by Brunello Rosa
7 September 2020
During the latest Jackson Hole symposium of central bankers and academics, which was held for the first time in a virtual format and, therefore, was open to the broader public, Chairman of the US Federal Reserve Jerome Powell provided the main conclusions reached in the Review of the Fed’s Strategy, Tools and Communication. In our recent analysis, we provide all the details of that decision.
In a nutshell, the Fed decided to introduce what has been labelled as Average Inflation Targeting (AIT), which means that the Fed will allow inflation to overshoot the 2% target for brief periods (by a limited amount), in order to make up for the lost price level during periods of target-undershooting. This system is clearly designed for the present period, during which the Fed has been undershooting the inflation target for a very long time. The new framework will therefore allow the Fed to keep rates low for longer, and to look through potential inflation spikes that may arise due to Covid-induced supply-side constraints.
Clearly, a potential side effect of this approach (typical of all “averaging” or “level-based” regimes) is what happens when there is a persistent period of above-target inflation. In theory, the Fed should then keep policy rates higher than they otherwise would, to send inflation below target for some time. In turn, that would possibly induce a marked slowdown or recession (as occurred during Paul Volcker’s experience to combat spiralling inflation in the 1970-80s). Although now that seems a distant problem, it might occur at some point if stagflationary pressures were to emerge. The Fed will likely cross that bridge only when the time comes to do so.
In any case, the immediate policy implication is that the Fed will likely keep interest rates at record lows for longer than previously thought, as now the Fed can wait for inflation to be above target before increasing rates, rather than start raising rate as soon as inflation starts moving, consistently and convincingly, towards the target level.
This has clear market implications for bond and equity prices (likely to be supported by the lower rates), credit spreads (likely to remain more compressed than would otherwise be the case) and for the US dollar, which will likely stay as weak as it currently is, and remain so in the future as well. Long-term yields have briefly edged up on the announcement of the Fed’s approach, as the implied breakeven inflation level embedded into them rose, together with inflation expectations.
The real question is how all other central banks (in the G10, but also in EMs), will react to this move by the Fed. They will not be able to afford staying put: when the “mothership” that is the US Federal Reserve moves, all others will have to react, and move in the very same direction. The real risk is therefore that a new race to the bottom will now ensue, of interest rates and other accommodative monetary policies. Such a process may be additionally likely as the other central banks seek to prevent their own currencies appreciating versus the dollar, in the middle of the most severe economic contraction since the Great Depression.
The first G10 central bank to meet after the Fed announcement was the Reserve Bank of Australia (RBA). As discussed in our review of the policy meeting, the RBA decided to leave its policy rates unchanged, but did increase the size of its credit easing facilities. This week, the Governing Councils of the ECB and of the Bank of Canada will each meet. As discussed in our previews, we expect both central banks to keep their policy stances broadly unchanged, while keeping a clear easing bias and adding a dovish twist as a response to the Fed’s policy review.
In the next few months, these and other central banks will meet. The risk is that another significant round of policy easing, carried out by a number of central banks, is just around the corner.
by Brunello Rosa
31 August 2020
Japanese PM Abe Shinzo resigned at the end of last week, suffering as he is from a pathology (ulcerative colitis) that had already previously caused him to resign in September 2007, back when he had only been in office for one year. This institutional crisis could not come at a worse time for Japan, which is facing a second wave of Covid and is in the middle of the worst economic contraction in decades, with GDP having fallen by 7.8% q/q in Q2, the third consecutive quarterly drop in the country’s GDP.
Abe’s second term in office started in December 2012, with the resounding victory in the general election that led to a solid majority for his party, with 328 MPs out of 480 in the House of Representatives of the Diet. With the support of a strong cabinet featuring former Prime Minister Tarō Asō as Deputy Prime Minister and Finance Minister, Yoshihide Suga as Chief Cabinet Secretary and Akira Amari as Economy Minister, Abe launched his celebrated Abenomics, consisting of three “arrows”: ultra-loose monetary policy, initial fiscal stimulus followed by fiscal consolidation, and structural reform.
As generally happens, the policy package started with the lower-hanging fruits, i.e. massive monetary easing in 2013, which led to the adoption of QQE (quantitative and qualitative easing), followed by the introduction of various forms of forward guidance, credit easing, negative policy rates and (last but not least) yield curve control. All these monetary innovations led to the weakening of the JPY, and the massive rise in Japanese equity valuations (Nikkei and Topix), with Japanese companies recording record profits, often hoarded abroad.
The other two arrows proved less successful: following an initial JPY 10tn stimulus package, fiscal consolidation came with the rise in the consumption sales tax, from 5% to 8% in April 2014. That fiscal tightening led to the Japanese economy to a stall and, eventually, a recession in Q2 and Q3 of that year, which plagued Abe’s second term in office. The decision to proceed with the planned second hike in the sales tax rate (from 8% to 10%) in 2019 led to similar results, with the ongoing recession aggravated by the arrival of Covid. The pandemic has also forced the government to postpone the flagship event with which Abe wanted to conclude his period in office: the Olympic games in Tokyo. They will now have to wait until 2021 at least.
The pandemic has also forced the government to postpone the flagship event with which Abe wanted to conclude his period in office: the Olympic games in Tokyo. They will now have to wait until 2021 at least.
The third arrow has been even less successful, as the planned and implemented structural reforms were watered down and ineffective at best, in a country where the population is rapidly ageing and shrinking (from almost 130 million today to around 100 million only a few decades from now, barring a significant change in birth rates or immigration). As a result of all this, the overarching aim of bringing the deflationary period to an end after almost thirty years has miserably failed, with inflation struggling to remain above zero. Other notable failures of Abe’s second term in power were the attempt to hold a referendum to change article 9 of the constitution in order to allow Japan to re-arm, and the failure to settle an old territorial dispute with Russia.
However, Abe’s period in office also saw some important successes, such as his ability to remain in power for 7 years in a row, ending the endemic instability of Japanese governments that had defined the decades before Abe’s ascent. The re-vitalisation of the Trans-Pacific Partnership (TPP) after Trump ditched it in 2016 was another success (it has been relabelled the Comprehensive and Progressive Agreement for Trans-Pacific Partnership). One could also classify as a success Abe’s ability to forge a good working and personal relationship with US President Trump, which may have helped lead the US to engage with North Korea, and stop North Korea’s missile tests of rockets sent over the Japanese territory.
What lies ahead for Japan? Next year, the general election was supposed to bring a new LDP leader and PM to power; now the process is accelerated. The race has begun, with credible contenders being Fumio Kishida (LDP’s head of policy), Shigeru Ishiba (former defence minister), Yoshihide Suga and the old Tarō Asō, who would not mind a final stint in power before retiring. More than their personalities, it is Japan’s policies that will matter. Assuming that for the time being monetary and fiscal policies will remain amply accommodative, one needs to understand how Japan will position itself strategically in international affairs, at a time when the US election is as uncertain as ever and China has become more assertive than ever. The next few months will determine the path Japan will follow in coming years.
by Brunello Rosa
24 August 2020
The Democratic National Convention (DNC) was held in Milwaukee last week – mostly in virtual format, given Covid-19 – with the nomination of Joe Biden as the Democratic candidate for the US presidential election on November 3rd. On August 11th, Biden chose Kamala Harris as his running mate and candidate for the Vice-Presidency of the United States. With Harris’ appointment and Biden’s nomination by the Democrats, the race for the White House against the incumbent Republican President Donald Trump and his VP
Mike Pence has officially begun.
Donald Trump is currently under attack for his management of the Covid-19 crisis, with the number of infected people in the US having reached 5.6 million people and the number of deaths 175,000, the highest number of confirmed cases and reported deaths in the world. This has led to the sharpest contraction of the economy since the Great Depression of the 1930s (-32.9% SAAR in Q2), with a rise in the number of unemployed people, which reached in 14.7% of the workforcein April 2020, before falling to the current level of 10.2%. The successful management of the pandemic and the economic track record will not be arguments that Trump will be able to credibly run on during the electoral campaign. Equally, the divisive and polarising nature of his presidency, including the rise of “white supremacist” movements across the US, will make Trump’s re-election harder.
At the same time, the incumbent President always enjoys a special status, which gives him a slight head start in the race. Policies, including further tax cuts and fiscal stimuli, can be adopted between now and the day of the election in an attempt to swing voters in his favour. Some further “successes” in foreign policy such as the recent agreement between the UAE and Israel, or the continued implementation of the Phase-1 deal with China can be used as “weapons of mass distraction”. So, in spite of his recent difficulties, it would be wrong to write Trump off at this stage.
In the opposite camp, Biden has emerged as the obvious centrist choice to fight against a polarising figure such as Trump. He can enjoy the support of former presidents Obama and Clinton (whereas Trump faces the disapproval of former presidents such as G.W. Bush and other GOP grandees), and Trump’s mistakes on Covid and the economy are defining the campaign for him. The choice of Harris as running mate is supposed to bring on board the votes of ethnic minorities and socially disadvantaged groups, in an attempt to win back crucial votes in swing states that in 2016 allowed Trump to win the race even with nearly 3 million fewer votes than Hillary Clinton.
At the same time, some of the Republican votes that might have gone for Biden just to get rid of Trump could be put off by Biden’s choice of a VP – a VP who could potentially become President, if Biden became “unavailable” for whatever reason during his first term in office. Additionally, Harris’ centrist approach might not be enough to win back the votes of the party’s left wing, represented by Bernie Sanders and Alexandria Ocasio-Cortez.
Pollsters are divided as to what the eventual outcome of the election will be. Recent national polls suggest that Biden is ahead, but we know that what really matters is the distribution of votes in key swing states. Those using sophisticated statistical methods that managed to predict Trump’s surprising victory in 2016 are also divided. The outcome is still uncertain at this stage, therefore. There are however three things we can be sure about: 1) The campaign will be acrimonious, and full of ruthless accusations thrown by both sides at their adversary. 2) In the event of a narrow defeat in the electoral college, Trump will fight hard not to leave the While House. 3) The US will emerge more divided than ever after this campaign, and a lot of effort will need to be made by whoever wins to unite the country behind the President.
by Brunello Rosa
17 August 2020
During the 20th century Europe was been plagued by dictatorships. The most known where those in Germany, Italy, Spain, and Portugal. Adolf Hitler and Benito Mussolini were removed from power at the end of World War II, when Germany and Italy returned to democracy; Portugal’s António Salazar lasted until 1968 (and his authoritarian government remained until 1974) and Francisco Franco until 1975, the year of his death. But somewhat incredibly, dictatorship remained a viable option in many other parts of Europe for much longer than this.
In Greece, the dictatorships of the colonels (τὸ καθεστώς τῶν Συνταγματαρχών), also known as the Junta (η Χούντα), lasted from 1967 until 1974. In Jugoslavia, the regime by Colonel Josip Tito lasted for a decade beyond the year of his death (1980), until the division of the country and Balkan wars of the 1990s. In Eastern Europe various forms of authoritarian regimes stayed in place until 1991, when the Soviet Union collapsed. Since then, the progressive expansion of the European Union and of NATO has gone together with an expansion of democratic regimes in the region.
In some cases, such as in the Baltic countries (Estonia, Latvia, and Lithuania), the adoption of the Euro has also meant a consistent transition to democracy and political freedom.
Other countries, such as Poland and Hungary, have backtracked on their progress towards democracy, with the arrival of the Kaczyński brothers and Viktor Orban, respectively. For this reason, both countries are now under the procedure foreseen by Article 7 of the EU Treaty for violating basic principles of the EU, including academic freedom, freedom of expression (particularly freedom of the media), and the independence of the judiciary. In other cases, such as in the Czech Republic, right-wing populist leaders threaten the existing democratic regime.
The two most remarkable cases in Europe remain Ukraine and Belarus. Ukraine has gone through a very complicated transition, including having to deal with the annexation of Crimea by Russia in 2014. The election of Volodymyr Zelensky in 2019 seems to have normalised the situation – or at least frozen the status quo, for the time being. Clearly, Ukraine remains in a situation that is less than ideal, as half of the country (especially its easternmost regions) remains under the heavy influence of Russia, and no real progress seems to be taking place in the negotiations for the association of Ukraine with the EU.
The second case, Belarus, has come back to the fore in the last few days, with the recent re-election of incumbent president Aljaksandr Lukashenko, who has been in power without interruption since 1994. The election was officially won by Lukashenko with 80.1% of votes, versus 10.1% for his only remaining rival, Svjatlana Tikhanovskaya. But the EU and the US have not recognised the result the elections, and are now discussing possible sanctions on Belarus. As violent riots occurred in the capital Minsk as well as in other parts of the country, Tikhanovskaya had to flee the country in order to avoid being arrested, and will now have to continue her fight from Lithuania. The question is whether Lukashenko will manage to stay in power for a long time yet, and eventually pass the baton to his young son (as he has planned for a long time) or if he will be ousted from power. The answer to this question probably lies in Moscow.
For decades the fragile Belarus economy counted on subsidies coming from Russia, assuring it full employment, rising wages, and the well-being of its population. But as Russia itself ran into economic difficulties following the collapse in oil prices in 2014, its economic help started to wane, and with it, political support for Lukashenko’s regime. The president cannot last unless Putin and Russia support him. So, Putin will have to decide what to do; that is the reason for the recent phone conversation held between the two presidents. Lukashenko warned Putin that the riots pose a threat to the stability of Russia as well. In a a not-so-veiled request for help, he claimed that if the riots do not get stopped in Belarus, they will spread to Russia as well. That’s why a military intervention by Russia in Belarus cannot be ruled out at this stage.
For some time, the idea has existed that the president of Russia would also become president of Belarus, in something akin to a new confederation being formed between the two states. This seemed to be one of the options that Putin was considering to extend further his own mandate within Russia. However, now that Putin has managed to change the Russian constitution, allowing him to remain in power until 2036, this option seems to be less palatable, considering the lack of support among the people in Belarus for a sort-of “annexation” of their country by Russia. At the same time, a nationalistic approach, in which Belarus would try to re-assert its independence from Moscow, is not particularly popular among the wider populace either.
So, perhaps the only option remaining on the table for Putin is to keep Lukashenko in power for longer and increase economic and financial support for the country. But this solution may prove to be more temporary than either of the two presidents desire, exposing them to further revolts.
by Brunello Rosa
10 August 2020
After the disastrous collapse in economic activity recorded in Q2, with real GDP falling by double digit percentage points in many economies, including in the most advanced ones, the global economy is attempting a timid rebound in Q3. The re-opening of economies after months of widespread lockdown, when 1/3 to half of the world population was estimated to be subject to more or less draconian restrictions, is facilitating a comeback in economic activity. However, this rebound is uneven and uncertain at best. In its latest statement, the US Federal Reserve’s FOMC warned about a slowdown in this timid rebound, as signalled by many leading and contingent indicators.
Governments remain alert and active in their plans to stimulate economic activity. Among others The US is preparing its third fiscal stimulus package, the EU has just adopted the new Recovery and Resilience Facility, and the UK has prorogued its furlough schemes (together with other forms of fiscal support).
Central banks remain fully accommodative after having launched what we called “Covid-related forward guidance”. In fact, in August the Reserve Bank of Australia (RBA), in deciding to re-start QE after the lockdown in the state of Victoria, joined the Fedand the ECB in explicitly linking the duration of its monetary stimulus to developments of the virus.
After the so-called “time-limited” and “state-contingent” forms of forward guidance, in which the central bank will continue to provide monetary stimulus until a certain date arrives or a pre-set economic condition materialises, some central banks seem to have decided to launch a new form of state-contingent forward guidance, in which the condition to be met to reduce the stimulus is fully exogenous. Specifically, central banks will continue to keep policy rates low (or lower) or make asset purchases until there is convincing evidence that the virus has been durably and credibly contained.
Considering that the number of cases is still accelerating in very large parts of the world, such as in the US, Brazil and India, this means that central banks will keep the tap of liquidity open for the foreseeable future. Most central banks, when showing their implicitly expected path of policy rates, do not show any sign of tightening over the forecast horizon.
Who is benefiting from this situation in financial markets?
Clearly risk asset prices have been the ones that have benefited from the combination of monetary and fiscal stimulus (sometimes coordinated in “helicopter money” fashion). But there is plenty of evidence that both equity and credit markets valuations are stretched, as they are under-pricing the risk of the chain of defaults and bankruptcies which is likely to manifest itself in coming months. Perhaps also because of this reason, the clear winner so far seems to have been gold.
The yellow precious metal has in fact reached and recently overcome the 2000$ per troy ounce for the first time since the Global Financial Crisis. Gold was trading at just over $250 in the early 2000, before starting a glorious rally that brought it to $1750 (monthly prices) during the Euro crisis in 2011-12. After retracing and falling to just over $1000 in 2015, the rally re-started with some conviction in mid-2019 (when the Fed started to implement its “insurance cuts”) with a serious acceleration in the last few months.
As discussed in our recent in-depth analysis, there are multiple reasons for this rally. Gold is perceived to be a good hedge against inflation, but also deflation (as it is a physical asset, but nobody’s liability, unlike government bonds). It is a store of intrinsic value and is also perceived to be a store of US dollar value, during a time when political uncertainty and turmoil in the US, ahead of the Presidential election in November, is making many investors nervous about the greenback.
by Brunello Rosa
3 August 2020
Last week, the US Bureau of Economic Analysis released its first estimate of the performance of the US economy in Q2 2020. After the 5% q/q drop in Q1 (a seasonally-adjusted annualised rate, SAAR), in Q2 the economy contracted by 32.9% q/q SAAR. This was slightly less than anticipated (34.1%), but still the largest contraction on record. This quarterly contraction of 8-9% (32.9% divided by four) is in line with the fall in income recorded by other major economies. It is explained, of course, by the adoption of lockdown measures that were introduced in order to slow down the spread of Covid-19.
As the Federal Reserve Chairman Jerome Powell said during the press conference following the FOMC decision to leave the central bank’s policy stance unchanged in July, this is the largest shock the US has had to endure in recent history. After an unexpected rebound in May and June, the recovery of economic activity since July has slowed down, as has been revealed by non-standard, high-frequency indicators, such as hotel occupancy and credit card use. In its latest statement, the Federal Reserve decided to establish a clear link between the expected path of economic activity and the likely evolution of the pandemic.
Following the release of the quarterly GDP figures, US President Donald Trump released a tweet in which he wondered whether the US election could be delayed “until people can vote properly, securely and safely.” Even if it is not in the president’s power to decide on the date of the election, this tweet created an outcry in the media and the Democratic party, where it was often viewed as a confirmation of Trump’s authoritarian tendencies and an attempt to undercut the US democracy. Since the power to postpone the date of the election has resided with Congress since 1845, Trump’s tweet must be read as a signal of how he is ready to contest any result that would not see him as the victor in the US presidential race in November, as we discussed in our column on April 20.
But the economy is not the only preoccupation of President Trump at the moment. After putting the popular video-sharing social medium Tik Tok under scrutiny for representing a possible threat to national security, Donald Trump said he was ready to ban its operations in the US, where it counts around 50 million users. The company responded that the data it collects is stored in US-based servers (confirming once again how relevant the concept of digital sovereignty is becoming), with limited and controlled access from its employees. Some read Trump’s move as a way of either jeopardising the potential sale of the US arm of Tik Tok to Microsoft, or as an attempt to reduce Tik Tok’s price.
This is yet another confirmation that one of the main battlefields of the ongoing Cold War 2 between US and China is the tech race between the two superpowers. In a separate, but related field, our recent report on the “stunning” alliance between China and Iran discusses how Cold War 2 is taking shape in the more traditional domain of strategic alliances.
While all of this is going on, the Democratic contender in the November race, Joe Biden, will soon announce the choice of his running mate. Many see this as a potential turning point in the campaign. Biden is set to choose a candidate who, unlike himself, is not old, or male, or white, and for this reason the most credited contenders for the position are Susan Rice and Kamala Harris. But this choice must be considered in the broader context of the US presidency.
Biden, if elected would at 77 years old be the oldest US president in history at the time of his inauguration. He already hinted at the possibility of running for only one term, making his VP the natural candidate for succession in 2024. There is also a possibility that Biden could resig duringhis first term, which would of course would directly make his VP ascend to the presidency. Knowing all this, any Republican voters or swing voters who might be inclined to vote for Biden just to make sure that Trump is not re-elected in November, might want to be reassured that Biden’s running mate is as mainstream a politician as possible.
by Brunello Rosa
27 July 2020
We have often discussed how a key component of the ongoing Cold War II is a technological conflict between the incumbent dominant power (the US) and the rising star (China). Last week, US microchip producer Intel, for decades the undisputed leader in its sector, announced that it had fallen behind its development plans by at least one year, thus leaving its main competitor, TSMC a Taiwan-based company, as the leader in its field. This has been read by some analysts as the latest confirmation of the US losing its dominant position in technology, an area that for decades was the ultimate key to American success.
But this is only the last episode of a much wider saga. In particular, the battle for the distribution of 5G technology represents a significant front in the ongoing tech wars. Recently, the UK has also joined its fellow countries of the Five Eyes (US, Canada, Australia and New Zealand) in the broader Anglosphere, with the decision to gradually phase out Huawei in the provision of technology for the 5G British network. This was a decision that came after repeated and heavy pressures were placed on PM Boris Johnson by the US.
In this raging tech war, we must note the impetus that the Coronavirus pandemic has given to cyber-wars, as we discussed in our recent two-part report on the subject. Part 1 of that report focused on US and international developments, Part 2 focused on national developments in Russia, EU, Israel and China. The rapid increase in digital technologies that has occurred in order to provide business continuity during the long months of widespread lockdowns has made most countries, institutions and companies much more vulnerable to cyber attacks than was already the case before the pandemic began.
In the future, we will have to assume that the failure of diplomatic avenues in any serious dispute between countries could result in one of those countries carrying out a cyber attack. Such attacks will, perhaps, be launched by non-state entities at the behest of a state, in order to provide that state with “plausible deniability”.
These technological developments will certainly impact traditional areas of finance as well, such as banking. As we have discussed in our recent in-depth report on the future of the banking industry, traditional lending institutions already find themselves under siege by fin-tech developments coming from the private sector. On the other side of the spectrum, central bank digital currencies (CBDCs) developed by the public sector will pose an additional threat to the traditional business model of financial institutions.
Both sides will continue to squeeze banks in the middle.
Given the widespread use of digital technologies, fin-tech developments will continue unabated in their aim of increasing efficiency and granting access of financial services to larger segments of the population which otherwise have little exposure to financial services. Central banks (with China and Sweden leading the race) will continue their journey to the eventual adoption of CBDCs, which are seen as the key to solving the next systemic crisis.
Traditional banks will have to adapt their modus operandi to fit this radically changed environment. As we discuss in our report, the key elements of their new business model will have to be digitalisation, a consumer-centricity, and further specialisation regarding local needs. This will be a process that will surely lead to further consolidation in the industry, with fewer players left on the battleground afterwards.
by Brunello Rosa
20 July 2020
Since last Friday, the special EU summit to decide on the implementation of the Recovery and Resilience Facility is taking place in Brussels, with European leaders meeting in person for the first time after months of video conferences.
The summit started with a great distance between the positions of the so-called Frugal Four (Austria, Netherlands, Denmark and Sweden) – which became Frugal Five when Finland joined the group – and those of the Mediterranean front of Italy and Spain (which is supported by France). The former group wants a reduction of the overall package proposed by the EU Commission, namely EUR 500bn in transfers and EUR 250bn in loans, and a significant reduction in the amount made up by transfers. Within this group, the most aggressive position is expressed by the Netherlands, whose PM Mark Rutte seeks to win a majority in his country’s parliamentary election next spring. The Netherlands, for a change, is not simply the “bad cop” of the duo with Germany. Rather, the two countries entered this meeting with two different strategic objectives. The second group of countries wants the overall size of the program to be left unchanged, and wants transfers to remain the bulk of it.
There is also a third front at the table, representing the nations of the so-called Viségrad group (Czechia, Slovakia, Hungary and Poland). Those countries, among the largest beneficiaries of EU funds (Poland in particular) want to make sure that their quota of funds in the new Multiannual Financial Framework (MFF) remains intact.
Alliances across regions (North/South, East/West) and political families (People’s party, Socialists and Democrats, Liberals) are variable, and subject to change opportunistically.
In the middle of these different positions is Germany, with Angela Merkel trying to broker a historic deal during the period in which Germany holds the rotating EU presidency, to make sure that the eventual result is acceptable to everybody. Germany is doubly putting its face on this deal.
