by Brunello Rosa
15 October 2018
Last week the IMF released its latest World Economic Outlook. In it, the IMF lowered its forecast of global growth in 2019 (by 0.2%, to 3.7%, the same rate of growth it predicts to occur in 2018), citing a number of “rising risks,” including multilateralism being challenged worldwide, the ongoing US-China trade dispute possibly morphing into a full-fledged trade war with global implications, the possible impact of continued Fed monetary tightening on US and global financial conditions, and rising political and economic risks in the EU. This outlook downgrade might have contributed to the continuation of the ongoing sell-off in global equity markets, which we discuss in an upcoming report. Last week, MSCI AWCI lost 3.9%, the S&P500 4.1%, Eurostoxx 50 4.5% and MSCI EMs 2.1%, while volatility rose above its 10-year average.
A focus on European political risk is warranted given developments that occurred during the past weekend. In Germany, the CSU (the CDU’s sister party in Bavaria) “won” the regional election with such a huge loss of votes, falling from an absolute majority to only around 37%, that it would be more correct to describe this electoral performance as a historical defeat. This election is important for a number of reasons. At a local level, the right-wing populist AfD, which entered the regional parliament for the first time with 11% of votes, is proposing an alliance with the CDU to govern the Land. Such an alliance would be another example of the “Austrian model”, wherein a right-wing populist party offers its support to prop-up a government led by the Christian-democratic party. (Italy’s Deputy PM Matteo Salvini is also actively pursuing this model, at the European level). For the time being, it seems that the CSU will look for other allies to govern with, but things may change in future. At a national level, the CSU’s defeat in Bavaria will make its positions even more radicalised, further putting at risk Angela Merkel’s fragile grosse coalition.
Finally at the European level, the more the German government moves to the right, the more likely it is that the necessary advancement of the EU and the EZ towards more integration will be slowed down.
In the UK, negotiations for a deal to be presented at the EU summit on Wednesday broke down on Sunday. The UK rejected the draft withdrawal treaty proposed by Brussels, as it was unwilling to accept the backstop that would allow Northern Ireland to remain within the EU customs union. This stand-off in the negotiations might imply that the extraordinary EU Council meeting that will be held in November to finalise the deal might not take place, and the UK might leave the EU without a deal. The 27 EU ambassadors have been summoned by chief negotiator Michel Barnier to participate in urgent meetings. Last week, the BOE warned that GBP 41 trillion of derivatives will face legal uncertainty after Brexit on 29 March unless the EU takes action to ensure the continuity of existing rules.
Finally, European governments will have to present their Draft Budgetary Plans by the midnight of 15 October, and all eyes are on Italy’s budget, which is at serious risk of non-compliance, which if it were to occur could mean the EU opening an excessive deficit procedure (EDP) for the country. The 10y BTP/Bund spread remains above 300bps, while Deputy PMs Luigi Di Maio and Matteo Salvini remain defiant and have said that the government will not backtrack on its budget plans, regardless of mounting market concerns. This increases the likelihood of an EDP being opened and downgrades by rating agencies occurring (in October, Moody's and S&P are expected to announce their ratings decisions). In Europe, Italian assets were the worst performers during the week, with FTSEMIB down by 5.4%.
by Nouriel Roubini and Brunello Rosa
9 October 2018
25 September 2018
“Wisdom is the reward you get from a lifetime of listening when you’d have preferred to talk.” Doug Larsen
Introduction: A world of high school class presidents
When I first began my decade in the shark tank of Washington, a kindly old hand offered me some lasting advice. ‘John, always remember that this town is overwhelmingly populated by high school class presidents, peacocks who are used to being heard and not used to hearing, If you can buck this dismal trend you’ll do well.’
And so it proved. For all that I love making speeches, being a peacock at the centre of things, I have also spent my life working on valuing the joys of listening, of learning from others, particularly when they didn’t share my point of view. After DC, this was made easier by the simple fact that I found myself a Thatcherite in Europe; if I only talked to those who agreed with me I would have been unbearably lonely.
But it is this lack of listening, that I was warned about so long ago, that explains the present Brexit negotiating debacle and why a loose Canada-style trade agreement or no agreement at all has always been the highly probable outcome. Other analysts (the lion’s share of whom got the Brexit outcome wrong in the first place) and political decision-makers ought to have seen this years ago (I’ve been saying the same thing on this topic for what seems like an eternity). But to get it right they would actually have had to listen, and to those they do not particularly like. The sad reality is that it seems this is beyond the powers of our mediocre age.
The London elites refuse to hear
The first example of this dialogue of the deaf is the least important, but also the most telling. The British, London-based, centre-left commentariat, stung beyond belief by the Brexit outcome (as it refutes their comfortable world view that they somehow speak for a majority of their country, despite their insufferable elitism) have opted for what the playwright Bertolt Brecht said about the communist East German regime, following the abortive rising against it in 1953. He wryly noted the regime ‘wanted to dismiss the people and appoint a new one.’
