WEEKLY COLUMNS (ARCHIVE)

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by Brunello Rosa

6 December 2021

In our column last week, titled “Covid’s Fourth Wave Risks Derailing Europe’s Economic Recovery” we discussed how the fourth wave of the pandemic was hitting Europe especially hard. We argued that the increased number of Covid cases registered in Europe was “mostly related to the delta variant”  but also specified that “other variants are likely to be in circulation as well.”

We have since had confirmation that a new variant, first identified in South Africa, has been recently added by the World Health Organisation (WHO) to the list of variants of concern. This new variant, dubbed Omicron (code name for B.1.1.529) presents 32 mutations of the spike protein, which the virus uses to infect the healthy cells of the human body. Some of these mutations were already present in previous variants, but some are new. There is a suspicion that the mutations have developed within the body of an immuno-depressed individual (perhaps affected by HIV), in which the virus had the opportunity to mutate and replicate. 

Whatever the origin of the virus, the new strain has been identified not only in South Africa, but also in Hong Kong, in a passenger coming from South Africa. Several cases have also been identified in flights from South Africa to the Netherlands and in other European countries. This means that the new strain is already circulating internationally; it is only a matter of time before it will be widespread throughout the world. It is likely, given its “genetic superiority”, that this strain will become prevalent, like the Delta variant did a few months ago.  

Though a number of countries have now banned flights from South Africa, this risks being a futile measure, as the virus has already reached several parts of the globe. Other countries have intensified the campaign for the third dose of the vaccine (the so-called “booster”).  

But it will take time (at least two weeks, Pfizer said), to ascertain whether the new strain is able to circumvent the defences provided by the currently available vaccines. Pharmaceutical companies are saying that they are already working towards a new version of the vaccine, tailored to Omicron, but it will take at least three months before these vaccines may become available to the wider population. 

Markets have already reacted to the news: fears of new restrictive measures, including new total or partial lockdowns that may derail the ongoing economic recovery, have resulted in market sentiment and equity prices plummeting. Last Friday some equity indices lost almost 5% in a day. Now the ball is in the court of policymakers attending to monetary and fiscal policy. How will these policymakers respond?

As we have discussed previously in several columns, central banks have been sending hawkish signals for months now, and some have already started to tighten their policy stance, in both DMs and EMs. The Fed started tapering its asset purchases in November, and the ECB announced in October that the pandemic emergency is over. Governments have started to plan measures of fiscal consolidation. Will they now all decide to put the reverse gear on? It’s too early to say. Paradoxically though, if the new variant results in further liquidity injections being made by central banks, in order perhaps to monetise additional fiscal deficits made by governments, markets may recover their recent losses and progress further towards future highs.

In any case, it seems to us that before the spring or summer of 2022 it will be very hard to tell if this pandemic is about to end, or whether new variants may emerge again. 

by Brunello Rosa

22 November 2021

In a number of countries, but especially in Europe, an increase in the number of Covid cases has been registered in recent days. These are mostly related to the delta variant, but other variants are likely to be in circulation as well. In continental Europe, the most alarming countries have been Germany(with 60,000 new Covid cases per day), the Netherlands (20,000 cases), Austria (15,000), and Belgium (20,000).

Countries’ reactions to these outbreaks have differed. In Germany, the government has introduced the 2G rule, whereby only those who have recovered from Covid or who have undertaken a full vaccination cycle may receive a Green Pass to access public places. In the Netherlands a partial form of lockdown has been introduced. In Austria, a 20-day full lockdown has been ordered by the government, and vaccination will become mandatory from February 1st.

In Italy, where the number of new cases is still relatively low (around 10,000 a day), the government is considering a tightening of the Green Pass rules. The Covid test may be accepted only to go to work; it would not be sufficient for social events. The validity of the tests would also be reduced from 2 days to 1 day for antigenic tests, and from 3 days to 2 for PCR tests. The government is also thinking of making vaccination obligatory, but it may not find the internal agreement necessary for a green light on that. 

Other European countries have reacted differently to the current situation. In the UK, for example, there has been a surge of new Covid cases since October. The number of new cases peaked in early October (at 51,000), and subsequently declined to around 40,000 now. Yet the government has resisted the pressure to introduce new restrictions after the “liberation day” was declared on July 19th. Instead the government accelerated the campaign for the booster shot of Covid vaccines, with the minimum time between second and third doses being reduced to 5 months.

The overarching principle in these government responses has been to preserve the recovery in economic activity, reduce the burden on fully vaccinated people, and incentivise (indeed almost oblige) those still reluctant to get vaccinated to get their shots. We agree with this approach. In principle, those who paid the price of getting vaccinated (in terms of the small risks associated with the process), to the benefit of the entire community, should be entitled to enjoy the benefits of more freedom of movement relative to the non-vaccinated, who risk their own and other people’s lives with their choice.

From an economic perspective, the consequences could be significant. After the link between Covid cases and economic impact had been severely reduced by the introduction of vaccines, the ongoing recovery in economic activity may experience a slowdown or a more significant and prolonged soft patch if new restrictive measures are introduced in large or numerous countries.

If the slowdown in economic activity growth proves to be deeper and longer-lasting than is currently assumed, policymakers may need to revisit their recently-expressed intentions. Governments may need to provide additional fiscal support, and central banks may need to rethink the phasing out of the extraordinary accommodation they have provided in the last couple of years. They may have to continue to purchase, for a longer period of time, private and public sector assets, and they may have to push back any intention of increasing their policy rates in the not-too-distant future.

If this proves to be the case, the implications for asset classes would also be large. Long-term sovereign bond yields would likely fall across the board. Equities may benefit from renewed liquidity injections, with EMs becoming interesting again. In the currency space, the USD may strengthen further versus European currencies, if the US government does not introduce new restrictive measures as much as the European countries will do.

by Brunello Rosa

15 November 2021

After a two-week marathon summit, an agreed-upon text finally emerged at the end of the CP26 conference in Glasgow. Signatory countries are committing to limit the increase in global temperature to well below 2C since pre-industrial times, and ideally to 1.5C. They are also committing to increase the funds available to help countries fight global warming and adapt to climate change. This 1.5C limit was already agreed on in Paris in 2015. The direction towards agreeing to these goals was established by the Kyoto Protocol in December 1997, when COP3 was held. 

The problem here is that global temperature has already increased by 1.1C since pre-industrial times, and so long as the amount of CO2 injected into the atmosphere continues at the current, or even a slightly decelerated pace, one cannot see a meaningful deceleration for the increase in global temperatures in sight. Though reaching zero net emissions by 2050 (which in practice would mean emissions that are fully compensated for by offsetting actions, such as planting new forests), or even by 2030 – which some countries are pledging to accomplish - may help to achieve the final goal, nevertheless international cooperation remains of the essence. 

In this respect, the final text of the COP26 contains an unwelcome last-minute change. Instead of aiming at “phasing out” carbon emissions, India has asked instead to phase them “down”, a significant softening of the initial proposal. Interestingly, while all eyes were focused on China, ultimately it was India that managed to water down the agreement. India is the country in the world that most relies on carbon emissions to satisfy its production needs, despite the fact that its per capita energy usage remains well below that of China or developed economies. 

This agreement therefore makes clear once again the division existing between emerging economies and developed countries. The latter are reluctant to provide the financing that is needed to smooth the transition toward a more ecologically sustainable economy. Meanwhile the emerging economies wonder why limits to pollutions are now being imposed upon them by developed countries, as it is the developed countries that are primarily responsible for the increase in global temperature from the beginning of the industrial revolution. 

The United States, for example, is estimated to have been responsible for 25 percent of cumulative emissions worldwide since pre-industrial times, compared to 13 percent for China and only 3 percent for India.   

What is positive about this new agreement? To begin with, having reached an agreement is an accomplishment in itself. Especially after the entrenchments between countries caused by the ongoing pandemic, it was not a given that a cooperative spirit would still be present internationally. Secondly, the agreement (however vaguely) does provide guidelines to implement the principles agreed upon six years ago in Paris. Third, it is important that most of the main actors of the global economy were at the table: the US, China, the EU, and India (among the 197 participating members), though Russia remained on the sidelines. 

The US returned to the table at Glasgow after the pull-out decided on by Donald Trump, with Joe Biden’s chief negotiator John Kerry being a heavyweight in US politics (Kerry was the Democratic presidential candidate in 2004, and the Secretary of State during Barack Obama’s second term as president). Chinese leaders initially attended the conference only virtually, but its contributions to the negotiations were felt all the same. The EU, meanwhile, was clearly one of the most sensitive participants, in that it has been one of the main advocates of the fight against climate change, and in this respect the speech by the EU Commission Executive Vice President Timmermans was considered a final push towards reaching an agreed statement. 

Between the US and the EU, there is clearly a different approach towards addressing China. The US is continuing to forge a hard line here, given the emerging Cold War II that is being waged between the two countries, as well as amid US allegations of China having started the global pandemic. The EU is softer on China mainly for commercial reasons, but also because the EU knows that one cannot constructively engage China on global warming if one continues to treat China as a strategic rival that needs to be contained. 

It is hard to say whether the COP26 result was a glass half full, or half empty, achievement. The objectives that were agreed to are clearly unambitious, and the lack of urgency regarding emissions reduction continues to persist in many countries. On the other hand, any agreement that fosters international cooperation and multilateralism is good in these fractious times. 

by Brunello Rosa

8 November 2021

There were three major central bank decisions among the G10 economies last week. In the US, the Federal Reserve decided to reduce the pace of its asset purchases by USD 15bn a month (USD 10bn of Treasuries and USD 5bn of MBS), beginning as of this November. As we discussed in our review, the Fed will retain some flexibility regarding the pace of further reductions, as the FOMC is aware that the winter season could see a spike in Covid cases and potentially new restrictive measures, and thus any decision may need to be reversed at short notice. Even in China, the zero-Covid policy is proving ineffective in spite of the country’s strict enforcement.

The Fed made this decision to reduce asset purchases independently of any fiscal policy consideration, but nevertheless it is a fact that during this same week the US Congress passed the long-waited USD 1.2tn infrastructure investment plan, which will provide fiscal support to the ongoing US economic recovery. President Joe Biden promised to pass an additional USD 1.75tn package to invest in the country’s social safety net in the coming weeks, but considering the wrangling that has been necessary to pass this bill in Congress, such additional spending seems “aspirational.” Democrats and Republicans have also fought recently over the increase of the debt ceiling – a battle that is likely to re-start in December. Also, Biden may need to act carefully while his approval rating is tanking (though it is not clear whether his approval has fallen because he is perceived as being too progressive by the moderate base of his party, or too moderate by the progressive side of his party).

In this informal coordination between monetary and fiscal policy, an important step will be the appointment of Jay Powell’s successor as Fed Chair during the coming term, which will start at the end of February 2022. It is worth remembering that the current Secretary to the Treasury, Janet Yellen, is a former Chair of the FOMC. Again, the two sides of the Democratic party will likely have different views as to this re-appointment. Lael Brainard, however, who has served on the Fed’s Board of Governors since 2014, is touted to be on the shortlist of potential candidates to succeed Powell.    

In the UK, meanwhile, the Bank of England left its policy rate unchanged, surprising the markets, which in the past few weeks had been alerted by the Bank itself about a possibly imminent rate increase. As we discussed in our preview, from a normative perspective we thought that the Bank could afford and should wait at least until February before raising rates. So, to some extent we were glad the Bank made that decision. On the other hand, we remain highly sceptical of the Bank’s communication, which clearly wrongfooted the market. In this case, the BoE also had the benefit of looking at the details of the budget plans of the UK government for 2022 and beyond. They probably saw that the budget plans were not as generous as one could have anticipated, implying that the country had to rely on additional monetary support from the central bank instead. 

In Australia, the RBA left its policy rates unchanged but brought forward the time in which raising rates could happen (from 2024), and de-facto ditched the yield curve control on the 3y government bond yield. This relatively hawkish move also came after the Australian treasury released a very expansionary budget in May and allowed the deficit to increase substantially over the course of the year, which permitted the central bank to start withdrawing some of their policy accommodation.  

As we discussed at the beginning of this crisis, the coordination between monetary and fiscal policy has been the real innovation of the crisis. It is good news that this coordination continues as public authorities now withdraw the extraordinary stimulus provided during the crisis.

by Brunello Rosa

1 November 2021

The Italian presidency of the G20 forum concluded this past weekend with the G20 meeting that was held in Rome. All the head of states of the twenty largest economies in the world gathered in Rome to discuss key themes such the fight against the pandemic (and against pandemics in general), climate change, and the implementation of a minimum corporate tax rate.

Regarding the pandemic, the G20 highlighted the importance of continuing and intensifying the vaccination campaigns in those countries that have already started them, and of pushing further for a fairer distribution of vaccines around the globe, particularly for developing economies. The target to reach is having 70% of the world population vaccinated by 2022. The monetary and fiscal response to the pandemic needs to remain coordinated to avoid beggar-thy-neighbour behaviours. G20 leaders also pledged to make their economies more resilient to future pandemics, which may become more frequent in coming decades as the world population increases. Attending the conference remotely by video, the Chinese president Xi Jinping asked that the discussion about the origin of the virus not be politicalized excessively, saying that doing so does not help the international cooperation and solidarity needed in the face of the ongoing emergency. 

Regarding the minimum corporate tax rate, the G20 has adopted the recommendations made by the G7 group, which first pledged to implement a minimum corporate tax at 15% in their economies. As we discussed at that time, the logical sequence was for G7 countries to first propose and adopt a policy of this kind, which is a key measure for social justice, and then enlarge its adoption to G20 countries and eventually at the OECD level, with 38 members including many EMs such as Colombia, Mexico and Costa Rica.

On climate change, the G20 highlighted once again the strong connection with pandemics, the two being aspects of the same phenomenon. We discussed in the past how, in our opinion, both climate change and pandemics derived in large part from the rapid rise in the world’s population, which has doubled in the last 40 years to 7bn people and is may reach 11bn by 2050. But clearly most of the advancement of the discussion on climate change will be made in Glasgow, when the crucial COP26 starts on Monday. We remain sceptical that lots of progress will be made, especially as China is clearly not engaging in the discussion. Without China’s strong commitment to reduce its carbon emissions, any effort to reduce gas emissions would be almost in vain, even if all other major industrialised economies were to reach carbon neutrality by 2040-2050.

There will also be two crucial central bank meetings this week. On Wednesday, the US Federal Reserve will likely announce the beginning of tapering of its asset purchases. As we discuss in our preview, this may happen in November or December, but the direction of travel seems set at this stage. The Bank of England will meet on Thursday and will confirm that it is ready to increase its policy rate – an action that could take place during that November meeting as well (as we discuss in our preview). When two of the four largest central banks in the world begin tightening their policy stance, it means we are at a turning point in the policy response to the pandemic and its economic repercussions.

by Brunello Rosa

25 October 2021

On July 19, the UK celebrated what was emphatically labelled “Freedom Day:” the end of all restrictions related to the pandemic after the difficult months of the second lockdown, which had been particularly severe. More recently, though, the summer holidays, the gradual re-opening of the economy, the return of social interaction without social distancing, and the spreading of the Covid Delta variant have all contributed to a rapid increase in Covid cases. 

According to government statistics, there are around 40,000 new daily cases of people having tested positive to Covid, and 330,000 new weekly cases. That is a 9.4% increase compared to the previous week. The number of people admitted to hospitals has also increased (it has surpassed 1000 cases daily), and the number of deaths is also increasing (it reached 72 per day and almost 1000 per week). This is also due to the spreading of a new sub-variant, called AY.4.2, VUI-21OCT-01 or “Delta Plus”, which is thought to be up to 10% more transmissible than the original Delta. The new sub-variant is responsible for 6% of the new cases recently registered in the UK.

For this reason, the government is said to be preparing to implement the so-called Plan B, which would include the return of certain restrictions, such as wearing masks in some public spaces, the obligation to show a “green pass” to attend some events or public places, and the suggestion of working from home whenever possible. 

If these new restrictions are adopted, this would likely result in less dynamic growth in economic activity, which was already downgraded by the IMF in its latest World Economic Outlook (as we discussed last week).   

All this  is happening at a time when the UK is already going through a very challenging period, in which it is having to deal with the effects of the pandemic and Brexit at the same time. 

The result has been labour shortages in a number of sectors, including hospitality and logistics, with the dearth of workers that can legally operate as waiters, car or truck drivers, for example. All this compounded the effects of higher gas prices, which led to the gasoline shortages at pump stations of a few weeks ago and the absence of key products (such as mineral water) in the shelves of supermarkets. Inflation, meanwhile, has reached 3.2% recently, and is expected to reach 4% or even 5% in coming months. 

Facing all these emergencies at the same time, what’s the policy response of the authorities? As far as fiscal policy is concerned, this Wednesday the UK Chancellor of the Exchequer will deliver its annual budget, which is expected to bring – among other measures - a new spending review, new investments in education, culture, digitisation of public administration. However, the budget is not expected to massively deviate from the gradual fiscal consolidation path that was envisioned when an increase in corporate tax rates was announced months ago. 

Monetary policy is also on the move, with the Bank of England expected to have “a live debate” on November 4th, when the new Monetary Policy Report will be issued, on whether or not the BoE should increase its policy rate by 15bps to 0.25%. At this stage, the MPC seems inclined to go in that direction. However, if the government will implement new restrictions and economic activity will suffer as a result of it, a rate increase in 2021 may prove premature. 

by Brunello Rosa

18 October 2021

Last week, the International Monetary Fund and the World Bank held their annual meetings, once again in virtual formats given the recurrence of the Covid-19 pandemic given the rise of the delta variant. The IMF released its latest edition of the World Economic Outlook (WEO), titled “Recovery During a Pandemic. Health Concerns, Supply Disruptions, and Price Pressures.” The heading summarises the content by saying: “Global recovery continues, but the momentum has weakened and uncertainty has increased.”

In fact, the Outlook has revised the forecast for global growth in 2021 downwards, from 6.0% to 5.9%, as US growth was revised down by 1% from 7.0% to 6.0%. Growth has been revised down in other major advanced economies as well, including in Germany, UK, Japan, and Canada, but by a smaller extent. China’s growth was also revised marginally down by 0.1%, to 8.0%. At the same time, inflation projections in 2021 and 2022 have been revised upwards in advanced economies (by 0.4% to 2.8%  and by 0.2% to 2.3%, respectively) and in emerging markets (by 0.1% to 5.5% and by 0.2% to 4.9%, respectively). 

These changes in forecasts chime with our own view, which is that there may be stagflation risks in the short and medium term, as we discussed in a recent column. In the short run, economic activity is endangered by disruptions in global supply chains, and by new restrictions deriving from the recrudescence of the pandemic, given the uneven distribution of the vaccines across the globe and their reduced efficacy a few months after injection. Short-term economic activity may also be endangered by diminished consumption as a result of higher energy prices. 

Inflation meanwhile is subject to upward pressures deriving from higher energy prices (in particular gas prices), base effects, the re-opening of specific sectors of the economy that were hit particularly bad by the pandemic (e.g. tourism and hospitality) and disruptions in global value and supply chains. 

In the medium term, stagflation risks emerge as inflation is subject to upward pressure from ongoing phenomena such as de-globalisation, a less inequal distribution of income between labour and capital (epitomised, for example, by an increase in minimum wages), balkanization of supply chains, debt monetisation and ecological transition processes; while growth in economic activity is endangered by prospective fiscal consolidation processes, monetary policy normalisation, disruption in global supply chains, and the economic impacts of ecological transition. 

The WEO also highlights the rise in uncertainty going forward, mostly due to policy actions. In the midst of the crisis the policy response was one-directional: easier monetary and fiscal stances emerged across the globe, in developed and developing economies. But in a recovery phase, the policy responses become more mixed, depending as they will on the idiosyncratic circumstances of each country. We have certainly noted a tendency toward tighter monetary policies in both DMs and EMs, but the degree of reduced accommodation varies greatly across the globe. All this is reflected in financial markets, which have experienced higher volatility in recent weeks, in equities, bonds, and currencies. 

by Brunello Rosa

11 October 2021

The Reserve Bank of New Zealand (RBNZ) increased its main policy rate by 25bps last week, to 0.50%. This move was its first rate increase since 2014, and marked the end of the policy easing cycle that began in 2019, back when the US Federal Reserve implemented its three “precautionary rate cuts”, before the Covid-19 pandemic was even on the horizon. 

As we said in August, the RBNZ was already ready to increase its policy rate this summer, but the sudden decision by the government to impose a national lockdown following a new Covid outbreak in Auckland convinced the central bank to postpone the announcement until October. 

What is interesting in the decision by the RBNZ is not just the recognition that the lockdown will lead to a localised contraction in economic activity, but also that the government has the tools to cushion its economic impact, and that the economy will be able to rebound quickly after these periods of contraction. As such, the Bank’s Monetary Policy Committee decided to carry on with the planned tightening of monetary policy, to counter the impact on inflation of rising capacity constraints. 

The RBNZ is the second central bank among the G10 economies to increase its policy rate during this cycle. The first was Norway’s Norges Bank, which increased its key sight deposit rate by 25bps at the end of September, to 0.25%. The Norwegian central bank had already telegraphed its intentions to do so in June, when it explicitly said that if the economy performed in line with its policy committee’s expectations, the central bank would have to increase its main policy rate by 25bps. In this case, the Norwegian economy was benefiting from the rise in oil and energy prices as well, being a net exporter of oil. 

These central bank decisions are coming after the ECB decided to “recalibrate” its Pandemic Emergency Purchase Program (PEPP) in September, and, most significantly, after the US Federal Reserve pre-announced its intention to taper its asset purchases by the end of the year. 

Some analysts are now wondering whether the weak US employment report in September, showing only 194,000 new jobs being created compared to the 500,000 that had been expected, may delay the decision to taper QE. During his latest press conference, Chair Powell said that he needed to see a “decent” employment report to be satisfied with the condition that further progress had been made towards achieving the Fed’s employment target. It is difficult to know whether an increase of  less than 200,000 jobs fits the bill, even as the unemployment rate falling to 4.8% (vs. the 5.1% that had been expected) is certainly an upward surprise. 

If the RBNZ example can be of any guidance for what the Fed may decide to do, it may show that  central banks are not likely to be disturbed by short-term volatility of economic variables, and will carry on with their stated intentions. At the same time, central banks want to err on the safe side so long as the pandemic continues and there is still a risk of new variants emerging. 

In any case, as we discussed in previous columns, the direction that G10 central banks are heading in seems to be well established. In the coming months most central banks will start to withdraw the extraordinary stimulus provided since the beginning of the pandemic, while continuing to provide the necessary backstop to governments and their expansionary fiscal policies   

by Brunello Rosa

4 October 2021

In March 2020, the world economy came to a standstill as half of the global population was forced into partial or total lockdowns. Economic activity collapsed by double-digit percentages. Oil prices went negative for the first time in history, as the price of storage soared while the use of energy sunk. Market dislocation at that time was unprecedented, with US Treasuries temporarily losing their safe-haven status.

Given the scale of the shock, the disruption in real economic activity and in financial markets that followed could be expected, as could have been the swings in GDP growth and in the prices of assets, goods and services, not just on a quarterly basis but also on a year-on-year basis, given base effects. Central banks have been keen in pointing out the temporary nature of these shocks, and in asserting that because of this temporary nature they needed to be patient, and not react precipitously.

