WEEKLY COLUMNS (ARCHIVE)

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by Brunello Rosa

16 November 2020

Last week, Pfizer reported initial results of the tests of its anti-Covid vaccine, exhibiting a 90% efficacy rate. The news sparked optimism among global investors, with equity markets rallying (MSCI was up 2.2% on the week). This occurred while a number of European countries started to enter national lockdowns (as we discussed last week), as the infection rates soared again, posing a risk that national health systems will be overwhelmed. This second round of lockdowns will have dramatic effects on societies and their economies. A double-dip recession has now become the baseline scenario for European economies, as Q4 is likely to be another quarter of negative growth. 

In the US, daily infection rates have reached 180,000, the highest level on record. Nonetheless, in spite of some localised restrictions, state governors are still reluctant to declare the total closure of economic activities. In this respect, the US presidential election might represent a slightly more positive direction being taken. With 306 votes in the electoral college, Joe Biden has won the presidential race. As we discussed in our in-depth analysis of the results, Donald Trump will try to launch a series of legal challenges to this outcome, but they are unlikely to succeed. 

With a 36-vote advantage in the electoral college, Joe Biden may afford to judicially lose a couple of relatively large states, and yet remain president elect. This means that, in spite of the short-term noise and the difficulty in the transition process, this huge element of political uncertainty has been removed for investors. A divided Congress (if the Senate remains, as it seems likely, controlled by the Republicans) means that the fiscal stimulus is likely to be smaller than would otherwise be the case had the Democrats won, but this means the Fed may be required to do a bit more.   

As we discuss in our “Brexit Endgame” preview, the Brexit saga is likely to enter its final crunch week. An agreed text needs to emerge at the end of the EU Summit on November 19 for a no-deal Brexit to be avoided on January 1st, 2021. A skinny FTA is likely to emerge this week or in coming days, as the government cannot conceal Brexit behind Covid anymore, as Covid has proved to be a national disaster anyway. 

Countervailing these events, a new round of monetary and fiscal stimulus is likely to be adopted by national governments and central banks. Central banks in particular are reacting. The ECB has already announced an expansion of its programs in December. The Bank of England (BoE) has approved a new increase in its APF facility by deliberating an increase of GBP 150bn in asset purchases until the end of 2021. The Reserve Bank of New Zealand (RBNZ) has launched a new credit-easing facility (a Funding For Lending Programme). Both the BoE and the RBNZ have contemplated the possibility of introducing negative policy rates, although the actual implementation of such a program may be postponed well into 2021. 

During all of this, equity markets have been continuing to make a timid comeback following the slump of early 2020, while remaining vulnerable to the series of corporate defaults that may follow the peak of the Covid-induced crisis. The only real winners seem to be the tech companies (well represented by NASDAQ), which can take advantage of the massive increase in digital application due to widespread lockdowns

by Brunello Rosa

9 November 2020

As we discussed in our recent publications, a number of countries, especially in Europe, have decided to enter a new phase of general lockdowns. France, for example, after adopting a curfew policy that proved ineffective, started to implement a general lockdown from October 30 to December 1st. Germany, which during the first phase of the pandemic witnessed an infection rate markedly lower than other countries (the result of more effective testing measures and a larger number of intensive care units) is also introducing a sort of semi-lockdown now, from November 2 to November 30. Italy is adopting a three-tiered restriction system which might easily morph into a national lockdown in coming days. The UK, which adopted a tiering system earlier on, switched to full lockdown on November 5, which for now is set to last until December 2nd. Other countries, such as Greece, Belgium and Spain, are adopting similar measures. 

These generalised lockdowns have been decided upon as the second wave of the pandemic hit following the reprieve that occurred during the summer (as we discussed in our recent column). Studies have shown that this second wave originated from a virus mutation that occurred in Spain during the summer. As Spain – together with France – decided to adopt an open-door policy during the summer holidays in order to save the tourism season, this mutated version of the virus has spread across Europe this autumn. Most governments seem to be flirting with the idea that a full lockdown in November will allow countries to reopen for Christmas, but this strategy seems self-defeating in the light of the Spanish example above: any sacrifices made during these weeks in November would likely be nullified by a reopening of shops and a restarting of domestic and international flights for the holiday season. 

The question is on what basis these new generalised closures were decided. Most governments got scared, and seemed frankly unprepared to this second wave, as the number of new cases soared in recent weeks (see map above). Some governments decided to adopt new lockdowns after a certain threshold of new daily cases was reached (a threshold that would purportedly translate into a relatively predictable percentage of hospitalisations, intubations and – eventually – deaths). 

But these metrics seem highly questionable. In a pandemic generated by an airborne virus, to reach “heard immunity” it is obvious that the number of cases will have to increase. Over a relatively short period of time, a vast proportion of the population will in theory have to get infected (even without necessarily being symptomatic) in order for herd immunity to be achieved. For the same reason, even the apparently more sophisticated metric of  the percentage of positive cases as a share of the overall number of tests (a metric which should control for the increase in the number of tests), appears to be wrong. Over time, as we reach heard immunity, that percentage will have to increase towards 70-80% without necessarily being a cause for alarm.

In that case, what metrics should actually be used? Well, first of all, in order to get a sense of the speed at which the virus is spreading, governments should compare the actual rate of infection with the theoretical rate of infection as calculated by epidemiologists.  

A natural progression of the virus’ spread should not lead to generalised closures of the economy, whereas a faster-than-expected spreading should prompt the adoption of increasingly severe restrictions. The second metrics should be based on the hospitalisation rate (and within it, the intubation rate), so as to make sure health systems are not overwhelmed. This is because the unfortunate statistic of Covid is that only 50% of those entering intensive care actually make it out alive (rendering intubation effectively a coin toss). But again, the solution to this problem is building more intensive care units (ICUs) and adopting more effective treatments, not adopting new lockdowns. Most governments did not increase their ICU capacity between the first and the second waves of the virus, in spite of the fact that the coming of the second wave was highly predictable.  

In fact, it seems anachronistic that social distancing, a medieval solution against pandemics, remains today the most effective way of stopping the virus, in the era of massive technological and medical advancement. The case of Donald Trump may serve as an example. He was hospitalised and then released within 3-4 days, after receiving innovative (indeed, almost experimental) cures, including a mix of remdesivir, an antiviral drug, with polyclonal anti-bodies and other substances. This example proves that an extremely effective treatment for the disease does exists, but is clearly not available to the vast majority of the population. 

Finding an effective cure might prove even more promising than developing a vaccine. The three most advanced products under trial (in phase three) won’t be ready before March 2021 at the earliest and won’t be available for the wider population before Q3-Q4 2021 at best.  Additionally, the effectiveness of these vaccines may prove elusive, if the virus mutates. Recently, the WHO has identified a new variant of the virus deriving from farmed minks in Denmark. If this new variant were to spread further, the vaccines currently under development may prove to be not very effective, and new vaccine trials may need to start from scratch. 

Clearly the solution to this pandemic must be a mix of social distancing, better treatments, and the development and usage of vaccines, with lockdowns being the extrema ratio. Perhaps the emphasis should now be put on treatments rather than vaccines, as countries needto reopen. Economies and societies cannot tolerate this “stop and go” approach, whereby total closures are followed by partial re-openings, for too long. The long-term economic, social and political consequences of such an approach could be devastating.  

Companies are now unable to plan and invest without any certainty about the near future, and workers are continuing to increase their levels of precautionary savings and are under-consuming out of the fear of  joblessness as a result of the pandemic. Mental illnesses are also becoming endemic, as a mix of fear, anxiety, and stress is faced by individuals around the globe. Entire sectors, for example the hospitality and transportation sectors, are on their knees and struggling to survive as their business  models simply cannot cope with pandemics. The political consequences of pandemics should never be under-estimated either. In 1919, Benito Mussolini formed the Fasci di Combattimento (the predecessor of the Fascist Party) not only immediately after World War 1, but also following the 1918-19 Spanish flu pandemic. It is not out of the question that political radicalisation could similarly follow Covid-19. 

 by Brunello Rosa

2 November 2020

This week investors’ attention will be focused on the US presidential election, which will take place on November 3rd. In reality, as of Wednesday last week, 75 million people have already voted, either in person or by post. This represents around 54% of the total turnout recorded in 2016. So, it is quite likely that this year the turnout will be higher than in the last election, even if the number of people who will physically vote on Tuesday is lower than usual, as it probably will be due to the Coronavirus pandemic. 

As we discussed in our preview, the Covid-19 pandemic - its economic and social effects, and the way it was managed - will clearly represent a determining factor of the final outcome of the election. According to the latest statistics, the US, with its 9.2 million reported cases (out of 46.2 millions worldwide) and 230,000 deaths (out of 1.2 millions globally), has had a very unfavourable track record. Despite being just 4.3% of the world’s population, the US has had almost 20% of reported cases and deaths. This means that something has gone wrong in the way the pandemic was managed, or the way the US healthcare system is organised. We know both elements are true: President Trump’s management of the crisis has been erratic at best, and large parts of the population are still not covered by public or private healthcare. 

Having said that, the US is not alone in this crisis. A number of countries, especially in Europe, are facing the second wave of the pandemic after re-opening their economies during the summer. As a result, new total or partial lockdowns (of at least one month) have been carried out by Germany, France, and the UK, and likely will soon be by Italy as well. 

The economic impact of these new restrictions will be large, and therefore the V-shaped recovery that some policymakers were fantasising about will not materialise (as early as March we have been saying that such a recovery was unlikely to happen). A long, uneven, bumpy U- or W-shaped recovery will likely take place instead. 

 Given all this, central banks have re-started their engines of monetary easing to complement fiscal stimulus. Last week, the European Central Bank explicitly said that in December it will recalibrate all its instruments, the Bank of Japan reiterated that it stands ready to act, and the Bank of Canada began a sort of semi-twist in its asset purchases to increase the effectiveness of QE. This week, we expect the Bank of England and the Reserve Bank of Australia to actually deliver more monetary stimulus with a combination of increased asset purchases, rate cuts, enhanced forward guidance and additional credit easing. 

This is the climate in which the US election will take place. In our previous comments, we discussed the successes and the failures of Trump’s presidency. In our preview we discussed how we believe that election night will likely be followed by a nasty legal battle by Trump, who has been saying for months that the postal vote (which Democrat voters prefer) is rigged. He might be trying to claim victory after a possible advantage deriving from the in-person voting during election night, but for the US television networks it will be hard to declare the winner in each state with 50% of the votes still to be counted. The only way the result will not be severely contested is if Biden wins a large majority in the electoral college, something could happen if he were to win a large state such as Florida. 