This tactic has been refined by the palpably anti-democratic EU, whose favourite trick is that when they lose a referendum on expanding their powers, they merely make the offending country in question keep voting, until they get the result they prefer. And we wonder at the reasons for the rise of populism and the utter, weary disdain politicians are held in by the electorate?
Following this dreadful playbook, the commentariat are now screaming for a second referendum vote, as though because they did not like the outcome of the first, it can merely be ignored, as elite (rather than democratic) buy-in is what matters in the UK. But going to the right school should not allow the commentariat to have a veto over their lesser-educated countrymen, at least not in a modern, democratic society.
Rather than listen to the people of the UK, who voted narrowly but cleanly voted to leave the EU, the commentariat, in order to avoid painfully looking in the mirror at the failure of both their world view and their analytical abilities (where what they wanted took precedence over the empirical facts, where wish fulfilment took precedence over reality) simply want to force their benighted countrymen to vote until they come up with the ‘correct’ result.
If this does come to pass—an unlikely but possible outcome—it will do the gravest damage, poisoning the notion of democracy in the UK itself. And this pestilence will spring fully formed because of the simple refusal of the country’s discredited elite to listen.
The hapless Prime Minister refuses to listen
But Theresa May has been no better. As a tepid remainer who (somewhat surprisingly) found herself at the helm of an overwhelmingly leave-dominated party, she has dutifully (if turgidly) pushed to leave Brussels, but somehow without upsetting either the Tory base or the countries that make up the EU, as if this was remotely possible. By trying to be all things to all men, May has miserably succeeded in being nothing to no one, her endless compromises (Chequers is just the most egregious example) amounting to nothing at all.
It is another galling example of the failure to listen, of wishing away real people with very different views of the world, as if either the EU leaders or the Tory base would be likely to cave; anyone who has listened to either side would know in five seconds this simply will not happen. A Norway-style or soft Brexit which Chequers represents, as it allows for UK rule-taking from the EU over goods, would never pass the laugh test with the Tory base, which literally anyone who actually talked to them and listened would know.
Utterly unsurprisingly, even before it was blown to bits by the EU leadership at their Salzburg ambush—in the rudest and haughtiest manner possible (does Europe, despite much of modern history, ever wonder about its endless hubris?)—the Tory base hated May's Brexit policy and rightfully so.
They voted to leave the EU to ‘take back control’ (as my friend Dominic Cummings put it so well); instead they are being offered by May less than they had before the vote, with absolutely no say in how the EU would determine its rules over goods. Instead of taking back control, this would amount to a form of excessive self-harm, where the UK truly becoming a self-declared vassal state. To put it mildly, the Tory base was never going to accept this.
But May—perhaps the most useless Prime Minister of my lifetime—also didn’t bother to listen to the European elite, either. The EU is nothing if not a religion for Europe’s elites; the worse things get objectively (and they have as the continent has slid into absolute decline) the more they cling to their false god of European federalism. They were unlikely to accept any deal that imperilled the four freedoms at the base of the EU, to allow the UK to cherry-pick its involvement with them, and make a mockery of the rules-based system that is at the heart of the EU creed.
This is even more the case as Europe’s prospects have dimmed. I remember playing a war game ahead of the Brexit vote with leading European politicians. The upshot of the exercise was starkly clear, and I did bother to listen. I was told matter-of-factly over and over again that the bottom line was that Britain was must not be allowed to enjoy a successful Brexit, or other countries were sure to leave.
If secession became a better outcome than staying unhappily together, the EU was finished. This is basically President Macron’s reasonable (from his point of view) position; Brexit must fail or Europe will fail. Given structural, endemic north-south divisions over the euro, and east-west divisions over immigration, a faltering Europe must stop the strategic bleeding by making Brexit a nightmare, and a cautionary tale for anyone else contemplating running for the exits. May must have been told this, as I was. But astonishingly, she chose not to listen.
Europe completes the dialogue of the deaf
But the Europeans, as they made so painfully clear at Salzburg, haven’t been listening either. Assuming they have the whip hand of the British, that the need for a deal went all one way, Monsieur Barnier has acted the part of a fussy schoolmarm, grading British negotiating proposals as if he were above it all, rather than engaging in the give and take that is always needed to reach a diplomatic agreement.
While the British have politely—if increasingly insistently—made clear that the German car industry, Europe’s future strategic defence and intelligence needs, and having a friendly neighbour next-door are all dependent on a mutually acceptable outcome, the EU has chosen its favourite tack of doing next to nothing, as if the UK were surrendering, and not negotiating.
But this is far from the case. The EU is losing one of its major economic players (and the most dynamic), one of two (along with France) serious military powers, and the country in the grouping with the closest ties to the troubling but vital superpower that is America. To save as much as they can from this grievous loss would seem an obvious thing to do, but that would mean eurocrats like Barnier would have to come down from Olympus and listen to the Jacob Rees-Moggs of the world. And listening isn’t something the haughty EU is remotely capable of doing. In the words of Talleyrand regarding the Bourbons, the EU has forgotten nothing and learned nothing.