As we approach the end of the second year of the pandemic (if we assume November-December 2019 as the starting point) we see that some of the imbalances created by the pandemic are being re-absorbed, as testified by the fall in unemployment rates throughout emerging markets and advanced economies. On the other hand, other types of disruptions are starting to emerge. 

Globally, the shortage of semiconductors for microchips is causing a temporary stoppage in the production of automobiles. Supply bottlenecks in general have increased over time, given the temporary closure of factories and mines in some key emerging markets, such as China, and in developed economies. 

These supply shortages so far have resulted in higher costs, but may soon result in slower economic growth, a sort of stagflation that could derail the global recovery from the pandemic.   

In the UK, the effects of supply bottlenecks are added to those of Brexit: shortages of truck drivers have resulted in a dearth of fuel, with cars queuing for hours to get their tanks filled. In mainstream supermarkets it is hard to find bottled water. The government has asked the army to intervene, and does not seem inclined to allow a higher number of visas to be granted to foreign workers in order to alleviate the labour shortages. 

We are not particularly worried about this short-term disruption of supply chains. Rather, we fear the balkanization of global supply chain that is likely to occur over the medium term, induced by the ongoing process of de-globalisation (even if such de-globalisation means making certain supply chains more reliable). But a shorter supply chain most likely means higher prices in the medium term, as we discussed in a recent column. The recent case of Australia cancelling its submarine order from France is an example of how supply chains may suddenly change in this post-pandemic, post-Brexit, bi-polar world, with the increased rivalry between US and China. 

Clearly, if central banks realise that these supply shortages are more persistent than is currently believed, they may decide to react accordingly and reduce the amount of policy accommodation they are now providing earlier or by a greater amount than is currently envisaged. This in turn would have serious repercussions throughout financial markets.  

by Brunello Rosa

27 September 2021

We have been discussing Germany's elections for months now. In our initial piece of analysis, we discussed Germany’s international position, noting how the CDU leader Armin Laschet was aiming for a more neutral position for the EU between the US and China. We discussed, for example, how Laschet took the German state of North-Rhine Westphalia, which he has run as Minister-President since 2017, and made it the hub for Chinese activities in the country. In a second piece on domestic politics, we noted how Germany, even with a new Chancellor, was ready to continue running the same course that Merkel has been leading the country on, as long as that new Chancellor is centrist and moderate. In a final preview, we noted how the CDU/CSU were losing ground in the polls to the advantage of the SPD, and how this meant that Germany would need a three-party coalition to form a government. 

This scenario has now materialised, with the polls closed and the provisional results showing the SPD ahead with around 26% of the votes, followed closely by the CDU with 24% and the Greens with 14.8%, the FDP with 11.5%, AfD with 10.3% and Die Linke (The Left) with 5%. What we already know is that we will need a three-party coalition to form a government, and such a coalition could be either the  SPD, Greens and Liberals (the “traffic light” coalition), the CDU, Greens and Liberals (the “Jamaica” coalition), or the SPD, CDU and Greens (the “new Grand Coalition”). But other possible, albeit less combinations could also emerge, involving Die Linke or AfD. 

Some of the lessons we can learn from these polls include the following: 

1) The era of stability in Germany is effectively ended, with the fragmentation of the political system requiring a three-party coalition being formed following lengthy negotiations, which could last for months before a “coalition contract” is finally signed.

2) The impact on the European integration process could be significant, as Germany remains the cornerstone of every key EU decision. France with President Macron and Italy with PM Draghi seem ready to take the baton from Germany in leading the next phase of the integration process, in which important decisions need to be taken regarding foreign policy and defence matters, among other things.  

3) A positive aspect of these elections is that the anti-EU, anti-system parties seem to be out of the picture for now, marginalised by the system. Clearly, though, these parties may be called in to help form a government if all other coalition options prove to be undoable. 

4) As we discussed in our recent column, this means that Germany remains committed to the European project, and that one of the three key elections of 2021-22 has not gone wrong just yet. However, the success of this election cannot yet be taken for granted either, and we still need to wait for the result of the Italian and French presidential elections in order to be sure that the EU integration process is not D.O.A.

Once the composition of parliament is completed it will become clearer what coalitions are actually feasible in parliament and not just on paper. It will be hard for anyone to form a government, but the ability of a party to form a coalition will be more relevant than finishing first in the polls.

That is why Armin Laschet could still become PM even if the SPD end up the party with the most votes. It is likely that long negotiations will now begin, under the auspices of the President of the Republic Frank-Walter Steinmeier. Whichever coalition eventually emerges, Germany will express one of the weakest governments it has had in the last 40-50 years. This cannot be considered good for the rest of Europe. 

 by Brunello Rosa

20 September 2021

A couple of years ago, when the pandemic was not even on the horizon and populist parties were on the rise throughout Europe, we identified the September 2021 – June 2022 period as the moment of truth for European politics. Three key elections at the EU (and Eurozone) level will take place during this period. First, on Sunday 26thSeptember, the German general election will take place. Several months later, in February 2022, will be the Italian Presidential election (carried out by a special electoral college, including all MPs and regional representatives). Finally, in April there will be the French Presidential election, which in turn will be followed by France’s parliamentary elections in June. As we discussed in depth in a previous analysis, if any of those crucial events were to result in the victory of anti-system, anti-European candidates, the European integration process may stall indefinitely, and perhaps reverse further than it has already with Brexit. 

As we discuss further in our forthcoming preview of the German election (after the in-depth analysis we published recently), the race has become more interesting than one could have expected. The choice of unsuitable candidates from the Greens (Annalena Baerbock) and the CDU/CSU (Armin Laschet) for the Chancellorship has given an unexpected boost to the SPD candidate Olaf Scholtz, who is now clearly leading the polls. Many combinations and permutations of coalitions will be attempted after the vote, but if the actual votes confirm the polls then it seems that a three-party coalition will be needed to form a government in Germany, for the first time since WWII. The so-called “traffic-light” SPD-Liberals-Greens coalition and the so-called “Jamaica” CDU-Liberal-Greens coalition appear to be the most likely to emerge. These coalitions are likely to be tenuous at best, and prone to collapse given cultural and political differences. The point is this: if Germany becomes politically unstable, that cannot be good either for Germany or – most importantly – for the EU and its integration process.

The Italian presidential election is also going to be a crucial moment. All eyes will be on Mario Draghi, and whether he will move from Palazzo Chigi to the Quirinale Palace. This could mark the beginning of renewed political instability in Italy, or the interruption of the reform project undertaken by Draghi’s government as a result of the Next Generation EU plan. The importance of the President in Italy is often underestimated, as is the crucial role Italian presidents have played in dampening the populist pushes within the country’s political system, or in preventing severe deviations from the Constitutional norm and spirit from taking place. Italy remains a cornerstone of the European project (one of the six founding members), and we have already seen how problematic EU policymaking becomes when Italy elects anti-system or populist leaders.

The French Presidential election is also crucial, especially if Germany become less of a bastion of stability in Europe. In theory, President Macron should have a relatively easy ride towards being re-elected, but in reality Marine Le Pen continues to be very close to President Macron in the polls for the second round of another election between them. Needless to say, if Le Pen were to become President, this would be yet another “French revolution”, which would likely mark the end of the EU integration process. President Macron still has time to recover, but he is going to face an uphill battle in this campaign. 

In conclusion, the EU is about to enter its most delicate period of any time in the last few years, with the EU integration process at risk of derailment in coming months. A political derailment of this kind would have clear implications for the ECB’s policy stance and market dynamics. 

by Brunello Rosa

13 September 2021

In the last few months, the US and other advanced economies have witnessed the highest rates of inflation for decades: headline inflation reached 5% in the US and 3% in the Eurozone, with core inflation (which excludes energy and food prices) also on the rise, sometimes significantly. 

These inflation rates, unseen for many years, have spooked market participants. Inflation erodes the real value of investments in equities, bonds, real estates and, if central banks were to increase their policy rates to stem rising inflation (considering that price stability if often their first, if not their only mandate), higher market rates would ensue: any valuation model based on discounted cash flows would observe a rapid fall in valuations if market yields used to discount future cash flows (either coupons for bonds, or dividends for equities) were to increase. 

Most of these recent price increases have been linked to the reopening of the economy after the global shock experienced in 2020 due to the pandemic. The rise in energy prices due to the rebound in economic activity has resulted in an almost 1:1 increase in headline inflation. Base effects have played a large role as well. In Q2 2020, headline inflation collapsed (also as a result of tanking oil prices): one year later, not surprisingly, these effects have been reversed. The reopening of the economy in specific sectors that came to a sudden halt during the pandemic (car rental, hospitality, travel, just to name a few) has meant selective increases in prices in those sectors, weighing on the overall inflation gauge. 

Supply side bottlenecks are having a large impact as well: when the availability of crucial components in several global supply chains (such as semiconductors for the car industry) collapsed, prices of the scarcer goods increased. Finally, some specific one-off factors (such as the reversal of previous VAT cuts, such as those implemented in Germany to stimulate economic activity) have played a role in the recent increase in inflation rates observed globally.  

For most central banks, these inflation spikes are temporary in nature, and will likely reverse themselves as soon as all these one-off factors wash out of the inflation calculations in coming months. However, some of them are starting to take some insurance against rising inflation ahead, by reducing the rate of monetary easing, lastly the ECB, which last week decided to buy EZ government bonds at a modestly lower pace in Q4 2021 compared to the first two quarters of the year. 

While we tend to agree with the central banks’ assessment, implying that market worries are probably exaggerated at this stage, we would highlight the medium-term risks of structurally higher inflation. After the pandemic, and especially considering the strained US-China relationships on the origin of the Covid-19 pandemic, global supply chains have been cut off and will likely be much shorter in coming years. Shorted supply chains are likely to be more robust and resilient, but are also conducive to higher prices: the dis-inflation experienced by the world as a result of China’s entering the global economy during the 1990s has likely come to an end and will likely reverse itself in coming years. 

Also, the unequal distribution of income, with progressively less attributed to the labour share and more to profits and rents since the 1970s has reversed itself, perhaps also as a result of the populist polices envisioned by many world leaders, including in the US. They also include an increase in minimum wages in a number of countries. 

These factors (shorter and balkanized value chains, higher minimum wages, more income attributed to the remuneration of labour rather than capital) will likely imply structurally higher inflation rates in the medium term. They may also imply a more subdued growth environment (for example to repay the large amount of debt issued during the pandemic), in which case we would observe stagflation rather than simply inflation. This increased risk, and its seriousness, has been highlighted by Nouriel Roubini in a recent article. 

by Brunello Rosa

6 September 2021

Taliban troops regained control of Kabul around three weeks ago, after having seized large parts of Afghanistan. The images of the Taliban entering the capital sitting on top of dusty tanks have been shown all around the world. By using traditional weapons, in a territory still seemingly controlled by the most sophisticated army in the world, that of the United States, the insurgent group managed to become once again the rulers of the central Asian country, 20 years after the last time they were in power. 

Even worse than that, the US have left behind traditional weapons of all sorts, worth billions of dollars. According to the US Government Accounting Office (GAO), the US army has left something like 42,000 pick-up trucks and SUVs, 8,000 trucks, 22,000 Humvees, almost 900 armoured vehicles (including 169 M113), 100 helicopters, 75 airplanes, 560,000 rifles, guns and machine guns, and 176 pieces of artillery. 

All these weapons will constitute the basis for the new Afghan army controlled by the Taliban. It is hard to imagine a peaceful use of all these weapons. In any case, the Afghan revolt was an example of a very traditional way of conducting wars: boots on the ground, rifles, tanks, talks conducted far away from the battlefield (in this case, in Doha, Qatar). 

But besides this old-fashioned form of warfare, a new, much more technologically advanced way of conducting wars is emerging. According to a recent article, in the May 2021 conflict between Israel and the Palestinians, the Israeli army deployed AI and supercomputers to identify and strike targets, in what has been labelled the “first artificial intelligence (AI) war.” The Israel Defense Forces “used a swarm of AI-guided drones and supercomputing to comb through data and identify new targets within the Gaza Strip. 

It's thought this is the first time a swarm of AI drones has been used in combat.” Supercomputers searched through a mountain of data that had been collected using a combination of “signal intelligence (SIGINT), visual intelligence (VISINT), human intelligence (HUMINT), geographical intelligence (GEOINT) and more”, to be able to identify targets to strike. 

This type of hybrid war is likely to become the standard for conflict in coming decades, whereby humans will be assisted, if not totally substituted, by robots, AI and other technological tools for military operations on the ground. Yet already most conflicts are not even fought on the ground: the preferred battlefield for a number of organisations, whether governmental or non-governmental, is becoming the cyber space. In this environment, humans are always in the background, and the battle is fought by the machines, through algorithms and artificial intelligence. 

A recent report by the United Nations’ Office of Counter Terrorism, titled “Algorithms And Terrorism: The Malicious Use Of Artificial Intelligence For Terrorist Purposes” discusses how “terrorists have been observed to be early adopters of emerging technologies, which tend to be under-regulated and under-governed, and AI is no exception.” The study reports how “it is predicted that the global AI market will exceed USD 100 billion by 2025 and AI enabled systems will continue to support many sectors – healthcare, education, commerce, banking and financial services, critical infrastructure, and security, among many others.”

It is very likely that the wars of the future will be much more technological in nature, with a larger use of artificial intelligence and less use of boots on the ground, except in such cases where they are deemed absolutely necessary.  

by Brunello Rosa

30 August 2021

In our column last week we wondered whether or not Jerome Powell, the Chair of the Federal Reserve’s Open Market Committee (FOMC), would suggest a change in the US central bank’s policy stance during his speech at the annual symposium of central bankers and academics in Jackson Hole, Wyoming. The meeting, initially scheduled to take place in a live, in-person format, eventually took place virtually instead, given the recent resurgence of Covid cases in the US due to the spreading of the Delta variant. 

The speech, titled “Monetary Policy in the Time of COVID”, discussed the various phases of economic activity experienced by the US economy since the inception of the pandemic, from the pre-pandemic slowdown whichll led the Fed to three pre-emptive rate cuts in 2019, to the sharp recession in 2020 (with drops in economic activity of unprecedented scale), and finally to the recovery phase, which started in Q3 2020 and, despite plenty of bumps along the way, still continues today.

The most relevant part of the speech was about the progress made towards meeting the two targets of the Fed: inflation and employment. Regarding inflation, Powell said that sufficient progress was made towards assuring that US inflation will be 2% over the forecast horizon on average. The recent spikes of inflation to 5% and beyond derive from “temporary factors” such as higher energy prices, base effects, supply bottlenecks and the re-opening of the economy in some specific sectors. The Fed is monitoring wages and inflation expectations to check whether inflation risks spiralling out of control. That is still a low-risk scenario at this stage.

Regarding employment, Powell said that more progress needs to be made towards meeting the target not just from a quantitative perspective, but also from a qualitative point of view. Yes, the unemployment rate has fallen significantly from its peak, and is now at 5.4%, but according to Powell it “is still much too high, and the reported rate understates the amount of labor market slack. Long-term unemployment remains elevated, and the recovery in labor force participation has lagged well behind the rest of the labor market, as it has in past recoveries.”

On the back of these considerations, and repeating what the minutes of the July FOMC meeting said, Powell concluded that “if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.” This will not provide, Powell said, any indication of when the Fed will start increasing rates, “for which [the Fed has] articulated a different and substantially more stringent test. [The Fed has] said that [it] will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time.” And that is still some time away from happening.

In conclusion, Jackson Hole provided the type of signal that market participants were looking for. If the economy evolves in line with current forecasts (which will be updated in September), the Fed may begin to taper its QE in December. This means that a formal announcement may come in September or November, but at this stage it will not make a massive difference. The market took the news out of Jackson Hole quite positively, as Powell’s hint was so nuanced and caveated that participants expect the Fed to always err on the cautious side. And so do we. 

 by Brunello Rosa

23 August 2021

This year, between August 26 and 28, the annual symposium of central bank governors and academics organised by the Kansas City Fed and held in Jackson Hole will return to a “live” format, after the 2020 edition was held in virtual format due to the pandemic. In the past, Jackson Hole was the occasion at which central bankers announced significant changes in the policy stances of their institutions, based on research presented in the informal and relaxed environment provided by the resort in the mountains of Wyoming.

Market participants are anxiously waiting for the speech by Jerome Powell, the Chair of the US Federal Reserve, which he is scheduled to give on Friday. They expect Powell to provide details about a possible change in the Fed’s policy stance, such as the beginning of the tapering in asset purchases. Currently the Fed buys USD 80bn/month of US Treasuries and USD 40bn/month of mortgage-backed securities (MBS). The Fed, through its usual communiques and press conferences, has been very careful not to provide hints of an imminent beginning of tapering. This is to avoid the repeat of the so-called “taper tantrum” of 2013. 

On that occasion, Fed Chair Ben Bernanke, during a Congressional testimony, indicated that the Fed will reduce the pace of its asset purchases, which it had been carrying out since 2008, “at some point”. That was enough for market participants to anticipate the beginning of the tapering process and fully discount it in market rates, which rose rapidly as a result, leading to a strengthening of the USD and a sudden outflow of funds from Emerging Markets. This year, in contrast, many EM central banks have already started to increase their policy rates, in anticipation of the Fed’s reduction in accommodation. In any case, the Fed will want to avoid the repeat of a similar episode to that of 2013, which caused a turmoil in financial markets for several weeks.  

So far, the Fed has said that until sufficient progress has been made towards meeting its employment and inflation targets, the Fed will not change its policy stance. However, in July Powell said that the FOMC had taken its first “deep dive” into the timing, size and composition of its asset purchase program. Additionally, the minutes of the July meeting showed that a majority of FOMC members thought that, if the economy evolved in line with the FOMC’s Summary of Economic Projections , the beginning of tapering should then be announced between September and December. 

We still expect the FOMC to formally announce tapering in December, but the meetings in September and November should acknowledge the progress made in meeting the policy goals. In Jackson Hole, the Fed will likely set the scene for these announcements to take place between now and the end of the year, supported in its decision to do so by evidence provided by its research staff.  

by Brunello Rosa

16 August 2021

Yesterday newswires around the world reported that Taliban troops have regained control of Afghanistan’s capital, Kabul. This comes after several days of advancement of Taliban troops within Afghan territory, which led them to regain the control of large cities such as Jalalabad. The news now is that the Taliban have entered the Presidential Palace, President Ghani having already fled the country. The Taliban have affirmed their intention to declare the re-birth of the Islamic Emirate of Afghanistan. 

Other press reports suggest that the two sons of historical figures such as the Mullah Omar (the emir of the Islamic Emirate of Afghanistan from 1996-2001, which hosted the militants of Al-Qaeda before the 9/11 terrorist attacks) and Massud (Aḥmad Shāh Masʿūd, the so-called Lion of Panjshir, the hero of the war against the Soviets in the 1980s, who was assassinated by Al-Qaeda two days before 9-11) are engaged in a distant race to become leader of the country now that it has been “liberated” by the presence of foreign troops for the first time in twenty years. 

In fact, all this is happening while foreign troops are engaged in a complicated mission of withdrawing from this theatre of war (or, to put it more diplomatically, are withdrawing from their peacekeeping mission). There are images of helicopters evacuating the last US troops left in Kabul, which resemble the images of the Americans leaving Saigon at the end of the Vietnam war. For this reason, some are calling this episode “Biden’s Saigon,” even if the two episodes cannot technically be compared from a military perspective.

All this has been happening while there were “peace talks” going on in Qatar, aimed at finding a compromise solution for the country after the US and other major countries have withdrawn. But these peace talks have now been overtaken by events and are effectively useless. If the Taliban wanted international recognition and legitimacy, nothing better than regaining control of the capital and the presidential palace could guarantee such a result. It is highly likely than the Taliban will impose on the country a new Islamic regime. Whether they declare it a new Emirate or any other denomination makes little difference at this stage.  

With the Taliban having regained control of Afghanistan, a long cycle begun in 2001, in the aftermath of the terrorist attacks in the US and the launch of the “war on terror” by George W. Bush, is coming to a very sorry end. USD 2 trillions of dollars spent in military expenses, many thousands of troops sent by dozens of countries over the last 20 years clearly have not been sufficient to stabilize a country that has been devastated by several decades of wars in the last century. 

Similar to what happened in Iraq and Syria, where the Islamic State (ISIS) took control after the US troops and their allies left the country (after which it took many more years of fighting to push ISIS back), the risk is that Afghanistan may become once again a place where terrorists from all over the world may convene and hide. The hope is that world leaders will find a diplomatic solution to prevent this from happening. The UK premier Boris Johnson has already recalled parliament to discuss this issue and urged international unity on this matter. Other leaders will likely follow suit. 

by Brunello Rosa

9 August 2021

As we have discussed in several previous columns, the world is being hit by the delta variant of the Covid-19 pandemic. This variant is considered to be much more transmissible than the beta variant, which was in turn more infectious than the original virus isolated in Wuhan. It is not yet clear whether this new variant is also more deadly than previous strains, in part because it is hitting countries with widely differing vaccination rates. In any case, infection rates are increasing globally. The US, for example, is now back to 100,000 new cases per day. 

For this reason, several governments are intensifying their vaccination campaigns and are providing either incentives or threatening to impose restrictions on the unvaccinated segments of their own populations. In the US, the government promises USD 100 to citizens willing to get the vaccine. In Europe, several governments are adopting “green passes” that citizens must show if they want to attend public events or enter bars, restaurants, museums, etc. At the same time, most governments and central banks have noted how the economic impact of Covid has been decreasing over time, most likely as a result of the vaccination campaigns, which are reducing the hospitalisation of patients. 

In effect, economic activity is enjoying the long-waited rebound following the end of the severe restrictions imposed until Q1/Q2 2021, before which time generalised or localised lockdowns and widespread bans on domestic or international travel were in place. Public and private forecasters are beginning to factor in the impact of the delta and other variants, but in general this results in shaving off only a few decimals in economic growth estimates, which are often very large in 2021. 

Meanwhile, inflation has showed up in several parts of the global economy. Mostly this has been as a result of base effects, higher energy prices, and supply bottlenecks. In some cases however, fiscal and income policies aimed at reducing inequality and increase the purchasing power of people who are less well-off (increases in minimum wages, for example) could mean that inflation may prove to be more persistent than currently thought. 

As a result, central banks in EMs have already started to tighten their policy stance. Even in the G10 countries economic thinking within policy committees is now shifting. The first banks to move have been the Bank of Canada (with a tapering of its net asset purchases) and Norges Bank(which has pre-announced a rate increase in September). In both cases, the domestic economies of these countries benefited from higher oil prices. The Reserve Bank of Australia has also tapered its weekly purchases, while introducing open-ended QE. The first hints of policy normalisation are starting to emerge among the major G10 central banks too, ahead of the annual summit at Jackson Hole which will be held on August 26-28. In the past, many central bankers used this forum to announce major policy shifts. 

The world’s four largest central banks are divided in this case, however. The European Central Bank and the Bank of Japan are still exhibiting a strong easing bias; their next moves may be to provide more, rather than less, accommodation. 

