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Financial Markets Celebrate Reduced Tail Risks And Increased Monetary Stimulus


By Brunello Rosa

4 November 2019  

In our column two weeks ago, we discussed how several key tail risks that were weighing on the global economy were in the process of being reduced, and how that could prove beneficial for risky asset prices. In particular, we noted the following: how the risk of hard Brexit was diminished since Boris Johnson had obtained a new deal from the EU and managed to obtain early elections; US-China trade tensions were lower after the Phase 1 agreement was reached between President Trump and Chinese Vice Premier Liu He; the risk of an open confrontation in the Middle East involving Iran, Saudi Arabia and the US currently seems to be relatively low; the risk of a collision course between Argentina and the IMF seems contained for now, even after the victory of Alberto Fernández in recent presidential elections.


Together with these reduced tail risks, there have been also some positive surprises from the real economy, in particular in the US. Last week, the advanced reading of Q3 US GDP showed a smaller deceleration of growth than initially feared (from 2.0% to 1.9% SAAR, versus 1.6% expected), and October’s Non-Farm Payroll increase was 128,000 (versus 89,000 expected), with September’s data upwardly revised from 136,000 to 180,000. Other positive figures from the US labour market were a small increase in average hourly earnings (3.0%) and an increase in the labour force participation rate (to 63.3%, versus an expected decrease to 63.1%, from September’s 63.2%), which partially justify the uptick seen in the unemployment rate, from 3.5% to 3.6%. 

Finally, the Federal Reserve provided an additional kick, with its third back-to-back insurance cut last week, which brought the Fed funds target range to 1.50%-1.75%. The impact on financial markets was powerful, with global equity indices rising substantially: MSCI ACWI was up +1.3% on a weekly basis, driven by strong performance in both DMs (MSCI World, +1.3% w-o-w and S&P 500, +1.5% w-o-w, to 3,067, its all-time high) and EMs (MSCI EMs, +1.3% w-o-w).  

Some analysts even wondered whether the easing the Fed has provided since July 2019 (and the interrupting of its tightening cycle since last December) were actually necessary. In our view the answer is yes, the easing was necessary. The manufacturing recession is still ongoing; on Monday the manufacturing ISM rose less than expected to 48.3, still well below the 50 mark, which separates expansion from contraction. Consumer and business sentiment remains fragile, and the risk of an increase in consumer tariffs on December 15th remains present, albeit diminished. So, most likely a mid-cycle policy adjustment was warranted, especially considering a reduced neutral real rate (r*), as was mentioned by Chair Powell during his latest press conference.

Where do we go from here? The Fed has already clearly signalled a period of long pause, which would require dramatic changes in economic and financial conditions in either direction to be interrupted. Indeed, it would likely require either a sharp and persistent increase in inflation above the 2% target, or a consistent deterioration in economic growth, for this pause to be ended. Other central banks are taking a cue from the Fed, meanwhile. The Bank of Canada left its policy rates unchanged (even if with a clear easing bias) in October. The Bank of Japan bought more time before providing more stimulus. The Riksbank even signalled its intention to increase its policy rate (and “normalise” it to 0%) before entering a long pause. This week, the Reserve Bank of Australia is expected to pause its easing cycle (after three 25-bps cuts this year). The Bank of England will remain on hold ahead of the December 12th general election. 

As a result, some of the euphoria currently observed in financial markets might be tamed in coming weeks. But don’t worry: in due course, when the situation will have deteriorated enough, central banks will be ready to deploy “helicopter money” to support the global economy and financial markets.   

Argentina and Uruguay Hold Elections, While Latin America Is In Turmoil


By Brunello Rosa

28 October 2019  

Argentina and Uruguay went to the polls yesterday to elect new presidents, at the same time as a wave of protests has been hitting Latina America. Argentina elected a Peronist president again: Alberto Fernández, who will have as his Vice President Cristina Fernández de Kirchner, the former president of Argentina from 2007 to 2015. This is coming after the failure of the Macri presidency to implement liberal reforms and bring Argentina back to international capital markets. When Mauricio Macri was elected president of Argentina in 2015, his campaign was based on the motto “Argentina is open for business.” Macri’s plan was to definitively end the preceding Peronist era, in which Argentina had experienced a very volatile economic performance, rising public subsidies and inflation, and endless disputes with international investors over bonds restructured after the 2001 default.

Things seemed to be going in the right direction until early 2018, when a drought hit the country and a series of policy mistakes led markets to massively short the peso. The subsequent collapse in economic activity, the rise in inflation (55% y/y, the highest in the world after Venezuela and Zimbabwe) and a shortage of reserves led Macri to go back, cap in hand, to the IMF to ask for a bailout. The IMF granted the bailout: USD 57bn, the largest loan in the IMF’s history. This gave Fernández a formidable argument against Macri in the recent election campaign. He was able to say that the 2018 bailout was brought about by the Macri government’s adoption of the IMF-inspired liberal reforms (just like how the 2001 default was caused in part by the collapse of the “currency board” inspired by the “Chicago school”). In other words, instead of opening the country for business, liberal reforms have led it to default. The obvious conclusion (Fernández’ argument goes) is that only Peronism can work in Argentina. This argument has clearly been accepted by Argentina’s population in 2019. 

At this point, the key question is what type of policies Fernández will adopt once he is elected. As we discussed in our recent in-depth analysis, Fernández is likely to opt for a middle ground between an orthodox approach and a fully populist approach. He knows Argentina needs a constructive dialogue with the IMF, as it will likely need more financial support in coming months. The IMF too knows that a constructive dialogue with Argentina is necessary: having already disbursed USD 44bn, it will need to keep the relationship healthy and intact if it wants to have a chance of seeing this debt repaid at some point.   

Argentina might be a special case, but other LatAm countries are undergoing a difficult transition period as well. As mentioned above, Uruguay also went to the polls yesterday, to elect a successor to President Tabaré Vásquez, who could not run again due to constitutional term limits. Polls were held in the middle of a surge in crime (specifically, of murders and burglaries), which some attribute to the liberalisation of cannabis adopted by the government. Bolivia just had its presidential election, meanwhile, the result of which was that Evo Morales managed to win a second term, which led to disputes about transparency and protests against claims of alleged fraud in the election results. 

Besides the basket case of Venezuela and the yet-to-be-confirmed hopes in AMLO’s Mexico, the two most worrying cases in the region of late are Ecuador and Chile. In Ecuador, protests recently erupted as Lenín Moreno, who in 2017 succeeded Rafael Correa (from the same party), in practice made a U-turn on a number of the government’s previous policies, for example by handing back a US military base that had previously been confisca­ted by Correa, and by steering the country back toward austerity and neoliberal reforms. In Chile, President Sebastian Piñera has reshuffled his entire cabinet as a result of the widespread protests that were triggered by an increase in transportation costs and the more general rise in inequality

All this has been occurring while, in Colombia, President Iván Duque Márquez is trying to secure a final peace arrangement with the FARC, and in Brazil President Bolsonaro is passing a controversial pension reform in parliament.  

Tail Risks Diminish Globally, Yet A Fragile Economic Environment Remains


By Brunello Rosa

21 October 2019  

The IMF/World Bank meetings that just concluded in Washington DC were an occasion for policy makers, market participants, academics and other observers to take stock of the current worldwide macroeconomic, financial and geo-political environment. In its latest edition of the World Economic Outlook, the IMF warned about the synchronised global slowdown now taking place - the opposite of the global synchronised expansion that occurred in 2017-18. The outlook for the global economy has been downgraded, with the forecasts for growth in a number of key economies being revised downwards. The downgrade could have been even larger if it was not for the large positive contribution to growth from countries such as Brazil, Iran and Turkey (whose economy have stabilised after a severe recession). All this is happening at a time when policy makers’ fears of a global recession are increasing.

In this precarious global economic environment, some of the tail risks that could have tipped this global slowdown into a global recession seems have been diminishing in the last few weeks. Just to focus on the four economic collision courses recently identified by Nouriel Roubini, we can say that the risk that such collisions actually materialise is, for the time being, slightly lower than had been the case until recently. In the US-China trade dispute, there now seems to be at least a “Phase 1” agreement, which should be finalised by the APEC meeting in November. If such finalisation does indeed occur, then perhaps the feared increase in tariffs on consumer goods that would have come into effect in mid-December is not going to occur. That would certainly help provide a respite to the global economy. 

Regarding Brexit, it seems that the new deal signed between the UK and the EUlast week should eventually lead - even if only at the end of a tortuous path - to an outcome that does not include a hard Brexit. In the Middle East, the tensions between the US, Saudi Arabia and Iran persist, but seem unlikely to escalate further into an open military confrontation. As the decision to pull out of Syriashows, the US seems inclined to disengage further from the region, rather than engaging in a new conflict that could mean putting US boots on Middle Eastern ground yet again. Thus for now the US seems inclined to resist the temptation to respond to Iranian provocations.   

Finally, as far as Argentina is concerned, it seems that Alberto Fernandez, the Peronist candidate supported by Cristina Kirchner, is aware of the need to constructively engage in a conversation with the IMF, rather than put up a fight which could lead to a nasty outcome for all sides involved. If all four of these tail risks are reduced – US-China negotiations, Brexit, the Middle East, and Argentina – the danger coming from some of these potential triggers of a global recession would be lessened as a result. 

Clearly, if these four fronts become less dangerous, new ones might open up. For example, by November 17th the US administration will have to decide whether or not to start imposing tariffs on the European auto sector. Such tariffs could have a large economic impact on the European economy. For the time being, it seems that the US administration will postpone the decision for a bit longer, as the Chinese front has not closed yet. Germany’s grand coalition could collapse as a result of new local elections or the change of leadership at the helm of the SPD. Older risks could resurface as well, for example if the Italian government were to collapse sooner than expected as a result of the continued tensions within its majority.

Reducing the likelihood of some of these triggers is as important as deploying a policy response to them. In this respect, the Fed and the ECB (and a number of smaller central banks, such as RBA and RBNZ) have started to do their part. More needs to be done, especially in terms of fiscal policy, but at least policy makers are alerted about the need to be vigilant and responsive, even if they are incapable of being proactive. At the same time, the IMF will begin a formal review of the effects of the unconventional monetary measures adopted by several central banks around the world, which hopefully will not lead to a sudden abandonment of such measures. In Europe, the ECB will carry out its own review of strategy, tools and communication, with the arrival of Christine Lagarde at the helm.

Given this background, risk in financial markets seems to be on rather than off. Risky asset prices are still close to their highs, long-term yields are low and credit spreads are tight. The IMF’s Global Financial Stability Report, also published last week, warns about the risks posed by a mounting level of corporate debt of dubious quality. The Financial Stability Board says that it is alerted to this, but is not yet alarmed by it; early in 2020 it will publish a report where is likely to acknowledge this. At the same time, market sentiment remains vulnerable to any swings in economic, geopolitical and policy developments. 

Erdoğan’s War In Syria Poses An Existential Threat To Europe


By Brunello Rosa

14 October 2019  

During a week in which the Nobel Peace Prize was granted to Ethiopia’s Prime Minister Abiy Ahmed Ali, for his “efforts to achieve peace and international cooperation, and in particular for his decisive initiative to resolve the border conflict with neighbouring Eritrea," still another new conflict is starting in the Middle East. After Donald Trump’s decision to withdraw US troops from the north-eastern corner of Syria, Turkey decided to occupy a strip of 20km inside that region to create a buffer zone. The occupation has two declared goals: to make it easier for the Turkish army to defend Turkey’s borders, and to relocate to Syria a portion of the 3.6m Syrian refugees currently living in Turkey. 

As part of this offensive (somehow ironically named “Operation Peace Spring”) Turkish troops have launched a series of airstrikes and artillery bombardment against the Syrian Democratic Forces (SDF), forces which have helped the US-led coalition in Syria to fight ISIS, but which Erdoğan considers effectively a terrorist organisation. This is because the SDF are led by the Kurdish People's Protection Units (YPG), which Turkey considers a terrorist group. So, this “Operation Peace Spring” will be directed mainly against the Kurdish ethnic groups, which Erdoğan has long considered a threat to Turkey’s national unity and security. 

The US position on this issue is contradictory at best. The US Department of Defense was reportedly against the abandonment of Northern Syria by US troops, and even Lindsey Graham, an ally of President Trump, said he would seek to introduce a bi-partisan resolution in the US Senate to reverse the decision and punish Turkey, if Turkey decides to attack the SDF. Trump himself, after giving green light to the Turkish invasion of Northern Syria, said that he would “obliterate” the Turkish economy if its actions were to be “off-limits”, or “inhumane.” In a spectacular U-turn, US Secretary of State Mike Pompeo said that the US did not give green light to the Turkish offensive in Syria, even as the official press statement following the phone call between Trump and Erdoğan states that “Turkey will soon be moving forward with its long-planned operation into Northern Syria”. 

Europe’s reaction has, for a change, been to unanimously condemn this brutal military operation. But it has also, as usual, been ineffective. This is because the EU is in no position to tell Erdoğan what to do, after making a treaty with him on 18 March 2016, the result of which has been that the EU has paid Turkey EUR 6bn for two years in return for keeping the Syrian refugees on Turkish territory. Ahead of the renegotiation of this atrocious deal in 2020, Erdoğan is now threatening to open the gates of its refugee camps and flood Europe with migrants, as happened in 2015. Then, Angela Merkel decided to accept 1.1 million refugees in Germany (and, in so doing, marked the beginning of her own political decline) and Italy and Greece also dealt with hundreds of thousands of migrants coming from (or through) the Middle East by land and sea, while Hungary and other countries closed their borders.

If Erdoğan were to do what he is threatening to do – a scenario we do not expect to happen – the EU would not now be able to cope with such a migration crisis the same way it did in 2015. Germany would be unwilling and unable to accept more migrants, since the CDU has been severely punished for that humanitarian decision by Merkel in 2015. Italy, after the “security decrees” by Salvini (which are still active), has closed its ports to the ships rescuing migrants. Greece is now governed by a centre-right government much tougher on migration than Syriza’s far-left positions were. The Viségrad group (Poland, Hungary, Czechia and Slovakia) remains resolutely against any re-distribution of migrants within the EU (even as they continue to collect, financially, the “solidarity contributions” from larger EU countries). The EU Commission is in the middle of a difficult transition from Juncker’s presidency to Von Der Leyen’s, preventing it from making any big decisions. So, another migration crisis would most likely destabilize Europe, sending it close to collapse. A dis-integration of Europe would have large economic, financial and social consequences. 

This means that Erdoğan’s threat is credible. Unfortunately, the likely conclusion to all this is that the EU will renew its deal with Turkey, and receive only a somewhat less “inhumane” war in Northern Syria than would otherwise occur.  

WTO Opens Up A European Front In The Trade Wars


By Brunello Rosa

7 October 2019  

Following a number of warning signals, a European front in the global trade wars has now been opened by the World Trade Organisation (WTO). In a recent ruling on a 15-year old dispute, the WTO ruled that the US is authorised to apply tariffs worth USD 7.5 billion annually on the UK, France, Germany, and Spain (the “Airbus nations”), as well as on the wider EU, as a compensation for the subsidies that the EU has allegedly given to Airbus, providing the company with an unfair advantage against its US rival Boeing. Similarly, in a separate ruling that is expected in the months ahead, the EU is likely to be authorised to impose tariffs (likely billions of dollars worth) on EU imports of US goods, due to the subsidies that the US government has provided to Boeing. This could mark the beginning of a tit-for-tat escalation between the EU and US, which could prove damaging for both sides. 

Ironically, it is the WTO, an international body devoted to the resolution of trade disputes, that is risking opening this new front in the ongoing international trade wars. As discussed in our previous analysis, US President Trump has opened a number of fronts for his country’s trade wars: he began by withdrawing the US from the TPP, then continued with a worldwide tariff increase on steel and aluminium (even imposing such tariffs on its close allies Canada, Europe and Japan, albeit with selective exemptions), then moved to the re-write of NAFTA with Canadaand Mexico, and finally finished in style with China, subjecting it to several rounds of tariff increases as well as technological disputes. When it seemed that on the Chinese front a deal could finally be reached, Trump was ready to wage war to Europe and the European car industry. 

The procrastination of the negotiations with the Chinese therefore meant that this European leg of the dispute has repeatedly been postponed. Now, however, the European front is officially open.     

The list of goods impacted as a result is very large: French wine, Italian cheese and olives, whisky, and cashmere sweaters, among other items. This cannot be good for Europe: its economy is already in stagnation, with some of its largest economies (such as Germanyand Italy) flirting with a recession.  In particular, while Franceand Germany have at least benefited from the positive impact of the aerospace industry to their economies, Italy, which does not belong to the Airbus consortium, would be hit by new tariffs without ever having directly or greatly benefited from the subsidies the company is alleged to have received. 

Neither will the US economy remain immune from the expected counter-ruling by the WTO, nor from any retaliatory tariffs that the EU might decide to implement. The American economy is decelerating as the effects of tax cuts are fading out, and the Fed is not following Trump’s game of forcing the central bank to provide monetary stimulus as an (imperfect) offset of the tariffs on various countries that the US government has imposed.

This new European chapter of the American trade war is unlikely to have a happy ending, especially as the most likely outcome for the US-China front of the trade war is not a fully-fledged deal or a total breakdown in negotiations, but rather a continuation of the “controlled escalation” that has been taking place. Unfortunately, the world economy will have to deal with the effects of these disputes for years to come, forcing policy makers to provide fiscal and monetary stimulus, and keeping markets unnecessarily volatile

Weekly Column - “Black Swans” Abound In Fragile Environments


By Brunello Rosa

30 September 2019  

In the beginning there was Minsky. According to Hyman Minsky’s financial instability hypothesis, during the expansionary phases of business cycles, the financial position of economic agents – companies, households, sometimes even governments – becomes increasingly fragile, as they move from relatively secure “hedge” positions towards speculative or, in extreme cases, “ultra-speculative” positions; the latter not dissimilar from infamous Ponzi schemes. In a more fragile environment, even a small shock to the system, such as a small increase in interest rates, has the potential to render the most exposed positions illiquid or even insolvent.  This eventually leads to a downturn in the financial cycle, not dissimilar to the debt-deflation spiral described by Irving Fisher. In turn, this collapse of financial positions triggers a downturn in the business cycle, which moves from expansion to slowdown and eventually into contraction. From a Shumpeterian perspective, this period of “creative destruction” is very healthy, as this process of selection and “survival of the fittest” allows the system to restore itself, shedding previous excesses that existed and therefore readying itself for the subsequent economic recovery. 

The particular segment of the business cycle when the cycle turns as a result of a financial shock has been popularised with the name “Minsky moment.” This is considered a real pity by those who are actuallyscholars of the great post-Keynesian economist, as the term completely misses the fact that Minsky’s analysis is a theory of the business cycle: its most interesting part is not the “moment” of shock, but rather is the recovery phase of the cycle, when the financial fragility of the system increases, completely undetected, thus preparing the ground for the later, inevitable downturn. Economic analysis has preferred to focus on the conditions (including shocks) that could trigger these “Minsky moments.” For example, Nassim Nicholas Taleb has written convincingly about “black swans”, extremely rare events that could trigger major changes in prevailing economic, financial and social conditions.   

Moving from theory to practice, press reports recently reported that market participants currently fear many black swans, with a potential spike in oil prices deriving from the US-Iran-Saudi Arabia tensions adding itself to a list that already included a possible collapse in US-China trade talks or UK-EU negotiations regarding Brexit. In his latest column for Project Syndicate, Nouriel Roubini spoke about four collision courses that could derail the global economy, adding to this list the victory by Alberto Fernandez in Argentina’s primary presidential election, which has triggered yet another debt restructuring by the Latin American country. 

But the list of these potential triggers could be expanded even further. in the US, an impeachment of Trump ahead of the 2020 presidential race could lead, under certain circumstances, to a severe market correction. In Europe, Germany’s recession could deepen, potentially leading to a government collapse and further political fragmentation. In Italy, Matteo Renzi’s newly formed party could pull the plug on Conte’s government, paving the way for a return of Salvini to power. In Asia, an increase in the Japanese consumption tax could lead to an economic contraction, deepening the global slowdown. And other examples could be made for Brazil, China, Russia, etc. 

What about the policy response? In the recent decision by the Fed to adopt “insurance cuts” there is a reminiscence of Minsky’s theory, insofar as the central bank decided not to increase rates further at a time when the economic and financial system seemed already to be fragile – to avoid providing a shock that might have triggered a downturn. After years of experimenting with monetary policy, there is now a great consensus among economists that fiscal policy should take up the responsibility of being the main counter-cyclical policy instrument. In effect, in Minsky’s theory, the policy prescription could be simplified with the expression “Big Government” – in other words, making sure that public expenditure is a large component of national income, so as to stabilize business cycles. As Richard Koo convincingly argued, in a balance sheet recession following a debt-deflation episode, the system needs at least one large borrower that can compensate for the deleveraging of the private sector, and that must be the government. 

Climate Strikes Are Pushing “Elites” To Rethink Advanced Economies’ Business Models


By Brunello Rosa

23 September 2019  

There have been a number of rallies around the world this 

past week, mostly of young people gathering to protest about the inaction of the global élites regarding the devastating phenomenon that is climate change.  Rallies were held in 150 cities, according to event organisers. These took place at the same time as the intervention at the United Nations by Greta Thunberg, one of the moral leaders of this global movement.

We have already previously written,in our column in August 2018, about the impact that climate change (or, more appropriately, global warming) could have on a number of economic, financial, political and geopolitical fronts. 

Last year we focused our attention on the existing link between climate change and migration flows, as immigration was and still is one of the most divisive political issues in both the US (where President Trump was suggesting to build a wall along the border with Mexico) and in Europe (where the support for populist parties was increasing as a result of the rise of immigration). In this respect, in 2019 the UN has made a giant leap forward in our view, by introducing the concept of “climate migrants”, a term that will be even broader in scope than the initial category of “climate refugees”. 

The introduction of this new concept might eventually have very practical political consequences. In their recent meeting in Rome, French President Macron (who is preoccupied by the rise of Marine Le Pen’s Rassémblement National) promised Italy’s PM Conte (who needs to contain Salvini’s propaganda about there being a “migrant invasion”) to automatically redistribute only the asylum-seeker refugees arriving on Italy’s shores, but not the “economic migrants.” But if – in the not-too-distant future – the EU accepted the idea that those who are now considered “economic migrants” (i.e. people supposedly looking for a better life) are in fact “climate refugees” (i.e. people escaping the effects of climate change) then the number of people subject to automatic re-distribution would increase dramatically, making migration an EU-wide phenomenon as opposed to just a “law-and-order” issue for Greece and Italy to address on their own. The sooner this happens, the better.   

Turkey’s Erdogan, who pocketed EUR 6bn from the EU to keep the Syrian refugees in his camps, has threatened to “open the gates” of migrants to Europe, unless the EU gives him more money to deal with this phenomenon. A new wave of migrants to Europe, similar to the 1.1mn people that Germany absorbed in 2015, could destabilise the EU and eventually lead to its implosion. 

In this respect, French President Macron is very active, and put climate change as one of the key agenda points of the G7 meeting in Biarritz. Macron suggested to provide financial resources (USD 20mn) to Brazil to help the government led by Bolsonaro to deal with the Amazon wildfires. The two had a lively exchange of views, which unfortunately has not led to a solution. Also in Europe, Germany’s government unveiled a EUR 40bn investment plan in “climate protection measures,” which is thought to be Germany’s vehicle to provide fiscal stimulus to its ailing economy, which contracted by 0.1% in Q2 2019.  

But the fight for climate change will involve also key actors from the financial industry. While the US continues to be on the side-lines of this fight, given Trump’s scepticism over the scientific foundations of global warming, Christine Lagarde (former IMF Managing Director) pledged to “paint the ECB green”  in her inaugural audition before the EU parliament as ECB President. As Lagarde said, the “discussion on whether, and if so how, central banks and banking supervisors can contribute to mitigating climate change is at an early stage but should be seen as a priority.” In effect one of the pioneers of evaluating the impact of climate change for central banking is BOE Governor Mark Carney

How to combine economic efficiency and productivity growth with the transition of major economic systems towards more sustainable sources of energy should be a key aspect of the new form of capitalism that thought leaders such as Martin Wolfbelieve should start to emerge in coming years, if liberal democracies want to survive.    

While They Wait For Fiscal Stimulus, Central Banks Are Back At Centre Stage Again


 By Brunello Rosa 

16 September 2019  

The world’s major central banks are taking to centre stage again. As we discussed in our review, last week the ECB kicked off the process by announcing a new stimulus plan, consisting of a cut to the deposit rate (accompanied by the introduction of tiered reserves to protect bank profitability), easier conditions for the new TLTRO long-term loans, a promise to keep interest rates at current or lower levels until inflation is closer to target, and new asset purchases that will last until shortly before rates start to be increased. While market participants expected a larger package in some ways, the ECB surprised to the upside by announcing an open-ended version of this easing program: the stimulus will continue until inflation stabilises at a level closer to target. 

This coming week, two other major central banks will hold their policy meetings: the Federal Reserve and the Bank of Japan (BoJ). The Federal Reserve is widely expected to cut its Fed funds target rate further, as part of the insurance cuts it started in July. The real question is what the Fed will say about future rate cuts. The market expects these insurance cuts to be just the beginning of a prolonged easing cycle. President Trump is putting as much pressure as possible on Fed Chair Jay Powell to make sure this is indeed the case. However, the Fed is trying to resist any political interference, including the pressure to cut rates to respond to the increases in tariffs unilaterally decided upon by the White House. The clash between the two is intensifying; the former President of the New York Fed William Dudley openly advised the Fed not to fall into this political game, which only serves the purpose of ensuring Trump’s re-election in November 2020. 

On Thursday, it will be the BoJ’s turn: analysts are split as to what the BoJ could do in September, just a couple of weeks before Japan’s planned sales tax increase from 8% to 10%. The BoJ might want to keep some of its ammunition for rainy days, but on the other hand it will not want to fall excessively behind the Fed and ECB in their easing cycles. In Europe, the Swiss National Bank and Norges Bank will also hold their policy meetings this week. Their policy decisions too will be greatly influenced by what the ECB and the Fed have done.   

The Bank of England’s MPC, also meeting on Thursday, is also widely expected to remain on hold, waiting for Brexit developments.  

In spite of all of the best efforts to reduce their relevance over time, the contribution of central banks remains absolutely crucial to countries’ policymaking. There is a lot of talk about the possibility of greater monetary-fiscal cooperation, if not explicit coordination. Some are even suggesting that the next step should be “helicopter money”, whereby central banks provide monetary instruments directly to the general public, thus circumventing the banking system. (Recently, key contributions in this direction have been given by Stanley Fisher, Philip Hildebrand, and others). Draghi himself, during his press conference last week, said that “government with fiscal space should act in an effective and timely manner.” But the reality on the ground, so far, is that fiscal policy is constrained, and monetary policy still remains, by and large, the only game in town when it comes to supporting economic activity during the ongoing slowdown. 

WEEKLY COLUMN: What Ever Happened To Prudence In Politics?


By Brunello Rosa

9 September 2019  

The level of recklessness existing in politics has increased remarkably during the past few years. This recklessness has produced unexpected outcomes and dangerous side effects that will impact certain countries for years to come. Examples of this phenomenon can be seen in most of the regions of the world. 

Let’s start with the UK. In 2016, PM David Cameron launched a referendum on the UK’s participation in the EU. He made this decision as a way of solving the internal debate taking place within the Conservative party, which had been divided for years over this issue (and still is!). The referendum, only the fourth held in the country in 40 years, did not include any precautionary mechanism that could prevent a small majority from deciding the fate of the entire country and its four constituent nations. One could have included a minimum threshold in the referendum (e.g. requiring at least 55% of votes to validate the outcome), or a provision that would have required a majority vote to be achieved in the referendum within each of England, Scotland, Wales, and Northern Ireland. Instead, the Leave camp won by a narrow 52-48% majority, and the Brexit process was initiated in March of 2017. 

In the two and a half years since then, the issue has still not been resolved. 

Partisanship in the country’s political debate has reached levels not seen in decades. The new Prime Minister Boris Johnson is further radicalising this clash, shutting down parliament and threatening further constitutional stretches in coming days. All this just to increase the stakes in the UK’s negotiations with the EU, to threaten the 27 with a no-deal scenario. This is yet another example of lack of a prudence being taken in contemporary politics. 

Moving over to Italy now, we can see that other notable examples of political recklessness have emerged as well, in recent years. In 2016, Matteo Renzi launched a referendum on his plan for constitutional reform, which was very controversial. As if that was not enough, Renzi said that his political career depended on the outcome of that referendum, thus raising the stakes to the point of risking his entire government. The referendum did not pass. Years of discussions over how to change the country’s constitution were wasted in a single day, and the government collapsed as well, paving the way to the Five Star and Lega victory in 2018. 

Lega’s Matteo Salvini made the same mistake in 2019: he pulled the plug on a government that was extremely popular at the national level (even if internally divided and quarrelsome). 


He bet everything on the fact that the PD and the Five Star would not make a deal with one another, and that the President would call early elections right in the middle of the budget season, thereby risking budget prorogation and market turmoil. All this did not occur, and so he lost power. In this case, this actually removed a risk factor from the political landscape; namely the possibility for Italy to leave the euro area. Nonetheless, the political calculus behind Salvini’s gamble was not prudent, and could have cost the country dearly.  

On the other side of the Atlantic, President Trump was after running a very divisive campaign, a campaign which radicalised the political landscape in the US and reduced the space available for cooperation between the two parties in Congress. After that, Trump started applying his “art of the deal” approach, consisting of assertive moves, veiled and not-so-veiled threats, and brinkmanship, to a number of situations: NAFTA, trade and tech disputes with China, the Iran nuclear deal, etc. This approach has made US leadership less predictable, leaving traditional allies confused. As a result of his trade wars and widespread uncertainty, the world economy has entered a slowdown, which affecting the US economy and risks jeopardising Trump’s chances of being re-elected in 2020. 

In Japan, meanwhile, PM Abe seems willing to spend all of his political capital on a referendum to change Article 9 of the country’s pacifist constitution, even as public opinion remains opposed to such a change. Here too, we see a political leader making a bet that could backfire massively on himself. In this case, the bet is taking place in a country that has been fighting deflation for the last 30 years.

These are only a few examples, from four prominent G7 countries, of the recent increase in political recklessness. Other examples could be given as well, both in advanced economies and in developing countries. Brazilian President Bolsonaro’s approach to the fires in the Amazon, for instance. Maduro and his mis-management of Venezuela. Argentina taking on the largest loan on IMF’s history, only to default on it after one year. North Korea’s development of a nuclear program. The list goes on. In our view, having political leaders who play with fire, as if there were no consequences to their mistakes, is very dangerous. When too many of them act in this same way, global risks increase and risk materialises in unexpected ways, with the result being that potentially catastrophic consequences can be realized following incidents that would otherwise have only minor negative effects.

Crucial Week Ahead For Governments In Italy And The UK


By Brunello Rosa

2 September 2019 


This week will be a crucial one for determining the fate of governments in Italy and the UK. In Italy, Giuseppe Conte will come back to President Mattarella to announce whether or not he has been able to form a coalition between the Five Star Movement, the Democratic Party, and other smaller parties. As we discussed in our scenario analysis, there are a number of unresolved issues between Five Star and the Democratic Party, including as to what their government’s program and composition would be. Di Maio’s tough speech last Friday(“either the PD accepts these 20 points, or better to vote. And I may add: the sooner, the better”), was widely regarded as an obstacle to eventual solving of the crisis (hence the fall in equity markets and the spike in the BTP/Bund spread). Additionally, there is a Damocles’ sword hanging over the coalition deal; that is, the vote on Five Star’s online platform Rousseau to ratify such a decision. 

Nonetheless, in our baseline scenario, we expect Conte to be able to positively resolve the “reservation” with which he accepted the charge of forming the government. The government would initially be very fragile, as Conte will have a strong political and social opposition to face, as well as a difficult economic condition (GDP contracted in Q2, among other concerns). At the same time, such a government could also count on some powerful allies. The US President openly hoped for Conte to be confirmed as PM. The outgoing European Commission, even with one of its most hawkish representatives (Guenther Oettinger) said it welcomes the possible formation of a pro-European parliament in Italy.  

The new Commission led by Ursula Von Der Leyen made Conte understand that Brussels will close an eye regarding the budget, so long as Italy remains fiscally prudent and moves in the right direction (even if not at the ideal speed). Even the Vatican showed sign of sympathy for the new government, with a short meeting between the Pope and Conte on Friday. So, while the navigation could be bumpy, the government’s ship does not necessarily need to sink if the coalition partners do not fight too much amongst themselves.  

Market concerns are now actually higher for the government in the UK than for Italy, for a change. During the past week PM Boris Johnson obtained from the Queen the possibility to suspend parliamentfor five weeks between September 9th -12th and October 14th, ahead of a new Queen’s speech. As discussed in our analysis, Johnson claims that this is a normal procedure to allow the new government to focus on its new legislative agenda. But the reality is that the decision was made to prevent opponents of Brexit (or at least, opponents of a no-deal Brexit), who are a majority in parliament, to undertake the legislative actions that would prevent a no-deal Brexit from occurring. When parliament reconvenes on September 3rd, after the summer recess, it will now only have 6 days, and even fewer working days, to try and react to this move. 