The EU Commission that made the initial proposal discussed at the summit is led by Ursula Von der Leyen, the former German defence minister and protégé of Angela Merkel. In addition, Merkel herself is looking to complete her long period in service with an agreement that could prove historical. Merkel’s goal is passing the EU to the next generation of European leaders, with some of the elements of solidarity that characterised the initial project still intact. So, Germany cannot risk that this summit ends with no results.
Given such distance between the positions of various blocs of countries to begin with, the sessions on Friday, Saturday and Sunday not surprisingly finished in acrimonious discord.
Various proposals have been presented by EU Council President Charles Michel to reduce the overall size of the package and the share of that package made up by transfers rather than loans, to make the deal more acceptable to the Frugal Five. The latest proposal foresees EUR 390bn of grants and will be discussed starting from Monday afternoon. We expect that, eventually, a compromise will emerge, if not at this meeting, at a new one later in July.
by Brunello Rosa
13 July 2020
The number of Covid-19 cases worldwide is increasing. It has now nearly reached the 13 million mark, causing almost 600,000 reported deaths. Some countries, especially in Europe and Asia, are experiencing an increase in new cases, though only to a limited extent so far, after re-opening their societies following long periods of lockdown. In other countries, such as the US and Brazil, the situation is worse; according to some experts, infection rates may already be out of control in these countries. In the US in particular, where the number of cases has now reached 3.2 million, the spread of the virus is still increasing exponentially, suggesting that the adoption of new social-distancing measures is likely to occur during the next few weeks.
As lockdown measures have eased, economic activity has been picking up, recovering from the lows touched in Q1 and Q2. Unless restrictions are re-imposed to the same extent as occurred during the first part of the year, or new restrictions imposed upon large economies such as the US have massive spillovers to the rest of the global economy, Q3 GDP growth should show a positive figure in many countries, given base effects.
In spite of the recovery in economic activity, the support of economic policy remains essential. As far as fiscal policy is concerned, most governments are still providing stimulus by way of new or renewed packages. In the US, a third fiscal easing package is underway. In the UK, the Chancellor of the Exchequer has just announced a new set of measures to support economic activity, such as the temporary reduction of VAT on certain products and services and of the stamp duty on certain real-estate transactions.
In the EU, this week there will be another summit to make progress towards the approval of the EU Recovery and Resilience fund, which should support the economies most hit by the Covid pandemic, such as Italy and Spain.
In all this, central banks are taking a breather. In recent weeks, after the massive monetary easing programs announced during H1, most central banks are adopting a wait-and-see approach. Some of them, such as the Reserve Bank of Australia, have even started to reduce their intervention in markets as the economy stabilises. This week, there will be the monetary policy meetings of the European Central Bank (ECB), Bank of Japan (BOJ) and Bank of Canada (BOC). The BoC will release its first set of forecasts since the pandemic begun, and the BoJ will update its economic outlook. As we have written in our preview, we expect them not to change their policy stance, while remaining ready to add monetary stimulus should economic and financial conditions deteriorate in coming weeks.
Central banks, which have been at the forefront of the policy response during the global financial crisis, have already used most of their conventional and unconventional arsenal. At this point, they prefer fiscal policy, and regulation, to be in the driving seat. At the end of July, the FOMC of the Federal Reserve, which sets the tone for most central banks with its decisions, will meet. It is likely to adopt a similarly cautious approach, although with the worsening healthcare conditions in the US discussed above, the meeting might result in the decision to further increase its stimulus, for example by widening the depth and spectrum of its credit-easing facilities.
by Brunello Rosa
6 July 2020
A few weeks ago we warned that the world will look very different after Covid from how things were at the end of 2019. Some of the changes we envisioned are already occurring.
We mentioned how China would try to use the crisis to make geo-strategic gains relative to its rivals, primarily the US and, more broadly, the Anglosphere. In this respect, the new more assertive geopolitical stance taken by China was visible in the military exchange that occurred between China and India in the disputed territories of the Himalayas. This direct military confrontation risks pushing India more towards the US sphere of influence, at a time when US President Trump has already expressed sympathy towards authoritarian or nationalistic leaders like Narendra Modi.
But the geopolitical confrontation between China and the Anglosphere is occurring on other fronts as well. As we discussed in a recent column, the blame game over the origin of the Covid-19 pandemic must be interpreted as part of a wider containment strategy with regard to China, a strategy which also includes the probable decision by the UK government to gradually phase out Huawei from its 5G network, following similar steps already taken by both the US and Australia.
Meanwhile, the US is still mired in the middle of a surge in Covid-19 cases, with erratic management of the crisis by US President Trump. The US now has about one quarter of the 11 millioncases of Covid recorded worldwide. As a result, the EU, which has just re-opened its external borders, has excluded the US from the list of countries from which citizens can arrive without having to undergo a period of quarantine. The US is about to enter one of the most heated presidential elections in its history, with Trump already openly speaking of “rigged” elections, alleging irregular vote-by-mail schemes and ballots printed by foreign countries.
There is even the risk that, unless the Democratic candidate Joe Biden obtains a large majority in the electoral college, the president will refuse to accept the result of the election and will not leave the White House in January 2021.
In the middle of the US and China, there is always Europe, which is trying to overcome its many contradictions. As we discussed in our recent in-depth analysis, the EU is in the middle of a difficult negotiation regarding the Recovery and Resilience Fund, with the Frugal Four (Sweden, Denmark, Austria and Netherlands) asking for much stricter conditionality attached to any funds sent to the countries that have been most impacted by the crisis, primarily Italy and Spain. In a recent interview, Greek PM Kyriakos Mitsotakis said that he will not accept the approval of a recovery instrument with too much additional conditionality compared to regular fiscal coordination and surveillance.
In our analysis we also discussed the national implications of such a deal, in particular in France. There, President Emmanuel Macron decided to sack Prime Minister Edouard Philippe, following the defeat of the president’s party in the local elections last week. He substituted Philippe, who had become more popular than the president for his good management of the Covid emergency, with Jean Castex, another “Enarque” who advised the president on the re-opening of the economy post-lockdown.
These movements, apparently simple domestic politics, are of the greatest importance ahead of the 2022 Presidential election. As we have said many times before, if Macron does not win a second mandate, the entire European integration project could be in serious jeopardy.
by Brunello Rosa
29 June 2020
Last week, equity indices suffered despite a rebound in economic activity in some key economies. This occurred as a rise in COVID-19 cases, especially in the US and Brazil, as well as fresh warnings over the global growth outlook and the Fed’s warning of a cap to ‘shareholder payouts’ all weighed on market sentiment.
On a weekly basis, global equity indices fell (MSCI ACWI, -0.6%, to 524), driven by the US (S&P 500, -0.5% to 3,084) and the EZ (Eurostoxx 50, -1.5% to 3,219). From the beginning of the year, the S&P 500 index is down 7%, Eurostoxx 50 is down nearly 15%, the UK’s FTSE 100 is down 18% and Nikkey 225 5%. These figures are very much in line with what we predicted a few months ago, perhaps with the only exception of NASDAQ, which has surprised us as well as market participants with a more positive than expected performance. The NASDAQ is up 9% year-to-date, mostly due to the fact that pandemic has further boosted the use of technology for business continuity.
Have these depressed valuations re-aligned equity indices with economic fundamentals? We don’t think so. Last week, the IMF released a revision of its World Economic Outlook (WEO), which featured a significant further downward revision of expected global growth, from the -3% predicted in April to -4.9% predicted now. US growth is expected to be -8.0% in 2020 (a 2.1% downward revision as compared to April’s prediction), the UK -10.2% (a -3.7% downward revision as compared to April’s), and the Eurozone at -10.2% (a -2.7% downward revision). These new forecasts are now more aligned with our own more pessimistic estimates made in April. This week, we will publish our revised forecasts alongside the Strategic Asset Allocation.
Recently, the OECD went even further than this economic outlook of the IMF. In its June forecasts, the OECD foresees a 6% contraction in global GDP (if no “second wave” of the pandemic occurs – the so called “single-hit scenario”), and -7.6% contraction in case of a second wave (the “double-hit scenario”). It expects the US to lose roughly 7.3%/8.5% of GDP in 2020 (depending on whether or not a second wave occurs), the Eurozone 9.1/11.5%, and the UK a staggering 11.5/14%. So, either these growth forecasts are too grim, or else market valuations are too optimistic.
At the beginning of the year, we warned that there was a large discrepancy between risk asset valuations, especially equities, and economic fundamentals. The collapse in valuations following the global outbreak of Covid-19, which marked the beginning of the fastest bear market in recent history, had temporarily solved that discrepancy, by bringing valuations closer in line with economic fundamentals. But the rapid recovery in equity indices (pushed by central bank liquidity) led also to the manifestation of the shortest bear market in recent history, with valuations departing again from economic fundamentals.
In our recent analysis, we warned about the possibility that a U-shaped (or W-shaped) recovery could be accompanied by a V-shaped rally in financial markets. However, our recent in-depth analysis shows that equity valuations seem to be mis-aligned not just with macroeconomic fundamentals, but also with microeconomic variables that serve as an input for equity valuation models, such as expected earnings per share. There is also a mis-alignment with the signals from the credit market, in particular the expected default rates. What is underpinning high valuations seems to be only low interest rates (both current interest rates and expected future interest rates), which is a purely circular argument. Clearly, central bank liquidity has been underpinning valuations for a long time now. It is perhaps to break the virtuous (but also vicious) circle that, after the easing spree of March/April, most global central banks are now adopting a more cautious stance, with a partial withdrawal of some of the extraordinary measures introduced in the last few weeks.
In any case, the evolution of the pandemic and the global economy remain highly uncertain, and so “prudence” should be the buzzword for market participants at this time.
by Brunello Rosa
22 June 2020
Last week, China announced that a number of boroughs in Beijing had to be locked down as a result of a new localised outbreak of Covid-19 in the city, possibly originating from another food market. The Chinese authorities said that investigations concluded that the coronavirus strain detected at the Xinfadi market in Beijing came from Europe, even if they admitted that this particular strain “has existed longer than the current coronavirus strain circulating in Europe.”
So, it appears that China is now making accusations of other countries and regions for the possible second wave of pandemic it might be suffering. This is, of course, similar to the way most countries have accused China for having caused the pandemic in the first place, whether “naturally” (if the virus spread out the wet market in Wuhan), or “artificially” (either intentionally, or by accident, given the presence of the notorious research lab in Wuhan itself). What then should we make of this blame game between China and the rest of the world?
One should not be confused by the exchanges of allegations between politicians and even heads of state and governments. In most cases, these allegations are made to assuage the domestic opinion more than to attack the foreign entity, in order to distract attention and divert responsibility away from themselves. This is a usual game in politics. However, there is also something deeper going on now, which makes the current situation different from those which typically exist.
As we discussed a few weeks ago, we believe that after this pandemic, and after the containment measures that have been adopted to counter this pandemic, the world will look very different from how it was until the end of 2019. In particular, the economic or political power ranking of countries and regions could change on a global scale.
For certain, the economic and political “distance” between the major global players will be very different: for example, China will be able to reduce the gap with the US on a number of dimensions. The US, with its erratic response to the pandemic, and its inability thus far to rein in the pandemic, will most likely lose ground versus China, whose response to the virus having been much more rapid and forceful. Europe is still debating which policies to adopt to recover from it.
The US and its closest allies in the Anglosphere (the so-called “Five Eyes”: the USA, UK, Canada, Australia and New Zealand) are trying to respond this evolution of events. Clearly, the first point of attack is about the origin of the crisis, which is undoubtably in China; emphasizing this fact also serves to diminish the relevance of Beijing’s strong response. For the first time in history, countries or state entities (such as Missouri and Mississippi) have expressed their intention to ask for “compensation” or “reparations” in non-war related circumstances, and this will continue to put pressure on China.
But there are other open fronts as well. As we know, the new Cold War between US and China has several components, one of which is the very relevant technological competition. Recently, the US imposed further restrictions on Chinese tech giant Huawei (which were subsequently partly eased).
Countries in America’s inner circle, such as Australia, have taken similar measures. This has meant a sharp deterioration in the bilateral relationships between Beijing and Canberra, even despite the fact that China has been the main importer of Australia’s iron ore and coal in the last few years. But in the “new world order” of disrupted global supply chains, geopolitical considerations will trump economic cost/benefit analysis. This is an unfortunate evolution. It will eventually hurt the end consumer globally, as it will lead to a reduced choice of products and higher prices.
by Brunello Rosa
15 June 2020
In this world of de-materialised data, where the control of the cyber space and the most advanced communication and information technologies seems necessary to gain a strategic advantage versus the geo-political rivals, it is quite dystonic to learn how global and regional powers still consider the control of the sea as a key factor for assert dominance over a geographical area.
We have discussed many times how the new Cold War between US and China was increasingly driven by the technological competition between the two world’s super-powers, in particular in the fields of artificial intelligence, big data and 5G technologies, with the US trying to at least slow down China’s Agenda 2025, foreseeing the Asian giant becoming the world’s first country in the most technologically advanced sectors of the future. More recently, we have discussed how Russia, the world leader in cyberwarfare techniques, was using the Covid-induced crisis to make geo-strategic advances by using its competitive advantage in the field.
But exactly when all the advanced world is making the greatest use of online technologies to carry on its economic activities and circumvent the restrictions imposed by the lockdowns, we learn how the good old control of key maritime routes and straits, or the acquisition of naval basis is still considered a key ingredient for asserting geo-strategic dominance.
In the G2 heightening rivalry between US and China, the disputes over the east and south China sea have acquired absolute prominence in determining how the rivalry will evolve, including regarding the still unresolved trade dispute. As discussed in our recent report, roughly $5 trillion of trade passes through the South China Sea (SCS) each year, including oil and natural gas. It’s clear that controlling SCS enables China to potentially choke off these routes and severely impair neighboring economies and global trade.
Press reports suggest that Beijing has steadily fortified seven islands or reefs, equipping them with military bases, airfields and weapons systems. This means, that while US President Donald Trump might be trying to apply the Art of The Deal in the negotiations, China might be applying the Art of War by general Sun Tzu, implying that any comprehensive trade deal with China might need to include a resolution of SCS sovereignty issues, potentially an unachievable result.
Clearly, China’s difficulty in projecting its geopolitical influence by controlling the seas is a massive constraint, compared to the US historical prevalence over the Atlantic and Pacific oceans. The Belt and Road Initiative (where the “Road” is a maritime route) is a way for China to break that constraint disguised behind commercial interests.
In other reports, we have discussed how the control of the strait of Hormuz was considered by Iran as a key to re-assert its authority in the Persian/Arabian gulf, potentially impairing global trade of oil from the region.
Finally, in our recent report, we have discussed how geopolitical tension was rising in the Mediterranean sea, with two open fronts in Syria and Libya, where regional powers are playing their chess game. Turkey and Russia seem now close to reach an agreement on the two fronts, with Tukey having completed its “Open Sea Training” operations (thus extending its maritime influence from the Dardanelles to Cyrenaica), and Russia getting closer to achieve its most cherished goal: naval bases in the west Mediterranean sea (in Bengasi – together with the air base in Al Jufra), to complement its historical posts in Latakia and Tartus in Syria. Controlling what the Romans called Mare Nostrum(“Our Sea”) seems to be, two thousand years later, still a desirable strategic objective.
by Brunello Rosa
8 June 2020
In our column in October of 2018, following Jair Bolsonaro’s victory in the first round of Brazil’s presidential election, we asked: “Will The World’s Next Strongman Come From Brazil?”. Bolsonaro, who had been an underdog in the election until he was stabbed at a campaign event only one month before the vote took place, had already been displaying all of the characteristics of the strongmen who were already populating the globe at that time (Trump, Putin, Xi Jinping, Orbán, Kaczynski, Erdoğan, Duterte, Modi, etc.), including a passion for (or in his case, a past within) the military, an admiration for non-democratic regimes, and a preference for the use of force to solve international and domestic disputes.
Fast forward almost two years later to today, and, taking into account the natural tendency of Covid-induced economic restrictions to strengthen autocratic behaviours, here we are: Bolsonaro is not only proving to be the world leader who is most reluctant to adopt containment measures against the spreading of Covid-19, a reluctance which has made Brazil the new epicentre of the pandemic, together with the US, but a judge from the country’s Supreme Court has also accused Bolsonaro of wanting to abolish democracy in Brazil in order to establish an “abject dictatorship”. Justice Celso de Mello, in a WhatsApp message leaked to the media, reportedly said: “We must resist the destruction of the democratic order to avoid what happened in the Weimar Republic when Hitler, after he was elected by popular vote, did not hesitate to annul the constitution and impose a totalitarian system in 1933.”
These allegations came after Bolsonaro attended a rally at which demonstrators, wearing paramilitary uniforms, called for Brazil’s parliament and supreme court to be shut down and be replaced with military rule, and after Bolsonaro’s Minister of Culture was forced to resign after quoting Joseph Goebbels, the Nazi minister of propaganda. This should not be surprising, given that Bolsonaro packed his government with more than 100 current and retired military officers, including his vice-president and at least 6 cabinet ministers.
In a recent in-depth analysis by John Hulsman, we discussed Bolsonaro’s record in government, showing how the president of Brazil has been out of his depth over myriad issues hamstringing his erratic presidency. In particular, we noted how three C’shave been plaguing the populist leader: (lack of) Competence, (lack of) Competition within the right-wing camp, and Corruption; and how these have dramatically morphed together into an existential threat to Bolsonaro’s continued rule.
At the same time, we also noted the three B’s that could lead to his political salvation: Beef (Agribusiness), Bullets (the Military), and the Bible (the growing number of Brazilian Evangelical Christians). In fact, much of the President’s enduring and loyal political base is clustered around these three groups. These constituencies could help Bolsonaro politically survive, or even thrive, for a continued period of time. Indeed, we concluded our analysis of Bolsonaro’s political record by noting that although Bolsonaro is embattled, he is probably in no immediate danger of impeachment.
But while the three B’s are protecting Bolsonaro from impeachment, and while his power base is holding for the present, none of the three C’s have been even remotely dealt with. As time passes, and these structural problems turn increasingly septic, what seems now to be a slow unspooling of the Brazilian president may suddenly become a torrent that washes away “The Trump of the Tropics” for good.
Before this happens, though, the risk remains that Bolsonaro will officially or unofficially suspend democracy in Brazil, bringing a return of the dictatorship that the country abandoned in 1985.
Picture Credit: Julio Cortez/AP
by Brunello Rosa
1 June 2020
In the last few days, the streets of Minneapolis and other major US cities have been filled by people protesting the treatment of George Floyd, who died while in policy custody. The facts are sadly well known, and the fact that the police officer Derek Chauvin has been arrested did not placate the ire of the African-American community or the wider population. Protests have become violent in the last couple of days, as they have in previous similar occasions, most notably in Los Angeles in 1992, after a trial jury acquitted LAPD officers’ accused usage of excessive force in the arrest and beating of Rodney King.
So, this type of episode is unfortunately not new, and it will likely happen again in future. What makes this episode peculiar and particularly noticeable in this period is that it is happening as social tensions are clearly on the rise, with a number of protests being staged in various parts of the US against the lockdown measures introduced in many states. The most worrying of these took place outside the Michigan Capitol building in Lansing on April 30, when a number of protesters showed up equipped with firearms.
This is quite concerning, considering this is a year in which one of the most tense presidential elections in US history will take place. The election will be tense not just because of the logistical difficulties resulting from Coronavirus, or from the fact that the margin between the two contenders is likely to be small, but also because there is widespread concern that if Trump were to lose, he might not accept the result – even were it to come in the form of a verdict from the Supreme Court – and will instead refuse to leave the White House.
These episodes are taking place in the US, but other parts of the world are not immune from this same sort of situation. Protests against lockdown measures are happening in many different countries: the UK, Germany, Australia, Belgium, Italy, Poland, etc. At this stage, most of these protests are motivated by social anger against the restrictions that have been placed on personal liberties. In some cases, they have also been motivated by dissatisfaction regarding the economic impact of the measures being adopted to stop the spread of the virus. But even if the lockdown measures were to be alleviated in coming months, social tension might not ebb.
In fact, the real economic impact of the anti-Covid measures will be felt in the autumn. In Q2, there was an immediate impact deriving from the closure of economic activities. But those companies that could remain open used these months to process the orders arrived until the end of Q1 2020. But in Q3/Q4 2020 it will be clearer how many businesses have in fact survived, and how many new orders will have arrived.
The risk is that the collapse in economic activity of Q1/Q2 will have a long-lasting impact on economic systems, with serious repercussions on employment and, therefore, on social cohesion. This is the reason why governments around the world are trying to gradually re-open their economic systems, and why support in the form of government policy will need to remain abundant for the foreseeable future.
by Brunello Rosa
26 May 2020
We have been following the vicissitudes of the EU integration process for years now. To recap the milestones of our view, we have been saying that unless the EU changes tack, it will be very hard for the incomplete federalisation process of Europe to survive in a new world in which continental economies (the US, China, and India) will make the most relevant geo-strategic and economic decisions. Covid will make this new world come sooner than anticipated, even if the relative ranking of countries will be different than would have otherwise been the case.
The EU is currently an incomplete transfer union, in which resources (human, physical and financial capital) move from the periphery to the centre. The two main poles of attraction have been the UK (within the EU) and Germany (within the euro area). Somewhat ironically, one of the greatest beneficiaries of these influxes, namely the UK, has decided to leave, because the influx of migrants became politically unsustainable (or so the Leave campaign sold it as being). Brexit has proved us right, that the EU dis-integration process has begun.
The optimists believe that without the UK a more cohesive union will emerge, and therefore the integration process will finally be able to proceed. This is likely to be an over-estimate of what will actually take place. The presence of the UK was the excuse all other reluctant countries were using not to proceed further with the integration process. Was the UK blocking the completion of the euro-area banking union with the adoption of EDIS (the European Deposit Insurance Scheme)? Of course not. It was Germany that was doing so.
With the rise of populist parties in all major EU countries(Germany, France, Italy, Spain, and Poland) and also in smaller countries (Hungary, Czech Republic, etc,), it was clear that, a soon as any severe crisis would arrive, it would constitute an existential threat to the EU.
And, at that point, the EU would reveal whether or not it was up to the game, by completing its integration process, or else accelerate the ongoing dis-integration process. The shock has now arrived, of course, with the Coronavirus. We wondered whether the EU would finally face its “Hamilton moment” (i.e. finish its integration process) or, instead, its “Jefferson moment” (return to some form of Confederation, with limited sharing of sovereignty).
Facing the abyss, France and Germany have tried to come up with a proposal to mitigate the devastating effects of Covid and lockdowns on the economy of the continent. In an interview, German Finance Minister Olaf Scholz has called it Europe’s “Hamilton moment.” We wish that was true. The proposal has merits, and is in line with our previewfor how the EU would respond to the Covid crisis.
But some of the details reveal that we are still quite far from any form of debt mutualisation, and the distrust that exists between the Northern “frugal four” (Finland, Denmark, Austria, Sweden) and the “profligate” Southern countries (Italy, Spain, Greece, etc.) remains high. We will see what the Commission proposal looks like on May 27, and what compromise the Council will be able to make in June and the following months.
Our suspicion is that we will merely witness another round of the eternal “muddle through” that seems to characterise recent European history. To some extent, this would be better than the immediate collapse of the EU project, as any such collapse would have enormous economic, social and political costs. On the other hand, we doubt that any “more of the same” approach will equip Europe to succeed in the post-Covid world.
by Brunello Rosa
18 May 2020
We have discussed several times how serious the Coronavirus-induced economic crisis is. The lockdown measures introduced by many countries to mitigate the spreading of the virus have created a collapse in economic activity, on the order of 20-40% on a quarterly basis. This could result in a fall in real GDP of about 7-10% in many developed economies, with a rebound next year that will be mushy and uneven at best.
To mitigate the economic impact of Covid-19, a number of countries have adopted large stimulus packages consisting of fiscal expansion and monetary easing, in most cases in a coordinated fashion that closely resembles helicopter-money drops. Financial markets have, as usual, anticipated economic developments – equity prices collapsed around the world at the end of February/beginning of March, sending most of them into bear-market territory (-30% from their peak). Other segments of the market have given clear signs of dislocation. As discussed in our recent outlook, oil prices turned negative for the first time in history on April 20, as the collapse in global demand more than offset the cut to production that was decided upon by OPEC+ (including Russia) on April 12th.
Since the lows reached on March 23rd, equity markets have tried to rebound, but have done so with varying degrees of success. In the US, the S&P500 has recovered around half of the losses; it is now only down 11% year-to-date. The NASDAQ has managed an even more astonishing rebound, being at par year-to-date, thanks to the even more widespread use of technology during the lockdown. The Dow Jones, in contrast, which represent more traditional industries, is down 17% year-to-date.