Eventually, we still expect Biden to emerge as the final winner, perhaps even leading a “blue sweep”, with the Democrats taking control of the Senate as well. However, a word of caution is needed. As Michael Moore - the movie director who predicted Trump’s victory in 2016 - said, “Trump electors are always undercounted in polls.” A surprise victory by Trump cannot be ruled out.  

by Brunello Rosa

28 September 2020

In many countries in Europe, a second wave of Covid-19 infections is materialising. According to the European Centre for Disease Prevention and Control, recent developments in Spain, France and the UK seem to be particularly serious. Unlike during the first wave, Italy is less exposed this time. The 14-day cumulative number of Covid-19 cases for 100,000 inhabitants is 320 in Spain, 230 in France, 96 in the UK and 32 in Italy. For reference, the same figure is 30 for Germany, which has responded best to the epidemic among large countries in Europe. 

As the map above shows, in Spain the situation already seems to be close to critical, with Intensive-Care Units (ICUs) on their way of being filled up again like they had during the first wave from March to June. In France, the situation is also alarming, with large portions of the country reporting some of the highest infection rates in Europe. In these two cases, the recurrence of the virus seems to be connected to the relaxation of social distancing policies during the summer, which had been adopted to at least partially save the tourism season. 

In Italy, the rules have remained as stringent as they had been before (although people became more relaxed in implementing them, as was the case in Sardinia), but the severity of the initial lockdown seems to be having beneficial long-term effects. In the UK, the situation is also becoming increasingly critical, as the government openly incentivised people to return to work and go out for dinner, with the scheme Go Out To Help Out. 

The idea that the situation is more severe in the UK than in Germany and Italy because “British people love freedom,” as declared by UK PM Boring Johnson during his recent Question Time, is simply laughable. [Italy’s President Mattarella’s response that “also Italians love freedom, as well as seriousness” was impeccable]. In all cases, the re-opening of schools is constituting, at the very least, an amplifying factor in the spread of the virus. 

As a result of this second wave of infections, governments are imposing new sets of restrictions. In particular, in the UK the government extended the emergency state for six more months and has taken a U-turn on public exercises (bars and restaurants must close by 10pm) and on business policies (once again suggesting people to work from home whenever possible). It seems to be a repeat of what happened in March-April, when the government declared a total lockdown after a series of initial restrictions. Press reports suggest that a total lockdown could be declared in coincidence with the two-week school holidays at the end of October. 

Needless to say, these new restrictions will take their toll on economic activity in Q4, making the materialisation of the so-called V-shaped recovery even less likely to occur. The big hope of having a vaccine ready by this winter seems to be vanishing rapidly, leaving us all no other option than co-existing with the virus for a few more months, perhaps until the summer of 2021. Financial markets will react to this new situation with further corrections in equity valuations and, given the continued accommodative stance by central banks, with a further fall in sovereign bond yields. 

 by Brunello Rosa

21 September 2020

The Abraham Accords Peace Agreement, signedbetween United Arab Emirates, Bahrain and Israel in Washington last week, is aimed at the normalisation of the former two countries’ diplomatic relations with Israel. It marks the shift towards various new geo-strategic equilibria being reached in the Middle East.

This process had begun in 2011, when the Obama administration started to withdraw US troops from Iraq. It continued in 2014, with the end of the US fighting mission in Afghanistan, and was then epitomised in 2015 by the Joint Comprehensive Plan of Action (JCPOA) signed between Iran and the five permanent members of the UN Security Council, plus Germany and the EU. Obama’s aim, following Metternich’s and (more recently) Kissinger’s example, was that of creating a “balance of power” among the major countries in the region, to allow a gradual withdrawal of the US from the Middle East, which had become less strategically important since the beginning of the shale oil and gas revolution. To achieve that goal, Obama aimed at creating a balance of power between NATO (represented by Turkey), Sunni Muslims (Saudi Arabia), Jews (Israel) and Shia Muslims (hence the JCPOA with Iran). 

The plan failed for two main reasons. First, as soon as the US started to withdraw from the region, Russia entered it with full force, becoming a decisive player. Second, the new US administration led by Trump reneged on the JCPOA and marginalised Iran in favour of the traditional US alliances with Israel and Saudi Arabia. This has led to an escalation of tensions with Iran, culminating in the assassination of General Suleimani by the US at the beginning of 2020.

Between 2016 and 2020, the only two countries that managed to make serious advances in the region were Russia and Turkey, the two deciding in effect to partition between themselves spheres of influence in Syria, Libya and the Easter Mediterranean. 

The Abraham Agreement marks the beginning of a new phase. First of all, the notion that in order to achieve a durable peace in the region, the Palestinian question needs to be addressed first, with the creation of two states between the Jordan River and the sea (deriving from the 1993 agreements in Oslo) has been wiped out. The logical order has been seemingly inverted. Rather than Palestinian statehood being a prerequisite to Sunni Arab states recognizing Israel, Sunni countries of the region will instead start normalising their relationship with Israel first, and this normalisation might eventually lead to the creation of a proper Palestinian state in the future. 

Second, the fact that the US administration was actively involved in the mediation process via its secretary of State Mike Pompeo, and the fact that the agreement was signed in Washington, means that the US is still actively engaged in the process. In other words, only when a new geo-strategic regional equilibrium is reached the US may start to dis-engage. The Democratic candidate Joe Biden has committed to continuity of this approach as well. 

Third, Turkey, as a NATO member, will be less able to play its own game in the region, having to abide by the superior interests of the US and of the alliance generally. 

Fourth, for the first time since 2015, Russia has been placed on the backfoot, and could not dictate its conditions. 

Finally, as it seems that many other countries in the region are now aiming at normalising their relationship with Israel as well, it is possible that this new, more pragmatic approach to a seemingly unsolvable problem might have the ability to lead to a new geo-strategic equilibrium being reached in the Middle East.  

 by Brunello Rosa

14 September 2020

Last week the UK government presented a bill to regulate the smooth functioning of the internal market following the withdrawal of the UK from the EU on January 31st, 2020, which will exert its full effects starting from January 1st, 2021, at the end of the so-called transition period. As has been widely reported by the media, many clauses of the internal market bill override the provision of the so-called Northern Ireland (NI) protocol, which was signed between the EU and the UK alongside the Withdrawal Agreement (WA) in order to ensure that a physical border between Northern Ireland and the Republic of Ireland does not return following the UK’s departure from the EU. 

As was clear from the very beginning, the implementation of the so-called Irish backstop would have effectively put a customs and regulatory border in the Irish sea, de-facto breaking the “union” of the Kingdom, while leaving Northern Ireland within the EU customs union. For that reason, Theresa May repeatedly refused to accept that option, considering that “no UK prime minister could ever accept” such a condition. Boris Johnson instead revitalised the plan, and that was the key to unblocking the negotiations with the EU in November 2019, perhaps knowing that he would have reneged that pact less than a year later. 

The UK government has explicitly said in parliament that the internal market bill would break international law and that the government’s intention was in fact that of overriding the Withdrawal Agreement with domestic legislation. Top EU officials (starting with the leaders of the Council and the Commission, Charles Michel and Ursula von der Leyen, respectively) have called on the UK to respect the pacts signed with the Withdrawal Agreement and the Northern Ireland protocol (pacta sunt servanda, tweeted von der Leyen). 

Where does all this leave the ongoing UK-EU negotiations?The two sides agreed that any deal would need to be reached by the EU Council by October 15th, to give enough time for EU parliament and national parliaments to ratify the treaties. For this reason, the EU sent the UK the ultimatum of either withdrawing the internal market bill or making it compatible with the Withdrawal Agreement and NI protocols by the end of September 2020, in order to have at least 15 days to make a final attempt to strike a skinny free-trade agreement (FTA).

This FTA would be even less ambitious than the one the EU recently signed with Canada (the so-called Canada-minus FTA). But it is self-evident that, given the tight schedule, the risk of a no-deal scenario has returned with a vengeance.    

Is this just hard-ball negotiation tactics by Boris Johnson? One could suspect that, with deadlines approaching, the two sides are trying to play chicken to see who gives up first. That’s a possibility. However, Boris Johnson is on the record saying that for him a no-deal scenario is a perfectly legitimate and desirable outcome. Also, “no deal” is the only logically consistent end-point of his entire Brexit campaign. 

Finally, no deal is the only way the UK would have a proper and final clean break from the rest of the EU, allowing maximum freedom in terms of state aid, taxation and regulatory divergence. It would be the final and cherished prize to secure in return for all the hardship of Brexit. Therefore, we do not think that this is just negotiation tactics. If the final outcome is no-deal, Johnson would sell it as his personal victory. 

What’s wrong with a “no-deal” outcome? While the UK can gain something in the short term from reneging on the pact with the EU that was signed just a few months back, doing so would represent a terrible precedent. For a country aiming at “striking trade deals around the world” (such as the one it recently signed with Japan) as the “Leave” propaganda said, being perceived as a counterparty that not only does not respect its word, but does not even respect the treaties it signs, would be a terrible signal to send to other countries that could be potentially interested in striking a deal with the UK. 

The UK has taken hundreds of years to move from encouraging piracy to providing one of the most reliable legal systems in the world. If Boris Johnson decides to go down that route, it could cause severe damage to the country’s international reputation. With the UK already being one of the countries hardest-hit by the economic repercussions of Covid, its PM needs to be careful in inflicting more damage from the effects of a no-deal Brexit, even if (as we discussed in our column of May 11th) he could get away with it in the short run by blaming Covid for the economic consequences of a disorderly exit from the EU.  

 by Brunello Rosa

7 September 2020

During the latest Jackson Hole symposium of central bankers and academics, which was held for the first time in a virtual format and, therefore, was open to the broader public, Chairman of the US Federal Reserve Jerome Powell provided the main conclusions reached in the Review of the Fed’s Strategy, Tools and Communication. In our recent analysis, we provide all the details of that decision.

In a nutshell, the Fed decided to introduce what has been labelled as Average Inflation Targeting (AIT), which means that the Fed will allow inflation to overshoot the 2% target for brief periods (by a limited amount), in order to make up for the lost price level during periods of target-undershooting. This system is clearly designed for the present period, during which the Fed has been undershooting the inflation target for a very long time. The new framework will therefore allow the Fed to keep rates low for longer, and to look through potential inflation spikes that may arise due to Covid-induced supply-side constraints.

Clearly, a potential side effect of this approach (typical of all “averaging” or “level-based” regimes) is what happens when there is a persistent period of above-target inflation. In theory, the Fed should then keep policy rates higher than they otherwise would, to send inflation below target for some time. In turn, that would possibly induce a marked slowdown or recession (as occurred during Paul Volcker’s experience to combat spiralling inflation in the 1970-80s). Although now that seems a distant problem, it might occur at some point if stagflationary pressures were to emerge. The Fed will likely cross that bridge only when the time comes to do so.

In any case, the immediate policy implication is that the Fed will likely keep interest rates at record lows for longer than previously thought, as now the Fed can wait for inflation to be above target before increasing rates, rather than start raising rate as soon as inflation starts moving, consistently and convincingly, towards the target level.