The US Federal Reserve and the Bank of England are moving in the opposite direction, meanwhile. In the US, Chair Powell said during the latest press conference that the FOMC has had its first “deep dive” into the size, composition and timing of its asset purchases in July. We expect more colour to be added to this in Jackson Hole, with more official hints being provided at the FOMC meetings in September and November and an official announcement of QE tapering to be made in December.

The Bank of England, while saying last week  that negative rates had become part of its official toolkit, also reviewed its exit sequencing, and explicitly said that if economic conditions were to evolve in line with the MPC forecasts, a modest amount of tightening would be then warranted over the next few years. 

Markets seem content with these developments.  Keeping inflation in check will keep bond and equity valuations up, as long-term yields that are used to discount future cash flows also remain low.

by Brunello Rosa

2 August 2021

Last week, the US Securities and Exchange Commission (SEC) ruled that Chinese groups would be subject to stricter controls and disclosures over their structures and ties to the Chinese state before being allowed to list shares in the US. This is only the latest example of the ongoing tensions between the US and China. The two world super-powers are engaging in intense competition in a number of areas, part of a rivalry we have previously labelled Cold War II. 

As we have discussed on numerous occasions, we believe there are three dimensions of this Cold War II. One is a trade dispute, which raged during the Trump’s presidency and culminated in the Phase 1 deal of January 15th, 2020. Another is a technological race, in which both countries are trying to prevail in the spheres of big data, artificial intelligence and cyberwarfare. This has led to the ban of Huawei as a provider of 5G technology by virtually all US allies. Finally there is the disruption of global supply chains, a process which was already taking place before the pandemic and now is a well-established phenomenon, causing bottlenecks that have been the origin of the recent rise of inflation around the globe. 

The Covid pandemic, and the arrival of the less confrontational Joe Biden to the US presidency have not led to a rapprochement between China and the US. In fact, because of the allegations made by the US and its allies (chiefly Australia) to China regarding the origin of Covid, and because of China’s repression of Hong Kong protests, there will likely be further tension occurring between China and the US.

Given this background, R&R decided to dig further into how Cold World II is impacting the three main actors of the global economy (namely, the US, China and Europe), by publishing a series of articles in John Hulsman’s Geopolitical Corner. 

In the first article, titled “After the Party: How China Is Planning To Become The World’s Dominant Power” we discuss how China sees itself today - 2021 being the 100th anniversary of the Chinese Communist Party, which was celebrated in China on July 1 - and how its leadership is planning to project the country’s geopolitical influence in the future. 

For China, the first geo-strategic goal is to break out of the straitjacket that is preventing the country from developing a naval dominance similar to that of the US.   

Unlike the US, which is unconstrained in projecting its naval military capabilities, China immediately encounters hostile waters to its east and south, guarded by Japan, South Korea, Taiwan, and the Philippines, all of which are close allies of the US. We believe that for China, the path of least resistance in this regard will be working hard to promote the re-annexation of Taiwan, however long, gradual and complex the process of doing so may be.

In the second article, titled “The Great Sea Change: Rightfully Changing American Perceptions Of China Made The New Cold War Almost Inevitable”, we discuss how China has moved from being considered a partner to a competitor, and eventually to being declared a strategic rival of the US. This required the US political elite, Republican and Democrat, to overcome the doctrine (by Barrington Moore) according to which China would democratise while getting richer (i.e. would follow the path of Western countries, whose bourgeoisie wanted more political power as it got richer). This doctrine had long permeated the US political leadership on both sides of the aisle. 

In the third article of the series, which we will publish shortly, we will analyse how Europe will figure between the two geopolitical superpowers, whether it will re-establish its long-term relationship with the US or else try to find a more independent position, one that is more equidistant between the two contenders of Cold War II. 

While the integration of China in the global economy is deepening, thanks in part to the gradual liberalisation of its financial system, it is clear that the US has now decided to decouple from China. As such, there is an ongoing Cold War II taking place between the two countries, a rivalry which is intensifying and is meant to last for the next few decades. We are only at the beginning of this competition. 

 by Brunello Rosa

26 July 2021

While many countries are re-opening their economies in sight of the summer holiday season, the rapid spread of the delta variant of Covid-19 is casting a shadow on the strength and durability of the recovery. In the UK, the July 19thFreedom Day occurred when there were 50,000 new cases per day in the country (which has now fortunately been reduced to just over 30,000 new cases per day). New daily cases, almost all linked to the delta variant, are however on the rise in many countries around the globe. 

In this environment, track and trace apps are posing their own challenges. With new cases on the rise, more and more people are being “pinged” by these systems, forcing them to self-isolate. In the UK, more than 500,000 people in a weekhave been contacted and had to stay home, posing a threat to the continuity of work operations. For example, around the time of Freedom Day, UK Health Secretary Javidtested positive to Covid, and PM Johnson and Chancellor Sunak both started to self-isolate.

In previous columns, we discussed how central banks are reacting to this increased uncertainty. Last week, the ECB decided to keep the tap of its accommodation wide open for the foreseeable future, especially as the recovery is still fragile and uneven among the various Eurozone countries. Previously the Reserve Bank of Australia (RBA) decided to move to open-ended QE, while reducing the weekly pace of its asset purchases. This week, the US Federal Reserve will reveal how advanced the discussion is within the FOMC with regard to tapering its asset purchases. Only the Bank of Canada (BoC) has continued its progression towards a reduction of its accommodation, which could lead to the end of net asset purchases by December 2021. 

Within this context, governments are making an additional push to foster their vaccination campaigns. Countries such as Canada, the UK and Spain have already more than 50% of their populations fully vaccinated.   In Canada, more than 70% of the population has received at least one dose of the vaccine. In the UK, 88% of adult population has received at least one dose of the vaccine. The new frontier is providing a vaccine to the younger segments of the population, which have been excluded during the first phases of the campaign but are now more affected by the resurgence of the virus.  
Since vaccination is not, nor can be made, obligatory (at least at this stage), governments are now introducing subtle (and not so subtle) methods to “nudge” their populations towards becoming vaccinated. Initially, perks such as free ice cream, beers, or other products were offered to people to entice them to get vaccinated. But now, more coercive measures are starting to be introduced. Countries are developing “green passes” for those who received at least one dose of the vaccine, or for those who recovered from Covid or tested negative in the preceding 24-48 hours. 

Those passes are now being made obligatory in order to carry out some activities such as dining in restaurants, using gyms or pools, entering cinemas, or attending sports events. In Italy, with a law decree, the government has imposed such an obligation as of August 6th. In the UK, the government is considering the idea of allowing attendance to large events to fully vaccinated people only. Some people are rallying in opposition to these decisions, protesting against what they perceive as a violation of their civil liberties. 

In effect, some of the restrictions introduced by governments around the world have been considered unlawful or unconstitutional by various courts. Making vaccination, or green passes, mandatory, could also fall into the same category, unless constitutional amendments are made. At the same time, as we discussed in previous articles, there is a difficult balancing act governments must pursue. They need to respect civil liberties, protect public health and keep the economy running at the same time. In all honesty, this is not an easy balance to achieve.  

by Brunello Rosa

19 July 2021

Last week, the countries belonging to the oil-producing cartel OPEC+ (the “+” refers to Russia and Kazakhstan, which are not in OPEC proper) decided to increase oil production by 400,000 barrels a day, in response to the surge in oil prices that has occurred in the past 15 months. In April 2020, oil prices turned negative for the first time in history, as storage costs soared in the middle of the first wave of the pandemic, when half of the world population was in lockdown. Since then, the price of Brent surged to $75pb, along the pick-up in economic activity in large parts of the global economy. OPEC+ also decided to increase the baseline production of oil in many countries, signalling that the cartel believes the recovery will continue and that higher production will be a persistent phenomenon, rather than a transitory one.

The increase in oil prices has led to a marked increase in headline inflation prints around the globe, sparking fears of incipient hyper-inflation, fears which are likely to be overblown. Most central banks have reacted calmly to the sudden rise in inflation prints, reassuring markets that policy rates will remain low for longer, and that short periods of moderately above-target inflation will be tolerated. This explains the fall in long-term yields observed in the US and elsewhere, which has puzzled investors. 

While central banks have reassured markets that they will be tolerant against above-target inflation, they have also changed their policy frameworks to start addressing the impact of climate change on financially sensitive matters. The Bank of Japan has recently launched a “green-lending” scheme, set to last at least 10 years, in which banks receive central bank financing at zero per cent if those funds are lent to projects aimed at reducing the impact of climate change. The ECB has included the fight against climate change among the goals of its recently released strategy review. These moves follow the Bank of England’s seminal work on central banks and climate change, championed by former governor Mark Carney. 

The inclusion of climate change among the goals of central banks, though it may seem esoteric, is justified by the risks potentially deriving from extreme climate events. Tragic examples have occurred in recent days, with the floods experienced in Germany and Belgium, which have claimed hundreds of victims and caused immense economic damage. The south of Italy has also recently been hit by storms resulting in flooding, though fortunately without causing any deaths thus far. These violent floods in the middle of the summer are extremely unusual, and scientists are saying they can only be explained by climate change (as the wildfires that ravaged Canada recently). 

by Brunello Rosa

12 July 2021

Many countries are now dealing with the new variant of the Coronavirus, the Delta variant, which we discussed recently. The spreading of this variant, which is already dominant in the UK and is gathering pace in the rest of the world, is following the same patterns exhibited by the original Covid-19 virus strain from Wuhan, if perhaps with slightly reduced hospitalisation and mortality rates. In spite of the rapid rise in cases in various countries, the UK government decided to lift all Covid-related restrictions by July 19, even if some scientists believe doing so could be premature.

In any case, as discussed in our previous columns, if a new wave were to emerge as a result of a further spreading of the virus, governments would have to re-introduce some restrictions. This would have an obvious impact on economic activity. In the EU, the latest economic forecasts exhibit a marked upward revision, as a result of the pick-up in economic activity recorded in Q2. However, if new restrictions were to be imposed, a downward revision of the estimates of economic activity would be inevitable. 

Facing this uncertainty, central banks are cautiously starting to signal a measured reduction of the extraordinary accommodation they have provided since the beginning of the pandemic. But they have to perform a complex balancing act here, signalling the end of extra-easy money and yet not spooking the market into thinking that monetary stimulus will be withdrawn prematurely. 

Some central banks, such as the ECB, the BOEand the Riksbank, explicitly reassured market participants that their monetary stance will remain as easy as currently they are. Conversely, other central banks have clearly signalled that they intend to start reducing the pace of accommodation. The Bank of Canada has already tapered its asset purchases from CAD 5bn a week to CAD 3bn, in successive steps, with a further reduction to 2bn expected this week. In between these cases, there are central banks which have to juggle many objectives at once. The RBA, for example, recently moved to implement open-ended QE, but it has also reduced the pace of asset purchases, and it has kept the 3y yield the April government bond as its point of reference to target, rather than using November 2021 as a reference, which would have been interpreted by the market as an intention to further extend QE. 

Next week, the BoJ will unveil more details about its green-related lending program, and during the following days the ECB and the Fed will further clarify their stance, with the Fed likely making more explicit its guidance that asset purchases will likely be tapered starting from the year end or early 2022. The ECB is instead a bit behind in the cycle; it will likely reaffirm its stance until March 2022. Throughout all this, market valuations will remain supported by central bank liquidity in the G7 economies, as last week fears of slowing growth and worries that new COVID-19 variants could stall the global economic recovery prompted an equity sell-off and pushed down longer-term US Treasuries.

by Brunello Rosa

5 July 2021

Last week, we discussed about the so-called Delta variant of the SARS-Covid-2 virus, which is causing a new wave of restrictions being imposed by countries, such as the UK, Australia and India. But even when countries reopen almost fully their domestic economy, they tend to keep severe restrictions to international travels. So most countries are adopting a dangerously autarchic model of domestic reopening and international closure. The reasoning behind this model is that banning virtually all international travels prevents the virus from spreading over the globe. 

However, this is proving to be an illusion: travels are still allowed for business, diplomatic and related reasons. So, the virus still goes around the globe one way or the other. So one wonders why, after the virus has become pandemic one and a half years ago, restrictions to international travels are still so severe: the US only allows US citizens to land on its soil; until recently, the UK considered travels for leisure illegal and still has the vast majority of other countries in the so-called “amber list” (requiring 10 days of quarantine on arrival); after the discovery of the delta variant, most EU countries have reimposed quarantine periods for people arriving from the UK.

As discussed in our in-depth analysis on the need to balance the economic and healthcare risks, we are in favour of all sensible restrictions that prevent the virus from spreading and the pandemic from claiming more victims, but wonder whether there are ulterior motives for keeping, introducing or re-introducing quarantine periods for travellers. The EASA/ECDC already in December 2020 urged governments to abolish quarantines given their ineffectiveness. The UK authorities have found that only 0.5% of passengers returning from amber list countries test positive to Covid after two days from arrival. This evidence derives from the fact that passengers are required to test negative before flying, so the likelihood of being infected with Covid at the time of travel is limited.

We suspect there is an opportunistic use of quarantine periods deriving from political motives. Most countries want to make sure that their citizens spend the money accumulate during the pandemic domestically rather than abroad. For example, internal travels in the US are booming while international travels are still restricted. In the UK, the government is trying to encourage people to spend their summer holidays in the country rather than flying to the popular holiday destinations in Spain, Italy and Greece. For this reason, most of these popular destinations are still in amber list. 

Italy has just introduced a bizarre form of quarantine: if a traveller spends less than 120 hours in the country for work reason, it does not need to quarantine. If it spends more than 120 hours it needs to quarantine immediately (when the two types of travellers clearly bare the same healthcare risk). Even more ironically, if a traveller thought it will spend less than 120 hours and ends up spending more, it will have to start quarantining at the 120th hour (after having toured the entire country, potentially). 

This new wave of quarantines is intertwined with the discussion on the opportunity for the UK to host the final of the Euro 2020 football tournament, with 60,000 people expected at the stadium. Germany’s Merkel and Italy’s Draghi have already spoken about the possibility of choosing a new location, but British PM is fiercely defending the initial choice.  

The conclusion that seems to emerge from this discussion is that, while the effectiveness of quarantines is questionable in this phase of the pandemic, their main motivation is political, with countries retaliating against other countries’ decision. In our view, this is hardly an effective wave of defeating the virus and its new variants.

by Brunello Rosa

28 June 2021

During the last few weeks a new mutation of the Covid-19 virus has emerged, the so-called Delta variant, previously known as Indian variant since it was first isolated in India. This has come after the Alpha variant (first isolated in Kent, in Britain), Beta variant (South African) and Gamma  variant (Brazilian), as documented by the World Health Organization. As the prestigious scientific journal Nature says, “Delta seems to be around 60% more transmissible than the already highly infectious Alpha variant (also called B.1.1.7) identified in the United Kingdom in late 2020.” 

It is not yet clear whether the new variant, apart from being more infectious, is also more deadly. The first indications suggest it is not more deadly, but one cannot rule out the possibility that it is just yet. For now, it seems that new infections are not leading to as many hospitalisations as during the first wave of the pandemic, but more data is needed before reaching a definite conclusion. 

As a result of the Delta variant’s high infectiousness, the number of new Covid cases has been increasing in a number of countries around the globe. In the UK, for example, new Covid cases have reached 18,000 on a daily basis, after having collapsed in the last few months as a result of the successful vaccination campaign. This has convinced the government to postpone the end of the Covid-related restrictions from June 21 to July 19, and there is no guarantee that a further push back will not be needed.

In Australia, the government has imposed two weeks of lockdown in Sydney, given the rapid rise in new Covid cases related to the variant. This is also due to the sluggishness of the vaccination campaign, which led to only 3% of the population having obtained both inoculations of the vaccine. In Portugal, the government has introduced new restrictions in the Lisbon area and the Tago valley. In Israel, the use of face-covering masks in closed places has been re-introduced. In India, the state of Maharashtra has re-introduced new restrictions.  

These examples show how insidious the Covid virus is. Its mutations risk rendering vaccination campaigns less effective, even as it is not yet clear whether or not a new jab will be needed to neutralise this variant. In any case, yearly vaccinations are likely to be the norm in the next few years. 

As we have discussed endlessly in the last few months, any healthcare development tends to have immediate economic repercussions. Most countries were just beginning their re-opening phases, and the new Delta variant risk derailing those plans. At the same time, economic recovery is linked to the re-opening of countries. As we have seen in Q3 2020 and in Q2 2021, a bounce back in economic activity can only occur if restrictions are lifted or at least drastically reduced. 

So the real risk of this Delta variant is that the planned re-opening of various countries will be severely slowed down or even go into reverse, until it will become clearer how dangerous this new mutation is. This risks stalling the nascent economic recovery, and so may force policymakers to provide more stimulus (monetary and fiscal) for longer than they otherwise would, with obvious implications for asset prices.

by Brunello Rosa

21 June 2021

As the Covid-19 pandemic hit in 2020, a synchronous wave of monetary easing took place in the world. Whether or not the pandemic would prove to have a negative effect on aggregate supply (as in fact did occur, as supply was constrained by lockdowns and severe restrictions), there was certainly a shock to aggregate demand, which needed to be supported by coordinated fiscal and monetary accommodation. In both DMs and EMs, central banks adopted a mix of policy rate cuts, asset purchases (in this case also by EM central banks), various forms of forward guidance, and credit-easing measures to stem the economic downturn due to the pandemic. 

In the DM world, G10 central banks resorted to the various instruments that had been created during the Global Financial Crisis (GFC) of 2008-09, and expanded these instruments further (for example, the ECB’s PEPP). Most central banks have brought their policy rate to the zero-lower bound (ZLB), or even closer to the effective lower bound (ELB), if the latter was in negative territory. In the G10 space, the biggest policy innovations have been, in our opinion, the following: 1) the yield curve control (YCC) at the short end by the Reserve Bank of Australia, to reinforce an otherwise not-very-credible forward guidance; 2) the maturity extension of asset purchases, along with a reduction of the quantity purchased by the Bank of Canada; and 3) the new deposit tearing system adopted by the Bank of Japan, allowing the central bank to reduce the deposit rate further into negative territory while protecting bank profitability. 

A number of central banks have also started to embrace policies accompanying the fight to limit climate change, primarily the ECB, BOE and BOJ. 

In EMs, many central banks cut their policy rates to their all-time lows, to levels that have always been more typical for G10 central banks. Some of them, for example the Banks of Israel, India, and South Korea (among others) even started QE programs, in spite of the inherent risks of FX stability, loss of credibility and fiscal dominance that those programs entail.

One year later in H1 2021, with the pandemic being gradually gotten under control, central banks have to decide what to do next. In the G10 space, there are three groups of central banks. Those which have started (or have announced they will start) reducing the pace of accommodation (chiefly the Bank of Canada, which started tapering QE in April, and Norges Bank, which announced it will raise rates in September). Then there are those which are carrying out their latest round of accommodation yet are ready to start considering a reduction of their easing stance (chiefly the US Federal Reserve). Finally there are those which are still finishing their latest accommodation programs and cannot afford to start thinking about tapering, namely the ECB, BOJ, and BOE. 

In EMs, a number of central banks have already started reversing their easing policies, and have raised rates. According to Reuters, there were already ten rate hikes that took place by the end of May, by central banks in countries such as Russia, Turkey, Indonesia, Brazil, and South Africa. These increases are to defend their currencies against the US dollar, which has been weak for years, and to stem inflation deriving from a rise in commodity prices and the reopening of economies. 

As BoJ Governor Kuroda said during his last press conference: it is not unusual for central banks to have divergent policy stances. And from these divergences, a number of interesting trading opportunities may emerge  

by Brunello Rosa

14 June 2021

During the G7 meeting in Cornwall a number of important issues were discussed, and some key decisions were made. The G7 agenda included, among other items, the adoption of a minimum corporate tax at the global level (of “at least 15%”; we discussed this issue in our previous column), a global vaccination plan that would allow a large share of the world population to be vaccinated against Covid by the end of 2022, and commitments on climate change (ahead of the crucial COP 26 conference, which will be held in Glasgow in November 2021). While each of these issues is of paramount importance, this G7 meeting is likely to be remembered as the beginning of a new relationship between the world’s major economies and democracies and China.

As we have discussed in the past, it was unrealistic to hope that after the end of the Trump’s presidency the relationship between the US and China would normalise. The US and China are at loggerheads with each other,as China is threatening the international supremacy of the incumbent super-power, the US. As Graham Allison argued, the two countries involved may be “destined for war”. In 12 out of the 16 historical cases analysed by Allison in which a rising power challenges the position of an established hegemon, the incumbent and challenger powers ended up in some form of open military conflict. In this case, the US and China are already involved in a new Cold War, which involves three fronts: a trade conflict; a technological rivalry and the breakup of historical value and supply chains. The strategic position of the US, which now views China as a strategic rival, as opposed to a partner or competitor, was always going to remain the same even after the end of the Trump’s presidency and the return of the Democrats to the White House.

Examples of this anti-Chinese stance in Cornwall abound. G7 Countries have invited South Korea, India and Australia to attend the proceedings of the conference; these three countries have recently soured their relationship with China. Additionally, President Biden has put “maximum pressure” on the G7 countries to stigmatise China’s repression of the Uyghurs in Xinjiang, as well as its actions in Hong Kong. Most importantly, the US has launched an infrastructure investment plan to counter China’s Belt and Road initiative, in an attempt to at least slow down the expansion of China’s sphere of influence in Asia, Africa and Europe.    

The plan called “build back better for the world” aims at providing the countries involved with improved access to financing for low-carbon projects such as wind farms and railways. The plan wants to provide an alternative to BRI’s investment, but one that is based on democratic values and Western standards of doing business, and which does not entail saddling recipient countries with large amount of debt that is difficult to repay and creates a de-facto dependence of the country on China (such as, for example, the recent case of Montenegro).

The Europeans and Japan have been asked to gang up against China by their US ally, but are reportedly lukewarm about the extent of the American initiative. They fear jeopardising their relationship with China, which remains a key trading partner and an indispensable ally in the fight against climate change and future pandemics. Also, Biden’s plan is already facing resistance in the attempt to pass it through the US Congress. So one can imagine how difficult it could be to convince six other sovereigns states to back it up with their own domestic legislation. In any case, the US will probably get away with what they want in terms of official commitment, but what portions of this commitment will translate into actually implemented policies remains yet to be seen. 

by Brunello Rosa

7 June 2021

At the end of a long meeting in London, G7 finance ministers agreed last week on the principles for a harmonisation of a global corporate tax regime, which were published in the meeting’s final communique. The agreement will be based on two pillars: 1) the allocation of profits among jurisdictions; and 2) a minimum corporate tax rate.

Regarding the first pillar, all multinational companies with at least a 10% profit margin will have to allocate at least 20% of the portion of their profits exceeding this 10% margin to the jurisdiction wherein the profit was generated. This is to avoid the shifting of profits towards jurisdictions with lower tax rates, a practice largely used by multinational organisations to reduce their effective tax bills. 

The second pillar, meanwhile, states that countries should have “at least a 15% rate” for their corporate tax. This means that if a country imposes a lower tax rate than 15%, the country of origin of the multinational could itself levy the differential in tax, rendering ineffective the corporation’s quest of achieving a lower tax regime. 

