WEEKLY COLUMNS (ARCHIVE)

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by Brunello Rosa

16 May 2022

Last week, financial markets were in turmoil once again. Global equities decreased on a weekly basis, with the MSCI ACWI index down by -2.2%, the US S&P 500 index dropping -2.4% and the MSCI EMs falling by 2.6%. With this week’s negative performance, this year is the second worst start to a year for the S&P 500 in history: -17.5% in the first 91 trading days. Logically, volatility has also risen considerably, with VIX rising to 29.35 (versus a 52-week average of 21.7 and a 10y average of 18.0). 

Volatility in markets is increasing as investors are becoming sceptical that central banks will be able to engineer a ‘soft landing’ for the economy after the series of rate increases that they are planning to implement in coming months in order to tame inflation. Reasons for concern abound, as investors have suffered from: i) the accelerated pace of monetary tightening that most central banks have announced, most recently the ECB, which may be increasing rates already in July; ii) geopolitical news, with Russia threatening a retaliation to a possible admission of Finland and Sweden to NATO; iii) persistently high inflation data; iv) the impact of strict lockdowns in China, which are further disrupting global value chains; and v) increasing recession fears as the global economy is slowing down. 

However, last week, something different from previous weeks occurred. US government bond yields (especially in the US and the eurozone) fell amid the sell-off in equity prices. So, the correlation between bond and stock prices went back to negative after being positive recently. Finally, credit spreads widened, with the effective yield on US “junk bonds” (US High Yield Master II) reaching 7.4%, the highest level since May 2020. All this while bank equity prices continue to fall, with the shares of the five largest US banks down between 20% and 25% year-to-date.  

How can we interpret all this? In the stagflationary scenario that we have observed so far, the combination of higher inflation, lower growth and higher long-term rates, have led to a parallel decrease of bonds and equity prices (positive correlation). But the increase in recession probability means that inflation may be lowered by the reduction of the demand side of the economy, making stagflation fears less pressing. As a result, there start to be risk-off flows into government bonds, thus lowering their yields. 

Additionally, rate increases tend to be good for banks, as they steepen the yield curve on which they profit with maturity transformation. But if rate increases risk causing a recession, the weakening of the economy would be bad for bank profitability. As a result, bank equity prices fall. 

In all this, price movements have been exacerbated by the sharp sell-off in the crypto-currency space, where Bitcoin has fallen below the psychological barrier of 30,000 and lots of stablecoins went under stress, with the Terra/Luna trade collapsing and even Tether shortly falling to 95.11 cents on the dollar. With USD 80bn held in assets as collateral, sharp liquidations to keep the peg at 1$ would eventually also impact traditional markets, not just the USD 1.3tn crypto-asset market.

by Brunello Rosa

9 May 2022

In February 2019 we identified the round of elections taking place between the German general election in September 2021 and the French parliamentary election in June 2022 as being crucial to determining the future of the EU integration process. Now, as we approach the end of this round of elections, we want to take stock of what has happened thus far, to revisit our earlier views on the subject.

The German general election (September 2021). The German election resulted in a collapse of the CDU. The CDU was narrowly overtaken by the SPD, which was able to form an unconventional “traffic light” coalition with the Greens and the Liberals. So far, this coalition has managed to navigate both the last phase of the pandemic and the war in Ukraine with relative tranquillity. The pro- European and Atlantic credentials of Germany have been re-affirmed, and the extreme wings of Germany’s political spectrum have been left out of government. However, the fragmentation of the political system, with the collapse of traditional parties, is not reassuring for the stability of Germany, the key pillar of the EU and Eurozone.

The Italian Presidential election (January/February 2022).The Italian Presidential election resulted in a non-event, with the re- election of Sergio Mattarella as Italy’s head of state for another 7-year term. His re-election, coupled with the permanence of Mario Draghi as PM, for now reassures Italy’s allies regarding its Atlantic ties and pro-European stance. On the other hand, the fact that Mattarella may not remain in charge for the entire duration of his second mandate does not guarantee that Italy will elect a pro-European President during the next parliament, if a Lega-FDI majority were to emerge after the general election of February/March 2023. 

The French Presidential election (April 2022). As we discussed recently, Macron’s victory is certainly the best reassurance that the EU integration process will continue (in the areas of defense, security, and migration policies, for example), however slowly. But it is a fact that the majority of Macron’s voters were over-60-year-old pensioners. At the same time, with 41.5% of the vote, Marine Le Pen has gathered the highest number of votes for a right-wing candidate since the beginning of the country’s Fifth Republic, and did so with a much larger geographical dispersion of the vote share than in previous elections. This is already the third time a Le Pen has reached the second round of the presidential election. In 2002 Jean-Marie, the father of Marine, lost to Jacques Chirac; in 2017 and now again in 2022 Marine has faced Emmanuel Macron in the second round of the presidential election. In each of these appearances the far right has increased its votes, both in absolute terms and as a share of total votes cast. One cannot rule out that Marine Le Pen may win the election in 2027, considering that Macron will be blamed for all the misfortunes French people may experience in the meantime. A Le Pen victory would represent a total regime change in France, which would put the EU integration process in peril.

As mentioned above, the results of this round of critical EU elections, which will finish this June with the parliamentary elections in France, has been something of a mixed bag thus far. On the one hand, traditional pro-European parties have “held the fort”, so to speak. On the other hand, this “fort” remains under the siege of the anti-European parties, which may want to stop the integration process, or even reverse it. A few years of high inflation, higher interest rates, low economic growth or recessions may change the tide in favour of these still-strong populist parties.

by Brunello Rosa

2 May 2022

We have discussed in previous columns that the war in Ukraine has contributed to the world becoming polarised into two camps: the US and its allies, including the EU and other European countries, on the one hand; China, Russia, and their allies (including Iran, North Korea, and Pakistan, for example) on the other hand – with India having to choose between the two camps.  

We have also discussed the two lines emerging within the Western alliance. The EU is more inclined to reach an immediate ceasefire between Russia and Ukraine, even at the cost of freezing the situation temporarily in an unstable equilibrium which Russia may be tempted to break 2-5 years down the line. The US however is more inclined to keep the conflict going for a little longer (perhaps until the mid-term elections in November).

Within this framework, it becomes of paramount importance to determine the fate of Ukraine, regarding among other things its application to join the EU. There’s no point in discussing how to reconstruct Ukraine from an economic standpoint, if its geopolitical status has not been determined yet. More generally, it is absolutely vital to determine what geopolitical configuration Europe may have in coming decades. For this purpose, it may be useful to resurrect an idea I launched many years ago in several publications (including here and here). 

In the aftermath of the Crimea annexation by Russia (just to remind ourselves how long ago this process started), Europe was also observing the rise of populism, at the same time in which secessionist regional forces were becoming stronger in places such as Northern Italy, Catalonia, Flanders, and Scotland. I suggested that two main policy actions and re-organisation processes needed to be implemented.

From a country perspective, countries had to be re-organised in concentric circles, with the inner circles being represented by the Eurozone and the EU and an outer circle being formed by countries which wanted some form of close cooperation with the EU without being formally part of it. Belonging to that circle there were countries such as the UK, Turkey, Albania and – hear hear – Ukraine (see picture above).  

Given the strengthening of the outer borders of Europe, I suggested – in terms of internal organisation – to promote a gradual weakening of the internal borders within the EU, and the formation of cross-border macro-regions, with real decision-making power being pushed down closer to the population, as sovereignty was pushed up at supra-national level. Recently a similar proposal has been formulated recently by the leader of the Italian Democratic Party (PD) Enrico Letta, former Dean of the Paris School of International Affairs at Sciences Po (PSIA), who spoke about a European Confederation, which comprises non-EU members; and by a former Italian Finance Ministry Vincenzo Visco. But in the past the newly re-elected French President Macron also expressed similar ideas.  

Given how the war in progressing, I believe the idea of re-organising Europe in concentric circles remains the only option  if we are to guarantee long-term security and peace in Europe. Admitting Ukraine in the EU will remain a long and controversial process, and is not even a given that a EU accession by Ukraine would represent a positive step for the overall viability and solidity of the EU. Instead, promoting a form of strong association of the EU with Ukraine, as well as with other countries in the outer circle, such as the UK, Turkey and Albania, could help stabilise the geopolitical situation in the decades to come

by Brunello Rosa

25 April 2022

The IMF and World Bank held their Spring Meetings last week, once again mostly in virtual format with only a limited number of events held in person, due to the still-ongoing restrictions associated with the Covid pandemic. 

As usual, the IMF released its updated forecasts in the World Economic Outlook (WEO). The WEO “certified” the stagflationary shock that hit the global economy as a result of the continuing impact of the pandemic and the simultaneous impact of the war in Ukraine and its related sanctions. Combined, these events represent a double negative supply-side shock, which tends to push inflation up and economic activity down. The latest issue of the WEO, titled “War Sets Back The Global Recovery”, says that “economic damage from the conflict will contribute to a significant slowdown in global growth in 2022 and add to inflation.” 