This has clear market implications for bond and equity prices (likely to be supported by the lower rates), credit spreads (likely to remain more compressed than would otherwise be the case) and for the US dollar, which will likely stay as weak as it currently is, and remain so in the future as well. Long-term yields have briefly edged up on the announcement of the Fed’s approach, as the implied breakeven inflation level embedded into them rose, together with inflation expectations.

The real question is how all other central banks (in the G10, but also in EMs), will react to this move by the Fed. They will not be able to afford staying put: when the “mothership” that is the US Federal Reserve moves, all others will have to react, and move in the very same direction. The real risk is therefore that a new race to the bottom will now ensue, of interest rates and other accommodative monetary policies. Such a process may be additionally likely as the other central banks seek to prevent their own currencies appreciating versus the dollar, in the middle of the most severe economic contraction since the Great Depression. 

The first G10 central bank to meet after the Fed announcement was the Reserve Bank of Australia (RBA). As discussed in our review of the policy meeting, the RBA decided to leave its policy rates unchanged, but did increase the size of its credit easing facilities. This week, the Governing Councils of the ECB and of the Bank of Canada will each meet. As discussed in our previews, we expect both central banks to keep their policy stances broadly unchanged, while keeping a clear easing bias and  adding a dovish twist as a response to the Fed’s policy review.

In the next few months, these and other central banks will meet. The risk is that another significant round of policy easing, carried out by a number of central banks, is just around the corner.

by Brunello Rosa

3 August 2020

Last week, the US Bureau of Economic Analysis released its first estimate of the performance of the US economy in Q2 2020. After the 5% q/q drop in Q1 (a seasonally-adjusted annualised rate, SAAR), in Q2 the economy contracted by 32.9% q/q SAAR. This was slightly less than anticipated (34.1%), but still the largest contraction on record. This quarterly contraction of 8-9% (32.9% divided by four) is in line with the fall in income recorded by other major economies. It is explained, of course, by the adoption of lockdown measures that were introduced in order to slow down the spread of Covid-19. 

As the Federal Reserve Chairman Jerome Powell said during the press conference following the FOMC decision to leave the central bank’s policy stance unchanged in July, this is the largest shock the US has had to endure in recent history. After an unexpected rebound in May and June, the recovery of economic activity since July has slowed down, as has been revealed by non-standard, high-frequency indicators, such as hotel occupancy and credit card use. In its latest statement, the Federal Reserve decided to establish a clear link between the expected path of economic activity and the likely evolution of the pandemic. 

Following the release of the quarterly GDP figures, US President Donald Trump released a tweet in which he wondered whether the US election could be delayed “until people can vote properly, securely and safely.” Even if it is not in the president’s power to decide on the date of the election, this tweet created an outcry in the media and the Democratic party, where it was often viewed as a confirmation of Trump’s authoritarian tendencies and an attempt to undercut the US democracy. Since the power to postpone the date of the election has resided with Congress since 1845, Trump’s tweet must be read as a signal of how he is ready to contest any result that would not see him as the victor in the US presidential race in November, as we discussed in our column on April 20.

But the economy is not the only preoccupation of President Trump at the moment. After putting the popular video-sharing social medium Tik Tok under scrutiny for representing a possible threat to national security, Donald Trump said he was ready to ban its operations in the US, where it counts around 50 million users. The company responded that the data it collects is stored in US-based servers (confirming once again how relevant the concept of digital sovereignty is becoming), with limited and controlled access from its employees. Some read Trump’s move as a way of either jeopardising the potential sale of the US arm of Tik Tok to Microsoft, or as an attempt to reduce Tik Tok’s price. 

This is yet another confirmation that one of the main battlefields of the ongoing Cold War 2 between US and China is the tech race between the two superpowers. In a separate, but related field, our recent report on the “stunning” alliance between China and Iran discusses how Cold War 2 is taking shape in the more traditional domain of strategic alliances. 

While all of this is going on, the Democratic contender in the November race, Joe Biden, will soon announce the choice of his running mate. Many see this as a potential turning point in the campaign. Biden is set to choose a candidate who, unlike himself, is not old, or male, or white, and for this reason the most credited contenders for the position are Susan Rice and Kamala Harris. But this choice must be considered in the broader context of the US presidency. 

Biden, if elected would at 77 years old be the oldest US president in history at the time of his inauguration. He already hinted at the possibility of running for only one term, making his VP the natural candidate for succession in 2024. There is also a possibility that Biden could resig duringhis first term, which would of course would directly make his VP ascend to the presidency. Knowing all this, any Republican voters or swing voters who might be inclined to vote for Biden just to make sure that Trump is not re-elected in November, might want to be reassured that Biden’s running mate is as mainstream a politician as possible.

by Brunello Rosa

27 July 2020

We have often discussed how a key component of the ongoing Cold War II is a technological conflict between the incumbent dominant power (the US) and the rising star (China). Last week, US microchip producer Intel, for decades the undisputed leader in its sector, announced that it had fallen behind its development plans by at least one year, thus leaving its main competitor, TSMC a Taiwan-based company, as the leader in its field. This has been read by some analysts as the latest confirmation of the US losing its dominant position in technology, an area that for decades was the ultimate key to American success.

But this is only the last episode of a much wider saga. In particular, the battle for the distribution of 5G technology represents a significant front in the ongoing tech wars. Recently, the UK has also joined its fellow countries of the Five Eyes (US, Canada, Australia and New Zealand) in the broader Anglosphere, with the decision to gradually phase out Huawei in the provision of technology for the 5G British network. This was a decision that came after repeated and heavy pressures were placed on PM Boris Johnson by the US. 

In this raging tech war, we must note the impetus that the Coronavirus pandemic has given to cyber-wars, as we discussed in our recent two-part report on the subject. Part 1 of that report focused on US and international developments, Part 2 focused on national developments in Russia, EU, Israel and China. The rapid increase in digital technologies that has occurred in order to provide business continuity during the long months of widespread lockdowns has made most countries, institutions and companies much more vulnerable to cyber attacks than was already the case before the pandemic began.

In the future, we will have to assume that the failure of diplomatic avenues in any serious dispute between countries could result in one of those countries carrying out a cyber attack. Such attacks will, perhaps, be launched by non-state entities at the behest of a state, in order to provide that state with “plausible deniability”. 

These technological developments will certainly impact traditional areas of finance as well, such as banking. As we have discussed in our recent in-depth report on the future of the banking industry, traditional lending institutions already find themselves under siege by fin-tech developments coming from the private sector. On the other side of the spectrum, central bank digital currencies (CBDCs) developed by the public sector will pose an additional threat to the traditional business model of financial institutions. 

Both sides will continue to squeeze banks in the middle. 

Given the widespread use of digital technologies, fin-tech developments will continue unabated in their aim of increasing efficiency and granting access of financial services to larger segments of the population which otherwise have little exposure to financial services. Central banks (with China and Sweden leading the race) will continue their journey to the eventual adoption of CBDCs, which are seen as the key to solving the next systemic crisis. 

Traditional banks will have to adapt their modus operandi to fit this radically changed environment. As we discuss in our report, the key elements of their new business model will have to be digitalisation, a consumer-centricity, and further specialisation regarding local needs. This will be a process that will surely lead to further consolidation in the industry, with fewer players left on the battleground afterwards.

by Brunello Rosa

20 July 2020

Since last Friday, the special EU summit to decide on the implementation of the Recovery and Resilience Facility is taking place in Brussels, with European leaders meeting in person for the first time after months of video conferences. 

The summit started with a great distance between the positions of the so-called Frugal Four (Austria, Netherlands, Denmark and Sweden) – which became Frugal Five when Finland joined the group – and those of the Mediterranean front of Italy and Spain (which is supported by France). The former group wants a reduction of the overall package proposed by the EU Commission, namely EUR 500bn in transfers and EUR 250bn in loans, and a significant reduction in the amount made up by transfers. Within this group, the most aggressive position is expressed by the Netherlands, whose PM Mark Rutte seeks to win a majority in his country’s parliamentary election next spring. The Netherlands, for a change, is not simply the “bad cop” of the duo with Germany. Rather, the two countries entered this meeting with two different strategic objectives. The second group of countries wants the overall size of the program to be left unchanged, and wants transfers to remain the bulk of it.

There is also a third front at the table, representing the nations of the so-called Viségrad group (Czechia, Slovakia, Hungary and Poland). Those countries, among the largest beneficiaries of EU funds (Poland in particular) want to make sure that their quota of funds in the new Multiannual Financial Framework (MFF) remains intact.  

Alliances across regions (North/South, East/West) and political families (People’s party, Socialists and Democrats, Liberals) are variable, and subject to change opportunistically. 

In the middle of these different positions is Germany, with Angela Merkel trying to broker a historic deal during the period in which Germany holds the rotating EU presidency, to make sure that the eventual result is acceptable to everybody. Germany is doubly putting its face on this deal. 

The EU Commission that made the initial proposal discussed at the summit is led by Ursula Von der Leyen, the former German defence minister and protégé of Angela Merkel. In addition, Merkel herself is looking to complete her long period in service with an agreement that could prove historical. Merkel’s goal is passing the EU to the next generation of European leaders, with some of the elements of solidarity that characterised the initial project still intact. So, Germany cannot risk that this summit ends with no results. 

Given such distance between the positions of various blocs of countries to begin with, the sessions on Friday, Saturday and Sunday not surprisingly finished in acrimonious discord. 

Various proposals have been presented by EU Council President Charles Michel to reduce the overall size of the package and the share of that package made up by transfers rather than loans, to make the deal more acceptable to the Frugal Five. The latest proposal foresees EUR 390bn of grants and will be discussed starting from Monday afternoon. We expect that, eventually, a compromise will emerge, if not at this meeting, at a new one later in July.

 by Brunello Rosa

13 July 2020

The number of Covid-19 cases worldwide is increasing. It has now nearly reached the 13 million mark, causing almost 600,000 reported deaths. Some countries, especially in Europe and Asia, are experiencing an increase in new cases, though only to a limited extent so far, after re-opening their societies following long periods of lockdown. In other countries, such as the US and Brazil, the situation is worse; according to some experts, infection rates may already be out of control in these countries. In the US in particular, where the number of cases has now reached 3.2 million, the spread of the virus is still increasing exponentially, suggesting that the adoption of new social-distancing measures is likely to occur during the next few weeks.

As lockdown measures have eased, economic activity has been picking up, recovering from the lows touched in Q1 and Q2. Unless restrictions are re-imposed to the same extent as occurred during the first part of the year, or new restrictions imposed upon large economies such as the US have massive spillovers to the rest of the global economy, Q3 GDP growth should show a positive figure in many countries, given base effects. 

In spite of the recovery in economic activity, the support of economic policy remains essential. As far as fiscal policy is concerned, most governments are still providing stimulus by way of new or renewed packages. In the US, a third fiscal easing package is underway. In the UK, the Chancellor of the Exchequer has just announced a new set of measures to support economic activity, such as the temporary reduction of VAT on certain products and services and of the stamp duty on certain real-estate transactions.  