This agreement to reform the global taxation system, defined by the signatories as “historical” and a “once in a century occasion”, has yet to be ratified by the G20 forum; the meeting to do so will take place in Venice on 9-10 July 2021. A further step for its global adoption will be the ratification by OECD countries, as the OECD has been since 2013 the forum in which this critical issue has been discussed. In any case, it will still take years for this agreement to become effective and operational, let alone binding. 

Other obstacles may further slow the agreement’s adoption. The US, for example, had asked for the immediate suspension of the digital taxes introduced by countries such as the UK, Italy and France, taxes aimed at the US tech giants. 

The Europeans have refused this approach, as they want to make sure that the agreement is eventually cast into law by US Congress before giving up their only chance to tax a part of the profits by the US tech companies, which have increased massively their profits during the pandemic.    

This budget will reinforce the fears, discussed in our previous columns (on May 3 and May 17) that the US economy will overheat over the next few years, thus leading to a rise in inflation, which eventually the Federal Reserve will have to stave off with a rise in interest rates, thus potentially leading to a recession. 

In effect, inflation has been rising in the last few months, with even the closely watched (by the Fed) headline personal consumption expenditures (PCE) gauge reaching 3.6% y/y in April, with core PCE having reached 3.1% y/y in April (a level not seen since 1992), up from the 1.9% recorded in March. For reference, the standard consumer price index (CPI) was up by 4.2% in April. We expect inflation prints to remain high in the next few months.  

In spite of some investor worries, the Federal Reserve remains relatively relaxed about these increases in inflation, which are still considered to be transient. Even recently, Fed Vice Chair Richard Clarida reassured the market that the Fed will look through temporary spikes in inflation due to base and supply-bottleneck effects. Even if the minutes of the April FOMC meeting showed that several FOMC participants were willing to begin a discussion on tapering asset purchases in the next few months, the probability of a rate increase in the near term is very low. We do not expect a rate increase to occur before 2023 at the very earliest. 

The market is jittery, but ultimately seems willing to follow the lead of the central bank. The USD remains weak versus the EUR, CAD, AUD, and NZD, among others. The 2y Treasury yield, at 0.14%, is still very close to the middle of the 0-0.25% range for the Fed funds target, and the 10y Treasury yield still remains at 1.58%, a level that is indicative of the fact that inflation expectations are not running out of control.

by Brunello Rosa

31 May 2021 

US President Joe Biden gave a speech in Cleveland last week, in which he provided his vision for the future of the US economy. He highlighted the importance of putting the middle class back at the centre of his project to rebuild the economy after the pandemic, partly at the expense of the wealthiest 1% of US citizens and large US corporations. 

Following the speech, he revealed his first, ambitious, USD 6tn annual budget, which Congress needs to pass by the end of September. The budget is large (as was the last budget of the Trump administration, at USD 4.8tn), and it come in addition to both the USD 1.9tn Covid stimulus bill approved earlier this year and the USD 2.2tn infrastructure plan (which has now been reduced to USD 1.7tn). 

This potentially transformative bill will allocate more than USD 800bn to fight climate change, including investments in environmentally-friendly energy, USD 200bn to provide free pre-school places for all 3-year-old and 4-year-old kids, USD 109bn for two years of free community college for all US students, USD 225bn for a national paid family and medical leave programme, USD 115bn for road and bridge repairs and USD 160bn for public transit and railways, and USD 100bn to improve access to broadband internet for every US household. It also includes USD 1.5tn for operating expenditures for the Pentagon and other government departments. 

To pay for this increased expenditure, the US administration proposes to increase the taxes on corporations from 21% to 28%, increase capital gains and the top income tax bracket to the tune of USD 3tn, and run a fiscal deficit of over USD 1.3tn over the next decade. The combined effects are expected to push the US debt-to-GDP ratio to 117%, a level not seen since WWII.

This budget will reinforce the fears, discussed in our previous columns (on May 3 and May 17) that the US economy will overheat over the next few years, thus leading to a rise in inflation, which eventually the Federal Reserve will have to stave off with a rise in interest rates, thus potentially leading to a recession. 

In effect, inflation has been rising in the last few months, with even the closely watched (by the Fed) headline personal consumption expenditures (PCE) gauge reaching 3.6% y/y in April, with core PCE having reached 3.1% y/y in April (a level not seen since 1992), up from the 1.9% recorded in March. For reference, the standard consumer price index (CPI) was up by 4.2% in April. We expect inflation prints to remain high in the next few months.  

In spite of some investor worries, the Federal Reserve remains relatively relaxed about these increases in inflation, which are still considered to be transient. Even recently, Fed Vice Chair Richard Clarida reassured the market that the Fed will look through temporary spikes in inflation due to base and supply-bottleneck effects. Even if the minutes of the April FOMC meeting showed that several FOMC participants were willing to begin a discussion on tapering asset purchases in the next few months, the probability of a rate increase in the near term is very low. We do not expect a rate increase to occur before 2023 at the very earliest. 

The market is jittery, but ultimately seems willing to follow the lead of the central bank. The USD remains weak versus the EUR, CAD, AUD, and NZD, among others. The 2y Treasury yield, at 0.14%, is still very close to the middle of the 0-0.25% range for the Fed funds target, and the 10y Treasury yield still remains at 1.58%, a level that is indicative of the fact that inflation expectations are not running out of control 

by Brunello Rosa

24 May 2021

In our Geopolitical Corner on 4 May, we discussed the letter that former generals of the French army sent to the right-wing magazine Valuer Actuelles, in which they claimed that the republic was in danger from the concessions purportedly made by government to “Islamism.” That letter was published on April 21st, on the 60th anniversary of the so-called Generals’ Putsch that aimed at first re-taking Algeria, then unseating President Charles de Gaulle through the use of military force in metropolitan France itself. 

In the same issue of the magazine, Marine Le Pen, leader of the Rassémblement National and likely the main contender of Macron in the April 2022 Presidential election, encouraged the generals to join forces to liberate France from the ruling of the current elites, as represented by Macron and his government. Prime Minister Jean Castex denounced that letter, which was penned by the former Captain of the gendarmerie Jean-Pierre Fabre-Bernadac, as unacceptable interference. France's top general vowed that those behind the letter would be punished. 

Before knowing whether those semi-retired generals were in fact punished, a second letter was published on the online version of the same magazine on May 10th, this time by anonymous officers of the army describing themselves as active-duty soldiers from the younger generation of the military, whose actual rank remains unknown. 

The authors of the letter claim that military officers have “offered up their lives to destroy the Islamism that you have made concessions to on our soil," speaking openly about the “survival of the country.” The letter concludes with a not-so-veiled threat: "If a civil war breaks out, the military will maintain order on its own soil... civil war is brewing in France and you know it perfectly well." Again, politicians and high-ranking officials promised to punish the authors of the missive, after having identified them. 

The fact that, according to the editors of the magazine, 145,000 people from the public signed the letter by the second day it appeared shows that support for this kind of initiatives is quite strong among the general public. Whether it will be channelled, or – even more – represented politically is yet to be seen. Clearly the army, a highly praised institution in the French Fifth Republic (itself founded by a general, De Gaulle), is showing increasing signs of discontent, however limited and isolated that discontent may be. 

This should not be underestimated. Since the affaire Dreyfuss between 1894 and 1906, movements in the army have led to serious political consequences. In that occasion, ministers resigned, new political groups emerged and a coup was attempted to overthrow the institutional architecture. As we discussed in our analysis, we do not think France is really at risk of a coup. However, a political earthquake may be brewing, with Marine Le Pen leading the polls for the first round of the presidential election and polling well even in those for the second round. France is a country of revolutions and restorations, not smooth and gradual political shifts. If Marine Le Pen were to win, this would represent a regime change, not simply a political victory. 

This is the reason we are saying that the most important political period for Europe is about to start. It will begin in September 2021, when the German general election will be held. After that, the Italian presidential election (by parliament and regional representatives) in February 2022 will determine whether the country will confirm its traditional pro-European stance. Finally, the French Presidential election in April-May 2022 and the subsequent parliamentary election in June 2022 will close this cycle of elections in the three major EU and Eurozone economies. If any of those elections were to go awry, the future of the European integration process would be seriously at risk.

by Brunello Rosa

17 May 2021

Last week, US inflation data for April came in much higher than expected. For headline figures, the month-on-month (m-o-m) inflation rate increased by 0.8% in April, versus an expectation of a 0.2% rise, up from the 0.6% rise registered in March. The year-on-year (y-o-y) inflation rate in the US rose to 4.2% in April, up from 2.6% in March and well above market expectations of a 3.6% increase. In terms of core inflation, the monthly increase was 0.9%, versus the 0.3% expected and recorded in March. The yearly increase was 3%, versus the expected 2.3%, a notable acceleration from the 1.6% recorded in March. 

Market participants got spooked, as the m-o-m increase in headline inflation was the highest jump since 2009, the y-o-y increase in headline inflation was the highest reading since September 2008, the m-o-m increase in core inflation was the largest jump since 1996 and the 3% y-o-y reading in core inflation was the highest since the mid-1990s. Is this fear justified?

The surge in inflation is due to the re-opening of the economy, which led to an increase in commodity prices, the emergence of bottlenecks in global supply chains (such as for semi-conductors and computer chips), and base effects, considering that in April 2020 the y-o-y inflation rate collapsed to 0.3% and oil prices became negative for the first time in their history. In fact, the biggest increases were recorded for gasoline (49.6% vs 22.5% in March), fuel oil (37.3% vs 20.2%) and used cars and trucks (21% vs 9.4%). Inflation slowed for medical care services (2.2% vs 2.7% in March) and food (2.4% vs 3.5%). 

So, it seems that inflation will exhibit, in the US, some high inflation readings for the next few months, until the situation stabilises, in terms of supply, demand, commodity prices and base effects. Should we worry about a persistent rise in inflation? For that to happen, we should observe a rapid increase in wages, following a closure of the output gap and the economy reaching full employment. 

It does not seem we are there yet. In April, non-farm payroll rose by “only” 266K, versus the 1 million expected (one of the largest misses ever recorded), a marked deceleration from the 770K record in March (downwardly revised from 916K). The unemployment rate, instead of decreasing further to 5.8% as expected, instead rose from 6.1% from 6.0%, perhaps as a result of the increase in the labour force participation rate, to 61.7% from 61.5%. Crucially, the yearly increase in average weekly earning fell from 4.2% to 0.3% .    

Now, it is possible that inflation will accelerate further as the output gap closes, as discussed in our recent analysis on US inflation. But we do not think inflation will start haunting us just yet. And even if it does, central banks will be cautious in withdrawing monetary accommodation as long as the pandemic lasts and economic activity needs to recover previous losses. In this respect, the Fed – even recently - was adamant in excluding the possibility that it will react to rises in inflation that are considered transient. 

Market participants seem to get this point: early last week, equity prices suffered the steepest selloff since October, but recovered most losses on Thursday and Friday, as buyers rapidly stepped back into the market. In the week ending May 12, US stock funds drew the most inflows since March. In the fixed income space, Eurodollars futures prices don’t fully price in a rate increase before 2023 at the earliest. As a result, the 2y yield is around 0.15% (in the middle of the 0-0.25% Fed funds target range). Further down the curve, the 10y US Treasury yield remains close to 1.60%, after the surge recorded from August 2020 (when it touched 0.5%) and March 2021 (when it surpassed 1.7%). 

In the currency space, the USD remain week versus the EUR (with EUR/USD at 1.21) and has weakened versus the CAD, NZD, and AUD recently. So it seems that the market is understanding the Fed’s reaction function. 

In the medium term, the situation may change, and as Nouriel Roubini recently wrote, the risk of a new era of stagflation over the coming decade is a real possibility. 

by Brunello Rosa

10 May 2021

This week, the Conference on the Future of Europe will formally begin. The conference had been scheduled to take place last year, but was postponed following the beginning of the Covid pandemic. A lot has happened since then of course, and this conference will be able to help set the discussion that will take place over the next few months in response to these events. 

When there was still the wrong impression that Covid represented an idiosyncratic shock to Italy last year, for example, the ECB President, on 12 March 2020, during the ECB’s press conference, said that the central bank’s job wasn’t that of closing the spread. Soon after, the ECB launched the PEPP program, with elements of flexibility in its operational mode that allow, among other things, the ECB to temporarily deviate from the capital key allocation for the determination of the quotas of asset purchases. Last week, speaking from Florence, EU Commission President Ursula Von der Leyen said that Italy was right in asking for solidarity in the early stages of the pandemic, when it was clear that Covid was a systemic and symmetric shock, rather than an idiosyncratic one. 

When that realisation became common sense, in July the EU heads of states and government agreed on the Next Generation EU package, which plans an increase of the EU Commission’s own resources, including by introducing EU taxation, as well as the launch of a large program of issuing EU debt which – even if it does not enjoy a formal joint and several guarantee – does resemble very closely common EU debt, and could be a potential embryo of future Eurobonds.

With so much progress made by policymakers in the response to the largest healthcare, social and economic shock to have occurred since WWII, one wonders what a formal Conference on the future of Europe can actually bring about. 

In reality, there is still a lot Europe needs to do before finding its ubi consistam. First, a roadmap must be designed that will lead to the completion of the EU (and – within it – Eurozone) integration. With the banking union still to be completed and the capital markets union still in its infancy, there is still a lot of ground to cover before the integration process, which eventually will include some form of fiscal and political union, can be considered anywhere near completed. 

Second, the EU will need to find some form of cooperation/association with large countries which are not, or not anymore, part of the EU but gravitate around it, such as Ukraine, Turkey and the post-Brexit UK. 

Third, in order to function properly and smoothly, the EU needs to introduce a more regular use of decisions taken with a majority vote, as opposed to with unanimity. The cases of Poland and Hungary being able to block the ratification process of the Next Generation EU plan for weeks shows how urgent this reform (or actual implementation of existing clauses) is. 

These changes are so radical that one would expect that the outcome of the Conference would allow a change in the EU Treaties. However, some countries, including Germany, have already said that this is not a possibility. But if that is the case, the Conference risks confirming the EU’s characteristic of having massive ambitions while moving at a snail’s pace. One would hope that such an important occasion helps political leaders understand that the EU does need, first and foremost, a change of pace in its integration and decision-making process. 

by Brunello Rosa

3 May 2021

Last week, US President Joe Biden gave his first speech to a joint session of Congress, flanked by the House Speaker Nancy Pelosi and the President of the Senate, US Vice-President Kamala Harris. Joe Biden outlined to Congress the massive three-pronged fiscal stimulus package that has been rolled out in the last few weeks: the USD 1.9tn American Rescue Plan, the USD 2.3tn infrastructure spending bill (dubbed a “blueprint for blue-collar America”), and the USD 1.8tn expansion of the dwindling US social safety net. This spending spree, equivalent to 30% of the country’s USD 20tn GDP, will be financed in part by the enormous amount of debt that has been issued since the pandemic crisis started, which has brought the US debt to GDP ratio to 133%. But it will also be financed by higher corporate taxes and by higher taxes on the richest segment of the population. 

The economic impact of this composite fiscal stimulus plan will be immediate, with real GDP growth expected to be between 6 and 7% in 2021. Yet it impact will also be protracted over time, with infrastructure projects likely to last many years. 

Its impact on inflation has caused concern among market participants and analysts. Even if only 1/3 of the American Rescue Plan ends up being effectively spent (with the rest either saved or used to pay down debt accumulated during the pandemic), there is the risk that this enormous amount of money injected into an already recovering economy may generate some inflationary pressures when the output gap eventually closes, especially as fiscal expansion has been monetised by the central bank. As we discussed in our in-depth report on this issue, US inflation has been on the rise for months now; CPI inflation has reached 2.6%.  

During his latest press conference, Fed Chair Powell recently said that the Fed expects base effects to add at least 1% to headline inflation (and 0.7% to core inflation), with bottlenecks in the supply chain of commodities or essential parts (such as semi-conductors), adding additional upward inflationary pressures. Even a fellow Democrat such as Larry Summers expressed some doubts, his concern being that the stimulus package might have been excessive. 

In our view, the risk that inflation will spin out of control is limited, and in any case after many years of inflation undershooting, a brief period of even 3-4% inflation cannot hurt too much, and would actually help in making the debt burden more sustainable in real terms.

Whatever the economic impact, it seems to us that this discussion misses the real motivations behind Biden’s stimulus package, which we believe are twofold. First, the Biden administration wants to use the occasion offered by the pandemic to make once-in-a-generation investments, in order for the US to catch up on the many fronts that it has been falling behind many other countries. For example, in the quality of its infrastructure, its public education and childcare, public transportation, digital and ecological transformation, to cite only some of the most prominent areas the US may need to address. This is really the implementation of the old Churchillian adage “never waste a good crisis.” 

Second, Biden has only two years (really, only a year and half now) to eradicate populism from the country’s political trajectory. Populism could easily resurface in the 2022 mid-term election, leading even to a comeback of Donald Trump, the US champion of populism. Economic malaise would be the obvious culprit for such a resurgence, and so Joe Biden wants to make sure that, by November 2022, the pandemic will be just a horrible memory, and that as many Americans as possible will have returned to work, and are not open to the sirens of the populist narrative. This is to make sure that, if Kamala Harris has to succeed him three years from now, or if he decides to run for a second term himself, the race won’t be lost from the get-go, but the Democrats will instead actually have good chance of success.

by Brunello Rosa

26 April 2021

By the end of this week, EU countries will be submitting their National Recovery and Resilience Plans to the EU Commission for an initial evaluation. If the Commission and the EU Council have no major objections to the countries’ plans, then up to 13% of the funds agreed on in July 2020 can be distributed this summer, in order to allow countries to begin their post-pandemic reconstruction efforts.

In reality, for the plans to become fully operational, the ratification of the EU Commission’s so-called “own resources” plan (linked to the 2021-2027 Multiannual Financial Framework) is required from all EU parliaments. If the Commission is unable to raise its own resources, it cannot issue the long-waited bonds that will finance a large component of the Next Generation EU plan. Unfortunately, only 17 out of 27 countries have so far ratified the plan. There is still opposition coming from part of the Viségrad Group, in particular from Poland, where the ratification of the plan risks opening a government crisis due to opposition from a component of the right-wing populist majority. But even Germany is making the rest of Europe hold its breath, as its Constitutional Court has been asked to judge whether the plan is in line with the principles of Germany’s fundamental law.  

While the ratification processes continue, governments across Europe are rushing to present their reconstruction plans. In this instance, the countries that were at the centre of the Euro crisis in 2009-12 are acting the most responsibly. Portugal was the first country to present its plan to the EU Commission, on 22 April, well ahead of the deadline. Its plan is innovative and contains a good mix of reforms and investments. 

Greece, meanwhile, has been widely recognised by the Eurogroup and the Ecofin as the country able to provide the best template for how to write a national plan and organise the governance of the reconstruction process and the eventual management of the attendant funds. Greece was so sure of the merits of its plans that it even asked the European Investment Bank (EIB) to manage EUR 5bn of its investment projects once the funds will be disbursed. Clearly, lots of water has gone under the bridge since the era of the Troika (or the Institutions, as Yanis Varoufakis called them).    

Italy is also going to be presenting its plan on time, and the presence of Mario Draghi (former president of the European Central Bank) is considered a guarantee that the plan will be approved by Brussels, with international press recognizing his role in making Italy a “power player” in Europe. (Much harder will be the actual implementation of the plan back in Italy, as Draghi may be Super-Mario but is not Superman). In contrast, countries that would be expected to easily win the approval of Brussels, such as Germany, received informal reprimands for the lack of reforms made in the initial drafts of their plans. 

Eventually we expect all 27 countries to ratify the “own resources” plan of the EU Commission, and present its national recovery and resilience plans, perhaps at the cost of some twisted arms and perhaps with some countries being slightly late with their submissions. This is an integral part of the EU’s overall policy response to the pandemic, which is already much smaller in scale than what the US has actually deployed. During its latest press conference, ECB President Lagarde said that the ECB can complement but not substitute the fiscal stimulus expected to come from the EU and national governments. 

The implementation of the Next Generation EU plan would be good for financial markets as well as for national economies. Market participants have been waiting for years for the issuance of a proper pan-European safe asset, which will allow the risk/reward profile of EUR-denominated portfolios to improve. 

by Brunello Rosa

19 April 2021

A number of studies have shown how income inequality and wealth inequality worldwide have risen during the past few decades. A few years ago, Thomas Picketty’s Capital in the Twentieth-First Century, a massive book on the rise of inequality, became an international bestseller. Even institutions such as the International Monetary Fund, for generations considered to be the “bad cop” of the international financial order, named “inclusive” growth among its set of goals. 

More in-depth analysis, such as this study by the IMF itself (and similar ones from the World Bank), have showed that inequality between countries has in fact diminished in the last few decades, especially thanks to China moving from being a low-income to middle-income country, lifting 850 million people out of extreme povertyin the process. At the same time, however, inequality within countries has increased, with the richer segments of populations becoming even richer than they had already been, and the poorer segments becoming poorer in comparison. 

There are several causes of this phenomenon, including the beginning of a new phase of globalisation of the world economy, kickstarted by US President Nixon’s decision to suspend the US dollar’s convertibility into gold, as well as by Nixon’s trip to China, which under the rule of Deng Xiao Ping was then becoming a (state-)capitalist economy. But above all, there was the beginning of the disconnect between the increase in labour market productivity and salary increases, while, at the same time, a massive reduction in corporate taxes occurred globally.

The net effect of this was that the so-called labour share of income started to decrease significantly, while the capital share, or corporate profits, started to increase massively. The ideology underpinning these policies, promoted by market fundamentalists, was the so-called “trickle-down economics”, the idea that making the rich richer would eventually also result in making the poor richer as well. We now know that did not work. 

After two systemic crises (in 2008-9 and in 2020-21, both of which hit the poorer segments of the population disproportionally more than the richer ones) and after endless protest movements (such as Occupy Wall Street), the establishment finally realised that it was time to act. Some countries, such as the UK and France, introduced extra taxes on higher incomes. Others, such as Italy, introduced various forms of wealth taxes. Finally, a number of European countries started to introduce “digital taxes”, to try and make the tech giants, especially those from the US, pay their fair share to society. 

However, without the US on board, none of these extemporaneous initiatives could really make a difference. But finally, the Biden administration, under the influence of Treasury Secretary Janet Yellen, has made a move. First, as part of the wider package put together to repay the gigantic amount of debt issued to counter the economic effects of the pandemic, the US administration has announced some increases in taxes for the richer, and more entitled, segments of the population. This includes personal income and corporate taxes. The expected rise of the corporate tax over the next few years represents a welcome reversal of the well-established secular trend. 

Second, the administration has launched the idea of creating a global minimum corporate tax rate, of around 21%, so that the international competition to attract companies from one country to another solely on the basis of taxation regimes would be discouraged. Third, the aim of the new tax system would be for companies, in particular the tech giants, to pay taxes not on profits, which are always reduced to virtually nothing thanks to various accounting gimmicks, but rather on revenues generated in a certain country, irrespective of whether or not the company is legally based in that jurisdiction. 