More specifically, the IMF reports how “global growth is projected to slow from an estimated 6.1 percent in 2021 to 3.6 percent in 2022 and 2023. This is 0.8 and 0.2 percentage points lower for 2022 and 2023 than projected in January. Beyond 2023, global growth is forecast to decline to about 3.3 percent over the medium term.” Regarding inflation, the IMF says that “war-induced commodity price increases and broadening price pressures have led to 2022 inflation projections of 5.7 percent in advanced economies and 8.7 percent in emerging market and developing economies—1.8 and 2.8 percentage points higher than projected last January.” In its commentary, the IMF says that “fuel and food prices have increased rapidly, hitting vulnerable populations in low-income countries hardest.”

The meetings schedule also foresees discussions on the legacy of the pandemic on younger generations and on the labour market with two discussion panels titled “The COVID Generation: Offsetting Opportunity Loss for Youth” and “Labor Market Slack in Advanced European Economies & North America.” As discussed in previous columns, the phenomenon of the “great resignation” has led to a significant slack in the labour market, while having a negative long-term impact of the employability of the younger generations. 

Given this economic backdrop, policymakers gathered in Washington DC had to figure out a policy response. At the “G20 Finance Ministers and Central Bank Governors” held in Washington under the rotating Indonesian presidency, G20 “members underlined the crucial role of the G20 as the premier forum for international economic cooperation to deal with the current multifaceted and complex global economic challenges.” In our recent article, we discussed how the ongoing polarisation of the world between US and China is leading to the ineffectiveness of international fora such as the G20 in dealing with ongoing policy challenges. It is good to see that central bank governors and finance ministers at least still believe in a multilateral approach to solving complex policy issues. 

Having said this, as the communique says, “G20 members expressed concerns about the wider and persistent inflationary pressures. This condition will push central banks to increase their interest rate policies which in turn will result in faster-than-expected tightening of global liquidity.” So, as we anticipated in our recent analysis, even the G20 forum “sanctioned” that, at this time, central banks should focus on fighting inflation, while governments focus on supporting economic activity.

by Brunello Rosa

19 April 2022

The war in Ukraine is at a crucial point. The Russian army has found itself facing more resistance in its advancement than it had anticipated. It apparently failed to conquer Kiev on its first attempt. Therefore, it has recently focused its efforts on securing the areas that would guarantee territorial continuity between Crimea and the Russian motherland. In this respect, conquering Mariupol has become the near-term tactical objective of the Russian army. Russian President Vladimir Putin needs to flag some victory at the May 9thparade that celebrates the “Great Patriotic War,” i.e. WW2. In his initial plan, he might have wanted to celebrate the definite submission of the entire Ukraine by that date, but this objective is clearly unattainable at this stage. 

Ukraine managed to stall the Russian invasion thanks to the substantial military aid it has received from NATO countries, which are providing weapons to its army and other supplies to the wider population to withstand the atrocities of the war. The US has already reportedly provided USD 3bn in direct and indirect support, while the UK’s navy seals are reportedly training the Ukrainian forces. In fact, for the time being, NATO countries have been providing Russian-made weapons to the Ukrainian forces. But in the future, Western-made artillery may need to be provided to the country under siege. 

Two lines are clearly emerging within the Western alliance. European countries would be more inclined to press on the diplomatic channel, in an attempt to achieve a ceasefire sooner rather than later. The US, with the “weaponised rhetoric” of its president, is clearly not interested in making any sort of deal with Putin, which means a likely extension of the conflict. If Sweden and Finland were to join NATO, as flagged as a possibility by the two countries’ respective prime ministers, that might imply an expansion of the conflict, if Russia were to retaliate in the Baltic as was recently threatened by Putin. 

Putin’s Russia can withstand the sanctions of the Western alliance for longer only if China will provide forms of direct and indirect support. There has been plenty of discussion about whether Putin is acting rationally or if he has already entered the typical end-phase of autocratic leaders, when they lose touch with reality and exhibit clear signs of “delusion of omnipotence.” Let’s assume that Putin’s actions are still borderline rational. In any case, he will remain a very difficult ally to control for China’s President Xi Jinping. Xi can at most “manage” Putin and the implications of his actions, but will not ever be able to fully control him. 

But here is the real question. How rational is it for China to rely on Russia as an ally in its Cold War II with the US? After all, the principal destination of China’s exports remains the US and the EU. In a fully balkanised world such as the one that is emerging as a result of Cold War II, economies like South East Asia and even India  (if it were to choose the Chinese camp, let alone an alliance with Russia) will not be able to replace the US and the EU as “consumers of last resort.” One therefore needs to wonder if Xi may also have entered the final phase of autocratic leaders, after the changes of the constitution that will allow him to remain in power indefinitely. These will take place just before this autumn’s key party congress, where Xi is seeking to be elected as leader for the third time.

People from China report a further “closure of the system” that has taken place in the last few years, as testified by the suppression of liberties in Hong Kong, for example. An old Chinese saying states: “When the sage points at the moon, the fool looks at the finger.” So perhaps when assessing the rationality of choices of leaders, one should not stop at looking at Putin’s “finger”, when instead Xi’s “moon” should be watched. With one frightening certainty in mind: while the West can barely contain Russia without triggering WW3, it will be much harder to contain China in coming decades, given the technological, economic, military and now geo-strategic advancements it has made in the last few years.

by Brunello Rosa

11 April 2022

Last week the UK government announced that it intends to issue regulations that will make the UK the global hub for crypto-finance. As part of this effort, the UK government will allow stablecoins to be recognised as a valid form of payment in the country. Regulatory measures will include legislation for a ‘financial market infrastructure sandbox.’ Additionally, the Chancellor has commissioned the Royal Mint to create a Non-Fungible Token (NFT) this summer. 

This is a quantum leap in UK regulation, vis a vis the crypto-financial industry. So far, the UK has taken a very cautious approach towards the world of digital assets. Even central bank digital currencies (CBDCs), which have been studied in all major jurisdictions, including in the US and the euro-area, received a very lukewarm welcome by the House of Lords, which tellingly issued a report on them with the title “A Solution In Search For A Problem?”. Recently, the Bank of England has issued a report highlighting the financial stability implications of adopting  crypto-assets and decentralised finance (de-fi) on a large scale.

The UK government has however clearly decided to change tack regarding this issue. Rather than demonize the digital asset revolution, the UK government is attempting to embrace it. 

Already, there are forms of digital assets, such as CBDCs, that are openly studied by monetary authorities and regulators. So, as soon as all the numerous technical and legal problems affecting these will be resolved, we can be reasonably sure that central banks will issue them, the same way the People’s Bank of China did with the e-CNY. 

Other forms of digital assets, such as stablecoins, are still under scrutiny, but will most likely become an acceptable form of payment relatively soon. 

After all, some versions of these already exist as forms of payment - the fidelity points issued by airline companies, for example - even if they can be only spent in closed circuits. In this respect, the UK government’s decision to accept stablecoins as acceptable forms of payment will represent a turning point for most regulators around the globe. 

What could be more surprising is the UK’s decision to include crypto-assets, sometimes labelled as crypto-currencies (which is a controversial term, considering that for most regulators, cryptos don’t have the three standard characteristics necessary to be considered a currency), in the new regulatory framework. What motivates this decision? 

In our view, the UK government is trying to find niches within which they can apply the regulatory divergence with the EU that the country has recently earned the ability to carry out as a result of Brexit. Bio-tech and fin-tech are clearly areas that can be exploited in this regard, and therefore we are not surprised by this decision. If the UK government wants to make Brexit a success, it will have to show that it can exploit some competitive advantages, and the crypto industry represents a perfect opportunity to do so. 

In the UK government’s view, it is not even necessary that crypto assets are actually viable, or even whether of not they are potentially illegal. As long as their financial activities are carried out in UK territory, the government believes it can control, steer and eventually regulate these activities. The UK government probably has the ambition of creating a City 2.0, in which the central role of London and sterling is re-established in the cyber realm. This may be an ambitious, aspirational or and even arrogant objective. But the UK has clearly shown that it intends to take a lead within this evolving environment.

by Brunello Rosa

4 April 2022

A bilateral meeting between China’s foreign minister Wang Yi and his Russian counterpart Sergei Lavrov took place in Beijing last week. This was the first bilateral meeting between the two sides since Russia’s invasion of Ukraine. Speaking in a video released by its ministry, Lavrov said that Russia and China are working together to establish "a multipolar, just, democratic world order". According to Lavrov, the world was "living through a very serious stage in the history of international relations", but that China and Russia, together with their “sympathisers, will create such a new world order". China’s Yi reiterated that China and Russia will continue to coordinate their foreign policies,and that will continue to “speak with one voice” on the world stage.  

