‘the Chinese consumer’ narrative has the hind legs of a rabbit or not. Recall that historically it doesn’t, despite rabbiting from Beijing about this topic, and that there were no Covid payments to households in China, so only a few of them are as cashed up as the charts show. Moreover, Robin Brooks of the IIF points out China’s electricity consumption plummeted to 2020 Covid lows in December, out of line with the strong data that so enthused the market, and the China Beige Book say a contraction was actually seen. So, yes, look for carrots, but also watch out for the data schtick.
However, let’s presume China is back and the worst fears for global growth are fading: why are central banks going to cut rates in 2023 or 2024, as Mr. Rabbit likes to see ahead? As someone noted on Friday, from recent lows we already saw iron ore +48%; silver +38%; Copper +35%; Uranium +32%; Aluminium +25%; Corn +20%; Gold +19%; Sugar +14%; Oil +16%; Coal +8%; and Wheat +2%. Now cut rates and see what happens. Indeed, notice headlines like ‘Summers Warns of 1970s Crisis If Central Banks Relent on Rates’, and the Financial Times reporting from Davos last week that ‘4% is the new 2%’, with everyone expecting inflation to come down, but nobody much outside central banks -- and the long end of the bond market -- expecting 2% to be where it finally settles.
Back in the US, perhaps rates will fall because unemployment rises? Yet @SteveMiran tweets outside of firings in tech’s cloistered circles (captured by TikTok’s ‘Day in the life of a Meta product manager’), US construction firms are not firing despite the collapse in home sales and prices. Perhaps labour data lag, which is the bond market’s argument; or perhaps its labour hoarding, which the bond market refuses to accept as a possible post-Covid structural trend; or, as Steve posits, perhaps it’s the infrastructure spending in the US IRA – if so, once again fiscal policy mattering more than monetary-policy obsessed market analysts expect.
Brazil and Argentina have announced plans to develop a common currency, the ‘Sur’, aimed at bringing the entire continent under one monetary umbrella. Yet those fist-pumping and shouting ‘Bretton Woods 3!’ should note it took closely-aligned, developed European economies 35 years to get the Euro up and running… and it still doesn’t work properly if you ask its critics. Let’s see how Latin America fares in trying to build a base on the foundations of Brazil and Argentina.
‘Sur’-e, this sits with the dedollarisation meme regular readers know is something I *do* see being attempted as the world ‘geopoliticizes’. Yet dedollarisation is still something I *don’t* see actually happening beyond more barter and countertrade for some, because a ‘geopoliticizing’ world suits the US better than most others.
The Financial Times last week asked, ‘The Era of Markets ended in 2019: What comes next?’ Our report ‘The Age of Rage’ from January 2019 said, ‘politicized central banks and a return to mercantilism’. I had long argued the US would get more mercantile – and look at the fears in Europe and China over what it means for them. More recently, I argued all the Fed needs to do is raise rates and keep them there, as under Volcker, after the initial policy flap in the 70’s after Bretton Woods collapsed. That and/or weaponize the financial system more. On which, a FinTwit rumour going round Sunday was that SWIFT had announced a new policy that it would not transfer funds into crypto exchanges for amounts below $100,000. It seems it was only Signature Bank dealing with Binance…. for now. But see how easily things are upended?
In short, you might think the year of the rabbit is the holy grail of lowflation, no recession, rates pivots, a lower dollar, asset booms, and that new baby smell. Yet the fluffy white rabbit you are looking at is far more likely to be the deadly decapitating one from that Monty Python movie.