In an effort to re-launch multilateralism, Biden has proposed the OECD as the correct forum for the discussion of these issues. The G20 is also taking a lead on this, under the Italian presidency. However difficult it will be for these proposals to become reality, we still think they are a step in the right direction, as a first attempt to tackle the rise in income and wealth inequality at the global level, a rise that has been exacerbated by the central bank’s policies (such as QE) adopted to counter the effects of the systemic crises. 

by Brunello Rosa

12 April 2021

During the Global Financial Crisis (GFC), central banks took centre stage in the policy response, while most governments opted for fiscal austerity, which made the economic contraction induced by the crisis longer and deeper than was necessary. Central banks deployed a number of innovative policy tools such as forward guidance, negative policy rates, credit easing, and quantitative (and qualitative) easing – in some cases accompanied by yield curve control. Especially with the adoption of large-scale asset purchases (LSAPs) the distinction between monetary and fiscal policy became quite blurred, yet a formal distinction was always kept. 

Now, during the pandemic crisis, the real economic policy innovation has been the increased coordination between monetary and fiscal policy, intended to make sure that financial conditions always remain favourable. The coordination has been such that some economists have openly spoken about “helicopter money”, and central banks have re-started LSAPs, partly to monetise the huge deficits and debts that have been created to soften the economic impact of the crisis.

In the aftermath of the pandemic crisis, the role of central banks is destined to change further, and most likely will become ancillary to other government policies. In the last few decades, central banks have been asked to get inflation back under control as their primary objective. As a secondary goal, all central banks have the wider mandate of supporting government policies such as full employment and low long-term interest rates. (In the case of the Fed’s dual mandate, full employment and low inflation are equally important goals). To achieve this objective, central banks have been granted operational and, in some cases, institutional independence. Going forward, the situation will likely evolve further. 

 The main job of central banks in coming years will be to monetise the huge fiscal deficits and debts created during the pandemic, by adopting various forms of financial repression (including keeping long-term rates low for longer, with explicit or implicit forms of yield curve control). Controlling inflation will be less important: the Fed’s new strategy explicitly allows inflation to overshoot the target by a limited amount and for a short period of time, to make up for inflation undershooting during the previous few years. A limited amount of inflation accompanying a recovery in economic activity, along with some targeted tax increases, are the other two key instruments to “digest” the fiscal imbalances created during the pandemic.

Recently however, central banks have been given goals that typically belong to the government’s sphere, such as pursuing or accompanying environmentally friendly policies to counter climate change, as part of a broader push to achieve Environmental, Social, and Corporate Governance (ESG) objectives and financial sustainability. In this respect, the new remit of the Bank of England is the most advanced in the G10 area, with the ECB being a close second. In the case of the Fed, the FOMC has decided upon quality of employment (across states, social classes, ethnic groups and genders) as the key variable for its forward guidance. 

Given these new goals, central banks will remain formally independent in most cases, but de-facto their actions will be determined by government policies. Governments will become the real centre of action in coming years, taking the baton from central banks. And perhaps, for this reason, some of the more notable central bankers of the last few years are now in government, or in similar positions. For example, the former Chair of the Fed, Janet Yellen, is now Secretary to the Treasury in the US. Former ECB President Draghi is now Italy’s Prime Minister (after being for many years Director General of the Italian Treasury). The former BOE Governor Mark Carney, who was also at the Treasury before joining the Bank of Canada, was recently appointed UN Special Envoy on Climate Action and Finance, and there’s speculation about him entering Canadian politics in coming months.  

by Brunello Rosa

6 April 2021

This week the traditional IMF-World Bank Spring Meetings will take place in Washington DC, albeit still in an online format for the most part. The IMF will be releasing its latest World Economic Outlook(WEO), the much-revered guidance as to how the world economy is expected to perform over the next several years. Even if most market participants believe that the IMF always provides very cautious forecasts – forecasts that tend to be less pessimistic during market downturns and less optimistic during upswings –  their projections will still be a very relevant baseline to consider. 

In its last two WEO editions (in October, followed by an update in January), the IMF has upwardly revised its forecasts for global economic activity, following the shock that occurred in Q1/Q2 2020 when economic activity collapsed by double-digit percentage points. This upward revision was mostly due to the rebound recorded in Q3 of 2020, as well as the fact that some key economies performed better than expected, with China even managing to stage positive growth in 2020 and the US weathering the crisis (from an economic perspective that is; less so from a healthcare standpoint) much better than had been feared. 

How will the IMF alter its forecasts in April 2021? After the rebound in Q3 2020, the global economy slowed down significantly in Q4 and Q1 2021 as a result of the new restrictions imposed by governments in response to the new waves of the pandemic, which are still partly ongoing. At the same time, some positive news started to emerge on the fight against the virus, and in particular with the beginning of vaccination campaigns in many countries. As discussed in previous columns, the dispersion in the success of those campaigns is huge.

Countries as diverse as the US, UK, Israel, Chile and the United Arab Emirates are exhibiting very encouraging vaccination rates, with large segments of their populations being vaccinated. But large countries or regions such as the EU, China, Russia and India are falling way behind in the vaccination schedule (to say nothing of Latin America – excluding Chile – and Africa). Clearly, the fact that the US and the UK could count on home-developed vaccines provided them with a competitive advantage. But the way the procurement was made and the vaccination campaign organised also played a significant role, as exemplified by countries such as Serbia, which has secured doses from all major vaccine producers and is even able to offer inoculations to foreigners. 

As discussed in our recently-published Global Outlook and Strategic Asset Allocation paper, for us this means that some countries will be able to exhibit a truly V-shaped recovery, most notably the US and China. Other regions however, such as the EU, will remain mired in a painful U-shaped recovery, with risk of permanent scarring and damage to growth potential. In the UK, meanwhile, the effects of Brexit will limit the potential economic upswing. This means that US long-term yields will likely continue to rise, however gently, as economic activity recovers and inflation increases. And the US dollar will continue to appreciate against major currencies; chiefly, against the EUR and JPY. 

But this means that Emerging Markets will become more vulnerable in coming months and years – as suggested by indicators such as the Brookings-FT Tracking Index for the Global Economic Recovery (Tiger), as the huge amount of debt issued to counter the pandemic will become harder to sustain. There is no doubt that the IMF’s  Global Financial Stability Report (GFSR), which will also be issued this week, will discuss the financial stability implications of this worrisome development. G20 Governors and Finance Ministers are set to use the IMF meetings as an occasion to discuss how to make EM debt more sustainable, including through debt-relief measures.

by Brunello Rosa

29 March 2021

The third wave of the Covid-19 pandemic is in full swing. According to the latest figures from Johns Hopkins University, there have now been 126 million cases and 2.8 million deaths. The number of variants has increased to the point that the new strain of the virus may be very different from the original strain – there are some who are already openly speaking about a Covid-21. A number of European countries are now introducing new restrictive measures, with Germany, France and Italy all now being very close to lockdown situations, which would last at the very least until Easter, and more likely until the end of April. As we discussed in previous columns, the evolution of the pandemic is dramatically uneven across different countries and regions. In the US and the UK the number of new cases (i.e. the pace of increase) is falling, while in other countries, such as Brazil and India, it is rising. In China and Japan, the virus seems to be contained for the time being. 

An important reason behind this difference in the pandemic’s evolution is the variety of success in vaccination campaigns. In the US, 100 million citizens have received at least the first inoculation of the anti-Covid vaccine thus far (in the first 59 days of Joe Biden’s presidency), corresponding to 40% of the US population. Biden now plans to have vaccinated the entire adult population of the US by May 1st. In the UK, almost 30mn people have been vaccinated, corresponding to 47% of the population. In other countries, Israel has already vaccinated 100% of its population, the United Arab Emirates 79% and Chile 50%. In the EU, only around 15% of the population has received at least a first dose, while China, India and Russia are clearly laggards, with 7.5% or less of people having received a first inoculation. 

As discussed previously, the US clearly enjoys the fact that three out of four vaccines developed in advanced economies are produced by US companies: Pfizer, Johnson & Johnson and Moderna. The UK, meanwhile, has been able to take advantage of the vaccine produced in Oxford by the Anglo-Swedish company AstraZeneca. The low level of vaccination in Russia is explained by the low trust the general population has in the government, and the fact that President Putin has not yet taken the Sputnik V vaccine himself.  

In the EU, it is astonishing how the pharmaceutical companies of the three largest economies (Germany, France and Italy), did not develop an in-house vaccine, but rather had to rely on the US, Russia and the UK to have access to vaccines. Badly written contracts meant a dearth of doses and a very slow start of the vaccination campaign. In its latest EU Council meeting on the subject, held last week, divergences regarding how to proceed on this issue emerged. Luckily, from the US, President Biden promised to help the Europeans as soon as the coverage of the US population is complete. Once again, the Europeans have to rely on their American ally to sort out their problems. A “Vaccine Marshall Plan” is clearly needed at this point, to allow EU countries to begin to catch up with the Americans.

Meanwhile, even the grand coordinated fiscal plan Europe has devised in order to counter the pandemic, the Next Generation EU, is encountering difficulties, whereas the gigantic USD 1.9tn fiscal package by Biden has been approved and is already operational. So far, only 14 out of 27 countries have ratified the European recovery plan, including Germany. However, the German constitutional Court has opened a case aimed at assessing the legitimacy of the plan according to the German constitution. This risks further delaying, if not derailing, the already slow response of the Europeans to the pandemic and the economic damage it has caused. Once again, Europe will have to rely on the spill-overs of US fiscal expansion (which the OECD calculated to be around 0.5% of its GDP) to revive its economic activity. 

by Brunello Rosa

22 March 2021

According to the latest IMF figures, the global economy lost 4.4% of gross domestic product (GDP) in 2020, as a result of the impact of the Covid-19 virus. This loss in income, however, only measures a fraction of the damage and pain inflicted on the global economy and the world’s population by the pandemic. We have discussed several times in this column, and more recently in an in-depth report, how the real impact of the pandemic will need to be evaluated over a number of years to come. We will need to take into account the lasting costs resulting from the loss of economic opportunity and social interaction, the damage inflicted to education and younger generations, and the imbalances in mental health caused by several rounds of lockdown and forced captivity for a social animal such as we are.

After all, income is only a portion of what general welfare is. 

Economics, back when the discipline was not yet independent from other social sciences, including philosophy, actually got off to a good start in recognizing this fact. Adam Smith, who can be considered the founding father of the discipline, wrote a treaty on the Theory of Moral Sentiments, the aim of which was to describe the motivations behind economic interactions among individuals. Karl Marx, who first theorised the social struggle, the theory of labour value and the conditions of proletariat, was a Hegelian philosopher. John Maynard Keynes wrote memorable pages discussing the animal spirits behind human decisions to invest, save or consume. Even the drier, dominant neo-classical economics put “welfare” and “utility” as the objectives to be maximised by atomistic individuals, or by society as a whole. 

When the theorists of “market fundamentalism” took over the discipline in the 1970-80s, economics became dominated by mathematics, and policy-making became dominated by loss functions expressed in terms of deviations from economic potential and inflation targets. Estimating “welfare,” “utility,” and -why not- “happiness” was considered far too complicated; market participants, policy makers and economic agents had instead to use proxies such as disposable per-capita income, and other similar statistics. In so doing, we lost the essence of policy-making and economics (itself already labelled the “dismal science”) which is not the pursuit of maximising incomes, but rather human welfare, or happiness. 

Several indicators of this difficult-to-define concept of welfare have been developed over the years. Some took into account, for example, the environmental sustainability of economic actions and their social impact and implications. It is worth mentioning here the work done by Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi on the “Measurement of Economic Performance and Social Progress”, and by Richard Layard from the London School of Economics aimed at “making personal happiness and wellbeing a goal of public policy.”  

More recently, a World Happiness Report has been developed by a group of academic and social organisations, starting from the results of the Sustainable Development Solutions Network (SDSN) and The Center for Sustainable Development at Columbia University, directed by Jeffrey D. Sachs. Its 9th edition, for 2021, has just being released. Not surprisingly, alongside indicators of economic performance and employment, a number of other indicators of environmental sustainability, social cohesion and inclusion, family support, and other such variables have been used to measure the “happiness” of countries. The report also uses data from Gallup surveys on quality of life self-evaluations, and on the frequency of experiencing positive and negative emotions. 

Looking at the ranking, one immediately sees that nine of the first ten positions on the list are occupied by European countries, with only New Zealand, ranked ninth entering the top ten outside Europe. Among those European countries, once again Nordic countries take the lion’s share, behind Finland, which was confirmed as the world’s “happiest” country for the third consecutive year. So, we find Finland, Iceland, Denmark, Sweden and Norway occupying positions 1, 2, 3, 6 and 8, respectively. “Germanic” countries are also well placed, with Switzerland, the Netherlands, Germany, and Austria occupying positions 4, 5, 7 and 10 on the list. 

Among the continental economies, the US does not perform badly, with a well respectable 14th rank, while China does very poorly, featuring only 52nd. La joy the vivre puts France 20th, while Italy’s dolce vita places the country 25th. 

What we learn from this report is that a mix of economic and technological development, social inclusion and cohesion, excellent public services, fairness, lack of corruption and – more recently – a positive response to the Covid pandemic are key factors behind countries’ happiness. European Nordic countries, once again, offer the world an example to follow. 

by Brunello Rosa

15 March 2021

Last week the US Congress finally approved the USD 1.9tn fiscal stimulus package presented by the Biden administration and its Treasury Secretary Janet Yellen. The package consists, among other things, of USD 441bn in direct support to household income (“stimulus cheques”), USD 246bn of unemployment benefit extensions, USD 143bn of tax credit expansion, USD 360bn of aid to state and local governments, USD 227bn for healthcare (including for Covid testing and containment), and USD 176bn for education. 

The Biden package is in addition to the 0.9tn fiscal stimulus approved by the US Congress around the time of the US presidential election in November 2020, which was presented by former President Trump. Together, the USD 2.8tn fiscal stimulus is equivalent to 13.3% of the US GDP, which in current dollars is around USD 21tn. Even assuming that only one third of the stimulus will be actually spent, and two thirds will be either saved or else used to pay down debt, this still represents a 4% net stimulus to the economy, which – on the basis of this stimulus – could grow at least 6% in real terms in 2021, and perhaps even 7% in an upside scenario. 

The probability of a downside scenario, wherein the US economy grows less than 6%, is quite low at this stage, for the following three reasons: 1) the fiscal stimulus has now been approved by the government and its actual implementation could be quite fast. Sending out cheques, extending unemployment benefits, and increasing tax credits are measures that can be put into action in a fortnight; 2) the risk that the market “undoes” some of the stimulus by demanding higher long-term yields (thus discouraging investment) is kept under control by the Fed’s program of asset purchases; 3) the successful vaccination campaign rolled out by the government, which has already led to around 30% of the US population being vaccinated (versus 10% of the EU, for example), means that new lockdowns and severe restrictions are unlikely to be adopted in the future. 

Regarding the successful vaccination campaign one should praise the logistical and organisational abilities of the US system as a whole, especially in situations in which the military gets involved. But other factors should also be considered, including the fact that three of the four internationally approved vaccines are produced by US-based companies (Pfizer, Moderna and J&J), which have favoured their home country in the production and distribution of the vaccine. Also, the low population density of the US may at times have acted as a competitive advantage, for example by providing space to allow Americans to queue inside theirs cars waiting to be vaccinated, whereas in most countries people have to stand in lines, thus creating possibilities for contagion. In any event, the number of new Covid cases in the US has recently collapsed from around 400K a day to 60K nationwide, as spring begins and larger segments of the country start experiencing warm weather, which has proved to be a more challenging environment for the virus to propagate.

With this rebound in economic activity, coming after the 4.3% reduction in real GDP in 2020, the US in 2021 is already on track to recoup most of the GDP level lost during the pandemic. By comparison, a number of European countries (and most emerging markets) will take years to observe their GDP returning to pre-pandemic levels. 

This remarkable comeback is therefore the result of a massive policy response provided by the US government through its various branches. The US federal fiscal deficit is forecast to be 10% of GDP in 2021, after being nearly 15% in 2020, the largest fiscal shortfall since 1945. This echoes the effort made by the US government to fight the Great Depression of the 1930s, and subsequently WW2, through Roosevelt’s New Deal. All this is clearly made possible by the de-factodeficit and debt monetisation carried out by the US Federal Reserve, the balance sheet of which has now reached USD 7.5tn, i.e. 35% of nominal GDP. We discussed in our previous columns how central banks, including the Fed, are fighting inflation fears and rising long-term yields. When the FOMC meets this week, it will decide whether or not more decisive actions, such an enhanced forward guidance, explicit yield curve control, or an extension of the maturity of purchased bonds, are needed at this stage. 

by Brunello Rosa

8 March 2021
 

Financial markets have been volatile during the past couple of weeks. Anti-Covid vaccination campaigns are attracting the attention of market participants, as the speed and effectiveness of the vaccination campaigns vary greatly around the world. In the US, President Biden managed to convince Johnson & Johnson (J&J), the producer of the last-approved anti-Covid vaccine, to cooperate with Merck, its long-term arch-rival, to increase the production capacity of the new vaccine. This way, the US will have three domestically produced vaccines – by Pfizer-BioNTech, Moderna and J&J, respectively – available for its population. 

For this reason, Biden said that all adults in the US may be given the chance of being vaccinated by May, which is two months earlier than had previously been expected. A similar success story is taking place in the UK, where 21 million people (more than 30% of the country’s total population) have received at least the first dosage of a Covid vaccine.

Much less successful are the campaigns in the EU and Russia. In the EU, the limited availability of vaccines, a more vaccine-sceptical population, and logistical difficulties are making the beginning of the vaccination campaign extremely slow, with only around 5% of the EU population having received a first dosage. The Commission may be blamed for the reduced availability of vaccines, as it wanted to negotiate on the price with the pharmaceutical companies, and its contracts were much less detailed, and hence enforceable, than those signed by the US and the UK. The limited supply has reached a point that Italy has forbidden AstraZeneca to export vaccines to Australia, attracting the criticism by UK PM Boris Johnson. 

Russia, meanwhile, is a peculiar case. Though having developed a vaccine much faster than its competitors (the notorious Sputnik vaccine), the level of scepticism among the general population against something offered by the government is such that only around 3% of the population has decided to be vaccinated. The fact that President Putin has not been willing to inoculate himself with the Sputnik vaccine certainly has not helped the cause.

Vaccination campaigns began while a lot of countries were still implementing severely restrictive measures, including full lockdowns in countries such as Germany and the UK. As such, economic activity remains subdued and Q1 2021 will likely be a quarter of very low or even negative GDP growth. Governments continue to provide generous fiscal stimuli: in the US for example the USD 1.9tn fiscal stimulus plan is likely to be implemented soon; and in the UK the Chancellor of the Exchequer has just announced another “spend now, tax later” Budget. Central banks remain fully accommodative, in part so as to monetise the large deficits exhibited by national governments.

Given this background, those countries such as the US, where vaccination campaigns are progressing more smoothly and the policy support is ample, economic activity has started to show early signs of vitality. Accompanying it there has been the return of some inflation fears, motivated by market participants’ awareness of the huge amount of liquidity injected by central banks into the system at a time when large fiscal stimuli have been provided and the output gaps are starting to close. In our recent in-depth analysis, we discussed how the return of high inflation is a risk scenario, rather than our baseline assumption of what will occur. Still, inflation fears have brought a sell-off in bonds, and therefore a rise in short- and long-term yields, as investors re-estimated the timing of central banks’ policy normalisation phases. This in turn has led to volatility in equity markets, which are sensitive to rises in long-term yields.

Central banks around the globe (with the Fed and the ECB at the forefront) were keen to reassure market participants that they are ready to look through short-term rises in inflation, perhaps even rises above the target levels the banks have set, as long as such rises are temporary. The US Fed has even changed its policy strategy to allow temporary inflation overshoots, as long as they are limited in size. Other, smaller central banks, such as the Reserve Bank of Australia, had to resort to additional market intervention in order to bring yields back in line with the policy targets.

In any case, central banks will have a hard time in coming years as they attempt to combine their traditional role as guardians against inflation with their current strategy of monetising the large deficits produced by countries combating the pandemic.

by Brunello Rosa

1 March 2021

The Chancellor of the Exchequer will present its first budget since March 2020 this week, the first time it has done so since the pandemic fully started. On March 8, Rishi Sunak will present to Parliament the new set of measures that are designed to provide support to the UK economy, which has been severely hit by the pandemic. 

In 2020, the UK real GDP fell by 9.8% over the previous year, one of the worst performances among G7 countries. The unemployment rate rose from 3.8% at the end of 2019 to 5.4% at the end of 2020, according to the latest IMF data. The collapse in economic activity has been contained by the fact that the government provided generous support through fiscal expansion. The rise in unemployment has been contained by a series of rounds of furlough schemes, which prevented many workers from being laid off. The latest scheme, which in November was extended until March 31, will most likely be further extended into June at the very least, and perhaps beyond it. 

In the meantime, the UK has gone through two additional rounds of lockdown, which have further weighed on economic activity. At the same time, the government has launched a successful Covid vaccination campaign, which has resulted in more than 20 million people receiving the first dose of one of the various vaccines available, corresponding to around 30% of the population. For comparison, in the entire EU/EEA, only 22 million doses have been distributed on a population of around 500 million, i.e. around 4.5%. If the UK’s vaccination campaign continues at its current pace, the government estimates that it will be able to provide vaccination to the vast majority of the UK population by the end of H1 2021. 

Given these estimates, Boris Johnson’s government has launched a 4-step plan for a cautious but irreversible reopening of the economy by the end of June 2021 This should hopefully provide some relief to the strained economy and public finances (it may include an anticipated GBP 5bn relief package for various categories of businesses that have been most hit by the pandemic), which have observed the public deficit rising to the astronomical level of 19%, while debt has soared well above the 100% threshold. Beyond this short-term fiscal expansion, Sunak will have to show a credible fiscal consolidation plan during the post-pandemic period. 

Despite all this, this week Sunak will likely announce a plan of further fiscal expansion, considering that all major national and supranational policy organisations now agree that withdrawing policy stimulus too soon is much more dangerous than withdrawing it too late, even for the overall soundness of public finances. (In the 1990s-2000s, notably, Japan showed the detrimental impact to public finances of a premature tightening of fiscal policy). Among the most anticipated measures there is the so-called Future Fund: Breakthrough, a fund that will invest up to £375m of public money in fast-growing UK technology companies, with the result being an increased exposure of taxpayers to stakes in tech start-ups.

Through all of this, Sunak will have to take into account the impact that Brexit has had on the UK economy, even if this impact has been concealed behind Covid, so far. But the impact thus far on the cost of imports and exports has much more to do with Brexit than Covid, for example, at a time when most households and businesses relied on deliveries by post or courier to keep their economic activity going during repeated lockdowns. It won’t be easy for the Chancellor (who has the ambition of becoming PM himself one day) to navigate the UK economy between the Scylla of Covid and the Charybdis of Brexit. 

Brunello Rosa

22 February 2021

The first G7 meeting since April 2020 was held in a virtual format at the end of last week, chaired by the UK Prime Minister Boris Johnson. The G7 leaders gathered to “discuss how the world’s leading democracies can work together to ensure equitable distribution of coronavirus vaccines around the world, prevent future pandemics and build back better from coronavirus.”

