By Michael Every of Rabobank
An awful lot happened yesterday, if you join the headlines, the dots, and the plot; yet not a lot of it played out the way the largest headlines and the most important dot plot would have it.
In the US, the Empire PMI collapsed to -32.9, showing further signs of real pain in the real US economy. By contrast, in Europe the German ZEW survey of investors expectations surprised to the upside at 16.9, as German Chancellor Scholz said there would be no recession this year. Adding more good cheer, the IMF is revising its latest call that one third of the world is heading for recession: another sterling projection from the Fund.
China’s Liu He then thrilled Davos by saying China will hit 6% GDP growth in 2023 — after the hilarious data yesterday, pencil it in now — and loves private business, foreign investors, markets, its property market, opening up, free trade, imports, and globalisation. Suddenly ‘common prosperity’ and national security are gone, even as Bloomberg separately reports the PLA is rebuffing all US efforts to re-establish military-to-military lines of communication. This was a 2017 redux moment, when global capital last rose as one to applaud a Chinese speech extolling exactly it, just before the opposite transpired.
Not much mention was made of the epochal first fall in China’s population since 1961, years ahead of official expectations. ‘A Midwife Crisis’ already flagged it in 2021, quoting a PBOC working paper that stressed the need to reverse the demographic trend, advocating controlling housing prices to do so, and arguing China should “be highly vigilant and prevent the savings rate from falling too quickly…if there is no accumulation there will be no growth…. [Developed economies are] not a model to learn from.” In short, China should consume less, automate more, and always run trade surpluses: just don’t tell Davos. ‘A Midwifer Crisis’ later in 2021 put the shift in China’s population into a global context: it’s staggering.
Eclipsing this long-term trend was the short-term rumor the ECB will shift from 50bp hikes to 25bp. We also got positioning for a BOJ meeting today where we might (or might not) see a further retreat from Yield Curve Control, something the FX market is already heftily pricing in, and which is negative for the US dollar. (The rights and wrongs of that are another matter.)
All in all, the market hummed at the ideas that the Fed was close to a rates peak; so was everyone else; that there wouldn’t be a recession; that the dollar is weakening; that rates would go down; and so assets would go up. The latter is of course all that really matters.
Are the assembled billionaires in Davos really worried about what was already projected as a mild recession that would reverse very low unemployment rates and very high (nominal) wage growth? No! What worries them are tight labor markets and nominal wage growth: that, and the asset-price recession in 2022 as interest rates rose in response.
With higher rates, the rich have already been in recession, and they didn’t like it. One year was quite enough, thank you very much, and now it’s time for central banks to make the rich richer and the poor poorer again, as before. Thus all the right headlines, speeches, data, and rumors are being mobilized in support of ‘Just not 2022!’ trades in 2023 – and working so far.
However, as mentioned, not all the headlines line up correctly for that happy, illogical narrative of no recession, no inflation, lower rates, and higher asset prices.
There were one or two loud voices at Davos flagging risks of the Fed having to go to 6% if the labour market won’t weaken. And so far, it isn’t weakening except in tech. On which note, Twitter is still working fine after shedding a swathe of its staff, whereas in the real economy things couldn’t get any leaner without economic bulimia. What if there is an ongoing shift from high-paid, irrelevant jobs of the kind Davos sees, because their kids work there, to less well-paid jobs, with rising wages from a low base, in places the Davos set never set foot?
More importantly, Russia just announced: 1) it will declare all treaties signed with the Council of Europe terminated; 2) it must maintain its food reserves, and not export everything – which sounds like weaponizing commodities again; and 3) it will expand its army to 1.5 million men, confirming reports another 500,000 are going to be mobilized shortly – such escalatory tactics won Russia many previous wars after badly-bodged beginnings.
Russia is going all in on war, ahead of a likely spring offensive, while markets are pricing for ‘war is over’ due to a European winter as warm as a summer. That doesn’t mean we will get the same scale of shock as in 2022 again, but one will likely come. It also underlines that the West is going to have to escalate its economic and military response in kind – or lose the war. Finland has already stated it is in this for the long term, be it 5, 10, or 15 years: who is next? But a long war is going to remain inflationary in 2023, and more so if we see more deliberate supply-destruction. Does mobilising illogical narratives really work against mobilising men?
Meanwhile, the US said that it so only going to rebuild its Strategic Petroleum Reserve slowly. Very, very slowly, one would presume. Or, to put it another way, unless energy prices crash –which would take a higher dollar via higher Fed Funds– the SPR is largely spent as geopolitical ammunition: add it to the list of key US inventory stockpiles that have been depleted in 2022, and which it will need years, much money, and disrupted supply chains to rebuild.
Saudi Arabia said that it is open to trading oil in other currencies than the US dollar; and Ghana, with lots of gold in the ground, is floating gold-for-oil swaps because it has few dollars. Having twice delved into ‘Why Bretton Woods 3 Won’t Work’, including recently, I am not going to repeat the exercise. Suffice to say that whatever currency the Saudis trade in, they will price in dollars, and sell the other FX they garner for dollars because they are pegged to it themselves. However, these kind of actions are aimed at chipping away at the walls of the ‘global dollar’ fortress, as are Russia’s; and we are seeing ongoing global efforts to shift towards barter trade to try to avoid the dollar, even if dollar pricing remains ubiquitous for now.
Most fortress owners don’t tend to relax when someone is messing with their foundations, even ineffectually. At least not successful fortress owners. That is another argument mobilising against the happy, illogical narrative of no recession, no inflation, lower rates, and higher asset prices. Meanwhile, if the fortress were to crumble due to a Death Star-style weakness, it would topple onto everyone’s heads, including those doing the chipping away at it. Again, that backs recession, inflation, higher rates, and lower asset prices.