These sentences are a clarification and a further confirmation of the joint declaration that Chinese President Xi Jinping and Russian President Vladimir Putin signed on February 4th, on the sidelines of the Winter Olympics in Beijing. That statement also added that the bonds between the two countries have “no limits” and that “there are no forbidden’ areas of cooperation.” That joint declaration opens with a statement that sends shivers down the spine, considering that is signed by two autocratic leaders: “The sides [i.e. China and Russia] share the understanding that democracy is a universal human value, rather than a privilege of a limited number of States, and that its promotion and protection is a common responsibility of the entire world community.”  

For those who are at loss here, this kind of language is not typically used in some second-tier commercial agreements, whereby the sides discuss  “joint interests”, “commercial opportunities”, etc. This kind of language is used in game-changing declarations, aimed at profoundly modifying the status quo and opening a new phase in the world history. As we discussed in our recent article by John Hulsman, China and Russia are paving the way for the creation of a new, polarised world, in which the “Eastern” hemisphere, geographically dominated by Russia and China, will oppose the traditional “Western” alliance, comprising the Anglosphere (US, UK, Canada, Australia, New Zealand), the EU and Japan. In a previous column, we discussed how this is already having an impact on the international payment systems, with China’s CIPS gaining ground versus the Western-dominated SWIFT.  

In this new polarised war, it is yet to be determined what side India wants to stay on. On the one hand, the US has forged the QUAD alongside India, Australia and Japan, an association of democracies in the Indo-Pacific area, which is widely considered an attempt to contain the growth of China’s influence in South-East Asia. The QUAD was revitalised at the time of the conflict between China and India in the Himalayas, when the tensions between the two countries reached a “local maximum.”  

More recently, though, there has been a rapprochement between Russia and India, even if Russia is siding with China. India is a very large and populous country, and is one of the few remaining democracies in the region, even if Modi has adopted nationalistic policies with some autocratic traits. So, knowing which side it will be on in the future it will be important.  

Nearby in the Middle East, numerous countries, especially those that are oil exporters within OPEC, have been very cautious and reluctant in openly condemning Russian’s invasion of Ukraine. They might have refrained from doing so for economic, or geopolitical, reasons. But we should never forget that there also exists a view of the world that does not coincide with that which is held by the West or the US. And considering this reality will become essential in the multi-polar world we are about to live in for the next few years.

by Brunello Rosa

28 March 2022

The war in Ukraine continues, resulting in thousands of victims, of soldiers and among the general population, causing widespread destruction and endless suffering. The Russian army is finding it harder to conquer Kiev and the centre of Ukraine than they initially planned, amid logistical difficulties and uncertainty regarding their strategy and ultimate mission. While the war rages on, diplomatic channels are open, but a diplomatic solution is also hard to find, especially given rhetoric that is further escalating tension instead of reducing it. 

In the last few days there has been an escalation of rhetoric by the US administration that will make it extremely complicated to reach an agreement between Russian President Vladimir Putin and the West. On 21 March US President Biden, when asked whether Putin was a war criminal, after having initially said no, he returned to the journalist to say “yes, he his”.A few days later, the US ambassador to Moscow was summoned by the Russian foreign minister, who told him that this answer put Russia and the US on a collision course. On March 26, US President Biden further hardened the US rhetoric by moving away from the prepared written speech in Warsaw to say that Putin cannot remain in power. US Secretary of State Blinken rushed to give assurances that the US is not actually seeking a regime change in Russia. 

Clearly, bombing cities and killing innocent civilians, as Putin has ordered his military to do, cannot be compared to the hardened rhetoric of the US president. But the implications of Biden’s choice of words could be equally devastating. To understand this point, it may be useful to remind ourselves the historical precedent of attempts made by the US and European nations in dealing with Germany’s Chancellor Adolf Hitler. 

Before the Munich conference in 1938, it was already clear what type of character Hitler was, and what intentions he may have had in terms of re-militarising Germany and extending its dominion over neighbouring countries. In spite of this, European leaders met with Hitler in Munich, took pictures with him and even signed an agreement with him. UK PM Chamberlain returned from Munich sure of having “saved peace in Europe.” 

But after the invasion of the entire Czechoslovakia (not just the Sudeten region, agreed upon in Munich) and then of Poland in 1939, it became clear that it was impossible to make agreements with Hitler, and that he needed to be removed militarily. No European, US or Soviet leader would have ever accepted signing a treaty with him, or be pictured beside him. 

After calling Putin a war criminal, and after saying that he cannot remain in power, US President Biden has in effect crossed that line that makes it impossible for him to sign a treaty or be pictured beside Putin. Who could possibly want to be seen beside a war criminal, or legitimise him by signing a joint declaration? 

The question now is: what are the consequences of all this? The most immediate consequence is that the war continues, and that even reaching a temporary ceasefire becomes virtually impossible. Also, if Putin fears that at the end of the war he may be called to respond to his “war crimes” by the International Criminal Court at the Hague, he may be tempted to take more risks, rather than fewer risks, in the short run. 

Normal people may have instinctive reactions regarding the war, but policymakers should be more careful in their choice of words. Biden’s hardened rhetoric, while certainly emboldening the Ukrainian resistance and uniting the NATO front, makes it harder to reach a conclusion of this conflict in the short run.

by Brunello Rosa

21 March 2022

The US Federal Reserve increased its Fed funds target range by 25bps last week,  to 0.25%-0.50%. The Fed also indicated that it could implement six additional rate increases this year, and three next year, and that it could start reducing the size of its balance sheet as early as May 2022. Additionally, the updated Summary of Economic Projections showed a median Fed funds rate at 1.9%, with a core PCE at 4.1% at the end of 2022, implying a negative real rate (of 1.2%) that indicates a still-accommodative monetary stance, which could be removed in coming months. 

Also last week, the Bank of England increased its Bank Rate by 25bps to 0.75%, for the third consecutive time since December, taking the rate back to the level it was at pre-pandemic. While the tone of the accompanying statement was less hawkish than it had been previously, thanks in part to the dovish dissent of Deputy Governor Jon Cunliffe, the BoE might still increase rates in the upcoming May meeting, at the same time as it releases its next Monetary Policy Report (MPR). Otherwise one would not understand the reason to rush with a rate increase in a non-MPR month. 

A week before these moves by the Fed and the BoE, the ECB ended its extraordinary pandemic-related PEPP program and accelerated the pace of tapering of its net asset purchases (which could finish entirely in June), while also upwardly revising its inflation projections by a significant amount.  

These moves signal a fact we correctly predicted, namely that central banks will remain relatively hawkish in spite of the war in Ukraine, being more concerned about the inflationary impact of the conflict than its potential negative impact on economic activity. The Bank of Japan, among the “Big 4” central banks, remains however an outlier here, having left its policy stance unchanged in March. But this can be explained by the still-low rate of inflation in Japan, following three decades of deflation/lowflation.

In our column we also argued that governments will need to do their part in supporting economic activity wile central banks focus on combating rampant inflation and preventing the de-anchoring of inflation expectations. A simple solution would be for governments to partly offset the rise in energy prices (gas and oil) by reducing the taxes on final energy products, such as petrol at the gas station. Some governments have started to do so. In Italy, Mario Draghi has announced a temporary reduction of the fuel duty by EUR 0.25 per litre. In the UK, Chancellor Rishil Sunak is widely expected to adopt a similar measure to reduce the impact on households and businesses in the Spring Budget Statement on Wednesday.

Hence, it seems that a division of labour is emerging between central banks (focusing on inflation) and governments (supporting economic activity). However, it is not so simple as this. Additional fiscal stimulus in this phase may prove inflationary, defeating the purpose of the central banks’ tightening, or at leasing making it more complicated. The example of the fiscal stimulus provided by the US during the pandemic, which is certainly one of the reasons behind the rapid surge of inflation in the country, is illuminating in that respect. 

Furthermore, the fiscal stimulus provided during the pandemic was directly or indirectly monetised by central banks, which is not going to be the case in this instance. This may result in higher market rates, i.e. in tighter financial conditions as a result of government intervention, at a time when central banks are already raising policy rates. 

All this suggests that although economic policy authorities are moving to do what they perceive to be their job, finding the correct policy mix, let alone the optimal policy mix, may prove elusive.

by Brunello Rosa

14 March 2022

The war in Ukraine is raging, with the latest reports being of the atrocities of the siege of Mariupol and continued deaths among the civilians. Diplomacy is not making much progress, as the meetings between the Russian and the Ukrainian delegations are effectively fruitless. The EU leaders held an informal meeting in Versailles in France, the final declaration of which asked for an immediate ceasefire, with Russian troops withdrawing from Ukrainian territory but without offering Ukraine a fast track to EU membership. 