In Europe, where the pandemic has led to harsher forms of lockdown (which are now being relaxed), the situation is less rosy, with the exceptions of Switzerland and Sweden. Equity markets remain down 25%-30% year-to-date. All these developments are in line with what we expected in our global outlook update.
As we previously discussed, a sustained recovery in market valuations could only occur when a durable solution (a vaccine or medication) to the healthcare crisis is in sight. Until then, market valuations will remain subject to downside risks. Nevertheless, as markets are leading indicators of economic activity, they will start to recover much sooner than the real economy. Conversely, the unemployment rate, which is a lagging indicator, will take much longer to normalise than economic activity in general. In the US, where unemployment insurance schemes and other similar automatic stabilisers are less widespread than in Europe, initial jobless claims reached 36 million in the first 7 week of the crisis. Non-farm payrolls dropped by 20.5mn in April, the largest monthly drop on record, with the country’s unemployment rate reaching 14.7%, up from the historically low 3.5% rate just a couple of months earlier.
Public authorities are coming to the rescue: the Fed has just launched a Main Street program of credit easing. But the reality remains the same as it has been since the Global Financial Crisis: the liquidity injections by central banks tend to translate into asset price reflation, which mostly helps Wall Street, while other measures, even those akin to helicopter drops of money, leave Main Street in the doldrums. Again, this could be the result of the difference between leading and lagging indicators of economic activity, with equity prices rising much more quickly than unemployment rates in the wake of a serious crisis. But perhaps it could also signal the need to refocus the aim of the stimulus packages in the first place.
by Brunello Rosa
11 May 2020
According to the most recent statistics, the UK is now third in the ranking of countries most affected by Coronavirus, after the US and Spain. It is second (after the US) in terms of number of deaths, with around 32,000 reported victims. Given the severity of the situation, the government, after initial hesitation, launched a complete lockdown of the country and its economy on March 23rd. Now, the government seems ready to relax some of these rules (for example, on daily exercise), while also tightening boarder controls (e.g. imposing a 14-day quarantine on anybody arriving in the UK). The central government – but not, for example, the devolved government in Scotland – is ready to move from the slogans “Stay Home/Protect the NHS/Save Lives” to “Stay Alert/Control The Virus/Save Lives”.
The impact of the pandemic and lockdown on the UK economy was recently estimated by the Bank of England, in the “illustrative scenario” described in its May Monetary Policy Report. The Bank estimated a 14% drop in the UK’s economic activity in 2020, followed by a V-shaped recovery of 15% in 2021. This estimate takes into consideration the overall policy response, namely a massive fiscal stimulus accompanied by a large monetary easing package, including rate cuts, increased QE and credit easing measures. The fiscal stimulus includes the innovative Job-Retention Scheme, by which the government will pay 80% of the salary of “furloughed” employees (up to GBP 2,500 a month) as long as their companies do not fire them, until June 30. The monetary stimulus includes a form of direct fiscal deficit, with the re-activation of the Bank’s “Ways and Means”, i.e. the Treasury account at the BoE.
While the pandemic and containment measures take their toll on the UK economy, the other major chapter of the UK’s political economy, Brexit negotiations, has re-started. As we have discussed in our previous analysis, the UK has no intention to seek another extension to the implementation period beyond December 2020.
The EU now seems to have accepted this position, which initially was motivated by the UK’s intention not to repeat the experience of requesting multiple extensions as occurred during the prime ministership of Theresa May, which led to political chaos. But now there are two additional motivations, which we consider to be even stronger.
First, as we explained in our analysis, “no deal” Brxit is the only logical conclusion of the approach brought forward by Johnson and his political side of the Conservative party, which won in a resounding way at the December 2019 elections. Second, the economic damage caused by the pandemic and the containment measures will easily mask any economic damage deriving from “no-deal” Brexit. The most visible aspect, namely travel restrictions and border controls, would be implemented anyway due to Covid.
Thus for now the UK government has all the advantages of not seeking for an extension by June 30 while knowing that it can always get one at the very last minute). It will make “no deal” more likely, thereby strengthening its negotiating position at the table. And if a hard Brexit does occur, it is probably what hard-Brexiteers such as Boris Johnson and his chief advisor Dominic Cummings, Dominic Raab (currently foreign minister and senior secretary of state) and Michael Gove (in charge of Brexit planning) ultimately want.
What happens if a no-deal, hard Brexit eventually occurs as a result of this tough negotiating approach? Well, the economic damage deriving from leaving the customs union and the single market without a deal, as well as increased border controls and customs checks, will likely be attributed by the government to the pandemic and the lockdown, rather than to the hard Brexit. The UK will also be free to respond to the additional economic shock by completely dis-aligning itself from the EU in terms of taxation, regulation, as well as product and labour standards. In the post-Covid world, where every country will try to do as much as possible just to remain afloat, the UK position might even not be perceived particularly at odds with that of other European countries, including those who will remain in the EU.
by Brunello Rosa
27 April 2020
We have discussed the macroeconomic impact of Coronavirus in several recent columns and research pieces. It is clear that we have already started witnessing large falls in economic activity around the globe in Q1. In some countries, GDP had fallen already 4-5% on a quarterly basis, and the collapse of real GDP growth will be in double digits in Q2. As a result, oil prices have collapsed into negative territory for the first time ever. Unemployment rates are soaring everywhere, with the US having witnessed a 30mn rise in initial jobless claims in the last six weeks, wiping out the gains made over the past several years.
Governments and central banks are coming to the rescue with large stimulus packages, but these will still struggle to reach small and medium sized enterprises (SMEs) and the self-employed, which will be decimated by the crisis. Helicopter money works only if money reaches every corner of the system, without remaining concentrated in the hands of a lucky few and without remaining concentrated in intermediary institutions such as banks.
When economies and societies do re-open, nothing will be like it was before. We will have to live together with the virus for so many months, potentially for another year until a vaccine becomes available on a large scale for most of the global population. Until that time social distancing will remain the mantra in most work and business environments.
Teams might need to work on alternate days or weeks. Open-space offices will remain unfilled for the months to come. In the aviation industry, planes will fly half empty and airports will devote much larger spaces to passengers.
In the hospitality industry, restaurants will have to find ways to serve food while complying with social distancing regulations, and hotels will remain half empty at best.
In such an environment, what is the right strategy to adopt in order for your business to survive? Well, during the financial crisis, Richard Koo’s theory of “balance sheet recession” got a lot of attention. It was based on the fact that, in a financial crisis, private sector agents are trying to deleverage, and therefore the only entity able to increase its debts is the government. In such an environment, private sector agents switch from being profit-maximisers to become debt-minimizers, to regain financial viability.
In this crisis, unless private-sector agents receive grants from public authorities, they will need to take loans, which banks will offer at a very cheap rate and with favourable conditions as a result of central bank’s credit-easing measures. In this crisis, therefore, private-sector agents cannot afford to be debt-minimizers. Also, especially companies should forget about being profit maximisers, in order to avoid frustration and disappointment. In an environment such as the one described above, they will be forced to run at half-capacity at best and therefore they will surely suffer losses.
Since losses will come no matter what, the ideal business strategy to adopt is to minimize such losses, without regretting too much the lost revenues and profits. Most of those losses, especially in public services, will likely be subsidised by the government. In some cases, subsidization will not be possible, and so the aim should be to develop enough internal efficiencies to minimise future losses. The development of the various forms of remote working point exactly in that direction.
by Brunello Rosa
27 April 2020
Last week, we analysed some of the ongoing issues that risk being overlooked as a result of the Covid-induced crisis. One of these issues was the impact of the crisis on carbon emissions. According to recent estimates, with 28 countries in the world having adopted full or partial lockdowns, the movements of a third of the world population are now enduring some form of restriction as a result of social distancing. Economic activity has been severely reduced because of this; the IMF is estimating a contraction of real GDP in 2020 of approximately 3% (but we expect it to be closer to 4%). Some sectors have completely shut down, and international travel, especially via planes, has collapsed. Statistics show that commercial air traffic has shrunk 41% below 2019 levels in the last two weeks of March. The situation since then has likely worsened even more, as more countries have adopted some form of lockdown.
As a result of this collapse in economic and travel activity, air pollution has collapsed, and greenhouse gas emissions have been dramatically reduced. According to the United Nations, since lockdowns and shutdowns begun, CO2 emissions have dropped by 6%. By the time the year ends, there will be an estimated 0.5%-2.2% reduction in CO2 emissions due to Covid (or even 5%, according to some experts), depending on the model adopted to predict the pick-up in economic activity in Q3 and Q4 2020. This could be the first reduction in global emissions since the 2008-2009 Global Financial Crisis.
To some extent, the Covid-induced lockdowns have provided an unexpected, yet welcome, massive natural experiment as to the impact that a reduction on human economic activity can have on greenhouse gas emissions that are responsible for global warming (the rise in the earth’s temperature, estimated to be around 0.2˚ C every decade). This hopefully will resolve once and for all the vexata quaestio of whether global warming is caused by human activity or other unrelated factors.
However, the UN warns, this temporary reduction in emissions will not stop climate change, which derives from the accumulation of the effects of many decades of human activity. Especially if the solution to this crisis will be the implementation of public infrastructure projects that have a significant environmental impact.
While having gone silent in the last couple of months, climate change activists have gained a number of arguments in their favour. Not just on the impact that a reduction of economic activity might have on pollution and global warming, but also on the need for international coordination and cooperation to achieve that result. There is, however, another argument that will likely get traction. As the chart above shows, carbon emissions have increased in tandem with world population, which has risen from the 3 billion people of 1960 to the 7.6bn of 2018 (more than doubling in two generations). The UN estimates that there will be 11.2bn people in 2100, and if greenhouse gas emissions continue to be correlated with world population, the world’s temperature will rise well above any target being discussed in the various Conferences of The Parties (COP) rounds.
Pandemics, if the virus is natural and not man made, may be partly a reaction to overpopulation (and therefore pollution). It is a clear signal the planet is sending that it may not have enough natural resources for all its inhabitants, at least not if resources are so unequally distributed. If the world does keep on increasing its human population without significantly changing its development model, pandemics will become more frequent and deadly in the future.
If, then, we want to learn some lessons from the immense tragedy represented by Covid, they might include the following: 1) human beings are for the most part responsible for the catastrophes that befall them; 2) if the world’s development model does not radically change in favour of sustainability and renewable resources, extreme weather events will continue to affect the planet and pandemics will plague its human (and more generally, animal) population; and 3) only a coordinated and cooperative international approach can provide the solution to these historical issues.
by Brunello Rosa
20 April 2020
We have lately been discussing four fundamental dimensions of COVID: healthcare, economics, policy, and market implications. On the healthcare front, advancements have been made that increase intensive-care capacity (with field hospitals and other logistical arrangements) as well as testing, treatment and progress towards a vaccine. On the economics front, we have just released our latest estimates of the macroeconomic impact of lockdowns around the world. We have often also discussed the policy reaction (fiscal, monetary and regulatory) that will be needed to mitigate the effects of the macroeconomic impact and market implications of all these factors.
Besides these four fundamental dimensions of COVID, we have also analysed what could be the long-term geopolitical implications of this crisis. Namely, China is set to gain the most from a strategic perspective, at the expense of the US, while the EU faces yet another existential crisis.
In this column, we want to discuss some of the events that are now occurring which risk being overlooked because of the pervasiveness of the news regarding the main dimensions of the crisis discussed above. We might call these the collateral effects of COVID. They too could have serious consequences, and perhaps even represent a turning point in the world’s history.
On the one hand, as we have recently discussed in our in-depth analysis, there is the progress that is still being made by various countries in technologies such as artificial intelligence, which could provide a massive geo-strategic advantage to those who master them first. Russia, for example, is certainly using this period to make gains vis-a-vis its international competitors, by making large use of AI, and not just to find a cure for COVID-19. Russia is certainly not alone in this game, but it has a historical head-start over most other countries where cyberwarfare is concerned.
On the other hand, the US is about to enter one of its more turbulent periods in recent history. The US is already the country in the world with the largest number of confirmed cases and deaths, and yet partisanship regarding how to face this pandemic still prevails, with science being regularly questioned by populist political leaders and media. The US will soon have to face an election in a time of the pandemic, the result of which (as we discussed in our recent analysis) is now too-close-to call. There are those who suggest that if Trump were to lose by a small margin and the vote were to be contested, he would not accept the verdict of the Supreme Court, like Al Gore did when he run and lost against George W. Bush in 2000. The requests on Twitter made by President Trump to “LIBERATE” a number of states that are being governed by Democratic governors who are imposing COVID-related restrictions, and the gathering of armed militias to protest those restrictions, do not bode well for the future.
Around the world, authoritarian leaders are using the excuse of lockdowns to increase their grip on power and leave even less freedom to opposition parties and the press. This is happening even in Europe, within the European Union, ostensibly the most advanced defender of civil and political liberties in the world, where Hungary’s PM Victor Orban has created a de-facto dictatorship.
On a larger scale, the fight against climate change has gone incredibly silent in the last few weeks. Clearly there is an even more imminent threat to deal with, but at the same time, the arguments made by those fighting against climate change have been made even stronger by the COVID crisis. The virus, if natural and not man made, is certainly a reaction of overpopulation and pollution. With lockdowns imposed in most countries, the world has just carried out its largest natural experiment as to how pollution can be greatly contained if human activities are drastically reduced. At the same time, the opponents of those advocating against climate change will say that the top priority now is re-starting the world’s economic engine, rather than worrying about the side effects such as pollution and climate change.
All these example show that even as we follow the news about the COVID crisis, we should not lose sight of what else is happening in the world, which could have long-lasting consequences that will become apparent only when the current emergency is ended.
by Brunello Rosa
6 April 2020
The Covid pandemic has now led to more than a 1.2 million people being infected around the world, and 68,000 confirmed deaths. It is now clearly understood that the economic impact of this crisis will be far worse than was the 2008-09 financial crisis, and maybe as bad as that of the Great Depression in the 1930s. It could, potentially, be even worse than the Great Depression (as Nouriel Roubini calls it, a Greater Depression).
After initial hesitations, in particular in the US, UK, Brazil and Sweden, the pandemic has now generated a policy response that is broadly homogeneous around the globe. From a healthcare perspective, partial or total lockdowns have been imposed by several countries, with severe restrictions that can be slightly less draconian in those countries which have a population historically used to self-discipline, such as the UK. Of the largest countries, only the US is still reluctant to adopt serious measures of suppression, preferring forms of light mitigation instead. This is a mistake that will cost dearly down the line.
In terms of fiscal policy, virtually every economy has launched schemes aimed at guaranteeing liquidity and credit to large, medium and small enterprises, and fiscal support to workers, without much distinction between protected salaried workers and unprotected self-employed ones. In terms of monetary policy, almost all central banks in the world have adopted a combination of cuts to policy rates, increasing asset purchases, funding for lending schemes, longer-term refinancing operations against wider collateral, easier access to emergency lending, FX intervention and swap lines. Regulators have relaxed capital and liquidity requirements for financial institutionsto increase their lending capacity.
Despite all this, stock prices in equity markets, sovereign yields of reserve currency countries and oil prices continue to fall. Why? The answer is simple: there is still no light at the end of the COVID-19 tunnel. Even if policy makers throw the kitchen sink at the crisis, they will not resolve the underlying issue, which is the containment of (or the cure for) the virus.
Only medical experts and scientists, in this occasion, hold the key to solving the crisis. The measures introduced so far and discussed above only aim at buying time for scientists to find a solution. Initially, they are intended to flatten the curve of contagion, reduce the influx of patients into hospitals requiring expensive intensive-care units (ICUs), and increase their ICU capacity, perhaps by building field hospitals.
Following these necessary initial measures, progress needs to be made in the other three directions that will lead to the eventual “victory” over the virus. First, testing needs to become available on a much larger scale, in order to trace the diffusion of contagion. And, more so than the current antigenic testing (which tells if somebody is currently infected), the development of reliable forms of antibody tests will be crucial, to easily determine who had been infected and has developed immunity (even if such immunity is only temporary) and could therefore – for example – return to work. Secondly, if a treatment is found that alleviates the symptoms and reduces the need for ICUs, this would mark a major change in people’s perceptions of the virus. It will help people calculate the risk of living in a world where the virus is still prevalent, which is likely to become necessary at some point unless we are willing to keep the world shut for the next 18 months.
Finally, there is the goal of developing a vaccine that would allow people to develop antibodies and return to work. On this front, there might be some promising progress that could speed up the process compared to the 12-18 months currently being estimated. Even still, we are talking about a timeline of several months before the fastest vaccine could possibly become available to millions of people.
Only when some breakthrough on a combination of these fronts occurs will it become possible to realistically say that there is some light that can be seen at the end of the tunnel. At that point, equity prices will find credible reason to rebound. The bad news is that we do not know when these breakthroughs might occur. The good news is that they could happen at any point in time during the next few weeks.
by Brunello Rosa
14 April 2020
As we discussed last week, the impact on economic activity and markets from Covid depends crucially on medical advancements made in the fight against the virus. When progress on the medical front is considered sufficient by market participants, it is likely that risky asset prices will then start to recover (certainly, they will do so before economic activity itself stabilises). The impact of the virus on economic activity could also become smaller if enough advancement is made on the medical front.
While China is facing its second mini-wave of contagion, deriving mostly from people returning home from abroad, there are reports that Spain is tentatively starting to re-open some of its non-essential activities, such as factories and some offices. Italy has started to plan a gradual re-opening, aimed at May 4th, and a task force led by former Vodafone CEO Vittorio Colao has been appointed by the government to plan a gradual re-opening of the economy. An undersecretary of Conte’s government even ventured to say that Italy’s beaches could be open this summer, if social distancing measures are in place.
The situation is very different in the UK, the US and Sweden, which have been late to adopt social distancing measures, and are still in the fast-accelerating part of the contagion curve. In particular, in the UK, the country has been following a path not too dissimilar from that of Italy, and its Prime Minister Boris Johnson admitted that he could have died of Covid-19 during his stay in the hospital. In the US, the scenes of public burials in New York has shocked people around the globe. In Sweden, PM Stefan Lofven had to apologise for being too slow and timid in adopting social distancing measures.
However, some glimmers of hope are starting to emerge from the medical front, which, as we said last week, consists of four sub-fronts. On the increase in intensive-care capacity, a lot of progress has been made worldwide, with the construction of field hospitals. This should help manage the expected increase in the number in patients admitted to hospitals in the most-hit countries.
On testing, the availability of antibody tests (which can tell if somebody had been infected and has developed some form of immunity to the virus) has increased massively, and the Lombardy region, one of the areas most affected by the epidemic, has stated that soon a large-scale distribution of what will be considered “Covid-19 health passports” will begin. On the other two medical sub-fronts, namely treatment and vaccine, plenty of progress has been made as well.
As to a possible cure for the virus, doctors have identified the three phases of infection. Against the first phase, when the virus starts to attack cells, at least two medicines have proved to be effective, Cloroquineand L-Asparaginase. If a virus still manages to infect the body, anti-inflammatory medicines (such as steroids that reduce inflammation and the immune response) can reduce the impact on the affected person.
In the third phase, when infection becomes serious, the virus causes an over-production of antibodies that clog the lungs and create small thrombus that start circulating throughout the body, causing multiple organ failure and eventually death. Against this, a group of doctors in various hospitals in Italy have started to test the efficacy of a traditional anticoagulant, the heparin, which prevents the formation of thrombus. Initial clinical tests show that this cure is effective and, if heparin is given early enough, patients might not need to be hospitalised. From this mix of cures, it is likely that very soon a clinical protocol to treat patients in the various phases of the disease will become standardised, thus reducing the need for intensive-care units. The good news is that most of these medicines are quite common and therefore not very expensive.
On the final front, the vaccine, good progress has also being made. Besides the progress that has been made in Pittsburgh, which we mentioned last week, another team of researchers, based in Italy in collaboration with Oxford University, has found a methodology that will be tested by the end of the month, which could result in a vaccine being ready by September (in small samples).
All this is to say that much effort is being made to reduce the impact of the virus on the health of people and on economic activity. While we need to remain vigilant against second and third waves of the virus (which could be more deadly than the first), three strains of which have already been identified, it is encouraging that some progress is being made on the medical front.
by Brunello Rosa
30 March 2020
In our column of March 16th, titled “The World Is Likely To Be Radically Different After The Coronavirus Crisis” we mentioned that the Coronavirus is posing an existential threat to the survival of the EU. In this column, we want to further elaborate on this issue, following the EU Council meeting on March 26, in which the heads of state and governments failed to reach a deal for a common strategy to fight the crisis.
The underlying principle behind the EU integration process is the solidarity that member states should display towards one another on all matters of common interest, after centuries of inter-European conflict. For this reason, the first embryo of the EU was the European Coal and Steel Community, coal and steel representing the key ingredients for the economic recovery in the post-War period. Once solidarity ceases to exist, there is no reason for the Union to exist either. In spite of the initial, delusional hope that COVID-19 was an asymmetric shock to Italy rather than a generalized crisis across the region, and could therefore be addressed by the activation of article 122.2 of the EU Treaty (i.e. grants to the country “seriously threatened with severe difficulties caused by … exceptional circumstances beyond its control”), it is now clear that is a symmetric shock to every country of the EU.
This means that the EU as a whole should react to it, with common instruments, rather than by simply adopting a coordinated approach of national policies by individual member states. Instead, so far national selfishness has prevailed, and countries have reacted by adopting a series of policies based on their individual circumstances. For example, at the fiscal level, Germany has announced a plan of EUR 550bn of fiscal easing (of which EUR 156 will be fresh expenditures), France a EUR 300bn plan, and Italy, given its more stringent budget constraints, only a first EUR 25bn plan followed by another EUR 25bn likely to be announced in April. Virtually all countries have re-instated national borders and suspended the Schengen agreement.
At the EU level, there has thus far been only a partial and temporary suspension of the Growth and Stability Pact (GSP) and an easing of the discipline regarding state aid to private-sector companies. Even the ECB was initially reluctant to engage in its mandatory spread-compression activities, until finally the EUR 750bn PEPP was launched, with the inclusion of Greece and the suspension of the issuer limits. But this is still too little compared to what the EU could and should do to face the existential crisis before it.
With Brexit underway, and the UK initially threatening to deviate from the continental practices of social distancing to follow a chimeric and flawed herd immunity approach; with Schengen and the GSP suspended; with every country following its own approach to COVID, from para-military lockdowns (in Italy, for example) to minimal social distancing rules (e.g. in Sweden), the risk is that re-converging when the crisis is finished will become virtually impossible, as every country will find it more convenient to pursue its national strategies and interests. A country might, for example, bitterly and understandably decline to pursue European reintegration because it felt that it was neglected during the crisis.
Take Italy, for example. In 2011-12 Italy was brought to the verge of default because of the slow and flawed response (by moral hazard considerations) from the EU/EZ to the Greek crisis. Italy, which participated in the rescue packages for Greece, Ireland, Portugal and Spain, came under speculative attack because it was perceived as being part of the PIIGS grouping of economies. Only Draghi’s “whatever it takes” pledge and the consequent OMT avoided the disaster. In 2015, during the migrant crisis, Italy was then left alone facing the arrival of ships landing on the southern shores of Europe. In 2020, after the symmetric exogenous shock deriving from COVID, the implicit message from the EU was: “deal with it by yourself, we’ll be lenient on your fiscal position, ex-post.” It is not clear where solidarity is in all this, and we should not be surprised if, at the end of the crisis, the levels of EU-scepticism will be at historical highs. Other countries are in similar positions, and if the EU fails to rise to the historical task it is now facing, it might end up being the largest, institutional victim of Coronavirus.
So, while Merkel and Von Der Leyen declared their opposition to Eurobonds/Coronabonds being used to finance a pan-European recovery plan, the Eurogroup has been tasked with coming up with technical proposal on the feasibility of risk-sharing instruments. Hopefully, it will come up with some serious proposals in the next couple of weeks, and these approaches will be adopted by the EU Council. But other roads are possible, such as the possibility of activating ESM loans with virtually zero interest rates and null or very limited conditionality. That, in turn, could open up the possibility of using the OMT to fight unwarranted widening of sovereign yield spreads within the EZ.
by Brunello Rosa
23 March 2020
We have discussed Coronavirus in a series of columns in our weekly Viewsletter this year. Discussing the virus is inevitable, considering the importance the COVID-19 will have on all aspects of life for a large part of the world population – with its health, economic conditions and financial repercussions. Our first column on COVID dates from February 3rd, when China was starting to impose some of its most draconian measures while all other countries were ignoring the risk or happily living in denial. On that occasion we warned that “Coronavirus Poses a Downside Risk To The Global Economy.”