In the EU, this week there will be another summit to make progress towards the approval of the EU Recovery and Resilience fund, which should support the economies most hit by the Covid pandemic, such as Italy and Spain.  

In all this, central banks are taking a breather. In recent weeks, after the massive monetary easing programs announced during H1, most central banks are adopting a wait-and-see approach. Some of them, such as the Reserve Bank of Australia, have even started to reduce their intervention in markets as the economy stabilises. This week, there will be the monetary policy meetings of the European Central Bank (ECB), Bank of Japan (BOJ) and Bank of Canada (BOC). The BoC will release its first set of forecasts since the pandemic begun, and the BoJ will update its economic outlook. As we have written in our preview, we expect them not to change their policy stance, while remaining ready to add monetary stimulus should economic and financial conditions deteriorate in coming weeks. 

Central banks, which have been at the forefront of the policy response during the global financial crisis, have already used most of their conventional and unconventional arsenal. At this point, they prefer fiscal policy, and regulation, to be in the driving seat. At the end of July, the FOMC of the Federal Reserve, which sets the tone for most central banks with its decisions, will meet. It is likely to adopt a similarly cautious approach, although with the worsening healthcare conditions in the US discussed above, the meeting might result in the decision to further increase its stimulus, for example by widening the depth and spectrum of its credit-easing facilities. 

by Brunello Rosa

8 June 2020

In our column in October of 2018, following Jair Bolsonaro’s victory in the first round of Brazil’s presidential election, we asked: “Will The World’s Next Strongman Come From Brazil?”. Bolsonaro, who had been an underdog in the election until he was stabbed at a campaign event only one month before the vote took place, had already been displaying  all of the characteristics of the strongmen who were already populating the globe at that time (Trump, Putin, Xi Jinping, Orbán, Kaczynski, Erdoğan, Duterte, Modi, etc.), including a passion for (or in his case, a past within) the military, an admiration for non-democratic regimes, and a preference for the use of force to solve international and domestic disputes. 

Fast forward almost two years later to today, and, taking into account the natural tendency of Covid-induced economic restrictions to strengthen autocratic behaviours, here we are: Bolsonaro is not only proving to be the world leader who is most reluctant to adopt containment measures against the spreading of Covid-19, a reluctance which has made Brazil the new epicentre of the pandemic, together with the US, but a judge from the country’s Supreme Court has also accused Bolsonaro of wanting to abolish democracy in Brazil in order to establish an “abject dictatorship”. Justice Celso de Mello, in a WhatsApp message leaked to the media, reportedly said: “We must resist the destruction of the democratic order to avoid what happened in the Weimar Republic when Hitler, after he was elected by popular vote, did not hesitate to annul the constitution and impose a totalitarian system in 1933.” 

These allegations came after Bolsonaro attended a rally at which demonstrators, wearing paramilitary uniforms, called for Brazil’s parliament and supreme court to be shut down and be replaced with military rule, and after Bolsonaro’s Minister of Culture was forced to resign after quoting Joseph Goebbels, the Nazi minister of propaganda. This should not be surprising, given that Bolsonaro packed his government with more than 100 current and retired military officers, including his vice-president and at least 6 cabinet ministers. 

In a recent in-depth analysis by John Hulsman, we discussed Bolsonaro’s record in government, showing how the president of Brazil has been out of his depth over myriad issues hamstringing his erratic presidency. In particular, we noted how three C’shave been plaguing the populist leader:  (lack of) Competence, (lack of) Competition within the right-wing camp, and Corruption; and how these have dramatically morphed together into an existential threat to  Bolsonaro’s continued rule.

At the same time, we also noted the three B’s that could lead to his political salvation: Beef (Agribusiness), Bullets (the Military), and the Bible (the growing number of Brazilian Evangelical Christians). In fact, much of the President’s enduring and loyal political base is clustered around these three groups. These constituencies could help Bolsonaro politically survive, or even thrive, for a continued period of time. Indeed, we concluded our analysis of Bolsonaro’s political record by noting that although Bolsonaro is embattled, he is probably in no immediate danger of impeachment. 

But while the three B’s are protecting Bolsonaro from impeachment, and while his power base is holding for the present, none of the three C’s have been even remotely dealt with. As time passes, and these structural problems turn increasingly septic, what seems now to be a slow unspooling of the Brazilian president may suddenly become a torrent that washes away “The Trump of the Tropics” for good. 

Before this happens, though, the risk remains that Bolsonaro will officially or unofficially suspend democracy in Brazil, bringing a return of the dictatorship that the country abandoned in 1985. 

                                                                 Picture Credit: Julio Cortez/AP

by Brunello Rosa

1 June 2020

In the last few days, the streets of Minneapolis and other major US cities have been filled by people protesting the treatment of George Floyd, who died while in policy custody. The facts are sadly well known, and the fact that the police officer Derek Chauvin has been arrested did not placate the ire of the African-American community or the wider population. Protests have become violent in the last couple of days, as they have in previous similar occasions, most notably in Los Angeles in 1992, after a trial jury acquitted LAPD officers’ accused usage of excessive force in the arrest and beating of Rodney King. 

So, this type of episode is unfortunately not new, and it will likely happen again in future. What makes this episode peculiar and particularly noticeable in this period is that it is happening as social tensions are clearly on the rise, with a number of protests being staged in various parts of the US against the lockdown measures introduced in many states. The most worrying of these took place outside the Michigan Capitol building in Lansing on April 30, when a number of protesters showed up equipped with firearms. 

This is quite concerning, considering this is a year in which one of the most tense presidential elections in US history will take place. The election will be tense not just because of the logistical difficulties resulting from Coronavirus, or from the fact that the margin between the two contenders is likely to be small, but also because there is widespread concern that if Trump were to lose, he might not accept the result – even were it to come in the form of a verdict from the Supreme Court – and will instead refuse to leave the White House.

Our two-part report on the successes and failures of Trump digs further in this matter. Part Two of the report will be published on Tuesday on R&R’s geopolitical corner.  

These episodes are taking place in the US, but other parts of the world are not immune from this same sort of situation. Protests against lockdown measures are happening in many different countries: the UK, Germany, Australia, Belgium, Italy, Poland, etc. At this stage, most of these protests are motivated by social anger against the restrictions that have been placed on personal liberties. In some cases, they have also been motivated by dissatisfaction regarding the economic impact of the measures being adopted to stop the spread of the virus. But even if the lockdown measures were to be alleviated in coming months, social tension might not ebb. 

In fact, the real economic impact of the anti-Covid measures will be felt in the autumn. In Q2, there was an immediate impact deriving from the closure of economic activities. But those companies that could remain open used these months to process the orders arrived until the end of Q1 2020. But in Q3/Q4 2020 it will be clearer how many businesses have in fact survived, and how many new orders will have arrived. 

The risk is that the collapse in economic activity of Q1/Q2 will have a long-lasting impact on economic systems, with serious repercussions on employment and, therefore, on social cohesion. This is the reason why governments around the world are trying to gradually re-open their economic systems, and why support in the form of government policy will need to remain abundant for the foreseeable future. 

by Brunello Rosa

26 May 2020

We have been following the vicissitudes of the EU integration process for years now. To recap the milestones of our view, we have been saying that unless the EU changes tack, it will be very hard for the incomplete federalisation process of Europe to survive in a new world in which continental economies (the US, China, and India) will make the most relevant geo-strategic and economic decisions. Covid will make this new world come sooner than anticipated, even if the relative ranking of countries will be different than would have otherwise been the case. 

The EU is currently an incomplete transfer union, in which resources (human, physical and financial capital) move from the periphery to the centre. The two main poles of attraction have been the UK (within the EU) and Germany (within the euro area). Somewhat ironically, one of the greatest beneficiaries of these influxes, namely the UK, has decided to leave, because the influx of migrants became politically unsustainable (or so the Leave campaign sold it as being). Brexit has proved us right, that the EU dis-integration process has begun. 

The optimists believe that without the UK a more cohesive union will emerge, and therefore the integration process will finally be able to proceed. This is likely to be an over-estimate of what will actually take place. The presence of the UK was the excuse all other reluctant countries were using not to proceed further with the integration process. Was the UK blocking the completion of the euro-area banking union with the adoption of EDIS (the European Deposit Insurance Scheme)? Of course not. It was Germany that was doing so.

With the rise of populist parties in all major EU countries(Germany, France, Italy, Spain, and Poland) and also in smaller countries (Hungary, Czech Republic, etc,), it was clear that, a soon as any severe crisis would arrive, it would constitute an existential threat to the EU. 

And, at that point, the EU would reveal whether or not it was up to the game, by completing its integration process, or else accelerate the ongoing dis-integration process. The shock has now arrived, of course, with the Coronavirus. We wondered whether the EU would finally face its “Hamilton moment” (i.e. finish its integration process) or, instead, its “Jefferson moment” (return to some form of Confederation, with limited sharing of sovereignty).

Facing the abyss, France and Germany have tried to come up with a proposal to mitigate the devastating effects of Covid and lockdowns on the economy of the continent. In an interview, German Finance Minister Olaf Scholz has called it Europe’s “Hamilton moment.” We wish that was true. The proposal has merits, and is in line with our previewfor how the EU would respond to the Covid crisis. 

But some of the details reveal that we are still quite far from any form of debt mutualisation, and the distrust that exists between the Northern “frugal four” (Finland, Denmark, Austria, Sweden) and the “profligate” Southern countries (Italy, Spain, Greece, etc.) remains high. We will see what the Commission proposal looks like on May 27, and what compromise the Council will be able to make in June and the following months. 

Our suspicion is that we will merely witness another round of the eternal “muddle through” that seems to characterise recent European history. To some extent, this would be better than the immediate collapse of the EU project, as any such collapse would have enormous economic, social and political costs. On the other hand, we doubt that any “more of the same” approach will equip Europe to succeed in the post-Covid world. 

by Brunello Rosa

18 May 2020

We have discussed several times how serious the Coronavirus-induced economic crisis is. The lockdown measures introduced by many countries to mitigate the spreading of the virus have created a collapse in economic activity, on the order of 20-40% on a quarterly basis. This could result in a fall in real GDP of about 7-10% in many developed economies, with a rebound next year that will be mushy and uneven at best. 

To mitigate the economic impact of Covid-19, a number of countries have adopted large stimulus packages consisting of fiscal expansion and monetary easing, in most cases in a coordinated fashion that closely resembles helicopter-money drops. Financial markets have, as usual, anticipated economic developments – equity prices collapsed around the world at the end of February/beginning of March, sending most of them into bear-market territory (-30% from their peak). Other segments of the market have given clear signs of dislocation. As discussed in our recent outlook, oil prices turned negative for the first time in history on April 20, as the collapse in global demand more than offset the cut to production that was decided upon by OPEC+ (including Russia) on April 12th.