What is clear is that Macron has gained the role of the de-facto head of Europe (to which he has aspired for some time), thanks in part to Germany’s and Italy’s relatively low profile (considering that Germany and Italy have the largest economic ties with Russia among major European countries, and will be the worst hit by the sanctions). In recent days Macron has spoken with Putin more than once, alone or together with German Chancellor Olaf Scholz. But these bilateral interactions have had little impact, apart from clarifying that Russia will not stop its invasion anytime soon, and certainly not before having reached the geo-strategic objectives discussed in our previous columns.

Besides this war on the ground, there is the economic conflict deriving from the sanctions imposed on Russia by a large portion of the international community. Among these, there is the disconnection of a number of Russian banks from the SWIFT massaging system for international payments. The SWIFT circuit is based in Brussels (EU) but is commonly perceived to be dominated by the US. We warned about the risks associated with this move even before Russia launched the attack on Ukraine on February 24th, when it was considered only an extrema ratio. Now that it has occurred, we reiterate our concerns.  

To begin with, China has already offered Russia use of its alternative payment system for international transactions, called CIPS (acronym for Cross-boarder International Payment System), which the country has developed over time and is used mostly in South-East Asia. Clearly CIPS is not as widely used as SWIFT, considering that China itself has partnered with SWIFT for the further development of its CBDC project, alongside CIPS. However, its importance is growing over time, and the acquisition of Russia among its users could provide an unexpected boost to its adoption, and accelerate the process of it becoming utilised more widely. 

Secondly, during the past few years the crypto-asset industry has created a system for international transactions that is completely alternative to the traditional circuits. Admittedly, crypto-assets, the most famous of which is Bitcoin, have ceased to be considered a viable and efficient system for international transactions when it became clear that traditional circuits, such as those provided by credit cards, could provide faster, cheaper and more environmentally friendly transactions. However, they may still be used to evade the implementation of sanctions, as recently warned by UK financial regulatory authorities and be used as an alternative channel to traditional payment systems.

Additionally, evidence is emerging that while banks are implementing the sanctions even beyond the letter, crypto exchanges are limiting themselves to adopting only the bear minimum measures to be sanctions compliant, presumably in an attempt to gain ground from this period of crisis of international payment systems. 

These two phenomena combined may eventually lead to the total polarisation of the international payment system, with the US and its allies continuing to use SWIFT and the traditional circuits (including the use of emerging “stable-coins”), while China and its allies, including potentially Russia, adopt alternative systems such as CIPS, or those deriving from digital assets such as CBDCs and crypto-assets. This bifurcation of the payment system could mirror the balkanisation of international relations and global supply and value chains of the physical, non-digital world, thus further accelerating the ongoing de-globalisation process. 

 by Brunello Rosa

7 March 2022

The war is raging in Ukraine. The Russian army is attacking the country from all fronts, focusing its recent efforts on the coastal cities of Mariupol and, possibly, Odessa. Meanwhile the capital Kiev is under siege, with 60 km of tanks having reportedly been deployed to the city for this mission alone.

In recent conversations with foreign leaders such as French president Emmanuel Macron and Israeli PM Naftali Bennet, Russia’s president Vladimir Putin has directly or indirectly declared his intentions as being the takeover of the whole of Ukraine. This may be one way of achieving the goal of splitting the country into two parts, as we discussed in last week’s column, even as negotiations continue intermittently between the two sides. 

While these negotiations are unconvincingly carried out by the two delegations, Putin’s army continues to tighten its grip on the country by escalating the nature of its targets, which recently included some of the Ukrainian nuclear power plants.

Western countries are responding to this military escalation with an increasing set of economic sanctions, which now include seizing the assets of various oligarchs around the world, banning selected Russian banks from using the SWIFT messaging system, and forbidding exports by large manufacturers (including computer chip and car makers) to Russia. At the same time, energy prices have soared, with Brent crude oil prices having reached $118 per barrel. 

As we discussed in our recent in-depth analysis, the economic impact of the war and the related economic sanctions is likely to be akin to a stagflationary negative supply-side shock, resulting in slower economic activity and higher prices.
How are central banks going to respond to such a shock? Central banks had been in the process of beginning to normalise their policy stances just before the war began. Some commentators thought that the economic impact of the war would induce them to take a less hawkish attitude towards their policy normalisation programs. However, the current shock has made the policy dilemma they had already been facing before the war even more acute.

The way central bankers will likely deal with these contradicting inputs from the real economy is by considering whether slower growth or higher inflation poses a more immediate and larger threat to their policy objectives. 

As far as growth is concerned, even assuming that the economic impact of the war and related sanctions will shave off some tenths of percentage points (or potentially full percentage points) from the growth rate expected by the largest economies in 2021, this is unlikely to be enough to push these economies into recession this year, as they are still enjoying the benefits of the rebound in GDP growth following the 2020 pandemic-related collapse. By contrast, the impact on inflation is likely to be larger and more immediate, given the increase in energy prices and the further disruption in global value and supply chains. 

As such, central banks are unlikely to deviate massively from their intentions declared just before the war, and are instead likely to press on with their policy normalisation plans in coming months. Certainly they will continue to assess the situation regularly and will react accordingly, with the war likely to cause at least a slight deceleration in their planned tightening of their policy stance.

As such, those who expect central banks to wildly revisit their policy intentions are likely to be disappointed in coming weeks.  

This images is taken from  this website 

by Brunello Rosa

28 February 2022

In spite of all of the intelligence provided by the US and UK security services, which warned about Russian President Putin’s belligerent plans, the world was shocked by last week’s images showing Russian tanks crossing the borders of Ukraine and beginning a full-scale invasion of the country. In the days preceding the invasion, we had assigned a probability of 25% to an immediate de-escalation taking place, with the remaining 75% divided between a 55% chance of there being a controlled escalation and a 20% probability of a full-blown invasion. 

Though the escalation has been ratcheted up gradually, we were also surprised by the intensity of the attack. The decision by the Russian army to directly target the capital Kiev suggests that we are clearly in an open conflict aimed at a full-scale invasion. 

We could discuss how we got to this situation. Russia annexed Crimea in 2014, so eight years have passed without the West being able to offer a possible solution to a crisis that was clearly brewing, while Putin had all the time in the world to carefully plan his country’s actions (starting from the constitutional change that will allow him to stay in power potentially until 2036). At this stage, however, we believe it is more relevant to discuss what a possible endgame could look like, and what the wider implications of the invasion might be.

From a geopolitical perspective, Russia is likely to have the upper hand here. NATO cannot intervene in defense of a non-member state, and even if it decided to do so, what would it do? Bomb Ukrainian cities? Attack the Russian army? Both options seem unfeasible, for easily understandable reasons. Other possible retaliatory strategic measures (such as including Finland in NATO, annexing Kaliningrad’s enclave, aiming at a regime change in Russia, re-integrating Moldova into Romania, or similar) all seem totally out of reach, unless one wanted to entertain the idea that WW3 is an immediate possibility (as President Biden put it). Hence this is, and will remain, an asymmetric war.  

This asymmetric war in which Russia can use tanks and the West only sanctions means that Putin will soon control the entire Ukrainian territory. At that point, it will be able to negotiate from a position of strength. We do not think it will proceed to an annexation of the entire Ukrainian territory to Russia: this would defeat the purpose of the invasion, i.e. preventing Russia from sharing a large border with NATO countries (such as Poland, Hungary, Romania and Slovakia). It is more likely that Russia will proceed with an annexation of the Russian-speaking regions of Ukraine (the central-east and south-east regions of the country – see map above). In the west and the centre of the country Putin may want to install a puppet government which will guarantee that what is left of Ukraine will never join the EU or NATO.

If this plan succeeds, Russia will have gained total control of the Azov sea. It will have achieved, among other things, a full continuity of navigation between the Caspian Sea and the Mediterranean Sea, via the Black Sea, by way of the navigable Don and the Volga rivers and the Volga-Don Canal. For this reason, Turkey decided to ban access to Russian military ships via the Turkish straits, which link the Mediterranean to the Black Sea. More importantly, however, Russia will have secured the so-called “geopolitical depth” it is looking for, with a series of “buffer states” between NATO and the Russian motherland: Belarus, (the remnants of) Ukraine, Georgia, Armenia and Azerbaijan. The recent advances made in Kazakhstan will have also secured the southern front, toward the borders with China. 

In future columns and pieces of research, we will also discuss the macroeconomic and financial implications of this war, which have been recently discussed in an article by Nouriel Roubini. Roubini highlighted how this war will impose another stagflationary shock on the global economy, making it even harder for central banks to respond to the slowdown in economic activity and rise in inflation that has been taking place in the last few months. 

by Brunello Rosa

21 February 2022

This week will be the second of three consecutive weeks of industrial actions involving university personnel over the issues of pension cuts, salaries, and working conditions. The trade union Unison explained that the offer of a 1.5% pay rise (which would be significantly below the current inflation rate) is not enough to compensate for the increased workload of teachers and university personnel that occurred during the pandemic. 