Though legal challenges have been made against Johnson’s decision, including from the former leader of the Tory party Sir John Major, the possibility that the Labour party will table a no-confidence vote to oust Johnson during this week are much higher now. It is yet to be seen whether this will be a feasible initiative and, if so, whether it will be a successful one. For the time being, markets are skeptical and the pound sterling is reaching all-time lows.  

In this Hot Summer Season, Policy Events Are in Full Swing


By Brunello Rosa

27 August 2019  

In spite of the hot weather and the summer holiday season, policy events are in full swing. In the US, the traditional summer meeting of central bankers in Jackson Hole was closely watched, observers attempting to detect signs that would indicate whether the Fed’s insurance cuts could become the beginning of a more prolonged and deeper easing cycle. The words of the Fed’s Chair Jerome Powell were scrutinised, the prevailing impression of them being that Powell remained cautious about providing precise indications as to what the Fed would do in September and beyond. President Trump, considering these words not dovish enough, even asked on Twitter, “who is our bigger enemy, Jay Powell or Chairman Xi?”.  

This question was motivated by the intensification of the trade war between the US and China, with China first announcing tariffs on USD 75bn of imports from the US (itself a retaliation to Trump’s decision to impose additional tariffs starting from September 1st), to which the US responded with a further retaliation. President Trump tweeted that tariffs on the USD 250 billion of imports already in place would be raised to 30% from 25% on October 1, and that the remaining USD 300 billion of imports set to become effective on September 1stwould be taxed at 15%, rather than 10% as had initially been announced.

Another front of the many US confrontations now taking place is Iran. On this front, there might be marginally positive news coming from the recently concluded G7 meeting in Biarritz. Iran’s Foreign Minister Javad Zarif was invited to the side-lines of that meeting. Though President Trump did not meet with Zarif, we can consider it positive news that a channel of communication was opened between the two sides (thanks to French President Macron, who organised the meeting).   

Other items on the agenda of the G7 meeting besides trade wars and tension with Iran included the digital tax that Macron wants to impose on US tech giants in France, and emergency measures to combat the fires in the Amazon forest.  The Amazon represents another very sensitive front in international relations, of course. Brazil’s President Jair Bolsonaro is insisting that Brazil’s portion of the rainforest belongs unequivocally to Brazil – but the rest of the world is claiming that the forest is the “global lungs”. 

Around the table in Biarritz there were key players in two other critical political developments that were cited by Powell as global risks; namely, “the collapse of the Italian government and Brexit”. Italy’s PM Conte – who resigned last week – is waiting to see whether he will be reconfirmed as prime minister in a new coalition government between Five Star and the Democratic Party.  Italy’s President Mattarella will hold a second round of consultations on Tuesday and Wednesday this week. If at the end of this round the possibility of forming a new government is not clear, the President will dissolve parliament to hold early elections, which will most likely take place on November 3rd or November 10th. 

UK PM Boris Johnson made his debut at the G7 in Biarritz meanwhile, and there had the chance to meet again with French President Macron and German Chancellor Merkel, together with EU President Donald Tusk. Johnson re-affirmed his tough stance on Brexit, threatening not to pay the GBP 39bn Theresa May had pledged to pay as part of the Withdrawal Agreement. He is facing a tough return to Britain. When parliament re-opens, he will have to face a no-confidence vote, which could bring down his newly formed government and allow for the formation of a caretaker government that would postpone Brexit and prevent a no-deal scenario from materialising. In response to this threat, Johnson has asked legal advice on whether he can shut down parliament (or, technically speaking obtain a “prorogation”) for five weeks, so as to make sure that no-deal Brexit cannot be blocked by parliament. The EU partners have given the UK the onus to come back to the negotiating table within 30 days with examples of “alternative arrangements” to the Irish backstop, for a deal to be signed. We are clearly going to have to wait until the last moment to find out whether or not a deal is reached. 

Inequality As A Cause Of The “Populist International”


By Brunello Rosa

19 August 2019  

We have written several times about the rise of populism at global level, and its repercussion on the political, economic, and financial developments of the countries in which the populist phenomenon is strongest. We have also discussed the potential repercussions for the liberal order and its institutions, such as the European Union, that were created after Word War II as a response to the damage caused by the nationalistic and populist movements of the first half of the 20th century. 

Plenty of studies have been published that discuss the origin of this new wave of populism. A useful taxonomy is one in which contemporary populists have been classified into three categories: those who reached power for cultural or “identity-related” reasons (e.g. Brexit); those who claim to be anti-establishment (e.g. Donald Trump), and finally, those who came to power as a result of a widespread socio-economic malaise (e.g. Five Star and Lega in Italy). In this column we want to focus on the underlying causes of the last of these three categories: socio-economic populism. At the core of any economic malaise there is under-development and lack of opportunity, especially in emerging markets. In developed economies, however, where per capita income is much higher, it is the uneven or unfair distribution of income and wealth that seems to be the driving force behind the rise of populist forces in recent years. 

As discussed in our recent in-depth analysis, income and wealth inequality (or lack of “inclusion”, to use the expression of the IMF/World Bank) is one of the main causes of subdued growth and historically low real interest rates. As the IMF said in its 2018 Annual Report, “reducing inequality can open doors to growth and stability.” Yet by causing subdued and uneven growth, inequality is also a primary origin of protest movements that want to rectify this situation, which sometimes are or have been classified as “populist.”   

In our analysis we discuss how income inequality has been increasing since the 1970s, when the primary distribution of income began to become skewed more towards profits, interests and rents and less to labour.  

At the same time, the neo-liberist revolution of Ronald Reagan and Margaret Thatcher also made the redistribution of income via taxation and subsidies less effective, on the back of what was labelled as trickle-down economics. Many years of increased globalisation, with its inherently deflationary forces (including on wages), reduced labour share of income in the most advanced economies (and parallel increase in the profit and interest share of income), diminished power of trade unions, mass privatisation of public goods, and inability of taxation and subsidies to redistribute income in a fairer way, have led to the current situation. Workers in many countries feel deprived, and are therefore willing to give a chance to political leaders who claim to be on their side, however inconsistent with this claim those leaders’ biographies might be. 

The policy solution to this problem seems quite straightforward: a more active role of fiscal policy, to promote income redistribution, increased public expenditure in infrastructure and education, the provision of job opportunities to younger generations by the public and private sectors. Some of these solutions are becoming popular even among the US electorate, with the rise of political leaders such as Bernie Sanders and Alexandria Ocasio-Cortez, who are not afraid of being labelled “socialists,” a description which just a few years ago would have killed any political career. Nevertheless these solutions are easier said than done. Once in power, even their proponents realise how difficult implementing such policies tends to be, given binding budget constraints. 

Wealth inequality is even harder to assess than is income inequality, as it is often a legacy issue (as wealth is accumulated over generations), and as it is the result of the cumulative effect of income inequality over a long period of time. A group of economists has suggested the adoption of a “wealth tax” as a solution to this issue. This might well be a solution, but the political economy of adopting such a tax would be complicated, and so might ultimately prove to be counter-productive. 

All this is to say that income and wealth inequality are here to stay for the time being, and will continue to feed populist movements around the globe. Policy solutions are available, but their implementation is complicated and sometimes politically toxic. This means that probably things will have to get worse before they can get better.   

Geopolitical and Political Risks Are On The Rise, In A Globally Fragile Economic Environment


By Brunello Rosa

12 August 2019  

Last week, we observed that political risk has been rising again, especially in Europe. In Italy, following months of indecision, Lega’s leader Matteo Salvini decided to pull the plug on Conte’s government by tabling a no-confidence motion in the Senate. As we discussed in our flash update last week, that officially marked the beginning of a government crisis which is expected to lead to a snap election being held in late October. If that election takes place, Salvini – who has asked the Italian voters to given him “full powers” – could become Italy’s Prime Minister by the end of the year. Salvini’s budget plans are certainly not in line with Italy’s budget discipline of the last few years, and therefore Italy is likely to soon be on a collision course with the EU Commission (again!). Markets are already reflecting these developments, with the 10y BTP-bund spread back to 240bps, and equity prices having fallen by 2.5% last Friday. Also on Friday, Fitch kept Italy’s rating at BBB, with a negative outlook, clarifying that a government collapse in H2 2019 was already part of their baseline. As we discussed in our medium-term scenario analysis in October 2018, Italy is now choosing what we labelled an Austro-Hungarian path. This could eventually lead the country to become an “illiberal democracy,” as theorised by Salvini’s maestro, Hungary’s Prime Minister Victor Orban. 

Italy is not the only country to be experiencing a political drama. In the UK, PM Johnson has confirmed that the country is ready to leave the EU with “no ifs and no buts” by October 31st, with or without a deal. He might have been lured into doing so by US assurances that the Trump administration will be at the UK’s doorsteps “pen in hand” to sign a free-trade agreement with the country. 

In fact, such a deal might be difficult to achieve: a number of US politicians with Irish roots would reportedly be very reluctant to ratify any trade deal that risks endangering the provisions of the Good Friday Agreement for Ireland, and in particular the existence of an open border between the two sides of the island. 

Also, former US Secretary to the Treasury Larry Summers said that any trade deal signed with the US after a “no-deal” Brexit would be particularly advantageous for the US (for example, health insurance companies could try to replace the NHS), but very dis-advantageous for the UK, given that the UK may be in a desperate position after crashing out of the EU. (Brexit uncertainty has already caused UK’s GDP to fall in Q2 2019). As a result of all of this, a new standoff between the UK and the EU Commission is likely to begin soon, which might lead to new elections. Press reports suggest these might take place immediately after Brexit, possibly even on November 1st. The effects of the no-deal would then not yet be immediately visible or able to influence voters’ opinion. 

All these domestic political risks are resurfacing at a time when geopolitical risks are also on the rise, and as the global economy is particularly fragile. As we will discuss in greater detail in John Hulsman’s Geopolitical Corner later this week, a few days ago India’s PM Modi reduced Kashmir’s autonomy, and by doing so inflamed a region that is geopolitically one of the hottest in the world (especially given that both India and Pakistan have nuclear military capabilities). Meanwhile the US has decided to rebrand China as a currency manipulator after many years, following the depreciation of the RMB to above 7 US dollars for the first time since 2008. (The RMB depreciation was caused by the threat of new US tariffs on Chinese imports, which we discussed last week). With this move by the US, the risk of a currency war has been added to the ongoing trade and tech wars between China and the US. It should not come as a surprise that all these political and geopolitical risks are taking a tolls on the global economy.  

Trump’s Threat Of New Tariffs On China Increases The Risk Of A Global Recession


By Brunello Rosa

5 August 2019  

At the end of last week, US President Donald Trump threatened to impose a 10% tariff on the remaining USD 300bn of imports from China beginning on September 1st, if by that date an agreement is not reached between the Chinese and US governments. After the small level of hope generated from the “positive” meeting between Trump and Chinese President Xi Jinping at the G20 meeting in Osaka, this turn of events makes the possibility of a comprehensive trade deal between the US and China being  reached soon even slimmer than it had previously been. In the days preceding this latest of Trump’s threats, he had warned markets and the general public that China’s tactics might have been to wait until November 2020 before signing any agreement, in the hope that by January 2021 they could deal with a more conciliatory, Democratic president. 

Unfortunately, events are unfolding in line with our view that a controlled escalation between the two countries is more likely than a full-fledged deal being reached, and that at best the US and China can only agree on temporary truces during what may prove to be a long-term technological and geo-strategicnew cold war— or Cold War 2, as we labelled it in early May. A comprehensive and long-lasting agreement is hard to envision, even if Trump were to win re-election in 2020. At most, a more prolonged truce between China and the US could be agreed upon, but such a truce would remain fragile and subject to interpretation and controversy. 

Needless to say, the market did not respond well to the latest turn of events. Equity market sold off massively throughout the world, reinforcing a move that was already taking place as a result of the disappointment that followed the Fed rate cut on Wednesday 31 July. Long-term sovereign bond yields in US, UK, Europe and Japan collapsed.  In those jurisdictions where the market could expect more rate cuts from central banks, sovereign yield curves steepened. Elsewhere, they continued to flatten. Even in the US, where the Fed has 225bps of easing space available, the 2y US Treasury yield closed the week down by 16bps, while the 10y yield fell by 24bps on the weekly basis. The net result has been a re-flattening of the yield curve, after the marginal steepening that had occurred in anticipation of the Fed’s rate cut. 

In the past, a flattening of the yield curve has been associated with upcoming recessions. In our analysis, we have argued that with the long end of the US yield curve being anchored by low yields in Germany and Japan, this correlation between the curve and recession probabilities has diminished. Nevertheless the latest developments do not bode well for the US or the global economy. 

To begin with, it would be delusional to think that lower policy rates by the Fed could compensate higher tariffs, which risk having a disproportionate and non-linear effect on the economy. 

Second, in addition to the ongoing trade and tech war there are also unabated tensions with Iran, which have recently escalated with the seizure by Tehran of a UK super-tanker. This stand-off is likely to be prolonged; the Iranian government might wait for the end of Trump’s presidency before re-opening the diplomatic channels of communication, in the hope of dealing with a less confrontational US president. 

Finally, as the global manufacturing recession continues, the global economy might be on the cusp of a downturn which looser monetary policy alone might be insufficient to avert.  

Weekly Column: Boris Johnson: A New Era In British Politics


By Brunello Rosa

29 July 2019  

Last week, Boris Johnson was elected leader of the Conservative Party and, as a result, Prime Minister of the United Kingdom. Johnson’s program has the acronym DUDE: Deliver Brexit, Unite the UK, Defeat (Labour’s leader) Jeremy Corbyn, and Energise Britain. His first speech, made  in front of 10 Downing Street, was a profusion of optimism; it was an attempt to rally the country’s sense of pride over its glorious past and purported luminous future outside the EU. Johnson promised to take the UK out of the EU by October 31st, “no ifs and no buts.” Polls show that this new, energetic and defiant approach has resulted in a 10% bounce in the Tory support, to 30%, ahead of Labour (25%), LibDems (18%) and the Brexit party (14%). 

The largely reshuffled cabinet reflects this new, assertive approach to Brexit. Leading Brexiteers have been given key ministerial roles. Dominic Raab is replacing Jeremy Hunt as foreign secretary, Andrea Leadsom is replacing Greg Clark as Business secretary, Jacob Rees-Mogg (the Chairman of the ultra-Brexiteer European Research Group) is replacing Mel Stride as Leader of the Commons (which organises the government’s activity in the House of Commons), Michael Gove is replacing David Lidington (Theresa May’s de-facto deputy PM) as Chancellor of the Duchy of Lancaster and key adviser to the PM, in charge of coordinating Cabinet activity. Additionally, former pro-Remain Sajid Javid is replacing Philip Hammond as Chancellor of the Exchequer, and is preparing an extraordinary budget to speed up preparations for a no-deal Brexit. Finally, political strategist Dominic Cummings, the former campaign director of “Vote Leave”, is now special advisor to the PM. 

In a series of updates, we have discussed what consequences the election of Boris Johnson could bring about. Regarding Brexit, Johnson’s attempt to renegotiate the deal with the EU will at first likely result in a firm “no way” from the EU. That could in turn trigger a confidence vote that, if lost by Johnson, could result in a Labour-led minority government being formed, a new general election being held or even a second referendum. In case of new elections, a tactical Tory alliance with Nigel Farage’s Brexit party would become likely. 

Such an outcome would change the nature of British politics: by making an alliance with Farage, the Conservatives, one of the cornerstone parties of the UK political system, would be institutionalising the populist movement (which morphed into a party at the latest EU elections) that has led to Brexit. In other European countries we have seen how fringe national-populist parties have come to power by making alliances with the traditional, mainstream parties (for example in Austria, under the government of Sebastian Kurz). Once contracted, the virus of populism is very difficult to get rid of: it tends to become part of the political discourse, and never fully leaves. A seemingly endless list of countries all around the world, from Latin America to Europe and Asia, know this all too well. What is astonishing to watch is the US and UK, countries that were leaders of the liberal-democratic order that was born after World War II, entering such a difficult phase of their history as well.

We believe a period of political turmoil is likely to begin for the UK. The Brexit plane is not going for a soft landing. In the best case, it is going to be a very bumpy landing – but no one can rule out a crash either. The key point to understand here is that what seems a failure to most of the international observers, including us, might not be perceived as such by the new Tory and British leadership. In the next article for his Geopolitical Corner published this week, John Hulsman will discuss in detail how Johnson perceives the Anglosphere to be his geo-strategic horizon, and this does not require any participation in the European integration process, which is perceived rather as a chain to be freed from.   

Major Central Banks Will Start Becoming More Accommodative This Week


By Brunello Rosa

22 July 2019  

This week, the long-awaited period in which G10 central banks start becoming more accommodative will begin, starting with the ECB’s Governing Council meeting on Thursday. As we wrote in our preview, the ECB will mostly just be laying the groundwork for more significant easing measures to be adopted in September, when a new set of staff forecasts will also be provided. It may, however, also give something of an appetizer in July, in terms of beginning the process of accommodation immediately to a certain extent. Currently markets remain buoyant about the arrival of Christine Lagarde at the helm of the ECB, as she is expected to provide continuity with Mario Draghi’s era. Additionally, press reports revealed that the ECB is looking at the appropriateness of its official goal (to keep inflation “below, but close to 2%”) to achieve its price-stability mandate. These reports suggest that a more “symmetrical” approach would provide less of a disinflationary bias and more headroom for an easier policy stance. 

Similar thinking seems to be underway in the US, where the Fed (whose FOMC meets next week) appears to be on the verge of moving de facto to some form of average inflation-targeting regime, suggesting that after a prolonged period of target under-shooting, monetary policy could be kept more accommodative than is justified by the stage of the business cycle alone, in order to make up at least part of the miss in the price level. As a result of these considerations, the recent testimony by Chair Jay Powell before the US Congress, and a speech by the President of the New York Fed John Williams (which required an unusual clarification), market expectations about the size of the rate cut in July have swung wildly in the last few weeks, between 25bps and 50bps. After this period of volatility in expectations (amounting to “confusion,” according to some press reports), they seem to have stabilised at 25bps. We will discuss all of this in greater detail in our upcoming preview for the FOMC meeting. 

The same week as the Fed meeting, the BOJ and the BOE will also hold policy meetings. As discussed in our recent overview of the policy stances of the G10 central banks, the BOJ could start making the first changes in its language as early as July, whereas the BOE will remain mostly reactive, with the change in the British government and Brexit developments dominating the macroeconomic environment. Other G10 central banks, such as the RBA, RBNZ, and BOC, have already acted or adjusted their rhetoric in response to these developments. But some other central banks, such as the Riksbank, have expressed more caution, in consideration of the more limited easing space available to them. On the other side of the spectrum, Norges Banks has, so far, remained fiercely hawkish

G10 central banks tend to set the pattern for all other central banks in the developed world (e.g. in South Korea, the central bank cut its policy rate for the first time in three years), but also in Emerging Markets. An easier stance in the G10 reduces the pressure on EM central banks to keep rates high to sustain their currencies and contain inflation. A number of EM central banks have already cut rates in recent months as a result of this changed landscape, including in China, India, Russia, the Philippines, and Malaysia.

Now the time seems ripe for even the embattled Central Bank of Turkey to cut rates, after the defenestration of its Governor by President Erdogan. At its meeting on Thursday 25 July, the TCMB is expected to cut rates by a whopping 250bps, from 24% to 21.5%, in a supposed sign of normalisation after the defensive hikes it adopted at the height of the Turkish Lira crisis during the summer of 2018.ns (amounting to “confusion,” according to some press reports), they seem to have stabilised at 25bps. We will discuss all of this in greater detail in our upcoming preview for te FOMC meeting. 

The EU’s Ruling Coalition Might Need Support From Populist Parties To Reach A Majority


by Brunello Rosa

15 July 2019  

Last week, when we commented on the selection of the new heads of the top five EU institutions, we highlighted how the end of the musical chairs game that the selection process resembled delivered only a very a fragile political equilibrium. We also took a non-consensus view of the situation, arguing that time is on the side of the national-populist parties in Europe, which, during the five-year tenure of this new parliament, will have the option of making a proposal to the European People’s Party (EPP) to form a coalition together. Already during the past week, events of this kind have been unfolding more rapidly than even we would have expected.

As numerous press reports suggest, the new EU Commission (EC) President Ursula Von Der Leyen is having a hard time securing the votes she will need on July 16thif she wants to win a vote of confidence from the EU Parliament. With the far-left GUE and the Greens having formally announced their vote of no confidence towards President Von Der Leyen, she now needs to rely on a three-party coalition of EPP (179 seats), Socialists & Democrats (153 seats) and Liberals (105 seats). Theoretically speaking, this ruling coalition could count on 437 votes, much more than the 374 necessary to reach a majority in the 750-seat European Parliament. 

However, a number of MEPs, especially those from the German Social Democrats, are still upset by the method by which Von Der Layen was chosen (in particular, the trashing by French President Macron and German Chancellor Merkel of the Spitzenkadidat system that was introduced in 2014). Others are unimpressed by the lack of ambition of her political program, which so far seems to be just a sensible continuation of the status quo. Additionally, some members of the EPP, such as Viktor Orban’s Fidesz, want a softer stance taken by the future EC regarding the application of Article 7 (namely, the sanction imposed on misbehaving countries) in exchange for their vote. So, what seemed to be a vote that Von Der Leyen could take for granted could instead become extremely problematic. 


Facing this situation, it was suggested to her to postpone the vote to September, so that she could gain more time to convince the rebellious MEPs to give her their support. But she understood that nothing would change in the next two months, and that her position could become even weaker if she were to let this situation fester for a longer period of time. 

But here is where the situation becomes intriguing, if perhaps also dangerous. A number of populist-nationalist parties have offered their support to Von Der Leyen, in exchange for a more favourable attitude taken by the EC President on the dossiers close to the various party leaders. PiS, the Polish party of the nationalistic leader Jarosław Kaczyński, has offered its support in exchange for a softer stance on the application of Article 7, like Hungary’s Fidesz. Lega and Five Star have offered their votes in return for a “heavy” portfolio for Italy in the new EC, such as Competition, or Industry. 

Von Der Leyen might manage to convince the rebellious MEPs from her own coalition to fall into line and allow the Commission to have a working and cohesive majority from the start of her term. But she might not have enough time for that. In that case, she may be forced to accept parties to allow for the birth of a Commission presided over by herself. Such a Commission would become vulnerable to the requests of the national-populists sooner than even we had anticipated. Von Der Leyen’s manoeuvring space to reform Europe in the direction of the “United States of Europe” (the way she reportedly would like to see the EU  become) would be further reduced. As a result, the process of EU dis-integration would likely accelerate further in coming years. 

If Von Der Leyen fails to reach a majority this week, this would open up a serious institutional crisis in the EU, forcing EU leaders to find another solution. Such a solution is difficult to identify, as Von Der Leyen was chosen as part of a “package” that is difficult to unbundle, a package which also included the selection of David Sassoli who has been already elected President of the EP, Charles Michel as President of the EU Council, and the arrival (which markets have already greetedpositively) of Christine Lagarde at the helm of the ECB.  

End of Political “Musical Chairs” Game Still Leaves the EU Vulnerable To Systemic Crisis


By Brunello Rosa

8 July 2019  

We have been following the “musical chairs” game that was the selection process for the EU’s top jobs since January 2018, when it began, well before it attracted the attention of investors, market participants, and a wider audience informed by the media. We followed its evolution closely; we noted, for example, when Mario Centeno was appointed as head of the Eurogroup in September 2008, and continued to monitor the selection process until its recent, final rush, which began with the Special EU Council meeting on June 30th. On July 2nd an agreement was reached that included the following appointments: EU Commission (EC) President: Ursula Von Der Leyen (Germany, CDU); EU Council President: Charles Michel (Belgium, Liberal); European Central Bank (ECB) President: Christine Lagarde (France, formerly EPP); EU Parliament (EP) President: David Sassoli (Italy, S&D), who will most likely serve half of the 5-year term (as usual convention); and EU High Representative (HR) for Foreign Policy: Josep Borrel (Spain, S&D).

As we said in our recent in-depth analysis of the European leadership selection process, our overall impression is that the outcome of this lengthy musical chairs game could have been worse. After all, the chosen leaders are all political heavyweights, and the main criteria to achieve a political equilibrium within the EU have been respected (with the exception of the Union’s East-West criterion, mostly because Eastern European countries were identified with the Viségrad group, which positioned itself in opposition of the solutions proposed by France and Germany). The fact that Germany will lead the Commission directly means that the country is taking direct responsibility for what takes place in the EU in the next five years. Even if Germany intends to slow down the Union’s integration process, it will still not oversee the collapse of the European project. At the same time, a high-profile French policymaker, Christine Lagarde, has been given responsibility for providing the liquidity that might prove necessary to the EU in moments of crisis. Germany could distance itself from the more radical choices the ECB might take under her leadership (as Germany did previously, with Draghi), while still benefiting from their results.

With the selection of Von Der Leyen and Lagarde, Germany and France are personalising  their joint commitment to on the continuation of the European project. This is a plus, especially if means that they will be willing to put their money on the table, so to speak, in terms of increased risk-sharing (something Germany always opposes) and additional sovereignty transfers from the national level to EU institutions (something France always despises), to ensure the project can be maintained. 

Together with these pluses, there are the minuses. First, the entire selection process has exposed once again how messy EU policymaking is, and how ugly it is to watch for the average EU citizen. Second, the compromise reached today is the result of the internal political equilibria that exist currently within the various EU countries. But these politics may change a lot, as elections in Germany (2021), France (2022) and most likely Italy are going to be held before the end of this EU parliamentary term. Third, as we said in previous analysis, with all the mainstream parties now lumped together at the EU level, it will be easy for the populist parties to blame the mainstream parties for whatever goes wrong in the next few years. 

And a lot could go wrong in the years ahead, including: 1) a recession is very likely to occur. We can see already the ECB preparing the ground for renewed easing in coming months. 2) Germany is in the middle of a challenge to its business model, deriving from trade tensions and the overhaul of its banking system; 3) Brexit is a process yet to be finalised (with a likely showdown by the end of October), and the UK is likely to enter a technical recession from Q2; 4) In Greece, the victory of New Democracy in the general election marks the end of the post-crisis era, but also the return to power of the party that caused the Greek crisis in the first place. 

Thus, it is very likely that the EU, Eurozone and Europe in general will face an existential threat in coming years. The people at the helm of the EU institutions are equipped to face it. The real question is whether they will actually have the needed political support and mandate to solve it.  

The Trade Truce At The G20 Meeting In Osaka Buys Time, But Does Not Resolve The Dispute


By Brunello Rosa

1 July 2019  

The truce agreed to by US President Donald Trump and Chinese President Xi Jinping at the G20 meeting in Osaka is a welcome development, but it does not resolve any of the underlying issues that exist between the two sides. 

According to press reports, the US will now refrain from imposing additional tariffs on Chinese exports to the US, and will allow US companies to sell their products to the retail section of Huawei’s business.  The Chinese will buy more US agricultural goods. The two sides also agreed to resume the talks that were abruptly interrupted on May 5th, talks aimed at possibly reaching an agreement in coming months. As President Trump tweeted, however, he is “not in a hurry,” since the quality of the deal is more important than the speed at which a deal can be reached. 

In advance of this truce, market participants had already largely been expecting this sort of outcome, in which no deal was reached, yet neither did a complete collapse of the negotiations occur, rather a generic commitment to resume talks was made, with the goal still being an eventual compromise that both sides would consider more advantageous than the status quo. We also expressed this view, but warned that the most likely way forward is not that eventually a long-term agreement will easily be reached, but instead a controlled escalation take place, which in turn will lead to another temporary truce, as part of a larger geo-strategic confrontation between the United States and China that will last for decades

In fact, Trump will not want to reach a deal until he has secured at least two, if not several, precautionary rate cuts by the Federal Reserve, ahead of the November 2020 Presidential election. 

He also still has to evaluate what type of rhetoric towards China the American voters will want to hear ahead of the election. It may be that, tired of the economic effects of these prolonged trade tensions, the American voters that Trump is trying to mobilise will be attracted by moderate language on China, suggesting the possibility of a compromise between the two countries being reached soon. 

Conversely, an angry working class that is deeply disappointed by the continuous disappearance of jobs and factories will want to hear incendiary rhetoric against China yet again, portraying China as the cause of all America’s economic troubles. Trump will want to keep all options open until well into 2020, to consider how events unfold in coming months. 

But keeping all options open will also come at a huge economic cost. The option value of waiting for a resolution to US-China negotiations is leading many big businesses to a sort of “investment strike”, which is already weighing on economic performances in the largest, most advanced economies, such as the US, Germany and Japan. The ongoing balkanization of global supply chains will have an impact on companies’ cost structure irrespective of whether a trade deal will eventually be reached or not. As such, the real risk is that the damage that will be inflicted upon the US and world economy by this Cold War 2 and its various components (the trade war, technological competition, disruption of supply chains) is larger than is currently being estimated, and that a few cuts by proactive central banks will therefore not be able to prevent a global recession from occurring in 2020-21

Thus, even if after the G20 meeting a few people around the world breathe a sigh of relief, the reality is that the underlying problems that exist between the two countries remain mostly unresolved. As fiscal policy remains largely constrained, once again[js1] central banks will have to be the first line of defence against the ongoing synchronised global economic slowdown.   

The Financial Stability Implications of Libra (And Private-Sector Money in General)


By Brunello Rosa

24 June 2019  

Last week, Facebook unveiled its plan to introduce a new means of payment for small transactions, called Libra. Although many of the details about it have yet to be revealed, some comments seem warranted based on what we know already. As far as we know, Libra, which will be backed by existing centralised payment systems such as Visa, Mastercard and PayPal, is not a crypto-currency. Facebook itself labelled it a “stable-coin” for this reason. Additionally, as persuasively argued by Nouriel Roubini and other leading economists, crypto-currencies are not currencies insofar as the volatility of their exchange rates with conventional currencies such as the US dollar does not make them a safe store of value, which is one of the key characteristics of money. At most, crypto-currencies can be considered as highly speculative, crypto assets. 

It is unclear for now how “regular” money will be transferred into Libra wallets, at what rate of exchange such transfers will occur at, or whether consumers will be charged a fee whenever they do so. But let us assume that at some point all 1.7bn people on Facebook will have a Libra wallet. That would be a momentous feat, at least in terms of the scale of such an operation. And it would be just the latest arrival with in an increasingly crowded space, in which non-financial corporations are entering en masse into the traditional space occupied by financial companies. Other examples of this include Apple Pay, Ali-Pay, We Chat Pay, and  Amazon’s loans to sellers on its own platform. 

It is now time to take stock of these developments, and assess some of the potential risks that could come along with some of the purported advantages for the consumer, such as reduced fees for small transactions. The fact that the private sector creates money is not cause for concern, nor is it anything new. Most of the money we use – which, incidentally, is already largely electronic, even if not “digital” – is created independently by commercial banks rather than by central banks, the latter of which maintain the monopoly to issue high-power money (the so-called monetary base). 

Banks creating money via their loans are however subject to strict prudential regulations, which establish that there needs to be a relationship between the deposit held and money created. Banks have a lender of last resort, the central bank itself, which has its own international lender of last resort, the Bank For International Settlements (BIS). Deposits at commercial banks enjoy a public guarantee (in Europe, it is up to EUR 100,000 per current account), and banks enjoy an implicit backstop by their sovereign (hence the too-big-to-fail problem, when the individual financial institution is much larger than the sovereign that is supposed to provide the backstop for it). None of these implicit and explicit guarantees will be available for Libra and other forms of digital currency. Who is going to police against fraud, or against money laundering activities, for example? If something goes terribly bad, who will be the ultimate lender of last resort? 

We are entering a dangerous territory here from the perspective of financial stability. For these reasons, leading regulators such as the BIS itself have started to give their warnings about the subject. As Mark Carney, Governor of the Bank of England and former President of the Financial Stability Board, reportedly said, If Libra is successful in attracting users it would “instantly become systemic and will have to be subject to the highest standards of regulation.” 

We are registering here the dramatic increase of offers of new forms of money, means of payments, etc., by private-sector participants, more often than not from non-financial corporations, clearly aimed at disintermediating the traditional channels dominated by banks. This is nothing new: during the eighteenth and nineteenth centuries, plenty of corporations issued their own private forms of payment. That proliferation was at the origin of some of the worst scams and financial instability episodes (for a collection of which, read “Manias, Panics, and Crashes”, the masterpiece written by Charles Kindleberger). The final users of such products, excited by what seem to be “innovations,” should remember these historical precedents when embracing these newly offered means of payment.

Weekly Column - Macro and Market Outlook: Fasten Your Seatbelts


By Brunello Rosa

17 June 2019  

In our latest Market Update and Outlook, published last week ahead of the upcoming quarterly asset allocation, we reviewed the major macroeconomic, political, geopolitical and market events of the last six months. We then provided an outlook for the next six and next twelve months, as well as further ahead in the future. 

From a macroeconomic perspective, the last six months have seen a synchronised deceleration of the global economy, starting from its three main regions (US, Eurozone and China), in spite of upward surprises in Q1 GDP growth. The ongoing trade and tech war between US and China, which is likely the beginning of a new Cold War, which we called Cold War II, is taking its toll on the global economy. The US and China (ahead of a possible truce, yet short of a full deal that would resolve their economic disputes) are importing less from each other, which is likely to benefit only a few select economies, such as Vietnam, Taiwan, Chile, Malaysia and Argentina. In our recent analysis we discussed why we believe that a controlled escalation, or contained commercial warfare, is more likely for the time being than a full-scale trade war or a full deal being reached between the two countries. 

