By Michael Every of Rabobank
Tales of the Very-Much-as-Expected
Once upon a time there was a popular UK show called ‘Tales of the Unexpected’, a pound-shop version of ‘The Twilight Zone’, but fun for all that. For most in markets, 2022 is proving to be a ‘tale of the unexpected’. For those who dwell in twilight zones, it’s sadly all very much as expected.
First, yesterday saw the previously-flagged fiscal package from the UK government worth a huge £15bn, giving households hundreds of pounds to offset soaring energy costs, and imposing a 25% windfall tax on energy firms. Doing so had been vociferously rejected for weeks, but the Australian election result cleared heads. As the Daily Mail put it, “In effect, what the Chancellor has announced is ‘helicopter money’ – cash handouts to ordinary citizens. Nothing else, it seems, could give the immediate help they need to get through this economic crisis.”
They are wrong, of course. Monetization is what everyone did during Covid. This time, taxes are being raised on the rich – so this is partial monetization and partial redistribution. The true-blue Mail is happy with that state action, which says a lot about where we are today: indeed, what are states there for if not this kind of thing? Yet while sensible policy, this is also inflationary. Unless energy supply increases, as demand now doesn’t fall, prices will increase.
On which note, the White House now says it supports opening more oil refineries – except that takes a long time to achieve, and more so when you have the prospect of windfall taxes and a dislike of fossil fuels. Oil is meanwhile back up to around $118 a barrel despite more releases from the US Strategic Petroleum Reserve (SPR). If China reopens, the US may have to refill the SPR at higher prices than it sold from it. ‘Sell low and buy high’ – there is a tale of the unexpected.
Second, agri commodity markets took a dip on rumors Russia was allowing vessels laden with grain to leave the Black Sea from Ukrainian ports. President Putin stated he was not driving the global food crisis, and that he would be willing to drop his naval blockade,… if the West removes its economic sanctions. This isn’t food blackmail, honest, as Davos rightly called it, and which we had flagged as a key risk before the was even started.
The White House response is that this quid pro quo is not on the cards; the EU, which may finally get an oil embargo over the line in days, is proposing making breaking Russia sanctions a crime; and Ukraine is unlikely to play the good cop knowing if its food starts flowing again (some via Russian hands), world attention will shift elsewhere.
In short, our agri markets team view remains that any price dips look to be temporary rather than structural. Indeed, while fertilizer prices are way off their highs, it is because farmers are using less of it, which will mean lower crop yields. Bloomberg’s David Fickling asks, ‘Now Even Chicken is Getting Too Expensive?’. US egg prices are also about to leap 21% y-o-y due to bird flu, it is reported. It’s a good job we don’t farm monkeys.
Third, US Secretary of State Blinken gave a speech framing the White House’s approach to China. Blinken and you missed anything new, however. With the physical and vocal presence of a junior-high school teacher failing to intimidate a class of 10-year olds, he laid out a new plan the same as the old one, with rebranding of “invest, align, and compete”. Yet there was the usual mixed messaging of China being an authoritarian threat to the international order, but also an essential partner in solving global problems. There was incremental movement in implying US businesses should think of ‘values not prices’ – yet no action at all to enforce such hard choices.
Indeed, the key message, again, was that the US does not want a Cold War with China,… as many other voices underline not only are they in one, but the risk is a slide towards something worse. This was a speech given against the backdrop of a Chinese diplomatic tour through Pacific islands to offer them security deals: look at the map here and spot a pattern? As China expert @BaldingsWorld puts it in his own blunt fashion, “China is preparing for war and the US is hoping to restart the Shanghai Four Seasons breakfast buffet for conferences. We aren’t even playing the same game at this point.” And there are darker claims out there on YouTube and Twitter (as is always the case).
Yet even in the bright lights of Congress, yesterday’s Senate Appropriations Committee hearing on the FY2023 Navy and Marine Corps budget heard the Secretary of the Navy stress, “Our national security depends on sea power”; Senator Shelby say the proposed budget does not appear enough due to inflation and the need to boost defence in a dangerous world – and that while the Navy is constrained in what budget it can present, the Congress is not; and Senator Graham argue it is incredibly dangerous, represents irresponsibility in terms of threats facing the nation, and that the US requires a bigger, not smaller Navy as, “Our enemies are going up and we are going down, which is a recipe for disaster.” That is obviously not the White House stance, but Congress can dispose much more than the president is proposing.