Since the lows reached on March 23rd, equity markets have tried to rebound, but have done so with varying degrees of success. In the US, the S&P500 has recovered around half of the losses; it is now only down 11% year-to-date. The NASDAQ has managed an even more astonishing rebound, being at par year-to-date, thanks to the even more widespread use of technology during the lockdown. The Dow Jones, in contrast, which represent more traditional industries, is down 17% year-to-date.

In Europe, where the pandemic has led to harsher forms of lockdown (which are now being relaxed), the situation is less rosy, with the exceptions of Switzerland and Sweden. Equity markets remain down 25%-30% year-to-date. All these developments are in line with what we expected in our global outlook update.

As we previously discussed, a sustained recovery in market valuations could only occur when a durable solution (a vaccine or medication) to the healthcare crisis is in sight. Until then, market valuations will remain subject to downside risks. Nevertheless, as markets are leading indicators of economic activity, they will start to recover much sooner than the real economy. Conversely, the unemployment rate, which is a lagging indicator, will take much longer to normalise than economic activity in general. In the US, where unemployment insurance schemes and other similar automatic stabilisers are less widespread than in Europe, initial jobless claims reached 36 million in the first 7 week of the crisis. Non-farm payrolls dropped by 20.5mn in April, the largest monthly drop on record, with the country’s unemployment rate reaching 14.7%, up from the historically low 3.5% rate just a couple of months earlier.  

Public authorities are coming to the rescue: the Fed has just launched a Main Street program of credit easing. But the reality remains the same as it has been since the Global Financial Crisis: the liquidity injections by central banks tend to translate into asset price reflation, which mostly helps Wall Street, while other measures, even those akin to helicopter drops of money, leave Main Street in the doldrums. Again, this could be the result of the difference between leading and lagging indicators of economic activity, with equity prices rising much more quickly than unemployment rates in the wake of a serious crisis. But perhaps it could also signal the need to refocus the aim of the stimulus packages in the first place. 

by Brunello Rosa

27 April 2020

Last week, we analysed some of the ongoing issues that risk being overlooked as a result of the Covid-induced crisis. One of these issues was the impact of the crisis on carbon emissions. According to recent estimates, with 28 countries in the world having adopted full or partial lockdowns, the movements of a third of the world population are now enduring some form of restriction as a result of social distancing. Economic activity has been severely reduced because of this; the IMF is estimating a contraction of real GDP in 2020 of approximately 3% (but we expect it to be closer to 4%). Some sectors have completely shut down, and international travel, especially via planes, has collapsed. Statistics show that commercial air traffic has shrunk 41% below 2019 levels in the last two weeks of March. The situation since then has likely worsened even more, as more countries have adopted some form of lockdown.

As a result of this collapse in economic and travel activity, air pollution has collapsed, and greenhouse gas emissions have been dramatically reduced. According to the United Nations, since lockdowns and shutdowns begun, CO2 emissions have dropped by 6%. By the time the year ends, there will be an estimated 0.5%-2.2% reduction in CO2 emissions due to Covid (or even 5%, according to some experts), depending on the model adopted to predict the pick-up in economic activity in Q3 and Q4 2020. This could be the first reduction in global emissions since the 2008-2009 Global Financial Crisis. 

To some extent, the Covid-induced lockdowns have provided an unexpected, yet welcome, massive natural experiment as to the impact that a reduction on human economic activity can have on greenhouse gas emissions that are responsible for global warming (the rise in the earth’s temperature, estimated to be around 0.2˚ C every decade). This hopefully will resolve once and for all the vexata quaestio of whether global warming is caused by human activity or other unrelated factors. 

However, the UN warns, this temporary reduction in emissions will not stop climate change, which derives from the accumulation of the effects of many decades of human activity. Especially if the solution to this crisis will be the implementation of public infrastructure projects that have a significant environmental impact.  

While having gone silent in the last couple of months, climate change activists have gained a number of arguments in their favour. Not just on the impact that a reduction of economic activity might have on pollution and global warming, but also on the need for international coordination and cooperation to achieve that result. There is, however, another argument that will likely get traction. As the chart above shows, carbon emissions have increased in tandem with world population, which has risen from the 3 billion people of 1960 to the 7.6bn of 2018 (more than doubling in two generations). The UN estimates that there will be 11.2bn people in 2100, and if greenhouse gas emissions continue to be correlated with world population, the world’s temperature will rise well above any target being discussed in the various Conferences of The Parties (COP) rounds. 

Pandemics, if the virus is natural and not man made, may be partly a reaction to overpopulation (and therefore pollution). It is a clear signal the planet is sending that it may not have enough natural resources for all its inhabitants, at least not if resources are so unequally distributed. If the world does keep on increasing its human population without significantly changing its development model, pandemics will become more frequent and deadly in the future. 

If, then, we want to learn some lessons from the immense tragedy represented by Covid, they might include the following: 1) human beings are for the most part responsible for the catastrophes that befall them; 2) if the world’s development model does not radically change in favour of sustainability and renewable resources, extreme weather events will continue to affect the planet and pandemics will plague its human (and more generally, animal) population; and 3) only a coordinated and cooperative international approach can provide the solution to these historical issues. 

by Brunello Rosa

20 April 2020

We have lately been discussing four fundamental dimensions of COVID: healthcare, economics, policy, and market implications. On the healthcare front, advancements have been made that increase  intensive-care capacity (with field hospitals and other logistical arrangements) as well as testing, treatment and progress towards a vaccine. On the economics front, we have just released our latest estimates of the macroeconomic impact of lockdowns around the world. We have often also discussed the policy reaction (fiscal, monetary and regulatory) that will be needed to mitigate the effects of the macroeconomic impact and market implications of all these factors.  

Besides these four fundamental dimensions of COVID, we have also analysed what could be the long-term geopolitical implications of this crisis. Namely, China is set to gain the most from a strategic perspective, at the expense of the US, while the EU faces yet another existential crisis.

In this column, we want to discuss some of the events that are now occurring which risk being overlooked because of the pervasiveness of the news regarding the main dimensions of the crisis discussed above. We might call these the collateral effects of COVID. They too could have serious consequences, and perhaps even represent a turning point in the world’s history. 

On the one hand, as we have recently discussed in our in-depth analysis, there is the progress that is still being made by various countries in technologies such as artificial intelligence, which could provide a massive geo-strategic advantage to those who master them first. Russia, for example, is certainly using this period to make gains vis-a-vis its international competitors, by making large use of AI, and not just to find a cure for COVID-19. Russia is certainly not alone in this game, but it has a historical head-start over most other countries where cyberwarfare is concerned.  

On the other hand, the US is about to enter one of its more turbulent periods in recent history.  The US is already the country in the world with the largest number of confirmed cases and deaths, and yet partisanship regarding how to face this pandemic still prevails, with science being regularly questioned by populist political leaders and media. The US will soon have to face an election in a time of the pandemic,  the result of which (as we discussed in our recent analysis) is now too-close-to call. There are those who suggest that if Trump were to lose by a small margin and the vote were to be contested, he would not accept the verdict of the Supreme Court, like Al Gore did when he run and lost against George W. Bush in 2000. The requests on Twitter made by President Trump to “LIBERATE” a number of states that are being governed by Democratic governors who are imposing COVID-related restrictions, and the gathering of armed militias to protest those restrictions, do not bode well for the future. 

Around the world, authoritarian leaders are using the excuse of lockdowns to increase their grip on power and leave even less freedom to opposition parties and the press. This is happening even in Europe, within the European Union, ostensibly the most advanced defender of civil and political liberties in the world, where Hungary’s PM Victor Orban has created a de-facto dictatorship.

On a larger scale, the fight against climate change has gone incredibly silent in the last few weeks. Clearly there is an even more imminent threat to deal with, but at the same time, the arguments made by those fighting against climate change have been made even stronger by the COVID crisis. The virus, if natural and not man made, is certainly a reaction of overpopulation and pollution. With lockdowns imposed in most countries, the world has just carried out its largest natural experiment as to how pollution can be greatly contained if human activities are drastically reduced. At the same time, the opponents of those advocating against climate change will say that the top priority now is re-starting the world’s economic engine, rather than worrying about the side effects such as pollution and climate change.

All these example show that even as we follow the news about the COVID crisis, we should not lose sight of what else is happening in the world, which could have long-lasting consequences that will become apparent only when the current emergency is ended. 

by Brunello Rosa

6 April 2020

The Covid pandemic has now led to more than a 1.2 million people being infected around the world, and 68,000 confirmed deaths. It is now clearly understood that the economic impact of this crisis will be far worse than was the 2008-09 financial crisis, and maybe as bad as that of the Great Depression in the 1930s. It could, potentially, be even worse than the Great Depression (as Nouriel Roubini calls it, a Greater Depression). 

After initial hesitations, in particular in the US, UK, Brazil and Sweden, the pandemic has now generated a policy response that is broadly homogeneous around the globe. From a healthcare perspective, partial or total lockdowns have been imposed by several countries, with severe restrictions that can be slightly less draconian in those countries which have a population historically used to self-discipline, such as the UK. Of the largest countries, only the US is still reluctant to adopt serious measures of suppression, preferring forms of light mitigation instead. This is a mistake that will cost dearly down the line. 

In terms of fiscal policy, virtually every economy has launched schemes aimed at guaranteeing liquidity and credit to large, medium and small enterprises, and fiscal support to workers, without much distinction between protected salaried workers and unprotected self-employed ones. In terms of monetary policy, almost all central banks in the world have adopted a combination of cuts to policy rates, increasing asset purchases, funding for lending schemes, longer-term refinancing operations against wider collateral, easier access to emergency lending, FX intervention and swap lines. Regulators have relaxed capital and liquidity requirements for financial institutionsto increase their lending capacity.

Despite all this, stock prices in equity markets, sovereign yields of reserve currency countries and oil prices continue to fall. Why? The answer is simple: there is still no light at the end of the COVID-19 tunnel. Even if policy makers throw the kitchen sink at the crisis, they will not resolve the underlying issue, which is the containment of (or the cure for) the virus. 

Only medical experts and scientists, in this occasion, hold the key to solving the crisis. The measures introduced so far and discussed above only aim at buying time for scientists to find a solution. Initially, they are intended to flatten the curve of contagion, reduce the influx of patients into hospitals requiring expensive intensive-care units (ICUs), and increase their ICU capacity, perhaps by building field hospitals.   

Following these necessary initial measures, progress needs to be made in the other three directions that will lead to the eventual “victory” over the virus. First, testing needs to become available on a much larger scale, in order to trace the diffusion of contagion. And, more so than the current antigenic testing (which tells if somebody is currently infected), the development of reliable forms of antibody tests will be crucial, to easily determine who had been infected and has developed immunity (even if such immunity is only temporary) and could therefore – for example – return to work. Secondly, if a treatment is found that alleviates the symptoms and reduces the need for ICUs, this would mark a major change in people’s perceptions of the virus. It will help people calculate the risk of living in a world where the virus is still prevalent, which is likely to become necessary at some point unless we are willing to keep the world shut for the next 18 months. 