But trade wars, tech wars and the disruption to global supply chains is not the only factor affecting the global economy. Geopolitical tensions are on the rise irrespective of trade tensions (with the US still being the instigator of these tensions). We discussed the risk of miscalculations and accidents taking place in the US-Iran standoff, and last week there was indeed an attack on two oil tankers in the Gulf of Oman, the gateway for over a third of the world’s shipped oil. Even if the situation in the region is set to remain tense for some time, oil prices still fell on a weekly basis, in response to the slowdown in the global economy. Also in the Middle East, the Turkish government confirmed its S-400 arms deal with Russia, after Turkey’s Defense Minister stated that “the language used in a letter sent by the US regarding Turkey’s removal from the F-35 fighter jet program does not suit the spirit of alliance".  

Finally, the regional geopolitical mess that is Brexit, with its potential global implications (the Fed quoted it among the most relevant cross-currents recently weighing on market sentiment), could deteriorate further, if the UK were to go for a no-deal exit following the arrival of the country’s new prime minister (Boris Johnson is the frontrunner). In fact, last week the House of Commons rejected (with a 309-298 vote) a motion designed by the opposition intended to block a “no-deal” exit on October 31st. 

With all of this taking place, and as fiscal policy remains constrained, central banks are already on the move. Joining the Fed, ECB, PBoC and BOJ, the Swiss National Bank (SNB) also claimed last week to have room to further ease its policy stance, and, also for this purpose, introduced its own SNB Policy Rate, in substitution of the 3m Libor target range. This week, the Fed will provide further indication as to whether or not it wants to proceed with its precautionary cuts, which the market now considers certain to be implemented by year end, considering the various cyclical and structural factors dampening upward pressures on US inflation. At the same time, Norges Bank will likely confirm that it will remain at odds with all other G10 central banks, and will likely proceed with its pre-announced 25bps increase in its policy rate. 

After a very volatile semester, the price of risky assets (primarily equities) and the price of long-dated government bonds are supported by this renewed dovishness of central banks. However, if the damage to the global economy proves to be larger than is currently estimated, central banks will have to do much more than a few insurance-based cuts to prevent a recession and severe market correction in the next few months

With A Slowing Global Economy, Monetary Policy’s Tide Is Turning


By Brunello Rosa

10 June 2019  


The global economy is now in the middle of an asynchronous slowdown, which is occurring mostly as a result of prolonged, intensifying trade tensions, rising geopolitical risks, and tightness in the labour market in a number of countries. Let us briefly examine the three major economic regions of the global economy. 

In the US, Q1 GDP growth was surprisingly positive, but domestic demand weakened substantially, providing little comfort for the economy’s future performance. The non-farm payrolls figures for May 2019, released last week, were weaker than expected; only 75,000 jobs were added, as opposed to the consensus expectation of 185,000  jobs or the previous reading of 224,000 jobs. This weaker figure was accompanied by slower growth in average hourly earnings: 3.1% y/y, versus a consensus expectation and previous reading of 3.2%. In a recent interview, Fed’s Vice-Chair Richard Clarida said that tariffs are expected to have a one-off effect on price levels, but a more lasting impact on economic activity. Therefore, if trade tensions do not subside, the negative demand shock to the economy from those tensions will eventually be larger than the negative shock to supply. 

In the Eurozone, Q1 GDP also surprised mildly to the upside, but the latest ECB projections suggest that economic activity will decelerate in Q2 and Q3, so the much-hoped for rebound in Q2 is unlikely to materialise. This is mostly because the largest European economy, Germany, is fighting to exit a prolonged period of stagnation (it has been flirting with recession), while the third largest Eurozone economy, Italy, has temporarily exited its technical recession in Q1 but risks entering a new one in Q2 2019. For the time being, France and Spain are the main drivers of economic growth in the Eurozone.  


In China, the policy stimulus of 2018 allowed the economy to also surprise to the upside in Q1, but the reignition of trade tensions this year have meant a new slowdown, which the authorities are fighting with fiscal, monetary and regulatory stimulus. Going forward, US tariffs are expected to continue weighing on exports and push inflation higher. All other regions in the world closely depend on developments from these three economic and geo-strategic giants, so economic activity is likely to decelerate globally. 

Facing this situation, and waiting for fiscal policy to provide a larger counter-cyclical contribution (even as most government are busy “fixing their fiscal roof” now that “the sun is still shining”), central banks have already begun to act. In a number of jurisdictions, monetary policy, which had at least had a tightening bias, has now become neutral if not overtly more accommodative. In developed markets, last week the Reserve Bank of Australia cut (after a long debate) its main policy rate to a record low of 1.25%, following the neighbouring RBNZ by a month. 

During its latest press conference, President Draghi said that the ECB’s Governing Council has discussed possible easing measures. While the BoJ has never abandoned its accommodative stance, the elephant in the room is clearly the Fed. The markets now price in the likelihood, indeed almost the certainty, that the Fed will cut rates in coming months. In Emerging Markets, central banks have been even more proactive. In China, the PBoC Governor announced “there is tremendous room to adjust monetary policy if the trade war deepens.” In India, a marked slowdown in the economy led the Reserve Bank of India to cut interest rates by 25bps (to 5.75%) for a third time this year, and suggest further cuts are in the pipeline. The central banks of the Philippines and Malaysia also recently cut their policy rates by 25bps, to 4.5% and 3% respectively.    

WEEKLY COLUMN - How Brexit Wrecked the UK’s Political System


By Brunello Rosa

3 June 2019  

From the beginning, the ill-designed Brexit referendum has intoxicated the UK’s political system and introduced an element of uncertainty into the country’s constitutional arrangements. In a parliament-centred political system such as the British possess, the source of legitimacy for political decisions rests squarely with Westminster (notwithstanding a strong role for the Prime Minister). From a purely procedural standpoint, then, simply labelling the Brexit referendum as “advisory” and non-binding might have saved the day. Unfortunately, since the day after the referendum its result has been considered politically binding on both sides of the political spectrum, which has committed to “deliver Brexit.”

The inability or unwillingness by Parliament to ratify the Withdrawal Agreement negotiated by Theresa May with the EU has made manifest the constitutional short-circuit that has taken place, as the primary source of legal and political legitimacy is now countervailing the “will of people” as  expressed in the referendum. 

The birth of the Brexit party led by Nigel Farage, and its first-place finish in the European election held on May 23rd, is a response to this inability by Britain’s parliament to deliver Brexit. The Tory party will try to respond to the rise of the Brexit party by choosing its new leader from the camp of Brexiteers, with different degrees of radicalism ranging from Boris Johnson to Dominic Raab and Michael Gove. At the same time, Farage might be tempted to “finish the job”, forcing a split in the Conservative party between pro-Europeans and Brexiteers and becoming the leader of the right-wing of Britain’s political spectrum.  

The British results of the European election has other implications as well. First, both parties entangled in negotiations (Tory and Labour) lost a large portion of their votes. Second, those parties in favour of Remain (chiefly the Lib Dems and the Greens) did very well, and if we sum their votes, they represent a larger proportion of the electorate than does the Brexit party. 

Moreover, a recent poll by YouGov shows that the Lib Dems would be the leading party in the UK if an election were to be held today, ahead of the Brexit party, the Conservatives, Labour and the Greens. If that poll is correct, Brexit would have made the unthinkable happen: a traditional two-party system governed by a first-past-the-post electoral law would become a messy four-party system with the major parties having only between 19% and 24 of the votes. Elections would become completely unpredictable, unless the four major parties coalesced ex ante into pairs (Labour-Lib Dem; Tories-Brexit). Alternatively, all parties might eventually break up and allow a new centrist formation to emerge and take control of parliament and the Brexit process. Such an outcome could lead, potentially, to the Brexit decision being reversed. 

During his visit to the UK, US President Donald Trump could not resist the temptation to make things even more complicated, with his suggestions that Boris Johnson should be the new Tory leader, Nigel Farage should be involved in negotiations with the EU, and the UK should throw out the deal agreed to by Theresa May with the EU and aim instead for a hard Brexit, without paying the GBP 39bn owed to the EU in the coming years. Trump might not have considered that the UK is much smaller than the US is, and that the EU has so far had the upper hand in negotiation, in part because Article 50 is designed to punish the leavers. 

EU Elections Change the European Political Landscape


by Brunello Rosa

27 May 2019  

Last week we discussed the European election, which took place between Thursday 23 and Sunday 26 May. The voter turnout for the election, at above 50 percent, was the highest in the last 20 years, testifying to this election’s importance. According to the preliminary results, most of the predictions made in advance of the election (by us and by others) are proving to be correct. The European People’s Party (EPP), will remain the largest group in the European parliament, with around 180 seats, but will lose more than 40 MEPs compared to its results in the previous election in 2014. The Socialist and Democratic (S&D) Party will be the second largest group, with around 150 seats; it too will have close to 40 fewer MEPs than it had in 2014. Conversely, the Liberals of ALDE and the Greens will both gain seats, going from 68 to more than 100 and from 52 to around 70 respectively. This means that in order to form a 376-strong majority, the EPP and the S&D will have to coalesce with the Liberals. (The Greens seem not to be necessary at this stage). 

What about the “national-populist” parties? The ENF group of Italy’s Salvini and France’s Le Pen will increase the number of its MEPs from 37 to around 60. The EFDD group of Farage’s Brexit Party and Italy’s Five Star will also rise, from 41 to around 60 seats. The ECR’s group of UK Tories, Poland’s PiS, Germany’s AfD and Finland’s True Finns will fall from 75 to around 60, mostly because of the UK Tories’ debacle. These groups together will not yet be big enough to make an offer to the EPP, but they will increase their influence in future decision-making processes. 

The press and most “mainstream” policymakers will probably take an unwarranted sight of relief following this election, as they will think that the “national-populist” parties have been kept at bay. We believe this view might prove to be incorrect, for two reasons. 

First, these elections are forcing increasingly unnatural alliances to be made at the European level. The fact that the Liberals may now be in the same camp as the EPP and S&D means that they will all be jointly blamed for anything that can and probably will go wrong in coming years, thereby leaving the national-populist parties (and perhaps the Greens) as the only remaining alternative. 

Second, some of the individual national-populist parties actually fared exceptionally well in these elections. In Germany, the CDU and SPD combined lost more than 18% of the vote, in favour of Greens (now Germany’s second largest party) and AfD (now its fourth largest party). In France, Le Pen’s National Rally Party has reportedly overtaken President Macron’s En Marcheparty. In Italy’s Salvini’s Lega is the first party with 34% of votes having overtaken the Five Star (collapsed to 17%). In the UK, the Brexit Party has gathered around 32% of votes, is the largest party in this election and will certainly campaign for an eventual hard-Brexit solution. In Poland and Hungary, PiS and Fidesz respectively remain the parties that received the most votes. 

Elsewhere, in Greece, New Democracy has reportedly overtaken PM Tsipras’ SYRIZA, and is getting ready to get back into power with the national elections of June 30th.

Thus, the parties forming what we have labelled the “Populist International” are still gaining ground. They know that the race to political power is a marathon, not a sprint. From their new, more powerful positions in EU politics, they will strongly influence the process of appointing the new heads of the EU Parliament, Commission, Council and, above all, the ECB. They will also be likely to have a greater say regarding the overall fiscal and monetary policy stance taken at the EU level. Overall, then, we continue to think that 2019 will be a crucial year for European politics. This EU election is likely to prove an inflection, if not a turning point, in the region’s affairs.

European Elections, 2019: A Key Test For The Survival Of The EU


by Brunello Rosa

20 May 2019  

All EU states will hold elections for the European Parliament this week, between Thursday May 23rd and Sunday May 26th. The EU Parliament will be completely renewed, with all 750 seats up for grabs. Because the UK will still take part in this election, the number of MEPs elected will not fall to 705, as had been planned to occur until the UK asked for its first extension to the Article 50 process in late March.

We have already discussed the importance of this election in a number of publications, particularly as a result of the increase in the share of seats that “populist” parties are expected to win. In our paper on the rise of the Populist International, we anticipated how these populist parties might eventually increase their power during this parliamentary term if an economic and financial crisis were to shatter the alliance between the European People’s Party (EPP), Socialists, Liberals, and, perhaps, the Greens, which is expected to emerge following the elections this week. In order to achieve that, the populist parties will have to make an agreement with the EPP, as, for example, has occurred in Austria, where the EPP’s Chancellor Sebastian Kurz is allied with FPÖ’s Heinz-Christian Strache. They would do this by making use of the presence of populist, authoritarian, or nationalistic parties within the EPP, such as Victor Orban’s Fidesz (which has been temporarily suspended from the EPP for its anti-Juncker campaign in Hungary). 

In this respect, there have been very interesting developments, recently. A couple of weeks ago, Orban himself declared several weeks ago that he will not support the EPP’s candidate for the European Commission presidency (so-called Spitzenkandidat) Manfred Weber. This could be a signal of an initial rupture between Fidesz and the EPP, which would have the effect of making the EPP smaller yet less “compromised” by populist parties. On the other hand, a rupture of this kind would also make the group of populist parties larger in the new EU Parliament. This week, the Austrian government itself collapsed after the release of a video showing Strache dealing with supposed intermediators of Russian interests.


So, the future of the EU is at stake in this election. But the election’s importance is not only limited to its historical and geo-strategic significance. The implications for future European policymaking have been discussed at length in a series of papers we wrote about the ongoing European musical chairs game, in which all the most important EU positions will be filled in coming months, including the presidencies of the EU Commission, Council and Parliament and, most importantly for financial markets, the ECB. 

The choice of who heads these institutions will make it clear what fiscal policy stance the EU will take; crucially, at a time when tensions over Italy’s deficit and debt are re-emerging. Consequently, this will determine what the ECB will be asked to do to support the fragile and uneven expansion of the Eurozone economy (which is now slowing down) or to save the euro area from a possible breakup when the next crisis hits (as the ECB did previously during the crisis of 2011-2012).

As usual, these European elections will also be read with a domestic lens within all of the EU countries. In Germany, they could mark the end of Angela Merkel’s tenure as Chancellor (in favour of her successor as CDU leader Annegret Kramp-Karrenbauer), especially if Merkel decides to lead the EU Council. In France, Macron will need to convince his electorate that he can still win more votes than Marine Le Pen’s party (now re-named Rassémblement National). 

In Italy, this election will be a referendum on Salvini’s leadership, and could mark the collapse of the fragile M5S-Lega coalition. In the UK, where the participation in this election is considered a national humiliation, these elections will probably mark the departure of Theresa May from Number 10 Downing Street in the coming weeks, whether Brexit is delivered or not  

In This Volatile Macro and Geopolitical Environment, G10 Central Banks Embark on Diverging Policy Paths


by Brunello Rosa

13 May 2019  

Last week we discussed the renewed trade tensions between China and the US. We feared that President Trump’s threat to increase the tariffs imposed on all goods imported from China to 25% would eventually materialise (reportedly due to China backtracking on a number of commitments made in previous stages of the negotiations) – as in fact did occur. These trade skirmishes might still lead to an eventual agreement, but we might also witness a repeat of what happened during the US negotiations with North Korea, which were also abruptly interrupted by Trump. There is now no deal in sight in that case, Kim Jon Un having reportedly started a new series of tests of tactical weapons. In the case of the trade negotiations with China, it is similarly not clear now how or when a deal could be reached. For the time being China will test whether or not President Trump is courageous enough to open a second front of his trade wars by imposing tariffs on the EU, and in partic

ular, on Germany, in the auto sector

According to one line of thought, this interruption in the negotiations was a result of Trump’s decision to use the window of opportunity he has to create new international tensions; a window being provided by a combination of the strong US economy, tight labour market, low inflation and buoyant equity markets thanks to the Fed’s pivot. Other analysts believe instead that it was China that misread Trump’s call for a 100bps cut to Fed funds rate, seeing it as a sign of weakness of the US economy, thereby inducing an unwarrantedly tougher Chinese stance in the final stage of the negotiations. Whatever the reason, a deal that seemed at hand fell apart last week. 

These types of miscalculations also seem to be taking place in the renewed tensions between the US and Iran. Iran has announced a partial withdrawal from the nuclear deal in response to the US decision to withdraw from the JCPOA months ago. In a typical tit-for-tat strategy reaction, the US has deployed the aircraft carrier Lincoln in the Middle East, further destabilising the region (where currency pegs to the USD have come under severe stress).  

All this is occurring while Turkey’s fragility is again becoming more prominent, the Lira having risen above 6 versus the US dollar, in spite of the central bank’s increase in policy rates from 24% to 25.5%, as international investors doubt the real firepower of the country to defend its currency in the event of a speculative attack. 

Some believe that Trump’s trademark ability is making deals, which might well be the case. Nevertheless, politics is more complicated than business, and the examples above show that the potential for geopolitical miscalculation is huge, as is the possibility of starting a conflict by accident. As historian Christopher Clark masterfully wrote, Europe “sleepwalked” its way into World War I.

These geopolitical tensions and lack of international coordination is leading to higher oil prices, which are contributing the global macro-economic environment becoming volatile and uneven, with some regions growing robustly with rising inflation, while others are weakening. To counter these developments, fiscal policy has been relaxed in the US, EU and China. Central bankers, observing this uneven scenario (which is leading to market volatility) are responding in different ways, depending on domestic circumstances. 

Within the G10 some central banks followed the Fed and turned dovish: the ECB, the BOJ, the BOC, the Riksbank, the Reserve Bank of Australiaand the Reserve Bank of New Zealand, the latter of these becoming, in the past week, the first G10 central bank to cut its policy rate during this cycle. On the other side of the spectrum there is the BOE, and above all Norges Bank, which last week increased its degree of hawkishness by pre-announcing a rate hike in June; this is likely to be indicative of an acceleration in its rate normalisation process.   

Trump’s Latest Twist On China Trade Deal Signals That Cold War II Is In Full Swing


by Brunello Rosa

7 May 2019  

The decision by US President Donald Trump to present China with the threat of imposing a 25% tariff on all Chinese imported goods as of Friday 10th of May marks yet another twist in this seemingly endless saga of US-China trade relations. The decision led to immediate heavy losses in global equity markets (in Asia, Europe and the US) and shows that Trump is willing to sacrifice positive momentum in financial markets in order to pursue his “art of the deal.” Analysts believe this is just another tactical move to force the Chinese to sign a deal on less favourable terms, and that an eventual agreement will be reached in the next few weeks. Still, the move is risky for a number of reasons.

First, this episode could end up like the recent failure at the summit with North Korea in Vietnam. After proclaiming with great fanfare that a deal with North Korea was at hand, Trump ended up leaving the negotiating table, accusing Kim of unreasonable requests. It is not clear when the two sides will meet again. In the meantime, Russia’s Putin has entered the scene and complicated an already difficult negotiation process. So, breaking off discussions with China now could imply that a long pause will take place before China and the US continue negotiating. 

Second, by May 18th the US will have to decide whether or not start imposing tariffs on auto sector trade with European countries, most notably Germany. It is possible that the Chinese were delaying any agreement to see whether or not Trump would have the nerve to start a trade war on two fronts at the same time. But the effects of today’s decisions on financial markets show that the first victim of any delay in reaching a deal is China itself (and other Asian markets by extension) – and Trump knows it.  

If Trump were to open the European trade front while the Chinese front is still open, it could result in a severe hit to confidence in financial markets and economies in general. Trump has certainly shown that he is willing to sacrifice a few percentage points of equity valuations to pursue his negotiating strategies. 

Even if China and the US were to return to the negotiating table and reach a deal quickly, today’s episode shows that the relationship between the two sides remains fundamentally fraught. The strategic rivalry between China and the US on a number of dimensions (military, security, economic, investment, technology) is in full swing and will not be assuaged by any short-term trade deal. We have discussed how the trade conflict is only the most visible component of a much wider geo-strategic rivalry that amounts to a new Cold War, which we can call Cold War II.

It is quite likely that, as during the Cold War between the US and the Soviet Union, there will be a series of “truces” that will allow the two contending nations to gather their energy for subsequent returns to outright competition, instead of the two being able to reach any sort of comprehensive compromise that would more permanently end such competition. With a Cold War II, we risk returning to a two-bloc system in which de-globalization would occur, implying a massive reversal of the previous global integration in trade, investment, supply chains, technology and data transfers. This potential fragmentation of the world economy would have significant economic, financial and political implications. Like its predecessor, Cold War II is likely to be won by the richer, faster-growing, and larger economy. Only this time the winning country might not be the US.    

Divergences Begin Emerging Within The Synchronised Global Slowdown


 by Brunello Rosa

29 April 2019  

A couple of weeks ago, we reported our impressions of the IMF meetings in Washington. The April edition of the World Economic Outlook put an official seal on the ongoing synchronised global economic slowdown, though with a hoped-for rebound in H2 this year. Within that context, some differentiations are starting to emerge. In China, the monetary, regulatory and fiscal stimulus provided by the authorities in response to the growth slowdown that occurred in H2 last year has managed to stabilise economic activity, with growth in Q1 coming out at 6.4% y/y, slightly stronger than the 6.3% anticipated by consensus expectations. As the economy shows signs of recovery, last week the PBoC offered banks USD 39.8bn of “lower profile, more targeted medium-term loans,” signalling a shift away from broad-based easing. The stabilisation of Chinese growth is among the factors underpinning the risk-on sentiment prevailing in financial markets, with equity valuation close to their historical highs. 

In the US, recent data are more of a mixed bag. Q1 GDP growth came out at 3.2% quarterly annualised, much stronger than the 2.3% that had been expected. However, this unexpected strong performance came more from net exports and a build-up in inventories, with underlying consumption remaining weak (final sales to private domestic purchasers decelerated). This week, the April Non-Farm Payroll figures (with 180K additional jobs expected, compared to 196K in March) will show whether the deceleration in economic activity will start to have an impact on the labour market. The Fed will also hold its April FOMC meeting, and the language of the statement and the press conference by Chair Jay Powell will clarify what the most recent take of the central bank is regarding the current economic and financial situation in the US. 

Japan and Europe are providing a less reassuring picture. In Japan, given the deterioration in trade and manufacturing indicators (with April industrial production falling more than the expected -4.6% y/y), Q1 growth is expected at 0% y/y. While inflation (Tokyo CPI) has recently risen to its highest rate in four years, it remains well below the 2% target, so the BOJ has re-affirmed its commitment to low rates at least until the spring of 2020, and tweaked its policy tools to signal that more easing is possible should economic conditions worsen further.  

In Europe, Q1 GDP growth (at 0.3% q/q, 1.1% y/y) is expected to remain broadly in line with Q4 2018 readings, but the economic and political landscape continues to provide worrying signals. In Germany, the March IFO business expectations sub-index declined to 95.2 from 95.6, sending the 10y bund yield back into negative territory. For the time being, talks of the possible merger between Deutsche Bank and Commerzbank have collapsed. The deceleration in economic activity and the need to invest is reportedly prompting a shift in economic thinking, with a possible relaxation of the stringent fiscal rules. In France, President Macron’s list of promised actions resulting from “Le Grand Débat National” might be read as an act of defiance by the Gilets Jaunes. In Italy, political instability and budget uncertainty are putting BTPs under renewed stress, with the 10y BTP-bund spread returning to 270bps recently. In Spain, the election has failed once again to provide a majority to support a government in parliament, where the alt-right movement Vox has entered for the first time with 24 seats. The UK remains mired in its Brexit mess. 

Given this background, all the G10 central banks apart from Norges Bank have turned dovish, following January’s pivot by the Fed. In Sweden, the Riksbank has returned towards its traditionally dovish positions. In Canada, the BOC has announced a long pause in its normalisation process. In Australia, following a collapse of inflation in March, the RBA might cut rates in May. While for now rate cuts are off the table in the US, the market-derived probability of a Fed rate-cut in 2019 has increased this week to 74%, versus 43% last week. 

In a recent study, we discussed whether the US could decouple from Europe if the EZ ended up in recession, and established that they can, so long as the EZ shock is mild. But if the shock to the EZ is large, even the US will not be able to escape it.  

WEEKLY COLUMN - Spain Kicks Off European Election Season


by Brunello Rosa

23 April 2019  

On Sunday, Spain will go to the polls to elect a new Congreso De Los Diputados and decide 208 of the 266 seats of the Senate. As we discussed in our recent analysis, the Socialist Party (PSOE), led by incumbent Prime Minister Pedro Sanchez, is leading the polls, with support from roughly 30% of the electorate. It is ahead of the People’s Party led by the new leader Pablo Casado, which has around 20% support. Domestically, the most relevant aspect of this election is the fact that the Spanish political system, which used to be solidly bi-polar until a few years ago, has now become a 5-party system. In addition to the Socialists and the People’s Party, Podemos, Ciudadanos, and the new alt-right Vox party are the other three parties looking to win significant numbers of seats.  Even if Sanchez were to win this election, he might have a difficult time forming a government. 

In our analysis of this week’s elections we explore all the possible parliamentary coalitions that could support a government (there are a number of these as the Spanish system allows minority governments, even minority-coalition governments, to survive in parliament for the entire political term). Sanchez’ Socialists might need to form a coalition with Podemos and other regional parties in order to remain in power, which would make the government particularly fragile and exposed to opposing demands from different parties. On the other hand, while the Socialist Party might win the most seats, the People’s Party might be tempted to repeat at the national level the experiment that has been carried out in Andalusia, where a right-wing coalition was formed with Ciudadanos and Vox. In any case, political instability and fragmentation has reached the shores of Spain, and will stay there for some time yet.

At the international level, the election in Spain will be followed a few weeks later by the European elections of May 23-26. Populist parties are expected to do very well in those elections, and, if the UK takes part in them, those parties might receive a further boost from the newly-formed Brexit Party, led by Nigel Farage, the pro-Brexit leader who left politics temporarily after achieving his historical goal of setting the UK on a course to leave the EU (with the referendum in 2016). Currently, the Brexit party is leading the polls with around 27% support. Of course, the other big question mark is whether the UK will also hold a snap election ahead of the new October 31st “Halloween” Brexit deadline. 

After the European elections, Portugal will go to the polls on October 6th for a national election. Portugal’s PM Antonio Costa (leader of its Socialist Party) will try to repeat the “miracle” of 2015 when, even though his party ended up in second place, behind the Social Democratic Party, he managed to become Prime Minister by putting together what seemed initially a very unlikely coalition with the communists and the radical left. Not only did this coalition survive, it also managed to put an end to the European-imposed austerity that had fatigued the country and increased its poverty and inequality. This coalition government has also allowed the Portuguese economy to recover, and re-balance the country’s fiscal budget. For these outstanding results, former German Finance Minister Wolfgang Schaeuble said that Mario Centeno (the former Finance Minister of Costa’s government, now head of the Eurogroup) was the “Cristiano Ronaldo of the Ecofin.”

Within this European landscape, the big unknown remains Italy. Will the expected large victory by Salvini’s Lega, at the expense of Di Maio’s Five Star, lead to new elections being held in the autumn? Some press reports suggest this might be the case, but one still needs to consider that President Mattarella might be unwilling to dissolve parliament during the autumn’s budget season. At this stage, all options remain on the table.   

The IMF-World Bank Meetings: Mixed Feelings About The Global Economy


by Brunello Rosa

15 April 2019  

The IMF has just published its April edition of the World Economic Outlook (WEO) entitled “Growth Slowdown, Precarious Recovery”. The WEO notes that after a synchronised expansion in 2017 and the first half of 2018, the world has entered a synchronised slowdown, with all three of the world’s major markets are now facing economic headwinds. In the US, the effects of the fiscal stimulus that was approved at the end of 2017 are fading, and the fist fight between Democrats and President Trump over the budget, which led to the longest government shutdown on record earlier this year, are having a negative impact on the economy. So too are trade tensions and the tightening financial conditions deriving from the Fed’s policy normalisation. 

China meanwhile has been affected by its trade tensions with the US, as well as by what the IMF calls “regulatory tightening to rein in shadow banking.” And the Eurozone has lost momentum as two of the largest economies, Germany and Italy, have significantly slowed down. Germany’s economy, which narrowly avoided a recession in Q4, has slowed because of the impact of new emission standards on car manufacturing. Italy’s , which did in fact enter a technical recession in Q4, has slowed because of the higher sovereign spread’s impact on business investment and consumer confidence, and the impact of Germany’s slowdown. Elsewhere in the world, Japan’s economy too has been affected by global trade tensions, as well as by natural disasters, and emerging markets have been affected by capital outflows deriving from Fed tightening and USD strength.  

The current narrative from the IMF and the World Bank is that these headwinds will be transitory, and that the economic outlook will improve in H2 2019. This improvement is also expected to occur because of the important contribution of central banks, almost all of which have turned dovish since the Fed’s U-Turn in January, and because of the use of some of the fiscal space that is available in certain countries.  The mood prevailing among market participants and policy makers attending the IMF and World Bank Spring Meetings also seems to be aligned with this narrative. Nevertheless, some of the risks we have identified in our recent research are still present, putting the recovery in danger and making it “precarious”. 

First is the US trade dispute with China: while it seems that a deal is at hand, it has not been reached yet. Press reports suggest that China might be waiting to see if the US will launch another offensive on Europe over trade in the auto sector before signing anything. China knows that Trump cannot afford to open multiple fronts on trade, and so might be strategically delaying any deal to make it harder for Trump to lunch another offensive against it. 

Second, even the new USMCA trade deal has not been ratified yet, and the threat of the US unilaterally withdrawing from NAFTA still exists

Third, the Chinese economy is stabilising thanks to policy stimulus, but new episodes of slowing activity are always possible if this stimulus proves insufficient. In Europe, Germany’s recovery is not fully secured yet, and Italy seems on the verge of starting a new fight with Europe over the introduction of further measures of fiscal easing (such as the introduction of the flat tax) it cannot afford. In the UK, Brexit has been postponed, but lingering uncertainty continues to weigh on business investment and consumer spending

Thus far central banks have come to the rescue, making markets happy. There might be further room for this rally in risky asset prices to continue if the headwinds cited above dissipate over time. However investors should be aware that, if any of the risks mentioned above were to materialise, new risk-off episodes would be likely to occur in the months ahead. 

G10 Central Banks Have All Turned Dovish Since The Fed’s U-Turn – Except Norges Bank


 by Brunello Rosa

8 April 2019  

Since the Fed’s sudden U-turn at the January 2019 FOMC meeting, when the institution led by Jay Powell delivered a surprisingly dovish 

statement suggesting that it could enter a prolonged pause in its tightening cycle, all of the G10 central banks have followed the Fed’s lead, modifying their policy stances and becoming more dovish. The only exception to this has been Norway’s Norges Bank.

Within the G4, the Bank of England, in coincidence the release of its February Inflation Report, mimicked the Fed by indicating its own shallower tightening cycle, with potentially longer intervals likely to take place between successive rate hikes. In any case, the BOE will have to wait for the result of Brexit negotiations before doing anything

The ECB even overtook the Fed in terms of dovishness, in a sense. Instead of simply indicating that there will be a longer period before it can start increasing rates, it decided to add policy stimulus by modifying its forward guidance and announcing a new round of TLTROs. This week the ECB will hold the April meeting of its Governing Council, which could shed more light on the details of its current policy stance. The decision to provide more policy stimulus moved the ECB closer to what the BOJ’s policy stance has been. The BOJ remains extremely accommodative – and there is as yet no end in sight to such a stance, so long as core-core inflation remains this low.

Moving now to the smaller central banks in Europe, the Swiss National Bank (SNB) is the one that is most closely following the ECB. It might have a hard time if more monetary stimulus is needed to counter a new downturn. The Danish National Bank shadows the ECB via the currency peg, and so far has not changed its policy stance. The Scandinavian central banks have been among the most hawkish recently. The Riksbank slotted in a rate hike in December (somehow unexpectedly), a hike which seemed to be ill-timed and is probably now regretted by the Executive Board. 

The SEK has remained weaker than it would have been in the past, but the renewed ECB accommodation might result in lower EUR/SEK, with an impact on inflation. The Riksbank has suggested that a new hike could come in H2 this year, but we see an increasing chance that this might not happen.  As mentioned above, Norges Bank is the most hawkish among G10 central banks and is the only one that has not changed its stance towards a more dovish position. It recently delivered a rate hike and, in line with our view, indicated that more tightening is coming in H2.

Moving to Oceania, in February (following the Fed) the RBA altered its policy stance and moved from a tightening bias to a neutral position, joining the RBNZ which had instead decided to stay put on that occasion. In March, the RBNZ altered its position in line with the Fed and indicated that its next move is likely to be a rate cut. In our view, this move put pressure on the RBA to also shift the balance of risks of its neutral stance to the downside. Indeed this is what happened in April, when central bank governor Philip Lowe changed a few words of the policy statement accompanying the decision to keep rate unchanged, to suggest that the RBA could be considering rate cuts much more closely than it has done so far

The Fed’s move has also had an impact on EM central banks. As we discussed in our recent Strategic Asset Allocation update, the more dovish stance taken by the Fed opens up policy space for shallower tightening cycles or even rate cuts by central banks that are less concerned about their currencies weakening relative to the USD. The recent decision by the Reserve Bank of India to cut its policy rate from 6.25% to 6% (the second cut in three months) is an example of this already beginning to take place.  

