By Michael Every of Rabobank
Looking forward with fingers crossed
Another wild, exhausting day of headlines and trading, but one simple summary: markets are ignoring everything actually happening to focus on what they think is going to happen, which involves keeping their fingers crossed when others may be doing the same in a different way.
Let’s start with the war. Again, markets tried to trade for peace, this time with the help of the Financial Times publishing a ‘15-point plan’ allegedly close to being agreed that included Ukraine being a neutral state like Switzerland or Austria, and having security guarantees from the US, UK, and Turkey. This was then almost immediately rejected by Ukraine. Indeed, a spokesperson said that plan reflected only the Russian position.
Instead, what we got by the end of the day was what I had been flagging – further escalation. Russia bombed a theater in Mariupol, likely killing hundreds sheltering there. Moreover, Putin gave a national speech which I share snippets of in order to convey its tone and message. He claimed Russia was ‘being cancelled’ and spoke of “fifth columns” and “national traitors” who “cannot do without oysters, foie gras, and gender freedoms,” who “by their very nature are located exactly there, not here, not with our people, not with Russia. This is, in their opinion, a sign of belonging to a higher caste, a higher race. Such people are ready to sell their own mother… The collective West is trying to split our society, speculating on the combat losses, on the socio-economic sanctions… and there is only one goal… the destruction of Russia. But I am convinced that… the Russian people will be able to distinguish true patriots from scum and traitors and simply spit them out like a midge that accidentally flew into their mouths. Spit them out on the pavement. I am convinced that such a natural and necessary self-purification of society will only strengthen our country, our solidarity, cohesion, and readiness to respond to any challenges.”
Does this sound like a man looking to deescalate, or one who is going to double down to get better terms? On social media, we ominously already see images of ‘Z’ symbols being painted on the doors of suspected ‘fifth columnists’. And, likewise, Ukraine began push-backs against Russian lines, shifting the narrative and perhaps to some extent the military positions, while the US announced it will massively expand the weaponry it is sending, including the latest-tech armed drones and reshuffled S-300 air defense systems from Slovakia, as President Biden called Putin “a war criminal.” In short, front-running Western geopolitical naïfs with itchy trade trigger fingers need to consider the following before rushing to keep pricing in ‘peace in our time’:
- How much of its territory can Kyiv give away as reward to the aggressor without prompting a civil war with its own nationalists?
- Austria and Switzerland are in the EU or have close association with it. Will ‘neutral’ Ukraine? If not, how does it recover and thrive without being sucked back into a Russian orbit?
- Providing security guarantees to Ukraine means the US, UK, and Turkey being prepared to fight the WW3 against Russia – so NATO’s Article 5 extended to Ukraine without actual membership. Without such a guarantee, how is Ukraine to live alongside a Russia that talks the way Putin?
- Even regarding a ceasefire, Russia (and Ukraine) can keep their fingers crossed behind their backs, regroup, and then start fighting again from better positions.
Now to the Fed. They hiked 25bp, as expected. They were hawkish in tone. Their dot plot now shows a 25bp hike every meeting this year. And May is now the live date to start to unwind QE. As Philip Marey notes of the remaining 6 hikes this year, “Given the deteriorating global economic outlook, we have our doubts whether the FOMC will deliver them… Indeed, in the next few meetings (May, June, July) we expect the Committee to continue hiking 25bp per meeting. However, by the September meeting the damage from the Ukraine crisis to the global economy may become a threat to the US economic expansion. The doves in the FOMC are likely to jump from the hiking bandwagon by then and demand a pause.”
The market is going even further. With 30-year yields dropping and US 5-10s inverting, and only 20bp to go on 2s-10s, and with stocks, gold, and crypto all up, we are now pricing for a policy error and the inevitable rate cuts and new QE that will have to follow. In other words, just as the Fed drives things off a cliff, Mr Market is already pricing in the trampoline at the bottom of it that will take us to even higher market-y highs.
Are markets right about the policy error? Yes. But are they right to ignore all the pain to come and to presume the Fed will do what it always does, and provide them with so much free stuff they look like Smaug the dragon, sleeping under a pile of treasure? Here is where fingers are being crossed, because if an angry, unequal, polarized society finds out it has turned into Japan without any of its former social contract, don’t think politics, and the politics of central banking, can’t change. Then even dragons get toasted.