One month later, on March 2nd, we commented on how financial markets had finally caught up with reality of the virus, saying that markets “Belatedly Correct on Coronavirus Concerns.” The week after that, we discussed how central banks had tried to come to the rescue with more of the same “medicine” (i.e. rate cuts and a limited increase in asset purchases). Finally, last week, we took a longer-term view that the world will look radically different a year from now.
This week, we are discussing how central banks and governments have finally realised the magnitude of the shock and the therapy needed to mitigate its impact. As we discussed in Part 1 of our Global Outlook Update, we now expect the global economy to experience a global recession in 2020, as our baseline scenario. In downside scenarios, the economic contraction could be much more pronounced and prolonged. As most countries are now realizing what was, in our opinion, self-evident, namely that Italy has simply been a leading indicator of what could happen if they do not contain the spreading of the virus early on, the policy decisions deriving from this “epiphany” are now finally starting to appear on the horizon.
As we discuss in Part 2 of the Global Outlook Update, most countries are now adopting monetary and fiscal expansion measures to limit the damage to the economy deriving from the draconian measures adopted to contain the virus. These draconian measures which include the partial or total lockdown of the country, suspension of all international travel, re-instatement of borders, even within the EU with the suspension of Schengen, etc. In the US, the Fed has brought its policy rate to zero and re-started QE, and the government has presented to the Senate a USD 1.6tn fiscal easing package, potentially including forms of cash directly sent to households. The UK government has announced a GBP 330bn fiscal easing package, while the BOE slashed rates to virtually zero and re-started QE. In France, President Macron has announced a EUR 300bn fiscal package, while Germany has finally thrown its ridiculous “schwarz null” policy out of the window and pledged EUR 550bn of fiscal stimulus (including loans and credit guarantees), of which EUR 156bn will be fresh money expenditures. The ECB, following the initial mishap by President Lagarde, has staged its “Whatever it Takes – 2” moment, launching its new PEPP plan of EUR 750bn of asset purchases.
The next stage in this process is increased coordination between the monetary and fiscal responses, both of which are needed for the overall response to the crisis to be effective. This will likely translate into forms of direct or indirect debt and deficit monetisation, which has been variously labelled as People’s QE, MMT or helicopter drops of money. It is with some relief that we finally see these “helicopters” taking off to fight the effects of COVID on the economy and financial markets.
by Brunello Rosa
16 March 2020
Now that the new Coronavirus (COVID-19) has officially been declared a pandemic by the WHO, an increasing number of countries are adopting measures to counter its spreading. Financial markets have collapsed as a result; it is clear that we are facing a serious health, economic and financial crisis. This is likely to be more serious than that in 2008-09, which was a banking, demand, and confidence crisis. This is a demand, supply, and confidence crisis, in which banks have not yet played a major role. In 2008-09 there was the element of uncertainty as to how low housing and asset prices would fall before finding a floor. Today, in contrast, there is a much larger element of uncertainty: How long will this crisis last?
In fact, the re-opening of economies even after the number of new cases is dropped to zero will remain gradual at best. Until a vaccine becomes available, the virus can always come back and force the authorities to close their economies all over again to stop the contagion. So, let us make the assumption that not until 12-18 months from now, if a vaccine then becomes available to everybody, will the end of the health emergency occur. For the sake of the argument, let us assume that we will be able to expedite the production of a vaccine to only 12 months from now. The world would then be in some form of emergency until Q1 2021.
What will the world be like that will emerge from this crisis? We believe that the world in 2021 will be radically different from that which exists today.
In China , there will be two opposing forces. On the one hand, there will be the conviction that the regime was able to contain the virus in three months of very hard work, which in turn gave much of the rest of the world the template to use when attempting to contain the virus themselves. The regime could use this to strengthen its grip on society, and on any form of dissent, or against any emerging appreciation for Western values such as “privacy”. On the other hand, the regime will at the same time be blamed for hiding the real nature of this pandemic for too long, causing the damage at global level that now plainly exists. Chinese society might also have to rethink some of its millennial traditions (including food and hygienic standards) that make China the origin of virtually every new flu strain. Overall, we believe China will come out stronger and even more modernised from this experience, even if its regime might need to make further strides to regain legitimacy and trust among the wider populace.
On the other side of the Pacific, there is the US, where the political leadership is held by a person, President Trump, who embodies of the polar-opposite attitude that led the Chinese to a rapid victory against the virus: indecisiveness, mis-representation of facts, open criticism of scientifically-proven theories in favour of his gut feelings, under-reaction followed by over-reactions. There is enough to make many people re-think the idea that a large and complex country like the US can be governed by virtually anybody so long as the “deep state” and its institutions are alive and well. Given its initial mistakes, the US will take much longer to rein in the disease. Perhaps the worst economic impact will be felt just before the November election, and therefore COVID could easily cost Trump the re-election. But the country will be shaken in its preference for relatively low personal and corporation tax levels at the cost of many public goods such as a universal healthcare system and good-quality education. The US has lost its supremacy in many domains versus China; this crisis will further shake its position as the world’s leading country.
In between these two countries, there is the EU, which will face its most serious existential crisis since its foundation. The uncoordinated health and fiscal response to the virus, plus the arbitrary and unilateral closures of the borders (i.e. suspending the Schengen agreement) have, once again, shown the fragility of the European construct and the possibility of its collapse. The only truly pan-European institution has missed this opportunity to show leadership, as it did during its previous existential crisis, the Euro crisis, in 2012. The package of measures adopted last week was borderline adequate given the stage of the threat, considering that the package could be further expanded in coming months. But the ECB cannot afford mishaps such as that which was made by President Lagarde, when she said that “it’s not the ECB’s job to close the spreads within the EZ sovereign bond yields.” In the absence of Eurobonds or EZ safe assets, it is precisely the ECB’s job to ensure that the spreads remain compressed, in order to ensure the smooth transmission of monetary policy. Additionally, the ECB has a facility (OMT) specifically designed to close widening spreads unwarranted by market fundamentals. In addition, because most countries will move into forms of fiscal-monetary coordination, the EU, with its 27 fiscal regimes and several central banks, will have much harder time than the ECB would at implementing a similarly coordinated response to the crisis.
In conclusion, we believe that all the three main areas of the world will face serious crises of political legitimacy and, in the case of the EU, existential threats. Other countries and regimes will equally come under severe stress and could collapse as a result of this crisis. The rankings of countries at the global level will change drastically after this crisis, in many dimensions. We should prepare to see debt/GDP ratios approaching 150-200%, as often occurs during wartime. Global supply chains will be further disrupted; the tendency towards de-globalisation will be reinforced. Returning to the “new normal” will be another enormous task of world leaders in 2021; at least, for those leaders who will have politically survived.
by Brunello Rosa
9 March 2020
The latest news from the COVID-19 front is a mixed bag. In China, following the draconian measures of containment the country adopted during the last few weeks, the official number of new cases is close to zero. A number of existing cases still need to be resolved, but there are not new infections occurring that would aggravate the situation. In the rest of the world, however, the situation is starting to become increasingly bad. In Italy, which has been the country with the second highest number fatalities (almost 370), the daily percentage increase of new cases is still around 20-25%, which means that the number of reported cases doubles every 4-5 days. Thus the diffusion of the infection is still in its exponential phase. And the number of cases is increasing in other countries too, including Germany and the UK and, of course, the US.
Albeit slowly, authorities in Germany, the UKand at EU level are awakening to the fact that COVID-19 is not going to remain a phenomenon limited to Italy, a conviction some European leaders have deluded themselves with for too long. This means that, in time, a larger response will be put in place. In the US, it seems that we are still in the delusional phase in which COVID-19 will remain primarily limited to China and Europe, with only a limited spread in the US. The response has therefore been limited and insufficient so far. The number of swab tests being carried out is still ridiculously low, and the official number of infected people is being kept artificially low by the fact that they are not being detected.
But the story of this virus always shows the same news cycle.
Initially, politicians delude themselves that the problem will remain limited to other countries. As soon as the first person dies in that country as a result of COVID-19, this delusion is no longer tenable, and so the initial timid admission and response occurs. When the number of deaths increases, one can easily infer the total number of infected people by knowing that the mortality rate at global level is around 3.4%. When the number of cases reaches the thousands, the response then becomes forceful. In Italy, the entire region of Lombardy has been quarantined, as have other provinces from neighbouring regions: people cannot get in or out.
As the disease spreads, the economic damage worsens. In our upcoming updated outlook, we will show how we expect global growth to be closer to 2% in 2020 than 3%. This means that in some countries, such as Italy and Japan, there will be a recession this year. Other countries could be equally badly affected – Germany might also fall into a recession, and US growth is likely to be around half of what was expected back in December. To prevent the economic downturn from becoming too large, policy makers are coming to the rescue. Fiscal authorities are trying to design targeted relief plans, in particular to support solvent but illiquid small and medium sized enterprises.
Central banks can also act faster to support market sentiment. A number of them have cut rates in the last few days: the Federal Reserve by 50bps to 1.00-1.25% (intra-meeting), the RBA by 25bps to 0.50%, the BoC by 50bps to 1.25%. Elsewhere, the central banks of Hong Kong and Malaysia cut their interest rates by 50bps (to 1.50%) and by 25bps (to 2.50%), respectively. These interventions are necessary to support market sentiment but will do little to solve the problem generally. The market understands all this, and therefore the selloff in equities continues. Equities will continue to adjust until market participants believe that the virus has been successfully contained at the global level. Even in the best-case scenario, this could take at least a couple of quarters. If the US delays its response to the virus in order to keep the economy strong during an electoral year, the process will be severely delayed, with the result being that immense damage to global health and economic activity could ensue.
by Brunello Rosa
2 March 2020
At very long last, financial markets caught up with the reality of the coronavirus, selling off last week in the worst market performance since the Global Financial Crisis of 2008. As the Financial Times reported, “mounting concerns at the rapid spread of the coronavirus caused one of the quickest market corrections in the benchmark US S&P 500 since the Great Depression in the 1930s.”
As we have written in our in-depth report on the subject, market participants are finally realising the impact that COVID-19 could have on the economic performance of the countries that have been most affected by the disease. In our column on the potential impact of COVID-19 (which we published a month ago already), we warned that the downside risks posed to the global economy by the public reaction to the virus could be huge, possibly greater even than the virus itself. In effect, last week market participants staged a panic reaction to the news coming from Italy, where entire cities were quarantined in the country’s northern region, which is the industrial powerhouse of the country, with Milan, the financial capital of the country, being the epicentre.
Since then, the situation has not improved: the number of infected people and fatalities worldwide have risen (albeit at a slower rate than in previous weeks), surpassing 85,000 and 3,000 respectively. At the same time, the number of people who have recovered from the disease has also increased, surpassing 42,000. Most importantly, the US has suffered its first fatality from COVID-19 (near Seattle). This could mark the beginning of a new phase in the crisis. In fact, as we have already said, unless the pathogen mutates suddenly in coming months, the mortality rate will remain relatively low, around 2% globally of those who become infected with it.
Nevertheless, the economic impact of the virus will derive from the reaction of governments to the news about it. No politician wants to be blamed for not having taken sufficient action in response to the virus. The first reaction from the US was the suspension of certain flights from the US to Northern Italy. As the number of cases and deaths increases in the US, however, so too will the escalation in the counter-measures the government takes. The economic impact of severe counter-measures in the US would take the economic impact of COVID-19 to a different order of magnitude, and would have a global economic impact. A global recession in 2020 is now becoming a real possibility.
The countries that have experienced the largest number of cases of infection show that the economic impact of the virus could be large, and might not necessarily be V-shaped as had been optimistically assumed by some commentators until just a few days ago. In China, the manufacturing PMI has collapsed to 35.7 in February, down from 50 in January, marking a new all-time low. Any figure below 42 in China signals an outright contraction in activity. The GDP in China, Japan, South Korea and Italy will contract sharply in Q1, and perhaps also in Q2. Fiscal packages to ease the sharp fall in economic activity are in the process of being approved in those countries. The latest is the EUR 3.6bn package announced by Italy on Sunday. These measures will help to a certain extent, but ultimately will not be able to achieve much. In particular, monetary policy, which will likely become more expansionary at the global level pretty soon, is likely to prove impotent against a supply-side shock.
Considering all of this, it is clear that market participants should brace themselves for more volatility and corrections in the weeks and months ahead. The impact of Coronavirus on global economic activity will be large and persistent. The policy response will be slower, smaller and less effective than expected. This will necessarily have to be reflected in the valuation of risky asset classes. Fasten your seatbelts.
by Brunello Rosa
24 February 2020
After entering the Democratic primary late, Michael Bloomberg is trying to establish himself as the only Democratic candidate who can defeat Trump in November. His strategy might prove to have been well-calculated. By not entering the race before the caucuses in Iowa and New Hampshire were held, he knew that by the time Super Tuesday takes place on 3 March one of the left-wing contenders (either Bernie Sanders or Elizabeth Warren) would be ahead in the game – an that would scare the median voter, financial markets, and also the Democratic leadership into preferring a candidate like himself. The result of the latest primary election, in Nevada, where Sanders once again finished ahead of centrist candidates such as Joe Biden and Pete Buttigieg, confirmed this trend (which can also be seen at a national level, according to recent polls), and thereby the validity of Bloomberg’s strategy.
Michael Bloomberg might have thought that, after scaring markets and centrist voters with the advancement of radical left-wing candidates (notably, of Bernie Sanders, who self-defines himself as a socialist), the democratic leadership would come to him, begging him to unify the party and lead it in the race against Trump in November. However, things might not work out as Bloomberg may have planned.
In the first televised debate in which he appeared against the other Democratic candidates, Bloomberg was frontally attacked by the left-wing contenders, in particular by Elizabeth Warren. He did not come across as particularly friendly in this exchange. A highly curated video clip of the debate, in which Bloomberg asks the other candidates who else has founded a successful business, did not do him great credit either. While he had a point, since he is indeed the only one among the remaining Democratic candidates with that achievement, the entire scene lasted no more than a couple of seconds on live television, while the video made it look much more dramatic than it had been in reality.
Also troubling the Bloomberg campaign is a series of NDAs signed by women who were allegedly mis-treated when working at Bloomberg LLC.. So, even if Bloomberg may be the only candidate who can defeat Trump in November, he still faces an uphill battle to win the Democratic nomination.
In particular, Bloomberg will have to mobilize a portion of the Democratic electorate – African-Americans, other ethnic minorities, women – that is essential to win the nomination and, eventually, the general election. Some fights with the black community when he was mayor of New York will not help him in this battle. Additionally, his profile might not be particularly attractive to this key portion of the Democratic electorate. While being a truly self-made man (unlike Donald Trump, who inherited his fortune from his father), Bloomberg is still the sort of New York-style billionaire who does not necessarily attract the sympathy of minorities and other traditional segments of the Democratic electorate. Also, the story of the women-related NDAs risks sticking to him much more than to Trump, who the electorate seems willing to forgive almost anything. (Certainly, the number and depth of allegations against Trump is much larger than those against Bloomberg).
Bloomberg, therefore, might not be the white knight he was presumably hoping to become. The race for the Democratic nomination remains open. The simple truth is that the Democratic party has not been able thus far to converge towards a candidate who can truly represent a credible threat to Trump in the coming general election. The president will present as victories his trade and tech wars with China, his hard-line on Iran, and other high-profile battles that could ultimately damage the international reputation of the US and its economy. His electorate might accept this narrative, securing his re-election in November. If the Dems want to avoid this, they better start getting their act together, and fast.
by Brunello Rosa
17 February 2020
During the weekend, the annual Munich Security Conference was held in the capital of Bavaria, Germany’s richest state. Media outlets extensively reported on the key proceedings of the conference, which this year focused on the concept of “Westlessness”; i.e., on whether the world has become less Western. This is a concept they also studied in depth in their annual report. As long as the “West” is defined by the alliance between North America and Europe, along with the key additions of Australia and New Zealand (part of the so-called Five Eyes), clearly the last few years have observed a marked deterioration in this relationship, and in particular of NATO, the military alliance underpinning it.
US Secretary of State Mike Pompeo came to Munich to reassure those present that NATO is alive and well, and that it is ready to deploy its benefits to its constituent countries. Pompeo specifically said that he was “happy to report that the death of the transatlantic alliance is grossly exaggerated. The West is winning, and we’re winning together.” However, only in November 2019, Pompeo himself warned that NATO was risking extinction unless it adapted itself to reality. This happened at the same time as French President Emmanuel Macron was reported as saying that NATO was brain-dead. So, what’s the current state of the transatlantic alliance, in reality?
It is true that NATO is still alive, but its cohesion has been severely tested recently. Trump has just approved a series of tariffs on the Europeans, following the WTO ruling on EU’s aid to Airbus in that company’s long dispute with Boeing. (Italy, which does not belong to the Airbus consortium, got exempted from these tariffs, thanks to their own successful bilateral negotiations). Other tariffs aimed at the auto sector are also being considered by the Trump administration at the moment, after being delayed by six months in May 2019.
In a few months, when the WTO will likely rule in favour of Airbus and the Europeans will be able to impose retaliatory tariffs on the US, we might be at the beginning of another tit-for-tat trade war, similar to that we have been observing between US and China in the last three years.
Within Europe, the situation is, at best, fluid. The UK has just left the EU, imposing a severe level of damage onto the geopolitical standing of the continental bloc, as discussed by John Hulsman in his recent analysis. PM Johnson is now mostly committed to establish his leadership within Whitehall, as the recent reshuffling of his government proves. What is left of the EU is in flux. In Germany, the decision by Annegret Kramp Karrembauer not to run for Chancellor at the next federal election has completely ruined Angela Merkel’s succession plans. As we discussed in our analysis of the German political scene, under certain circumstances, this might eventually lead to a desirable outcome, for example a Green-Black coalition. On the other hand, it might make Germany even more inward-looking and undecided as to how to exert its leadership on the continent. And Germany is absolutely needed by French President Macron if he wants any of his grandiose plans for the future of Europe to ever become a reality. As we discussed in our recent trip report, both the social and political opposition to Macron are weak or weakening, paving the way to his re-election in 2022 (bar a global economic crisis occurring in the meantime). But without its German dance partner, there is very little France will be able to do.
So, the West might be still in the position of taking on China, weakened by the impact that the Coronavirus might have on the Chinese economy and on the legitimacy of its regime. But the West needs to find a new sense of unity if it wants to win the battle for the geo-strategic hegemony of the future. At a time when China is trying to reach out to the Europeans, to convince them to break ranks with their historical US ally, and with Trump not hiding his distaste for the EU concept, this might be easier said than done.
by Brunello Rosa
10 February 2020
Two crucial regional elections took place in Italy a couple of weeks ago, one in Emilia-Romagna (in northern Italy) and the other in Calabria (in southern Italy). Lega’s leader Matteo Salvini greatly increased the significance of the election in Emilia-Romagna, a region that has been a stronghold of the Democratic Party (PD), making the election appear, in effect, as a referendum on the government. As we discussed in our in-depth analysis following the election, if Lega’s candidate Lucia Borgonzoni had won with a relatively ample margin, this could have led to the resignation of Nicola Zingaretti from the leadership of the PD. Since Di Maio had already resigned from his national leadership role in the Five Star Movement, a resignation by Zingaretti could have led to the collapse of the government altogether. Since Borgonzoni did not win, however, and since her opponent, the incumbent leader Stefano Bonaccini, won with a 7-point difference in the regional election, this scenario did not happen. So, Giuseppe Conte and his government could relax for the moment. Still, this respite might prove short-lived.
In fact, theoretically speaking, if the governing coalition manages to survive the additional round of elections in May/June 2020, the possibility for this parliament to last until 2022 (after the election of the new president), could be quite high, either with the current governing coalition or with a slightly different one. Elections in 2020 would become extremely unlikely and, if the coalition were to stick together for six more months from January to June 2021, then in September President Mattarella would lose his power to dissolve parliament. Thus the only theoretical window for an election would be between March and June 2021.
In reality, things might prove more complicated than this. Matteo Renzi is restless in his attempt to force a change of the Prime Minister, and is now using a parliamentary battle over the reform to the statute of limitations in criminal trials to re-launch his assault. An already fragile majority is vulnerable to defections in parliament, and the possible support from MPs from other parties (for example, from Forza Italia), would not be reassuring for PM Giuseppe Conte. He could become hostage to all sorts of vetoes. If MPs from a new party were to vote in favour of the government in a confidence vote, President Mattarella might call Conte for an update on parliamentary developments, and send him back to the Chambers for a new confidence vote, to re-assess the “perimeter” of the coalition supporting the government. The reality is that the Italian government remains fragile, and could collapse as a result of a parliamentary incident at any time.
What is the centre-right doing during all this? Salvini’s Lega continues to poll above 30%, and Meloni’s Fratelli D’Italia has now reached 10% in the polls, well ahead of Berlusconi’s Forza Italia, which now struggles to get to 6%. Altogether, the centre-right coalition polls around 50%. Salvini’s popularity remains very high, but not as high as it was previously. The belief in his infallibility has been now severely hit by two consecutive mistakes: his decision to make the Conte-1 government collapse in August 2019, and his decision to transform the regional election in Emilia-Romagna into a referendum on the government. He will soon face a vote in the Senate, which will decide whether or not he will have to stand a trial for “kidnapping” the migrants of the Gregoretti ship. And he will probably lose the constitutional referendum over making a cut to the number of MPs, which will take place in March. Investigations into “Moscow-gate” are continuing, meanwhile.
Can Salvini stage a comeback through all this, and so ascend to power in the coming months or years? Theoretically speaking, yes, he can, especially if the governing coalition proves incapable of sticking together. Polls suggest that Italians still seem inclined to give Salvini a chance to prove himself as PM. But the biggest obstacle to his final ascent to power is… himself. The recent re-organisation of Salvini’s party shows that he might have understood the underlying problem that has led him to all the mistakes mentioned above. During his period in government, when he was gaining popularity, he managed to antagonise the US allies (his trip to Washington was reportedly a disaster), the Europeans (his preferred target), the Chinese (by not signing the MoU on the silk-road) and the Russians (with Moscow-gate). In addition, he antagonised the vast majority of the global economic and financial establishment, which fears a breakup of the Eurozone following a potential decision by Italy, led by Salvini, to leave the euro area. It will take time for Salvini to gain credibility within all these powerful circles.
So, somewhat ironically, the centre-right led by Salvini needs time to become a credible governing coalition. And the centre-left hopes to stay in power for as long as possible. These two converging tendencies might keep this parliament alive for longer than is currently believed, even if it remains true that an accident could occur that would bring down the government at any time.
by Brunello Rosa
3 February 2020
In the last couple of weeks, the world has witnessed the outbreak of the Coronavirus (2019-nCov) infection, and its global diffusion. According to the most recent statistics, there are 14,500 people reported as infected in Asia, more than 9000 of whom are in China. The virus has been detected in at least 24 countries. Even then, it is likely that the number of infected people has been under-reported. So far, 305 people have died, with the first victim reported being located outside of China, in the Philippines.
It is understood that the virus originated in Wuhan, a city of 11 million people in central China. It was initially reported that the origin of the virus was the seafood and poultry market in Wuhan. However, the origin remains disputed. A study published on Lancet says that the Wuhan market might not be the origin of the virus. According to some theories (bordering on conspiracy theories), the virus might have originated from a biosafety laboratory – also based in Wuhan – housing some of the world's most deadly illnesses. The lab, opened after the outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003, is used to study class four pathogens (P4), referring to the most virulent viruses which pose a high risk of “aerosol-transmitted person-to-person infections,” according to a press release. It is possible that we will not be able to establish for certain the origin of this virus, but we cannot exclude a-priori that the virus originated from lab experiments.
Plenty of comparisons have been made with the SARS episode, which in 2002-03 infected more than 8,000 people, killing around 700 of them. Some studies have also analysed the economic costs of SARS (estimated to be around USD 13bn). According to initial statistics conducted on the first 99 patients at a hospital in Wuhan, the Coronavirus has a case-fatality rate (the percent of deaths among those infected) of 11%. Initial estimates show that the virus has an R0 of 2.2, meaning each case patient could infect more than 2 other people. If those statistic prove accurate, this virus would be more infectious than the 1918 “Spanish-Flu” pandemic virus, which had an R0 of 1.80.
Based on current statistics, Coronavirus is definitely more infectious and deadly than SARS, and possibly also than the Spanish Flu of 1918-19, which infected more than half a billion people and killed an estimated 20-50 million (statistics were not very accurate in that case, in part because of World War I). At the same time, to most people’s surprise, the Coronavirus is less severe than the usual seasonal flu. Just to give an example, seasonal influenza epidemics cause 3 to 5 million severe cases and kill up to 650,000 people every year, according to the World Health Organization. So far in this season, there have been an estimated 19 million cases of flu, 180,000 hospitalizations and 10,000 deaths in the US alone, according to the Centers for Disease Control and Prevention.