Conclusion: The obvious train wreck
For all these reasons, but above all for the lack of listening that underlies these myriad analytical follies, the most likely outcome of the Brexit talks remains what it has been for two years; a loose Canada-style agreement or no agreement at all. The train wreck that is this process merely confirms for me every day that the inability to listen, expressed by all sides, is the basic structural reason the UK’s membership in the EU was doomed in the first place.
This article was originally published on the Author's LinkedIn Page. John Hulsman's new book, To Dare More Boldly: The Audacious Story of Political Risk, was published by Princeton University Press in April 2018.
Week 15 - 21 October 2018
In the US, the publication of the FOMC meeting minutes will reiterate the Fed’s intention to gradually increase rates. In 2018, the Fed foresees unemployment to remain at 3.7% (a 49-year low) and growth to accelerate to 3.0% (from 2.3% in 2017). The Fed’s position is unlikely to be altered by: i) last week’s softer-than-expected inflation (September CPI, a: 2.3%; c: 2.4%; p: 2.7%; September PPI, a: 2.6%; c: 2.8%; p: 2.8%) or; ii) pressure from President Trump—who sharply escalated his criticism to higher rates. In December 2018, the Fed is likely to hike the policy rate to 2.25-2.50%.
US retail sales growth is expected to remain flat (retail sales ex-autos September m-o-m, c: 0.3%; p: 0.3%).
In the EZ, inflation is expected to remain unchanged (September CPI y-o-y, c: 2.1%; p: 2.1%).
Global growth will continue to decelerate. Last week, the IMF lowered its estimate for global growth (by 0.2 pps, to 3.7% for 2018 and 2019), citing “rising risks”, as: a) multilateralism is being challenged worldwide; b) the ongoing US-China dispute could develop into a trade war, with global implications; c) in the US, the Fed will continue to tighten monetary and financial conditions; and d) in the EU, political and economic risks will continue to rise, as: i) in the UK, a Brexit deal is unlikely before the October 18 EU summit; and ii) in Italy, Deputy PM Matteo Salvini said: “the government will not backtrack on its budget plan, regardless of mounting market concerns” – increasing the likelihood of rating agencies downgrades (in October, Moody's and S&P are expected to announce their decisions). In Europe, Italian assets were the worst w-o-w performers (FTSEMIB, -5.4%; 10y sov. bond yields, +17bps, to 3.58%).
A hard landing in EMs weakness is unlikely. In a tighter-liquidity environment, most large EMs are managing their economic challenges.
China is financing growth through debt issuance. Last week, China issued USD 3bn in USD-denominated bonds at 5, 10 and 30y maturities; strong demand (6 times oversubscribed) suggests that investors are not concerned about: i) decelerating growth—next week, Q3-2018 GDP growth will be announced (c: 6.6% y-o-y, p: 6.7%); or ii) trade policy uncertainty.
Turkey is moving towards policy normalization. Last week, the TRY appreciated against the USD (+4.4%, to USD/TRY 5.871) supported by: a) the release of US Pastor Brunson, which is expected to reduce US economic pressures; b) a C/A surplus (August: USD2.6bn, compared to a USD0.9bn deficit a year earlier); and c) a new program to reduce inflation, launched by the government in collaboration with the private sector.
In Brazil, Mr. Jair Bolsonaro, the populist right-wing candidate, is likely to win the presidential elections. The leader of PSL won the first round with 46% of the votes, a 17-point lead over left-wing leader Haddad. The second round will take place on October 28. The BRL appreciated by 1.5% w-o-w against the USD (to USD/BRL 3.783).
In GCC, Kuwait will strengthen its collaboration with Turkey and China. Kuwait and Turkey signed a defense agreement to enhance military cooperation starting in 2019, while China is expected to participate in the future development of the northern islands.
Brent oil price will likely remain close to 80 USD/b. The price declined to 81.1 USD/b (-4.8% w-o-w), as fears about demand growth started to weigh on traders.
The fall in stock prices gathered speed, as investors focussed on: a) rising UST yields, which could lead to higher borrowing costs for heavily indebted companies; and b) global trade tensions, in a context of growth deceleration. In w-o-w terms, stocks fell across the world (MSCI AWCI, -3.9%; S&P500, -4.1%; Eurostoxx 50, -4.5%; MSCI EMs, -2.1%), while volatility rose above its 10y average (VIX, +6.5 points to 21.3; 52w avg.: 14.1; 10y avg.: 19.2).
Global bond indices rose moderately as investors rotated into fixed-income (BAML Global, +0.2%; BAML EMs, +0.2%). The UST 10y yield declined by -9bps w-o-w, to 3.14%.
The USD weakened w-o-w against: 1) a currency basket (DXY, -0.4%); 2) the EUR (EUR/USD +0.3%, to 1.156); and 3) EMs currencies (MSCI EM Currency index +0.2%).
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