The final communique emphasised the role of “strengths and values as democratic, open economies and societies”, with an aim to “work together and with others to make 2021 a turning point for multilateralism.” To a certain considerable extent, the arrival of Joe Biden as president of the Unites States has marked the return of multilateralism as a method of tackling the massive challenges that the leading world economies face.

In particular, the leaders of the G7 will cooperate to fight the Covid pandemic, with a global plan for vaccine production and distribution. The G7 countries pledged to work together “to strengthen the World Health Organisation (WHO),” and support “its leading and coordinating role” to “accelerate global vaccine development and deployment.” This reference to the WHO is particularly important as one can remember when former US president Donald Trump decided to defund the organisation at the time the global pandemic was starting. 

But by now experience should have thought us that the only way to fight global challenges such as air pollution and ocean pollution, climate change, and pandemics is by fostering international cooperation, not by diminishing it.

In this respect, the final statement makes a very important point: “On the 23rd February the Prime Minister will chair a virtual meeting of the UN Security Council on the link between climate change and conflict... The discussions at the meeting will inform crucial action ahead of the UK-hosted COP26 Summit in November.”  

Other commitments on this front include the need to “promote global economic resilience; harness the digital economy with data free flow with trust; cooperate on a modernised, freer and fairer rules-based multilateral trading system that reflects [G7] values and delivers balanced growth with a reformed World Trade Organisation at its centre; and, strive to reach a consensus-based solution on international taxation by mid-2021 within the framework of the OECD.”

The return of multilateralism is definitely good news. In a period of disruption of global supply and value chains due to the pandemic, and interrupted international travel, the risk of de-globalisation has never been stronger. The rise of autocratic and populist leaders around the world has only worsened the situation. In this respect, G7 countries also made progress in mentioning the strengths and values of democratic, open economies and societies at the beginning of the statement, and deciding not to invite Russia at the upcoming meeting in Cornwall in June (as had initially been planned by Donald Trump), at the time when severe repression is occurring within Russia following the arrest of Vladimir Putin’s main opponent Aleksej Naval'nyj.

On the economic front, the G7 stated that they have given “unprecedented support…over the past year totalling over $6 trillion across the G7.” G7 countries will continue to support their “economies to protect jobs and support a strong, sustainable, balanced and inclusive recovery.” 

To tackle global challenges, the world needs a multilateral and inclusive approach. The populist threat is still too strong to be under-estimated, especially at a time when pandemic-related restrictions and border closures have marked the return of nation-states to the centre of the policy response.

Brunello Rosa

15 February 2021

The recent rise in Eurozone inflation, from -0.3 y/y to +0.9% y/y in January 2021,has sent some shivers down investors’ backs, especially considering that inflation has also risen from +0.2% y/y in May 2020 to 1.4% y/y in January 2021 in the US. Mostly it is technical factors that are behind this rapid increase in inflation numbers: base effects kicking in after one year of pandemic, the recent rise in oil prices (partly driven by the economic rebound after the slump in economic activity experienced in 2020), the recalibration of the basket of goods and services being used to calculate inflation gauges, and in the case of Germany and the Eurozone the fading of the deflationary effect of the 2020 VAT cut that was taken to counter the worst effects of the pandemic. 

In spite of the recent increases, inflation remains definitely under control, well below the central banks’ targets, which are usually set around 2% in most developed markets. In the short term, some potential increases may derive from supply bottlenecks due to the disruption of global supply and value chains, which can reduce the availability of goods and services. The pandemic has shown that although these supply and value chains were very long and efficient during the merry years of globalisation, they are also very fragile. 

So, the main reasons behind a potential increase in inflation in the short run may be technical factors and supply shortages. To observe a more persistent rise in inflation we would need to wait for the closure of the largely negative output gaps that exist around the world, when economic activity returns towards potential and unemployment rates approach the non-accelerating inflation rate of unemployment (NAIRU). We do not expect this normalisation in economic activity to occur before H2 2021 at the earliest, with 2022 and 2023 more likely candidates. 

Even then, the “new normal” in economic activity may be very different from the era that preceded it. Jobs will be even more precarious than they were pre-crisis; the gig economy may become the new paradigm for an entire generation; the bargaining power of unions will be virtually zero for years to come. Hence, the possibility of strong, persistent, domestically-generated inflation will be limited in any case.

Considering this, how will central banks react? The vast majority of central banks in both DMs and EMs will likely look past temporary inflation spikes, especially if they are easily explained by technical factors. They can certainly tolerate transient increases in inflation due to short-term shortages of supply, so long as the output gap remains largely negative. They may be less tolerant towards a rise in inflation if the output gap is closing (even if that inflation is generated by technical factors or supply shocks), as a closing output gap may feed into inflation expectations. They will definitely be very vigilant against domestically-generated, demand-driven inflation deriving from the closure of the output gap and from unemployment rates reaching the NAIRU. 

Even in those circumstances, however, the reaction of central banks is likely to be moderate, at least to begin with. The adoption of formal or informal versions of Average Inflation Targeting (AIT) regimes will dictate that banks keep their monetary policy stance looser than they otherwise would, so as to recoup some of the price level lost during the years of inflation overshooting target levels. 

In any case, inflation is the variable to watch in coming years, given the impacts it could have on asset prices. A rapid rise in inflation will likely dent the valuation of all major asset classes, and will certainly hurt bonds (both sovereign and corporate), and most likely equities as well (via their dividend discount models of valuation) if central banks are expected to normalise their policy stances sooner than they otherwise would.

Even assets that are traditionally considered to be inflation hedges, such as gold, may need to prove their resilience in the event of rising inflation. Certainly crypto-assets will have to prove that they really are a good inflation hedge, even if these days they are highly sought after given mounting inflation concerns. Indeed, inflation may be the one variable that could transform the expected “roaring twenties” into the “moaning twenties” – if investors are disappointed by asset prices.

by Brunello Rosa

8 February 2021

At the beginning of last week, Italy’s President Sergio Mattarella shocked the Italian political system by announcing that he will confer the charge of forming the government upon Mario Draghi, one of the most well-known public figures at the international level. Mario Draghi has been President of the European Central Bank, inaugural Chair of the Financial Stability Board, Governor of Bank of Italy and Director General at the Italian Treasury. This career in public service has been briefly interrupted by a significant stint between 2002 and 2005 at Goldman Sachs, as Vice Chairman and Managing Director and member of the Executive Committee. 

Mario Draghi is mostly known, internationally, for his pronouncement “whatever it takes” , when he promised in July 2012 in London that the ECB will do anything to preserve the integrity of the Euro. These few words anticipated the introduction of the Outright Monetary Transactions (OMTs), i.e. potentially unlimited purchases of bonds of countries subject to idiosyncratic speculative attacks. Between 2014 and 2015 he managed to introduce negative policy rates and even direct purchases of public and private assets, the so-called Quantitative Easing, in the conservative setting of the ECB, a Frankfurt-based institution still dominated by the Bundesbank monetarist approach. 

By making those moves, Draghi was internationally praised for having “saved the euro” from what technically was called “redenomination risk”, but what in reality would have been a catastrophic collapse of the single currency and – with it – of the entire European integration project. 

Now Draghi has been called upon to save the European project from another danger. Because of the pandemic, Italy (the first country to be hit by Covid-19) has lost almost 10% of GDP in 2020, its public deficit has exploded to 10% of GDP and its debt/GDP ratio skyrocketed to almost 160%, only a tad below Greece in the Eurozone. As the pandemic hit other European countries, it became evident that Covid was not a idiosyncratic shock to Italy, but rather a systemic shock that – once again – threatened the survival of the EU.

After many months of negotiations, EU leaders finally agreed an economic rescue plan in July 2020, the so-called Next Generation EU plan, which contains the crucial Recovery and Resilience Facility (RRF). The Next Generation EU plan is the legacy that Germany’s Chancellor Angela Merkel wanted to leave to the next generation of EU leaders, a plan to make the EU more resilient, just, environmentally sustainable and digitalised. It was also an extreme exercise of solidarity from the countries “of the North” (Germany, Netherlands, Finland, Sweden, etc.) to the countries “of the South” (Italy, Spain, etc.) at the time in which most of the latter needed it. 

Now it is obvious that if this exercise of solidarity were to fail because the southern countries (chiefly Italy) prove not to be able to spend the funds coming from Europe efficiently and effectively, while accompanying them with a plan of reforms, the entire edifice of European solidarity would be badly shaken, with the risk of collapse of the integration process existing again over the next few years. Draghi’s job in Italy will need to show that the country as a whole is able to devise a plan of investment and reform that would make Italy ready for the challenges of the future. For him, the biggest challenge will be convincing a highly divided and reluctant parliament to vote for such a plan of reform to re-launch the country, however painful that may be. 

by Brunello Rosa

1 February 2021

Last week, media attention was attracted by the epic fight between day traders and the giants of Wall Street. That story is largely known now. Thousands of retail investors, organising themselves on platforms such Reddit and trading on online exchanges such as Robin Hood, have been purchasing the shares of the moribund company GameStop (considered a sort of “Blockbuster” for gaming), a company that funds such as Melvin Capital, which specialises in equity long/short strategies, had been heavily shorting in previous months. 

With the price of the stock rising from $17 per share on January 4th to $347 on January 27th, those funds were scrambling to purchase the stocks they needed to cover their short position. But the extent of the bet was such that those shares did not exist, resulting in their prices being pushed up at the speed of light. Eventually, regulators such as the SEC decided to intervene, to calm a market dynamic that was becoming uncontrollable, with retail investors prevailing against hedge funds and Melvin Capital closing its short position and needing to be rescued by its competitors. As the theory says, to be successful a speculative attack needs coordination among the agents involved in it, and a coordinated signal that suggests when the attack should start. The Reddit community had both. 

Taking sides in an issue of this sort is hard. One could feel sympathy for the market Lilliputians revolting against the giants of Wall Street, and especially the millennials behind this movement. Nevertheless, the coordination of actions in this way is dangerously close to market manipulation. Hedge funds do not attract popular sympathy, especially hedge funds that short the equities of struggling companies and so can result in the bankruptcy of businesses that might have otherwise survived. But this very strategy – shorting – is also the one instrument that market participants have to signal inefficiencies in the management or unviability of business models. 

As for the regulators, they are supposed to be the guardians of the market but tend to act too late, when the damage has already been done. Often, during severe market corrections, some regulators also ban short selling altogether, leaving the impression that market forces should be left free to act only if they push market prices up (the so-called Bernanke Put – now the Powell put). 

In the end, it does not really matter who is the good guy in this story, and who is the felon. The real question is what this episode signals, and what the lessons are that must be learnt. It seems to us that this “Reddit army” is following the tradition of fight-the-system/anti-globalisation movements that started with the Seattle WTO protests at the end of the 1990s (remember Naomi Klein’s “No Logo”?) and continued with protests such as Occupy Wall Street.  

One could even claim that the entire crypto-asset movement (net of its abundant scams, illegal activities and manipulation) was originally a way to disrupt “the System”. 

So, there is a fil rouge that connects all these protest movements in their “rage against the machine”, represented in dystopian movies such as The Matrix franchise. But one needs to be careful here. History teaches us that most revolts and revolutions aimed at democratising the system end up with autocratic regimes or even ferocious dictatorships. Even the mother of all revolutions, the French Revolution of 1789, ended up with Napoleon’s empire and eventually the “restoration” of the Congress of Vienna. 

The revolutions of 1848 (the year in which the Manifesto of the Communist Party by Karl Marx was published), which led to the temporary fall of many absolutist monarchies in Europe, similarly ended up with the election of Napoleon III to become the President of France. He too later became Emperor and an absolutist ruler. On a much smaller scale, the anti-globalisation sentiment prevailing among the middle- and low-income classes in the United States was eventually channelled by a plutocrat from New York: Donald Trump.

The lessons to learn here seem to be the following: 

1) Social malaise due to the restriction and loss of job opportunities induced by the pandemic is leading people to find other sources of income perceived as rapid and safe, such as day stock trading. 

2) Central bank liquidity, issued to help banks survive and sovereigns monetise public debts, is making one-way bets too widespread in the markets, thanks to the perceived “Bernanke put”.

3) The financial system seems more de-anchored from economic fundamentals than ever, increasing the chances of all sorts of distortions and manipulations occurring, which can end in devastating market crashes. 

4) The revolt of the people by way of coordination through electronic platforms is a signal of the underlying social malaise that, though exacerbated by the pandemic, originated decades ago with the decoupling of salary and productivity growth and the beginning the globalisation process. 

5) These events are further confirmation that politics, markets and geopolitics these days are taking place first and foremost within cyber space. Politicians around the world should take note of these events, if they do not want to see this revolt exiting the computer screens and taking to the streets. 

by Brunello Rosa

25 January 2021

The Covid-19 pandemic has now entered its second year, and its second wave that began in the autumn is now mixing with the expected third wave, which was forecast to peak in the spring of 2021 (following the example of the Spanish flu of 1918-19). The vaccination campaign has started, but the recent delays experienced in Europe in particular mean that heard immunity may not be reached before the autumn of 2021, at the earliest. 

After a year of the pandemic, we are now in a position to start evaluating the effectiveness of the overall policy response that has been employed against it. By way of comparison, during the Global Financial Crisis, which originated with a banking crisis in 2007-2009, the policy response was initially inadequate, as the policy arsenal available at the time was incomplete, and even the theoretical framework employed by policymakers was shaky at best. The knee-jerk reaction by public authorities at the time consisted of the nationalisation of troubled lenders, unlimited liquidity provisions and timid cuts in the policy rates by central banks. Only later in the process did central banks develop their full arsenal of tools, consisting of zero or negative rate policies, purchases of public and private assets, forward guidance on policy rates, asset purchases and reinvestment policies, and credit easing through the introduction of funding-for-lending schemes. 

It took years for many governments to realise that fiscal policy had to be part of the policy mix as well, and that a level of government coordination with monetary policy would not imply fiscal dominance. It took even longer to develop macro-prudential instruments to control financial imbalances in the economy and adopt smarter ways of stabilising troubled financial institutions than simply using taxpayer money (which later fuelled anti-establishment movements and populism). 

Because of the lessons learned from the Global Financial Crisis (GFC), at the beginning of the current pandemic the economic policy response was quick, adequate and effective.  

Central banks immediately reactivated their entire arsenal of policy tools, plus some additional innovations (for example the Reserve Bank of Australia’s yield curve control at the shorter end of the curve, to reinforce forward guidance).   

Governments meanwhile realised that ideology-driven fiscal budget constraints could not be accepted in a pandemic, and so launched large fiscal stimulus packages that drove deficits and debt into territories generally seen during wartime. Banks were little affected by the shock, as they had become more resilient after the GFC.

The economic policy response was, therefore, adequate for the most part, and has been partially effective in alleviating the worst impacts of the pandemic. The healthcareresponse was, however, suboptimal, especially in Western countries. In China, where the pandemic originated, the overall healthcare response was more forceful (in part, thanks to reduced sensitivity to citizens’ privacy as well as social rights by the government), and, as a result, more effective. In Western countries, the policy responses were more erratic and less effective. Vaccination campaigns started much later in Western countries than in China and Russia; though, of course, that may have been largely because the vaccine trials followed standards that were probably more accurate. 

Still, the concern remains that, as during the GFC, the initial policy response has been too conservative, and driven by questionable metrics. The measures that have been adopted, such as social distancing and lockdowns, derive from the medieval age. Policymakers have adopted the minimisation of deaths as the objective function, as opposed to considering it a constraint for the maximisation of true objective function, which is social welfare across the spectrum of social, economic and age groups. This conservative approach has resulted in disastrous repeated lockdowns, which will likely have massive long-term social and economic consequences that will be hard to manage once the pandemic emergency is over. 

As happened after the GFC, it will take years to realise what the best policy mix would have been. And, when this realisation finally happens, it will probably already be too late.  

by Brunello Rosa

18 January 2021

In our recent column, we noted how political risk was on the rise at the beginning of the year. This week will prove particularly challenging in this regard. 

In the US, the inauguration of the 46th  president in US history on January 20th, rather than merely featuring a speech by the new “leader of the free world”, as usually takes place, will instead be a highly risky event, with the state of emergency still in place after the “insurrection” that occurred on January 6th, when Donald Trump supporters entered the US Congress to stop the parliamentary ratification of the electoral college vote. The FBI warned that there may be armed protests in 50 states planned on the day of the inauguration, organised by far-right movements. To make things worse, the incumbent president said he will not attend the inauguration ceremony, thus opening a wound in the transition of power in the world’s leading democracy. 

In Europe, Italy is staging yet another government crisis. As is typical when centre-left governments are in power, a component of the majority detached itself in a sign of disapproval over the management of the pandemic and the process followed by the government in drafting the recovery and resilience national plan. Similar episodes occurred in 1998 when Rifondazione Comunista left Prodi’s first government, and in 2008, when UDEUR left the second Prodi government. The centre-right found itself in a similar situation in 2010 when Fini’s component of the Popolo della Liberta’ left Berlusconi’s fourth government. On that occasion, the government managed to survive a confidence vote by parliament thanks to a group of MPs (the so-called “Responsabili”) coming from opposition parties which joined the majority. 

As we discuss in our in-depth scenario analysis, we believe that Giuseppe Conte is tempted to follow this example of the centre-right, by trying to find support in a group of MPs coming from the current opposition (or, from Italia Viva, Matteo Renzi’s party that has been part of Conte’s governing coalition until now). 

But this is proving harder than anticipated. At this stage, a new government with “Responsabili” coming from opposition parties, or a new pact with Italia Viva, seem the likeliest scenarios. Elections seem the least likely outcome, yet cannot be completely ruled out.   

In Germany, Armin Laschet, currently the president of North-Rhine Westphalia, Germany’s most populous state, was elected to succeed Annegret Kramp-Karrenbauer as Chair of the CDU and, therefore, become the frontrunner to be the next Chancellor when general elections are held in September 2021. We anticipated the potential election of Laschet in May 2018, when he was totally out of the political radar screen. Laschet is a continuity candidate, so very reassuring in this respect, and he could easily lead a new centre-right coalition, or a new grand coalition with the SPD or the Greens after the elections. 

He may yet be challenged in his race to the become CDU/CSU candidate for the Chancellorship by Jens Spahn, the health minister whose effective management during Covid has boosted his profile at the national level, or by Markus Söder, the popular leader of the CDU’s Bavarian sister-party. In our view, as we discussed in an in-depth analysis of German politics, the main political weakness of Laschet is that he might leave the right flank of the party uncovered, as compared to Fredrik Merz. That political space on the right that may then be occupied by the AfD, thus posing risks to the Germany’s leadership in the European integration process. 

Last but not least, in the Netherlands, PM Mark Rutte and his cabinet resigned last weekin response to a child welfare fraud scandal. Rutte will, however, remain in office until the March 2021 general election, in which he hopes to be confirmed as party leader and Prime Minister. The election in the Netherlands has been one of the main reasons behind the slow ratification process by national parliaments of the Next Generation EU recovery plan. This delay poses a serious threat to the actual implementation of the plan.

by Brunello Rosa

11 January 2021

While new, more infectious, but so far not more deadly variants of Covid-19 are being discovered in many countries across the globe – for example in the UK, the USand South Africa – anti-Covid vaccines are being rolled out to limit the virus’ spread. The Pfizer-BioNTech, Moderna and AstraZeneca products have started being distributed in many countries, and vaccination campaigns will be carried out for months to come. 

A number of countries are adopting more severe restrictions to movement and social interactions in the meantime, by imposing new lockdowns. Germany has just extended its lockdown until the end of the month. The UK has launched its third full lockdown in nine months, and Spain is doing similarly. There is hope that after a third wave of the pandemic in the first few months of 2021, and an initial adjustment period to the vaccine rollout, the worst part of the crisis might end by June and, gradually, the pandemic may be overcome as we approach the end of 2021. 

While we are still in the middle of the battle, it may be hard to think about what comes after the pandemic is over. But this is an effort that we need to start making. We have already discussed how we think that the geopolitical ranking of countries will change after the pandemic, most notably with the US losing ground in favour of China. The latest episodes in Washington, with rioters entering and devastating Capitol Hill while Senators and Representatives were certifying the results of the electoral college that voted Joe Biden as the 46th US President, will damage the image of the US democracy for a long time, especially if one thinks that Trump might try to run for President again in four years.

In a previous column, we reminded readers how, after the 1918-19 pandemic and WW1, the fascist party was born in Italy, and totalitarian leaders emerged subsequently in various parts of Europe. Some analysts are making a comparison between the rise of fascism and the events in Washington on the 6th of January.    

But there will be more far-reaching consequences still. Social distancing and quarantines are not novel inventions: they have been the defense of humanity against pandemics for centuries. Their effects have been felt for decades after the end of their respective crises. For example, a parallel has been recently drawn between the roaring Twenties of the twentieth century, which begun after the end of the Spanish flu pandemic of 1918-19, and the situation that will exist a year or so from today. Various analysts wonder what will happen after the harsh restrictions on people’s movement are finally lifted. 

On the one hand, there is a theory that some of the limitations on people’s movement will remain for a long period of time even after the pandemic ends, inducing safer behaviour in society at large, with less travel, endless commuting, and extravagant social interaction taking place than was the norm before 2020. Opposite theories exist however, which suggest that once limitations will be lifted people will over-compensate by engaging in even more extreme social interaction, at the limits of debauchery even, lifted by over-excited animal spirits. 

In reality, a combination of these two scenarios may eventually emerge: more social control via digital platforms, more authoritarianism able to impose limitations on people's movement, but also more extreme forms of social interaction, especially in private life, to compensate for the reduced social and political freedom and limited economic opportunity that has been experienced this past year.

by Brunello Rosa

4 January 2021

In our global outlook published at the end 2020, we argued that 2021 will be a volatile macroeconomic and geopolitical year. From a purely macroeconomic perspective, if the anti-Covid restrictions in place in 2021 are milder than those put in place for 2020, the global economy should experience a rebound that could see it grow by 4% (according to our central scenario). This means that, following a 5% contraction in 2020, by the end of this year economic activity might still be at a level lower than it was at the end of 2019. There are significant upside and downside risks to this central scenario, and the unfolding of events directly and indirectly related to the evolution of the pandemic will likely lead to a volatile 2021 from a macroeconomic perspective. 

Geopolitics will be volatile as well. 2020 started with the killing of Quasem Suleimani, the head of Iran’s Islamic Revolutionary Guard Corps, by the US, and ended with the assassination of Mohsen Fakhrizadeh, the father of Iran’s nuclear programme, presumably by Israel. There are fears of renewed tensions between the US, Israel and Iran occurring on the anniversary of the assassination of Suleimani on January 3rd. 

The US and Israel will themselves be at the centre of heightened political risks in the next few days and weeks. In the US, this week will be crucial, given the runoff election for the two Senatorial seats in Georgia. As discussed in our report, if these seats were to be won by the Republicans (currently the baseline scenario), there might be a last attempt by the Republican party in the Senate to block the ratification of the results of the Electoral College for the election of Joe Biden as 46th President of the United States, which is scheduled to take place January 6th. If this were to happen, we could witness the beginning of a serious constitutional crisis, which could end up in the Supreme Court. 