So, what is making the Coronavirus so special, and worthy of attention, to the point that every major central banker (e.g. Fed’s Powell, BoE’s Carney and ECB’s Lagarde) had to answer a question about its impact? The point is that the panic that the outbreak has created, and the defensive reactions to it, might be causing quite a severe level of damage to the global economy (even if perhaps only temporarily, in which case the losses might be mostly recouped in the following quarters). A number of airline companies have completely interrupted all of their flights in an out from China; British Airways, which has cancelled every flight until March, being only a very notable example of this. Most importantly, the US has barred entrance to any foreigner travelling from mainland China. A number of other countries, such as Australia, have followed the US’ example. China has reacted with anger to the measures adopted by the US and other countries. China risks being isolated by the rest of the world, a position that is politically and economically difficult for Beijing to tolerate, especially as the trade and tech negotiations with the US are still ongoing, following the Phase-1 deal between the two countries.
So, more than the virus per se, it is the various countries’ reactions to the virus which pose serious downside risks to the global economy. Indeed, the global economy risks another year of stagnation, following a disappointing 2019. If that happens, central banks and fiscal authorities will likely have to do their part to support aggregate demand in the various countries directly or indirectly hit by the outbreak.
by Brunello Rosa
27 January 2020
We have discussed several times the importance of climate change and the repercussions it may have for the economies of various countries and the global geopolitical order as a whole. Among other things, climate change causes increased desertification in areas such as Sub-Saharan Africa, the Middle East and Latin America, inducing millions of people to migrate in search for a chance to live. This in turn has helped lead to the rise of populist leaders trying to block the arrival of undesired migrants. Lately, the devastating fires in Australia show what an extraordinarily hot summer can mean for the environment, here and now, not just in some distant future.
More recently, climate change has risen to the top of the agenda for institutions that were previously considered quite removed from this issue, such as the International Monetary Fund with the arrival of Kristalina Georgieva at its helm, the European Commission with Ursula Von der Leyen’s “Green Deal”, and central banks, with Christine Lagarde’s ECB and Mark Carney’s Bank of England leading the way. Not surprisingly, this issue were given high priority at this year’s meetings in Davos, even if it still remains unclear how and when governments and multinationals will finally decide to seriously tackle this crucial issue. Many hopes now rest on the result of the COP26 Conference in Glasgow, to be held at the end of this year. But the experience with previous COP conferences suggests that there is a need to keep expectations at a realistic level.
In any case, it is extremely important that the level of awareness of the climate issue has finally increased, and that climate change now features very high in the agenda of policy makers.
The European Union has decided to become a world leader in this regard, and to shape a large component of its future choices on environmental sustainability. The “Green Deal” recently launched has the potential to unlock up to EUR 1tn of public and private investments, generating hundreds of thousands of job opportunities. The Bank of England has already asked financial institutions to stress-test their resilience to climate change, considering that (as the BIS recently stated) climate change could be a cause of financial instability, if a “green swan” materialises.
Among the various initiatives mentioned during her latest press conference, Christine Lagarde said that the ECB will make sure that its corporate bond portfolio will be designed to incentivise environmental sustainability. In Germany, the rise of the Green Party in opinion polls is constant, and in Austria the Greens joined the new conservative government formed by Sebastian Kurz.
While the US seems still to be missing in action, the key risk identified by some is the so-called “greenwashing” process, whereby anything that seems socially acceptable or politically advantageous is promoted as being a “green” initiative. Some key policy figures, such as Bundesbank President Jen Weidmann, recently made the point that central banks cannot replace good environmental policies decided by democratically elected political leaders. Others fear that good old-fashioned counter-cyclical fiscal stimulus might be masked by “green investment” to stimulate aggregate demand, thus producing good results in the short run, but no effects in the future.
As it often happens, “in medio stat virtus”. Climate change will need to be front and centre of policy makers’ agendas. But abusing the term for marketing reasons might eventually damage the cause rather than support it.
by Brunello Rosa
20 January 2020
At the end of last year, in our paper on the six Grey Swans facing the global economy, and in our 2020 Global Economic Outlook, we said that geopolitical instability was set to increase during the US election year ahead. The strategic calculus by Trump to secure his re-election, going into 2020, was to make sure that the US economy was as strong as possible (perhaps with a bit of help from the three insurance rate cuts “independently” delivered by the Fed in 2019, which came after plenty of pressure was put on the Fed by the President), while closing some of the open geopolitical fronts, in particular the trade dispute with China.
In fact, Trump’s “art of the deal” consists of brutally shaking his counterpart before inviting it to the negotiation table and concluding a deal on more favourable terms for himself. Following this paradigm, Trump had a window of opportunity from the mid-term elections until 2020 to unsettle the system and shake his opponents, in order to then use 2020 as the period to reach compromises with his negotiating partners that he could “sell” as victories to the US public during the electoral campaign. But, as we mentioned in previous analysis, while this tactics might work in the corporate sector, where an aggressively confrontational approach could lead the counterpart to the brink of bankruptcy and therefore make it more willing to accept the harsh terms that Trump offers, in public affairs things are not that simple. States do not go bankrupt that easily, and opponents can react in unexpected ways.
So, while Trump’s preferred choice could have been that of having a strong economy and some tail risks reduced (risks such Brexit; during Trump’s intrusion in the recent electoral campaign in the UK, he basically “ordered” Nigel Farage to step back and allow Johnson’s victory), his opponents saw a clear opportunity in 2020 to “mess things up” in order to jeopardise Trump’s re-election. Domestically, the Democrats have launched an impeachment trial, which is unlikely to succeed but will still keep Trump on his toes and will expose him on a number of fronts.
The delay in sending the impeachment article to the Senate, while being borderline acceptable, has prevented Trump from having the news on the impeachment obfuscated by escalating tensions with Iran that would have otherwise occurred at the same time as one another.
Internationally, Iran is clearly at the forefront of the historical foes that would like to see Trump go, hoping to get a Democratic president to deal with instead. This is the reason why we believe that Iran will do much more in coming months to retaliate against the killing of Qassem Suleimani, and why we believe the market is under-pricing the risk of a further escalation down the line, closer to the election date.
According to press reports, Kim Jong UN sacked its “moderate” foreign minister Ri Yong Ho, replacing him with the more hawkish Ri Son Gwon. This is seen by the intelligence community as a signal that a season of testing of ballistic missiles (launching them over key regional allies such as Japan) is about to re-start, after a period of pause.
China remains the big unknown: signing the Phase-1 deal certainly gives Trump a trophy to show during the electoral campaign, and gives China the much needed break in the escalation of tariffs. At the same time, it is clear that the trade, technological and geo-strategic dispute between the two countries will continue. One possible interpretation is that China, instead of wanting to see Trump leave office, might prefer having him remain for a second term, given the damage he is doing to the US and their international relations.
All this is to say that the historical foes of the US will use the opportunity of this electoral year and Trump’s impeachment trial to take advantage of the difficulty Trump will face in providing anything other a constrained response to any moves they may make. If Trump goes from disputes to battles to open wars, he would tip the economy into recession, thus jeopardising his re-election. As such, his options this year will be relatively limited. 2020 will be most likely “a year lived dangerously” for the world.
by Brunello Rosa
13 January 2020
Financial markets became excited at the end of last week, by signals that some of the most feared tail risks hanging over the global economy could be diminishing. On a weekly basis, global stock indices rose (MSCI ACWI rose by +0.6%, to 570), driven by DM equities (S&P 500 +0.9% to 3,265; Eurostoxx 50 +0.4% to 3,790). EM indices also rose (MSCI EMs +0.9% to 1,134), and, as markets rallied, volatility fell (VIX S&P 500 fell by -1.4 points to 12.6, below its annual average of 15.0).
Regarding tensions between US and Iran, the “measured” retaliation by Iran to the killing of Quassem Soleimani, in which rockets were fired at two US military bases in Iraq without causing casualties and major damages, and the decision by the US not to respond to that attack, was interpreted by market participants as a signal of de-escalation. Some might even hope that, after a period of increased tension, the status quo ante between the two countries might return. While it is certainly a positive development that Iran’s retaliation was not followed by further US counter-attacks, we would be much more cautious before considering the events of the last few days to be merely isolated incidents that are now effectively concluded.
In our scenario analysis, we discussed how events might still develop less favourably than markets currently imply they will be and Nouriel Roubini argued that financial markets are still seriously under-pricing the possible future evolution of events. This is true for a number of reasons. First, Iran’s Supreme Leader Khamenei said that the initial attack on US bases was just the beginning of the retaliation, and that much more will occur in coming weeks. Secondly, President Trump’s invitation to the UK, France and Germany to also abandon the Joint Comprehensive Plan of Action (JCPOA) means that tensions will remain elevated for some time. Third, Iran would benefit from striking closer to the November Presidential elections, when mis-calculations could lead to Trump’s defeat. Fourth, the US has in any case launched a new series of sanctions against Iran, which could eventually lead to a further reaction by Tehran.
And finally, the unintentional downing of the Ukrainian plan by Iran on the night of the retaliation show how things can go wrong even when there is no intention to kill. In his upcoming Geopolitical Corner, John Hulsman will discuss how the Iranian story is intertwined with the electoral campaign and Trump’s impeachment process.
The second piece of good news that excited market participants was that the market the announcement by the US President that he is “ready for the Phase-1 trade deal with China to be signed on January 15th at the White House”. Trump also said he would “sign the deal with high-level representatives of China”, and that he would later “travel to Beijing to begin talks for the next phase”. The market believes that this might signal the end of the saga that rattled the global economy during the past couple of years. But again, reality might be slightly harsher than what is being hoped for. Until the deal is actually signed, anything can happen, and time is on China’s side. Why should the Chinese government provide Trump with the argument that he succeeded in containing China’s trade mis-practices ahead of the election?
Moreover, even if the trade tensions do ease, the geo-strategic rivalry between the two countries will continue, with its impact on global supply chains and technological developments. In any event, once the China issue is finally considered to be done with, Trump will then simply be ready to start a fight with Europe, over various issues such as Airbus versus Boeing, auto sector trade, digital taxes, etc. So, trade tensions worldwide could very well continue going forward.
Finally, the UK parliament has at last approved the PM’s Brexit deal, opening the gates to an orderly Brexit on January 31st, if the House of Lords does not object. At the same time, a series of cliff-edges are likely to present themselves in the next 11 months, especially now that the possibility of extending the transition period beyond 31 December 2020 has been excluded by law.
All this is to say that, while some tail risks have not materialised so far, market participants should remain aware of their presence and remember the stretched valuations that now exist in most asset classes.
by Brunello Rosa
6 January 2020
The year has just begun, and geopolitical and political events are already accumulating. From a geopolitical perspective, the most relevant development has been the escalation of tensions in the Middle East, with the US and Iran likely to begin some form of direct and indirect military confrontation following the killing of Iranian general Quassem Soleimani in Baghdad. US President Trump reportedly ordered the attack as a retaliation for an Iran-backed militia’s attack of the US embassy in Iraq, and for the killing of a US civilian contractor on an Iraqi military base in Kirkuk. These events followed months of provocations from Iran to which the US has not responded, including a drone attack on Aramco’s refinery facilities in Saudi Arabia. Tensions between the US and Iran have been on the rise since President Trump decided to pull out of the JCPOA , the agreement between Iran and six international counterparts to limit the development of its nuclear program. That agreement was negotiated by Trump’s predecessor Barack Obama in 2015. We have discussed the run-up to these events in previous papers and scenario analyses, and shortly we will publish an updated scenario analysis, with its implications for oil prices.
From a political risk perspective, these developments have a clear bearing on the US political environment. As discussed in our recent 2020 global outlook, 2020 will be an election year in the US, and most of the macroeconomic and policy events will be driven by the developments in the US presidential race. To make things even more complicated, the US President was impeached by the House of Representatives at the end of December, and his “trial” in the Senate will start soon. As we discussed in our analysis of September 2018, regarding the risk of a global recession materialising in 2020, Trump might be tempted to “wag the dog” with military operations during his campaign for re-election, with Iran being the most likely designated target. The recent developments in the Middle East will surely help Trump obfuscate the news about his impeachment trial. He might also hope that the country will rally behind him in the event an overt conflict takes place, as it often does to presidents is similar circumstances. However, the political spectrum has thus far been divided by Trump’s decision, which reportedly was not discussed and agreed to in advance with other political leaders.
In Europe, there are interesting political developments taking place in Spain and in Austria. In Spain, Pedro Sanchez seems on the verge of being confirmed Prime Minister, with a second vote for his “investidura” on January 7th. He managed to strike a deal not just with Podemos, but also with the independentist parties of Catalonia and the Basque Country. This solution is fraught with risks. The leader of the Esquerra Republicana de Catalunya(ERC), Oriol Junqueras, has spent the last couple of years in prison, and has been ordered to be released only recently, given his election to the European Parliament. Depending on the votes of ERC is clearly a gamble for Sanchez, considering that his government fell precisely because the Catalan parties did not support his budget. On the other hand, having both the Catalan and the Basque pro-independence parties in government could mean that a peaceful solution to Spain’s domestic conflict is likely, considering that the Catalans have always asked to be given at least the same powers and autonomy granted to the Basque Country in return for dropping their quest for independence.
In Austria, following months of negotiations, the Chancellor Sebastian Kurz managed to strike a deal to form a government with the leader of the Greens, Werner Kogler. This coalition between the conservative Austrian People's Party (ÖVP), which belongs to the European People’s Party (EPP), and the Greens, could provide the model for the next German coalition government, if the next general election (scheduled for 2021) were to result in yet another hung parliament. Such a solution could stabilise Germany’s political landscape, and provide the platform to push further European integration and stop the ongoing process of European dis-integration. European political risk was another factor discussed in our September 2018 paper on the risk of a global recession in 2020. As the recent examples from Spain and Austria show, the news from this front is mixed, and worth following in coming months.
by Brunello Rosa
30 December 2019
In our column last week, we discussed some of the key points of our Global Economic Outlook and Strategic Asset Allocation for 2020. This week we want to focus on what we can expect from a policy perspective in the year ahead, and on policy’s implications for markets.
A number of key equity indices in the US have reached their all-time highs during the past few days. The NASDAQ, for example, touched the 9,000 mark for the first time ever on Friday 27th December. The question is whether this rally in risky asset prices is being driven by fundamentals, or whether it is being driven rather by policy intervention (or the anticipation policy intervention), in particular the large liquidity injections made by both the Fed (with the re-increase in the Fed’s balance sheet to stabilise the repo market, which some have labelled QE-4) and the ECB (which has recently re-started its own QE program).
In our Outlook we discussed how, from the monetary policy side of the equation, after the three “insurance cuts” implemented by the Fed in 2019, we now expect the US central bank to remain on hold during the 2020 electoral year, remaining open to further easing only if the economy materially worsens. We also discussed how the ECB is now undertaking open-ended QE and has an easing bias on policy rates (but its strategic review might induce a less accommodative stance). The BOJ will remain extremely accommodative; it might even add a further level of modest accommodation to accompany Japan’s fiscal stimulus. The BoE will react to Brexit developments, but is mulling over the possibility of rate cuts. The PBOC is likely to continue to provide modest monetary stimulus to cushion the Chinese economy, given trade frictions and disruptions in global supply chains.
On the other hand, fiscal policy remains constrained but is becoming modestly expansionary. In the US, the divided Congress means that no fiscal stimulus is likely in 2020; in the Eurozone some additional fiscal flexibility is underway, especially to accompany its “green deal” and “energy transition” plans that may be attempted. Japan has approved a large fiscal stimulus (as a headline figure), which could be the basis for an effective initial version of “helicopter money”. China will keep providing some additional fiscal stimulus, despite its high fiscal deficits.
Given these considerations, we believe that in 2020 there will likely be a moderately ‘risk-on’ environment, given the improving chances that growth will stabilize, inflation will remain under control, and monetary and fiscal policies will be supportive, as well as the fact that some significant tail risks have diminished recently. Additionally, the anticipation by market participants that “helicopter drop” policies could eventually be introduced when the next economic recession and severe market downturns occur (a situation that we have labelled a “helicopter put”) is keeping the markets happy for the time being, and even frothy in some instances.
At the same time, we warned how geopolitical and domestic political tensions, a possible re-intensification of trade wars, the continued disruption of global supply chains, tighter financial conditions, and market valuations disconnected from underlying macro fundamentals could cause sudden market corrections that investors should be wary of during the new year ahead.
By Brunello Rosa
23 December 2019
Last week we published our Global Outlook and Strategic Asset Allocation for 2020. We discussed our growth, inflation, policy and market forecasts for the year that is about to begin, with baseline, downside and upside scenarios. We also discussed the main macroeconomic and market themes for 2020, with their implications for market and asset allocation.
In our global overview, we mentioned how 2019 was characterised by a synchronized global economic slowdown, but with a strong rally of risky assets, such as US and global equities. The slowdown was driven by a number of geopolitical risks, such as the escalating trade and tech war between the US and China, the risks of a hard Brexit, and increasing tensions in the Middle East. These helped lead to a recession in the manufacturing sector. Now, in our baseline scenario for 2020, we expect this slowdown and stagnation of the major developed market economies to continue. We are less convinced however by the global reflation story that other research houses, especially in the sell-side of the financial industry, are pushing these days.
Equally, we consider a global recession in 2020 to be a risk scenario, at this stage. In a series of articles published in the second half of 2018 we discussed the possibility of a severe market correction and a global recession occurring as early as in 2020, and we outlined the ten factors that could lead to such an outcome. At the same time, in a more in-depth analysis, we discussed the ten reasons why a milder scenario could materialise, in spite of those threats.
Chief among these ten reasons were an accommodation in the global monetary policy stance and a containment of the geopolitical risks, both of which have occurred since then, thereby reducing the probability of a global recession in 2020. Nevertheless, geopolitical and domestic political tensions, an increase in trade wars, disruption of global supply chains, tighter financial conditions, and market valuations disconnected from underlying macro fundamentals could still cause sudden market corrections: investors need to remain aware of these risks in the year ahead.
Given this background, the current environment calls for a moderately ‘risk-on’ position in 2020. There is a high probability that trade and political tensions will de-escalate. A more balanced policy mix is expected to emerge. Variants of “helicopter money” policies could eventually be introduced when the next economic recession and severe market downturn finally occur. From an asset allocation perspective, over the next few years, the investment environment remains challenging, because central bank liquidity and geopolitical risks are likely to matter more than fundamentals and market volatility is likely to rise, hampering portfolio performances and increasing the likelihood of corrections and, eventually, bear markets. As a result, “expected returns” are likely to be lower than in the pre-2008 crisis period. Investors, over a multi-year horizon, will therefore have to accept lower expected returns in exchange for lower volatility, and while riding the liquidity wave remain aware of the risks mentioned above.
By Brunello Rosa
16 December 2019
As we discussed in our in-depth analysis, the UK general election resulted in a historic victory for the Tory Party, which will now gain the largest parliamentary majority of any British government since 1987, under PM Thatcher. It was also the worst electoral defeat for the Labour Party since 1935. The Conservatives gained 48 seats (for a total of 365) compared to their performance in the 2017 general election. The Scottish National Party gained 13 seats (for a total of 48), while Labour lost 59 seats (bringing it down to 202) and the Liberal Democrats lost 1 (it now has 11). Still, the Conservative victory was unquestionable only in England, where Labour now remains strong only in urban areas. Regional parties won their respective nations: Plaid Cymru in Wales, Sinn Fein and DUP in Northern Ireland, and especially the SNP in Scotland.
As of now, we believe that the main political consequences of the vote will be the following: (1) Boris Johnson remains prime minister and, as discussed below, will carry on with his Brexit plan; (2) Jeremy Corbyn, who already said that he will not lead the Labour party at the next general election, will likely resign from his position as party leader in the next few weeks; Labour will now face a harsh leadership contest between the so-called “True Corbynistas”, such as Rebecca Long-Bailey, currently the shadow business secretary, and moderate left-wing figures such as Keir Starmer, the shadow Brexit secretary. If the party does not want to disappear, it will likely shift back to the centre in coming years, following the disastrous results of Corbyn’s attempt to bring Marxism back into the UK political system; (3) Jo Swinson, the Lib-Dem leader who lost her seat in favour of a SNP MP, will also likely resign her position as party leader in the next few days. She carries the responsibility for having forced Labour to accept this snap election that has led to the largest Tory victory in recent history; (4) Nicola Sturgeon, whose SNP party has won 48 out of the 59 seats in Scotland, will press further for a second referendum on Scottish independence.
At this point, Brexit will happen for certain, most likely by January 31st, as is currently planned. This does not automatically mean the end of the Brexit uncertainty. Boris Johnson has promised to conclude a trade deal with the EU by 31 December 2020, a virtually impossible task unless by reaching a deal he means merely an agreement in principle, or only a sort of UK version of the “Phase-1 deal” from the US-China trade dispute. A renewed phase of uncertainty might therefore occur towards the end of the year, when a no-deal Brexit could once again become a possibility if the transition period is not postponed to 2022. The decision must be made by 30 June 2020, and given the ample majority that will now exist in parliament, and the government’s strong negotiating position deriving from the large popular mandate the election has given it, it is unlikely as of now that Johnson will request such an extension in the summer.
Most importantly, if Johnson’s deal is finally approved by parliament, Northern Ireland will become a very special zone. It will be part of both the UK and the EU customs unions, a privileged position that Scotland especially would aspire to have. As in the case of Spain, where the Catalans ask to have the same privileges of the Basque Country in return for giving up their quest for independence, Scotland will probably ask to obtain the same status as Northern Ireland in return for giving up its intention to ask for a second independence referendum.
To conclude, while this election has removed some of the Brexit-related uncertainty and all of the Corbyn-related fears, the road ahead for the UK remains bumpy and winding. For this reason, it is likely that fiscal policy will be more growth-friendly, and monetary policy will remain supportive. As such, the election-induced GBP rally might prove to be more short-lived than is currently thought.
By Brunello Rosa
9 December 2019
After a few weeks during which G10 central banks did not make any major decisions, in December nearly all ten of them will hold their policy meetings. Last week, the boards of both the Bank of Canada (BoC) and the Reserve Bank of Australia (RBA) met to decide the course of their respective monetary policies for the coming months. The BoC left its policy rate unchanged at 1.75%, as had been expected it would. It is the highest such rate among the G10 countries. The BoC’s position is, broadly speaking, “neutral”: the Bank’s statement did not express any particular bias towards either raising rates further or cutting them in the near term. The Bank can enjoy Canada’s inflation being on target and growth being not too distant from its potential level, and so can afford to wait longer before deciding what to do. Clearly, the most relevant factor will be the outcome of the trade negotiations between China and US, given that the Canadian economy is highly dependent on both those economies. It will also depend on oil prices, which tend to move in tandem with global growth.
If the US and China manage to agree to at least the Phase-1 deal (as we expect they will), the Bank of Canada will be able to stay on hold for longer, hoping that a pickup in global growth does not eventually lead to cutting its policy rates.
On the other side of the world, in Australia, the RBA also kept its rate unchanged at 0.75%, but in this case after having already cut rates three times this year, for a cumulative amount of 75bps. Like Canada, the Australian economy is highly dependent on the US, China, global growth and the commodity cycle, which is why the RBA has already also started to explore which unconventional measures it might use if and when its policy rate reaches the effective lower bound of 0.25%. Governor Lowe said that the RBA would be ready to start a QE program of purchases of sovereign bonds in case extra easing is needed, also thanks the additional supply of bonds deriving from the expected fiscal stimulus. So, while the BoC’s position was effectively neutral, in the case of the RBA we can see there exists a clear easing bias.
In the week ahead, the two largest central banks will meet: the Fed and the ECB. As we will discuss in our forthcoming preview, the Fed, which has officially declared itself to be “on pause”, will have to calibrate this message in order not to be pushed around further by President Trump during the coming election year, Trump wanting rates to be cut even more. The ECB’s job is equally challenging. Its policy stance is currently on some sort of auto pilot: open-ended QE, full reinvestment of proceeds, easing bias on rates, and reserve tiering for core-EZ banks and TLTROIII for periphery-EZ banks. But the arrival of a new president at the helm of the institution – namely, Lagarde replacing Draghi – marks the beginning of a transition period that could last a few months. The announced review of policy strategy is a double-edged sword. On the one hand, Lagarde my end up taking ownership of the current policy stance; on the other hand, the review could be the beginning of a reversal of some policy tools. Also this week, the central bank of Switzerland (the SNB) will meet, but as we will discuss in our forthcoming preview we do not expect major changes in its policy stance to be made.