Which is a segue to China, where yesterday saw a barrage of news that led Chinese, Hong Kong, and US China stocks to surge crazily. Premier Liu He stated the government would ensure markets remain stable, soon stop the aggressive regulation of big tech names, reform and open up, and ease policy as needed; and that was followed by dropping pilot plans for a property tax. So, hallelujah, the CCP called a market bottom!
Are markets right to now switch from bearish bets? Yes. But are they right to ignore all the pain to come and to presume China will do what it always does, and provide them with so much free stuff they look like Smaug the dragon, sleeping under a pile of treasure? No – or only if you keep your fingers crossed and hope the other side is not keeping its crossed in a different way. Chinese is not admitting to its own policy error: but markets are pricing moves to national security, ‘dual circulation’, and a ‘common prosperity’ decrying the “barbaric expansion of capital” are going to be reversed… “because markets”.
Yes, China did not want to see a blow up just before the crucial political meeting this November, and there were already expectations we would see policy tweaks to get a high enough growth figure by end-year. Yes, now the Fed is out of the way, China can cut rates next month (as Brazil just hiked 100bp, by the way, as expected.) However, no, that is NOT the same as presuming China is going to have a Damascene conversion and move back to asset bubbles and inequality. Unlike the US, it sees these as an existential threat, not a staple diet.
We therefore have another contradiction, just as with China’s desire for being a global reserve currency without the prerequisite open capital account, because of the loss of political control it entails. Yet which logic wins on that front every time, despite promises? And so which one might logically win out over US speculators in stocks and Chinese speculators in residential property – albeit not until after November 2022? Even from the US side, not every administration will vacillate between ‘right on’ hawkishness and then enfeebled ‘right, I’m off’ outreach. Yes, the US might fudge a deal so Chinese firms don’t de-list. Yet might that change after the 2022 or 2024 elections? The Republican Party does not even appear to be pretending it will do that deal while keeping its fingers crossed.
The same is true for the Iran nuclear deal, which appears be on, and which perhaps allows the Iran Revolutionary Guards Council to be removed from terrorist watch-lists. The White House is planning a trip to Saudi Arabia now: I don’t think they will get swords this time round, or not in a nice way. UK PM Johnson just beat them to it, with The Independent dubbing his trip: “…an embarrassing and needless quest for oil” – I am not sure about the needless part. It certainly all adds to wild energy volatility: more peace news and some say we could see Brent back in the low 80s; less news and no Russian supply and others say by Q2 and Q3 we are at $130. Meanwhile, Iran is going to leap into LNG, and those who can join dots think this might be how Europe decouples from Russian gas. Those who can join more dots than that wonder how Europe coupling with what many in the Middle East see as their version of Russia is going to play out longer term. And Tehran has never, ever kept its fingers crossed.
Against this backdrop, the LME had another farce where nickel trading re-opened, plunged limit down, and then closed again. We have the ridiculous situation where the market price is still well above any historical norms, and everyone knows it, and yet there are limits to how far it can go down in a day; and we know large players are still shorting it; and that they cannot be allowed to blow up. Normal trading will resume soon, says the LME, with its fingers crossed too. Right. And as Bloomberg opinion tweets: "Commodity traders have largely escaped regulatory scrutiny in the EU despite their potentially significant role in derivatives markets," quoting the ECB Financial Stability Review from 2017. One wonders what future iterations will say.
On farces, the Aussie jobs number came in at 77.4K vs. an expected 37K despite a collapse in part-time employment to -44.5K. (And recall this all needs to be multiplied by 13 to get US payrolls equivalents.) The RBA really needs to find new reasons not to now hike, it seems.
The Bank of England are out of such excuses, and in what is now partially a war economy are going to hike 25bp again today to take rates to 0.75%, just as British taxes jump too. Policy errors all over, it seems.
So, what to expect more broadly today? Markets ignoring everything actually happening to focus on what they think is going to happen, which involves keeping their fingers crossed when others may be doing the same in a different way.