Meanwhile, British Airbus workers have also decided to go on strike over “unacceptably low” pay offers they received from the company. These are only two recent examples of industrial action (aka strikes) undertaken by workers and trade unions in several public and private sector organisations. 

This phenomenon is not limited to the UK. In the US, the month of October was characterised by several industrial actions within large corporations (such as Kellogg), which led to the nickname “striketober”. October was the peak of an increasing chain of strikes that took place throughout 2021. This is set to continue in 2022, when a number of large contracts will be up for renewal in several sectors. 

In absolute terms, the number of actions and the number of cumulative working days lost are still tiny compared to the hot decades of the 1970s and 1980s. Just to give an example: in the UK, in January 1979 there were 3 million working days lost to strikes. In January 2018 there were only 9,000 working days lost to strikes.

Still, the pandemic has certainly marked a turning point. The first phenomenon to emerge was that of the so-called Great Resignation, when thousands of people around the globe voluntarily left their jobs in search of better opportunities, higher salaries, more decent working conditions, and perhaps also in protest of what was perceived to be the worker “exploitation” their companies engaged in during the pandemic (for example, when working from home became the excuse for companies pressuring their employees into seemingly endless working days and weeks).  

After that, labour shortages and sharp increases in living costs have done the rest: workers who kept their jobs are fighting for better working conditions in terms of working hours and pay, as inflation is clearly eroding the real value of their salaries. 

In more general terms, workers are fighting for a more equal distribution of income between labour and capital, following decades in which the labour share of income in the economy has diminished in favour of rents, interest and profits. Trade unions, the power and representativeness of which  collapsed with the rise of neo-liberal economics and supply-side policies in the 1980s and 1990s, are regaining power. 

What could be the risks of these shifts, going forward? While a more equal distribution between labour and capital is certainly desirable, in this period of high inflation that is taking place in part due to supply bottlenecks, further disruptions in value chains due to industrial actions may cause an additional increase in prices, making even this short-term inflation more persistent than it is already proving to be. 

Furthermore, if wage increases are asked to compensate for higher costs of living, the infamous wage-price spiral that characterised the “dark ages” (in terms of industrial relations) of the 1970s and 1980s may return. Especially if mechanisms of automatic indexation of wages and pensions were to return (which hopefully they will not). A new wage-price spiral could lead to a sustained increase in unit labour costs (this occurs when wages increase faster than productivity), which is the engine of domestically-generated inflation – the type of inflation that is more difficult to eradicate. 

In order to avoid these risks, moderation and common sense need to be exerted by all parties involved.  

by Brunello Rosa

14 February 2022

Tensions at the border between Russia and Ukraine have reached a point of almost no return during the past few days. As we discussed in an in-depth analysis by John Hulsman, Russia has amassed at least 125,000 troops in the areas neighbouring Ukraine. Last week, Russia and Belarus began a 10-day joint combat training exercise, which reinforces the impression that Russia is ganging up with its satellite states to prepare an internationally coordinated invasion of Ukraine. A large swathe of countries, including the US, have ordered their own diplomatic forces and citizens to leave Ukraine. 

Most importantly, diplomatic efforts have intensified in the last few days in an attempt to dissuade Russian President Putin from invading Ukraine. French President Emmanuel Macron flew to Moscow and agreed with Putin that they “share security concerns” in Eastern Europe. US President Biden has recently spoken to Putin and warned that the US will react forcefully to a possible Russian invasion of Ukraine, a concept that will be repeated tomorrow by German Chancellor Scholz, when he will travel to Kyiv and Moscow. 

Tensions between Russia and Ukraine are not new of course. Recently they reached a peak in 2014, when Russia annexed Crimea, following months of destabilisation of the Russian-speaking regions in east Ukraine (Donbass in particular). Eventually, the Minsk Protocol and the Minsk II agreement (consisting of 12 points, including an immediate ceasefire) emerged to at least freeze the situation and re-establish diplomatic relations. But progress has been modest. Even the election of Volodymyr Zelens'kyj to the Ukrainian presidency in 2019 has not helped.  

The issue on the table remains the same: Russia does not want Ukraine to become part of the various European communities beyond the existing association agreement, let alone a member of NATO. The ideal solution would be Ukraine following the Finnish example, of remaining a neutral country (i.e. not becoming NATO member), even as Finland has become over time a member of the EU and even the Eurozone. 

But Russia does not trust the word of the West since 2004, when the Baltic republics, once part of the Soviet Union, joined NATO, leaving the Russian border directly exposed to NATO member countries in spite of all the reassurances provided to Russia that this would never happen. Since then, Russia has tried to re-gain the “geopolitical” depth that has always allowed Russia to prevent a foreign invasion.  

The possibility of avoiding an open conflict still exists, but it is diminishing by the hour. The West is trying to use both sticks and carrots with Putin to change his calculus and lessen the attractiveness of an invasion, given the potential consequences that such an invasion might entail. But there is something the West would be ill-prepared for: the possibility of an asymmetric or covert act of war, such a domestic putsch in Ukraine or a large-scale cyber attack on key infrastructure. 

How would the West respond to attacks that only supposedly can be attributed to Russia, attacks that could be covered by the usual “plausible deniability” disclaimer? Ukraine is reportedly shoring up its cyber defences against a possible attack of this kind, given that Russia  is the leading country in the world in terms of cyberwarfare capabilities. After all, one of the most famous cyber attacks in recent history, the infamous Petya/NotPetya malware, which paralysed large multinational companies such as the shipping and logistic giant Maersk, originated from Russian attempts to destabilise the Ukrainian cyberspace. 

One way or another, tensions between Russia and Ukraine are unlikely to settle soon. Policymakers, market participants and populations at large would be better to prepare for the worst to happen.

 by Brunello Rosa

7 February 2022

The 1970s were characterised by structurally high inflation. A number of events contributed to that environment. In 1971, US President Richard Nixon announced the end of the USD convertibility into gold, causing  the collapse of the Bretton Woods agreements between 1971 and 1973. This meant the end of the fixed-exchange regimes that had regulated the international financial environment since the end of WWII. 

Central banks had to switch their “nominal anchor” from the exchange rate to the inflation rate, and they were unprepared to do so. The two oil shocksof 1973 (following the Yom Kippur war) and 1979 (following the Iranian revolution) meanwhile contributed to global inflation rates reaching double-digit territory. And the indexation mechanisms of salaries and pensions induced a price-wage spiral, which underpinned the high inflation rates of that decade and of the 1980s. 

Gradually, during the 1980s and 1990s, central banks gained operational independence from their government, to set interest rates, and by the end of the 1990s were able to reign in inflation. Meanwhile, globalisation, which also started in the 1970s with Nixon's trip to China in 1972 and the opening up of the Chinese economy to capitalism under Deng Xiaoping, also induced a rapid deflation in the price of manufactured and technological goods. Overall, one may consider the period between 1985 and 2020 as the “great dis-inflation” era, with inflation rates well below the established targets for the past 10 years or so, during which time central banks have been struggling to make inflation return to target. 

The 2020-22 pandemic has radically changed this dynamic. Supply bottlenecks, high energy prices, labour shortages following “the great resignation” phenomenon have induced a short-term increase that has clearly caught global central banks by surprise. They thought these phenomena would be “temporary”, “transitory”, or “transient”, but have instead had to realise that inflation deriving from such a large negative supply shock and positive fiscal stimulus has proved to be higher and more persistent than they had initially anticipated.

As we discussed in previous columns, even once this short-term inflation has subsided, a more persistent inflationary environment will emerge as a result of the technological and ecological transition the world is now going through, as well as a result of the more equal distribution of income between capital and labour that is about to happen and is badly needed, and the balkanisation of global supply chains deriving from incipient de-globalisation. After the inflationary era of 1970-1985 and the deflationary era of 1985-2020, a new inflation era is about to start.

Central banks are getting ready for this new inflation era. In the last few weeks, the world’s major central banks have clearly changed tack. The Fed confirmed that QE tapering will end in March and that the first rate increase will also occur in March, opening the road to four if not five rate hikes in 2022. The Bank of England increased its policy rate on back-to-back occasions after its December hike, for the first time since 2004, and almost half of the Policy Committee wanted a 50bps increase instead of the standard 25bps that was in fact adopted. 

Finally, the ECB also hinted at an imminent policy shift that is likely to materialise in March, when the new staff macroeconomic projections will be released. Of the four major central banks, only the Bank of Japan so far has remained in the old era of the deflationary environment – but this is because inflation rates remain close to zero in Japan. For now. 

by Brunello Rosa

31 January 2022

Sergio Mattarella was re-elected Italy’s President of the Republic on Saturday, after seven inconclusive ballots. Nervousness had been mounting in political circles, as well as in the country at large, for the inability of the electoral college (made up of MPs and regional representatives) to converge on a figure who would be able to win at least 505 out of the 1009 “grand electors”. The political leaders of the parliamentary majority that supports Draghi’s government decided in the end to converge on Mattarella, the only name that would find unanimous support (with the exception, perhaps, of Fratelli d’Italia). 