The following week, on Thursday, there will be a number of important central bank meetings: the BoJ, the BoE, Norway’s Norges Bank and Sweden’s Riksbank. The BoE is unlikely to do anything just a week after the general election: it remains to be seen whether the dissenters within the Monetary Policy Commitee will keep or change their vote to “no change”. Norges Bank has already reached “pause” levels, and we do not expect them to do anything at this meeting. More interesting will be to see what the BoJ will do, since the government has finally launched a supplementary budget (which includes a larger-than-expected USD 121bn stimulus package), as the Bank had been clearly demanding it do. Finally, and perhaps surprisingly, the Riksbank is likely to increase its policy rate, as we mentioned in our latest review. It may take its repo rate from -0.25 percent to zero, before entering what will likely be a long period of pause.
By Brunello Rosa
2 December 2019
Two important events shook Germany’s political landscape this past weekend. On the left, the Social-Democratic Party (SPD) chose the radical couple Norbert Walter-Borjans and Saskia Esken as new co-leaders of the party, instead of finance minister Olaf Scholz and Klara Geywitz who they defeated in the party’s leadership race. Scholz and Geywitz were perceived as champions of the status quo, which basically means the SPD remaining in the grand coalition with Angela Merkel’s CDU. Walter-Borjans and Esken however have proposed a more radical platform, which requires the re-negotiation of the “coalition contract” and foresees the rupture of the grand coalition as a possibility.
At the opposite side of the political spectrum, Alternative für Deutschland (AfD) chose a relatively moderate (by AfD standards) ticket to lead the party, after the unifying figure of Alexander Gauland decided not to run again for the party’s leadership in order to allow a generational changeover to occur (Gauland is 78 years old). The party, which already holds 94 seats in the German Bundestag (out of 709) and is the third largest party after the CDU and the SPD, chose as co-leaders Tino Chrupalla and Joerg Meuthen. Chrupalla is a legislator from Saxony, who will represent the former communist states of the East where AfD surged in three elections this year. Meuthen is a professor of economics in the industrial south-western state of Baden-Wuerttemberg. Contrary to the SPD’s decision to choose a leadership ticket that may distance itself from Merkel’s CDU, the unusually moderate choice by the AfD was specifically made to allow the AfD to become a potential ally of the CDU, at least at the local and state government levels.
The selection of these new leaders of the SPD and the AfD occured just over a week after the CDU confirmed Annegret Kramp-Karrenbauer (AKK) as leader of the CDU. Where do these events leave Germany, and what implications might they have for the broader European integration process?
From a domestic standpoint, Germany’s political instability is now clearly on the rise. If the SPD does pull the plug on the government, Merkel might either lead a minority government, or try to strike another coalition deal, or call a snap election. In such an election, the Greens would likely emerge as the first party of the left, which would open up three options (assuming that no party has enough seats to govern alone): 1) A CDU-Green grand coalition, if the CDU emerges as the first party in the election. (But, such an outcome might not be the case if AKK remains as CDU party leader, as she might not be able to guarantee that the CDU will end up as the first party in the election); 2) A new attempt of the Jamaica coalition (CDU-Greens-Liberals); and 3) an alt-left coalition between the Greens, the SPD and the Linke. That is, assuming the three parties together have enough seats, and assuming the Linke compromises on key policies such as Germany’s participation in NATO. In any case, it is clear that the myth of Germany’s political stability is now a relic of the past.
For the broader European integration process (now that Ursula Von Der Leyen has been confirmed as president of the EU Commission) these political events could be either positive or negative. They might be positive if the ongoing political tsunami in Germany were to bring to power the Greens in a relatively stable coalition (a “grand” coalition with the CDU, a leftist coalition with the SPD and Linke, or the “Jamaican” coalition). The Greens are undoubtedly pro-Europeans even if in favour of fiscal discipline, and are advocates of the “green” new deal that in Europe is likely to become the proxy for much-needed fiscal stimulus. German politics might be negative for European integration, on the other hand, if the country’s political instability were to lead to a stalemate within its own decision-making process: Germany remains the largest, richest and most influential country in Europe, without which no decisions are made. The events of the next few weeks will determine which of these outcomes will ultimately prevail.
By Brunello Rosa
25 November 2019
For better or worse, 2020 will be characterised by the US Presidential race, which will not end until November 3, the day the election will be held. President Trump has made all possible efforts to make this election a referendum on himself and his style of being president. He has polarised the US political landscape like very few presidents before him ever have, with his abrasive conduct of government affairs, partly inherited from his business days when he was using his “art of the deal” to get things done.
In politics, and especially in foreign policy, his approach of hitting counterparts as hard as possible before inviting them to the negotiating table has not always worked. Sovereign institutions are not businesses that can be brought to the brink of bankruptcy to soften their negotiating positions. Hence the failed negotiations with the North Korean dictator over that country’s nuclear program, the standstill with the Iranians over the nuclear deal and Middle East policy in general, and the protracted negotiations with China over trade and tech arrangements, which have so far produced at most a “Phase-1” informal agreement.
Regarding the US domestic agenda, President Trump is trying to show that he continues to side with the deprived working class in urban areas and with under-privileged populations in rural areas. For some reason, the president’s narrative is still popular in the country, even though the reality is that some of these domestic issues are actually bi-partisan. For example, every president, Republican or Democratic, would have had to start taking on China and its trade surplus vis-a-vis the US, as well as its unfair tech and IP practices. Perhaps Trump’s unorthodox style and abrasive approach make his positions less acceptable to many who would otherwise support such positions if it were a more conventional politician who was championing them.
Indeed, to some extent Trump may have actually surprised to the upside in his policy stances, by being less trigger happy than what could have been expected from him, especially after surrounding himself with very hawkish advisers and officials such as John Bolton and Mike Pompeo. For example, he did not respond to the provocations of North Korea and Iran in the last couple of years, and has not directly intervened in Venezuela as some of his predecessors would perhaps have done. Trump might turn out to be just another isolationist Republican president.
In any event, the electoral campaign is beginning to heat up. The impeachment hearings are turning awry for Trump, with the testimony of people close to the president such as Gordon Sondland, the US ambassador to the EU, and Fiona Hill, a senior National Security Council official. For now, the baseline scenario will continue to be that President Trump is likely to be impeached in the House, but not convicted in the Senate, where 20 Republican votes are needed to reach the necessary two-third majority of 67 votes.
However, the more embarrassing the hearings become for the Trump administration, the more Republican senators might decide to turn their back on the president if and when an impeachment vote is held. If the president’s position weakens as a result, he might induce some of his external enemies, like China, Iran, or North Korea, to scale up the level of provocations during the electoral year, to see whether a more tense international environment make Trump lose enough votes in the key swing states he will need to win a second term.
What about Trump’s Democratic opponents? As we discussed in our recent analysis, the frontrunner Joe Biden has been damaged by “Kyiv-gate” more than Trump has so far, so much so that Pete Buttigieg now seems to be leading the race in Iowa and New Hampshire, which are the first states that will hold primary elections. To counterbalance the rise of Elizabeth Warren, a left-wing candidate who has spooked the market with her radical reforms made up of universal healthcare coverage and wealth taxes, Michael Bloomberg, the former mayor of New York, has now launched his own campaign to win the Democratic nomination. His presence will make the race in the Democratic camp more uncertain. If he wins the nomination, we would then see two New York billionaires running against each other to become, or in Trump’s case, to remain, President of the United States in November.
By Brunello Rosa
18 November 2019
A number of economists and commentators are discussing the question of what the most effective fiscal and monetary policy response to the next global financial and economic downturn will be. There seems to be a consensus forming that, with global interest rates as low as they currently are (in some regions, nominal policy rates are negative), some form of fiscal and monetary coordination will be needed when the next crisis hits. Most recently, Gavyn Davies has discussed the role of automatic stabilisers, like indirect taxes and forms of unemployment insurance, in such a context, highlighting how this form of automatic support to aggregate demand is weaker in the US than in Europe, for example.
In our recent analysis, we discussed in depth what form this monetary/fiscal cooperation could take, citing the examples of “helicopter drops of money,” “People’s QE”, “Modern Monetary Theory” and other more mainstream forms of fiscal-monetary coordination such as that which was recently proposed by former Fed’s Vice Chairman Stanley Fisher and former SNB chief Philipp Hildebrand, and describing their pros and cons. Our impression is that this idea of monetising fiscal deficits, far from being new (let alone “modern”), is actually becoming mainstream, and will likely provide the theoretical foundation for the policy response to the next economic and financial downturn, especially if the next downturn is severe.
This discussion is already having a very positive impact on financial markets. As we discussed in our column two weeks ago, markets are already celebrating the reduction of tail risks (US-China trade tensions, Brexit, the IMF-Argentina confrontation, etc.) and the additional monetary stimulus (such as that which was delivered by the Fed at the end of October) that are accompanying the stabilisation of key macroeconomic indicators such as manufacturing PMIs (which seem to be bottoming out, while remaining in contractionary territory). We concluded that column by saying that markets are already pricing in some form of fiscal and monetary backstop that they expect to be provided when the next crisis hits. This is like counting on a massive “fiscal and monetary put” available at the global level.
In this imaginary bridge between where we are now (a synchronised global slowdown) and where we are likely to be in a few quarters from now (a recovery phase driven by a coordinated fiscal and monetary policy response at the global level) the question is what will take place in between. For certain, monetary authorities will be prudent, and policy rates will be kept lower than what they would have been if this recovery had taken place pre-2008 crisis. Hence, policy rates are likely to be kept low, if not lower than they are now, for longer.
This might not be enough to prevent a sudden reversal in the imbalances that are building up and will continue to build up, in part even as a result of this very prudent monetary policy. For example, in H1-2019, global debt rose above USD 250tn, with China and the US accounting for more than 60% of new borrowing (with worrisome levels in the corporate debt sector). As such, a “non-linear” event in the middle of the bridge between the current global slowdown and future global recovery seems hard to avoid at some point. A coordinated fiscal-monetary action will then occur, providing the necessary policy response.
By Brunello Rosa
11 November 2019
Spain’s general election has resulted in yet another hung parliament. The final results suggest that the Socialist Party (PSOE) of the incumbent Prime Minister Pedro Sanchez has obtained a plurality of votes (around 28%), but very far from a level that would allow Sanchez to obtain a majority of seats in the Congreso De Los Diputados, the country’s main legislature at the national level. The Socialist Party will have 120 seats, out of the possible 350. Pablo Iglesias’ Unidas Podemos has collapsed, meanwhile, receiving only around 13% of votes and 35 seats. Podemos probably paid a political price for the intransigent position they had taken during the negotiations that followed the April 2019 election, which had failed to lead to the formation of a new Sanchez government. The new party born to the left of PSOE, Mas Pais, obtained 2.4% of votes (most likely from both PSOE and Podemos) and 3 seats.
On the right of the political spectrum, the Ciudadanos party led by Albert Rivera has also collapsed in these elections, from 16% of votes and 57 seats to 6.8%of votes and 10 seats.
Critics are saying the party has run out of “marketable” political material. It is also true that Ciudadanos’ intransigent position regarding the Catalan separatists had already paid off, with the incarceration and severe sentences of the leaders of the “rebellion”, and that its outlook is in any case well represented by the even tougher positions taken by the rising Vox party.
Vox, led by the controversial figure Santiago Abascal, has staged the best performance of all, rising from 24 seats in the previous legislature to 52 in the new one. It received 15.1% of all votes, which despite being only around half as many as the Socialists, is nevertheless a 30% increase from the votes Vox had received in April 2019. This is yet another confirmation that nationalist-populist parties are still strong in Europe, and still represent a serious threat to the European integration process. The People’s Party (PP), led by Pablo Casado, has also increased its votes (+4.1% to 20.8%) and seats (+22 to 88). Other parties, including regional ones from Catalonia and the Basque Country, gained a combined 42 seats.
Where will Spain go from here? As we discussed in our in-depth election preview, Spain’s political stability is long gone, as the fact that this was its fourth general election in four years clearly shows. At the same time, Spain’s two traditional parties, PSOE and PP, plus the newer parties from the left (Podemos) and the right (Ciudadanos), cannot afford not to be able to form a government after this election. If they do not manage to form a government, there is a risk that the protest vote will rally around the newest party on the political scene, Vox, which has the potential to wipe out both Podemos and Ciudadanos and drain further votes from PP and PSOE. As such, we believe that these parties will do all it takes to form a government this time.
Given the number of seats available, Sanchez is very likely to be given the first chance to form a government. He will probably go back to Podemos and try to form a majority with them and some of the other left-wing parties (such as Mas Pais) and regional parties, or if not a majority than at least a parliamentary bloc large enough to form a minority coalition government. If this attempt were to fail, the three right-wing parties (PP, Ciudadanos and Vox) might try to form a coalition – the same grouping that took over the Andalusian regional parliament in December 2018, following decades of unrivalled Socialist rule in that region.
If neither of these two relatively “natural” solutions work out, Spain might instead try to form, for the first time in its recent history, a German-style “grand coalition” between PSOE and PP, which together would command a comfortable majority. A weaker form of this grand coalition could be a PSOE-only minority government, which can be formed thanks to the abstention of the PP (which, in this way, would “return the favour” that the PSOE did to Rajoy in 2016). But the risks deriving from this type of solution are well-known in those countries that have experienced them (chiefly, in Germany, Austria and, more recently, Italy). Grand coalitions tend to reinforce support for extremist parties, especially those on the right side of the political spectrum (AfD, FPÖ, and Lega, respectively). With Vox already on the rise, a PSOE-PP coalition is therefore a solution we believe will be attempted only at the very end, if all else has failed.
By Brunello Rosa
4 November 2019
In our column two weeks ago, we discussed how several key tail risks that were weighing on the global economy were in the process of being reduced, and how that could prove beneficial for risky asset prices. In particular, we noted the following: how the risk of hard Brexit was diminished since Boris Johnson had obtained a new deal from the EU and managed to obtain early elections; US-China trade tensions were lower after the Phase 1 agreement was reached between President Trump and Chinese Vice Premier Liu He; the risk of an open confrontation in the Middle East involving Iran, Saudi Arabia and the US currently seems to be relatively low; the risk of a collision course between Argentina and the IMF seems contained for now, even after the victory of Alberto Fernández in recent presidential elections.
Together with these reduced tail risks, there have been also some positive surprises from the real economy, in particular in the US. Last week, the advanced reading of Q3 US GDP showed a smaller deceleration of growth than initially feared (from 2.0% to 1.9% SAAR, versus 1.6% expected), and October’s Non-Farm Payroll increase was 128,000 (versus 89,000 expected), with September’s data upwardly revised from 136,000 to 180,000. Other positive figures from the US labour market were a small increase in average hourly earnings (3.0%) and an increase in the labour force participation rate (to 63.3%, versus an expected decrease to 63.1%, from September’s 63.2%), which partially justify the uptick seen in the unemployment rate, from 3.5% to 3.6%.
Finally, the Federal Reserve provided an additional kick, with its third back-to-back insurance cut last week, which brought the Fed funds target range to 1.50%-1.75%. The impact on financial markets was powerful, with global equity indices rising substantially: MSCI ACWI was up +1.3% on a weekly basis, driven by strong performance in both DMs (MSCI World, +1.3% w-o-w and S&P 500, +1.5% w-o-w, to 3,067, its all-time high) and EMs (MSCI EMs, +1.3% w-o-w).
Some analysts even wondered whether the easing the Fed has provided since July 2019 (and the interrupting of its tightening cycle since last December) were actually necessary. In our view the answer is yes, the easing was necessary. The manufacturing recession is still ongoing; on Monday the manufacturing ISM rose less than expected to 48.3, still well below the 50 mark, which separates expansion from contraction. Consumer and business sentiment remains fragile, and the risk of an increase in consumer tariffs on December 15th remains present, albeit diminished. So, most likely a mid-cycle policy adjustment was warranted, especially considering a reduced neutral real rate (r*), as was mentioned by Chair Powell during his latest press conference.
Where do we go from here? The Fed has already clearly signalled a period of long pause, which would require dramatic changes in economic and financial conditions in either direction to be interrupted. Indeed, it would likely require either a sharp and persistent increase in inflation above the 2% target, or a consistent deterioration in economic growth, for this pause to be ended. Other central banks are taking a cue from the Fed, meanwhile. The Bank of Canada left its policy rates unchanged (even if with a clear easing bias) in October. The Bank of Japan bought more time before providing more stimulus. The Riksbank even signalled its intention to increase its policy rate (and “normalise” it to 0%) before entering a long pause. This week, the Reserve Bank of Australia is expected to pause its easing cycle (after three 25-bps cuts this year). The Bank of England will remain on hold ahead of the December 12th general election.
As a result, some of the euphoria currently observed in financial markets might be tamed in coming weeks. But don’t worry: in due course, when the situation will have deteriorated enough, central banks will be ready to deploy “helicopter money” to support the global economy and financial markets.
By Brunello Rosa
28 October 2019
Argentina and Uruguay went to the polls yesterday to elect new presidents, at the same time as a wave of protests has been hitting Latina America. Argentina elected a Peronist president again: Alberto Fernández, who will have as his Vice President Cristina Fernández de Kirchner, the former president of Argentina from 2007 to 2015. This is coming after the failure of the Macri presidency to implement liberal reforms and bring Argentina back to international capital markets. When Mauricio Macri was elected president of Argentina in 2015, his campaign was based on the motto “Argentina is open for business.” Macri’s plan was to definitively end the preceding Peronist era, in which Argentina had experienced a very volatile economic performance, rising public subsidies and inflation, and endless disputes with international investors over bonds restructured after the 2001 default.
Things seemed to be going in the right direction until early 2018, when a drought hit the country and a series of policy mistakes led markets to massively short the peso. The subsequent collapse in economic activity, the rise in inflation (55% y/y, the highest in the world after Venezuela and Zimbabwe) and a shortage of reserves led Macri to go back, cap in hand, to the IMF to ask for a bailout. The IMF granted the bailout: USD 57bn, the largest loan in the IMF’s history. This gave Fernández a formidable argument against Macri in the recent election campaign. He was able to say that the 2018 bailout was brought about by the Macri government’s adoption of the IMF-inspired liberal reforms (just like how the 2001 default was caused in part by the collapse of the “currency board” inspired by the “Chicago school”). In other words, instead of opening the country for business, liberal reforms have led it to default. The obvious conclusion (Fernández’ argument goes) is that only Peronism can work in Argentina. This argument has clearly been accepted by Argentina’s population in 2019.
At this point, the key question is what type of policies Fernández will adopt once he is elected. As we discussed in our recent in-depth analysis, Fernández is likely to opt for a middle ground between an orthodox approach and a fully populist approach. He knows Argentina needs a constructive dialogue with the IMF, as it will likely need more financial support in coming months. The IMF too knows that a constructive dialogue with Argentina is necessary: having already disbursed USD 44bn, it will need to keep the relationship healthy and intact if it wants to have a chance of seeing this debt repaid at some point.
Argentina might be a special case, but other LatAm countries are undergoing a difficult transition period as well. As mentioned above, Uruguay also went to the polls yesterday, to elect a successor to President Tabaré Vásquez, who could not run again due to constitutional term limits. Polls were held in the middle of a surge in crime (specifically, of murders and burglaries), which some attribute to the liberalisation of cannabis adopted by the government. Bolivia just had its presidential election, meanwhile, the result of which was that Evo Morales managed to win a second term, which led to disputes about transparency and protests against claims of alleged fraud in the election results.
Besides the basket case of Venezuela and the yet-to-be-confirmed hopes in AMLO’s Mexico, the two most worrying cases in the region of late are Ecuador and Chile. In Ecuador, protests recently erupted as Lenín Moreno, who in 2017 succeeded Rafael Correa (from the same party), in practice made a U-turn on a number of the government’s previous policies, for example by handing back a US military base that had previously been confiscated by Correa, and by steering the country back toward austerity and neoliberal reforms. In Chile, President Sebastian Piñera has reshuffled his entire cabinet as a result of the widespread protests that were triggered by an increase in transportation costs and the more general rise in inequality.
All this has been occurring while, in Colombia, President Iván Duque Márquez is trying to secure a final peace arrangement with the FARC, and in Brazil President Bolsonaro is passing a controversial pension reform in parliament.
By Brunello Rosa
21 October 2019
The IMF/World Bank meetings that just concluded in Washington DC were an occasion for policy makers, market participants, academics and other observers to take stock of the current worldwide macroeconomic, financial and geo-political environment. In its latest edition of the World Economic Outlook, the IMF warned about the synchronised global slowdown now taking place - the opposite of the global synchronised expansion that occurred in 2017-18. The outlook for the global economy has been downgraded, with the forecasts for growth in a number of key economies being revised downwards. The downgrade could have been even larger if it was not for the large positive contribution to growth from countries such as Brazil, Iran and Turkey (whose economy have stabilised after a severe recession). All this is happening at a time when policy makers’ fears of a global recession are increasing.
In this precarious global economic environment, some of the tail risks that could have tipped this global slowdown into a global recession seems have been diminishing in the last few weeks. Just to focus on the four economic collision courses recently identified by Nouriel Roubini, we can say that the risk that such collisions actually materialise is, for the time being, slightly lower than had been the case until recently. In the US-China trade dispute, there now seems to be at least a “Phase 1” agreement, which should be finalised by the APEC meeting in November. If such finalisation does indeed occur, then perhaps the feared increase in tariffs on consumer goods that would have come into effect in mid-December is not going to occur. That would certainly help provide a respite to the global economy.
Regarding Brexit, it seems that the new deal signed between the UK and the EUlast week should eventually lead - even if only at the end of a tortuous path - to an outcome that does not include a hard Brexit. In the Middle East, the tensions between the US, Saudi Arabia and Iran persist, but seem unlikely to escalate further into an open military confrontation. As the decision to pull out of Syriashows, the US seems inclined to disengage further from the region, rather than engaging in a new conflict that could mean putting US boots on Middle Eastern ground yet again. Thus for now the US seems inclined to resist the temptation to respond to Iranian provocations.
Finally, as far as Argentina is concerned, it seems that Alberto Fernandez, the Peronist candidate supported by Cristina Kirchner, is aware of the need to constructively engage in a conversation with the IMF, rather than put up a fight which could lead to a nasty outcome for all sides involved. If all four of these tail risks are reduced – US-China negotiations, Brexit, the Middle East, and Argentina – the danger coming from some of these potential triggers of a global recession would be lessened as a result.
Clearly, if these four fronts become less dangerous, new ones might open up. For example, by November 17th the US administration will have to decide whether or not to start imposing tariffs on the European auto sector. Such tariffs could have a large economic impact on the European economy. For the time being, it seems that the US administration will postpone the decision for a bit longer, as the Chinese front has not closed yet. Germany’s grand coalition could collapse as a result of new local elections or the change of leadership at the helm of the SPD. Older risks could resurface as well, for example if the Italian government were to collapse sooner than expected as a result of the continued tensions within its majority.
Reducing the likelihood of some of these triggers is as important as deploying a policy response to them. In this respect, the Fed and the ECB (and a number of smaller central banks, such as RBA and RBNZ) have started to do their part. More needs to be done, especially in terms of fiscal policy, but at least policy makers are alerted about the need to be vigilant and responsive, even if they are incapable of being proactive. At the same time, the IMF will begin a formal review of the effects of the unconventional monetary measures adopted by several central banks around the world, which hopefully will not lead to a sudden abandonment of such measures. In Europe, the ECB will carry out its own review of strategy, tools and communication, with the arrival of Christine Lagarde at the helm.
Given this background, risk in financial markets seems to be on rather than off. Risky asset prices are still close to their highs, long-term yields are low and credit spreads are tight. The IMF’s Global Financial Stability Report, also published last week, warns about the risks posed by a mounting level of corporate debt of dubious quality. The Financial Stability Board says that it is alerted to this, but is not yet alarmed by it; early in 2020 it will publish a report where is likely to acknowledge this. At the same time, market sentiment remains vulnerable to any swings in economic, geopolitical and policy developments.
By Brunello Rosa
14 October 2019
During a week in which the Nobel Peace Prize was granted to Ethiopia’s Prime Minister Abiy Ahmed Ali, for his “efforts to achieve peace and international cooperation, and in particular for his decisive initiative to resolve the border conflict with neighbouring Eritrea," still another new conflict is starting in the Middle East. After Donald Trump’s decision to withdraw US troops from the north-eastern corner of Syria, Turkey decided to occupy a strip of 20km inside that region to create a buffer zone. The occupation has two declared goals: to make it easier for the Turkish army to defend Turkey’s borders, and to relocate to Syria a portion of the 3.6m Syrian refugees currently living in Turkey.