Uncertainty Weighs On The Macro and Market Environment And Necessitates Policy Easing


by Brunello Rosa

1 April 2019  

A growing number of policy and macroeconomic uncertainties are weighing on household and business confidence and, by extension, are weighing on global economic activity. Between the world’s major superpowers (US and China) there is a trade dispute that remains unresolved, and the two sides admit that it might take months before a deal that can satisfy both sides is finally struck. Meanwhile Italy is making side deals with China regarding China’s Belt and Road Initiative, a move that has infuriated its American and European partners alike. In Europe, the Brexit saga is getting more and more complicated, with Britain’s parliament having rejected for a third time the deal its prime minister negotiated with the EU. There are less than two weeks left before the UK crashes out of the EU without any formal arrangement; EU Council President Donald Tusk has called an extraordinary summit for April 10th. Theresa May is likely to try to push her deal through parliament for a fourth time before giving up. If she fails to do so, then a further extension of Article 50, snap elections, or a new referendum cannot be ruled out. 

All of this is occurring just a few months before crucial EU elections will take place, elections in which populist parties are expected to do very well an could potentially bring about a radical shift in the European policymaking. Perhaps a small sign of hope came last week, with the election of a pro-European, anti-corruption candidate, Zuzana Caputova, as president of Slovakia, breaking for the first time the unity of the fiercely anti-European Viségrad group (the group of countries that includes Poland, Hungary, Slovakia and Czechia).

In emerging markets, local elections in Turkey were held yesterday at a time of renewed tensions for the Lira. The central bank in effect increased the policy rate to 25.5% by suspending the regular 1-week repo auctions (priced at 24%), thereby forcing banks to borrow through the O/N lending facility. In Ukraine, the first round of a presidential election could result in the victory of the comedian Volodymyr Zelensky, who has almost no political experience to oversee the ongoing results of the tragic developments that have taken place in the country during the last few years.  

This is just a sampling of events currently weighing on investor and consumer confidence, as economic growth is slowing down globally and inflation is falling back below central bank targets. Where some policy space is available (and sometimes even where it is not), governments are trying to cushion economic activity with fiscal support. Equally, central banks have all turned dovish, have paused their tightening cycles, or are prepared to cut rates again if necessary, at the same time as yield curves are (chiefly in the US) becoming inverted. As we discussed in our recent analysis, the Fed might even amend its inflation targeting regime to make sure that lost inflation does not become foregone (sometimes called bygone) inflation. 

The ECB recently provided more accommodation, and, at its recent Watchers conference in Frankfurt, confirmed that it is looking at measures to protect bank profitability from rates being low for a longer period of time. The BOE again left its rates unchanged at its MPC meeting in March, knowing that the key driver of any future move will be the outcome of the Brexit process. The RBNZ has just updated its forward guidance and indicated that its next move is likely to be a cut, putting pressure on the RBA to move the balance of risks to the downside. In EMs, central banks have less pressure to defend their currencies from an appreciating dollar, given the recent dovish U-turn by the Fed. Some of them are ready to cut rates in coming months, as inflation has generally fallen within a manageable 5-10% range. 

As we discussed in our latest Strategic Asset Allocation and Market Update, risky asset prices will be supported by reduced liquidity withdrawal by central banks, even as these asset prices remain vulnerable to bouts of volatility. In such an environment, investors will likely maintain a defensive risk profile, and continue to focus on and prioritize capital preservation above other investment goals.  

China’s Belt and Road Initiative: Is Italy “Open For Business” or “Up For Sale”?


Sources: NDRC, Commerce Ministry, Digital Silk Road Project, IMF,  

by Brunello Rosa

25 March 2019  

China’s President Xi Jinping and Italy’s Prime Minister Giuseppe Conte were present at a ceremony in Rome on Friday, in which 29 protocols of a “non-binding” Memorandum of Understanding (MoU) were signed by several members of their two governments. The protocols cover areas including agriculture, e-commerce, satellites, beef and pork imports, media, culture, banking, natural gas, steel, science and innovation. They also set up a dialogue mechanism between the two countries’ respective finance ministers. Among the various deals signed between China and Italy were two port management agreements between China Communications Construction and the ports of Trieste (which is situated in the northern Adriatic Sea) and Genoa, which is Italy’s biggest seaport. Luigi Di Maio, Italy’s deputy prime minister, said that the value of the various deals is around EUR2.5bn, with the potential of rising to EUR 20bn over time, if and as Italy succeeds in its intention to rebalance the trade deficit it has with China by increasing Italian exports to China as well as Chinese investment in Italy.

This Memorandum of Understanding has raised more than one eyebrow in Europe and in Washington, as Italy is the first G7 country and the largest country in the EU and Eurozone to have yet signed up for China’s flagship Belt and Road Initiative (BRI). The EU has re-affirmed that China is a “strategic rival” of the EU, and the US fears that Rome might be weakening its traditional Western ties with NATO, the EU and the Eurozone. Press reports preceding Xi’s trip to Rome suggested that Italy’s top-ranking officials had discussed with their Chinese counterparts the possibility of China buying Italian sovereign debt (which is the third largest amount of sovereign debt in the world). Italy’s European partners have warned the country not to fall into a “debt trap” in which its strategic decisions would eventually be made by the owner of its sovereign debt rather than decided upon by the Italian government.

The reason for China to sign such a deal is obvious: Xi will be able to show, both domestically and to his strategic rivals (particularly the US), that he managed to bring a large G7, NATO and EU member country to China’s side in the BRI, which is regarded as the most important Chinese geostrategic initiative. The level of commercial commitment China is making with this deal is minimal (as its effects will only be produced over a long period of time), while the political prize of the deal (prestige, which is being realized immediately) is huge. When Xi will get to Paris this week, the tune will be different. France, Germany and Brussels are worried about China scooping up strategic European assets, so they are likely to impose restrictions – albeit less draconian than the US ones – to Chinese takeovers of strategic European assets. France and Germany are also trying to build European champions to avoid US and China dominate key industries.

Now, why would Italy sign such a memorandum? There are several explanations. First, historically the starting point of the Silk Road (or its terminus, depending on which direction you were travelling) was Venice, the city from which the explorer and merchant Marco Polo departed to discover China, in what President Xi labelled as the first contact between China and Western civilisation. So, one cannot be surprised if China views Trieste’s port (near Venice) as the end of a modern “sea road”. Trieste is strategically important for China because it offers a connection from the Mediterranean to landlocked countries such as Austria, Hungary, the Czech Republic, Slovakia and Serbia, all of which are markets China hopes to reach through its BRI. 

Secondly, Italy has been known for decades for its ability to have friendly relationships with strategic rivals: the USA and the Soviet Union, Iran and Iraq, Israel and the Palestinians, etc. (This is a reason why often Italian troops are used in peace-keeping operations by the United Nations). Italy could very much remain a loyal member of the Western alliance while also doing business and even signing deals of this kind with China. (Indeed, the US itself, while remaining the cornerstone of the Western alliance, is seeking to sign an MoU with China to end the ongoing trade war. And the largest holder of US sovereign debt is China). Third, a stagnating economy like Italy needs to show it is “open for business” if it wants to attract foreign investment, including from China. 

Yet there are also risks involved in signing this deal. Foremost of these would be China gaining a level of geo-strategic influence in Europe much greater than the acquisition of Greece’s port of Piraeus allowed it at the end of the Greek economic crisis in 2015. Another risk is that, with Italy already taking an ambiguous stance vis-à-vis its position versus the EU and Russia, Italy risks not being considered a loyal partner to Europe, and instead is perceived to be, in effect, “up for sale” to the  highest bidder, no matter who that might be. 

Third, this entire story shows – once again – how weak the European construction is when it is comes to defending common European interests. In a world that is increasingly becoming bi-polar, wherein countries have to pledge their alliance to either the US or China, the EU could play a vital role in presenting itself as a global actor pushing for peace, prosperity, the welfare state, democracy and environmental protection. Yet when EU countries do not work together, they have little leverage to advance even their own positions. Unless the EU completes its transition towards becoming a cohesive political entity, it will not be able to play a positive global role in coming years.   Sources: NDRC, Commerce Ministry, Digital Silk Road Project, IMF,  

A US-China Trade Agreement Might Not Be Good News for Europe (or the World)


by Brunello Rosa

18 March 2019  

With US-China trade negotiations being granted a deadline extension by President Trump on March 1st, it seems that an agreement between China and the US on their long-lasting trade disputes could finally be at hand. What might the elements of the deal include? In brief, the deal could include a commitment by China to increase its import from the US, while the US is granted increased access to the Chinese market, more protection for its intellectual property, reduced technology transfer via obligatory joint ventures, and other similar guarantees. If we only focus on the quantitative aspects of such an agreement, we could brutally summarise it as follows: China would commit to buy more stuff from the US and the US will be able to sell more stuff to China. (That is, after all, the way to reduce the US’ trade deficit with China, which recently reached an all-time high). 

Now, would this be a good deal for the world economy? On the one hand, reduced trade tensions would mean less volatility in markets, which could be beneficial for developed economies and emerging markets (EMs) both. Less protectionism would also imply a reduced drag on global growth, which in turn might also imply higher prices for certain commodities, another factor that could be beneficial for commodity-exporting Ems. (Moreover, so long as commodity prices do not increase too much, this would not necessarily impact DMs too negatively). As part of the trade deal China might also commit to stabilizing its trade-weighted exchange rate and allowing more transparency regarding its reserves and reserve policy. Trade-weighted currency stabilization would be better for Europe than China pegging to the US dollar alone, which tends to hurt the Eurozone at times when the dollar is weak.

On the other hand, not all that shines is gold. Even if a temporary agreement were to be agreed on between China and the US, the cold war between the two global geopolitical superpowers will continue. The sub-components of this wider rivalry, such as the technological competition between them and the balkanisation of the global supply chains, will also continue, and, as the recent row around Italy’s memorandum with China on the Belt and Road Initiative may show, other countries and regions will be forced to choose sides between either the US or China.  

In addition, there might be direct losers from a US-China deal of this sort. If China commits to buying more goods from the US, other countries’ exports to China might suffer, especially countries or regions which have economies that are export-led, such as Japan and the Eurozone. If China also commits to buying more US goods such as soybeans, fossil fuels, and other commodities, exporting EMs may suffer as well. Thirdly, as we discussed in a recent column, if the US and China come to an agreement , Trump will then be able to devote his full attention to an attack on Germany and its car industry (another popular bipartisan subject in the US), threatening to slap tariffs on US car imports in order to strongarm the Germans into taking a deal that is advantageous to the US.

As we discussed in recent reports, both Japan and Europe are now undergoing a severe economic slowdown, which is having important political repercussions. Germany’s slowdown means that other countries in its supply chain, such as Italy, are already in a recession. EMs are stabilising after a difficult 2018 thanks to the Fed’s more dovish stance. If those economies were to suffer again, possibly falling into a recession, the world economy as a whole would be affected, being then able to rely only on the US and China, both of which are also slowing down economically. 

Germany could seize the opportunity to rethink its business model and become less dependent on foreign demand. But that would mean revitalising its domestic demand and promoting the transformation of the EU and the Eurozone into full-fledged transfer unions (perhaps organised in concentric circles), with a vibrant internal market like the US. However, as we discussed in our recent Europe Update this seems very unlikely to happen in the near future. This will leave Europe, Japan, EMs and the world vulnerable to the volatile mood of the US president.

WEEKLY COLUMN - A Crucial, But Not Yet Critical, Week For Brexit And The UK


by Brunello Rosa

11 March 2019  

This will be one of the most crucial weeks yet in the entire Brexit process: On Tuesday March 12th there will be a second “meaningful” vote on Theresa May’s deal. The aim of the government is to present a revised version of the deal, on which the UK and EU have worked over the weekend. The UK is seeking legally binding reassurances that the backstop solution for Northern Ireland will be temporary. The EU has made it clear that it cannot re-open negotiations for the withdrawal treaty, yet seems willing to compromise. If the vote is in favour of May’s deal, the UK will leave the EU on March 29th as planned, but am “implementation” period lasting until December 2020 will ensure a smooth transition and allow the UK to reach a final arrangement with the EU. Theresa May is pledging resources for the constituencies in which current Labour MPs might be willing to vote in favour of her deal. As discussed in our recent update, if Labour decides to allow some defectors within its own party to vote in favour of May’s deal, this strategy could pay off.

If the result of this vote goes against the deal like the previous vote did, yet another vote will take place on Wednesday March 13, as the UK parliament will have to decide whether or not it is in favour of exiting the EU with no deal whatsoever. We expect the UK parliament to reject the possibility of the no-deal Brexit that the hardline Brexiteers want. There does not seem to be a majority in favour of it. On the same day, the UK Chancellor of the Exchequer will make its Spring Statement (i.e. a budget update), where revised growth and inflation forecasts will determine whether the UK’s fiscal trajectory is still in line with the October budget.  Chancellor Philip Hammond will reiterate that the UK has plenty of fiscal resources to counter a potential no-deal scenario and cushion the economy against a possible crash. If for any reason the UK were to crash out of the EU without a deal, the figures of the Spring Statement update would quickly be thrown out of the window and a fresh, emergency budget would need to be passed. 

On Thursday March 14th, the UK parliament will vote to authorise a possible extension of Article 50, which would be the logical course of action in the event that its elected officials vote to reject May’s deal on Tuesday and then vote against a no-deal Brexit on Wednesday. The EU is ready to provide a short (2 or 3 month) extension, but wants to be sure that the UK parliament will spend that time trying to converge towards a definite solution, so this cannot be taken for granted at this stage. The UK might also be blackmailed by all other European countries into conceding their vote in favour of the extension (which needs to be voted unanimously for by the remaining 27 EU countries). So, even if parliament authorised the government to ask the EU for an extension, such a request would be unlikely to be sent to Brussels until the very last minute, in order for the UK not to end up in such an uncomfortable position.

What this suggests is that this week might not be the truly definitive week in which to decide the fate of Brexit, crucial though these votes may be. As discussed in our recent Europe Update, it is still  uncertain whether or not May will manage to pass her revised deal through parliament, but even if we were to assume that her deal is rejected, and that parliament then votes against a “no deal” Brexit and in favour of seeking to extend Article 50, it would still be quite possible that the final word on this issue will only come at the very last minute, before the real deadline on March 28-29. This sort of final-hour decision has happened in a number of EU negotiations during the past few years. 

A Fed "Collar" To Support Markets in 2019


by Brunello Rosa

4 March 2019  

During the 1990s, the tendency by the US Federal Reserve to backstop the stock market was named “Greenspan’s put”, after the then-chairman Alan Greenspan. This was named for the option strategy by which the buyer of a “protective put” has the right to sell the underlying asset at a pre-determined “strike” price. If equity prices fell more than 20%, the Fed led by Greenspan would cut rates to allow equity prices to bounce back (since equity valuations would be inflated by a lower discount rate). This happened on occasions such as the “Savings and Loans” crisis in 1986, the stock market crash in 1987, the Asian financial crisis in 1997, and the dot-com bubble bursting in 2000. 

When Ben Bernanke succeeded Greenspan in 2006, he inherited this put (which duly became the “Bernanke’s put”). This was proved by the decision to slash Fed funds rates to zero during the global financial crisis of 2008 following the collapse of the US housing market and sub-prime mortgages. But in December 2015 the Fed timidly started to normalise its policy rates, bringing them to 2.50% by the end of last year. As we discussed in our review of the FOMC meeting held then, the market was very upset by the Fed’s decision to increase its target range by 25bps to 2.25%-2.50%. That action was accompanied by a press conference by Fed Chairman Jay Powell that was considered too hawkish, in spite of the reduction in expected additional rates increases signalled by the “Dot Plot”. As a result, equity markets collapsed at the end of last year. In January this year, the unexpected U-turn by the Fed, which wiped out any indication of further monetary tightening, marked the return of the Fed’s “put”, according to some market commentators. 

In our recent analysis by Alessandro Magnoli Bocchi, we discuss why we do not believe the FOMC’s U-turn marks the arrival of “Powell’s put” on the market, but rather the implementation of a “collar” strategy, aimed at supporting the market to the downside while limiting the upside. A collar option strategy, which provides a pay-off at expiration like the one depicted in the picture above, is obtained by financing the purchase of a traditional (protective) put option by selling a call option with a higher strike price. This way, if the price of the underlying asset (say, the S&P 500 index) falls below the level of the put’s strike price, the buyer of the put option is protected (its protection getting larger as the size of the stock market’s fall increases). If instead the stock market index rises above the strike price of the sold call option, the upside is limited as the seller of the option will have to pay the difference between the strike price and the level of the stock market index. 

In fact, we expect the Fed to protect the downside, as it did in January, but not unconditionally and not to the point of inflating a stock market rally that could reignite inflation and financial stability fears. If core inflation were to again rise above 2% (for example as a result of higher wages deriving from the current tight labour market) the Fed would not hesitate in raising rates again, thus likely limiting the possibility of further rapid increases in stock market prices. Thus, in our view the Fed is more likely to introduce pauses in its tightening cycles rather than cutting rates. We re-affirm our view that 2019 will be a transition year characterised by looser monetary (and fiscal) policy, endogenously responding to the macroeconomic slowdown and weakness in risky asset prices. 

The Fed is not alone in taking this approach. The ECB as well is likely to shift towards a more accommodative approach when the Governing Council meets this week, while the Bank of Canada and the Reserve Bank of Australia too are likely to remain on hold this week. 

Key Deadlines Are Pushed Back This Week


by Brunello Rosa

25 February 2019  

Two crucial deadlines were looming this week: US-China trade talks on March 1st and the second meaningful vote on Brexit on February 28th. 

Regarding US-China trade talks, Donald Trump said the US could extend the negotiations (perhaps by 30 or 60 days) from the March 1st deadline and meet with President Xi Jinping at Mar-a-Lago after the National People’s Congress on March 5th, given the progress made. 

Negotiators are preparing six Memorandums of Understanding (MoUs) on key structural issues such as: forced technology transfer and cyber theft; intellectual property rights; services; currency manipulation; agriculture; and non-tariff trade barriers. 

Later, in April, the Department of the Treasury will issue its semiannual report to Congress of its reviews of developments in international economic and exchange rate policies across the United States’ major trading partners. In its latest issue of October 2018, the US refrained from labelling China as a “currency manipulator” (as it did between 1992 and 1994), while reiterating that China’s foreign-exchange practices deserved close monitoring, especially in light of the recent weakening of the renminbi. If sufficient progress is not made in the US-China trade talks, it is likely that the US will start branding China as a currency manipulator again, thereby justifying a series of retaliatory actions. Interestingly, also in the list of countries deserving close monitoring is Germany (for its large current account surplus), confirming that Germany might be the target for the US’ next round of trade wars (as discussed in last week’s column).

Regarding Brexit, Theresa May announced on Sunday that a second meaningful vote by parliament will be held on March 12th, instead of February 28th; in other words, just a couple of weeks before the official Brexit deadline on March 29th. Scheduling the second vote so close to the deadline is clearly intended to put pressure on MPs to accept Theresa May’s revised deal, or else face a no-deal Brexit. MPs are getting increasingly nervous from this approach by the PM and are openly rebelling against it, with three cabinet ministers threatening to vote against a proposal that allows a no-deal Brexit to occur. Meanwhile, a new Independent Group of MPs was  created in the House of Commons, formed by nine former Labour party members and three Tories. This group is already larger than the delegation of Lib-Dems and of the DUP (which props up May’s majority) in the Commons and might end up holding the balance of power in the final vote, especially if it grows further.


Theresa May is convinced that, in the end, a last-minute deal relaxing the terms of the Irish backstop (either with a time limit, or with the possibility of unilateral withdrawal, or with an additional legal document making clear that the UK would not be kept permanently in the arrangement) will be made with the EU. In Brussels, the sentiment is less sanguine. We believe an agreement will eventually be found – perhaps after an extension of Article 50 by three months, but the risk of a “Br-accident” is increasing. 

This protracted uncertainty regarding key issues, together with the global economic slowdown, is weighing on investor sentiment and pushing an increasing number of central banks to dilute their normalization plans. After the Fed, the ECB, and other major central banks, the RBA has also now dropped its hiking bias and has a neutral stance, joining the RBNZ in such a position. Among G10 economies, the only central bank that still has not made any move is the Swiss National Bank, which risks having to fight increasing domestic and international risks with little policy ammunition.  

Trump’s Never-Ending Trade Wars: Germany Is Next In Line


by Brunello Rosa

18 February 2019  

On March 1th, the truce between US and China that was agreed to regarding their bilateral trade war will officially end, as will the time available to reach an agreement to avoid increasing tariffs from 10% to 25% on USD200bn of Chinese exports to the US. Officials from both sides seem to suggest that a deal might be in sight, nevertheless a number of issues will remain open. Most important of these is that any agreement will be temporary, as the underlying cold war between the US and China will continue to be waged on different battlefields, as we have discussed in previous columns and research papers. In particular, the two countries will continue to compete intensely over technology (as the ongoing Huawei case proves). 

In addition, the implementation of any plan to reduce the bilateral trade imbalance between China and the US will not be frictionless. Regardless of whether China agrees to import more from the US, or export less to the US, there might be severe consequences on global trade flows, technological transfers, CNY and USD valuations, the level of Chinese reserves of US Treasuries, long-term US Treasury yields and, ultimately, global price and financial stability. The optimal strategy of pursuing global free trade with flexible exchange rates on a multilateral basis (for example by continuing to push China towards greater openness of its capital account) does not seem at hand in an increasingly protectionist world dominated by strongmen.   

However, let us assume for the time being that some sort of deal between US and China is achieved by March 1st. Will this mean peace at last in the global economy? 

To the contrary, it will probably mean that, with one front temporarily closed, Trump will instead start devoting its full attention to another “trade war” close to his heart: the international auto sector, the most notable victims of which would be European and Asian producers, were the US to raise tariffs. In fact, President Trump will soon receive a report from the US Department of Commerce addressing his question of whether imports of cars pose a threat to national security. It is not yet known what the report, expected to be sent by February 17th, will recommend the president to do, but it is very likely that it will offer a range of options, including imposing quotas or voluntary export restrictions, or tariffs. The one thing that Trump managed to obtain with the transformation of NAFTA into USMCA is less favourable conditions for producers to export cars to the US. He is likely to want to adopt a similar stance towards other car producers, particularly German ones. 

In fact, it is almost certain that among the biggest losers of the upcoming round of trade wars will be Germany, the economy of which – as we discuss in our recent trip report – is already suffering from a deteriorated external environment. The slowdown in Germany is affecting the entire Eurozone economy, with the more fragile countries, such as Italy, having already entered a recession. At the Munich Security Conference just concluded, the US and Germany have further exposed the fact that they have opposing views regarding global security, as expressed by Chancellor Merkel and Vice-President Pence. We would not be surprised if a US trade war with Germany over the auto sector become just another example of geopolitical diplomacy, fought with different weapons.   

The Rise of the “Populist International”, And What This Means For The World


Picture from the “Populism Research Group” at Loughborough University 

by Brunello Rosa

11 February 2019

Eduardo Bolsonaro, one of the sons of Brazil’s newly elected president Jair Bolsonaro, was chosen as the head of “The Movement” in Latin America last week. “The Movement” is the organisation created by Steve Bannon, former advisor to US President Donald Trump and Chief Strategist at the White House, to coordinate the activities of populist groups and political parties around the world. It is expected to be launched with an event in Brussels in March. 

In effect, “The Movement” aims at creating a unifying ideology for the various populist experiments around the world, connecting groups which thus far have been mostly disconnected from one another (in part, because they tend to have a nationalistic bias, which has made it harder for them to be “internationalists” working together to promote similar goals). Their manifesto is clear: “We stand together in our pursuit of a populist nationalist agenda for prosperity and sovereignty for citizens throughout the world.”

The creation of “The Movement” and its official expansion in Latin America marks the formal launch of what we have called, in our previous columns and recent analysis, the Populist International. Its motto could be “Populists of the World, Unite!” There is no hidden agenda here: the Populist International aims to “reclaim sovereignty from progressive globalist elitist forces and expand common sense nationalism,” against the “globalist world order,” with “governments re-asserting their sovereignty…against the dangerous [United Nations’] Global Pact on Migration.”      

What could the implications for the world be if the Populist International were to become established and eventually succeed in implementing its agenda? In our recent analysis, we discussed how, in Europe, this could mean that the process of dis-integration, which is ongoing and is accelerating with Brexit, could continue and eventually lead to a continent that, instead of being orderly organised in concentric circles, might re-group itself into clusters, with the strongest of these being one formed around Germany and its core allies. Such an outcome would have massive macroeconomic and financial implications, which we describe in detail. In Latin America, a success of the initiatives promoted by “The Movement” would likely accelerate the ongoing shift of political systems from populist regimes of the left to authoritarian regimes of the right (discussed in our column last week). This might have implications for commodity price, including oil, considering that Latin American countries are among the major commodity exporters (and China among the key importers). 

At the global level, the success of populist/nationalist policies would likely favour the rise or further strengthening of “strongmen”, who are already populating the world scene. The first victim of strongmen tends to be the independence of regulatory bodies and central banks. Sometimes markets like strongmen, but markets also tend to stigmatise and punish those regimes in which central bank independence is, or appears to be, compromised. Typically markets do this by selling off such countries’ currencies (Turkey being the most notable recent example). In addition, the autarkic solutions, generally favoured by strongman at national level, are not compatible with each other at the international level, and this tends to create geopolitical tensions, which eventually weigh on market sentiment.

WEEKLY COLUMN - Venezuela and the Shifting Tectonic Plates of Geopolitics


by Brunello Rosa

4 February 2019  

Recent events in Venezuela show that the world’s geopolitical tectonic plates continue to move. Whether or not Juan Guaidó succeeds in becoming the country’s next president (and if so, whether that will happen peacefully or only after another bloodbath) is yet to be determined. Clearly the missing link in Guaidó s puzzle is the support of the army: if he were to receive that, his ascension to power would soon be completed, with or without another election being held. But the fact that all of the world’s major powers took a position on the Venezuelan saga suggests that something is going on there that is much deeper than a typical power struggle inside of a medium-sized Latin American country.

Guaidó could not have made the bold move he did without receiving the direct or indirect support of the US, which was in fact the first country to recognize him as president (followed shortly by the UK and Canada; several major European countries are threatening to do the same, unless Maduro calls new presidential elections). Taking the opposite position, Russia, China, and Turkey stood by Maduro. John Bolton, President Trump’s National Security Adviser, said that US oil companies are ready to invest in Venezuela, which has the largest oil reserves in the world. Still, this political saga is not only about oil. 

The world’s geopolitical order is changing. Trump’s decision to leave Syria (against the advice of his former Defence Secretary James Mattis), in conjunction with his decision to back Guaidó in Venezuela, could be viewed as a move to re-pivot US attention to Latin America, after many years of neglecting the region. As we discussed in previous columns, a number of Latin American countries seem ready to rapidly switch from populist or authoritarian regimes of the left (with Chavez and Maduro being primary examples) to populist or authoritarian regimes of the right (with Brazil’s Bolsonaro being the primary example). Political shifts of this kind have already occurred in Brazil and Colombia. Venezuela seems ripe for a similar transition, and other countries in the region, such as Argentina, might follow suit.   

If the US refocuses on Latin America, which it has considered to be its backyard since US President Monroe, other global powers seem quite unlikely to be able to counter this shift. Russia has recently made it clear that Venezuela will not be another Syria. China for the time being is mostly using only its economic position to exert influence in Latin America, for example by being among the major importers of the region’s natural resources. China however is also focusing its attention on the Belt and Road Initiative (BRI), which will imply a massive influence in Asian and African countries. As Parag Khanna discusses in his recent book, the major geopolitical arena of this century will be Afro-Eurasia, given the influence that China and India will have on a number of African countries. 

So far, the response of the US after Obama (who tried his own pivot to Asia)  has been inward looking: pull out of the Middle East, weaken NATO and the EU, re-focus on Latin America and attempt to build a wall along the border with Mexico. However, this tactical response might prove insufficient, unless the US wants to give up its global supremacy sooner than it otherwise would. The US might soon re-discover the importance of the Western alliance with Europe, the importance of maintaining influence in the Middle East, the importance of making sure that China does not promote regime changes in Africa and excessively influence regions like Latin America economically. Accomplishing these goals would likely require a new political leadership in the US, with a different view of the world. 

With Market Sentiment Subdued Even in Davos, Central Banks Are Becoming More Cautious


by Brunello Rosa

28 January 2019  

The 2019 annual meeting of the World Economic Forum highlighted a number of themes and risks, most of them related to the effects of climate change on the global environment and its repercussions for human conditions and economic activity. Participants highlighted rising political and geopolitical risks (as exemplified by the recent leadership challenge in Venezuela,

which is polarising the positions of the most influential nations in the world), as well as the possibility of a bursting bubble in risky asset prices. 

Overall, the sentiment of market participants and policy makers was quite subdued, in spite of the underlying optimism encouraged by the prospects of the Fourth Industrial Revolution (a theme launched by the Forum’s founder, Klaus Schwab). Nouriel Roubini presented R&R’s views on the possibility of a new global financial crisis and recession taking place in 2020 and found a very attentive audience, much less sceptical than it was in 2006 when he predicted the Global Financial Crisis of 2008. Having said that, sentiment in the Forum has been in the past a contrarian indicator of eventual outcomes, as participants might tend to have adaptive, rather than forward-looking expectations. 

Within the context of a weakening global economic expansion, the endogenous policy response we expected to take place is materialising. Last week the Bank of Japan left its policy stance unchanged but downwardly revised its inflation projections, suggesting that it might remain on autopilot even beyond spring this year. The ECB, meanwhile, downgraded its risk distribution around the growth projections from “balanced” to “negative”, suggesting that it might take longer before starting to normalise rates, and that new forms of monetary stimulus (such as a new round of (T)LTROs) might be adopted quite soon. 

In its first January press conference this week, we expect the Fed to signal (without pre-committing) the possibility that a pause in the tightening cycle might take place as early as March. Conversely, confirming its hawkish bias, Norges Bank left its policy stance unchanged but confirmed that a new rate increase might still occur in March.   

Financial markets are buffeted by worries about the weakening global economy, rising geopolitical risks, and the endogenous policy response that these risks are generating. For the time being, they are still recovering the losses made in the last few weeks of 2018, but have not yet completed that process. As we said in previous columns, 2019 will be all about this tug of war between bad macro and geopolitical news on the one hand and policy responses on the other. By 2020 it should be clearer which of the two sides has prevailed. 

Certainly, a risk that is worth monitoring is the solidity of the global financial system, of which banks are a crucial component. In 2008, the fragile global banking system was the propagator of the financial crisis, triggered by the small sub-prime mortgage market. In 2019, banks are generally better capitalised, with sounder business models, and with higher levels of liquidity to face sudden market reversals. However, as some notable examples have shown in recent months, banks nevertheless remain exposed to all sorts of risks: market, credit (with particular reference to the leveraged loan market), reputational, legal, business. In our recent report on the future of banking, we discuss all these risks and suggest the market implications of these developments.

It is not yet known whether a new global financial crisis is coming. Certainly, if banks will once again be part of the problem instead of the solution, such a crisis is likely to be much worse than it would be otherwise. We hope this is not going to be the case. 

Short-Term Macro Wobbles, Long-Term Demographic Issues


by Brunello Rosa

21 January 2019  

The global economy continues to decelerate. As a result of its longest ever government shutdown, US growth is likely to suffer in the coming months. (US PMI’s are expected to show this starting this week). The glimmers of hope coming from US-China trade talks, with China offering to increase its imports from the US to USD 1tn in the next six years (from 190bn in 2018), might not be enough to stop this deceleration, in the absence of fiscal and monetary stimulus. In China, Q4 GDP figures this week are expected to confirm a deceleration from 6.5% to 6.4% y-o-y, led by a contraction in exports. In the Eurozone, Germany’s preliminary GDP growth figures showed a deceleration to 1.5% in 2018 (down from 2.2% in 2017), after its GDP contracted in Q3. 

According to Banca d’Italia, Italy seems destined for a technical recession, its GDP having contracted in Q4 2018 after also doing so in Q3. The central bank has updated its forecast for Italy’s GDP growth in 2019 to 0.6%, a pace of growth that is only about half of the most recent 1% growth forecasted by the country’s government (a forecast that does not even rule out the possibility of a supplementary budget during the year, in order to realign Italy’s fiscal deficit to the level agreed upon with the EU). 

Given these decelerating conditions, and considering that inflation remains easily in check, short-term policy responses are underway. Last week, the PBoC injected a net CNY 560bn (USD 83bn) into its banking system, the highest amount ever recorded in a single day. Next week, the Fed is likely to provide further hints about a pause in its tightening cycle. This week, the ECB should acknowledge the ongoing economic deceleration and suggest continued or increased gradualism regarding its exit from the extraordinary accommodation it has provided in the last five years. 

Also this week, we expect the BoJ not to take any meaningful action while downwardly revising its growth and inflation outlook. We also expect Norges Bank not to move this week while confirming its forward guidance for a hike to take place in March. In the UK, on Monday the government will present its Plan B for Brexit, but no vote is expected until next week. The BoE remains ready for any eventuality. Considering these moves, markets are having a bit of respite: risky asset prices are slowly recovering the losses they experienced at the end of last year.   