This is the most reassuring outcome that one could hope for in the short run, as it guarantees total institutional and governmental continuity. Mattarella is well-respected internationally and is able to guarantee Italy’s position within the geopolitical landscape. Draghi, moreover, will remain PM,  guaranteeing the implementation of the country’s recovery plan, which gives access to the funds of the NextGenEU. For these reasons, this political solution is by far the most favoured by market participants (as we discussed in this interview). 

On the other hand, Mattarella’s re-election only postpones the resolution of the uncertainty about Italy’s medium-term institutional setting by a couple of years, pushing it back to after the election of the country’s next parliament in 2023. In fact, Mattarella will likely resign as soon as he perceives that a majority can be found in the new parliament to elect his successor, possibly in early 2024. 

Draghi will also start encountering difficulties as PM, as political parties will likely be less willing to accept his decisions in the year ahead of the general election. Furthermore, the fact that the political parties that support his government could not agree on his name to become the next president, even after four or five inconclusive ballots, reveals that they do not want to give him carte blanche on every issue. 

Additionally, if one needed further proof of the inability of Italy’s political system to achieve even the most basic goals, this election showed that parties cannot even discharge their duty of electing Italy’s top institutional figure. The complaints that political leaders often make about being subject to the rule of technocrats are therefore totally mis-placed. They had the chance of showing effectiveness in their actions, and failed miserably. But this is hardly a surprise.     

If we look at the broader European political landscape, we said that 2021-22 was the crucial period to test the resilience of the European construct. If any of the German general election, Italian Presidential election and French Presidential and parliamentary elections were to “go wrong”, the survival of the European project itself would be at risk. German elections have delivered a very fragmented parliament, but a “traffic light” majority, however heterogeneous and weak, ultimately emerged. Italy kicked the can down the road. Now it is France’s turn.     

In France, Macron is still ahead in the polls and may be re-elected, but the emergence of Valérie Pécresse as leader of the Republicans will make the June parliamentary elections more uncertain, with Macron possibly forced to his first co-habitation. In any case, both Macron and Pécresse are mainstream politicians and would keep France on track with the European integration process. A different story would be if Eric Zammour or Marine Le Pen were to prevail, though this outcome remains only a risk scenario at this stage.    

Two out of three electoral risks have not materialised so far, and the third – France’s – is unlikely to. This bodes well for the continuation of the EU integration process. But EU leaders need to remain alert, as populist parties are still strong in many countries of the Union, including in France and Italy. 

by Brunello Rosa

24 January 2022

The process to elect the next Italian president begins this week. The president is elected by an electoral college composed of 1008 “grand electors”, made up of current MPs (deputies and senators) as well as 58 regional representatives. A super-majority of 2/3rd of votes is necessary for a president to be selected in the first three rounds of voting. From the fourth round onward a simple majority of 505 votes will be sufficient. 

There are a lot of misconceptions regarding the role of the president in Italy. Most people believe it is only a ceremonial position, carrying little weight in the actual decision-making political process of the country. This may be true in relatively tranquil times, in which political parties have full control of parliament and the government in general. But in turbulent times, when a political crisis emerges, the president is akin to the “reset button” of the system. The president appoints the PM and, by way of the PM’s suggestion, all the ministers as well. The president can also dissolve parliament, calling early elections. Other  powers at the president’s discretion include the possibility of vetoing a law before it is promulgated (though he or she can do so only once), as well as being the formal commander in chief of the military. The president also presides as the governing body of the judiciary. 

As we have previously discussed, the next Italian parliament will be reduced in size relative to the current parliament, a result of the referendum which cut the number of MPs by almost half. The next parliament will also be a balkanized one, given the fragmentation of the political system and the reduced electoral size of the major parties (the four largest parties each poll between 16% and 21%). In such a situation, we know that the next president will almost inevitably be the “deus ex machina” of the political system. 

So, who will be chosen by the parties to be “commanded” for the next seven years? The parties may opt for a second-tier political figure, as has happened in the past. Such a pick would be less likely to disturb their political manoeuvring, after all. At the same time, the proven inability of parties to provide viable political solutions in the past suggests that political leaders may be wise to choose somebody of a higher calibre, somebody who can actually resolve possible future crises constructively. 

At the same time there is the need for Italy to have a very competent PM who is able to implement the recovery plan, which will allow Italy to receive around EUR 50bn in the next few months as part of the NextGenEU plan. 

Both of these requirements point to the figure of Mario Draghi, who is certainly an extremely competent PM and would be an equally good president. Already in 2020 we discussed the pros and cons of having Draghi at Palazzo Chigi (as PM) or at Quirinale palace (as President). At that time, Draghi was nowhere near entering Italy’s political system. 

More recently, we said that Draghi would be able to better exert his influence on the system as president, while most commentators thought he should remain PM. More recently, there seems to have been a conversion on the road to Damascus moment: all of the most influential press is pushing for Draghi to become president and thereby hope to ensure seven uninterrupted years of institutional stability. Most recently the FT joined this group calling for Draghi to become president, in an unsigned editorial.

We still consider Draghi at Quirinale a far better option than at Chigi, especially if the government remains similar to the current one, and if its parliamentary majority remains intact. But we know from experience that the election of the president is a roulette. Even much more powerful first-tier political leaders of the so-called First Republic (1948-1994) did not manage to ascend to the Quirinale. If Draghi does not make it, then, perhaps an institutional figure from the centre -right (Marcello Pera, Elisabetta Casellati, Gianni Letta, etc.) may emerge instead, or else perhaps a relatively independent institutional figure will emerge (such as the former president of the Chamber Pierferdinando Casini. The centre-left however does not seem to stand a chance to elect its president this time around, even if it could put forward credible candidates such as Romano Prodi or Paolo Gentiloni. 

by Brunello Rosa

17 January 2022

When the Covid-19 pandemic began, many countries had been in the process of unwinding some of the extraordinary measures they had introduced years before to counter the effects of the global financial crisis and the ensuing Great Recession of 2007-2009. Central banks had taken the lead in the policy response to the crises of 2007-2009, as some governments, especially in Europe, had mistakenly reacted with a mix of fiscal austerity and structural reforms, policies which deepened a recession which was eminently being driven by the (lack of) demand side of the macroeconomic equation. 

Central banks meanwhile introduced ultra-long term repo operations (extended to 3-4 years maturity) against wider collateral, large-scale asset purchases (LSAPs), credit-easing facilities, forward guidance on rates and asset purchases, and negative policy rates. This arsenal was deployed in various forms and at various points in time throughout the 2010s. Some governments admittedly introduced forms of fiscal support, and certainly they indemnified central banks (whether directly or indirectly) for taking additional risks on their balance sheets, especially credit and liquidity risks, together with a massive increase in reputational risk. But both central banks and governments were keen to emphasise how these decisions were taken independently of one another, so as not to compromise their respective areas of autonomy and independence. 

In early 2020 most central banks had been in the process of winding down the policies created ten years before, but then had to quickly reverse their course of action in order to respond to the pandemic. Central banks had to re-implement those measures they had been unwinding, to some extent on an even larger scale than had been the case pre-pandemic. This time around however governments realised that they too needed to react with large fiscal stimuli, causing fiscal deficits to reach double digit figures in many countries. 

In this case, the policy response was “coordinated” with central banks, which were asked to directly or indirectly monetise these large deficits. Investors praised this monetary-fiscal coordination, which represented the main policy innovation of this crisis.  

As the economy normalises, and as central banks start focusing on inflation developments more than on supporting economic activity, it seems that this coordination with fiscal authorities is becoming less pronounced. Central banks are re-focusing their policy actions toward fighting inflation, after decades of dis-inflation and of inflation targets undershooting and the fear that if central banks continue to provide a backstop to the bonds of highly indebted countries, it may eventually lead to some form of “fiscal dominance.”

But this may hardly prove to be the case in the short run. 

Governments extended large amounts of fiscal support  to their populations knowing, or assuming, that central banks would effectively monetise the debts they incurred to do so – this prevented debt-issuing and debt-financing costs from spiralling out of control. Policy and short-term and long-term market rates actually fell to new lows during this period. But things seem to have changed recently. As central banks announced the end of their extraordinary measures, market rates increased, as the banks’ moves were not announced in coordination with their respective governments. 

In fact, central banks seem to fear that, if they continue coordinating with governments, they will become subject to some form of “fiscal dominance,” de-facto losing their independence. While the risk exists that central banks will eventually fall back within the sphere of influence of their respective Treasuries over the medium term, in the short term coordinating with their governments to exit from the policies they implemented in the last few years would simply be common sense. In fighting inflation central banks will necessarily exhibit independent decision-making processes. Ensuring that the cost of borrowing for governments remains tolerable in the short term will not endanger central bank independence.

 by Brunello Rosa

10 January 2022

The first week of trading in 2022 delivered a very bumpy start to markets. Major equity indices recorded heavy losses during the week (especially the US NASDAQ), and only some European indices managed to close the week in slightly positive territory. There are multiple reasons behind this bumpy start. 