As part of this offensive (somehow ironically named “Operation Peace Spring”) Turkish troops have launched a series of airstrikes and artillery bombardment against the Syrian Democratic Forces (SDF), forces which have helped the US-led coalition in Syria to fight ISIS, but which Erdoğan considers effectively a terrorist organisation. This is because the SDF are led by the Kurdish People's Protection Units (YPG), which Turkey considers a terrorist group. So, this “Operation Peace Spring” will be directed mainly against the Kurdish ethnic groups, which Erdoğan has long considered a threat to Turkey’s national unity and security.
The US position on this issue is contradictory at best. The US Department of Defense was reportedly against the abandonment of Northern Syria by US troops, and even Lindsey Graham, an ally of President Trump, said he would seek to introduce a bi-partisan resolution in the US Senate to reverse the decision and punish Turkey, if Turkey decides to attack the SDF. Trump himself, after giving green light to the Turkish invasion of Northern Syria, said that he would “obliterate” the Turkish economy if its actions were to be “off-limits”, or “inhumane.” In a spectacular U-turn, US Secretary of State Mike Pompeo said that the US did not give green light to the Turkish offensive in Syria, even as the official press statement following the phone call between Trump and Erdoğan states that “Turkey will soon be moving forward with its long-planned operation into Northern Syria”.
Europe’s reaction has, for a change, been to unanimously condemn this brutal military operation. But it has also, as usual, been ineffective. This is because the EU is in no position to tell Erdoğan what to do, after making a treaty with him on 18 March 2016, the result of which has been that the EU has paid Turkey EUR 6bn for two years in return for keeping the Syrian refugees on Turkish territory. Ahead of the renegotiation of this atrocious deal in 2020, Erdoğan is now threatening to open the gates of its refugee camps and flood Europe with migrants, as happened in 2015. Then, Angela Merkel decided to accept 1.1 million refugees in Germany (and, in so doing, marked the beginning of her own political decline) and Italy and Greece also dealt with hundreds of thousands of migrants coming from (or through) the Middle East by land and sea, while Hungary and other countries closed their borders.
If Erdoğan were to do what he is threatening to do – a scenario we do not expect to happen – the EU would not now be able to cope with such a migration crisis the same way it did in 2015. Germany would be unwilling and unable to accept more migrants, since the CDU has been severely punished for that humanitarian decision by Merkel in 2015. Italy, after the “security decrees” by Salvini (which are still active), has closed its ports to the ships rescuing migrants. Greece is now governed by a centre-right government much tougher on migration than Syriza’s far-left positions were. The Viségrad group (Poland, Hungary, Czechia and Slovakia) remains resolutely against any re-distribution of migrants within the EU (even as they continue to collect, financially, the “solidarity contributions” from larger EU countries). The EU Commission is in the middle of a difficult transition from Juncker’s presidency to Von Der Leyen’s, preventing it from making any big decisions. So, another migration crisis would most likely destabilize Europe, sending it close to collapse. A dis-integration of Europe would have large economic, financial and social consequences.
This means that Erdoğan’s threat is credible. Unfortunately, the likely conclusion to all this is that the EU will renew its deal with Turkey, and receive only a somewhat less “inhumane” war in Northern Syria than would otherwise occur.
By Brunello Rosa
7 October 2019
Following a number of warning signals, a European front in the global trade wars has now been opened by the World Trade Organisation (WTO). In a recent ruling on a 15-year old dispute, the WTO ruled that the US is authorised to apply tariffs worth USD 7.5 billion annually on the UK, France, Germany, and Spain (the “Airbus nations”), as well as on the wider EU, as a compensation for the subsidies that the EU has allegedly given to Airbus, providing the company with an unfair advantage against its US rival Boeing. Similarly, in a separate ruling that is expected in the months ahead, the EU is likely to be authorised to impose tariffs (likely billions of dollars worth) on EU imports of US goods, due to the subsidies that the US government has provided to Boeing. This could mark the beginning of a tit-for-tat escalation between the EU and US, which could prove damaging for both sides.
Ironically, it is the WTO, an international body devoted to the resolution of trade disputes, that is risking opening this new front in the ongoing international trade wars. As discussed in our previous analysis, US President Trump has opened a number of fronts for his country’s trade wars: he began by withdrawing the US from the TPP, then continued with a worldwide tariff increase on steel and aluminium (even imposing such tariffs on its close allies Canada, Europe and Japan, albeit with selective exemptions), then moved to the re-write of NAFTA with Canadaand Mexico, and finally finished in style with China, subjecting it to several rounds of tariff increases as well as technological disputes. When it seemed that on the Chinese front a deal could finally be reached, Trump was ready to wage war to Europe and the European car industry.
The procrastination of the negotiations with the Chinese therefore meant that this European leg of the dispute has repeatedly been postponed. Now, however, the European front is officially open.
The list of goods impacted as a result is very large: French wine, Italian cheese and olives, whisky, and cashmere sweaters, among other items. This cannot be good for Europe: its economy is already in stagnation, with some of its largest economies (such as Germanyand Italy) flirting with a recession. In particular, while Franceand Germany have at least benefited from the positive impact of the aerospace industry to their economies, Italy, which does not belong to the Airbus consortium, would be hit by new tariffs without ever having directly or greatly benefited from the subsidies the company is alleged to have received.
Neither will the US economy remain immune from the expected counter-ruling by the WTO, nor from any retaliatory tariffs that the EU might decide to implement. The American economy is decelerating as the effects of tax cuts are fading out, and the Fed is not following Trump’s game of forcing the central bank to provide monetary stimulus as an (imperfect) offset of the tariffs on various countries that the US government has imposed.
This new European chapter of the American trade war is unlikely to have a happy ending, especially as the most likely outcome for the US-China front of the trade war is not a fully-fledged deal or a total breakdown in negotiations, but rather a continuation of the “controlled escalation” that has been taking place. Unfortunately, the world economy will have to deal with the effects of these disputes for years to come, forcing policy makers to provide fiscal and monetary stimulus, and keeping markets unnecessarily volatile.
By Brunello Rosa
30 September 2019
In the beginning there was Minsky. According to Hyman Minsky’s financial instability hypothesis, during the expansionary phases of business cycles, the financial position of economic agents – companies, households, sometimes even governments – becomes increasingly fragile, as they move from relatively secure “hedge” positions towards speculative or, in extreme cases, “ultra-speculative” positions; the latter not dissimilar from infamous Ponzi schemes. In a more fragile environment, even a small shock to the system, such as a small increase in interest rates, has the potential to render the most exposed positions illiquid or even insolvent. This eventually leads to a downturn in the financial cycle, not dissimilar to the debt-deflation spiral described by Irving Fisher. In turn, this collapse of financial positions triggers a downturn in the business cycle, which moves from expansion to slowdown and eventually into contraction. From a Shumpeterian perspective, this period of “creative destruction” is very healthy, as this process of selection and “survival of the fittest” allows the system to restore itself, shedding previous excesses that existed and therefore readying itself for the subsequent economic recovery.
The particular segment of the business cycle when the cycle turns as a result of a financial shock has been popularised with the name “Minsky moment.” This is considered a real pity by those who are actuallyscholars of the great post-Keynesian economist, as the term completely misses the fact that Minsky’s analysis is a theory of the business cycle: its most interesting part is not the “moment” of shock, but rather is the recovery phase of the cycle, when the financial fragility of the system increases, completely undetected, thus preparing the ground for the later, inevitable downturn. Economic analysis has preferred to focus on the conditions (including shocks) that could trigger these “Minsky moments.” For example, Nassim Nicholas Taleb has written convincingly about “black swans”, extremely rare events that could trigger major changes in prevailing economic, financial and social conditions.
Moving from theory to practice, press reports recently reported that market participants currently fear many black swans, with a potential spike in oil prices deriving from the US-Iran-Saudi Arabia tensions adding itself to a list that already included a possible collapse in US-China trade talks or UK-EU negotiations regarding Brexit. In his latest column for Project Syndicate, Nouriel Roubini spoke about four collision courses that could derail the global economy, adding to this list the victory by Alberto Fernandez in Argentina’s primary presidential election, which has triggered yet another debt restructuring by the Latin American country.
But the list of these potential triggers could be expanded even further. in the US, an impeachment of Trump ahead of the 2020 presidential race could lead, under certain circumstances, to a severe market correction. In Europe, Germany’s recession could deepen, potentially leading to a government collapse and further political fragmentation. In Italy, Matteo Renzi’s newly formed party could pull the plug on Conte’s government, paving the way for a return of Salvini to power. In Asia, an increase in the Japanese consumption tax could lead to an economic contraction, deepening the global slowdown. And other examples could be made for Brazil, China, Russia, etc.
What about the policy response? In the recent decision by the Fed to adopt “insurance cuts” there is a reminiscence of Minsky’s theory, insofar as the central bank decided not to increase rates further at a time when the economic and financial system seemed already to be fragile – to avoid providing a shock that might have triggered a downturn. After years of experimenting with monetary policy, there is now a great consensus among economists that fiscal policy should take up the responsibility of being the main counter-cyclical policy instrument. In effect, in Minsky’s theory, the policy prescription could be simplified with the expression “Big Government” – in other words, making sure that public expenditure is a large component of national income, so as to stabilize business cycles. As Richard Koo convincingly argued, in a balance sheet recession following a debt-deflation episode, the system needs at least one large borrower that can compensate for the deleveraging of the private sector, and that must be the government.
By Brunello Rosa
23 September 2019
There have been a number of rallies around the world this
past week, mostly of young people gathering to protest about the inaction of the global élites regarding the devastating phenomenon that is climate change. Rallies were held in 150 cities, according to event organisers. These took place at the same time as the intervention at the United Nations by Greta Thunberg, one of the moral leaders of this global movement.
We have already previously written,in our column in August 2018, about the impact that climate change (or, more appropriately, global warming) could have on a number of economic, financial, political and geopolitical fronts.
Last year we focused our attention on the existing link between climate change and migration flows, as immigration was and still is one of the most divisive political issues in both the US (where President Trump was suggesting to build a wall along the border with Mexico) and in Europe (where the support for populist parties was increasing as a result of the rise of immigration). In this respect, in 2019 the UN has made a giant leap forward in our view, by introducing the concept of “climate migrants”, a term that will be even broader in scope than the initial category of “climate refugees”.
The introduction of this new concept might eventually have very practical political consequences. In their recent meeting in Rome, French President Macron (who is preoccupied by the rise of Marine Le Pen’s Rassémblement National) promised Italy’s PM Conte (who needs to contain Salvini’s propaganda about there being a “migrant invasion”) to automatically redistribute only the asylum-seeker refugees arriving on Italy’s shores, but not the “economic migrants.” But if – in the not-too-distant future – the EU accepted the idea that those who are now considered “economic migrants” (i.e. people supposedly looking for a better life) are in fact “climate refugees” (i.e. people escaping the effects of climate change) then the number of people subject to automatic re-distribution would increase dramatically, making migration an EU-wide phenomenon as opposed to just a “law-and-order” issue for Greece and Italy to address on their own. The sooner this happens, the better.
Turkey’s Erdogan, who pocketed EUR 6bn from the EU to keep the Syrian refugees in his camps, has threatened to “open the gates” of migrants to Europe, unless the EU gives him more money to deal with this phenomenon. A new wave of migrants to Europe, similar to the 1.1mn people that Germany absorbed in 2015, could destabilise the EU and eventually lead to its implosion.
In this respect, French President Macron is very active, and put climate change as one of the key agenda points of the G7 meeting in Biarritz. Macron suggested to provide financial resources (USD 20mn) to Brazil to help the government led by Bolsonaro to deal with the Amazon wildfires. The two had a lively exchange of views, which unfortunately has not led to a solution. Also in Europe, Germany’s government unveiled a EUR 40bn investment plan in “climate protection measures,” which is thought to be Germany’s vehicle to provide fiscal stimulus to its ailing economy, which contracted by 0.1% in Q2 2019.
But the fight for climate change will involve also key actors from the financial industry. While the US continues to be on the side-lines of this fight, given Trump’s scepticism over the scientific foundations of global warming, Christine Lagarde (former IMF Managing Director) pledged to “paint the ECB green” in her inaugural audition before the EU parliament as ECB President. As Lagarde said, the “discussion on whether, and if so how, central banks and banking supervisors can contribute to mitigating climate change is at an early stage but should be seen as a priority.” In effect one of the pioneers of evaluating the impact of climate change for central banking is BOE Governor Mark Carney.
How to combine economic efficiency and productivity growth with the transition of major economic systems towards more sustainable sources of energy should be a key aspect of the new form of capitalism that thought leaders such as Martin Wolfbelieve should start to emerge in coming years, if liberal democracies want to survive.
By Brunello Rosa
16 September 2019
The world’s major central banks are taking to centre stage again. As we discussed in our review, last week the ECB kicked off the process by announcing a new stimulus plan, consisting of a cut to the deposit rate (accompanied by the introduction of tiered reserves to protect bank profitability), easier conditions for the new TLTRO long-term loans, a promise to keep interest rates at current or lower levels until inflation is closer to target, and new asset purchases that will last until shortly before rates start to be increased. While market participants expected a larger package in some ways, the ECB surprised to the upside by announcing an open-ended version of this easing program: the stimulus will continue until inflation stabilises at a level closer to target.
This coming week, two other major central banks will hold their policy meetings: the Federal Reserve and the Bank of Japan (BoJ). The Federal Reserve is widely expected to cut its Fed funds target rate further, as part of the insurance cuts it started in July. The real question is what the Fed will say about future rate cuts. The market expects these insurance cuts to be just the beginning of a prolonged easing cycle. President Trump is putting as much pressure as possible on Fed Chair Jay Powell to make sure this is indeed the case. However, the Fed is trying to resist any political interference, including the pressure to cut rates to respond to the increases in tariffs unilaterally decided upon by the White House. The clash between the two is intensifying; the former President of the New York Fed William Dudley openly advised the Fed not to fall into this political game, which only serves the purpose of ensuring Trump’s re-election in November 2020.
On Thursday, it will be the BoJ’s turn: analysts are split as to what the BoJ could do in September, just a couple of weeks before Japan’s planned sales tax increase from 8% to 10%. The BoJ might want to keep some of its ammunition for rainy days, but on the other hand it will not want to fall excessively behind the Fed and ECB in their easing cycles. In Europe, the Swiss National Bank and Norges Bank will also hold their policy meetings this week. Their policy decisions too will be greatly influenced by what the ECB and the Fed have done.
The Bank of England’s MPC, also meeting on Thursday, is also widely expected to remain on hold, waiting for Brexit developments.
In spite of all of the best efforts to reduce their relevance over time, the contribution of central banks remains absolutely crucial to countries’ policymaking. There is a lot of talk about the possibility of greater monetary-fiscal cooperation, if not explicit coordination. Some are even suggesting that the next step should be “helicopter money”, whereby central banks provide monetary instruments directly to the general public, thus circumventing the banking system. (Recently, key contributions in this direction have been given by Stanley Fisher, Philip Hildebrand, and others). Draghi himself, during his press conference last week, said that “government with fiscal space should act in an effective and timely manner.” But the reality on the ground, so far, is that fiscal policy is constrained, and monetary policy still remains, by and large, the only game in town when it comes to supporting economic activity during the ongoing slowdown.
By Brunello Rosa
9 September 2019
The level of recklessness existing in politics has increased remarkably during the past few years. This recklessness has produced unexpected outcomes and dangerous side effects that will impact certain countries for years to come. Examples of this phenomenon can be seen in most of the regions of the world.
Let’s start with the UK. In 2016, PM David Cameron launched a referendum on the UK’s participation in the EU. He made this decision as a way of solving the internal debate taking place within the Conservative party, which had been divided for years over this issue (and still is!). The referendum, only the fourth held in the country in 40 years, did not include any precautionary mechanism that could prevent a small majority from deciding the fate of the entire country and its four constituent nations. One could have included a minimum threshold in the referendum (e.g. requiring at least 55% of votes to validate the outcome), or a provision that would have required a majority vote to be achieved in the referendum within each of England, Scotland, Wales, and Northern Ireland. Instead, the Leave camp won by a narrow 52-48% majority, and the Brexit process was initiated in March of 2017.
In the two and a half years since then, the issue has still not been resolved.
Partisanship in the country’s political debate has reached levels not seen in decades. The new Prime Minister Boris Johnson is further radicalising this clash, shutting down parliament and threatening further constitutional stretches in coming days. All this just to increase the stakes in the UK’s negotiations with the EU, to threaten the 27 with a no-deal scenario. This is yet another example of lack of a prudence being taken in contemporary politics.
Moving over to Italy now, we can see that other notable examples of political recklessness have emerged as well, in recent years. In 2016, Matteo Renzi launched a referendum on his plan for constitutional reform, which was very controversial. As if that was not enough, Renzi said that his political career depended on the outcome of that referendum, thus raising the stakes to the point of risking his entire government. The referendum did not pass. Years of discussions over how to change the country’s constitution were wasted in a single day, and the government collapsed as well, paving the way to the Five Star and Lega victory in 2018.
Lega’s Matteo Salvini made the same mistake in 2019: he pulled the plug on a government that was extremely popular at the national level (even if internally divided and quarrelsome).
He bet everything on the fact that the PD and the Five Star would not make a deal with one another, and that the President would call early elections right in the middle of the budget season, thereby risking budget prorogation and market turmoil. All this did not occur, and so he lost power. In this case, this actually removed a risk factor from the political landscape; namely the possibility for Italy to leave the euro area. Nonetheless, the political calculus behind Salvini’s gamble was not prudent, and could have cost the country dearly.
On the other side of the Atlantic, President Trump was after running a very divisive campaign, a campaign which radicalised the political landscape in the US and reduced the space available for cooperation between the two parties in Congress. After that, Trump started applying his “art of the deal” approach, consisting of assertive moves, veiled and not-so-veiled threats, and brinkmanship, to a number of situations: NAFTA, trade and tech disputes with China, the Iran nuclear deal, etc. This approach has made US leadership less predictable, leaving traditional allies confused. As a result of his trade wars and widespread uncertainty, the world economy has entered a slowdown, which affecting the US economy and risks jeopardising Trump’s chances of being re-elected in 2020.
In Japan, meanwhile, PM Abe seems willing to spend all of his political capital on a referendum to change Article 9 of the country’s pacifist constitution, even as public opinion remains opposed to such a change. Here too, we see a political leader making a bet that could backfire massively on himself. In this case, the bet is taking place in a country that has been fighting deflation for the last 30 years.
These are only a few examples, from four prominent G7 countries, of the recent increase in political recklessness. Other examples could be given as well, both in advanced economies and in developing countries. Brazilian President Bolsonaro’s approach to the fires in the Amazon, for instance. Maduro and his mis-management of Venezuela. Argentina taking on the largest loan on IMF’s history, only to default on it after one year. North Korea’s development of a nuclear program. The list goes on. In our view, having political leaders who play with fire, as if there were no consequences to their mistakes, is very dangerous. When too many of them act in this same way, global risks increase and risk materialises in unexpected ways, with the result being that potentially catastrophic consequences can be realized following incidents that would otherwise have only minor negative effects.
By Brunello Rosa
2 September 2019
This week will be a crucial one for determining the fate of governments in Italy and the UK. In Italy, Giuseppe Conte will come back to President Mattarella to announce whether or not he has been able to form a coalition between the Five Star Movement, the Democratic Party, and other smaller parties. As we discussed in our scenario analysis, there are a number of unresolved issues between Five Star and the Democratic Party, including as to what their government’s program and composition would be. Di Maio’s tough speech last Friday(“either the PD accepts these 20 points, or better to vote. And I may add: the sooner, the better”), was widely regarded as an obstacle to eventual solving of the crisis (hence the fall in equity markets and the spike in the BTP/Bund spread). Additionally, there is a Damocles’ sword hanging over the coalition deal; that is, the vote on Five Star’s online platform Rousseau to ratify such a decision.
Nonetheless, in our baseline scenario, we expect Conte to be able to positively resolve the “reservation” with which he accepted the charge of forming the government. The government would initially be very fragile, as Conte will have a strong political and social opposition to face, as well as a difficult economic condition (GDP contracted in Q2, among other concerns). At the same time, such a government could also count on some powerful allies. The US President openly hoped for Conte to be confirmed as PM. The outgoing European Commission, even with one of its most hawkish representatives (Guenther Oettinger) said it welcomes the possible formation of a pro-European parliament in Italy.
The new Commission led by Ursula Von Der Leyen made Conte understand that Brussels will close an eye regarding the budget, so long as Italy remains fiscally prudent and moves in the right direction (even if not at the ideal speed). Even the Vatican showed sign of sympathy for the new government, with a short meeting between the Pope and Conte on Friday. So, while the navigation could be bumpy, the government’s ship does not necessarily need to sink if the coalition partners do not fight too much amongst themselves.
Market concerns are now actually higher for the government in the UK than for Italy, for a change. During the past week PM Boris Johnson obtained from the Queen the possibility to suspend parliamentfor five weeks between September 9th -12th and October 14th, ahead of a new Queen’s speech. As discussed in our analysis, Johnson claims that this is a normal procedure to allow the new government to focus on its new legislative agenda. But the reality is that the decision was made to prevent opponents of Brexit (or at least, opponents of a no-deal Brexit), who are a majority in parliament, to undertake the legislative actions that would prevent a no-deal Brexit from occurring. When parliament reconvenes on September 3rd, after the summer recess, it will now only have 6 days, and even fewer working days, to try and react to this move.
Though legal challenges have been made against Johnson’s decision, including from the former leader of the Tory party Sir John Major, the possibility that the Labour party will table a no-confidence vote to oust Johnson during this week are much higher now. It is yet to be seen whether this will be a feasible initiative and, if so, whether it will be a successful one. For the time being, markets are skeptical and the pound sterling is reaching all-time lows.
By Brunello Rosa
27 August 2019
In spite of the hot weather and the summer holiday season, policy events are in full swing. In the US, the traditional summer meeting of central bankers in Jackson Hole was closely watched, observers attempting to detect signs that would indicate whether the Fed’s insurance cuts could become the beginning of a more prolonged and deeper easing cycle. The words of the Fed’s Chair Jerome Powell were scrutinised, the prevailing impression of them being that Powell remained cautious about providing precise indications as to what the Fed would do in September and beyond. President Trump, considering these words not dovish enough, even asked on Twitter, “who is our bigger enemy, Jay Powell or Chairman Xi?”.
This question was motivated by the intensification of the trade war between the US and China, with China first announcing tariffs on USD 75bn of imports from the US (itself a retaliation to Trump’s decision to impose additional tariffs starting from September 1st), to which the US responded with a further retaliation. President Trump tweeted that tariffs on the USD 250 billion of imports already in place would be raised to 30% from 25% on October 1, and that the remaining USD 300 billion of imports set to become effective on September 1stwould be taxed at 15%, rather than 10% as had initially been announced.
Another front of the many US confrontations now taking place is Iran. On this front, there might be marginally positive news coming from the recently concluded G7 meeting in Biarritz. Iran’s Foreign Minister Javad Zarif was invited to the side-lines of that meeting. Though President Trump did not meet with Zarif, we can consider it positive news that a channel of communication was opened between the two sides (thanks to French President Macron, who organised the meeting).
Other items on the agenda of the G7 meeting besides trade wars and tension with Iran included the digital tax that Macron wants to impose on US tech giants in France, and emergency measures to combat the fires in the Amazon forest. The Amazon represents another very sensitive front in international relations, of course. Brazil’s President Jair Bolsonaro is insisting that Brazil’s portion of the rainforest belongs unequivocally to Brazil – but the rest of the world is claiming that the forest is the “global lungs”.
Around the table in Biarritz there were key players in two other critical political developments that were cited by Powell as global risks; namely, “the collapse of the Italian government and Brexit”. Italy’s PM Conte – who resigned last week – is waiting to see whether he will be reconfirmed as prime minister in a new coalition government between Five Star and the Democratic Party. Italy’s President Mattarella will hold a second round of consultations on Tuesday and Wednesday this week. If at the end of this round the possibility of forming a new government is not clear, the President will dissolve parliament to hold early elections, which will most likely take place on November 3rd or November 10th.
