By Michael Every of Rabobank
Kamikaze Strategies
It’s a bad market strategy to stick to a fundamental view while ignoring a price trend the other way: it’s a kamikaze strategy when that fundamental view doesn’t capture reality.
In 2021, inflation was not going to happen: then it rose sharply, but was called “transitory”. In 2022, inflation was not going to soar, nor rates rise: then it did, and rates rose. In 2023, disinflation and a rates pause, then a rates pivot, loomed: yet hot January US jobs data, CPI, and PPI have been followed by scorching personal consumption expenditure (PCE)/deflators. Even so, Bloomberg was this weekend running the headline ‘Bets on the Year of the Bond Are Still on Even as Losses Return’. Ahead of key PMI data this week, is that view cleverly looking down from an intellectual cockpit, or being in one and shouting ‘Bonds, I!’
PCE data showed services spending still surging. Plot a trend line, and the Covid collapse and current up-leg is not V- but J-shaped: that outweighs above-trend nominal goods PCE stalling. Moreover, the Fed’s favoured core PCE services excluding shelter inflation was 0.6% m-o-m in January, 7% annualised – seven percent! Larry Summers and the market, following Rabo’s Philip Marey, are now worrying about 6% Fed Funds, and 10-year yields are moving steadily higher: how long until 4%, and until serious cross-asset market volatility returns?
The view the US will pivot while other central banks are more hawkish also looks kamikaze. The ECB may do 100bps, but 6% Fed Funds would mean the US doing 125bps, and the ECB has to look at German Q4 GDP -0.4% q-o-q and capex -2.5%, as BASF closes some German operations and fears of deindustrialisation rise. True, some point to soaring US debt-servicing costs as the reason Fed funds must fall: interest will soon be larger than the Pentagon’s budget. Some point to this being how hegemons fall – though it will fall on them. However:
The Fed is leaning the other way, even on more QT. If it is to cut, and inflation fall, it will only be after a biting global recession which takes everyone down with it, not a mild dip;
US public debt rose from 40% to 100% of GDP during WW2: we are already over that level on some metrics even before any (larger) wars start; and again this is seen as how hegemons fall. However, @LynAldenContact rightly points out actual US debt went from $43bn to $258bn in five years, or up 500%, and the smaller rise in debt-to-GDP masked a inflationary surge in the size of GDP. That is an historical fact, and future US option, not to be blithely dismissed; or
As this Daily continues to suggest, if push comes to shove, expect rate hikes *and* QE to reallocate capital much more forcibly from bubbles to munitions.
Indeed, it’s been a kamikaze strategy to ignore geopolitics. In 2022, most everyone was wrong on Ukraine; in 2023 the view was we would see that war wind down. Yet yesterday Putin declared the West wants to “dismember” Russia into new states, making it an existential struggle. China’s 12-point peace plan came and went: the South China Morning Post headline was ‘’China has taken Russia’s side’: EU dismisses Beijing’s misplaced’ plans for Ukraine peace.’ So, we face a longer, more inflationary war.
Yet things are worse than that. Der Spiegel says China is considering selling kamikaze drones to Moscow, and the Washington Post alleges it may also sell it munitions. This has potentially huge market ramifications: it could mean a rapid, wrenching China/Russia/Iran – US/Europe decoupling: and yet more structural inflation.
Ill omens were G-20 finance ministers failing to agree a common statement over Ukraine due to resistance from Russia and China; China’s foreign minister Wang Yi ask the EU’s Borrell, “Why do you show concern for me maybe providing arms to Russia when you are providing arms to Ukraine?”; and President Zelenskiy saying he would like to discuss the peace plan with Xi Jinping, then Beijing inviting Belarus’s Lukashenko.
Markets will argue it would be a kamikaze strategy for China to arm Russia. However, the counter-argument is that China believes the threat of mutual economic destruction will see the EU blink first, splitting it from the US. (And US investment banks from the White House?) After all, France and Germany are reportedly keen for Kyiv to negotiate with Moscow: President Macron argues Paris and Berlin made peace post-1945. Yet Hitler had to be defeated first. So, some decry the US as willing to fight Russia to the last Ukrainian; others decry the French and Germans as willing to appease Russia to the last of Ukraine. Ukraine itself still wants to fight - and the war will go on; and tensions with China will rise. Markets will catch up to that reality eventually.
Relatedly(?), rumors are that China’s March National People’s Congress --which Bloomberg says is making some market autopilots bullish about Chinese stocks (again)-- may see the Ministries of Public Security and State Security move from the State Council into a Commission of Internal Affairs under the direct control of the CCP Central Committee, the party's highest organ of authority. That sounds dull, Marxist, and technical: so did early warnings of Common Prosperity before markets were roiled (as China Renaissance CEO Bao Fan’s recent disappearance is due to him “assisting with inquiries”).
Meanwhile, ‘geopolitics’ is evident all over:
Against all of the above, Bloomberg’s weekend front page on Saturday was, incredibly, ‘Good Times’ for a few hours. What can one say to that --and to those expecting painless lower inflation, lower rates, lower bond yields (so higher stocks), and a lower dollar-- but “Banzai!”