First, it is still unknown what the impact of Omicron on economic activity will be. Data suggest that the variant seems less deadly than Delta, but much more transmissible. As a result, the absolute number of hospitalisations is expected to increase significantly (even if the rate of hospitalisation – of mortality – is lower than that caused by Delta). This is forcing many countries to adopt restrictive measures that may have an impact on economic activity in Q1. PMI numbers seem to have peaked in most advanced economies, and are beginning to signal a slowdown in growth. Investors remain puzzled and on the fence regarding the ultimate impact of Omicron and the reimposition of restrictions it is causing. 

Second, inflation continues to bite. In the Eurozone, inflation has now reached 5%, and may increase further. In the US, CPI is expected to reach 7% this week and core CPI 5.4%, the highest readings in decades. We have made a distinction between short-term and long-term inflation, which to us is much more significant than that between “transitory” and “permanent” inflation. We think that short-term inflation has yet to peak in many countries, after which it may finally start falling towards the central banks’ target levels during the second half of this year (since China’s PPI seems to have peaked at the end of last year). But long-term inflation, which includes energy and tech transitions, will be the theme to watch for in coming years.

Third, central banks continue to be hawkish. Last week, the minutes of the Fed’s meeting in December showed that the US central bank may be prepared to start increasing rates in March, and could start reducing the size of its balance sheet soon after its initial rate increases. This would be a much more aggressive stance than is currently expected. Jay Powell’s and Lael Brainard’s confirmation hearing in the US Senate this week will shed more light on the current FOMC thinking. 

Equally, ECB President Christine Lagarde’s remarks at the Bundesbank’s change of office this week may provide more insights as to the ECB’s views on inflation.  

Fourth, oil prices continue to rise. Even in the first week of the year Brent prices rose by 3.6%, to $81.8pb. As President Lagarde said in December, two-thirds of the recent rise in inflation was due to increases in energy prices. So as long as energy prices continue to increase, headline inflation will continue to rise. The upcoming meeting of OPEC+ may reduce some tensions in oil markets, if the group agrees on an increase in production, but there may be geopolitical obstacles that prevent such an agreement. 

Finally, geopolitical tensions persist in countries that have a large impact on commodity prices, including Russia, Ukraine and Kazakhstan. The situation at the eastern border of Ukraine remains extremely tense, with Russian troops possibly ready for an invasion. Upcoming US-Russia talks in Geneva (where the EU would like to be involved) may provide some short-term relief, but the situation will remain problematic for years to come. Meanwhile, Kazakhstan seems on the verge of a regime change, perhaps through a coup. Clearly the former Soviet republic has now entered the Russian radar screen. Kazakhstan is a major oil producer, but also a major centre of crypto-mining, hence the recent collapse in Bitcoin, Ethereum and other crypto-asset prices. 

All these factors, and in particular the rise in inflation and oil prices, and the hawkish reaction by central banks, have caused a sizeable increase in short- and long-term interest rates in the US and the Eurozone. In the US, the 10y Treasury yield has reached 1.75%, and in the Eurozone, the 10y bund yield is now almost back into positive territory. 

Clearly a combination of higher inflation and market yields is severely detrimental for most asset valuations, including bonds, equities, real estate, and risky assets such as tech stocks (which have suffered their worst week in more than a year). Unfortunately, those factors most likely will remain in place for most of 2022. And for this reason, 2022 is likely to be a much more volatile year in markets than 2021 was, as was recently discussed by Nouriel Roubini.

by Brunello Rosa

4 January 2022

With 2022 upon us, it is worth discussing the key themes to watch during the early part of the year. New themes emerge will doubtless occur as the year progresses and events unfold, but for now, here are some of the issues we are keeping a close eye on.

The Pandemic – The Beginning of The End? With the arrival of the Omicron variant, 2022 is unfortunately beginning in the same way that 2021 did with the Delta variant. By February/March 2022 we will have marked two full years of pandemic, and at least four waves of it. It is confirmed that Omicron is much more transmissible than all other strains, as proven by the spike in infections observed around the globe. But its hospitalisation and mortality rates are not worse than its predecessors, thanks in part to the diffusion of vaccines, especially for those who received their third, “booster” dose. This means that it is possible that Omicron represents the lucky mutation we are all looking for: a very transmissible but not very serious virus, which renders Covid akin to a severe flu, rather than a deadly disease. The first few months of the year will clarify whether this is the case or not.

Inflation – The Monster Is Raising Its Ugly Head Again. There will be plenty of inflation data coming out this week, especially from Europe, where CPI reached nearly 5% recently. Coupled with the (nearly) 7% figure reached in the US, this means that large parts of the developed world have now been experiencing rates of inflation unseen during the past few decades. This short-term inflation, due to supply bottlenecks, base effects, and the reopening of economies, may be coming to an end (Omicron permitting) and in the meantime central banks have also been very alert to it. We remain more concerned about medium-term inflation, influence by the balkanisation of global supply chains, a more equitable distribution of income between labour and capital (including an increase in minimum wages) and the cost of ecological and related technological transitions.

All these factors may result in a one-off price-level adjustment (in a positive scenario) or in persistently higher inflation rates (in a less favourable scenario).  

Central Banks – Barking and Biting? Central banks have certainly turned more hawkish in December as a result of recent inflation outturns, in what we believe is an under-appreciation of the economic impact of the new restrictions imposed by governments as a result of Omicron’s emergence. Some of them have already started to “bite”, with interest rate increases (such as the BOE, Norges Bank, RBNZ and many EM central banks), or by accelerating the process of tapering asset purchases (such as the US Fed). Others, such as the ECB, have only “barked” so far, and it will take time for their words to be followed by action. But we are certainly entering a phase in which central banks will give priority to fighting inflation rather than supporting economic activity. 

The Italian Presidential Election. Italy will elect its new president at the end of January. As discussed several times, this could fundamentally change the equilibria that exist within Europe, if a EU-sceptical president is elected to succeed Mattarella. Draghi remains the key candidate, but if he goes to Quirinale palace, a new government must be formed, and that could result in renewed political instability. 

The Risk of A Russian Invasion of Ukraine Persists. Russia has massed troops at the border with Ukraine, threatening an invasion if Ukraine makes further moves to approach Western alliances such as the EU and NATO. The US has reacted by saying that an invasion will result in a very serious response. What Russia wants is Ukraine becoming like Finland, i.e. neutral. But mistakes may be made by both sides, threatening to cause an unwanted escalation. 

by Brunello Rosa

27 December 2021

In the last few years, government bonds have been some of the most successful asset class available to investors, together with equities. In response to the dot.com bubble in early 2000s, central banks have brought their policy rates down to zero and in response to the Global Financial Crisis of 2008-09 they have started to conduct large scale asset purchases (LSAPs), in what has been called “Quantitative Easing” (Q.E.). All these policies, together with forward guidance, have brought market rates to historically low levels, in some cases in negative territory in important jurisdictions such as the Eurozone and Japan. 

But the beginning of the secular bull market in sovereign (and, by extension, corporate) bonds dates back to the 1980s. After Paul Volcker rose the Federal Reserve’s policy rates into double digit territory to defeat the persistent inflation originating from the two oil shocks of the 1970s and the rupture of the Bretton Woods agreement, the subsequent secular fall of policy and market rates has originated a bull market that is still persisting today, almost half a century later. 

But in 2021, inflation has raised its ugly head after many years, as a result of the pandemic. Bottlenecks in global supply chains, base effects, higher energy prices, the re-opening of the economy have all led to a rise in inflation around the globe, especially in the US, where it has reached almost 7% y/y, and in the Eurozone, where it is already above 5% y/y. As a result of all this, central banks have reacted by turning hawkish, as discussed in several columns recently.  

This volte face has surprised the market, and there is the possibility that central banks will tighten their policy stance more quickly than currently anticipated. Several central banks, in both DMs and EMs have already increased their policy rates in the last few weeks.  

As a result of all this, sovereign and corporate bonds have severely underperformed recently. According to a recent article by the Financial Times, “the Barclays global aggregate bond index — a broad benchmark of $68tn of sovereign and corporate debt — has delivered a negative return of 4.8 per cent so far in 2021.” This negative performance could spill into 2022 if inflation proves to be more persistent and central banks prove to be more proactive in trying to tame inflation than currently expected. 