Even if that fails, a Senate in the hands of the Republicans mean that Biden’s presidency will be held hostage to Mitch McConnell’s delaying practices.  

If the Democrats win both seats (currently a risk scenario), the 50-50 count in the Senate would give Kamala Harris the decisive say in many crucial votes, including in confirmation hearings for cabinet ministers. At that point Biden may become hostage to the leftist component of the Democratic party, which would push him to spend large amounts of money to fund infrastructure projects and fiscal stimuli. Between these two risks, perhaps paradoxically the traditionally moderate and centrist Biden may actually prefer being hostage to McConnell’s practices, rather than to those of his own party’s left wing. 

Israel meanwhile will hold another general election on March 23rd, its fourth in two years. These frequent elections are a sign that Israel’s political system remains highly fragmented and ineffective. The formal reason for the collapse of Benjamin Netanyahu’s government was the refusal by the prime minister to pass a budget that would cover 2020 and 2021, as demanded by the leader of the Likud’s coalition partner Benny Gantz, who was supposed to take over from Netanyahu in November 2021 according to the agreements made at the time the current government was formed in May 2020. Netanyahu’s intention in holding another election in March is to avoid having to give up his job to Gantz. 

In Europe, Italy is about to start a period of political instability which might eventually lead to general elections in the spring (an unlikely outcome at this stage), if a compromise for a new government, or a new version of the current government, is not reached between the parties supporting Giuseppe Conte in parliament. In fact, press reports suggest that by the 7th of January, Matteo Renzi might withdraw Italia Viva’s delegation from government, thus formally opening the political crisis, whose final outcome is yet unknown. 

by Brunello Rosa

28 December  2020

Just hours before Christmas, the UK and EU Brexit delegations announced that they reached an agreement which will prevent the most catastrophic effects of a no-deal Brexit from materialising. The agreement, reportedly in thousand pages of legal text, will regulate some of the most contentious issues, including: 

Tariffs and Quotas: most of the deal is centred around eliminating tariffs and quotas on goods crossing the borders between the UK and the EU. The UK had a goods import deficit of GBP 79bn with the EU in 2019.  

Financial Services: The deal mostly regards goods, and very little is said about financial services, and services in general, even as they still represent 80% of the UK economy and the UK has a GBP 18bn export surplus in services to the EU in 2019. The debate on “equivalence” will continue for years and so will the negotiations around it. 

Level Playing Field and State Aid: The UK and the EU will maintain common standards on workers’ rights, and on social and environmental regulations. The UK will adhere to common principles on state aid. 

Dispute Resolution and the Role of the European Court of Justice (ECJ): If either the UK or the EU departs significantly from common standards existing on 31 December 2020, resulting in a negative impact on to other side, a dispute mechanism will ensue, which could lead to tariffs being imposed on imported goods. The EU lost the battle to have the ECJ police the governance of the deal. The ECJ will continue to exert its authority over Northern Ireland, given the special status deriving from the Brexit withdrawal agreement.

Data and Security: The EU has the most advanced regulation of data protection on the planet (the so-called GDPR directive), and has not yet recognized the UK’s data protection regulation as being “equivalent.” For the time being, there will be a transition period of four months, in which data will continue to flow freely between the two sides of the English Channel. Regarding security matters, the exchange of information will not occur “in real time” as it has supposed to have done until now. 

Fishing: for some reason, this relatively unimportant issue became politicised. The agreement states that the value of the fish caught by the EU in UK waters will be cut by 25% with a phasing in period of five and a half years. Once the transition period is over, the UK will have full control of the access to its waters, and could make much larger cuts to the value of fish the EU catches within them.

So, regarding this last-minute agreement in its entirety, should we view the glass as half full or half empty? In our opinion it is half full. As we discussed in our preview (in which we predicted a skinny deal to be reached by the end of the year, without further delays), the risk existed that a no-deal Brexit would materialise, as the UK government might have masked the negative effects of a no-deal Brexit behind the Covid disaster. It is therefore especially good news that the more catastrophic consequences of a no-deal Brexit have been prevented. 

However, clearly a number of issues remain unresolved. First and foremost is the issue of financial services, which is the most notable absentee in the deal. Also, data sharing and protection as well as the issue of “regulatory divergence,” which remains the real “holy grail” of Brexit, remain to be finalised in coming months and years. The UK will have some manoeuvring space to diverge in coming years, but maybe not as much as it would have liked. 

In the end, the Brexit saga developed itself as we expected in terms of process and outcome. In terms of process, as we predicted at the very beginning of this saga, Brexit had similar dynamics to Grexit: referenda, multiple elections, changes in government, breaking points followed by temporary agreements. In terms of end result, stepping back a few years, the final outcome is very similar to what we predicted just over three years ago, in November 2017, when we said “Hard Brexit With Canada-Style FTA Is The Most Likely Outcome”. We were correct in predicting that (1) Brexit would eventually occur; (2) it would not be reversed by parliament or by another referendum; and (3) a grand bargain over the various aspects of the post-Brexit transition was unlikely to emerge at any point in time; and (4) the final outcome would be hard-Brexit with a skinny deal on some basic aspects. 

by Brunello Rosa

21 December 2020

Cyberspace has become just another dimension of our physical environment. The Covid-19 global pandemic, in forcing billions of people to limit their physical interactions, has shown how many activities can be moved to the cyberspace, including those that traditionally were aimed at increasing social networking, such as conferences and seminars. The global economy has become very much dependent on the well-functioning of cyberspace. At a time in which physical interaction is de-facto forbidden, a crash in the digital world would have severe economic and social repercussions. Yet last week one of the worst cyber-attacks in recent history was reported by many US federal agencies. Microsoft was also reported to be exposed to this attack. 

In geopolitics, the continuity between the cyberspace and the physical environment has become equally evident. Cyber-security has become the buzzword in this field; national security threats mostly come from technological developments. It is well known that the ban on 5G technology coming from Huawei and ZTE by the US and their allies was based on geo-strategic considerations. In this respect, the examples of Stuxnetand NotPetya are illuminating. Stuxnet, a computer worm directed against uranium-enriching centrifuges in Iran, has been considered the “world's first digital weapon.” The NotPetya attack against Merck and its clients and suppliers was, similarly, referred to as being akin to an “act of war.”

Following these developments, the concept of “Digital Sovereignty” has emerged. The contest over the ownership of data (the “oil” of the digital era) could lead to cyber-wars in the 21st century. Finding international rules in this very sensitive field is imperative if we want to keep a peaceful geopolitical environment, in cyberspace as well as in the tangible world. Most countries are developing their “cyber armies” to defend cyberspace, which has become in effect the fifth dimension in national security programs, together with land, sea, air and extra-terrestrial space.  

But technology is also a formidable enabler of positive developments for mankind. In our most recent FIN-TECH report, written along with Klecha & Co., we discuss how technology could be the vehicle to fast-tracking further European integration, for example. We discussed how one of the key goals of the Von Der Leyen Commission is to promote the digital transformation of EU countries. The new Recovery and Resilience Facility also requires that around a third of investments will be aimed at increasing the digitalisation of economic activities. And  the European Central Bank has just launched a report on the possible adoption of a digital euro as a way of accelerating the process of European banking union. 

In the geo-strategic arena, with the role of NATO coming under increasing scrutiny even in the US, the Europeans know that they will need to increase their military cooperation if they want to find a niche space in the developing Cold War between US and China. In this respect, the launch of the military Permanent Structured Cooperation (PESCO) among European countries and of the European cyber-security agency(ENISA) represent crucially important first steps. 

by Brunello Rosa

14 December 2020

As we discussed in our column last week, 2020 is ending with a number of issues unresolved. The second wave of the pandemic is raging across the globe, with the US registering the highest number of daily cases and deaths since the beginning of the crisis, Europe mired in its second round of severe restrictions (with Germany moving to a full lockdown that is set to last until January 10th), and a number of EMs still struggling to flatten their infection curves. 

Today, the US electoral college will finally elect the country’s 46th President, after the Supreme Court ruled against a lawsuit filed by Texas’ attorney general against Michigan, Georgia, Pennsylvania, and Wisconsin. However, alt-right supporters of Trump (including the so-called Proud Boys) gathered in Washington until yesterday to protest against the electoral result, suggesting that another four years of political tensions in the United States may underway. The EU, meanwhile, is getting closer to approving its multi-annual budget, but the implementation of the Recovery and Resilience Facility remains problematic. A no-deal Brexit looms large. As a result of these uncertainties, economic activity remains weak, and Q4 is likely to be another quarter of stagnation , or even contraction, with carry-over effects likely into Q1 2021. 

Given this background, policymakers know that monetary and fiscal stimulus is still very much needed to support aggregate demand and supply. Job-retention and salary-support schemes have been renewed anywhere. New rounds of fiscal stimuli are being planned globally. Even in the US, after the formal election of Joe Biden as president, the long-waited-for USD 1tn plan seems ready to be agreed upon. 

Through all this, central banks realised that they could not just sit on their hands. In the G10, a number of central banks have decided to provide another “shot” of monetary stimulus before the year ends. In November, the Reserve Bank of Australia cut rates to its alltime low, and begun formal QE; the Reserve Bank of New Zealand introduced a Funding For Lending Program ahead of a possible adoption of negative rates in 2021; the Bank of England (BoE) increased the size of QE by GBP 150bn (while keeping its powder dry in case of no-deal Brexit); the Riksbank increased and extended its QE program by SEK 200bn. So far, in December, the ECB increased the size of its PEPP program by EUR 500bn, while also further boosting its credit-easing facilities (TLTRO3 and PELTROs). 

This week, another four G10 central banks will hold policy meetings: the Federal Reserve (Fed), Norges Bank, the Bank of England, and the Bank of Japan (BoJ). The Fed is unlikely to add further monetary stimulus after the strategy review made it clear that the Fed will not increase rates and that QE will remain part of the “conventional” landscape for the foreseeable future. The BoJ has been happy to be on the back-seat of the policy response for some time, following years of audacious monetary experiments, including yield curve control. It will likely remain so in December, though it may announce an extension of its credit easing facilities. The BoE is not expected to do anything after last month’s surprisingly large package; not before knowing whether or not it will have to use its bazooka to stem the effects of a final breakdown in the Brexit negotiations with the EU. Norges Bank will likely keep its key policy rate unchanged at zero, and continue promising to keep it at that level for the foreseeable future. 

In any case, even with rates at zero, or negative, and all sorts of monetary instruments being put in place, G10 central banks will remain ready to intervene to support aggregate demand. Meanwhile they are working on their next big tool: their own digital currency (the Riksbank, PBoC and ECB are at the forefront of this trend), which will allow them to take policy rates deep into negative territory to fight the next systemic crisis – which hopefully will not manifest itself for many years yet. 

by Brunello Rosa

7 December 2020

As we approach the end of the year, many issues that have characterised 2020 remain unresolved, even if some of those issues may be inching towards being solved, or at least towards a stabilisation period. The most dramatic of these remains the Covid pandemic of course, with many European countries dealing with a severe second wave and the US registering the highest number of infections and deaths since the beginning of the crisis. The commercial and social restrictions imposed by countries to avoid the spread of the virus are pushing a number of economies to  the verge of a new contraction in Q4 2020, which could become another technical recession if these restrictions continue in Q1 2021. 

It is unclear as of yet when the most acute phase of the pandemic will end. A third wave is possible between January and March, and a number of central banks, including the ECB – the Governing Council of which meets this week – assume that there will not be significant stabilisation before June 2021, when the vaccination process of large segments of the population is expected to be underway. Regarding vaccines, some good news is emerging: in the UK, regulatory authorities have approved, in an emergency procedure, the diffusion of the Pfizer Covid-19 vaccine as of this week; EU authorities are waiting for further tests before giving the vaccine the green light. 

Having said all this, the real effectiveness of these vaccines will not be tested until applied to large parts of the population; in part, because the procedure (based on mRNA procedure) is highly innovative and experimental. In any case, as vaccines are applied and as more effective treatments are discovered, there should hopefully be better news regarding the pandemic by mid-2021.

Another open issue regards the result of the US presidential elections. Incumbent US President Donald Trump still refuses to concede victory to President-Elect Joe Biden, threatening to take the legal challenge to the Supreme Court. However little the chance of succeeding he has, clearly Trump’s refusal to concede is creating a wound to the US electoral (and therefore democratic) system. By law, all legal challenges should be settled at least six days before the electoral college meets. 

This year this happens on December 14th, so by December 8th  all legal challenges are supposed to be settled – the so-called “safe-harbor deadline”. So, hopefully within the next few days the result of the US presidential election will be settled.   

However, the type of presidency that Biden will embark on may depend heavily on the run-off elections for the two senatorial seats in Georgia that will be held on January 5th. As discussed in our analysis, if the Democrats manage to win both of these run-offs, they will have fifty senators, which would give Vice-President Kamala Harris the deciding vote in the Senate. If the Republicans win at least one seat, then they will likely block a number of very important decisions by the Biden administration until at least the mid-term elections are held in 2022. 

Two other notable issues that remain open are Brexit and the approval and implementation of the Recovery and Resilience Facility (RRF) in the EU. Regarding Brexit, after yet another round of inconclusive talks, the two sides agreed to make a final attempt this week to see if some of the remaining issues on state aid, fisheries and regulatory divergence can be ironed out. We still expect a skinny agreement to emerge, in order to avoid at least the most catastrophic effects that would result from a no-deal Brexit. But, as the number of days remaining to December 31 shrinks, tensions in the negotiating process are set to increase.

Regarding the RRF, Poland and Hungary have applied a veto to its approval, which they intend to use so long as the link between the rule of law and the disbursement of funds remains part of the final agreement. Again, we still expect a final agreement to be reached, with sticks and carrots used to convince the two countries to remove their veto. But this means that the implementation phase will be at least delayed, and most likely will be a bumpier process than had initially been expected. 

Given all these uncertainties, which are weighing on economic sentiment and activity, policymakers have promised to keep the tap of monetary and fiscal stimulus open. As discussed in our latest Markets Review and Outlook, markets remain edgy and volatile, buffeted by the news on the uncertainties described above on the one hand, and the support provided by policymakers on the other.

 by Brunello Rosa

30 November 2020

In mid-November, the member states of the Association of Southeast Asian Nations (ASEAN), together with Australia, China, Japan, South Korea and New Zealand signed the Regional Comprehensive Economic Partnership (RCEP) Agreement. The Agreement will improve market access with tariffs and quotas eliminated in over 65% of goods traded and make business predictable with common rules of origin and transparent regulations, upon entry into force. The RCEP is likely to be the one of the largest free trade agreements in history. It  will cover “a market of 2.2 billion people, with a combined size of US$26.2 trillion or 30% of the world’s GDP,” according to its signatories. 

Most importantly, the agreement signals that although globalisation may be not be in the greatest shape, it is not dead. It should not come as a surprise that the signing of the agreement came around two weeks after the US presidential election that have brought back an internationalist president such as Joe Biden to the White House. Biden was among the architects of the defunct Trans-Pacific Partnership (TPP), which was resurrected by Japan’s PM Shinzo Abe under the name of Comprehensive and Progressive Agreement for Trans-Pacific Partnership.

In fact, after four years in which the Trump administration has worked to demolish the international order created by Republican and Democratic presidents alike over the past few decades – pulling out the US of the Joint Comprehensive Plan of Action with Iran, the Paris agreement on climate change, the above-mentioned TPP, NAFTA with Mexico and Canada, the World Health Organization, and withdrawing US soldiers from the Middle East and Afghanistan and even from NATO member states such as Germany (to take just a few examples) – the new administration will likely try to reassert the US role in the world as being the cornerstone of globalisation.

This is happening at a time in which even a Conservative government in the UK, just about to pull out of the EU, is signing trade deals with Japan and Canada.  

As discussed in our recent report, while Biden will try to undo some of the damage made to the international position and reputation of the US by his predecessor (just as Trump tried to undo what he thought were the mistakes of the Obama administration), he would nevertheless be making a mistake if he simply tried to turn the clock back by a few years and ignore what has happened in the world in the meantime.

The backlash against globalisation has been real, even if represented by unlikely champions such the billionaire Trump. In France, the Gilet Jaunes protests has threatened a globalist leader such as Emmanuel Macron, while around the world autocratic and protectionist leaders have emerged. Biden will have to take into account the events of the last few years if he wants to succeed on the world stage of today. 

In any case, the Covid pandemic has balkanised the global supply and value chains, fostered protectionism and led to border closures. The damage caused to the global economy is immense, and its social consequences will be felt for years to come. It is impossible to think of an enduring recovery without a reopening of the economy and relaunching of international travel and trade. 

Globalisation has had plenty of flaws, and caused endless discontent, but it has managed to take hundreds of millions of people out of poverty, especially in Asia. That is a fact the newly signed RCEP agreement makes abundantly clear. 

 by Brunello Rosa

23 November 2020

In July 2020, an agreement was made between EU leaders to approve the Next Generation EU (NGEU) rescue package to assist the recovery of economies that are being plagued by the pandemic and its socio-economic consequences. The agreement was saluted by some as Europe’s “Hamilton moment” (when US states’ debt were federalised). While we consider the agreement a historic step in the process of European integration, we never subscribed to the idea that NGEU represents the EU’s Hamilton moment. , at the very least because there is no “joint and several” guarantee by member states on the bonds issued by the Commission. 

Moreover, the amount of “federal” fiscal expenditure remains modest compared to national budgets and the overall EU GDP. In our analysis of the agreement, we also highlighted the risks to the ratification process, which requires each parliament of the 27 EU countries to approve the package (a unanimous process akin to a Treaty change). 

The implementation of the NGEU package, which includes the Recovery and Resilient Facility (RRF), is proving as hard as we expected it to be. Two countries, Hungary and Poland  (both of which are currently subject to the proceedings of Article 7 for the violation of basic EU values, such as the independence of the judiciary) blocked the adoption of the agreement, and also vetoed the Multiannual Financial Framework for the years 2021-27, unless the provisions of the agreement regarding the respect of the rule of law are removed or softened. The ratification process is likely to be bumpy in the Netherlands as well, given the upcoming general elections in the spring of 2021. We expect these hiccups to be overcome eventually, but the actual introduction of the package is likely to be postponed at best.

Additionally, it is taking time for countries to present their respective national recovery plans, on the basis of which EU funds will eventually be disbursed. Only 5 out of 27 countries have presented such plans, without which the RRF remains a theoretical exercise. Recently, the EU Commissioner for economic affairs, Paolo Gentiloni, encouraged countries to speed up the process of presenting those plans, by establishing emergency procedures. He was particularly explicit in the case of Italy, one of the largest beneficiaries of the NGEU in absolute terms (though less so as a percentage of its GDP).  

As we have highlighted in our analysis, the NGEU package would have never been approved in its current form if the UK had remained part of the EU. In 2015, the UK opted out of the establishment and use of the EFSM, the facility created to sort out the Greek – and subsequent Eurozone debt – crisis, the model from which the NGEU and RRF have been designed. 

Post-Brexit, the presence of the UK was not an obstacle to the approval of a package that further pushed the process of European integration. As we discussed in our recent publication, the UK and EU are approaching the endgame of the Brexit negotiations. We expect a skinny deal to emerge eventually, in order to avoid the most catastrophic consequences of a no-deal Brexit. 

Meanwhile, the UK has struck a deal in principle with Canada, rolling over the terms of the deal that Canada and the EU made in 2017. This follows the trade agreement the UK made with Japan. Both agreements get the UK closer to joining, or at least benefiting from, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, i.e. what remained from TPP after the US pulled out of it. If Trump had won the US presidential election (and it is becoming increasingly unlikely that he will do so, as most of his lawsuits against Joe Biden’s victory are being rejected by judges), the UK might have struck an FTA with the US and used it to put pressure on the EU to compromise on Brexit. But now this solution is not at hand. Also, the UK could reach FTAs with Canada and Japan quickly only because they are based on the deals made by the EU with those countries in recent years, both made following years of negotiations. 

Given these circumstances, it is becoming increasingly clear that an agreement on Brexit between the UK and the EU is the most convenient option for both sides. 

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

26 October 2020

Months ago, UK PM Boris Johnson said that unless an agreement between the UK and the EU was found by the October 15th EU Summit, both sides should start preparing for a “no deal” scenario at the end of the transition period on 31 December 2020. The EU Summit ended without such an agreement, and Johnson said that negotiations will be over unless the EU becomes ready for a “fundamental change” in perspective. In effect, the UK government has been repeatedly telling companies and individuals to prepare for a no-deal environment.

After a few more days of back-and-forth declarations from the two sides, negotiations have in fact re-started in London in “submarine mode”, i.e. with sherpas from the two sides aiming at preparing a joint text, without consulting with their political stakeholders and without briefing the press as to the level of progress they have made. At the end of this “tunnel phase” of the negotiations, a joint text agreed by the two sides may emerge. 

There are three main areas of contention here: fisheries, state aid and dynamic regulatory alignment. Regarding fisheries, the EU would want EU boats (mostly from France, Spain and Ireland) to continue fishing in British waters, whereas the UK wants exclusive access. Regarding state aid, the UK wants to be able to subsidise its industries, which will need to adjust (sometimes heavily) post Brexit, whereas the EU wants the UK government to follow EU rules that forbid countries (outside of the current Covid-19 emergency) to provide state aid to private companies, so as not to distort the existing “level playing field”. For the same reason, the EU wants the UK to continue aligning also in the future (i.e. “dynamically”) with EU regulations even after the end of the transition period, something the UK will resist as much as possible as it attempts to reap the benefits of Brexit. 

At the same time as these talks proceed, a number of other major events are occurring that could have an effect on the positions of Britain and the EU. In the US, the presidential race is entering its last phase ahead of the November 3rd vote. 

As discussed in our preview, we currently expect Joe Biden to win the race, even if perhaps after a nasty legal battle. If Biden wins, Johnson’s negotiating strategy might fail, as he needs the support of Donal Trump to show that the UK has a viable alternative to trading with the EU (however credible the threat of severing trade ties with Europe might actually be). 

Meanwhile the UK has managed to strike a trade deal with Japan, which – according to the UK government – will be able to “secure additional benefits beyond the EU-Japan trade deal, giving UK companies exporting to Japan a competitive advantage in a number of areas… The deal is also an important step towards joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).”

Given this background, the EU and the UK will now have to 

decide whether to make at least a “skinny deal” in order to avoid a cliff edge at the end of December, without which major disruptions could  possibly occur in the financial industry, in transportation and trade. Room for compromise exists: the UK can give in on fisheries and state aid in exchange for the freedom to diverge from the EU from a regulatory standpoint. Indeed, the UK will never be able to absorb all the fish available in its seas with its small domestic market, and has never been particularly keen on state aid since the Thatcher’s liberal revolution. 