One can understand why Blinken wants to cool hot heads to avoid terrifying scenarios. Yet does such a placatory stance work, or makes things worse with a lag? Many voices point to Vegetius (“Si vis pacem para bellum”) and the undeniable fact that Western olive branches have failed to act as any kind of carrot (or stick) against both Russia and China for over a decade. Worse, the White House, which left Taiwan out of the newly-launched IPEF trade deal to appease China, is now talking about separately deepening economic ties with it bilaterally(!) According to reports from Bloomberg, the focus will be on enhanced cooperation and supply-chain resiliency –which seems a somewhat odd choice given the CLS analysis above– as well as agri products, although not a full free-trade deal. Beijing will be livid. And fat tail risks fatten further.
Focusing on the commercial side of this, Columbia Law School (CLS) discusses SEC guidance over potential legal claims US firms could face for allegedly misleading shareholders about the impact of risk events on their supply chains, looking at Covid-19, Russia-Ukraine, and the “next domino” of Taiwan. On the latter they conclude:
“The implications for ocean-going trade is at once simple, and terrifying… a PRC invasion of Taiwan could result in a termination of all commercial shipping within 1,500 nautical miles… Issuers would not only lose access to the PRC, but also to ports and markets in Japan, the ROK, Vietnam, Thailand, and Indonesia. It is also highly unlikely that insurers would underwrite any coverage for vessels transiting the Pacific, given the distinct possibility that either Taiwan or the PRC would misidentify a merchant vessel as a combatant. The same is likely true for air freight passing within missile range of the PRC or Taiwan borders.”
Furthermore, they add:
“A final feature of a PRC-Taiwan conflict is the likely nationalization of PRC natural resources and manufacturing facilities owned by western companies, or controlled by US-PRC joint ventures. The same is true for manufacturing facilities used by US issuers to source production from private PRC entities. In the event of an invasion of Taiwan, the PRC is likely to seize these facilities, and issuers are unlikely to have any viable means to recover resulting losses.”
Imagine the impact on supply chains and financial markets! Some are laughing at Western stock-pickers who called China “uninvestable” just before some key stocks saw a huge rally. Good point: but who laughs last laughs longest, as they say.
CLS also stresses that SEC’s ‘Pandemic Guidance and Sample Letter’ provides a valuable blueprint for US firms with such potential exposures in how to make them clear to investors: proactive disclosures of Taiwan-related risk (rather than “It won’t happen” stances); and mitigating potential litigation risk by reviewing all statements referencing supply chains, considering single points of failure and inventory, and monitoring developments in Asia. Which, I would suggest, best involves more than listening to Blinken, or indeed any one voice.
Fourth, Fed Vice-Chair Brainard just spoke to Congress about digital assets. Her view was clear: she wants to see robust action on a US Central Bank Digital Currency in the wake of the recent crypto market collapse – and because China is pushing ahead with its own. However, she sees this is something Congress needs to act on. She also wants a clear crypto “regulatory guardrail” to protect investors and financial stability, probably meaning no more of this please, or perhaps taxing it close to the same point. After all, we need to get people back in the labor force again chop-chop, rather than day-trading at home and making far more than minimum wage in some cases. (Until recently.)
In short, the same kind of ‘national security’ wave we got in the UK with its windfall taxation and helicopter money, which we see in regard to Ukraine and global food supplies, and that we heard from Congress over the size of the US Navy and the risks around it, is likely coming for crypto too.
At least Brainard implied she didn’t want to remove physical dollar deposits, which is much of the appeal of the currency around the world. (For good, and bad ‘Twilight Zone’, reasons.)
* * *
Take this all together and look ahead. What will be the market ‘tale of the unexpected’ for the second half of 2022 and 2023, and what will prove the ‘tale of the very-much-as-expected’?