Other asset classes sensitive to inflation and higher yields, such as equities and real estate, may suffer as well, but the greatest impact would be felt by sovereign and corporate bonds. Having said all this, this may still not be the end of the story. As discussed last week, central banks don’t seem to have factored in enough the impact that Omicron (and the restrictions related to the variant) will have on economic activity. The combination of new restrictions and tighter monetary policy may result in such a dramatic halt in economic activity that inflation will eventually fade, and central banks may need to undo some of the policy tightening introduced so far. This may lead to a renewed phase of bullishness in bond market in the earlier part of 2022. 

In conclusion, while the prospects for bond markets don’t see particularly rosy at this stage, we think it’s still a bit too early to write off this asset class in 2022 just yet. 

by Brunello Rosa

20 December 2021

Two sets of events took place last week. The first was that governments started to move much more resolutely against the spread of the Omicron variant across the globe. New restrictions began being re-imposed by several countries. The Netherlands imposed a form of lockdown; Ireland re-introduced a curfew; a number of countries, including the UK and Italy, are thinking about introducing additional restrictions after Christmas. The “Rule of 6”, or similar limitations on the number of people that can meet at the same time may be re-introduced by several countries. 

International travel has been actively discouraged, meanwhile. In Austria, people can enter the country only if they have received a third dose of vaccine. France banned non-essential travel from the UK. A number of countries, including Italy and the UK, have re-introduced pre-departure tests for incoming travellers.  

These new restrictions are likely to have a significant economic impact, as did the restrictions introduced in previous winters in H1 2020 and in H1 2021. They are likely to reduce economic activity and possibly induce a further increase in inflation. Although the restrictions’ impact on prices is likely to be ambiguous at the beginning, and the reduction in economic activity they cause may imply a moderation in prices, they may also cause supply bottlenecks to persist for longer, and this may induce a further increase in prices. 

Thus far, governments have not considered introducing financial compensation for companies and workers that may be forced to close or work less as a result of Omicron’s spread. 

To some extent, therefore, the task of providing policy accommodation remains with central banks. Central banks however now seem to worry mainly about inflation, and much less about the potential impact of Omicron on economic activity.       

Indeed, the second set of events that took place last week was that the policy committees of a number of G10 central banks, and also EM central banks, met, and nearly all of them opted for a less accommodative policy stance.

As we discussed in our in-depth analysis, virtually all central banks became more hawkish and announced a variety of reductions to the policy accommodation they have so far provided during the pandemic. The Fed announced a faster pace of QE tapering and a speedier policy normalisation path. The ECB announced a severe reduction in net asset purchases starting in March 2022. The Bank of England and Norges Bank actually increased their policy rates, as did the central banks of Chile and Russia. And the BoJ partially reduced the level of stimulus it has been providing until now. 

These tightening measures are meant to counteract the rise in inflation that has been observed globally during the past few months. But they also risk doing harm to an economy that is already being hit by the new wave of the pandemic. So, unless governments introduce some form of compensation for companies and individuals, central banks may need to revisit their tightening plans in coming months. 

Through all of this, markets are remaining volatile, being buffeted by the news of the pandemic and the uncoordinated policy response to it that is now taking place.

by Brunello Rosa

13 December 2021

The Omicron Covid variant continues to make the headlines as it spreads around the globe. New cases are being registered in every continent, and they seem to confirm that this new variant is more contagious than the Delta variant. It is yet unclear whether Omicron causes more severe symptoms than previous variants, but preliminary evidence seems to suggest that it does not. 

The biggest question though is whether or not the vaccines that have been administered to large swathes of the world population will remain effective against Omicron. In this regard, the evidence is mixed. The CEO of Moderna, one of the providers of the mRNA vaccines, suggested that its vaccine was effective, only to say a day later that this suggestion may have been false, and that a new version of the vaccines need to be developed in order to counter the Omicron variant. On the other hand, Pfizer-Biontech has been more constructive, saying that three doses of their vaccine are enough to provide protection against the Omicron variant. Pfizer-Biontech also confirmed that a new version of their vaccine, specifically tailored to Omicron, will become available in March 2022. One may notice the slight inconsistency here. If three doses of the old vaccine are effective, why do we need a new one?

At any rate, it seems we are back to square one: the race between new variants and mankind’s ability to develop new vaccines is still ongoing. As vaccine development takes time, governments are resorting to the usual methods, reintroducing various forms of restrictions in Europe especially (in Germany, the Netherlands, Austria, Belgium and, to a lesser extent, Italy and France), including social distancing, quarantining after international travel, obligatory wearing of face masks, working from home policies, partial or total lockdowns for entire populations or for unvaccinated people only. Even in the UK, where for months PM Johnson has resisted the pressure to introduce the so-called plan B, the government had to capitulate and re-introduce a series of restrictions that had been lifted after the “freedom day” of July 19th, 2021.  

The economic impact of the introduction of these restrictions is yet to be ascertained, but one can imagine a slowdown in the pace of the recovery resulting from them, and a further increase in prices deriving from yet another negative supply shock. This mild stagflationary situation is the nightmare scenario for central banks, which hate being confronted with the ugly pairing of rising inflation and slowing economic activity. Additionally, central banks are impotent against supply-side shocks, both positive and negative.

After about a month of relative tranquillity, a number of G10 central banks will meet this week. On Wednesday, the Fed will likely announce an increase in the pace of tapering its asset purchases. On Thursday, there will be policy meetings for the ECB, the Bank of England, Norges Bank, the Swiss National Bank. The ECB will likely announce the policy package that will become operational in the post-pandemic emergency, beginning in March 2022. The Bank of England will likely announce that there is still time until February before it will need to raise rates. Norges Bank will likely carry on with its planned 25bps increase in its sight deposit rate, and the Swiss National Bank will likely remain on hold, preferring to intervene in the FX market to stem any excessive appreciation of the Swiss Franc. The Bank of Japan will close the week with a meeting held on Friday, but it is unlikely to announce any major change to its policy stance after the innovations it introduced during the last few months.

Given this background, markets will remain wobbly, with equities see-sawing in response to the news about vaccines. Paradoxically, they may find themselves in a win-win situation. If Omicron proves less deadly than many currently anticipate, equity markets may rally on the prospect of the end of the pandemic finally approaching. If Omicron proves more dangerous than currently expected, central banks may pause their exit from the extraordinary accommodation they have provided in the last couple of years, and instead provide more liquidity to the market and so boost market sentiment. The fly in the ointment in this case remains inflation, which can severely impact the valuation of all asset classes.  

by Brunello Rosa

6 December 2021

On Saturday, France’s Republican Party (Les Républicains) chose by way of a primary election its candidate for the presidential race that will take place in April 2022. The winner of the contest was Valérie Pécresse, president of the Île-de-France region since 2015 and former minister for higher education and the budget under Nicolas Sarkozy. She defeated some party heavyweights, such as Michel Barnier, who had been touted as the most credible candidate a serious potential contender against Macron in the general election. 

The Republicans are the heirs of the glorious tradition of Gaullist presidents (such as Giscard D’Estaing and Jacques Chirac), but realized their worst ever result in 2017 when their candidate François Fillon was embroiled in an embezzlement scandal which prevented him from reaching the run-off stage of the election against Emmanuel Macron. Given the party’s historical tradition, as we discussed in our recent trip report, we would have not considered the presidential election to have started until the Republican candidate was chosen.

Valérie Pécresse is a moderate centrist within the party, who defeated right wingers such as Eric Ciotti. The party is clearly trying to win back their centrist voters who preferred Macron’s political offer in 2017. At the same time, it is the right flank of the political specturm that Pécresse should guard more closely against. Plenty of competition will come from Marine Le Pen, the leader of the Rassemblement National (formerly the Front National), who reached the run-off round of the election in 2017, and from Eric Zemmour, the former journalist and polemicist who is also running with a radical right-wing agenda, especially regarding immigration. 

With current polls suggesting no more than 11% support for her candidacy, Pécresse will have to erode support from the right-wingers if she is to reach the run-off vote against (presumably) Macron. At the same time, her victory in the Republican primary may not make Macron’s life easier. With her modern anti-climate change agenda, Pécresse may also attract some moderate and even progressive voters of Macron’s. 

Macron also faces the risk that Marine Le Pen does not reach the second, run-off round of the election. Macron believes that the unwritten “republican pact” that has existed in previous elections, which implies that all non-extremist voters will vote for anyone who is not the representative of the Front/Rassemblement National, will hold once again. But If Le Pen does not reach the second round, this pact may simply no longer apply.

As we discussed in previous analysis, the French presidential and subsequent parliamentary elections, together with the German general election of September 2021 and the Italian presidential election of January/February 2022, will represent the three key elections of the 2021-2022 period, which together may determine the future of Europe. The German election has now resulted in a three-party coalition (unheard of in Germany’s recent history), which still needs to prove its cohesiveness. The Italian presidential election may result in the choice of a strong pro-European president such as Mario Draghi, but could also lead to controversial political figures such as Silvio Berlusconi. The results of these three important votes will determine the shape and speed of the European integration process in coming years.

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.