Underlying these short-term wobbles are much deeper economic challenges. In our recent in-depth report on demographics, we discuss how current demographic trends tend to impact economic and political developments, policy choices and market outcomes more profoundly than short-term policy (monetary, fiscal, regulatory) fixes. In our global overview, we look at demographic developments in the US, Latin America, Europe and Asia, finding that most of the policy choices we see being made today are already partly the result of underlying trends that have been in place for decades. The coming generation of policymakers will be bounded and constrained by these persistent trends. The moral of the story here is quite simple. While managing short-term macroeconomic developments, policy makers should also address long-term issues. Otherwise, the challenges these long-term issues pose will eventually become insurmountable by conventional instruments. 

Clouds Are Gathering On The Horizon


by Brunello Rosa

14 January 2019  

As we discuss in greater detail on page two of this ViewsLetter (below – for the website), clouds are starting to gather for the global economy. In the US, the stalemate in Congress regarding the budget, in particular the controversial USD 5bn financing for the wall at the border between US and Mexico, has caused a government shutdown that is now entering its fourth week, becoming the longest in US history. Apart from the obvious collapse in the provision of services (in airports, national parks, museums and other publicly-managed organisations), the pain is starting to be felt by 420,000 government employees, whose payslip are showing “zero salaries” for most of them. All this will eventually have a macroeconomic impact, when the figures for Q4 2018 and Q1 2019 growth will be released in coming months.

In Europe, the situation is not much rosier: industrial production in the largest Eurozone economies (Germany, France, Italy) has collapsed recently, partly as a result of the difficulties of German car manufacturers to adapt to new emission standards. In France, the protest of the Yellow Vest continues to be intense, and is putting pressure on President Macron. In Italy, after the contraction recorded in Q3, there is a serious risk that Q4 2018 GDP growth will also witness a negative growth figure. That would mark the beginning of a technical recession in Italy (so much for the supposedly expansionary policies of the new populist government). In the UK, it is almost certain that Theresa May’s deal with the EU will be voted down by parliament, marking the beginning of a political crisis that will be protracted for weeks, and will likely have severe economic repercussions. 

In Emerging Markets, the situation remains problematic: China is undergoing an economic slowdown resulting from the trade tensions of 2018 have yet to be reversed, in spite of the expansionary (fiscal, monetary and credit policies) adopted by the authorities. Glimmers of hope derive from the unexpected extension of trade talks with the US, but make no mistake – whatever deal can be agreed on will only be partial and temporary; the cold war between the US and China is set to continue for decades. In Brazil, Bolsonaro’s government has yet to show its true colours, but the market is giving it the benefit of the doubt. Regarding Turkey, our latest scenario analysis discusses the evolution of the country over the next few years. We do not expect a real stabilisation to begin before the local elections there in March.

Given this background, it is not a surprise that the World Bank (whose president’s impending departure in February has opened a complicated transition phase) has revised lower its global growth forecasts. How are policymakers and financial markets reacting to all this? 

As one might expect, an endogenous policy response has already begun. The Fed has signalled that it can be more patient in policy tightening cycle, making a pause in March more likely. The Bank of Canada has kept its policy rate on hold in January, as it did in December. The ECB and BOJ are currently on autopilot, and the BOE is ready to react to Brexit developments in any way that may be needed, so its tightening cycle is on pause until May at the earliest. With central banks more cautious regarding the withdrawal of liquidity, risky asset prices could take a breath: equity prices are slowly recovering the losses they suffered in the final few weeks of December. This is what 2019 will be: a transition year between the 2017-18 expansion and a possible crisis and recession in 2020. Financial markets will be cushioned from the effects of bad economic and geopolitical news by the endogenous policy response.

This Week, Activity Resumes in Full Swing


by Brunello Rosa

7 January 2019  

After the holiday break, activity resumes in full swing this week. An appetizer came last Friday, with the release of the Non-Farm Payroll (NFP) and related data. The US economy showed signs of continued strength with the labour market adding 312k jobs (versus 177k expected) and the unemployment rate ticking up to 3.9% (versus an expected 3.7%, unchanged from the previous month), pushed by higher labour force participation (at 63.1%, versus 62.9% previously). On the inflation front, average hourly earnings also rose to 3.2% y-o-y (more than the expected decline to 3.0% from the previous 3.1% reading); this week’s data on CPI will clarify whether the tightness of the labour market will be able to translate into higher headline and core inflation. 

Also this week, the minutes of the FOMC meeting in December will shed further light on the Fed’s thinking concerning its 25bps rate increase in the Fed funds target range, to 2.25%-2.50%. The policy stance of the Fed in the first few months of the year will be a key driver of market sentiment. While the market-implied probability of there being no Fed hikes in 2019 has increased to 90% (versus 64% last week), currently the Fed is strictly data dependent and unlikely to commit to any specific policy action in coming weeks. The Fed has three instruments at its disposal: rate policy, Quantitative Tightening (QT, i.e. the reduction of its balance sheet) and forward guidance via the “dot plot.” We believe that the bar for altering the pace of QT, which is pre-set and mostly dictated by technical factors, is quite high. The Fed might opt for a combination of rate policy, forward guidance and communication (including its press conferences at every meeting) to steer market sentiment. 

Equally important for market participants will be the resumption of trade talks between China and the US,  following the truce agreed to on the sidelines of the G20 meeting in Buenos Aires at the end of November.  We continue to believe that trade tensions are only the visible skirmishes in a much deeper, geopolitically-motivated technological competition between the rising power of China and the incumbent American superpower; a competition that is rapidly becoming a new Cold War. 

On Wednesday, the Bank of Canada will also meet for its policy meeting and the release of its latest Monetary Policy Report. Until a few months ago, January was considered the chosen month for an additional 25bps increase to a rate of 2.0%, but the situation has changed in the last few weeks, with the collapse in oil prices and the correction in risky asset prices that has affected most developed markets, including in North America. Market consensus is now expecting no interest rate change to occur.

Another central bank at the centre of investor attention this week will be the ECB, which will release the accounts of its December monetary policy meeting. Market participants will look for further clarification on the ECB's re-investment policy, following the end of its bond-buying program. 

So, this week market participants will again have their plates full with news to digest. All this activity will mark the beginning of another challenging year, one that could possibly lead to another global economic slowdown and financial crisis occurring in 2020.   In this respect, while investors exited equity funds amid the correction in risky asset prices at the end of last year, gold prices started to rise again, together with inflows into gold-backed ETFs. 

Macroeconomic, Geopolitical and Market Outlook For 2019: Skating on Thinner Ice


by Brunello Rosa

2 January 2019  

At the end of the year, we published our Global Outlook and Strategic Asset Allocation for 2019. In it, we discussed how in 2019 the global economy is likely to enter a slowdown phase, the result of a deceleration of growth in the US, China and the Eurozone, and EM economies remaining fragile. This deceleration will involve a number of large economies returning towards (or even below) their trend growth levels, a reversal of the acceleration they experienced in H2 2017 and H1 2018, the latter as a result of the US fiscal impulse. While output gaps continue to close, core inflation still finds it difficult to reach and remain consistently at levels that are compatible with central banks’ inflation targets. This is a result of the persistent flatness of the Phillips curve in a number of countries, especially developed economies. 

As core inflation remains subdued, the world’s major central banks (Fed, ECB, BOE, BOJ) can be more cautious in their approach to monetary policy normalisation. A number of EM central banks will have to continue to strike a difficult balance between defending their currencies and supporting economic activity. At the same time, fiscal policy is likely to remain globally neutral, with the US fiscal impact expected to fade away towards the end of 2019.

From a geopolitical perspective, John Hulsman made his top predictions for 2019, which can be summarised as follows: 1) While there will be a Sino-American deal that will temporarily limit the trade war, the bigger story is an approaching cold war between the world’s two most important powers. This will be a decades-long strategic conflict that the US is likely to win (though such a triumph is far from being an inevitable outcome). 

2) With Macron politically damaged following the yellow vest protests, the European establishment’s hopes for desperately needed reform have come to nothing. The continent’s terminal decline will become apparent in 2019.  3) Contrary to the fantasies of much of the commentariat, President Trump will not be removed from office. But the Democrats in the House will torment him with endless investigations, and almost nothing will get done in America domestically with the exception of two Fed rate hikes. 4) The process of Emerging Market differentiation will continue in 2019, as investors increasingly come to evaluate developing countries on their own terms rather than considering them as part of a homogeneous group. 

So, while overall the global economy is still in a growing, albeit decelerating, phase, clouds are gathering on the horizon. Risky asset prices have recently shown signs of fragility, to say the least, reflecting ongoing risks (rising geopolitical tensions – including in the Balkans, worries about Fed policy, trade wars, balkanisation of global supply chains) and the potential for a deceleration in economic activity. In most markets, especially in Europe, bank shares have underperformed general indices, a result of the impact of regulation, rising short-term rates, low long-term rates and the negative feedback loop between fragile sovereign bonds and their balance sheets. Financial institutions could again be the canary in the coal mine of the next financial crisis

In this environment, investor are likely to continue de-risking by adopting a defensive approach and reducing exposure to assets with stretched valuations (credit products, leveraged loans, some real estate), without completely abandoning risky assets.

All The President’s Men (Have Left)



by Brunello Rosa

24 December 2018  

In our column on March 26th, entitled Who Checks on “The Boss” in Washington, we discussed the possible implications of a series of resignations by key respected figures of the Trump’s Administration,  among them  the Director of the National Economic Council (NEC) Gary Cohn, Secretary of State Rex Tillerson, and National Security Advisor H.R. McMaster. At that time, we highlighted how the team of experts that was advising the president on strategic economic and geopolitical matters (and to a certain extent was even managing to moderate some of his more extreme policy plans) was in the process of being dissolved, to be replaced by more hawkish figures such as neoconservative John Bolton as the new National Security Advisor and Larry Kudlow as the new Director of the NEC. 

On that occasion we warned that “one can reasonably wonder when the other two former generals that currently are in key government positions, James Mattis as Defense Secretary and John F. Kelly as Chief of Staff, will also depart, leaving room for less moderate substitutes.” We also added: “As the example of Jay Powell shows, the choice of people in charge determines the credibility, policy direction and ability to deliver of institutions.” 

The time for both Kelly and Mattis to leave has now come. 

Meanwhile, Jay Powell’s position has come under attack, as has Steve Mnuchin, the Secretary to the Treasury who de-facto chose him. If these changes were not enough, the US anti-ISIS envoy Brett McGurk also quit over Trump’s decision to withdraw US troops from Syria, which was made almost at the same time as the decision to withdraw about 7000 troops from Afghanistan

The impression one gets from this raft of news is that all the key, respected and moderating advisors to President Trump have left, some abrupt decisions on Syria and Afghanistan have been taken, and this political shake-up could continue if Mnuchin were also to be let go (or decides to quit) and Powell’s position were to be put under further scrutiny. 

From a geopolitical standpoint, the risk now is that the US might become more vulnerable at the same time as its forces are withdrawing from hostile theatres of war, as key members of the administration coming from the military have left. As we warned in our review of the US mid-term election results, Trump’s loss of the House of Representatives would have meant a re-focusing of his attention on foreign policy, considering the limited ability the executive branch has to dictate the agenda on domestic and economic issues independent of Congress, as proven by the government shutdown (which we also thought would become likely after the Democratic victory in the House). 

From a financial market perspective, as we have observed in Turkey, India, and Argentina, when the independence of a central bank comes under attack (a fortiori if we talk about the most influential central bank in the world, the US Federal Reserve), serious market volatility tends to ensue. Hopefully Trump will refrain from continuing to put pressure on the Fed and its chairman, otherwise 2019 could get off to a very troublesome start.  

Central Banks Take Centre Stage At Year's End


by Brunello Rosa

17 December 2018  

As 2018 comes to an end, central banks are taking centre stage once more. As we discuss in greater detail on the second page of this Viewsletter, economic activity is slowing down globally. Economic activity is reverting to trend growth, and in Q3 experienced episodes of contraction in Japan, Germany, Sweden, and elsewhere. In spite of tightening labour markets, closing output gaps, and rising salaries, core inflation in developed markets (DMs) remains subdued while headline inflation is being dragged down by falling oil prices. (Low core inflation has been due to technological innovations, labour re-organisation and weaker unions, and disruptions in global supply chains, among other factors, all of which are contributing to keep Phillips curves flatter than they would be otherwise). In this environment, central banks in DMs can afford to adopt a more cautious approach to monetary policy normalisation, while some central banks in emerging markets are increasing rates to defend their currencies and achieve inflation targets.  

Last week, the European Central Bank kept its policy stance unchanged and confirmed its intention to terminate its net asset purchases at the end of this year. It will proceed with full reinvestment for an extended period of time after the first rate increase, which is unlikely to occur before Q4 2019 (and will possibly occur later than that, given the balance of risks is shifting to the downside). Earlier in the month, the Bank of Canada kept its overnight rate unchanged at 1.75% and struck a dovish note, citing lower oil prices and constrained investment. 

This week, the Fed is expected to increase its Fed funds target range by 25bps to 2.25-2.50%, and suggest a slower pace of policy tightening going forward. The Bank of Japan is expected to keep its policy stance unchanged and extremely accommodative, until core inflation starts to rise convincingly. The Bank of England is also expected to remain on hold this week, as it observes the unfolding of the Brexit saga. Finally, we expect the Riksbank to wait until 2019 before raising its repo rate, and we expect the Swiss National Bank to shadow very closely any changes in the ECB’s policy stance. 

In emerging markets, while the Turkish CBRT left its policy rate at 24% last week and while the People’s Bank of China continues to provide monetary accommodation as part of the broader stimulus package implemented by Chinese authorities to cushion the effects of trade wars with the US, the Reserve Bank of India, which is in the middle of the crisis with the government over its independence, left its key policy rate steady at 6.5% on December 5th as part of its gradual tightening process. On December 12th, meanwhile, the central bank of Brazil voted unanimously to hold its key Selic rate steady at 6.50%, amid soft GDP growth and below-target inflation. In contrast, last Friday the central bank of Russia unexpectedly raised its benchmark one-week repo rate by 25bps to 7.75%, in order to limit rising inflation risks, given the upcoming VAT rate increase expected to occur on January 1, 2019. This move followed the unexpected decision by the South African Reserve Bank to raise its repo rate by 25bps to 6.75% at the end of November (its first hike since March 2016) given rising inflation on the back of a weakening currency.

With global growth decelerating, inflation remaining subdued in DMs and rising in some EMs (given EM’s weaker currencies), still-constrained fiscal policy, and financial markets becoming volatile and nervous, central banks will continue to play a crucial role in shaping macroeconomic and market dynamics also in 2019 and subsequent years. 

AKK as CDU Party Leader Ensures Short-Term Continuity, But the Political Battles Continue


(Picture by Associated Press, from

by Brunello Rosa

10 December 2018  

The victory by Annegret Kramp–Karrenbauer (AKK, for short) in the contest to replace Angela Merkel as CDU party leader ensures a level of short-term continuity in Germany’s political affairs. It is, however, unlikely to settle Germany’s political situation once and for all. As we discuss in depth in our travel notes from Berlin, AKK was most closely aligned to Angela Merkel of the three contenders for the party leadership, but also the least charismatic and the least able to promote the shift to the right that the party needs to carry out in order to regain the popular support and votes that have gone to the AfD in the last few years. 

The other two contenders for the CDU leadership, Friedrich Merz and Jens Spahn, drove the agenda of the party conference and are likely to shape the CDU’s political trajectory in coming years, for a number of reasons. First of all, AKK defeated Merz in the second round of the election only by a very tight margin, 51.75% to 48.25%. The fact that Wolfgang Schäuble decided to support Merz in his bid for the candidacy and reportedly did not applaud Merkel’s final speech as CDU leader shows that the party is profoundly divided on the question of which direction to follow. Second, AKK will have to re-affirm and consolidate her power over the next few months, which will feature a number of important elections: European parliament (on May 26th, 2019), Brandenburg and Saxony (September 1st, 2019) and Thuringia (October 27th, 2019). The two defeated candidates might even hope for a poor CDU showing in these elections, to demonstrate that the party needs a radically new course of action (led by them, of course) to regain lost votes and centrality in German politics. 

Third, the tide of history currently appears to favour right-wing candidates (such as Merz and Spahn) able to appeal to the anti-immigrant sentiment now prevalent among the German and European population. And fourth, the anti-European forces within the EU as well as outside the EU (in America and Asia) will give AKK a hard time in the coming years, and will continue to push for the dis-integration of the EU.  

Angela Merkel can rightly claim a political victory with AKK’s election, following upon a number of political defeats. Merkel can now plan for her exit from German politics in less haste. She has bought a few more months to decide whether she want to bid for a big EU job, in order to make sure the European project does not crumble following her political departure. The fact that the European People’s Party (EPP) has chosen Manfred Weber as Spitzenkandidat for the EU Commission presidency means that Germany and the EPP more widely have already started to plan for a post-integration future, a future in which the EPP will have to deal with the populist parties now proliferating throughout Europe (as we discuss in our recent travel notes from Italy). 

But time is running out. As the “Gilettes Jaunes” protests in France show, anti-élite, anti-establishment and inherently anti-European anti-Western sentiment is on the rise even in the country with the most explicitly pro-European leader in Europe, i.e. French President Macron. There is a risk that, if this anti-European sentiment ends prevailing, then even if Macron and Merkel/AKK were to come out with the best plan to complete the European Union and the Eurozone, that plan would still be rejected by the respective populations of European countries, thereby de facto starting the process of European dis-integration, whether the establishment likes it or not. 

All the above is not just a list of interesting political considerations. As we discuss in our recent market update, geopolitical events and the political economy of nations (such as those we discuss in our “geopolitical corner” column) now have a direct impact on markets’ prices. So, while AKK’s victory might provide a sigh of relief for market participants in the short run, it cannot prevent them from entering a rollercoaster ride in the next few months.

The US and China Reach a Truce on Trade, But the G20 Fails to Condemn Protectionism


by Brunello Rosa

3 December 2018

As we predicted in our column last week, the meeting between US and China that occurred on the sidelines of the G20 summit in Buenos Aires resulted in an agreement that will allow the countries to continue negotiating with one another on trade during the next few months. The US has agreed to postpone by three months its planned increase in tariffs, from 10% to 25%, on $200bn worth of Chinese goods exported to the US; tariffs which would have otherwise gone into effect on January 1st, 2019. 

As we expected, this meeting was not the place at which a full-fledged agreement could take place,  given the unresolved issues that exist between the two countries (especially in terms of the protection of intellectual property and the imbalance resulting from the closed nature of the Chinese economy relative to the American economy) and the deeper technological competition that is underlying their “trade skirmishes” with one another. All the same, this Christmas truce is a welcome development, as it removes one element of uncertainty for market participants on the verge of closing their books for 2018. 

In contrast, the communique released at the end of the G20 summit is not likely to be a step in the right direction. Apart from being vague in general, there are three clear commitments the G20 fails to make in it. First, the communique does not explicitly condemn “protectionism” as it used to, but instead only says that world leaders “note current trade issues…recognize the contribution that the multilateral trading system has made”, and that the “system is currently falling short of its objectives and there is room for improvement.”  

Second, the G20 failed to endorse the UN’s Global Compact For Migration after a number of countries, including the US, Hungary, Switzerland, and Italy, explicitly pulled out or showed reservations. 

The communique simply says that “large movements of refugees are a global concern with humanitarian, political, social and economic consequences. [G20 leaders] emphasize the importance of shared actions to address the root causes of displacement and to respond to growing humanitarian needs.” 

Finally, the G20 communique confirms that Europe remains united in its support for the Paris agreement on climate change, whereas the US has confirmed its withdrawal from the agreement (only one day before the COP24 climate summit in Poland is set to begin), failing to put the weight of the entire G20 behind global environmental commitments.  

Somebody willing to see the glass half full could say that at least this G20 meeting ended with less acrimony than did the G7 meeting in Canada in June 2018, where even the pictures taken showed tensions among various world leaders. For those inclined to be optimistic at the beginning of this festive season, one can perhaps focus on a few factors that are now lifting investor sentiment. In addition to this new truce in the US-China ”trade war”, there is also the more cooperative approach that has recently  taken by the Italian government regarding its budget (an attempt to prevent the opening of a excessive deficit procedure by the European Commission early next year), as well as the less hawkish tone taken by US Federal Reserve chairman Jay Powell in his recent speech on financial stability

All of these factors, though somewhat clouded by the possibility of there being a negative reaction should the UK parliament reject the deal between the UK and the EU on the British withdrawal agreement on December 11th, might provide positive support to risky assets as 2018 comes to an end. Still, given the number of risks that remain, investors are likely to stay cautious during the final part of 2018 and into 2019.

G20 Meeting Unlikely to Result in Anything More Than Merely Cosmetic Agreements


by Brunello Rosa

26 November 2018

The G20 meeting scheduled to take place on November 30th and December 1st in Buenos Aires could be an occasion for US President Trump and Chinese President Xi Jinping to try to resolve trade tensions that have been escalating for months, when the two meet privately on the sidelines of the event.

As we discussed in our report earlier this year, this G20 meeting in Argentina was already going to be quite an odd affair, considering it is going to be hosted by a country that had intended to show to the world that it was open for business again thanks to the reforms introduced by the liberal-conservative government of Mauricio Macri, but instead has rapidly fallen back to being an economic “problem child,” given its mis-management of the economy, monetary policy, and public relations (with heavy consequences for financial markets as a result). These have forced Argentina to yet again seek the help of the IMF, an organization that is much-hated in the country. The usual themes will be on the agenda at the G20 meeting, including finance, economic sustainability, “digital divide,” agriculture, energy, and – above all – trade and investment

The attention of all investors, business leaders and international policy makers will however be devoted to the meeting between Trump and Xi, which will be held just a few weeks before the threatened increase in tariffs, from 10% to 25% on $250bn worth of Chinese exports to the US, is scheduled to take place on January 1st, 2019. As we discussed in our recent travel notes from China, we do not expect Trump and Xi to discuss, much less to agree upon, tedious and detailed trade agreement terms.

Rather, the best one can hope for is that a cosmetic agreement to continue trade negotiations will be reached in principle. Whether or not the planned increase in tariffs would then be suspended is currently unclear. But the chances of Trump and Xi reaching a deal are still small for the time being, as the two sides are still very far apart in terms of what they are willing to compromise on.


The Chinese economy has been hit hard by the increase in tariffs adopted by the US earlier this year (as have Chinese equity markets), so China might be inclined to offer more than it has done so far in terms of opening up its economic system. At the same time, there are limits on what the Chinese are willing to give up in order to keep world trade relatively freer. As for the US, as we discussed in our recent review of the US mid-term elections, the hardline position on China has bipartisan support in Washington, as it remains popular among the US electorate. As such, the space for a compromise between the two countries is limited. In addition, there is a much deeper, underlying confrontation taking place between the US and China within the technological and geo-strategic battlefields, one that may be on the verge of becoming a new “cold war”.

What this means is that, behind the handshakes, pats on shoulders, and pompous declarations that occur at summits like the G20 meetings, any agreement of substance reached there is likely to remain limited. That will continue to weigh on investor sentiment in weeks, months, and likely even years to come.  

Economic Hiccups And Political Risk Raise Questions Over Global Monetary Policy


by Brunello Rosa

19 November 2018

Before the October market sell-off and the recent outbursts of political risk, the direction of monetary policy stances taken by the major central banks over the next 12 months seemed to be pretty much set, within limited “confidence intervals”. The Fed seemed destined to increase its Fed funds rate once again in 2018 and another 3-4 times in 2019. The ECB seemed destined to finish QE in December 2018 and then carry out a first rate increase around September 2019. The Bank of England seemed likely to continue its “gradual and limited” rate normalisation process, and the BOJ to only start removing some of its extraordinary measures of monetary accommodation very gradually in 2019

However, the October sell-off did take place, as a result of fears over a global growth slowdown, with China having joined the economic deceleration in the Eurozone, Japan and EMs, and oil prices having risen substantially - given renewed US sanctions on Iran. The correction carried with it a tightening in financial conditions, exacerbated by the further strengthening of the USD as compared to the EUR, GBP and most EM currencies.  The US economy is still in very good shape, adding jobs at an extraordinarily good pace given the point in the business cycle it appears to be in. That is the reason why the Fed is likely to carry on with its additional 25-bps rate increase in December (as hinted in the November FOMC statement), taking the upper end of the Fed funds range to 2.5%, in spite of President Trump’s discontent with such increases. At the same time, however, the strength of the dollar, the impact on long-term rates deriving from the reduction in the Federal Reserve’s balance sheet (the so-called Quantitative Tightening) and the economic hiccups coming from Europe and Japan might convince Jay Powell to display some caution regarding future rate hikes, leaving the door open to some pauses in the normalisation process. 

Indeed, in Q3 Germany recorded a 0.2% contraction in its quarterly GDP, mostly due to the impact on the car industry of new regulations on emission standards. Italy’s economic performance was also flat, with 0% growth registered in Q3, a result of the collapse in business investment due to the uncertainty generated by the government’s bickering with the EU Commission on the budget. Q3 GDP was also negative in Japan (-0.3% q/q), where natural disasters weighed on personal consumption, investment levels and exports. These sobering figures suggest prudence is likely to be shown in the next monetary policy announcements by the ECB and the BOJ. As far as the ECB is concerned, in a recent speech President Draghi remarked how the Governing Council will use the new set of forecasts that become available in December to decide on the Bank’s re-investment policy, forward guidance on rates, and the possible adoption of a new round of long-term repo operations (LTROs or TLTROs). The BOJ, as we discussed in our recent analysis, remains very cautious regarding any possible changes to its policy stance. As such, the newly available data on GDP growth will only serve to confirm the BOJ’s prudent position. 

As far as the BOE is concerned, as we discussed in our recent trip report, everything is dependent on the outcome of the Brexit process. As Governor Carney said during his latest press conference, a swift resolution of the uncertainty surrounding Brexit negotiations could unleash pent-up demand for consumption and investment, leading to an acceleration of the BOE’s normalisation process. However, recent developments on the Brexit front seem to suggest instead that a political (and possibly economic) crisis might be needed to break the Brexit impasse. In that case, the BOE can only remain in a wait-and-see mode, ready to react in either direction depending on developments impacting supply, demand, and the FX rate. 

In conclusion, the possibility of a more gradual policy normalization by the major central banks, the aggressive monetary easing adopted by China’s PBOC and the waivers given by the US to several countries on oil imports from Iran (which led to a substantial fall in oil prices) have helped the recent recovery in risky asset prices. 

History is On the Move in the Anglosphere


by Brunello Rosa

12 November 2018

Important events occurred both in the US and the UK last week, events which deserve plenty of attention from investors. In the US, President Trump’s Republican Party managed to increase its majority in the Senate and win the majority of gubernatorial races, but lost its control of the House of Representatives. As we will discuss at length in our upcoming report on the results of this election, the Democrats managed to elect to Congress a number of high-profile first time politicians (including Alexandria Ocasio-Cortez), but the “blue wave” many had expected did not materialise. The Democrats will now be able to scrutinise the Trump administration’s actions more closely (and possibly even launch an impeachment process), and choose whether or not to block legislation initiatives the Republicans might put forth, such as a new round of tax cuts or a serious infrastructure spending program. Nevertheless, if the Democrats want to win the presidential race in 2020, they need to start trying to identify a suitable candidate soon. In fact, in spite of losing control of the House, Trump felt emboldened by the election results. Following the election, he pushed attorney general Jeff Session to resign, thus putting the future of the Mueller’s investigation in doubt. With Trump's domestic agenda perhaps likely to be blocked by the Democratic majority in the House, will Trump focus on foreign policy instead, as most presidents tend to do during the second half of their terms in office?  As we discussed in a recent report, there is a risk of there being a wag-the-dog moment in 2020, if Trump is tempted to embark upon military adventures in order to secure a second term. 

Meanwhile, the new round of sanctions on Iran has indirectly led to a fall in oil prices, as other countries increased their production. Oil prices have now entered a bear market, after having recently touched their 2018 highs. In forthcoming research, we will update our outlook for oil in coming years. If a new round of US tax as cuts becomes less likely, the risk of inflation surprises would be reduced, and the likelihood that the Fed will need to speed up its pace of tightening will be lower as a result. This has helped the bull flattening of the US Treasury curve, with the long end of the curve remaining in check in spite of the near certainty of there being a fourth 25-bps increase in the Fed funds rate in December, after this week’s FOMC meeting. The long end of the yield curve also remains anchored by persistently low Japanese long-term yields. (In our recent BOJ report we discuss why we believe this is likely to continue well into 2019.)   

On the other side of the Atlantic, as we discussed in our recent UK trip report, Brexit negotiations are now entering crunch time. The days ahead will be crucial; an agreement between the EU and the UK ideally needs to be reached in time for EU President Tusk to call a special EU summit by the end of November and pass the “deal” through the British parliament before Christmas, leaving enough time for other European parliaments to ratify this “divorce deal.” This schedule might prove to be too optimistic, however. There is a risk that a political and economic crisis might first be needed in order to break the impasse that exists between the UK and the EU. 

As a proof of this, on Friday the British government lost another key member: Transport Secretary Jo Johnson (brother to former foreign secretary Boris) resigned, while calling for a second referendum in which three choices should be available to voters: accept a deal potentially brought back by Theresa May, leave the EU without a deal, or remain in the EU. This week might prove essential to see whether the government and the EU might at least agree on a withdrawal deal. (Whether the British government's cabinet and, more importantly, Britain's parliament will accept such a deal, is of course a different matter). It will be some time yet before all this uncertainty is dissipated. 

The Failure Of Germany’s Grand Coalition


by Brunello Rosa

5 November 2018

In the inaugural column of this Viewsletter, we asked: Is a German “Grand Coalition” Necessarily Good News?. Even though the creation of such a coalition had resolved the uncertainty related to the German government’s formation (a process that lasted more than six months), nevertheless we highlighted the presence of a series of downside risks resulting from it. We wrote: “if the grand coalition fails, there is a risk of making euro-skeptic AfD and FDP stronger…This means that, at the end of this experience (in 3-4 years), Germany runs the risk of finding itself with an even more fragmented political spectrum, unable to form a governing coalition, and express a government strong enough to complete the European integration process, when centrifugal forces could be even stronger.”

The results of state elections in Bavaria and Hesse, which saw the collapse of the SPD and the CDU/CSU and the rise of the AfD and the Greens, leading to Chancellor Merkel’s decision not to run again for her party's leadership in December, showed that those concerns were well placed. The risk is that Germany will soon experience a government crisis in which (among other things) Merkel could be forced to step down from her Chancellor’s position much earlier than has initially been anticipated. In fact, of the various contenders now being considered for the future leadership of the CDU, a possible “co-habitation” between Merkel as Chancellor and someone else as CDU leader could be envisioned only with Merkel’s chosen successor, Annegret Kramp-Karrenbauer, while a diarchy with either Friedrich Merz or Jens Spahn is difficult to imagine. The fourth potential candidate, Armin Laschet may therefore eventually emerge as a good compromise candidate able to reunite the party (as we discussed already in our recent trip report).   

As we will discuss in detail in forthcoming research, Merkel’s eventual departure has a number of consequences at the domestic as well as international level. Domestically, her departure means that the CDU will have to move more towards the right. This will also occur because of the parallel rise of the Greens, a party that has occupied a strategic position within Germany’s political spectrum, being more conservative than the SPD on fiscal issues yet more progressive on migration, social rights and technological evolution. The Greens now occupy that centrist political space that the CDU wanted to cover within this “GroKo”. So the CDU will instead have to try to re-absorb the moderate/conservative votes that have abandoned it, votes that are temporarily “parked” with the AfD. 

From an international perspective, as we discussed in a recent trip report, there are a number of implications as well, especially at the European level. First of all, Merkel’s departure would make the window of opportunity in which to promote EU and EZ reform in the next few years even smaller than it was already (or even make it virtually non-existent). Secondly, if Merkel were to eventually decide to run for a top European job (something she is currently denying thinking about), it would fundamentally change the ongoing European musical chairs game, as – at the very least – France would demand to be fully “compensated” with adequately powerful appointments, such as the head of the European Central Bank, in response. Finally, after Merkel’s departure, the possibility of an agreement to rule the EU between the European People’s Party and the populist front, emerging after the May 2019 EU election, becomes more likely. 

Meanwhile, European tensions related to Brexit and budget negotiations will continue to see German bunds in high demand, implying long-term yields being lower than what economic fundamentals (growth, employment, inflation, etc.) would typically justify, with well-known consequences even for long-dated US Treasury yields.

Bolsonaro’s Presidency: A Likely Mix of Trump, Peron, and Pinochet


by Brunello Rosa

29 October 2018

After three weeks, our column now returns to discuss the second round of Brazil’s presidential election, which was held yesterday evening. The election resulted in the victory of right-wing candidate Jair Bolsonaro, the leader of the Social Liberal Party, over his opponent Fernando Haddad, of the Workers’ Party. Bolsonaro received 55% of the votes, Haddad 45%. Most of the analysis we provided in our previous column on Brazil in early October, when Bolsonaro won the first round of the election with 46% of the votes, is still valid today. Now that he has won the final round of the election, we want to focus on his economic plans, and discuss what type of president he might be. To begin with, the victory of Bolsonaro marks the return of a sui-generis “populist” extreme right-wing candidate to power in Latin America, after decades in which populist leaders had been coming mostly from the left of the political spectrum (e.g. Hugo Chavez and Nicolas Maduros in Venezuela, Evo Morales in Bolivia, etc.). His anti-democratic rhetoric and continued defence of the military dictatorship of the 1964-1985 period also make him more akin to leaders like Chile’s Augusto Pinochet (whose dictatorship lasted from 1973 to 1990) than to recent examples of left-wing populists. 