Finally, there is the goal of developing a vaccine that would allow people to develop antibodies and return to work. On this front, there might be some promising progress that could speed up the process compared to the 12-18 months currently being estimated. Even still, we are talking about a timeline of several months before the fastest vaccine could possibly become available to millions of people.  

Only when some breakthrough on a combination of these fronts occurs will it become possible to realistically say that there is some light that can be seen at the end of the tunnel. At that point, equity prices will find credible reason to rebound. The bad news is that we do not know when these breakthroughs might occur. The good news is that they could happen at any point in time during the next few weeks.  

by Brunello Rosa

14 April 2020

As we discussed last week, the impact on economic activity and markets from Covid depends crucially on medical advancements made in the fight against the virus. When progress on the medical front is considered sufficient by market participants, it is likely that risky asset prices will then start to recover (certainly, they will do so before economic activity itself stabilises). The impact of the virus on economic activity could also become smaller if enough advancement is made on the medical front. 

While China is facing its second mini-wave of contagion, deriving mostly from people returning home from abroad, there are reports that Spain is tentatively starting to re-open some of its non-essential activities, such as factories and some offices. Italy has started to plan a gradual re-opening, aimed at May 4th, and a task force led by former Vodafone CEO Vittorio Colao has been appointed by the government to plan a gradual re-opening of the economy. An undersecretary of Conte’s government even ventured to say that Italy’s beaches could be open this summer, if social distancing measures are in place. 

The situation is very different in the UK, the US and Sweden, which have been late to adopt social distancing measures, and are still in the fast-accelerating part of the contagion curve. In particular, in the UK, the country has been following a path not too dissimilar from that of Italy, and its Prime Minister Boris Johnson admitted that he could have died of Covid-19 during his stay in the hospital. In the US, the scenes of public burials in New York has shocked people around the globe. In Sweden, PM Stefan Lofven had to apologise for being too slow and timid in adopting social distancing measures. 

However, some glimmers of hope are starting to emerge from the medical front, which, as we said last week, consists of four sub-fronts. On the increase in intensive-care capacity, a lot of progress has been made worldwide, with the construction of field hospitals. This should help manage the expected increase in the number in patients admitted to hospitals in the most-hit countries.

On testing, the availability of antibody tests (which can tell if somebody had been infected and has developed some form of immunity to the virus) has increased massively, and the Lombardy region, one of the areas most affected by the epidemic, has stated that soon a large-scale distribution of what will be considered “Covid-19 health passports” will begin. On the other two medical sub-fronts, namely  treatment and vaccine, plenty of progress has been made as well.

As to a possible cure for the virus, doctors have identified the three phases of infection. Against the first phase, when the virus starts to attack cells, at least two medicines have proved to be effective, Cloroquineand L-Asparaginase. If a virus still manages to infect the body, anti-inflammatory medicines (such as steroids that reduce inflammation and the immune response) can reduce the impact on the affected person. 

In the third phase, when infection becomes serious, the virus causes an over-production of antibodies that clog the lungs and create small thrombus that start circulating throughout the body, causing multiple organ failure and eventually death. Against this, a group of doctors in various hospitals in Italy have started to test the efficacy of a traditional anticoagulant, the heparin, which prevents the formation of thrombus. Initial clinical tests show that this cure is effective and, if heparin is given early enough, patients might not need to be hospitalised. From this mix of cures, it is likely that very soon a clinical protocol to treat patients in the various phases of the disease will become standardised, thus reducing the need for intensive-care units. The good news is that most of these medicines are quite common and therefore not very expensive. 

On the final front, the vaccine, good progress has also being made. Besides the progress that has been made in Pittsburgh, which we mentioned last week, another team of researchers, based in Italy in collaboration with Oxford University, has found a methodology that will be tested by the end of the month, which could result in a vaccine being ready by September (in small samples). 

All this is to say that much effort is being made to reduce the impact of the virus on the health of people and on economic activity. While we need to remain vigilant against second and third waves of the virus (which could be more deadly than the first), three strains of which have already been identified, it is encouraging that some progress is being made on the medical front.  

by Brunello Rosa

2 March 2020

At very long last, financial markets caught up with the reality of the coronavirus, selling off last week in the worst market performance since the Global Financial Crisis of 2008. As the Financial Times reported, “mounting concerns at the rapid spread of the coronavirus caused one of the quickest market corrections in the benchmark US S&P 500 since the Great Depression in the 1930s.”

As we have written in our in-depth report on the subject, market participants are finally realising the impact that COVID-19 could have on the economic performance of the countries that have been most affected by the disease. In our column on the potential impact of COVID-19 (which we published a month ago already), we warned that the downside risks posed to the global economy by the public reaction to the virus could be huge, possibly greater even than the virus itself. In effect, last week market participants staged a panic reaction to the news coming from Italy, where entire cities were quarantined in the country’s northern region, which is the industrial powerhouse of the country, with  Milan, the financial capital of the country, being the epicentre. 

Since then, the situation has not improved: the number of infected people and fatalities worldwide have risen (albeit at a slower rate than in previous weeks), surpassing 85,000 and 3,000 respectively. At the same time, the number of people who have recovered from the disease has also increased, surpassing 42,000. Most importantly, the US has suffered its first fatality from COVID-19 (near Seattle). This could mark the beginning of a new phase in the crisis. In fact, as we have already said, unless the pathogen mutates suddenly in coming months, the mortality rate will remain relatively low, around 2% globally of those who become infected with it. 

Nevertheless, the economic impact of the virus will derive from the reaction of governments to the news about it. No politician wants to be blamed for not having taken sufficient action in response to the virus. The first reaction from the US was the suspension of certain flights from the US to Northern Italy. As the number of cases and deaths  increases in the US, however, so too will the escalation in the counter-measures the government takes. The economic impact of severe counter-measures in the US would take the economic impact of COVID-19 to a different order of magnitude, and would have a global economic impact. A global recession in 2020 is now becoming a real possibility.    

The countries that have experienced the largest number of cases of infection show that the economic impact of the virus could be large, and might not necessarily be V-shaped as had been optimistically assumed by some commentators until just a few days ago. In China, the manufacturing PMI has collapsed to 35.7 in February, down from 50 in January, marking a new all-time low. Any figure below 42 in China signals an outright contraction in activity. The GDP in China, Japan, South Korea and Italy will contract sharply in Q1, and perhaps also in Q2. Fiscal packages to ease the sharp fall in economic activity are in the process of being approved in those countries. The latest is the EUR 3.6bn package announced by Italy on Sunday. These measures will help to a certain extent, but ultimately will not be able to achieve much. In particular, monetary policy, which will likely become more expansionary at the global level pretty soon, is likely to prove impotent against a supply-side shock.  

Considering all of this, it is clear that market participants should brace themselves for more volatility and corrections in the weeks and months ahead. The impact of Coronavirus on global economic activity will be large and persistent. The policy response will be slower, smaller and less effective than expected. This will necessarily have to be reflected in the valuation of risky asset classes. Fasten your seatbelts. 

by Brunello Rosa

24 February 2020

After entering the Democratic primary late, Michael Bloomberg is trying to establish himself as the only Democratic candidate who can defeat Trump in November. His strategy might prove to have been well-calculated. By not entering the race before the caucuses in Iowa and New Hampshire were held, he knew that by the time Super Tuesday takes place on 3 March one of the left-wing contenders (either Bernie Sanders or Elizabeth Warren) would be ahead in the game – an that would scare the median voter, financial markets, and also the Democratic leadership into preferring a candidate like himself. The result of the latest primary election, in Nevada, where Sanders once again finished ahead of centrist candidates such as Joe Biden and Pete Buttigieg, confirmed this trend (which can also be seen at a national level, according to recent polls), and thereby the validity of Bloomberg’s strategy. 

Michael Bloomberg might have thought that, after scaring markets and centrist voters with the advancement of radical left-wing candidates (notably, of Bernie Sanders, who self-defines himself as a socialist), the democratic leadership would come to him, begging him to unify the party and lead it in the race against Trump in November. However, things might not work out as Bloomberg may have planned. 

In the first televised debate in which he appeared against the other Democratic candidates, Bloomberg was frontally attacked by the left-wing contenders, in particular by Elizabeth Warren. He did not come across as particularly friendly in this exchange. A highly curated video clip of the debate, in which Bloomberg asks the other candidates who else has founded a successful business, did not do him great credit either. While he had a point, since he is indeed the only one among the remaining Democratic candidates with that achievement, the entire scene lasted no more than a couple of seconds on live television, while the video made it look much more dramatic than it had been in reality. 

Also troubling the Bloomberg campaign is a series of NDAs signed by women who were allegedly mis-treated when working at Bloomberg LLC.. So, even if Bloomberg may be the only candidate who can defeat Trump in November, he still faces an uphill battle to win the Democratic nomination.   

In particular, Bloomberg will have to mobilize a portion of the Democratic electorate – African-Americans, other ethnic minorities, women – that is essential to win the nomination and, eventually,  the general election. Some fights with the black community when he was mayor of New York will not help him in this battle. Additionally, his profile might not be particularly attractive to this key portion of the Democratic electorate. While being a truly self-made man (unlike Donald Trump, who inherited his fortune from his father), Bloomberg is still the sort of New York-style billionaire who does not necessarily attract the sympathy of minorities and other traditional segments of the Democratic electorate. Also, the story of the women-related NDAs risks sticking to him much more than to Trump, who the electorate seems willing to forgive almost anything. (Certainly, the number and depth of allegations against Trump is much larger than those against Bloomberg).

Bloomberg, therefore, might not be the white knight he was presumably hoping to become. The race for the Democratic nomination remains open. The simple truth is that the Democratic party has not been able thus far to converge towards a candidate who can truly represent a credible threat to Trump in the coming general election. The president will present as victories his trade and tech wars with China, his hard-line on Iran, and other high-profile battles that could ultimately damage the international reputation of the US and its economy. His electorate might accept this narrative, securing his re-election in November. If the Dems want to avoid this, they better start getting their act together, and fast.  

by Brunello Rosa

20 January 2020

At the end of last year, in our paper on the six Grey Swans facing the global economy, and in our 2020 Global Economic Outlook, we said that geopolitical instability was set to increase during the US election year ahead. The strategic calculus by Trump to secure his re-election, going into 2020, was to make sure that the US economy was as strong as possible (perhaps with a bit of help from the three insurance rate cuts “independently” delivered by the Fed in 2019, which came after plenty of pressure was put on the Fed by the President), while closing some of the open geopolitical fronts, in particular the trade dispute with China. 