At the same time, for Brexit to be a success, obtaining regulatory divergence over time (especially on new areas such as data collection, management and protection) is absolutely essential for the UK. The EU might accept this trade-off, as long as the UK does not become a de facto offshore financial centre and does not engage in savage regulatory competition. If such a compromise does eventually emerge, it will still be “hard Brexit,” but perhaps less hard than it otherwise could be. 

by Brunello Rosa

19 October 2020

As the second wave of the pandemic is in full swing, its economic impact is becoming increasingly evident. The rapid increase of new daily Covid cases in Europe, which have recently surpassed those of the US, is forcing a number of European countries to implement renewed restrictions, such as partial lockdowns, or tiered systems such as those adopted by the UK. If the experience of the Spanish flu is of any guidance, the world might even experience a third wave in spring 2021, before a combination of incipient herd immunity, better treatment and availability of vaccines finally manage to tame the pandemic in H2 2021.

As a result of a longer than expected pandemic and more restrictive measures, the economic impact of Covid-19 is likely to be larger and longer than initially estimated. 

According to the latest estimates of the IMF, although global growth should fall less this year than had been expected in June (by 4.4% in 2020, with a 0.8% upward revision) the rebound after that is also expected to be shallower (5.2% in 2021, vs the 5.4% that had been expected in June). So, the IMF too is getting closer to the idea that the recovery will be U-, rather than V-shaped. But we consider even these projections to be too optimistic. 

If that is the case, it means that policy support is likely be larger and more prolonged than had been initially envisioned. During the IMF meeting a message emerged clearly: fiscal stimulus needs to be at the forefront of the policy response, with monetary policy either complementing fiscal policy or – bluntly said – simply monetising the ballooning fiscal deficits and debts.   

In fact, according to the latest forecasts in the IMF’s fiscal monitor, the US will reach a deficit of 18.7% of GDP, the UK of 16.5%, and the euro area of 10.1% in 2020, with France 10.8% and Italy at 13%. In terms of gross public debt in percentage of GDP, the IMF estimates the US to reach 131.2% in 2020, the UK 108%, the Euro area 101.1, with France at 118.7% and Italy at 161.8%. 

As a result of these ballooning levels of public deficits and debts, rating agencies are starting to re-evaluate the sustainability of public finances, and starting to take action accordingly. During the last week end, Morningstar DBRS downgraded France from AAA to AA, with the outlook moved from negative to stable. Equally, Moody’s has downgraded the UK from Aa2 to Aa3, also changing the outlook from negative to stable. The downgrades of these solid sovereign issuers will have little market impact, especially because the respective interest rate curves in those countries remain historically low. But for other countries, rating actions might have a larger impact. 

For example, the Italian rating will be reviewed by S&P Global, DBRS and Moody’s between October 23rd and November 6th. After the recent downgrades of more solid sovereigns such as the UK and France, a downgrade of the Italian rating becomes more likely. However, Italy’s position is more precarious as the country is already at the bottom of the investment grade grid, being Baa3 for Moody’s, BBB for S&P, BBB- for Fitch and BBBh for DBRS. A downgrade by Moody’s and Fitch would make Italy one of the most significant “fallen angels” of this crisis. 

In terms of immediate impact, the effects of a potential downgrade have been partially softened by the ECB, which has already said that “fallen angels” will continue to be used as collateral in refinancing operations or in PELTROs. However, asset managers following indices may need to start rebalancing their portfolios as a result of a downgrade. All this is to say that Covid-19 not only can attack the human body in unexpected ways, but may have larger economic repercussions than was initially envisaged.

by Brunello Rosa

12 October 2020

This week, the annual meetings of the International Monetary Fund (IMF) and the World Bank will begin. Though large component of the scheduled events will take place virtually, the IMF will still be releasing the latest edition of its World Economic Outlook (WEO), which includes updated estimates of growth and inflation for the vast majority of the economies of the world. According to the Brookings – FT tracking index, the recovery will remain fragile and patchy. This is in line with the column we published on 28 September, titled “Covid’s Second Wave Threatens Economic Recovery and Market Stability.” 

This is also in line with our latest Global Outlook Update - Market Views - Q4-2020 Strategic Asset Allocation, titled “Volatility To Create Opportunities, While Investors Keep Focus On The Long Term”. In that report we discussed how the Covid pandemic was likely to come in at least two, if not three, waves, the same way the “Spanish flu” pandemic did in 1918-19. In our analysis, we discussed how the second wave was the most deadly of the three waves during that pandemic a century ago. Given the rise in cases registered globally in the last few weeks, it is clear we are at the beginning of the second wave of the current pandemic. We cannot rule out there being a third wave in the months ahead, if the vaccine is not found before Q1 2021 (as we assume in the baseline scenario of our Global Outlook Update). 

Our report also discusses how we expect global growth to be worse than had been estimated by the IMF in June (we expect -5.3% growth, vs the -4.9% the IMF estimated), with the rebound in 2021 more anaemic as well. As a result, monetary and fiscal accommodation will still be required. 

In terms of fiscal policy, most governments will continue to provide protection to companies and individuals, but,  as UK Chancellor of the Exchequer Rishi Sunak said in parliament at the end of September  governments will not be able to save every company and every job. In Europe, where the institutional setting remains more fragmented, the approval and implementation process of the Next Generation EU plan is now encountering some difficulties, which might delay the arrival of its funds further into 2021. 

For this reason, monetary policy needs to remain highly accommodative. Following the Fed’s de facto promise of keeping rates extremely low for a much longerperiod of time, all other central banks are reacting, both in developed and emerging markets. In the G10 sphere, we expect imminent moves (in November) from the Bank of England, the Reserve Bank of Australia and the Reserve Bank of New Zealand, featuring a combination of rates cuts, revised forward guidance, larger asset purchases and new credit-easing facilities. Negative policy rates have started to enter the radar screen of the central banks in the so-called Anglosphere (the US, UK, Canada, Australia, and New Zealand), which so far have been the most reluctant to adopt them. 

Through all of this, markets remain volatile, with equity markets having just experienced the second week of a rebound after four weeks of market losses. Meanwhile we are entering the most delicate part of the US electoral campaign, which could culminate in a 10% correction in equity markets in case of a highly contested result. In this volatile environment, strategic asset allocators should focus on longer-term investment horizon.  

Picture source: Taubenberger JK, MorensDM. 1918 Influenza: the Mother of All Pandemics. Emerg Infect Dis. 2006;12(1):15-22.

 by Brunello Rosa

5 October 2020

Last week US President Donald Trump tested positive with the SARS-CoV-2 (Covid-19) infection, together with a number of members of his family, his inner circle and White House staff. Press reports suggest that he might have contracted the virus from his senior advisor Hope Hicks (former director of strategic communications at the White House) or, possibly, during what was defined as a “super-spreader” event, held at the White House on September 26th, just a few days before he tested positive. 

The first obvious concern is whether, how and when the US President will fully recover from the disease, for which he was hospitalised and treated with innovative (indeed, almost experimental) cures, including a mix of remdesivir, an antiviral drug, with polyclonal anti-bodies and other substances. In a recent message from the hospital, Trump declared himself to be in good shape and on his way to recovery. 

The second concern is what type of impact this event could have on the US Presidential race. Since the first debate between Trump and the Democratic nominee Joe Biden took place on September 29th, it is not impossible that Joe Biden also contracted the virus, possibly from Trump, Trump’s family, or his inner circle, members of which were not wearing a facemask at the debate. If both candidates were to have Covid, it is possible that at least one, if not both of the subsequent debates (currently scheduled for October 15th and October 22nd) will be cancelled. This would be a real novelty for US Presidential elections; the American public has been able to watch televised presidential debates since 1960. 

Another issue is that Trump’s infection might fundamentally alter his political strategy. Clearly, most of his bold communication was centred around his attempt to downplay the significance of the virus. 

This was an attitude that he shared with all of the other major Covid-sceptics, such as UK Prime Minister Boris Johnson and Brazil’s President Jair Bolsonaro, both of whom have also fallen ill with Coronavirus in the last few months.   

Having contracted the virus himself, and being hospitalised (in a military facility), it will be hard for Trump to continue downplaying the significance of the pandemic and its impact on public health, the economy and society in general. There have now been almost 210,000 cases directly attributed to Covidin the United States. 

Additionally, given Biden’s advantage in the polls, it was clear that Trump was getting ready for a nasty legal battle following the night of the vote on November 3rd. Trump thought the election result could reach the Supreme Court, as it did in 2000 in the contested election of George W. Bush and Al Gore. That partially explained the heist with which he appointed Amy Coney Barrett as his Supreme Court pick in substitution of the late Ruth Bader Ginsburg, who died on September 19th. If Trump (and – a fortiori – if both Trump and Biden) were still to be in hospital in November, would that strategy still pay off?

Finally, and most importantly, will Trump’s infection fundamentally alter the American voters’ perception of how Trump handled the pandemic? The obvious narrative from the Democrats would be that, the same way that Trump didn’t care for his own health (and his family’s and inner circle’s health), he was way too nonchalant on his approach to the pandemic for the country, ultimately allowing the virus to spread out of control and result in a death toll much higher than what would have been the case had he had adopted more stringent containment measures. 

The Republican response is likely to be based on Trump’s recovery: a fast and full recovery would be used as an argument to say that the significance of the virus and the pandemic is vastly over-stated. This would help Trump’s light-touch approach to appear be justified. The voters will ultimately decide whose narrative gets more traction. 

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

31 August 2020

Japanese PM Abe Shinzo resigned at the end of last week, suffering as he is from a pathology (ulcerative colitis) that had already previously caused him to resign in September 2007, back when he had only been in office for one year. This institutional crisis could not come at a worse time for Japan, which is facing a second wave of Covid and is in the middle of the worst economic contraction in decades, with GDP having fallen by 7.8% q/q in Q2, the third consecutive quarterly drop in the country’s GDP. 

Abe’s second term in office started in December 2012, with the resounding victory in the general election that led to a solid majority for his party, with 328 MPs out of 480 in the House of Representatives of the Diet. With the support of a strong cabinet featuring former Prime Minister Tarō Asō as Deputy Prime Minister and Finance Minister, Yoshihide Suga as Chief Cabinet Secretary and Akira Amari as Economy Minister, Abe launched his celebrated Abenomics, consisting of three “arrows”: ultra-loose monetary policy, initial fiscal stimulus followed by fiscal consolidation, and structural reform. 

As generally happens, the policy package started with the lower-hanging fruits, i.e. massive monetary easing in 2013, which led to the adoption of QQE (quantitative and qualitative easing), followed by the introduction of various forms of forward guidance, credit easing, negative policy rates and (last but not least) yield curve control. All these monetary innovations led to the weakening of the JPY, and the massive rise in Japanese equity valuations (Nikkei and Topix), with Japanese companies recording record profits, often hoarded abroad.

The other two arrows proved less successful: following an initial JPY 10tn stimulus package, fiscal consolidation came with the rise in the consumption sales tax, from 5% to 8% in April 2014. That fiscal tightening led to the Japanese economy to a stall and, eventually, a recession in Q2 and Q3 of that year, which plagued Abe’s second term in office. The decision to proceed with the planned second hike in the sales tax rate (from 8% to 10%) in 2019 led to similar results, with the ongoing recession aggravated by the arrival of Covid. The pandemic has also forced the government to postpone the flagship event with which Abe wanted to conclude his period in office: the Olympic games in Tokyo. They will now have to wait until 2021 at least.

The pandemic has also forced the government to postpone the flagship event with which Abe wanted to conclude his period in office: the Olympic games in Tokyo. They will now have to wait until 2021 at least.    

The third arrow has been even less successful, as the planned and implemented structural reforms were watered down and ineffective at best, in a country where the population is rapidly ageing and shrinking (from almost 130 million today to around 100 million only a few decades from now, barring a significant change in birth rates or immigration). As a result of all this, the overarching aim of bringing the deflationary period to an end after almost thirty years has miserably failed, with inflation struggling to remain above zero. Other notable failures of Abe’s second term in power were the attempt to hold a referendum to change article 9 of the constitution in order to allow Japan to re-arm, and the failure to settle an old territorial dispute with Russia. 

However, Abe’s period in office also saw some important successes, such as his ability to remain in power for 7 years in a row, ending the endemic instability of Japanese governments that had defined the decades before Abe’s ascent.  The re-vitalisation of the Trans-Pacific Partnership (TPP) after Trump ditched it in 2016 was another success (it has been relabelled the Comprehensive and Progressive Agreement for Trans-Pacific Partnership). One could also classify as a success Abe’s ability to forge a good working and personal relationship with US President Trump, which may have helped lead the US to engage with North Korea, and stop North Korea’s missile tests of rockets sent over the Japanese territory.

What lies ahead for Japan? Next year, the general election was supposed to bring a new LDP leader and PM to power; now the process is accelerated. The race has begun, with credible contenders being Fumio Kishida (LDP’s head of policy), Shigeru Ishiba (former defence minister), Yoshihide Suga and the old Tarō Asō, who would not mind a final stint in power before retiring. More than their personalities, it is Japan’s policies that will matter. Assuming that for the time being monetary and fiscal policies will remain amply accommodative, one needs to understand how Japan will position itself strategically in international affairs, at a time when the US election is as uncertain as ever and China has become more assertive than ever. The next few months will determine the path Japan will follow in coming years.

by Brunello Rosa

24 August 2020

The Democratic National Convention (DNC) was held in Milwaukee last week – mostly in virtual format, given Covid-19 – with the nomination of Joe Biden as the Democratic candidate for the US presidential election on November 3rd. On August 11th, Biden chose Kamala Harris as his running mate and candidate for the Vice-Presidency of the United States. With Harris’ appointment and Biden’s nomination by the Democrats, the race for the White House against the incumbent Republican President Donald Trump and his VP 

Mike Pence has officially begun. 

Donald Trump is currently under attack for his management of the Covid-19 crisis, with the number of infected people in the US having reached 5.6 million people and the number of deaths 175,000, the highest number of confirmed cases and reported deaths in the world. This has led to the sharpest contraction of the economy since the Great Depression of the 1930s (-32.9% SAAR in Q2), with a rise in the number of unemployed people, which reached in  14.7% of the workforcein April 2020, before falling to the current level of 10.2%. The successful management of the pandemic and the economic track record will not be arguments that Trump will be able to credibly run on during the electoral campaign. Equally, the divisive and polarising nature of his presidency, including the rise of “white supremacist” movements across the US, will make Trump’s re-election harder. 

At the same time, the incumbent President always enjoys a special status, which gives him a slight head start in the race. Policies, including further tax cuts and fiscal stimuli, can be adopted between now and the day of the election in an attempt to swing voters in his favour. Some further “successes” in foreign policy such as the recent agreement between the UAE and Israel, or the continued implementation of the Phase-1 deal with China can be used as “weapons of mass distraction”. So, in spite of his recent difficulties, it would be wrong to write Trump off at this stage.

In the opposite camp, Biden has emerged as the obvious centrist choice to fight against a polarising figure such as Trump. He can enjoy the support of former presidents Obama and Clinton (whereas Trump faces the disapproval of former presidents such as G.W. Bush and other GOP grandees), and Trump’s mistakes on Covid and the economy are defining the campaign for him. The choice of Harris as running mate is supposed to bring on board the votes of ethnic minorities and socially disadvantaged groups, in an attempt to win back crucial votes in swing states that in 2016 allowed Trump to win the race even with nearly 3 million fewer votes than Hillary Clinton.   

At the same time, some of the Republican votes that might have gone for Biden just to get rid of Trump could be put off by Biden’s choice of a VP – a VP who could potentially become President, if Biden became “unavailable” for whatever reason during his first term in office. Additionally, Harris’ centrist approach might not be enough to win back the votes of the party’s left wing, represented by Bernie Sanders and Alexandria Ocasio-Cortez. 

Pollsters are divided as to what the eventual outcome of the election will be. Recent national polls suggest that Biden is ahead, but we know that what really matters is the distribution of votes in key swing states. Those using sophisticated statistical methods that managed to predict Trump’s surprising victory in 2016 are also divided. The outcome is still uncertain at this stage, therefore. There are however three things we can be sure about: 1) The campaign will be acrimonious, and full of ruthless accusations thrown by both sides at their adversary. 2) In the event of a narrow defeat in the electoral college, Trump will fight hard not to leave the While House. 3) The US will emerge more divided than ever after this campaign, and a lot of effort will need to be made by whoever wins to unite the country behind the President.   

by Brunello Rosa

17 August 2020

During the 20th century Europe was been plagued by dictatorships. The most known where those in Germany, Italy, Spain, and Portugal. Adolf Hitler and Benito Mussolini were removed from power at the end of World War II, when Germany and Italy returned to democracy; Portugal’s António Salazar lasted until 1968 (and his authoritarian government remained until 1974) and Francisco Franco until 1975, the year of his death. But somewhat incredibly, dictatorship remained a viable option in many other parts of Europe for much longer than this. 

In Greece, the dictatorships of the colonels (τὸ καθεστώς τῶν Συνταγματαρχών), also known as the Junta (η Χούντα), lasted from 1967 until 1974. In Jugoslavia, the regime by Colonel Josip Tito lasted for a decade beyond the year of his death (1980), until the division of the country and Balkan wars of the 1990s. In Eastern Europe various forms of authoritarian regimes stayed in place until 1991, when the Soviet Union collapsed. Since then, the progressive expansion of the European Union and of NATO has gone together with an expansion of democratic regimes in the region. 

In some cases, such as in the Baltic countries (Estonia, Latvia, and Lithuania), the adoption of the Euro has also meant a consistent transition to democracy and political freedom. 

Other countries, such as Poland and Hungary, have backtracked on their progress towards democracy, with the arrival of the Kaczyński brothers and Viktor Orban, respectively. For this reason, both countries are now under the procedure foreseen by Article 7 of the EU Treaty for violating basic principles of the EU, including academic freedom, freedom of expression (particularly freedom of the media), and the independence of the judiciary. In other cases, such as in the Czech Republic, right-wing populist leaders threaten the existing democratic regime. 

The two most remarkable cases in Europe remain Ukraine and Belarus. Ukraine has gone through a very complicated transition, including having to deal with the annexation of Crimea by Russia in 2014. The election of Volodymyr Zelensky in 2019 seems to have normalised the situation – or at least frozen the status quo, for the time being. Clearly, Ukraine remains in a situation that is less than ideal, as half of the country (especially its easternmost regions) remains under the heavy influence of Russia, and no real progress seems to be taking place in the negotiations for the association of Ukraine with the EU. 

The second case, Belarus, has come back to the fore in the last few days, with the recent re-election of incumbent president Aljaksandr Lukashenko, who has been in power without interruption since 1994. The election was officially won by Lukashenko with 80.1% of votes, versus 10.1% for his only remaining rival, Svjatlana Tikhanovskaya. But the EU and the US have not recognised the result the elections, and are now discussing possible sanctions on Belarus. As violent riots occurred in the capital Minsk as well as in other parts of the country, Tikhanovskaya had to flee the country in order to avoid being arrested, and will now have to continue her fight from Lithuania. The question is whether Lukashenko will manage to stay in power for a long time yet, and eventually pass the baton to his young son (as he has planned for a long time) or if he will be ousted from power. The answer to this question probably lies in Moscow.

For decades the fragile Belarus economy counted on subsidies coming from Russia, assuring it full employment, rising wages, and the well-being of its population. But as Russia itself ran into economic difficulties following the collapse in oil prices in 2014, its economic help started to wane, and with it, political support for Lukashenko’s regime. The president cannot last unless Putin and Russia support him. So, Putin will have to decide what to do; that is the reason for the recent phone conversation held between the two presidents. Lukashenko warned Putin that the riots pose a threat to the stability of Russia as well. In a a not-so-veiled request for help, he claimed that if the riots do not get stopped in Belarus, they will spread to Russia as well. That’s why a military intervention by Russia in Belarus cannot be ruled out at this stage. 

For some time, the idea has existed that the president of Russia would also become president of Belarus, in something akin to a new confederation being formed between the two states. This seemed to be one of the options that Putin was considering to extend further his own mandate within Russia. However, now that Putin has managed to change the Russian constitution, allowing him to remain in power until 2036, this option seems to be less palatable, considering the lack of support among the people in Belarus for a sort-of “annexation” of their country by Russia. At the same time, a nationalistic approach, in which Belarus would try to re-assert its independence from Moscow, is not particularly popular among the wider populace either. 

So, perhaps the only option remaining on the table for Putin is to keep Lukashenko in power for longer and increase economic and financial support for the country. But this solution may prove to be more temporary than either of the two presidents desire, exposing them to further revolts.  

 by Brunello Rosa

10 August 2020

After the disastrous collapse in economic activity recorded in Q2, with real GDP falling by double digit percentage points in many economies, including in the most advanced ones, the global economy is attempting a timid rebound in Q3. The re-opening of economies after months of widespread lockdown, when 1/3 to half of the world population was estimated to be subject to more or less draconian restrictions, is facilitating a comeback in economic activity. However, this rebound is uneven and uncertain at best. In its latest statement, the US Federal Reserve’s FOMC warned about a slowdown in this timid rebound, as signalled by many leading and contingent indicators. 

Governments remain alert and active in their plans to stimulate economic activity. Among others The US is preparing its third fiscal stimulus package, the EU has just adopted the new Recovery and Resilience Facility, and the UK has prorogued its furlough schemes (together with other forms of fiscal support). 

Central banks remain fully accommodative after having launched what we called “Covid-related forward guidance”. In fact, in August the Reserve Bank of Australia (RBA), in deciding to re-start QE after the lockdown in the state of Victoria, joined the Fedand the ECB in explicitly linking the duration of its monetary stimulus to developments of the virus. 

After the so-called “time-limited” and “state-contingent” forms of forward guidance, in which the central bank will continue to provide monetary stimulus until a certain date arrives or a pre-set economic condition materialises, some central banks seem to have decided to launch a new form of state-contingent forward guidance, in which the condition to be met to reduce the stimulus is fully exogenous. Specifically, central banks will continue to keep policy rates low (or lower) or make asset purchases until there is convincing evidence that the virus has been durably and credibly contained.

 Considering that the number of cases is still accelerating in very large parts of the world, such as in the US, Brazil and India, this means that central banks will keep the tap of liquidity open for the foreseeable future. Most central banks, when showing their implicitly expected path of policy rates, do not show any sign of tightening over the forecast horizon. 

Who is benefiting from this situation in financial markets? 

Clearly risk asset prices have been the ones that have benefited from the combination of monetary and fiscal stimulus (sometimes coordinated in “helicopter money” fashion). But there is plenty of evidence that both equity and credit markets valuations are stretched, as they are under-pricing the risk of the chain of defaults and bankruptcies which is likely to manifest itself in coming months. Perhaps also because of this reason, the clear winner so far seems to have been gold. 

The yellow precious metal has in fact reached and recently overcome the 2000$ per troy ounce for the first time since the Global Financial Crisis. Gold was trading at just over $250 in the early 2000, before starting a glorious rally that brought it to $1750 (monthly prices) during the Euro crisis in 2011-12. After retracing and falling to just over $1000 in 2015, the rally re-started with some conviction in mid-2019 (when the Fed started to implement its “insurance cuts”) with a serious acceleration in the last few months. 

As discussed in our recent in-depth analysis, there are multiple reasons for this rally. Gold is perceived to be a good hedge against inflation, but also deflation (as it is a physical asset, but nobody’s liability, unlike government bonds). It is a store of intrinsic value and is also perceived to be a store of US dollar value, during a time when political uncertainty and turmoil in the US, ahead of the Presidential election in November, is making many investors nervous about the greenback. 

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