Second, Bolsonaro’s economic plan, which was prepared by Paulo Guedes (a PhD graduate from the University of Chicago, former investment banker at Bozano Investimentos, and one of the founders of BTG Pactual), is to be centred around fiscal reform, budget discipline and the reform of the pension system (in spite of the fact that the military is one of the major beneficiaries of the generous system that currently exists in Brazil). These actions would be accompanied by an aggressive plan of privatising state-owned enterprises (such as Banco do Brasil and oil company Petróleo Brasileiro), which would be expected to raise around 800 billion reais ($215 billion), enough to reduce Brazil’s federal debt by a fifth. Very much like Donald Trump, however, Bolsonaro, even while remaining market friendly and appointing market-friendly advisors (such as the former president of Goldman Sachs and current director of the National Economic Council Gary Cohn, in Trump’s case), will have to deliver to his electoral base, a population that is among the hardest hit by the economic recession Brazil had faced.   

In this respect, Bolsonaro is unlikely to deviate too much from the path indicated by the archetype of all right-wing populists in Latin America, namely Juan Domingo Peron of Argentina. (Peron, unlike Pinochet who came to power by way of a military coup in 1973, was elected to office). The US under Trump is likely to remain very sympathetic to Bolsonaro’s Brazi, and unlikely to slap tariffs on Brazil’s exports. The markets are likely to be enthused by Bolsonaro’s victory as well; as can already been seen in the recent excellent performance of Brazilian equities (+7% in a week, +13% year to date, in spite of the ongoing sell-off/correction that has been especially impacting EMs). Bolsonaro’s victory is therefore likely to strengthen the BRL relative to the USD and other EM currencies, thereby opening up the space for a cut in interest rates in coming weeks (as inflation in Brazil, at 4.5%, is under control, and real policy rates, at around 2%, have room to be trimmed). 

As such, assuming that Bolsonaro will be a mix of Trump, Peron, and Pinochet (perhaps even to the point of severely reducing Brazil’s democratic rule) how will his presidency be remembered? There have been a number of studies on the economic impact of Pinochet’s combination of liberist policies - including his reform of the pension system - and authoritarian governance. Most of these studies were partial, if not heavily biased, especially given the explicit support provided to Pinochet by the then-champions of neo-liberism, Ronald Reagan and Margaret Thatcher. 

However, even more balanced evaluations suggest that Pinochet’s policies had an overall positive impact on Chile’s economy, even if the costs in terms of political, social and human rights were immense. At the same time we would consider it wise not to forget the lesson that Rudiger Dornbush and Sebastian Edwards gave us in 1990 in “Macroeconomic Populism in Latin America”: “populist policies do ultimately fail; and when they fail it is always at a frightening cost to the very groups who were supposed to be favored... the macroeconomics of various experiences is very much the same, even if the politics differed greatly.”

Markets Stabilise After Large Sell-Off, But Risks Remain


by Bruello Rosa

22 October 2018

After several weeks of equity re-pricing and heightened volatility, markets started to stabilise near the end of last week. As we discussed in an in-depth report, this sell-off episode was both healthy and unsurprising. This is primarily because further increases in equity valuations would have sent prices increasingly far above their historical ranges. US equities were already 40-50% above their average PE ratios, and already three standard deviations above their average CAPE ratios. Indeed, as we discussed in our strategic asset allocation report for 2018, investors this year should have considered moderate risk-taking only within the context of defensively positioning themselves. 

For now, there remains enough momentum in the economy (supported by global monetary and fiscal stimulus) to offset some of the negative factors affecting risky asset prices. Such negative factors may include rising inflation, global economic deceleration and divergences in growth, rising interest rates (coming from various central banks, including the Bank of Canada this week), trade skirmishes or trade wars impacting Chinese growth, geopolitical tensions, and a number of idiosyncratic instances of risk each of which has the potential to cause widespread damage if badly handled (in DMs chiefly Italy, but also the UK; in EMs, Turkey, Argentina and a number of other countries). Eventually, however, perhaps by 2020, these risks are likely to outweigh the factors that have been supporting the economy, and the market will correct. In the meantime, for the first time since the financial crisis (apart from very short periods during 2014-15) the interest rate offered by US 3m T-bills is higher than headline and core inflation, offering a real-return alternative to equities

This recent sell-off has occurred just before the US mid-term elections, and perhaps partly because of them. As discussed in our recent report, the possibility of a divided Congress makes it less likely that legislation will be passed that would allow the government to avoid the “fiscal cliff” that awaits the US when the effects of tax cuts passed earlier this year fade in late 2019. But there are also a number of other crisis situations that remain unresolved and will weigh on the performance of asset prices. 

While the situation in Turkey seems to be stabilising (following the release of Pastor Brunson), developments in the Brexit negotiations and in Italy appear increasingly unfavourable. This past Saturday there was a large rally in London to ask for a second referendum; the likelihood of a no-deal scenario is increasing by the day, and the prospect of a special EU Council meeting being held in November has been shelved

Last Friday, Moody’s downgraded Italy’s creditworthiness by one notch to Baa3 (with a stable outlook) - i.e. just one notch above “junk” status. This downgrade occurred as a result of the prospective deterioration of Italy’s fiscal position following the Italian government’s proposed budget for 2019, which foresees an increase in the budget deficit. The EU Commission sent a harsh letter urging the government to reconsider its generous spending plans, asking for a reply to letter to be given by Monday 22 October. During the weekend, an extraordinary Council of Ministers meeting, which was called to resolve the fiscal amnesty dispute that has emerged within the governing coalition, failed to approve an alternative deficit profile, which is what would be needed to prevent an excessive deficit procedure from being opened. This occurred in spite of Finance Minister Giovanni Tria’s reported request that the government consider a reduction in the planned deficit for 2019, to 2.1% from the current 2.4% .

Thus, the deficit stand-off is likely to continue until mid-November, when the budget will be either approved or rejected by the Commission. In the meantime, on October 26 S&P might follow Moody’s and cut Italy’s credit rating. Italy is currently alone in this battle against the rating agencies, the EU, and in particular the market (the 10y BTP-Bund spread having reached 340bps last Friday). Mario Draghi, while striking a conciliatory tone and being confident that a compromise with Italy would be reached, recently said that for idiosyncratic situations as might occur there is still the possibility of OMTs, and any extra call for ECB action is misplaced. This week, the ECB will likely buy more time before announcing any details of its reinvestment plans, which could either help Italy or put additional pressure on it.   

IMF Downgrades World Economic Outlook in 2019, Citing “Challenges To Steady Growth”


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%.   

Will The World’s Next Strongman Come From Brazil?


by Brunello Rosa

8 October 2018

Jair Bolsonaro, the populist leader of Brazil’s right-wing Social-Liberal Party (PSL), won the first round of the country’s presidential election last night, with around 46 percent of the votes. His closest rival, the Workers’ party (PT) candidate and former mayor of São Paulo Fernando Haddad, trailed behind Bolsonaro with only 29 percent of the votes. Bolsonaro’s party is also expected to receive the most votes in in the accompanying parliamentary elections. Other presidential candidates are even further behind in the polls. For the first time since 1994, Brazil’s president might not come from either of the two major parties, the centrist Brazilian Social Democracy Party (PSDB) or the leftist Workers’ Party (PT). The incumbent president Michel Temer, of the Brazilian Democratic Movement Party (PMDB), decided not to run when his approval rating sank into the single digits.

As we discussed in a detailed country report published last week, Brazil’s enormous political divisions are currently preventing the country from capitalizing on its equally huge economic potential (an example of which is Brazil’s successful aeronautical industry, which competes efficiently on the world stage). After experiencing the worst recession in the country’s recent history, a recession in which it lost around 8% of its GDP between 2015 and 2016 and witnessed one of its worst ever corruption scandals (which, in turn, led to the imprisonment of former President Inácio Lula da Silva and the impeachment of his successor and protégé Dilma Rousseff), Brazil has been left with deep political scars, negatively influencing what had already been a massively divided society to begin with. 

Congressman Bolsonaro has used rhetoric typical of right-wing populists around the globe, resorting to so-called “politically incorrect” expressions against women, minority groups, and disadvantaged people generally. On the other hand, unlike other right-wing populists, Bolsonaro’s agenda is fiscally conservative, focused on the reduction of public spending and taxes, as well as on privatisation.  He is also in favour of structural reform, such as the reform of the pension system. If his agenda were implemented and worked, Brazil’s growth potential could be revitalised. Perhaps as result of this focus, the Brazilian real (BRL) appreciated against the USD last week, with USD/BRL falling by 5.4% on a weekly basis (to 3.841). Brazilian equity prices are also up, by more than 8% since the beginning of the year.  

It is still possible for other candidates to win the second round of the election, three weeks from now. If the support for other left-wing and centrist candidates is consolidated by Haddad, and if Haddad then manages to stage a comeback (helped also by support from numerous political groups, such as EleNão, that have emerged in the past few months to protest the ascent of Bolsonaro), then Bolsonaro might still not become Brazil’s next president. At this stage, this seems to be a relatively improbable scenario, however. Bolsonaro’s popularity has increased dramatically during the past few months, especially after being stabbed by a left-wing extremist during an election rally in early September. Bolsonaro’s efficient social media campaigners managed to use that  event to his favour. 

If Bolsonaro’s victory in the first round is followed by another victory in the second round, there will be yet another strongman on the world stage, this time in a key BRIC and G-20 economy. Bolsonaro would join an already numerous group that includes Trump, Putin, Xi Jinping, Orbán, Kaczynski, Erdoğan, Duterte, and Modi - to name only the most preeminent of such politicians. Bolsonaro might even be one of this group’s most explicit believers in the desirability of autocracy: “I am in favor of a dictatorship … We will never resolve serious national problems with this irresponsible democracy,” he once said. Bolsonaro might also set the stage for the return of populist right-wing leaders in Latin America, a year before Argentina’s presidential elections will be held. We have discussed in a previous column (on March 19th, 2018) the risks the world faces from the increasing number of autocratic leaders, at a time when tariffs and protectionism are rising and global economic growth is slowing. By definition, strongmen do not want to avoid engaging in overt confrontation (on borders, tariffs, policy actions, etc). As such, their ascendance means that open conflicts, of various types, could unsurprisingly ensue. 

The Final Quarter of 2018 Begins, With Plenty of Risks (and Some Opportunities)


by Brunello Rosa

1 October 2018

This week, the final quarter of 2018 begins. During the previous quarter, Q3, the global economy continued to grow, but the cyclical acceleration that began in 2017 had already ended in most developed markets (DMs), with the exception of in the United States. In emerging markets (EMs), declining global liquidity and domestic fragilities triggered periphery-to-core flows, with Argentina and Turkey being the most highly impacted countries. The Fed and Bank of England continued their policy normalisation plans (though their plans differ widely in the pace at which they will raise rates), while the ECB and BOJ both remained extremely accommodative. A number of EM central banks had to embark upon “defensive” policy rate hikes in order to prevent further depreciations of their currencies. 

As discussed in the latest edition of our strategic asset allocation and market update, global equities rose by around 2.5% during Q3, led by US stocks, while market volatility remained subdued. In contrast, EM equities lost more than 4% on a quarterly basis and 20% since their highs of January 2018, with a number of stock indices having entered “bear market” territory. In the fixed-income space, 10-year bond yields remained broadly stable during Q3, as strong demand compensated for an increasing supply and rising inflation. Bond indices in DMs and EMs fell marginally, however. In commodity markets, oil prices remained around USD 75 per barrel, supported by supply constraints (e.g. output declines in Venezuela and sanctions on Iranian exports), while copper prices fell more than 10% as a result of concerns about the potential impact a US-China “trade war” on global growth.   

In Q4, growth in global economic activity will continue but will be even more asynchronous, as a deceleration continues in Europe, Japan and most emerging markets. The Fed will continue to tighten its policy stance, no longer “accommodative”, while the ECB will end its QE program in December.  The BOJ might also continue to tweak its policy to continue exiting its extraordinarily accommodative stance of the last few years.

As a result, during this final quarter of 2018 (and continuing in 2019), the risk of a correction in European and EM equity prices will increase due to liquidity withdrawal and political tensions. Analysts’ expectations of stock markets for the next 12 months - expectations of a more than 10% rise in DMs, and around a 20% rise in EMs - seem overoptimistic. 

US 10-year bond yield will likely remain above 3% in Q4  because of declining liquidity and rising issuance, but steady demand is likely to keep it capped. In EMs, bond yields are also likely to increase. We expect oil prices to remain above USD 70/b, supported by strong demand and supply constraints in OPEC and the US. Given diminishing USD liquidity and rising risks in Europe and EMs, investors’ portfolios are likely to gradually de-risk. A number of “special situations” will attract investor attention, meanwhile. In DMs, US mid-term elections in November, Brexit negotiations, Italy’s budget fist-fight with the EU will all attract attention; in EMs, elections in Brazil at the end of this week (on which we will publish a forthcoming report) will do so, as will US-China trade wars and the ongoing situation in Argentina and in Turkey.

Further ahead, in 2019, growth is likely to soften at the global level, with both DM (including the US) and EM economies decelerating. At this stage, we believe that a generalised EM crisis is unlikely because global liquidity remains elevated (even if it is contracting) and fundamentals remain solid in most emerging economies. In 2020, however, the risk of a global recession is higher than most analysts currently foresee.  On a multi-year horizon, then, investors’ portfolios are likely to be re-adjusted to ensure capital preservation.

In Q3 Final Week, Investors will Focus on the Fed, Brexit and Italy


by Brunello Rosa

24 September 2018

This is the final week of the 2018 third quarter, a quarter which saw some diverging trends take place within the global economy. On the one hand, the US has continued to grow at a robust pace, adding 200K jobs per month and reaching an unemployment rate that is below 4%. Inflation in the US is now consistently above the Fed’s 2% target. As a result, equity markets have registered new record highs, the yield curve is almost inverted, and the US dollar is stronger than it was at the beginning of the year (in trade-weighted terms). 

Conversely, the stock market indices of many emerging economies, including China, have entered bear-market territory, and their currencies have depreciated significantly against the USD. This divergence between the US and emerging economies has been partially a consequence of the intensification of trade skirmishes between the US and China (and between the US and the rest of the world, in spite of its recent deals with Mexico and the EU), and of their underlying technological war

As we discuss in our preview, the  Fed will increase its policy target range by 25bps this week, but it will also have to address the following issues: the inversion of the yield curve and its implications for the real economy; USD strength; effects on EMs; and US policy normalisation occurring during a period in which the world economy is weakening. With the 2021 “SEP dots” being revealed for the first time, will the Fed start taking into account the mounting concerns about a 2020 recession? Or will it ignore these concerns, as it did when it carried out is most recent rate increase in June? After all, during this quarter the 10th anniversary of Lehman’s collapse took place, and there is a risk that a new financial crisis might already be brewing.

In the final week of the third quarter, two long-standing issues will come to the fore: Brexit and Italy’s budget. In the wake of the EU having rebuffed Theresa May’s Chequers proposal, we are entering the final stage of the Brexit negotiations. These should lead to an agreement on the Withdrawal Treaty being reached by the end of October, in time for UK and EU approval before the date of Brexit on March 29th, 2019. This week, the Labour Party conference will help to clarify the party’s position on the Withdrawal bill; Jeremy Corbyn recently said that Labour MPs are ready to vote against the bill if it fails the Six Tests (as it is certain to do). Labour seems ready to exploit May’s failure in the negotiations in order to return to power after eight years in opposition. 

As discussed in our column on September 3rd, next week’s Tory party conference will be the last chance for the Conservatives to find a common position on Brexit negotiations. 

Also this week, as we discussed in our recent trip report, the Italian government will have to present its update of the Document of Economy and Finance, i.e. the draft of the budget for the 2019-21 period. There is an ongoing tug of war between the prudent finance minister Giovanni Tria and his technocrats (who recently came under heavy attack from one of Prime Minister Conte’s spokesmen), and the political leaders of the Five Star and Lega, who are pushing for the budget to include at least a preliminary implementation of the massive fiscal promises made during the electoral campaign, such as the introduction of a minimum income, the reduction of pensionable ages, and the introduction of a flat tax regime. The market expects the finance minister’s prudent approach to eventually prevail; it expects the budget to indicate a fiscal deficit for 2019 that will not be too far from the 1.6% level that would allow Italy to remain committed to its fiscal consolidation plan. Should this fail to occur, a new period of market volatility, accompanied by rating agencies’ downgrades of Italy’s creditworthiness, would be likely to ensue. 

10 Years After Lehman’s Collapse, Economies Are Sowing the Seeds of the Next Crisis


Picture by Mark Lennihan/Associated Press 

by Brunello Rosa

17 September 2018

September 15th, 2008: financial services firm Lehman Brothers files for Chapter 11 bankruptcy protection. This is the largest default in U.S. history, and marks the beginning of the Global Financial Crisis (GFC), the most severe episode of financial instability and economic contraction since the Great Depressions of the 1930s. From late 2006/early 2007, when the first elements of the crisis start to emerge, until September 2008, the crisis is mostly confined to the financial sector, having little impact on real economic activity. After Lehman’s collapse, however, the crisis becomes truly global. A number of economies enter a severe recession in 2009; they will emerge from this recession only a number of years later, profoundly transformed. 

September 15th, 2018: ten years after Lehman’s collapse, it is evident how the consequences of the 2008 GFC have gone far beyond the financial industry and the real economy. New political movements have emerged, and a world-wide retreat of globalization has begun, in a process that is still ongoing. The eventual outcome of this process has not yet become clear. In a Special Paper published by the Systemic Risk Centre of the London School of Economics(derived from a video interview by Angela Antetomaso with Nouriel Roubini and myself, which is available on a page dedicated to the 10th anniversary of the GFC of our website), we analyse what went wrong in 2008, and what lessons have been learnt to prevent another crisis of similar proportions from emerging again. We discuss the perverse relationships that often exist between academics, regulators, market participants and politicians, and why the institutions that were supposed to look after the economic and financial stability of countries failed to prevent the excesses of finance from occurring.


We analyse the effectiveness of the instruments of fiscal and monetary policy adopted to counter the effects of the crisis, and we highlight the insufficient use of fiscal policies, which at least in Europe would have helped alleviate the effects of the economic downturn. The link between financial crisis, economic contraction and the rise of populist parties, which led to Brexit and the election of Donald Trump, can clearly be seen. In this context, rising geopolitical tensions occurring within a deteriorating macro environment, as well as increased financial fragility, might trigger a new crisis that could be worse than the GFC. 

In recent articles published by the Financial Times and Project Syndicate, we explain how economies today have already sowed the seeds of the next global recession and financial crisis. We expect such a crisis to materialise by 2020, for the following ten reasons: 1) the fiscal drag on the US economy in 2020, as Trump’s fiscal stimulus expires; 2) the continuation of monetary policy tightening by the Fed and the beginning of interest rate normalisation by the ECB and BOJ, as inflation rates return toward central banks’ target levels; 3) the effects of trade wars and protectionism; 4) the restrictions to FDI and immigration, both reducing economic growth potential; 5) economic burdens deriving from the increase in public and private debt; 6) economic, financial and political fragilities in the Eurozone, China, and other EMs; 7) the potential for bubbles to burst in many over-priced markets; 8) the potential for fire-sales to take place in increasingly illiquid markets; 9) a “wag-the-dog” political risk in the US; e.g. Trump embarking on foreign policy adventures in the lead-up to the 2020 general election; and, 10) the constraints, deriving from the rise of populist parties, that policy makers will face in using policy tools to counter a crisis.  

Populists of All Countries, Unite!


by Brunello Rosa

10 September 2018

Given recent developments, and paraphrasing the famous incipitof Karl Marx’s Communist Manifesto, we could start this column by saying: “A specter is haunting Europe - the specter of Populism.” In fact, the clear threat to the future of the European integration process is the rise of populist parties across the old continent. In spite of the proclaimed nationalism and “sovereignism” of these parties, their level of coordination is increasing, and is doing so with the help of external forces. In January 2017, France’s Le Pen, Italy’s Salvini, Germany’s Petry and Netherlands’ Wilders met in Koblenz to launch a sort of Populist International, forming an embryonic bloc of parties that would work to block, and possibly reverse, any further European integration process. In the subsequent Dutch elections of 2017, the party of Geert Wilders became the second largest party in parliament, achieving massive gains in votes and seats. In France, Marine Le Pen reached the second round during the presidential elections in 2017, where she lost to Macron. Salvini has now also entered into the government, as a Deputy Prime Minister; the AfD is now the main opposition party within the German Bundestag, having forced the CDU/CSU and the SPD again into forming an unnatural Grosse Koalition. The AfD is now, according the polls, the leading party in East Germany. In a recent rally in Chemnitz (ironically, the city in which Marx was born) AfD and Pegida (a far right, nationalist and racist movement) marched together to protest the killing of a German-Cuban man by two immigrants.

Meanwhile, Italy’s Salvini has also established a strong relationship with Hungary’s Orban, and sided with his Visegrad Group (together with Poland, Czech Republic and Slovakia and Hungary). Whereas populist Babis, as new Czech Prime Minister, has joined KaczyńskI’s  Poland. In Austria, the far right party FPO, led by Heinz Christian Strache, has also made it into government, where it holds crucial ministries in Kurz’s administration. Austria has in effect nearly become an additional member of the Visegrad Group. 

This quick recap of past events can help us to understand the most recent developments. In Sweden, for example, the Swedish Democrats gained in the elections held on Sunday 9th September, reaching 18% of votes and becoming an obstacle to the formation of any new majority government, possibly forcing mainstream parties into forming a grand coalition. 

Most importantly, Donald Trump’s controversial former advisor Steve Bannon has put together an organisation, called “The Movement”, based in Europe, the purpose of which is to coordinate the activities of all the “sovereignist” and nationalist parties that aim to promote European dis-integration. The first top-notch politician to join the movement is Italy’s Salvini. The Movement might be pursuing the same goals of Russia, in weakening Europe as a global geopolitical actor. And that could be Donald Trump’s own goal as well, in spite of the “Resistance” of the “Deep State” that may exist within the White House and the US government. All these developments are relevant not simply from a political and geopolitical standpoint, but also for their macro and market implications. 

The sovereignist movements might make large gains in the European elections held in May 2019, and by doing so influence the appointment of top officials of European institutions and block any further European integration efforts, in spite of Macron’s and others’ efforts. Just by way of example, European institutions have been critical to solving the recent euro debt crises (in the EZ periphery); thus, their weakness would imply a greater level of vulnerability for those struggling countries and for the EZ as a whole, when the next recession or crisis does occur. As the recent increase in the Italian BTP/Bund spread showed, financial market volatility due to political developments in Europe could contribute to uncertainty and macroeconomic and financial under-performance in the countries that they affect the most.

Holidays Are Over: Resumption of Full Activity Brings Major Risks to the Fore


by Brunello Rosa

3 September 2018

This week, following US Labor Day on Monday September 3rd, the holiday season will be over. The return to work will be accompanied by several events that indicate the possibility of a high and imminent level of risk existing in a number of developed economies (DMs) and emerging markets (DMs). 

Starting with DMs, Brexit negotiations will enter their final stage in the coming days for a deal that needs to be struck by the end of September in order to be brought to the EU Council for approval on October 10th. This will occur just after the annual Tory party conference, which will be held in Birmingham between September 30th and October 3rd. This will be the last chance for the Conservatives to find a common position and present a united front in final rush to conclude the Brexit negotiations. The risk of a no-deal Brexit outcome is increasing, but at the same time, the chief EU negotiator said that the Commission might be prepared to offer an arrangement that has never been given to other countries before, rather than continue to stick to the dichotomy of the Canada/Norway models that has dominated the negotiations thus far. The GBP has been quite sensitive to this news, and has recovered somewhat of late versus the EUR and the USD

Further south, Italy is about to enter its month of passion, with the Document of Economic and Finance (DEF) Update set to be approved by Parliament by September 27th. The market is eagerly awaiting the number that Finance Minister Giovanni Tria will designate for Italy’s budget deficit in 2019, which will be compared with the 0.9% level previously agreed upon with the EU. The new level will certainly be higher than 0.9%, but will it be also higher than Italy’s current budget deficit level of 1.8%? If it is set higher than 1.8%, that would likely signal the interruption of Italy’s convergence towards the Medium-Term Objective of a balanced structural budget.   

Indeed, market participants are widely expected to start a speculative attack against Italy’s public debt and banking system, with rating agencies getting ready to downgrade the country’s creditworthiness, potentially leading to the collapse of the newly formed populist government. This could, in the medium-term, lead to a Eurozone break-up. In a recent report, we discuss how to hedge against that risk. 

Moving to the EM space, the Turkish crisis that has dominated August has subsided since the TRY has stabilised thanks to the central bank “stealth” increase in interest rates. The underlying issue has not been resolved, however. More decisive actions will need to be taken by Erdogan to end the crisis and avoid a collapse of the newly formed presidential regime. The government will try to continue avoiding asking for IMF assistance, which is considered politically toxic in Ankara given the relationship between Trump and Erdogan. 

In contrast, Argentina has been desperately asking the IMF to speed up its intervention; Argentina’s central bank was forced to increase its interest rates by further 15% to 60% last week to stem the peso’s depreciation. USD/ARS reached the record high of 38.7 (with intraday beyond 42) as investors continue to steer away from Argentina’s bonds and currency. The actively risky situations in Argentina and Turkey are at risk of involving other emerging markets as well, as we have discussed in previous reports and will analyse further in an upcoming paper. The presidential elections on October 7th in Brazil might offer further scope for such EM contagion. 

In conclusion, market participants have hopefully gotten plenty of rest during the summer, as the autumn will probably prove to be extremely bumpy, and is likely to bring a number of sleepless nights.

U.S. Stock Market Record Is Welcome, But Still Suggests Caution



by Brunello Rosa

28 August 2018

The S&P500 index rose by 0.9% last week, reaching an all-time high of 2,874.7 points. The VIX index declined by 0.6 points, to 12; it is now well below its 52-week average of 13.6 and its 10-year average of 19.5. A high level of economic activity is underpinning this strong performance in U.S. equity markets. A 4% annualised rate of GDP growth in Q2 of 4% is expected to be confirmed this week. The US unemployment rate is near its historic lows, at 3.9%. Inflation also remains well behaved: this week core PCE is expected to be confirmed to have remained at the Fed’s target level of 2%. 

Developments in other financial markets are helping too. The long end of the US yield curve remains low despite strong growth and rising inflation; the 10y yield is still below the crucial 3% threshold level. This confirms what we discussed at length in a recent report on US fixed income; namely, that the flattening US yield curve (the 2y10y yield spread recently reached 21bps, the lowest level in more than a decade) does not necessarily indicate that of a recession is imminent. 

In FX markets, the USD depreciated against a basket of currencies last week. The dollar index DXY fell by 0.7%. This fall also helped US equity valuations. Some commentators have attributed this (temporary?) interruption to the USD rally to President Trump’s criticism of the Fed’s policy tightening. There might be an element of truth to this view; that said, Fed chairman Jay Powell, in his inaugural speech at Jackson Hole’s annual symposium of central bankers last week, reaffirmed the current Fed’s policy of gradually tightening policy rates. The Fed continues to foresee two more rate hikes in 2018 and three in 2019.  

US financial markets are being buffeted but not shaken by the political and geopolitical risks the US is facing (or, in some cases, has actively been working to create). Investigation into "Russia-gate" are increasingly focusing on the President’s inner circle, but they do not necessarily seem to be leading towards impeachment. Indeed, the probability of impeachment will decline if the Democrats do not manage to win at least one of the two houses of Congress in November. Meanwhile, negotiations on NAFTA had seemed destined to fail until a recent breakthrough with Mexico re-opened the possibility of a positive conclusion being reached. Trade tensions with China, though they are still escalating, do not necessarily seem to be leading to a full-blown trade war. Even Trump's recent spat with Turkey’s President Erdogan seems to be only a small political skirmish in the grand scheme of things. 

The US performance is broadly in line with our strategic asset allocation (which will be updated in September), which still foresees a skew towards equities and some cautious risk taking. The US performance also remains in line with our analysis following the stock market fall in early February, when we warned that volatility and inflation fears would likely continue to weigh on markets. Indeed, it took a full seven months to recover the equity valuation highs that had been reached on January 26th. 

At this point, we continue to suggest caution. The factors that could lead to further stock market rises in the US might be countered by increasing fragilities in the world economy, particularly in emerging markets, which have started feeling the pain of the Fed’s tightening and USD strength. Politics and geopolitics may also affect financial markets in unexpected ways, even if a U.S. equity bear market is not on our radar screen just yet.

The Turkish Crisis Deepens, Sending EM Stocks Into A Bear Market


by Brunello Rosa

20 August 2018

The Turkish crisis continues, and it does not seem likely to abate anytime soon. Last week Turkey’s Finance Minister Berat Albayrak announced that the country's government will reduce inflation by way of fiscal discipline and structural reforms. Meanwhile Turkey's central bank announced a new set of measures intended to support financial stability, including a 250bps reduction of reserve requirement ratios for all maturities and a 400bps reduction of non-core FX liabilities for selected maturities. At the same time, relations with the US have worsened since Turkey's President Erdogan doubled import tariffs on certain US products (in response to US President Trump’s initial move), US Treasury Secretary Mnuchin confirmed that more sanctions on Turkey are being considered, and a Turkish court rejected a new appeal for the American pastor Andrew Brunson’s release from house arrest. As a result of all of this, S&P and Moody’s both downgraded Turkey’s rating by one notch, and USD/TRY closed the week at 6.012 (-6.4% in the past week). 

As we discussed in recent reports, the risk of a full-blown crisis may rapidly become the baseline scenario for Turkey. Contagion risks have risen significantly, with European and EM funds continuing to suffer outflows. In the Eurozone, the Eurostoxx 50 closed 1.6% lower than it had the previous week, amid worries over Eurozone banks’ exposure to Turkey. Stock prices declined in emerging markets, with the MSCI EM index down by 5.2% from a week ago. EM stocks have now reached bear market territory; i.e. they have declined by more than 20% since their January peak.  With Argentina having resorted to accepting an IMF assistance program earlier this year, it would seem obvious that Turkey should or will soon do the same. However, given the tense relationship between Turkey and the US, asking for money from a Washington-based institution like the IMF, which is dominated by US voting rights, is politically toxic for Erdogan. As a result, Turkey is looking for other “white knights” to assist it, whether it be Russia, China, or  Qatar.  

Turkey's looking to the east for alternative sources of funding will have profound geopolitical implications. As discussed by John Hulsman in his most recent Geopolitical Corner, it could mean that NATO as we know it is now likely to be over; transatlantic relations will never be the same in the future as they have been to this point. This means the US can continue to disengage from the Middle East “reimagining itself as an off-shore balancer", according to Hulsman, "only getting seriously involved in the area if one of the many regional powers (Turkey, Israel, Egypt, Iran, Saudi Arabia) comes to dominate the others.” 

The Turkish crisis has already spread beyond its epicentre to affect other emerging markets. It could soon impact the more fragile developed economies as well, by way of exposure to banking channels. The ECB has already singled out Spain, France and Italy as warranting the most concern in this regard. Italy in particular is quickly approaching the end of the grace period that international investors were willing to give the new “populist” government ahead of its presentation of a budget at the end of September. The country better be ready for when this grace period eventually comes to an end.

Turkey’s Debacle and Wider Contagion Risks



by Brunello Rosa

13 August 2018

The Turkish Lira (TRY) collapsed last Friday, losing around 15% of its value against the dollar in a single day.  The Lira’s loss against the dollar has now reached almost 45% since the beginning of the year. 

We have been following Turkish developments very closely in the last few months, so this crisis did not come unexpected. On August 9th, we warned that the risk of a full-blown balance of payments crisis was rising, thus increasing the downside risks to the muddle-through scenario, which was considered until recently the most likely course of action (chiming with our previous analysis). The volatility we expected to increase ahead of the elections of June 24th, which gave President Erdogan increased political powers deriving from the 2017 constitutional referendum, has persisted even after the elections. This volatility has occurred especially as a result of statements and appointments made by Erdogan, which have reduced the independence of Turkey’s central bank (as discussed in our column on July 23rd) and the credibility of Turkey’s Ministry of Finance.

The repercussions of the Turkish crisis for international markets can be divided into two fronts: emerging markets (EMs), and financial markets in general. For the former, our working paper published today (Turkish Lira Tumbles, Contagion Risk Rises) suggests that contagion from Turkey to other emerging markets is increasing. The impact of Turkey on stocks in India, Brazil, Russia and South Africa has been marginally negative. In the fixed income space, 10-year government bond yields have increased in India, Russia, and especially Brazil (+28bps, to 11.76%) and South Africa (+17bps, to 8.86%). EM currencies have depreciated in China, India, Brazil, Russia and South Africa. This is the result of the increased fragilities we discussed in our recent EM outlook and strategic asset allocation paper.   

Somewhat more worrying, however, is the contagion risk that Turkey might pose to financial markets and economic performances in general, in particular via exposure to Turkish banks. As discussed in a recent press report, European banks (especially in Spain, Italy and France) own significant stakes in the Turkish banking sector, which in turn carry an exposure of more than USD 130bn to the Turkish non-banking private sector. In particular, three major lenders— France's BNP Paribas (holder of 72.5% of the retail bank TEB), Spain's BBVA (49.9% of Garanti bank) and Italy's UniCredit (40.9% of Yapı Kredi bank) lost 3.0%, 5.3% and 4.7% of their share value on Friday, respectively. The European Central Bank expressed concern about the three banks’ exposure to Turkey; the Turkish market accounts for 14% of BBVA’s total loans, 4% of Unicredit’s, 3% of ING’s and 2% of BNP Paribas’. 