In fact, Trump’s “art of the deal” consists of brutally shaking his counterpart before inviting it to the negotiation table and concluding a deal on more favourable terms for himself. Following this paradigm, Trump had a window of opportunity from the mid-term elections until 2020 to unsettle the system and shake his opponents, in order to then use 2020 as the period to reach compromises with his negotiating partners that he could “sell” as victories to the US public during the electoral campaign. But, as we mentioned in previous analysis, while this tactics might work in the corporate sector, where an aggressively confrontational approach could lead the counterpart to the brink of bankruptcy and therefore make it more willing to accept the harsh terms that Trump offers, in public affairs things are not that simple. States do not go bankrupt that easily, and opponents can react in unexpected ways. 

So, while Trump’s preferred choice could have been that of having a strong economy and some tail risks reduced (risks such Brexit; during Trump’s intrusion in the recent electoral campaign in the UK, he basically “ordered” Nigel Farage to step back and allow Johnson’s victory), his opponents saw a clear opportunity in 2020 to “mess things up” in order to jeopardise Trump’s re-election. Domestically, the Democrats have launched an impeachment trial, which is unlikely to succeed but will still keep Trump on his toes and will expose him on a number of fronts. 

The delay in sending the impeachment article to the Senate, while being borderline acceptable, has prevented Trump from having the news on the impeachment obfuscated by escalating tensions with Iran that would have otherwise occurred at the same time as one another.   

Internationally, Iran is clearly at the forefront of the historical foes that would like to see Trump go, hoping to get a Democratic president to deal with instead. This is the reason why we believe that Iran will do much more in coming months to retaliate against the killing of Qassem Suleimani, and why we believe the market is under-pricing the risk of a further escalation down the line, closer to the election date. 

According to press reports, Kim Jong UN sacked its “moderate” foreign minister Ri Yong Ho, replacing him with the more hawkish Ri Son Gwon. This is seen by the intelligence community as a signal that a season of testing of ballistic missiles (launching them over key regional allies such as Japan) is about to re-start, after a period of pause. 

China remains the big unknown: signing the Phase-1 deal certainly gives Trump a trophy to show during the electoral campaign, and gives China the much needed break in the escalation of tariffs. At the same time, it is clear that the trade, technological and geo-strategic dispute between the two countries will continue. One possible interpretation is that China, instead of wanting to see Trump leave office, might prefer having him remain for a second term, given the damage he is doing to the US and their international relations.

All this is to say that the historical foes of the US will use the opportunity of this electoral year and Trump’s impeachment trial to take advantage of the difficulty Trump will face in providing anything other a constrained response to any moves they may make. If Trump goes from disputes to battles to open wars, he would tip the economy into recession, thus jeopardising his re-election. As such, his options this year will be relatively limited. 2020 will be most likely “a year lived dangerously” for the world.

by Brunello Rosa

13 January 2020

Financial markets became excited at the end of last week, by signals that some of the most feared tail risks hanging over the global economy could be diminishing. On a weekly basis, global stock indices rose (MSCI ACWI rose by +0.6%, to 570), driven by DM equities (S&P 500 +0.9% to 3,265; Eurostoxx 50 +0.4% to 3,790). EM indices also rose (MSCI EMs +0.9% to 1,134), and, as markets rallied, volatility fell (VIX S&P 500 fell by -1.4 points to 12.6, below its annual average of 15.0).

Regarding tensions between US and Iran, the “measured” retaliation by Iran to the killing of Quassem Soleimani, in which rockets were fired at two US military bases in Iraq without causing casualties and major damages, and the decision by the US not to respond to that attack, was interpreted by market participants as a signal of de-escalation. Some might even hope that, after a period of increased tension, the status quo ante between the two countries might return. While it is certainly a positive development that Iran’s retaliation was not followed by further US counter-attacks, we would be much more cautious before considering the events of the last few days to be merely isolated incidents that are now effectively concluded.

In our scenario analysis, we discussed how events might still develop less favourably than markets currently imply they will be and Nouriel Roubini argued that financial markets are still seriously under-pricing the possible future evolution of events. This is true for a number of reasons. First, Iran’s Supreme Leader Khamenei said that the initial attack on US bases was just the beginning of the retaliation, and that much more will occur in coming weeks. Secondly, President Trump’s invitation to the UK, France and Germany to also abandon the Joint Comprehensive Plan of Action (JCPOA) means that tensions will remain elevated for some time. Third, Iran would benefit from striking closer to the November Presidential elections, when mis-calculations could lead to Trump’s defeat. Fourth, the US has in any case launched a new series of sanctions against Iran, which could eventually lead to a further reaction by Tehran. 

And finally, the unintentional downing of the Ukrainian plan by Iran on the night of the retaliation show how things can go wrong even when there is no intention to kill. In his upcoming Geopolitical Corner, John Hulsman will discuss how the Iranian story is intertwined with the electoral campaign and Trump’s impeachment process. 

The second piece of good news that excited market participants was that the market the announcement by the US President that he is “ready for the Phase-1 trade deal with China to be signed on January 15th at the White House”. Trump also said he would “sign the deal with high-level representatives of China”, and that he would later “travel to Beijing to begin talks for the next phase”. The market believes that this might signal the end of the saga that rattled the global economy during the past couple of years. But again, reality might be slightly harsher than what is being hoped for. Until the deal is actually signed, anything can happen, and time is on China’s side. Why should the Chinese government provide Trump with the argument that he succeeded in containing China’s trade mis-practices ahead of the election? 

Moreover, even if the trade tensions do ease, the geo-strategic rivalry between the two countries will continue, with its impact on global supply chains and technological developments. In any event, once the China issue is finally considered to be done with, Trump will then simply be ready to start a fight with Europe, over various issues such as Airbus versus Boeing, auto sector trade, digital taxes, etc. So, trade tensions worldwide could very well continue going forward.  

Finally, the UK parliament has at last approved the PM’s Brexit deal, opening the gates to an orderly Brexit on January 31st, if the House of Lords does not object. At the same time, a series of cliff-edges are likely to present themselves in the next 11 months, especially now that the possibility of extending the transition period beyond 31 December 2020 has been excluded by law. 

All this is to say that, while some tail risks have not materialised so far, market participants should remain aware of their presence and remember the stretched valuations that now exist in most asset classes.  

by Brunello Rosa

6 January 2020

The year has just begun, and geopolitical and political events are already accumulating. From a geopolitical perspective, the most relevant development has been the escalation of tensions in the Middle East, with the US and Iran likely to begin some form of direct and indirect military confrontation following the killing of Iranian general Quassem Soleimani in Baghdad. US President Trump reportedly ordered the attack as a retaliation for an Iran-backed militia’s attack of the US embassy in Iraq, and for the killing of a US civilian contractor on an Iraqi military base in Kirkuk. These events followed months of provocations from Iran to which the US has not responded, including a drone attack on Aramco’s refinery facilities in Saudi Arabia. Tensions between the US and Iran have been on the rise since President Trump decided to pull out of the JCPOA , the agreement between Iran and six international counterparts to limit the development of its nuclear program. That agreement was negotiated by Trump’s predecessor Barack Obama in 2015. We have discussed the run-up to these events in previous papers and scenario analyses, and shortly we will publish an updated scenario analysis, with its implications for oil prices. 

From a political risk perspective, these developments have a clear bearing on the US political environment. As discussed in our recent 2020 global outlook, 2020 will be an election year in the US, and most of the macroeconomic and policy events will be driven by the developments in the US presidential race. To make things even more complicated, the US President was impeached by the House of Representatives at the end of December, and his “trial” in the Senate will start soon. As we discussed in our analysis of September 2018, regarding the risk of a global recession materialising in 2020, Trump might be tempted to “wag the dog” with military operations during his campaign for re-election, with Iran being the most likely designated target. The recent developments in the Middle East will surely help Trump obfuscate the news about his impeachment trial. He might also hope that the country will rally behind him in the event an overt conflict takes place, as it often does to presidents is similar circumstances. However, the political spectrum has thus far been divided by Trump’s decision, which reportedly was not discussed and agreed to in advance with other political leaders.       

In Europe, there are interesting political developments taking place in Spain and in Austria. In Spain, Pedro Sanchez seems on the verge of being confirmed Prime Minister, with a second vote for his “investidura” on January 7th. He managed to strike a deal not just with Podemos, but also with the independentist parties of Catalonia and the Basque Country. This solution is fraught with risks. The leader of the Esquerra Republicana de Catalunya(ERC), Oriol Junqueras, has spent the last couple of years in prison, and has been ordered to be released only recently, given his election to the European Parliament. Depending on the votes of ERC is clearly a gamble for Sanchez, considering that his government fell precisely because the Catalan parties did not support his budget. On the other hand, having both the Catalan and the Basque pro-independence parties in government could mean that a peaceful solution to Spain’s domestic conflict is likely, considering that the Catalans have always asked to be given at least the same powers and autonomy granted to the Basque Country in return for dropping their quest for independence. 

In Austria, following months of negotiations, the Chancellor Sebastian Kurz managed to strike a deal to form a government with the leader of the Greens, Werner Kogler. This coalition between the conservative Austrian People's Party (ÖVP), which belongs to the European People’s Party (EPP), and the Greens, could provide the model for the next German coalition government, if the next general election (scheduled for 2021) were to result in yet another hung parliament. Such a solution could stabilise Germany’s political landscape, and provide the platform to push further European integration and stop the ongoing process of European dis-integration. European political risk was another factor discussed in our September 2018 paper on the risk of a global recession in 2020. As the recent examples from Spain and Austria show, the news from this front is mixed, and worth following in coming months.

by Brunello Rosa

30 December 2019  

In our column last week, we discussed some of the key points of our Global Economic Outlook and Strategic Asset Allocation for 2020. This week we want to focus on what we can expect from a policy perspective in the year ahead, and on policy’s implications for markets. 

A number of key equity indices in the US have reached their all-time highs during the past few days. The NASDAQ, for example, touched the 9,000 mark for the first time ever on Friday 27th December. The question is whether this rally in risky asset prices is being driven by fundamentals, or whether it is being driven rather by policy intervention (or the anticipation policy intervention), in particular the large liquidity injections made by both the Fed (with the re-increase in the Fed’s balance sheet to stabilise the repo market, which some have labelled QE-4) and the ECB (which has recently re-started its own QE program). 

In our Outlook we discussed how, from the monetary policy side of the equation, after the three “insurance cuts” implemented by the Fed in 2019, we now expect the US central bank to remain on hold during the 2020 electoral year, remaining open to further easing only if the economy materially worsens. We also discussed how the ECB is now undertaking open-ended QE and has an easing bias on policy rates (but its strategic review might induce a less accommodative stance). The BOJ will remain extremely accommodative; it might even add a further level of modest accommodation to accompany Japan’s fiscal stimulus. The BoE will react to Brexit developments, but is mulling over the possibility of rate cuts. The PBOC is likely to continue to provide modest monetary stimulus to cushion the Chinese economy, given trade frictions and disruptions in global supply chains.     