This situation could be especially concerning for peripheral Eurozone countries, such as Italy, which are already the focus of investors’ concerns as a result of their own domestic issues. Italy’s “populist” government is in the process of drafting its first budget, even as it faces serious divisions within the governing majority. The Turkish crisis is yet another reminder of the interconnectedness of financial networks; of how a crisis in one area of the global economy can quickly affect wider markets.

The Flip Side of This Very Hot Summer


by Brunello Rosa

6 August 2018

It’s August, schools are closed and some of our readers are probably enjoying well-deserved holidays. This year summer temperatures are warmer than usual, in many parts of the world. In Europe average temperatures are reportedly 6-12 degrees Celsius above normal seasonal averages, and have touched 40 degrees Celsius (104 Fahrenheit) in a number of countries, even in Northern Europe. These extreme weather conditions could make holidays more enjoyable for those spending time at beaches, lakes, or mountains, but on a larger scale they are unlikely to be good news. Because of the hot weather, forest fires have been raging in a number of places: California, Sweden, Britain, and Australia. In Greece, the fire that recently claimed more than 90 victims near Athens was partly caused by high temperatures and drought. 

Assuming that high temperatures are the result of climate change, their long-term implications are likely to be severe. In his seminal book Connectography, Paragh Khanna provided a picture of how the world might look at temperatures 4 degrees warmer than usual. Comparing that picture with maps showing present-day migration flows (maps from the International Organization for Migration, for example), one can already see astonishing similarities. People are leaving places of recent or impending desertification. As far as Europe is concerned, the largest places of origin for migrants are countries in the Sahel and Sub-Saharan Africa. This is because the Sahara Desert has expanded to the south, making living conditions in some areas (via agriculture, drinkable water, etc.) impossible. People from these regions try to reach Europe by crossing the Mediterranean, leaving Africa from countries such as Libya where border controls have been reduced by political weakness of public authorities.  

Political authorities in Europe, the US, and other parts of the world continue to make the distinction between a refugee (“someone who has been forced to flee his or her country because of persecution, war or violence”, according to UNHCR) and an economic migrant (“a person who leaves their home country to live in another country with better working or living conditions”, according to Cambridge Dictionary). Only the former is entitled to receive international protection by being granted asylum in recipient countries. 

There is an inconsistency here: people escaping declared and recognised wars are classified as refugees and are entitled to apply for asylum and remain in the countries they have arrived in, while those escaping an equally certain death due to incipient desertification are considered economic migrants and can be sent back to their countries of origin. In our opinion, this distinction is flawed and outdated. As Prof. Jeffrey Sachs wrote in a recent article, “we are all climate change refugees now.” As discussed in a recent book, because of the social and political implications of climate change and migrations, conflicts are also more likely to emerge in migrants’ countries of origin. 

Political authorities need to start acting in accordance with this new reality, since ignoring it only feeds populism. There are now tens of millions of internally-displaced people, refugees and “economic migrants.” They will all want a chance for a better (or any) life, and will go to the most advanced economies. In 2015, for example, Germany became the single largest recipient of new individual asylum claims globally, with 441,800 registered individuals. It became the second most common destination for international migrants globally, one spot behind the US and ahead of Russia. One can understand traditional or populist political parties being resistant to this new phenomenon, but that will not change the fact that it will become more evident in the years to come. According to Prof. Sachs, “there is still another 0.5º Celsius or so of warming to occur over the coming decades based on the current concentration of CO2”. The environmental effects of this have yet to be observed.

Climate change, to be sure, is not just an environmental phenomenon to be discussed in large international symposia. It is an emergency, with massive economic, social, and political ramifications that need to be tackled with the utmost determination and sense of urgency. Before it is too late.     

(Links to examples of fires this year were taken from Prof. Sach's article.) 

Weekly Column - Central Banks In Focus


by Brunello Rosa

30 July 2018

While the independence of central banks starts to be questioned or, in some cases, openly challenged (as we discussed in last week’s column), central banks continue to do their job of trying to deliver price and wider macro-economic stability. 

Last week, the European Central Bank left its policy stance unchanged and did not provide further details of its future re-investment policy, which probably still needs to be agreed upon within the bank’s Governing Council. We will probably need to wait until after the summer break to know more about this crucial aspect of the ECB’s policy stance. 

In Turkey, the CBT unexpectedly kept its policy rate, the one-week repo rate, on hold at 17.75%. This decision surprised analysts and market participants, who had been looking for a 100bps increase in the repo rate. It therefore triggered currency outflows that weakened the TRY, with the USD/TRY rising by 1.2% over the week, to 4.852. The bank’s decision might be the first instance of Erdogan using his influence over the CBT’s policymaking now that his mandate has been renewed and reinforced as a result of the June 24th elections. 

On the other hand, press reports suggest the PBoC further eased its policy stance, reducing a specific capital requirement for local financial institutions in order to help them meet their credit demands more effectively. The PBoC easing is part of a wider strategy by the Chinese authorities to implement an expansionary monetary and fiscal stance to cushion the Chinese economy from the potential effects of the trade tensions deriving from commercial wars initiated by US President Trump. 

This week, three of the world’s major central banks will also hold policy meetings. On Tuesday, the Bank of Japan will conclude its two-day policy meeting and release the new bank’s forecasts. Press reports have been suggesting for days that the BoJ will change its policy stance, for example by dropping its Yield Curve Control policy. We don’t expect the BoJ to do so, as the inflation target is still too far from present rates for the central bank to tighten its stance (core-core inflation is still close to zero). 

On Wednesday, the Federal Reserve will hold its Federal Open Market Committee (FOMC) meeting, which is likely to be concluded with the Fed funds target range being left unchanged at 1.75%-2%. The bank’s formal statement following the meeting will be watched closely, as the FOMC will most likely prepare the ground for the further 25-bps increase in the policy rate to be implemented at the end of September. 

On Thursday, the Bank of England will hold its August MPC meeting and is expected to increase its Bank Rate by 25bps to 0.75%, in effect the first tightening of policy rates in a decade (the 25bps increase to 0.5% in November 2017 was merely a return to the effective lower bound, as estimated in 2008). The BoE has probably found a window in which to slot in a rate increase before the Brexit debate becomes even more heated this autumn. 

Central banks continue working to ensure that the transition of the real economy to levels consistent with its supply-side structure remains as smooth as possible. Hopefully they will be able to continue to do so in an independent and non-conditional manner in the years to come.

The Ongoing Challenge To Central Bank Independence


by Brunello Rosa

23 July 2018

The independence of central banks from political influence is one of the pillars of the world order as we know it. Central bank independence started to be granted in many countries during the 1980s, when central banks began to be tasked with the goal of achieving price stability (fiscal policy, meanwhile, remained mostly in charge of supporting economic activity). Since then, the benefits deriving from central bank independence have been evident in the structurally lower inflation rate that has occurred at a global level, which has contributed to lower long-term interest rates. Nevertheless, in the same way that other pillars of the post-WWII world order, such as NATO, the EU, and even the role of the US as the hegemonic global super-power, are now being questioned, central bank independence is also being challenged. One could even say that central bank independence is “under attack.” 

To a certain extent, the quantitative easing programs begun by the major global banks in 2008 were meant to blur the distinction between monetary and fiscal policies. The risk of “fiscal dominance” (i.e. the use of monetary policy to keep governments solvent) was contained solely by the fig leaf that those policies were “independently” adopted by central banks in order to pursue the banks’ price-stability objectives (e.g. by minimizing deflation risks). Also, it was inevitable that after this golden era of the central bank semi-godscoming to the rescue of the world economy – since fiscal policy was still constrained by anti-Keynesian ideological approaches – their apparent unlimited power would come under more severe scrutiny by the political authorities. But here we are not simply talking about central bankers returning to their traditional roles, by giving up the exorbitant powers granted to them in the aftermath of the Global Financial Crisis. Rather, we are talking about the return of political interference in matters that have traditionally been decided by central bankers, such as the right of independently setting interest rates. 

Examples of this new tendency are starting to become common. In Argentina, when the government increased the inflation target from the 8%-12% range to 15% at the end of last year, the central bank “found the space” (to use a euphemism) to cut rates at a time when inflation was not giving any sign of moderating. This upset international investors, who then sold the peso en masse, thereby forcing the government to go cap in hand to the IMF for a USD 50bn emergency loan. In Turkey, ahead of the elections that certified Tayyip Erdoğan’s acquisition of new presidential super-powers, Erdoğan himself explicitly said that he would reduce central bank independence, thus causing a sharp sell-off of the Turkish lira. After the election the president granted himself the power to appoint the new central bank governor, after choosing his son-in-law as head of the new treasury and finance ministry. 

Unfortunately, even in developed markets central bank independence is also not as sacred as it used to be. Last week U.S. President Donald Trump criticised the Federal Reserve’s recent decision to increase rates. Reportedly, Trump said: “I am not happy about it. But at the same time I’m letting them do what they feel is best […] So somebody would say, ‘Oh, maybe you shouldn’t say that as president. I couldn’t care less what they say, because my views haven’t changed. I don’t like all of this work that we’re putting into the economy and then I see rates going up.” It is worth reminding Trump of the experience of Fed Chair Paul Volcker, who in the early 1980s engineered a recession in order to combat inflation, and eventually succeeded in achieving his goal.  

Given the considerations above, it is certainly a possibility, but definitely would not be a welcome one, that a lack of central bank independence will become, together with populism, nationalism and rising authoritarianism, yet another ingredient of the new world “dis-order” we seem to be heading for.  

Trade Skirmishes And Technological Wars


by Brunello Rosa

16 July 2018

A series recently-published of articles (for example in the New York Times and Le Figaro) reported on the rapid development of facial-recognition and other surveillance technologies in China that allow the authorities (central and local governments, public administrations, school boards, etc.) to follow almost any moment of people’s lives, in a country with a population of 1.4 billion. The authors of these articles suggest how these systems are the technological evolution of other forms of social control that have traditionally characterised Chinese society for centuries, from household communities to workplaces. These surveillance technologies would also allow the government to finally implement a system of “social reputational scores” that was conceived in the 1990s as way of assessing people’s creditworthiness, only now expanded to take in a much greater scope.  

In schools, systems of continuous surveillance would allow the teaching board to make a complete, 360-degree evaluation of scholars, not just through traditional test scores but also by assessing the presence, participation and activity of pupils during school hours, interest in the subjects studied, and overall behaviour during examinations as well as during recess. This way, the authorities claim, only the best of the best (not just academically, but also in terms of behaviour) will emerge in a dramatically competitive environment such as Chinese society today. At the same time, it is quite natural to think that, with these technologies, governmental control of people’s activities (including those of a political, or politically-sensitive, nature) can also be more fully implemented and enhanced. 

Let’s set aside, for a moment, the moral, ethical and political implications of these technologies, which could amount to a rather dystopian, Orwellian big-brother future, where the combination of artificial intelligence (AI), Internet of Things (IOT), big data, robots and automation eventually lead to the emergence of a combined system of machines not dissimilar to the Skynet of the Terminator saga, which eventually becomes self-sufficient and auto-directed. (With some sense of humour, the Chinese police chose the name “Skynet” for their system of surveillance cameras). What is mostly relevant for us at this juncture is the fact that the new battlefield for world economic leadership is precisely within the perimeter marked by AI, IOT, big data, robots and automation. This technological battlefield also includes a geopolitical component constituted by the use of cyberwarfare, as well as a financial aspect deriving from the addition of Fin-Tech to the mix. 

As discussed in a recent report by Nouriel Roubini, in this race to the 21st century economic supremacy, China is ahead of any other country in the world, having set the goal of being the number one performer in the 10 most advanced technologies of the future (including AI, robotics, EV and driverless cars, biotech, aerospace, and others) by 2030, even using aggressive industrial policies that will include government funding, subsidies and below-market rates loans in order to achieve this goal. One can see how the ongoing trade tensions (with tariffs and counter-tariffs between US and China) are just skirmishes (that could still lead to a full-blown trade war, if not contained), compared to the much deeper and broader lingering technological war between the world’s super-powers.

Yield Curve Flatness Does Not Imply US Recession


Read R&R Full Analysis Here

by Brunello Rosa

9 July 2018

Last week, the combination of the minutes of the Fed’s June FOMC meeting, the employment report on Friday 6th and continued trade tension (with the implementation of tariffs and counter-tariffs between US and China) had the usual flattening impact on the U.S. yield curve, with the 2/10y yield spread now just above 30bps, the lowest level for the last ten years. Mechanically, the twist of the yield curve is easy to understand. 

At the short end, a buoyant economy, boosted by a late-cycle fiscal stimulus, with a very tight labour market and rising salaries leading to above-target inflation (with the June figures to be released during this week) imply a central bank continuing its monetary policy normalisation for at least another 18-24 months, and this is reflected in a 2-year yield at its highest level since 2008. Upward pressure on short-term rates derive also from increased issuance of T-bills, to finance the larger budget deficit. 

At the longer end, international factors seem to be playing a larger role than domestic ones. As long as the ECB and the BoJ continue to conduct very accommodative monetary policies (they are both still increasing the absolute level of their balance sheets, albeit at a reduced pace) long-dated German bund yields will remain low in historical terms, and JGB yields near zero, given the BoJ’s Yield Curve Control policy. In fact, quantitative easing depresses the term premium embedded in long-term yields, which even in the U.S. (where the Fed is reducing its balance sheet and increasing rates), remain very low, if not negative. In such a context, international arbitrage continues to suggest investor to buy US Treasuries any time their yield (at 10y maturity, for example) approaches 3%, in spite of the appreciating dollar (and/or after having taken into account cross-currency hedging). Additionally, increasing trade tensions continue to suggest potentially lower growth potential in the medium term, adding downward pressure to the already low and diminishing real “global” long-term rate, with risk aversion pushing further the safe-haven bid for Treasuries. 

So, given the combination of macro-financial and geopolitical phenomena, it is absolutely natural that the U.S. yield curve flattens. The question is: does a flatter - or even inverted - yield curve, necessarily indicate an incoming recession (say, over a 12-month horizon) as the traditional literature suggests? In a speech of a few months ago, former New York Fed President Bill Dudley discussed the several reasons why this wasn’t the case. 

However, his successor John Williams, has more recently suggested that inverted yield curves are still a very powerful signal of incoming recessions. This seems to confirm a recent study by the Federal Reserve of San Francisco, concluding that “while the current environment is somewhat special—with low interest rates and risk premiums—the power of the term spread [i.e. the difference between long-term and short-term interest rates] to predict economic slowdowns appears intact.” On the back of this assumptions, the New York Fed continues to publish on a regular basis an estimate of the recession probability based on the slope of the yield curve. Based on the latest data, the probability of a recession in June 2019 would now be around 12.5%.

In our opinion, international factors play such a huge role on the shape of the U.S. yield curve that any estimate of a recession probability in the U.S. based solely on the U.S. term spread is likely to be largely overstated. On the other hand, it is quite likely that the cumulative effects of the Fed’s monetary policy normalisation (moving at some point into the neutral/restrictive territory) will eventually be felt by the economy, which will inevitably face a new contraction in coming years. 

EU Summit Yields Little Results, As European Crisis Intensifies



by Brunello Rosa

2 July 2018

The results of the EU summit on June 28th-29th have been disappointing, as we predicted in our recent travel notes from Berlin. A lot of the media attention was focused on the discussion over migration, and the agreement reached seems insufficient for all sides. Merkel made bilateral agreements with Spain and Greece to allow a re-patriation of the migrants caught in Germany and first registered in those countries. Similar agreements have been discussed with other governments, but not from the Visegrad group. 

Additionally, Italy has not ratified any similar bilateral agreement (given the opposition of Interior Minister Salvini, also leader of the League), and this was the most important for Merkel to sign. More importantly, Germany’s Interior Minister, and leader of the CSU Horst Seehofer said that even if those agreements had been signed, they would not be as effective as his proposal of rejecting migrants engaging in “secondary movements” within the EU at the German border. This was a proposal that Merkel refused to accept, fearing a domino effect that would lead all European countries to close their borders, thus marking the end of Schengen but also of one of the four freedoms of Europe – that of free circulation. As a result, Seehofer has offered his resignations, which means that Germany’s government crisis is far from over and might actually intensify in coming days.


On the Eurozone reform, vague language on the “beginning [of] political negotiations on the European Deposit Insurance Scheme” accompany the only tangible result, the agreement on the fact that the “ESM will provide the common backstop to the Single Resolution Fund (SRF).” All other elements supposed to be discussed, (Euro budget, macroeconomic stabilisation mechanism, European unemployment insurance scheme – presented in a letter by Eurogroup president Mario Centeno to Donald Tusk) have been postponed until December 2018.  On a side note, Greece eventually got the long-waited measures of debt relief that would allow a clean-ish exit from its third program of international financial assistance.  

Finally, on Brexit, as we anticipated, the Europeans could only welcome the “further progress made on parts of the legal text of the Withdrawal Agreement,” while expressing “concern that no substantial progress has yet been achieved on agreeing a backstop solution for Ireland/Northern Ireland,” and reiterating that “work must also be accelerated with a view to preparing a political declaration on the framework for the future relationship, [which] requires further clarity as well as realistic and workable proposals from the UK as regards its position on the future relationship.” Effectively the Europeans told the Brits to put their act together and make a decision on what kind of Brexit they want, at the same time warning all member states to be ready for any possible outcome (read: no-deal).

On the back of the considerations above, it is hard not to see an intensification of the European crisis (discussed in a previous column), which will eventually crystallise in one or more of the following ways: a German government collapse; a collision course between Italy and the market, possibly leading to a renewed Euro- or banking crisis; a political crisis in the UK following failed negotiations for an acceptable deal in October; an outbreak of populist parties in the many countries of Europe in which they are gaining power, and most likely in the European elections in 2019.   

These events are likely to induce increased volatility in FX rates (especially EUR/USD and GBP/EUR), in bond yields (in particular bunds and gilts) and eurozone peripheral spreads (chiefly the 10y BTP/bund yield spread).

Q2 Ends With Some Hopes and Many Warning Signals


by Brunello Rosa

25 June 2018

This week the second quarter of 2018 will end, with some hopes and a few warning signals on the economic, financial and geopolitical front. From a macroeconomic perspective, Q2 saw a re-acceleration of growth in US economic activity, partly boosted by the tax cuts approved in January, while the soft patch that affected economic growth in the Eurozone, UK and Japan seems now to be a more persistent phenomenon than initially anticipated, in spite of recent better PMI data. As a result, while US inflation is now above target in both headline and core terms, core inflation remains subdued in the Eurozone and Japan, and is falling fast in the UK and is now just above the BOE target. China’s economy has performed decently in both Q1 and Q2, although recent data have been mixed and regulatory tightening in credit this year is likely to slow down economic growth. 

Central banks have reacted accordingly. The Federal Reserve has signaled that, unless something goes wrong, it will carry on with its policy normalization at the pace of one 25-bps increase in the Fed funds target range per quarter in 2018, with two additional hikes expected during the remainder of the year. The Bank of Japan has remained on hold this year and will likely wait much longer to review its policy stance, especially after the unexpected economic contraction in Q1. The European Central Bank, while announcing the tapering of its asset purchases, has signalled that the first rate hikes might not occur until Q3 2019. The Bank of England has postponed to at least August (if not later), the rate hike that most market participants (but not us) expected to occur in May. The PBoC cut the reserve requirement ratios for many banks after soft economic data and just announced a new round of cuts to deal with the expected growth slowdown from trade frictions.

The most vulnerable emerging markets have suffered from the combined effects of USD strength (in turn deriving from US rate policy normalisation, Fed’s balance sheet reduction and US Treasury’s increased issuance to finance the greater budget deficit created by the tax cuts), oil price increases (due to past cuts to production, partly eased at the latest OPEC meeting), policy mishaps and still-large current account deficits: top of the list were Argentina and Turkey. A number of EM central banks (in Argentina and Turkey, but also in Brazil, India, Indonesia, Mexico) have been forced to increase their policy rates or intervene in the FX market to defend their currencies against the USD appreciation. Oil exporting countries, such as Russia and Saudi Arabia, have done better, thanks to higher oil prices. 

From a geopolitical standpoint, most developments don’t seem particularly reassuring. Slightly easier tensions on the Korean peninsula, to the full advantage of Kim Jong-Un, have been more than offset by the beginning of a full-fledged trade war between the US and the rest of the world, starting from China, and including Canada and Mexico (with NAFTA being put on hold) and the European Union. In Europe, a new severe crisis seems inevitable, whether due to the lack of agreement on migrants, on fiscal policy or on Brexit. The new “populist” government in Italy is likely to be only modestly confrontational initially, but the truce with the EU and the markets might only last until the autumn. 

Markets have reflected those economic and geopolitical developments. As we expected, US equity prices have not returned to their January 2018 peak yet, and we don’t expect them to do so for the rest of the year. The 10y US Treasury yield finds it hard to go beyond 3% on a sustained basis, especially as long as the ECB and the BOJ continue with the asset purchases, depressing bund and JGB yields. This week, we will publish our asset allocation update, which will suggest how to position in this difficult environment. 

London Caput Mundi (for This Week)


by Brunello Rosa

18 June 2018

This week, the UK will stage a series of high-profile events. First of all, the House of Commons will continue to vote on the EU Withdrawal Bill, on the series of amendments that have been approved by the Lords and that the lower chamber has started to reject last week, including on the continued participation of the UK in the EU customs union or even in the single market. The most relevant front that is still open, on which there will likely be a vote on Wednesday, is the possibility for the UK parliament to have a “meaningful vote” on what the government should do in case of “no deal” between the UK and the EU. 

Last week, the Commons rejected the original amendment by the Lords by 324 votes to 298, i.e. with a majority of 26. This means that when the bill returns to Commons on Wednesday, only 14 Tory MPs would have to change their vote to defeat the government. It is estimated that there are currently around 15 pro-Remain Tory MPs that could vote against their own government. If that occurred, Theresa May’s negotiating strategy might need to change completely, as it would be enough for the EU to reject any deal (however advantageous for both sides) to create turmoil in the UK and de-facto postpone Brexit indefinitely. 

As discussed in our recent analysis, the post-Brexit customs arrangements are far from being simple technical commercial options and mask instead deep political choices that the country needs to make, also to preserve its territorial integrity. The risk is of course that the country makes no clear choices, goes un-prepared to meetings (including the June 28-28 EU Summit) and will undergo a few more rounds of political turmoil, before entering a permanent limbo or – worse – falling down a cliff-edge.  

All this would have serious implications for the UK economy, which will be discussed at the Mansion House dinner on Thursday, when both BOE Governor Carney and Chancellor Hammond will speak and provide their views. Carney will speak just a few hours after having concluded its Monetary Policy Committee meeting, which we – in line with the market – expect to be concluded with an unchanged policy stance. However, this meeting will be important for two reasons. First, it will conclude the summer round of G4 central bank meetings that started last week (with the Fed, the ECB and the BOJ) and will help us taking stock of how global central banks are currently seeing the world and their domestic economies. Secondly, it will be the last meeting before August, when the BOE might be carry on with its stated plans, and increase its policy rate by 25bps to 0.75%. Hopefully the language of the statement will shed some light on the BOE’s current inclination in favour of further tightening, given the recent fall in headline inflation (to 2.4%, from the 3.1% recorded as recently as in November 2017). 

Even if the BOE rightly keeps its decision-making process separate from the day-to-day Brexit developments, it is clear that, if something goes horribly wrong between June 2018 and March 2019, BOE’s policy actions will be the first line of defense (including for the GBP), as it was the case in the aftermath of the June 2016 referendum.

Central Banks Return to Centre Stage


by Brunello Rosa

11 June 2018

Immediately after the disastrous conclusion of the G7 meeting in Canada (which we anticipated in last week’s column), and ahead of this week’s historical meeting between US President Donald Trump and North Korea’s leader Kim Jong-un, central banks return to centre stage, with the policy meetings of the US Federal Reserve, the ECB and the Bank of Japan. 

In line with consensus, we don’t expect any change in BOJ’s policy stance, especially after the Japanese economy contracted by 0.2% in Q1, and inflation has fallen back from the 1.5% yearly increase recorded in February to 0.6% recently. Following our recent analysis, and on the back of these data, we don’t expect the BOJ to make any significant change to its communication until March 2019 at least. Regarding the ECB, we expect the Governing Council to start its discussion on if and how to continue with its asset purchase program, but we don’t expect any major announcement to be made at this stage yet. The major obstacles to pre-commitments are the ongoing soft patch the EZ economy is experiencing and the resurgent political instability, following the formation of new governments in Spain and in Italy (on which we publish a working paper in bullet points). 

Regarding the Fed, in line with consensus, we expect a 25-bps increase in its Fed funds target range to 1.75-2.0%, while we don’t expect the dot plot to indicate four total hikes in 2018 yet

The key aspect of this policy meeting might be the repercussions that a further increase in US rates and strengthening of USD might have on emerging markets. As we discuss in greater detail in the section “The Quarter Ahead,” the recent increase in US policy rates, reduction in the Fed’s balance sheet and dollar appreciation are starting to generate significant outflows of funds from EMs, forcing some central banks to implement “defensive” rate hikes or FX interventions to defend the value of their currencies (with Brazil, Indonesia, Mexico and India having joined Turkey and Argentina). 

As discussed in a recent article for the FT by India’s central bank governor Urjit Patel, the combination of Fed’s balance sheet reduction and increased issuance of US Treasury bills and notes to finance the higher fiscal deficit due to Trump’s tax cuts, is creating a dollar shortage that is putting pressure on EM currencies (especially of the most fragile countries). Initially, the Fed might shrug off the effects of its policies on other countries, but eventually it might be forced to look back into it. If the dollar appreciates notably, its policy normalisation to control inflation dynamics might afford to be slower than otherwise. If the rest of the world goes into an economic slowdown as a result of localised (but numerous) currency crises, global growth will also slow down eventually, thus affecting the Fed’s policy path. It will be interesting to watch whether or not Jay Powell, in his press conference on Wednesday, will address this issue.

G8, G7, G6+1 and ?


by Brunello Rosa

4 June 2018

This week the world’s seven most advanced economies will convene in Canada for their periodic G7 meeting. Not long ago, this reunion was called G8, as also Russia was participating (from 1997 to 2014, when it was excluded due to the Crimean annexation). In our recent trip report from Russia, we discuss how the series of sanctions that have hit Russia from 2014 onward has convinced its omnipotent President Putin to pursue more in-ward looking policies as opposed to the structural reforms suggested by his advisors, aimed at opening up the Russian economy and increasing its sluggish growth potential. However, the rise of autocratic, inward-looking, protectionist and sometimes nationalistic leaders (discussed in a previous column) is a widespread phenomenon, as testified by the upcoming presidential and parliamentary elections in Turkey (on June 24th), where President Erdoğan aims at further increasing its grip on the country, as discussed in our recent paper

In the US, the democratically elected President Trump is adopting an increasingly protectionist stance, as demonstrated by the decision to impose tariffs on US import of steel and aluminium from Mexico, Canada and the EU, after the exemption period expired this week. This comes at the time the US is already in a potential trade war with China and is re-negotiating NAFTA. At the G7 meeting of finance ministers and central bank governors, six countries asked US Treasury Secretary Steve Mnuchin to convey their "unanimous concern and disappointment" about the tariffs to the President. Somebody has already started to re-label next week’s G7 meeting as a G6+1. 

Is it the end of it?  Well, in Italy, the new Conte government has just been sworn in, supported by reportedly populist parties such as Five Star and League. For the time being, the EU has shown its friendly face to Italy, saying (with Juncker, Moscovici and Merkel) that European partners are ready to cooperate with the new Italian government. But what if Italy starts significantly drifting away from its traditional pro-European and pro-NATO stance? Will the G7 become G5+1+1? 

What about Germany? For the time being, as discussed in our recent trip report, the political system is trying to revitalise the centre ground, but – in case of failure – populist and extremist parties from the right and the left are ready to make significant electoral progress and render Germany as ungovernable as Italy is. Would that mean we are going to have a G4+1+1+1? Maybe, unless also the UK starts significantly deviating from its traditional free-trade policies by making the wrong customs arrangements, post-Brexit (as we discuss in our upcoming trip report); in which case we might have a G3+1+1+1+1. What if Macron fails to reform France and Abe manages to change the Japanese pacifist constitution? At that point, there wouldn’t be much left of the once seemingly invincible consensus of the world’s "most industrialised" nations. 

The reality is that the pendulum of history is swinging in a direction that is opposite to the one that led to the equilibria reached after World War II, and the formal and informal institutions that emerged from them. Physics tells us that, unless a lot of effort is made to stop its movement, the pendulum will continue to swing until the opposite (dis-)equilibrium is reached. 

Yet another European Crisis is Looming


by Brunello Rosa

29 May 2018  

We have discussed in a number of papers the various dimensions of the European political economy debate. From the prospects of further EU and EZ integration to the Brexit saga, from the Catalonia independence issue to Macron’s efforts to promote a faster unification process, from the rise of populist parties in Italy to the attempt by Germany to revive the political centre ground, not to mention our deep dive into the Balkans, or Russia’s influence on the region - and we will soon publish the second part of our trip report to Germany, a comment on the recent evolution of Italy’s political crisis and our latest update on the customs union options for the UK, post-Brexit. In this column, we try to make sense of all these moving parts, and find the fil rouge connecting all these dots.


Since Europe is still enjoying a generalised economic expansion, with GDP growing above potential in many countries (including the traditional laggards, such as Italy), inflation finally grinding higher and unemployment (slowly) falling, it would be easy to discard all the above-mentioned issues as individual pieces of the messy European jigsaw, relevant domestically, but irrelevant at global level, and from a micro-financial perspective. We wouldn’t agree with this interpretation, for a number of reasons.

First, it is true that economic expansion eases most socio-political tensions, but if they remain in place when the next recession hits (sooner or later, it will happen), they could deflagrate in a less controllable fashion, also from an economic standpoint. Second, if European countries haven’t found a modus operandi in a more integrated union, when the next crisis hits, the asymmetric shocks that would hit the continent could stall any form of further integration process and potentially send it into reverse. Third, Europe has been the epicentre of two world wars in the 20th century, and that was the origin of the European integration process. If that fails, Europe could become again the epicentre of global geopolitical tensions.


So, the question is: how likely is that Europe will experience another severe crisis sooner rather than later? At this juncture we would say: quite likely, with the June 28-29 EU Council meeting being the first step in that direction. In fact, unless a compromise (or a fudge) is found on the Irish border issues, the possibility of a disorderly Brexit with no deal and no transition in 2019 will increase significantly; on the European banking union very little progress will be made, meaning that any form of risk mutualisation will be pushed into the distant future; and now, the euro-redenomination risk will come back on the table, after Italy has adopted another technocratic government which populist parties will use as their target to gain even more votes at the next general election, in September/October 2018 or February/March 2019 at the latest. 

Additionally, Spain is facing its own political crisis, which could also lead to snap elections, and Greece will have to deal with a complex exit from the Troika program. All this, while Germany’s willingness and ability to do “whatever it takes” to save Europe (or at least the Eurozone) has severely diminished. The risk is that summer 2018 will be very hot, not just for climatic reasons.

US - China Trade War On Hold For Now, But Strategic Rivalry Likely To Continue


by Brunello Rosa

21 May 2018 

On Saturday 19 May, US and China issued a joint statement saying that “there was a consensus on taking effective measures to substantially reduce the United States’ trade deficit in goods with China” and that “to meet the growing consumption needs of the Chinese people and the need for high-quality economic development, China will significantly increase purchases of United States goods and services.” The statement remains extremely vague on the detailed actions that will need to be taken in order to achieve the intended results (for example, there is no mention of the USD 200bn target reduction in deficit – from the current USD 350bn – initially mentioned by the US administration). At the same time, it probably marks the beginning of a truce between the two sides, with a dangerous escalation of tariffs and counter-tariffs being put on hold for the time being. 

This is probably good news, at least on a short-term basis, as the combination of rising US Treasury yields, strengthening USD and economic soft patch is key areas of the world economy (e.g. Eurozone and Japan) was already putting the resilience of the ongoing global expansion into question. A full-fledged trade war between two global economic heavyweights would have made the situation much worse, especially for emerging markets, the most fragile of which are already suffering from this dangerous cocktail (especially when domestic policy mishaps are added to the mix, as in the case of Argentina, as discussed in our recent report). 

However, this short-term truce is unlikely to imply the end of the strategic rivalry between the US and China, which instead has just begun. As discussed in our recent paper on US – China trade tensions, what really matters in this story is not the bilateral trade deficit of the US versus China, or the tit-for-tat tariff skirmishes of the last few weeks, but rather the beginning of a long-term rivalry (in both the economic and geo-strategic realms) between US and China, which – according to the new US National Security Strategy, defining China as a new “strategic competitor” – needs to be contained. If this interpretation is correct, the trade, technology, FDI, investment tensions between the US and China will likely escalate in the next few years regardless of any short-term agreement.  

Even if an agreement to avoid a short-term trade war is eventually reached this year, after further negotiations in coming months, this will not be the end of the serious trade and technology tensions between the two sides that will likely increase and escalate over the next few years. A key battlefield in this technological rivalry between the US and China will be in the Artificial Intelligence area, where the formal goal of China is to become the technological leader by 2030. In this respect, the joint statement provides little (if any) reassurance, given the absence of any serious discussion on intellectual property rights (a major complaint by the US administration), as exemplified by the case of the Chinese telecommunications equipment maker ZTE , which is not mentioned in the statement.  In conclusion, whether or not a tactical agreement to avoid a short-term trade war between US and China is reached this year, the strategic economic and geo-political rivalry between the two sides is likely to intensify in coming years.

Italy’s Government Puzzle About to Be Solved (One Way or the Other)


by Brunello Rosa

14 May 2018 

After more than two months after March 4th general election, Italy’s government puzzle is likely to be solved in the next 2-3 days, although we still don’t know the exact details. Until a week ago, it seems that Italy was destined to have a politically “neutral” government, led by a technocrat appointed by President Mattarella, to take the country to new elections in July or September 2018, or – at the latest – March/May 2019. This government would have run as a minority government, with or without a confidence vote from parliament (in the latter case, it would have been only in charge of current affairs). Parties in parliament got scared of a possible election at the end of July, when the collapse in turnout would likely imply a random result, and an assured punishment to those parties that were unable to find a compromise for months.  At that point, Five Stars and League took the lead – with the benevolent consent of Berlusconi’s Forza Italia – and started negotiations (which are still ongoing) to form a government between the two. In theory, this Five Stars- League coalition government (which we discussed in our comment after the elections) could count on a relatively solid majority in the Chamber, and a quite thin majority in the Senate. 

At this point, there are two main possibilities: 1) Less likely - M5S and Lega do not succeed in finding a compromise, especially on the name of the prime minister, acceptable to Mattarella. This would mean the failure of any attempt to form a political government, and the return of the “neutral” government option on the table, which would be formed this week, with new elections likely to occur relatively soon; 2) More likely - M5S and Lega do succeed in finding a compromise, especially on the name of the prime minister, a “third” figure between Matteo Salvini and Luigi Di Maio – both likely to be part of the government team (possibly as Interior and Foreign minister, respectively).  

So, by the end of this week Italy is likely to have a new government, one way or the other. A few considerations: First, a “neutral” technocratic government is better than the current situation, in which Gentiloni’s administration (however good it might be in people’s opinion) is expression of the past parliament, with no political legitimacy (and in fact only in charge of current affairs) and unable to make politically binding decision. Also, technocratic governments have often represented a good solution in difficult political and economic transition periods. However, we would be inclined to think that, in this case, even a weak political government would be preferable to a technocratic solution, which would be unlikely to find the necessary legitimacy in parliament and the country to make politically strong and binding decisions such as those the country needs to face in coming months (starting with the June EU Council meeting). 

Second, a M5S-Lega government would face a number of obstacles to succeed, including: a) unless Salvini and Di Maio agree that one of them becomes PM (or possibly both, in succession), the “third figure” would be subject to continued and opposed political pressures from both side; b) the “government contract,” instead of being the “intersection” between Lega and M5S’s respective programs, seems to be the “union;” so, for example, both the “citizenship income” and the “flat tax” are there, not to mention various forms of reduction/abolition of the pension reform approved by Monti in 2011. This means that implementing this program would likely imply a severe deviation from Italy’s fiscal consolidation program, likely resulting in a clash with markets and the EU at some point; c) Salvini – as still being formally part of the centre-right coalition – will tend to remain more loyal to that coalition than to that with Di Maio’s Five Stars. 

Given this background, we reiterate what we said in our latest Italy trip report. While in the short run we believe the country has the means to muddle through, without clashing excessively with the EU and the markets, in the medium term (especially once the ECB’s umbrella will be diminished), its structural fragility will likely re-emerge.  

Emerging Markets Face Tough Test of Resilience


by Brunello Rosa

8 May 2018 

By the end of the week (most likely on Tuesday 8th May, with a self-imposed deadline on May 12th), the US will decide whether or not to withdraw from the Iran nuclear deal. To force the hand of its historical ally, Israel’s PM Benjamin Netanyahu, in a recent press conference, said that Iran has lied regarding its compliance with the agreement, having continued to develop military nuclear capabilities. If Israel decided to launch airstrikes on Iran’s nuclear sites at the time the US decides to re-impose (at least part of the) sanctions on the same country, this could represent a quite substantial risk scenario that could cause a spike in oil prices, which have been rising in the last couple of years (and have now reached 70 USD per barrel, for the first time since 2014) thanks to the production cuts agreed between OPEC (and in particular Saudi Arabia), and Russia. In our recent outlook for oil prices over the 2018-2020 horizon, we discuss in detail this and other (risk and baseline) scenarios.

Geopolitical risks (with perhaps the exception of the Korean situation, which might enter a period of reduced tensions), increasing oil prices, softening growth, rising U.S. Treasury yields and strengthening US dollar constitute a dangerous mix for emerging markets, whose most fragile components have already started to suffer. 

Last week, the Argentinian central bank had to increase rates again (outside scheduled meetings, for the third time since April 27th, for a cumulative amount of 12.5% to 40%) to stem ARS depreciation versus the USD. This was due to the decision of cutting rates in January 2018 (at a time inflation wasn’t giving signs of moderating from the current 25%) as well as of moving the inflation target upward, from the 8-12% range to 15%, once the objective was missed and appeared unlikely to be reached in the foreseeable future. In our recent report, we discussed the dangers associated to central banks moving the goal posts when they felt they could not reach their inflation targets. Turkey was also at the centre of investors’ concerns last week, with the USD/TRY having increased by almost 5% in a week to 4.23, on the back of the S&P’s credit rating downgrade and rising inflation, in the context of upcoming general elections, still-large current account deficit and a high and rising stock of external debt. 

Market participants are now braced to see whether these cases will remain idiosyncratic episodes or will prove contagious for the entire EM space. Some oil-producing EM economies (e.g. Russia) would certainly benefit from the rise in oil prices. We have argued in the past that a number of EM currencies were able to better withstand US rates normalization, thanks to improved macroeconomic fundamentals and also noted how EMs proved quite resilient during the market correction in February. In the next few days and weeks we will see whether or not EMs have in fact sufficient stamina to weather this period of increased investor nervousness.  

Market Prices Re-Aligning to Economic Fundamentals and Policy Differentials


by Brunello Rosa

30 April 2018

Last week’s column discussed how uncertainties on the solidity and durability of the ongoing global expansion were keeping central banks more cautious than otherwise they could be, given the stage of the business cycle. We correctly predicted that the ECB’s Governing Council would discuss the soft patch the EZ economy is experiencing (in this respect – watch this week’s Eurozone Q1 GDP growth, inflation and unemployment data), that the BOJ would keep its policy stance unchanged, that the Riksbank would postpone the timing of its first policy rate increase. We also reiterated our view that the BOE would be more likely to raise rates in August than in May, and the preliminary reading of Q1 2018 GDP (which came in at +0.1%, versus 0.3% expected, and declining from the 0.4% recorded in Q4 2017) makes a rate hike on May 10th quite unlikely at this stage.  


On the other hand, the US economy last week exhibited data that came in above expectations on March retail and home sales, and in particular Q1 2018 GDP which featured a 2.3% q/q annualised growth (compared to a consensus view of 2% - but decelerating from the 2.9% recorded in Q4 201). This data came out ahead of this week’s FOMC meeting, which we expect (in line with consensus) to result in unchanged policy, ahead of a further increase in Fed Funds target range in June. The statement accompanying the decision is likely to signal the upcoming further incremental tightening in early summer.

On the back of these data and policy divergence, the USD rose against a basket of currencies (DXY was up by 1.3% on a weekly basis, its second largest weekly gain in 2018), EUR/USD declined by 0.8% to 1.213 on a weekly basis and GBPUSD fell significantly below 1.40. The UST 10-y yield remained unchanged on the week (at 2.96%), after having crossed the 3% level for the first time since 2013. Some technical analysts would suggest this could be the beginning of a bear market in bonds. We believe that as long as Bund and JGB long-term yields remain this low, also the long end of the US Treasury curve will remain anchored.  

A stronger dollar would help other DM central banks to reach their inflation target, and so last week’s moves were likely welcomed across the board. This was probably less true for EM economies, which tend to experience capital outflows when the dollar strengthens. However, as we discussed in a recent analysis on EM currencies, EM countries are now more resilient to US policy normalisation, in spite of the notable rise in private-sector debt, even denominated in USD (the exception could be Argentina, where the central bank last week was forced to increase rates intra-meeting by 300bps to 30.25%, to prevent a slide of the ARS versus the USD). All this to say that when market pricing follows economic fundamentals and policy differentials, the life of policymakers is easier. Unfortunately,  this alignment has been the exception rather than the rule recently, with USD weakening is spite of the fiscal stimulus and higher monetary policy rates. The next few weeks will tell whether this re-alignment will continue or not.

Central Banks Remain Cautious as Clouds Gather on Global Expansion


by Brunello Rosa

23 April 2018 

At the IMF/World Bank Spring Meetings just concluded in Washington DC, the mood was still relatively upbeat, as the synchronised global expansion continues. At the same time, IMF MD Christine Lagarde, on the eve of the meetings said it quite openly: dark clouds are starting to gather on the horizon, especially as a lingering trade war threatens the global economy

In our recent reports, we looked at this and other threats: in our scenario analysis on the US-led airstrikes on Syria, we discussed the geopolitical risks building up in the Middle East. In our report on the ECB and Eurozone, we discussed the macroeconomic risks deriving from the plateauing of growth in the Eurozone, which is becoming evident in some hard data (e.g. industrial production, exports) and leading indicators (e.g. composite PMIs). Our trip report from Japanhighlighted the macroeconomic (persistently low inflation), geopolitical (developments in the US-North Korea relationship) and political (Abe’s shaky position) risks prevailing in the country. Finally, our trip report from the UK looked at the consequences on fiscal and monetary policy deriving from Brexit developments. In the upcoming Italy trip report we will discuss the rising political risks that could eventually pose a threat to the European integration process. 

To summarise: the world economy is doing fine, but risks exist, and their materialisation could turn the global expansion into a global slowdown in coming quarters, and eventually into a contraction, in some selected countries and regions. 

So, how are policy authorities reacting to this changed environment? The sentiment prevailing among central bankers could be summarised with one word: prudence. The BOE, on the back of inflation falling more than expected, is now putting into question the rate hike the market was expecting to occur in May. The ECB will eventually finish its net asset purchases, but at the IMF meetings Mario Draghi made it clear that “an ample degree of monetary stimulus remains necessary for underlying inflation pressures to continue to build up.” The BOJ, on the back of the macro, political and geopolitical risks mentioned above, appears to be willing to keep its policy and communication unchanged for at least another year. The Fed is, for the time being, the only central bank of the big four, that seems ready to continue with its policy normalisation program: but three hikes in 2018 seem more reasonable than the four that some market participants expect.

But once again: central banks cannot be the only policy game in town. Other policy areas need to do their part to make the world a better and safer place – fiscal authorities, regulators and governments at large. Diffusing dark clouds on the horizon is a collective exercise, which cannot succeed unless there is broad domestic and international policy coordination. 

Red Lines or Red Flags?



by Brunello Rosa  

16 April 2018 

On April 14th, the United States, the United Kingdom and France launched airstrikes targeting sites associated with Syria’s chemical-weapons capabilities. As we discuss in the scenario analysis that we publish today, in our baseline, this will remain a one-off episode, whose economic impact and repercussions on financial markets are likely to be limited, apart from some short-lived volatility in equity and oil prices, and a possible fall in US Treasury long-term yields. 

If our baseline is correct, this military strike was justified by the need to punish the Syrian regime for the alleged use of chemical weapons in the April 7th attack on the city of Douma, which the government denies. Chemical weapons have been internationally banned since April 1997. Former US President Barack Obama set the use of chemical weapons as a “red line,” and therefore a trigger for intervention in Syria, but subsequently avoided any involvement following the September 2013 Ghouta chemical attack. Therefore, President Trump would be rightly reacting to Syria crossing an internationally sanctioned “red line:” he has taken retaliatory measures after both April 2017 and April 2018 chemical attacks.   

“Tit for Tat” is the game-theoretical strategy of “equivalent retaliation” that seems to be very much in vogue in DC in this period: let’s not forget the lingering trade war between US and China, which the two sides are fighting along the same lines. The problem with that strategy is that it might lead to the stabilisation of the situation with a new (not necessarily better) equilibrium. Or it might, conversely, lead to a further escalation of tensions if the response is not considered proportionate by one of the two contenders, or if other actors enter the scene (in the Syrian crisis, it could be Russia intervening in the conflict). It’s too early to say whether these two (very different types of) wars will further escalate or subside. But there is definitely a more “assertive” stance prevailing in DC at this stage, compared to the past, on a number of dossiers. 

We discussed in previous columns how the changes recently occurred in the team of advisors of the US President and top US officials (moderate pragmatists were replaced by more ideologically driven hawks) could eventually lead to increased tensions on a several fronts. We didn’t need to wait too long to see the effects of those changes. A collateral effect of a state of war in the US is that the President, as commander-in-chief, gains manoeuvring space and alignment of the administration, including the so-called “deep state,” behind him. 

In conclusion, it is perfectly legitimate and justified to react when "red lines" are crossed. The question here is whether the series of events of the last few weeks are starting to represent "red flags" for how the situation can evolve in the months and years to come. 

Trade War Fears Continue Weighing on Investor Sentiment


by Brunello Rosa

9 April 2018

Last Friday, equity markets sold off sharply on the back of the lower-than-expected NFP figures (103K jobs added in March, versus 193K expected) and renewed trade war fears. The below-consensus NFP figure need to be considered on a multi-month basis and could have been expected, to some extent, after the sharp 313K increase recorded last month (more than 100K above consensus). So the March figures don’t need to be considered per se as a sign of a weakening labour market, especially after Fed Chairman Jay Powell said (earlier last week), that subdued wage growth signals that the US labour market “is not excessively tight.” A fortiori, this month’s NFP figures cannot be considered indicative of an imminent slowdown of the US economy, which might, in fact, be in acceleration phase, partly as a result of the fiscal stimulus imparted by the tax cuts and the fiscal spending deliberated by the US administration in the last few months. 

More worrying is the impact that fears of a potentially escalating trade war between US and China is having on investor sentiment and equity price dynamics. After the initial move by the US (which threatened to impose 25% duties on 1333 products, worth around $50bn, related to China’s alleged theft of US intellectual property), and the initially modest retaliatory move by China, threatening to impose tariffs on (well-targeted) imports worth USD 3bn, the US has threatened to impose additional USD 100bn in tariffs on imports from China, when China threatened to impose tariffs on 106 products (including soybeans, cars and chemicals) worth USD 50bn. This tit-for-tat game (which, as history teaches, ends up destroying value for all sides, with no eventual winner) is unnerving market participants, who fear a full-blown trade war that could eventually spark a global recession. 

Clearly, a trade war is not in the interest of either contender: the US cannot seriously threaten a major holder of its public and agency debt, without endangering its financial stability, and the value of the US dollar; China cannot seriously threaten a major buyer of its global exports, and the currency in which most of its foreign reserves are denominated. So, game theory would suggest that a solution can be found after the US administration would have symbolically proven that the US will not observe the rise of China as a strategic rival without reacting, and the promise by China to open up its markets over time; and after China would have proven to be the rising hegemonic power, able to call the US as the violator of WTO rules. But it will take time for that equilibrium to be reached. In the meanwhile, markets will remain jittery, and investor sentiment under the cosh. 

In our analysis in February, we discussed how hard it will be for equity markets to return to the January peaks, and recent developments seem to confirm that this will be the case. In such an environment, our updated pro-forma strategic asset allocation continues to favour a moderate risk taking within a defensive positioning, with slightly greater exposure to sovereign bonds and lower to commodities. 

Q1 Proved to Be a Challenging Quarter - Q2 Won’t Be Much Easier


by Brunello Rosa

3 April 2018

Year 2018 witnessed one of the best starts in the last couple of decades, with the stock market rallying on the back of the fiscal reform (aka “tax cuts”) approved by the US administration at the end of last year, which was followed in short order by the approval of additional fiscal spending, partly devoted to infrastructure plans. This fiscal expansion by the largest economy in the world at the time the global economy is already experiencing a synchronised expansion, on the one hand further boosted investor confidence, on the other hand fuelled inflation fears that crystallised at the beginning of February, when US average hourly earnings for January came out at 2.9% y/y. Those fears, and the related fears of a faster tightening by the Fed, conjured to create the correction in the equity market experienced in February. At that point, we were of the view that a full-fledged bear market would be unlikely, but also that stock indices would be unlikely to return to January peaks, as four factors would continue weighing on valuations: (1) inflation scares (as opposed to outturns); (2) rising protectionism; (3) volatility and (4) (geo)political issues. 

At the end of the quarter, most equity markets (especially in DM) closed Q1 in the red, with the S&P500 experiencing the first quarterly loss since 2015, as those factors are all still at play. Inflation fears remain, in our opinion, over-hyped, as the structural factors that keep global inflation in check (technological advancement, globalisation, flatter Phillips curve) are still very much at work, but investors remain concerned that those central banks normalising their policy stance (and chiefly, the Fed), would react to rising inflation by raising rates faster and higher. The imposition of tariffs on steel, aluminium and IP by the US, which is generating some retaliatory action by the affected countries, are weighing on investor sentiment, although the policy uncertainty related to the actual implementation of those protectionist measures is creating volatility in the market, as testified by last week’s equity rally, prompted by reduced fears of an imminent trade war. Finally, geopolitical events remain on the back of investor’s minds, as they have not been able so far to dent their sentiment, but have the potential of causing massive cumulative effects if they materialise. Between trade wars and geopolitical events sits Brexit, which could prove very costly for the UK if the country will end up leaving the EU with no deal, thus falling into WTO rules (or “below”) for international trading, at the time of rising protectionism.

All these issues will remain in place also in Q2, when a new set of challenges will come to the fore, and chiefly: will the Fed continue its policy normalisation at the currently forecast pace of three hikes in 2018, or will increase its pace? Will the ECB signal further tapering of QE in June? Will Italy be able to form a government that will remain compliant with EU fiscal discipline, or will it start adopting a much more confrontational stance with the EU? The good news is that an expanding global economy allows reforms to be made and provides resilience in the face of materialising risks. On the other hand, it’s the accumulation of risks that eventually dents investor confidence and prompt a re-thinking of perspective returns on investment. 

Given this background, our updated strategic asset allocation continues to favour a moderate risk taking (i.e. skew towards equities) within a defensive positioning, with a slight increase in exposure to sovereign bonds and lower exposure to commodities.

Who Checks On “The Boss” in Washington?


by Brunello Rosa

26 March 2018  

Last week, the Fed implemented the widely expected 25-bps increase in the Fed funds target range: the FOMC delivered a “relatively” hawkish hike, accompanied by an upward revision to the growth, inflation, employment and policy rate outlook. The main reason why the overall message was only “relatively” hawkish (in line with our preview), is that the new Fed Chair, Jeremy Powell, performed a very convincing press conference (his first), in which he abundantly caveated the FOMC forecasts, arguing that the future is so uncertain that effectively anything can happen, to the point that there is no urgency to start indicating already in March that four Fed funds hikes in 2018 are necessary. 

Jay Powell was appointed by President Trump to provide continuity with his predecessor, the dovish Janet Yellen, and make sure that the Fed would not undo all the efforts the US administration is making to further boost economic activity (with the risk of “over-heating”) with a faster monetary policy tightening. And, as a corollary, make sure that the dollar does not strengthen too much in spite of the rate normalisation, but actually remains relatively weak (even in presence of tariffs on steel, aluminum and now intellectual property rights). With a gradual monetary policy tightening, a Fed’s balance sheet reduction effectively on auto-pilot, and by keeping a low profile, Jay Powell is delivering on the job he was given and can be considered with reason a good choice by Trump.

Less reassuring, though, are other changes that have been taking place within the US administration in recent weeks. The departure, for various reasons, of respected figures such as Gary Cohn as Director of the National Economic Council, Rex Tillerson as Secretary of State, H.R. McMaster as National Security Advisor give the impression that the team of experts that was advising the President on key strategic matters (of both economic and geopolitical nature) and to some extent “moderating” some of his more extreme intentions and policy plans is now being dissolved, in favour of more hawkish figures (chiefly the neo-Con John Bolton as new National Security Advisor). One can reasonably wonder when the other two former generals that currently are in key government positions (James Mattis as Defense Secretary and John F. Kelly as Chief of Staff) will also depart, leaving the room to less moderate substitutes. 

As the example of Jay Powell shows, the choice of people in charge determine the credibility, policy direction and the ability to deliver of the institutions. The choice of the US administration to start imposing tariffs on key inputs for the globalised economic system, exposing the US to the risk of retaliations and a potential trade war, suggests that the new course of action in DC (likely shaped by new advisors) is less favourable for the global economy and even financial markets (as shown by the sell-off in equity markets last week, the worst in more than the last two years. In mid-February, we warned this could be the case). It is not a mystery that geostrategic and macrofinancial issues are now intimately interrelated: the geopolitical tensions between US and North Korea (ahead of a foreseen meeting between Trump and Kim) and the trade war with China, still one of the largest holders of US Treasuries, are all parts of the same complex jigsaw. Equally, the relationship with Russia has both economic and geopolitical ramifications.  

As discussed in our previous columns, the rise of authoritarian leaders at the time protectionism and trade wars are re-emerging does not bode well for the global economy and financial markets (even if those risks might crystallise only in the medium term). In this dangerous environment, it is legitimate to question whether or not the US want to remain the global champion of liberal democracy and free markets, as they have been for the last several decades.  

The Rise of Authoritarian Leaders: A Downside Risk to the Global Economy


by Brunello Rosa

19 March 2018


On Saturday, the Chinese parliament re-elected Xi Jinping as President of China, while a week before the constitution was amended to allow Xi to remain in power indefinitely. Xi’s choice of Wang Qishang (a key ally of Xi who was in charge of the anti-corruption campaign) as vice-president also signals the intention of the president to continue consolidating and concentrating the power in his hands. China exhibits a number of socio-economic fragilities, but the system as a whole has the economic and financial resources to withstand a systemic crisis. With the latest consolidation of power, the president has ensured that China could even face an additional systemic crisis and be able to preserve the integrity of the political system. 

On Sunday, Vladimir Putin was re-elected Russian President for his fourth mandate, which will last six more years, until 2024. At the end of this term (assuming he does not change the constitution to remove the clause that prevents a third consecutive mandate), he would have been in power (as President or Prime Minister) for 25 years. After Putin’s accession to power, Russia has rapidly moved from a presidential democracy, albeit imperfect, to an increasingly autocratic regime. The annexation of Crimea in 2014 shows how cynically Russia could move on the international stage. 

In April 2017, a referendum in Turkey has transformed the Republic into a Presidential system, in which President Erdogan is the deus ex machina. Also Erdogan has been in power, initially as Prime Minister and then as President, since 2003. Since Erdogan’s accession to power, also Turkey has moved from being an imperfect secular democracy to an increasingly Islamic-inspired autocracy, as testified by the repression that followed the failed coup in July 2016. 

Russia and Turkey are two examples of the increasing tendency of political systems to evolve from relatively democratic organisations into autocratic regimes, and other could be made (e.g. the Philippines under Rodrigo Duterte). China shows how power can be further consolidated and concentrated even in already authoritarian regimes. Statistics show (see map above) how this phenomenon is increasingly happening throughout the world.

The recent crisis of the Russian spy killed in the UK, which has led to the summoning of a UN security council meeting, show how dangerous can be the rise of authoritarian regimes: they represent a problem not just from a (geo)political perspective, but also from an economic perspective, if this leads, for example, to the imposition of economic sanctions. In fact, sanctions tend to have negative repercussions not just on the target country, but also on all those countries linked to the targeted one via trade and financial flows. 

Therefore, the rise of authoritarian regimes in a period of increasing protectionism (which is also a typical move adopted by autocratic leaders) represents not just a danger for the already fragile and shifting world geopolitical order, but also a downside risk – over the medium term – to the sustainability of the ongoing synchronised global expansion, and related equity valuations. Market participants tend to underestimate the importance of such political shifts, as they occur slowly and their effects tend to be felt overtime, or because they are perceived only as tail risks, even when they carry a potentially large downside. Nonetheless, historical experience show that the cumulative impact of such political shifts tend to be large, when they materialise.

US Tariffs: The Return of Protectionism and Trade Wars?



by Brunello Rosa

12 March 2018  

The announcement of U.S. President Trump to introduce tariffs on import of steel (25%) and aluminum (10%) follows by only a few weeks Treasury Secretary Steve Mnuchin’s statement (subsequently softened) that a weak dollar would be good for the U.S. and marks a new element of discontinuity with the economic international order that the U.S. themselves have contributed to build in the last few decades, based on multilateralism and a free trade/free market doctrine. 

Once again, the clearest (analytical) response from Europe came from ECB President Draghi, during the press conference following ECB’s Governing Council in March, when he said that this latest move by the U.S. administration was dangerous from a number of perspectives: (1) it seems reintroducing the concept that decisions on international trade can be taken unilaterally rather than multilaterally; (2) it opens up the risk of retaliation by the affected countries (3) it could have a long-lasting impact on confidence able to derail the global recovery; (4) it introduces elements of geopolitical uncertainty, because, if this is how the U.S. treats its “allies,” how is it going to treat its “enemies?”; (5) it might represent another another leg of the “lingering” currency wars discussed in our previous column. In fact, protectionism could result into the strengthening of the dollar if the Fed normalises its monetary policy faster than previously to counter increasing inflation due to tariffs; but tariffs could also result into a weaker dollar if they signal a "policy view” on desired dollar weakness, if they cause retaliation and if they change the investors' perception about how safe and attractive US assets are. 

There are various reasons why Trump might be launching such a dangerous initiative. On the one hand, he continues speaking to his own electorate, by saying that tariffs will help protect jobs and factories in the U.S. (even if the actual effect is likely to be the opposite), ahead of mid-term elections later this year. It is also possible that President Trump is using these tariffs as a negotiating tactics on other tables: for example, the decision to carve out Canada (the largest exporter of steel to the US) and Mexico from the tariffs is a signal sent to the two countries with which the U.S. is re-negotiating NAFTA: if they “behave” in those negotiations, they will be exempt from the tariffs that the U.S. is now imposing on other economies. If they don’t “behave,” they will also be included in the list of affected countries. 

The main concern about these developments is the potential for retaliatory actions, in particular from the EU, the bloc of countries mostly affected by this decision. Unfortunately, history teaches us that when the world goes down the route of increased protectionism and currency wars at the time the political scene is dominated by autocratic leaders, the endpoint is not a favourable one: at the very least, we could see a reduction in global trade, which could pose a sudden halt to the ongoing synchronised global expansion and eventually a reduced global output potential (as globalisation might have increased inequality within countries, but has also dramatically reduced differences in economic performance between countries). 

But things can go even more wrong, if we add a geopolitical dimension. Protectionism tends to create spheres of influence, and with them geopolitical fault-lines and tectonic plates that eventually collide, if not appropriately governed. At the time in which the UK is leaving the EU, Italy observes the rise of populist parties, and the 2019 European elections are likely to stage again the success of anti-system movements, we seriously run the risk of witnessing a further shift of the global macro and geopolitical situation towards the danger zone.

Europe Between Germany’s Renewed Stability and Italy’s Political Shift


by Brunello Rosa

5 March 2018  

As we wrote last week, the 4th of March proved a crucial day in European politics. Germany found some temporary stability with the result of the referendum among SPD party members, who approved with a relatively large majority of 66% the Grand Coalition between the SPD and CDU/CSU. This opens the door to Angela Merkel’s fourth term in power, which might not last the entire four years of parliament (6 months of which have already passed in negotiating the new coalition contract), but should last at least two years, perhaps before Merkel’s accession to a top European job in 2019. 

On the other hand, following its general election, Italy observes a massive political shift, whose extent will become clearer in coming days. As it takes time to translates votes into seats, thanks to the complications of the new electoral system, some facts are starting to emerge: 

1) The Five Stars Movement (M5S) emerges as the first party in Italy, with around 30% of votes; 

2) The centre-right emerges as the first coalition, with around 35-37% of votes; 

3) Within the centre-right coalition, the League (with around 18%) has more votes (and perhaps seats) than Forza Italia;

4) The PD collapses to around 20% of votes, if not below, and its coalition is unlikely to reach 25%.

We have discussed at length in our in-depth analysis what would be the options emerging from such a scenario. 

At this stage (but again, scenarios might change in coming days, when the distribution of seats will be clearer and the positions of parties more definite), we could envisage three main options: 

a) A centre-right government led by Salvini, with seats missing to reach a majority found in parliament among other parties;

b) A M5S-led government, with the potential support of Lega;

c) Less likely, a sort of “coalition of losers” between PD and Forza Italia, plus centrist parties.

All these options, as mentioned above, represent a massive political shift from the current political equilibrium, whose pillar was represented by the pro-European policies of the PD. Italy will now likely have a government whose attitude towards Europe, in terms of fiscal stance and other sensitive themes such as migration, much more confrontational than before. The market might not initially like this new approach, even if – in case it proved stable – might get used to it. In our analysis, we highlighted this risk that has now materialised: a massive shift towards Euro-sceptical forces.

So, the future of the European integration process is now much less certain: as long as Germany was mired in its own political mess, all other countries had some time for a bit of “respite.” But once a new, fully legitimised, government will be in place, it is likely that Germany will join France in its effort to reform Europe, perhaps with a slightly less austere fiscal stance. What will be Italy’s position in this process is yet to be determined. The government is now much more likely to be led by Euro-sceptical forces, so Italy’s position might be much less pro-European than before, putting any further integration at risk.

March 4th, 2018: The Day of Reckoning for European Politics


by Brunello Rosa

26 February 2018  

At the end of this week, we’ll know something more about the future of the European integration process, as the results of the referendum among the SPD party members on the proposed Grosse Koalition (GroKo) with the CDU/CSU and of the Italian general elections will be known.

The conventional narrative says that the SPD will eventually give green light to the GroKo, and that Italy will manage to find a parliamentary majority for a new government to emerge, even if this means that political forces that fought on opposite sides during the electoral campaign (in particular Forza Italia and PD), will have to find a compromise and form what would look like the Italian version of the German GroKo. The result of these expected outcomes is that the European integration process will re-start, with some progress made between the EU Council meetings in March and June. We don’t disagree that this could in fact be the eventual outcome, although we have already warned that any further integration step will be minimal at best, at this stage. We have also identified an upside scenario in which this process is accelerated by Merkel’s accession to a top EU job (head of the Commission or head of the EU Council) in 2019, while Macron continues to pushed on its pro-European platform at a national level.

At the same time, we have also highlighted the risks surrounding this conventional narrative. Regarding Germany, as we wrote in the inaugural column for this Viewsletter (on 4 December 2018), the risk is that of finding a short-term solution while creating a long-term problem, meaning a further collapse of the SPD (as junior party in the GroKo) and a further fragmentation of the German political system, with continued growth of Die Linke, the AfD and FDP, making Germany virtually ungovernable three-four years from now. The polls have recently shown that the voting intentions in favour of the SPD have already collapsed, to 15-16%, i.e. below that of the AfD, which in the meanwhile have increased. It is true that the SPD, having won the places for both the Finance and the Foreign Ministers will have greater chance to influence the policies of the GroKo, in particular its fiscal stance. But while the SPD in the Finance Ministry can at the margin make Germany’s fiscal stance less rigid and more investment prone, it’s unlikely to be able to make the final push for the EU/EZ to become the full-fledged transfer union it needs to become in order to survive in the long run.

Regarding Italy, we have written that there is still too much complacency in the market, given the level of uncertainty on the eventual outcome. Even the EU Commission President Jean Claude Juncker has expressed similar concerns last week, before moderately backtracking when accused of interfering in domestic political matters. But the uncertainty of the outcome is a fact. An untested electoral law, a record-high level of expected abstention and undecided voters, the fragmentation of the political system means that nobody can say with any level of credibility what the eventual distribution of seats will be, and therefore what parliamentary majority will eventually emerge to support a government. It is well possible that a protracted period of political uncertainty following the election will keep markets nervous about Italy, penalising its sovereign debt and bank equity prices.

March 4th will be an important day for Europe: If events unfold broadly as expected, the European integration process could re-start and progress in its usual bumpy way, muddling through economic and political difficulties. If instead events unfold differently, the process will likely suffer a sudden and protracted stop, which will take time to reverse.

Volatility Abates But Inflation Fears Will Continue to Weigh on Markets


 by Brunello Rosa

19 February 2018  

Last week staged a rebound in equity markets after the sell-off of the previous days: on a weekly basis, the S&P500 rose by 4.2%, and VIX declined by 30% to 19.5. So, for the time being, the market has moved along the lines we highlighted at the beginning of the sell-off (see our weekly column of 5 February 2018), when we thought this would not represent the beginning of a bear market, and we suggested investors should get used to an environment of higher volatility in equity and bonds and higher sovereign yields due to the increase in the inflation risk premium included in the term premium embedded in long-term rates. 

At the same time, the market remains particularly susceptible to inflation surprises (which can easily translate in “inflation scares”), as the sell-off in equities showed last week at the time of the publication of US inflation data, when January CPI came in unchanged from December at 2.1% y/y