On the other hand, fiscal policy remains constrained but is becoming modestly expansionary. In the US, the divided Congress means that no fiscal stimulus is likely in 2020; in the Eurozone some additional fiscal flexibility is underway, especially to accompany its “green deal” and “energy transition” plans that may be attempted. Japan has approved a large fiscal stimulus (as a headline figure), which could be the basis for an effective initial version of “helicopter money”. China will keep providing some additional fiscal stimulus, despite its high fiscal deficits.

Given these considerations, we believe that in 2020 there will likely be a moderately ‘risk-on’ environment, given the improving chances that growth will stabilize, inflation will remain under control, and monetary and fiscal policies will be supportive, as well as the fact that some significant tail risks have diminished recently. Additionally, the anticipation by market participants that “helicopter drop” policies could eventually be introduced when the next economic recession and severe market downturns occur (a situation that we have labelled a “helicopter put”) is keeping the markets happy for the time being, and even frothy in some instances. 

At the same time, we warned how geopolitical and domestic political tensions, a possible re-intensification of trade wars, the continued disruption of global supply chains, tighter financial conditions, and market valuations disconnected from underlying macro fundamentals could cause sudden market corrections that investors should be wary of during the new year ahead.

By Brunello Rosa

25 November 2019  

For better or worse, 2020 will be characterised by the US Presidential race, which will not end until November 3, the day the election will be held. President Trump has made all possible efforts to make this election a referendum on himself and his style of being president. He has polarised the US political landscape like very few presidents before him ever have, with his abrasive conduct of government affairs, partly inherited from his business days when he was using his “art of the deal” to get things done. 

In politics, and especially in foreign policy, his approach of hitting counterparts as hard as possible before inviting them to the negotiating table has not always worked. Sovereign institutions are not businesses that can be brought to the brink of bankruptcy to soften their negotiating positions. Hence the failed negotiations with the North Korean dictator over that country’s nuclear program, the standstill with the Iranians over the nuclear deal and Middle East policy in general, and the protracted negotiations with China over trade and tech arrangements, which have so far produced at most a “Phase-1” informal agreement. 

Regarding the US domestic agenda, President Trump is trying to show that he continues to side with the deprived working class in urban areas and with under-privileged populations in rural areas. For some reason, the president’s narrative is still popular in the country, even though the reality is that some of these domestic issues are actually bi-partisan. For example, every president, Republican or Democratic, would have had to start taking on China and its trade surplus vis-a-vis the US, as well as its unfair tech and IP practices. Perhaps Trump’s unorthodox style and abrasive approach make his positions less acceptable to many who would otherwise support such positions if it were a more conventional politician who was championing them.    

Indeed, to some extent Trump may have actually surprised to the upside in his policy stances, by being less trigger happy than what could have been expected from him, especially after surrounding himself with very hawkish advisers and officials such as John Bolton and Mike Pompeo.  For example, he did not respond to the provocations of North Korea and Iran in the last couple of years, and has not directly intervened in Venezuela as some of his predecessors would perhaps have done. Trump might turn out to be just another isolationist Republican president. 

In any event, the electoral campaign is beginning to heat up. The impeachment hearings are turning awry for Trump, with the testimony of people close to the president such as Gordon Sondland, the US ambassador to the EU, and Fiona Hill, a senior National Security Council official. For now, the baseline scenario will continue to be that President Trump is likely to be impeached in the House, but not convicted in the Senate, where 20 Republican votes are needed to reach the necessary two-third majority of 67 votes. 

However, the more embarrassing the hearings become for the Trump administration, the more Republican senators might decide to turn their back on the president if and when an impeachment vote is held. If the president’s position weakens as a result, he might induce some of his external enemies, like China, Iran, or North Korea, to scale up the level of provocations during the electoral year, to see whether a more tense international environment make Trump lose enough votes in the key swing states he will need to win a second term. 

What about Trump’s Democratic opponents? As we discussed in our recent analysis, the frontrunner Joe Biden has been damaged by “Kyiv-gate” more than Trump has so far, so much so that Pete Buttigieg now seems to be leading the race in Iowa and New Hampshire, which are the first states that will hold primary elections. To counterbalance the rise of Elizabeth Warren, a left-wing candidate who has spooked the market with her radical reforms made up of universal healthcare coverage and wealth taxes, Michael Bloomberg, the former mayor of New York, has now launched his own campaign to win the Democratic nomination. His presence will make the race in the Democratic camp more uncertain. If he wins the nomination, we would then see two New York billionaires running against each other to become, or in Trump’s case, to remain, President of the United States in November.     

By Brunello Rosa

18 November 2019  

A number of economists and commentators are discussing the question of what the most effective fiscal and monetary policy response to the next global financial and economic downturn will be. There seems to be a consensus forming that, with global interest rates as low as they currently are (in some regions, nominal policy rates are negative), some form of fiscal and monetary coordination will be needed when the next crisis hits. Most recently, Gavyn Davies has discussed the role of automatic stabilisers, like indirect taxes and forms of unemployment insurance, in such a context, highlighting how this form of automatic support to aggregate demand is weaker in the US than in Europe, for example. 

In our recent analysis, we discussed in depth what form this monetary/fiscal cooperation could take, citing the examples of “helicopter drops of money,” “People’s QE”, “Modern Monetary Theory” and other more mainstream forms of fiscal-monetary coordination such as that which was recently proposed by former Fed’s Vice Chairman Stanley Fisher and former SNB chief Philipp Hildebrand, and describing their pros and cons. Our impression is that this idea of monetising fiscal deficits, far from being new (let alone “modern”), is actually becoming mainstream, and will likely provide the theoretical foundation for the policy response to the next economic and financial downturn, especially if the next downturn is severe.

This discussion is already having a very positive impact on financial markets. As we discussed in our column two weeks ago, markets are already celebrating the reduction of tail risks (US-China trade tensions, Brexit, the IMF-Argentina confrontation, etc.) and the additional monetary stimulus (such as that which was delivered by the Fed at the end of October) that are accompanying the stabilisation of key macroeconomic indicators such as manufacturing PMIs (which seem to be bottoming out, while remaining in contractionary territory).   We concluded that column by saying that markets are already pricing in some form of fiscal and monetary backstop that they expect to be provided when the next crisis hits. This is like counting on a massive “fiscal and monetary put” available at the global level. 

In this imaginary bridge between where we are now (a synchronised global slowdown) and where we are likely to be in a few quarters from now (a recovery phase driven by a coordinated fiscal and monetary policy response at the global level) the question is what will take place in between. For certain, monetary authorities will be prudent, and policy rates will be kept lower than what they would have been if this recovery had taken place pre-2008 crisis. Hence, policy rates are likely to be kept low, if not lower than they are now, for longer. 

This might not be enough to prevent a sudden reversal in the imbalances that are building up and will continue to build up, in part even as a result of this very prudent monetary policy. For example, in H1-2019, global debt rose above USD 250tn, with China and the US accounting for more than 60% of new borrowing (with worrisome levels in the corporate debt sector). As such, a “non-linear” event in the middle of the bridge between the current global slowdown and future global recovery seems hard to avoid at some point. A coordinated fiscal-monetary action will then occur, providing the necessary policy response.  

By Brunello Rosa

11 November 2019  

Spain’s general election has resulted in yet another hung parliament. The final results suggest that the Socialist Party (PSOE) of the incumbent Prime Minister Pedro Sanchez has obtained a plurality of votes (around 28%), but very far from a level that would allow Sanchez to obtain a majority of seats in the Congreso De Los Diputados, the country’s main legislature at the national level. The Socialist Party will have 120 seats, out of the possible 350. Pablo Iglesias’ Unidas Podemos has collapsed, meanwhile, receiving only around 13% of votes and 35 seats. Podemos probably paid a political price for the intransigent position they had taken during the negotiations that followed the April 2019 election, which had failed to lead to the formation of a new Sanchez government. The new party born to the left of PSOE, Mas Pais, obtained 2.4% of votes (most likely from both PSOE and Podemos) and 3 seats. 

On the right of the political spectrum, the Ciudadanos party led by Albert Rivera has also collapsed in these elections, from 16% of votes and 57 seats to 6.8%of votes and 10 seats. 

Critics are saying the party has run out of “marketable” political material. It is also true that Ciudadanos’ intransigent position regarding the Catalan separatists had already paid off, with the incarceration and severe sentences of the leaders of the “rebellion”, and that its outlook is in any case well represented by the even tougher positions taken by the rising Vox party. 

Vox, led by the controversial figure Santiago Abascal, has staged the best performance of all, rising from 24 seats in the previous legislature to 52 in the new one. It received 15.1% of all votes, which despite being only around half as many as the Socialists, is nevertheless a 30% increase from the votes Vox had received in April 2019. This is yet another confirmation that nationalist-populist parties are still strong in Europe, and still represent a serious threat to the European integration process. The People’s Party (PP), led by Pablo Casado, has also increased its votes (+4.1% to 20.8%) and seats (+22 to 88). Other parties, including regional ones from Catalonia and the Basque Country, gained a combined 42 seats.  

Where will Spain go from here? As we discussed in our in-depth election preview, Spain’s political stability is long gone, as the fact that this was its fourth general election in four years clearly shows. At the same time, Spain’s two traditional parties, PSOE and PP, plus the newer parties from the left (Podemos) and the right (Ciudadanos), cannot afford not to be able to form a government after this election. If they do not manage to form a government, there is a risk that the protest vote will rally around the newest party on the political scene, Vox, which has the potential to wipe out both Podemos and Ciudadanos and drain further votes from PP and PSOE. As such, we believe that these parties will do all it takes to form a government this time. 

Given the number of seats available, Sanchez is very likely to be given the first chance to form a government. He will probably go back to Podemos and try to form a majority with them and some of the other left-wing parties (such as Mas Pais) and regional parties, or if not a majority than at least a parliamentary bloc large enough to form a minority coalition government. If this attempt were to fail, the three right-wing parties (PP, Ciudadanos and Vox) might try to form a coalition – the same grouping that took over the Andalusian regional parliament in December 2018, following decades of unrivalled Socialist rule in that region. 

If neither of these two relatively “natural” solutions work out, Spain might instead try to form, for the first time in its recent history, a German-style “grand coalition” between PSOE and PP, which together would command a comfortable majority. A weaker form of this grand coalition could be a PSOE-only minority government, which can be formed thanks to the abstention of the PP (which, in this way, would “return the favour” that the PSOE did to Rajoy in 2016). But the risks deriving from this type of solution are well-known in those countries that have experienced them (chiefly, in Germany, Austria and, more recently, Italy). Grand coalitions tend to reinforce support for extremist parties, especially those on the right side of the political spectrum (AfD, FPÖ, and Lega, respectively). With Vox already on the rise, a PSOE-PP coalition is therefore a solution we believe will be attempted only at the very end, if all else has failed.

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.   

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. 

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.    

 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. 

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.

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.  

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.   

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. 

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.