UK PM Boris Johnson made his debut at the G7 in Biarritz meanwhile, and there had the chance to meet again with French President Macron and German Chancellor Merkel, together with EU President Donald Tusk. Johnson re-affirmed his tough stance on Brexit, threatening not to pay the GBP 39bn Theresa May had pledged to pay as part of the Withdrawal Agreement. He is facing a tough return to Britain. When parliament re-opens, he will have to face a no-confidence vote, which could bring down his newly formed government and allow for the formation of a caretaker government that would postpone Brexit and prevent a no-deal scenario from materialising. In response to this threat, Johnson has asked legal advice on whether he can shut down parliament (or, technically speaking obtain a “prorogation”) for five weeks, so as to make sure that no-deal Brexit cannot be blocked by parliament. The EU partners have given the UK the onus to come back to the negotiating table within 30 days with examples of “alternative arrangements” to the Irish backstop, for a deal to be signed. We are clearly going to have to wait until the last moment to find out whether or not a deal is reached.
By Brunello Rosa
19 August 2019
We have written several times about the rise of populism at global level, and its repercussion on the political, economic, and financial developments of the countries in which the populist phenomenon is strongest. We have also discussed the potential repercussions for the liberal order and its institutions, such as the European Union, that were created after Word War II as a response to the damage caused by the nationalistic and populist movements of the first half of the 20th century.
Plenty of studies have been published that discuss the origin of this new wave of populism. A useful taxonomy is one in which contemporary populists have been classified into three categories: those who reached power for cultural or “identity-related” reasons (e.g. Brexit); those who claim to be anti-establishment (e.g. Donald Trump), and finally, those who came to power as a result of a widespread socio-economic malaise (e.g. Five Star and Lega in Italy). In this column we want to focus on the underlying causes of the last of these three categories: socio-economic populism. At the core of any economic malaise there is under-development and lack of opportunity, especially in emerging markets. In developed economies, however, where per capita income is much higher, it is the uneven or unfair distribution of income and wealth that seems to be the driving force behind the rise of populist forces in recent years.
As discussed in our recent in-depth analysis, income and wealth inequality (or lack of “inclusion”, to use the expression of the IMF/World Bank) is one of the main causes of subdued growth and historically low real interest rates. As the IMF said in its 2018 Annual Report, “reducing inequality can open doors to growth and stability.” Yet by causing subdued and uneven growth, inequality is also a primary origin of protest movements that want to rectify this situation, which sometimes are or have been classified as “populist.”
In our analysis we discuss how income inequality has been increasing since the 1970s, when the primary distribution of income began to become skewed more towards profits, interests and rents and less to labour.
At the same time, the neo-liberist revolution of Ronald Reagan and Margaret Thatcher also made the redistribution of income via taxation and subsidies less effective, on the back of what was labelled as trickle-down economics. Many years of increased globalisation, with its inherently deflationary forces (including on wages), reduced labour share of income in the most advanced economies (and parallel increase in the profit and interest share of income), diminished power of trade unions, mass privatisation of public goods, and inability of taxation and subsidies to redistribute income in a fairer way, have led to the current situation. Workers in many countries feel deprived, and are therefore willing to give a chance to political leaders who claim to be on their side, however inconsistent with this claim those leaders’ biographies might be.
The policy solution to this problem seems quite straightforward: a more active role of fiscal policy, to promote income redistribution, increased public expenditure in infrastructure and education, the provision of job opportunities to younger generations by the public and private sectors. Some of these solutions are becoming popular even among the US electorate, with the rise of political leaders such as Bernie Sanders and Alexandria Ocasio-Cortez, who are not afraid of being labelled “socialists,” a description which just a few years ago would have killed any political career. Nevertheless these solutions are easier said than done. Once in power, even their proponents realise how difficult implementing such policies tends to be, given binding budget constraints.
Wealth inequality is even harder to assess than is income inequality, as it is often a legacy issue (as wealth is accumulated over generations), and as it is the result of the cumulative effect of income inequality over a long period of time. A group of economists has suggested the adoption of a “wealth tax” as a solution to this issue. This might well be a solution, but the political economy of adopting such a tax would be complicated, and so might ultimately prove to be counter-productive.
All this is to say that income and wealth inequality are here to stay for the time being, and will continue to feed populist movements around the globe. Policy solutions are available, but their implementation is complicated and sometimes politically toxic. This means that probably things will have to get worse before they can get better.
By Brunello Rosa
12 August 2019
Last week, we observed that political risk has been rising again, especially in Europe. In Italy, following months of indecision, Lega’s leader Matteo Salvini decided to pull the plug on Conte’s government by tabling a no-confidence motion in the Senate. As we discussed in our flash update last week, that officially marked the beginning of a government crisis which is expected to lead to a snap election being held in late October. If that election takes place, Salvini – who has asked the Italian voters to given him “full powers” – could become Italy’s Prime Minister by the end of the year. Salvini’s budget plans are certainly not in line with Italy’s budget discipline of the last few years, and therefore Italy is likely to soon be on a collision course with the EU Commission (again!). Markets are already reflecting these developments, with the 10y BTP-bund spread back to 240bps, and equity prices having fallen by 2.5% last Friday. Also on Friday, Fitch kept Italy’s rating at BBB, with a negative outlook, clarifying that a government collapse in H2 2019 was already part of their baseline. As we discussed in our medium-term scenario analysis in October 2018, Italy is now choosing what we labelled an Austro-Hungarian path. This could eventually lead the country to become an “illiberal democracy,” as theorised by Salvini’s maestro, Hungary’s Prime Minister Victor Orban.
Italy is not the only country to be experiencing a political drama. In the UK, PM Johnson has confirmed that the country is ready to leave the EU with “no ifs and no buts” by October 31st, with or without a deal. He might have been lured into doing so by US assurances that the Trump administration will be at the UK’s doorsteps “pen in hand” to sign a free-trade agreement with the country.
In fact, such a deal might be difficult to achieve: a number of US politicians with Irish roots would reportedly be very reluctant to ratify any trade deal that risks endangering the provisions of the Good Friday Agreement for Ireland, and in particular the existence of an open border between the two sides of the island.
Also, former US Secretary to the Treasury Larry Summers said that any trade deal signed with the US after a “no-deal” Brexit would be particularly advantageous for the US (for example, health insurance companies could try to replace the NHS), but very dis-advantageous for the UK, given that the UK may be in a desperate position after crashing out of the EU. (Brexit uncertainty has already caused UK’s GDP to fall in Q2 2019). As a result of all of this, a new standoff between the UK and the EU Commission is likely to begin soon, which might lead to new elections. Press reports suggest these might take place immediately after Brexit, possibly even on November 1st. The effects of the no-deal would then not yet be immediately visible or able to influence voters’ opinion.
All these domestic political risks are resurfacing at a time when geopolitical risks are also on the rise, and as the global economy is particularly fragile. As we will discuss in greater detail in John Hulsman’s Geopolitical Corner later this week, a few days ago India’s PM Modi reduced Kashmir’s autonomy, and by doing so inflamed a region that is geopolitically one of the hottest in the world (especially given that both India and Pakistan have nuclear military capabilities). Meanwhile the US has decided to rebrand China as a currency manipulator after many years, following the depreciation of the RMB to above 7 US dollars for the first time since 2008. (The RMB depreciation was caused by the threat of new US tariffs on Chinese imports, which we discussed last week). With this move by the US, the risk of a currency war has been added to the ongoing trade and tech wars between China and the US. It should not come as a surprise that all these political and geopolitical risks are taking a tolls on the global economy.
By Brunello Rosa
5 August 2019
At the end of last week, US President Donald Trump threatened to impose a 10% tariff on the remaining USD 300bn of imports from China beginning on September 1st, if by that date an agreement is not reached between the Chinese and US governments. After the small level of hope generated from the “positive” meeting between Trump and Chinese President Xi Jinping at the G20 meeting in Osaka, this turn of events makes the possibility of a comprehensive trade deal between the US and China being reached soon even slimmer than it had previously been. In the days preceding this latest of Trump’s threats, he had warned markets and the general public that China’s tactics might have been to wait until November 2020 before signing any agreement, in the hope that by January 2021 they could deal with a more conciliatory, Democratic president.
Unfortunately, events are unfolding in line with our view that a controlled escalation between the two countries is more likely than a full-fledged deal being reached, and that at best the US and China can only agree on temporary truces during what may prove to be a long-term technological and geo-strategicnew cold war— or Cold War 2, as we labelled it in early May. A comprehensive and long-lasting agreement is hard to envision, even if Trump were to win re-election in 2020. At most, a more prolonged truce between China and the US could be agreed upon, but such a truce would remain fragile and subject to interpretation and controversy.
Needless to say, the market did not respond well to the latest turn of events. Equity market sold off massively throughout the world, reinforcing a move that was already taking place as a result of the disappointment that followed the Fed rate cut on Wednesday 31 July. Long-term sovereign bond yields in US, UK, Europe and Japan collapsed. In those jurisdictions where the market could expect more rate cuts from central banks, sovereign yield curves steepened. Elsewhere, they continued to flatten. Even in the US, where the Fed has 225bps of easing space available, the 2y US Treasury yield closed the week down by 16bps, while the 10y yield fell by 24bps on the weekly basis. The net result has been a re-flattening of the yield curve, after the marginal steepening that had occurred in anticipation of the Fed’s rate cut.
In the past, a flattening of the yield curve has been associated with upcoming recessions. In our analysis, we have argued that with the long end of the US yield curve being anchored by low yields in Germany and Japan, this correlation between the curve and recession probabilities has diminished. Nevertheless the latest developments do not bode well for the US or the global economy.
To begin with, it would be delusional to think that lower policy rates by the Fed could compensate higher tariffs, which risk having a disproportionate and non-linear effect on the economy.
Second, in addition to the ongoing trade and tech war there are also unabated tensions with Iran, which have recently escalated with the seizure by Tehran of a UK super-tanker. This stand-off is likely to be prolonged; the Iranian government might wait for the end of Trump’s presidency before re-opening the diplomatic channels of communication, in the hope of dealing with a less confrontational US president.
Finally, as the global manufacturing recession continues, the global economy might be on the cusp of a downturn which looser monetary policy alone might be insufficient to avert.
By Brunello Rosa
29 July 2019
Last week, Boris Johnson was elected leader of the Conservative Party and, as a result, Prime Minister of the United Kingdom. Johnson’s program has the acronym DUDE: Deliver Brexit, Unite the UK, Defeat (Labour’s leader) Jeremy Corbyn, and Energise Britain. His first speech, made in front of 10 Downing Street, was a profusion of optimism; it was an attempt to rally the country’s sense of pride over its glorious past and purported luminous future outside the EU. Johnson promised to take the UK out of the EU by October 31st, “no ifs and no buts.” Polls show that this new, energetic and defiant approach has resulted in a 10% bounce in the Tory support, to 30%, ahead of Labour (25%), LibDems (18%) and the Brexit party (14%).
The largely reshuffled cabinet reflects this new, assertive approach to Brexit. Leading Brexiteers have been given key ministerial roles. Dominic Raab is replacing Jeremy Hunt as foreign secretary, Andrea Leadsom is replacing Greg Clark as Business secretary, Jacob Rees-Mogg (the Chairman of the ultra-Brexiteer European Research Group) is replacing Mel Stride as Leader of the Commons (which organises the government’s activity in the House of Commons), Michael Gove is replacing David Lidington (Theresa May’s de-facto deputy PM) as Chancellor of the Duchy of Lancaster and key adviser to the PM, in charge of coordinating Cabinet activity. Additionally, former pro-Remain Sajid Javid is replacing Philip Hammond as Chancellor of the Exchequer, and is preparing an extraordinary budget to speed up preparations for a no-deal Brexit. Finally, political strategist Dominic Cummings, the former campaign director of “Vote Leave”, is now special advisor to the PM.
In a series of updates, we have discussed what consequences the election of Boris Johnson could bring about. Regarding Brexit, Johnson’s attempt to renegotiate the deal with the EU will at first likely result in a firm “no way” from the EU. That could in turn trigger a confidence vote that, if lost by Johnson, could result in a Labour-led minority government being formed, a new general election being held or even a second referendum. In case of new elections, a tactical Tory alliance with Nigel Farage’s Brexit party would become likely.
Such an outcome would change the nature of British politics: by making an alliance with Farage, the Conservatives, one of the cornerstone parties of the UK political system, would be institutionalising the populist movement (which morphed into a party at the latest EU elections) that has led to Brexit. In other European countries we have seen how fringe national-populist parties have come to power by making alliances with the traditional, mainstream parties (for example in Austria, under the government of Sebastian Kurz). Once contracted, the virus of populism is very difficult to get rid of: it tends to become part of the political discourse, and never fully leaves. A seemingly endless list of countries all around the world, from Latin America to Europe and Asia, know this all too well. What is astonishing to watch is the US and UK, countries that were leaders of the liberal-democratic order that was born after World War II, entering such a difficult phase of their history as well.
We believe a period of political turmoil is likely to begin for the UK. The Brexit plane is not going for a soft landing. In the best case, it is going to be a very bumpy landing – but no one can rule out a crash either. The key point to understand here is that what seems a failure to most of the international observers, including us, might not be perceived as such by the new Tory and British leadership. In the next article for his Geopolitical Corner published this week, John Hulsman will discuss in detail how Johnson perceives the Anglosphere to be his geo-strategic horizon, and this does not require any participation in the European integration process, which is perceived rather as a chain to be freed from.
By Brunello Rosa
22 July 2019
This week, the long-awaited period in which G10 central banks start becoming more accommodative will begin, starting with the ECB’s Governing Council meeting on Thursday. As we wrote in our preview, the ECB will mostly just be laying the groundwork for more significant easing measures to be adopted in September, when a new set of staff forecasts will also be provided. It may, however, also give something of an appetizer in July, in terms of beginning the process of accommodation immediately to a certain extent. Currently markets remain buoyant about the arrival of Christine Lagarde at the helm of the ECB, as she is expected to provide continuity with Mario Draghi’s era. Additionally, press reports revealed that the ECB is looking at the appropriateness of its official goal (to keep inflation “below, but close to 2%”) to achieve its price-stability mandate. These reports suggest that a more “symmetrical” approach would provide less of a disinflationary bias and more headroom for an easier policy stance.
Similar thinking seems to be underway in the US, where the Fed (whose FOMC meets next week) appears to be on the verge of moving de facto to some form of average inflation-targeting regime, suggesting that after a prolonged period of target under-shooting, monetary policy could be kept more accommodative than is justified by the stage of the business cycle alone, in order to make up at least part of the miss in the price level. As a result of these considerations, the recent testimony by Chair Jay Powell before the US Congress, and a speech by the President of the New York Fed John Williams (which required an unusual clarification), market expectations about the size of the rate cut in July have swung wildly in the last few weeks, between 25bps and 50bps. After this period of volatility in expectations (amounting to “confusion,” according to some press reports), they seem to have stabilised at 25bps. We will discuss all of this in greater detail in our upcoming preview for the FOMC meeting.
The same week as the Fed meeting, the BOJ and the BOE will also hold policy meetings. As discussed in our recent overview of the policy stances of the G10 central banks, the BOJ could start making the first changes in its language as early as July, whereas the BOE will remain mostly reactive, with the change in the British government and Brexit developments dominating the macroeconomic environment. Other G10 central banks, such as the RBA, RBNZ, and BOC, have already acted or adjusted their rhetoric in response to these developments. But some other central banks, such as the Riksbank, have expressed more caution, in consideration of the more limited easing space available to them. On the other side of the spectrum, Norges Banks has, so far, remained fiercely hawkish.
G10 central banks tend to set the pattern for all other central banks in the developed world (e.g. in South Korea, the central bank cut its policy rate for the first time in three years), but also in Emerging Markets. An easier stance in the G10 reduces the pressure on EM central banks to keep rates high to sustain their currencies and contain inflation. A number of EM central banks have already cut rates in recent months as a result of this changed landscape, including in China, India, Russia, the Philippines, and Malaysia.
Now the time seems ripe for even the embattled Central Bank of Turkey to cut rates, after the defenestration of its Governor by President Erdogan. At its meeting on Thursday 25 July, the TCMB is expected to cut rates by a whopping 250bps, from 24% to 21.5%, in a supposed sign of normalisation after the defensive hikes it adopted at the height of the Turkish Lira crisis during the summer of 2018.ns (amounting to “confusion,” according to some press reports), they seem to have stabilised at 25bps. We will discuss all of this in greater detail in our upcoming preview for te FOMC meeting.
by Brunello Rosa
15 July 2019
Last week, when we commented on the selection of the new heads of the top five EU institutions, we highlighted how the end of the musical chairs game that the selection process resembled delivered only a very a fragile political equilibrium. We also took a non-consensus view of the situation, arguing that time is on the side of the national-populist parties in Europe, which, during the five-year tenure of this new parliament, will have the option of making a proposal to the European People’s Party (EPP) to form a coalition together. Already during the past week, events of this kind have been unfolding more rapidly than even we would have expected.
As numerous press reports suggest, the new EU Commission (EC) President Ursula Von Der Leyen is having a hard time securing the votes she will need on July 16thif she wants to win a vote of confidence from the EU Parliament. With the far-left GUE and the Greens having formally announced their vote of no confidence towards President Von Der Leyen, she now needs to rely on a three-party coalition of EPP (179 seats), Socialists & Democrats (153 seats) and Liberals (105 seats). Theoretically speaking, this ruling coalition could count on 437 votes, much more than the 374 necessary to reach a majority in the 750-seat European Parliament.
However, a number of MEPs, especially those from the German Social Democrats, are still upset by the method by which Von Der Layen was chosen (in particular, the trashing by French President Macron and German Chancellor Merkel of the Spitzenkadidat system that was introduced in 2014). Others are unimpressed by the lack of ambition of her political program, which so far seems to be just a sensible continuation of the status quo. Additionally, some members of the EPP, such as Viktor Orban’s Fidesz, want a softer stance taken by the future EC regarding the application of Article 7 (namely, the sanction imposed on misbehaving countries) in exchange for their vote. So, what seemed to be a vote that Von Der Leyen could take for granted could instead become extremely problematic.
Facing this situation, it was suggested to her to postpone the vote to September, so that she could gain more time to convince the rebellious MEPs to give her their support. But she understood that nothing would change in the next two months, and that her position could become even weaker if she were to let this situation fester for a longer period of time.
But here is where the situation becomes intriguing, if perhaps also dangerous. A number of populist-nationalist parties have offered their support to Von Der Leyen, in exchange for a more favourable attitude taken by the EC President on the dossiers close to the various party leaders. PiS, the Polish party of the nationalistic leader Jarosław Kaczyński, has offered its support in exchange for a softer stance on the application of Article 7, like Hungary’s Fidesz. Lega and Five Star have offered their votes in return for a “heavy” portfolio for Italy in the new EC, such as Competition, or Industry.
Von Der Leyen might manage to convince the rebellious MEPs from her own coalition to fall into line and allow the Commission to have a working and cohesive majority from the start of her term. But she might not have enough time for that. In that case, she may be forced to accept parties to allow for the birth of a Commission presided over by herself. Such a Commission would become vulnerable to the requests of the national-populists sooner than even we had anticipated. Von Der Leyen’s manoeuvring space to reform Europe in the direction of the “United States of Europe” (the way she reportedly would like to see the EU become) would be further reduced. As a result, the process of EU dis-integration would likely accelerate further in coming years.
If Von Der Leyen fails to reach a majority this week, this would open up a serious institutional crisis in the EU, forcing EU leaders to find another solution. Such a solution is difficult to identify, as Von Der Leyen was chosen as part of a “package” that is difficult to unbundle, a package which also included the selection of David Sassoli who has been already elected President of the EP, Charles Michel as President of the EU Council, and the arrival (which markets have already greetedpositively) of Christine Lagarde at the helm of the ECB.
By Brunello Rosa
8 July 2019
We have been following the “musical chairs” game that was the selection process for the EU’s top jobs since January 2018, when it began, well before it attracted the attention of investors, market participants, and a wider audience informed by the media. We followed its evolution closely; we noted, for example, when Mario Centeno was appointed as head of the Eurogroup in September 2008, and continued to monitor the selection process until its recent, final rush, which began with the Special EU Council meeting on June 30th. On July 2nd an agreement was reached that included the following appointments: EU Commission (EC) President: Ursula Von Der Leyen (Germany, CDU); EU Council President: Charles Michel (Belgium, Liberal); European Central Bank (ECB) President: Christine Lagarde (France, formerly EPP); EU Parliament (EP) President: David Sassoli (Italy, S&D), who will most likely serve half of the 5-year term (as usual convention); and EU High Representative (HR) for Foreign Policy: Josep Borrel (Spain, S&D).
As we said in our recent in-depth analysis of the European leadership selection process, our overall impression is that the outcome of this lengthy musical chairs game could have been worse. After all, the chosen leaders are all political heavyweights, and the main criteria to achieve a political equilibrium within the EU have been respected (with the exception of the Union’s East-West criterion, mostly because Eastern European countries were identified with the Viségrad group, which positioned itself in opposition of the solutions proposed by France and Germany). The fact that Germany will lead the Commission directly means that the country is taking direct responsibility for what takes place in the EU in the next five years. Even if Germany intends to slow down the Union’s integration process, it will still not oversee the collapse of the European project. At the same time, a high-profile French policymaker, Christine Lagarde, has been given responsibility for providing the liquidity that might prove necessary to the EU in moments of crisis. Germany could distance itself from the more radical choices the ECB might take under her leadership (as Germany did previously, with Draghi), while still benefiting from their results.
With the selection of Von Der Leyen and Lagarde, Germany and France are personalising their joint commitment to on the continuation of the European project. This is a plus, especially if means that they will be willing to put their money on the table, so to speak, in terms of increased risk-sharing (something Germany always opposes) and additional sovereignty transfers from the national level to EU institutions (something France always despises), to ensure the project can be maintained.
Together with these pluses, there are the minuses. First, the entire selection process has exposed once again how messy EU policymaking is, and how ugly it is to watch for the average EU citizen. Second, the compromise reached today is the result of the internal political equilibria that exist currently within the various EU countries. But these politics may change a lot, as elections in Germany (2021), France (2022) and most likely Italy are going to be held before the end of this EU parliamentary term. Third, as we said in previous analysis, with all the mainstream parties now lumped together at the EU level, it will be easy for the populist parties to blame the mainstream parties for whatever goes wrong in the next few years.
And a lot could go wrong in the years ahead, including: 1) a recession is very likely to occur. We can see already the ECB preparing the ground for renewed easing in coming months. 2) Germany is in the middle of a challenge to its business model, deriving from trade tensions and the overhaul of its banking system; 3) Brexit is a process yet to be finalised (with a likely showdown by the end of October), and the UK is likely to enter a technical recession from Q2; 4) In Greece, the victory of New Democracy in the general election marks the end of the post-crisis era, but also the return to power of the party that caused the Greek crisis in the first place.
Thus, it is very likely that the EU, Eurozone and Europe in general will face an existential threat in coming years. The people at the helm of the EU institutions are equipped to face it. The real question is whether they will actually have the needed political support and mandate to solve it.
By Brunello Rosa
1 July 2019
The truce agreed to by US President Donald Trump and Chinese President Xi Jinping at the G20 meeting in Osaka is a welcome development, but it does not resolve any of the underlying issues that exist between the two sides.
According to press reports, the US will now refrain from imposing additional tariffs on Chinese exports to the US, and will allow US companies to sell their products to the retail section of Huawei’s business. The Chinese will buy more US agricultural goods. The two sides also agreed to resume the talks that were abruptly interrupted on May 5th, talks aimed at possibly reaching an agreement in coming months. As President Trump tweeted, however, he is “not in a hurry,” since the quality of the deal is more important than the speed at which a deal can be reached.
In advance of this truce, market participants had already largely been expecting this sort of outcome, in which no deal was reached, yet neither did a complete collapse of the negotiations occur, rather a generic commitment to resume talks was made, with the goal still being an eventual compromise that both sides would consider more advantageous than the status quo. We also expressed this view, but warned that the most likely way forward is not that eventually a long-term agreement will easily be reached, but instead a controlled escalation take place, which in turn will lead to another temporary truce, as part of a larger geo-strategic confrontation between the United States and China that will last for decades.
In fact, Trump will not want to reach a deal until he has secured at least two, if not several, precautionary rate cuts by the Federal Reserve, ahead of the November 2020 Presidential election.
He also still has to evaluate what type of rhetoric towards China the American voters will want to hear ahead of the election. It may be that, tired of the economic effects of these prolonged trade tensions, the American voters that Trump is trying to mobilise will be attracted by moderate language on China, suggesting the possibility of a compromise between the two countries being reached soon.
Conversely, an angry working class that is deeply disappointed by the continuous disappearance of jobs and factories will want to hear incendiary rhetoric against China yet again, portraying China as the cause of all America’s economic troubles. Trump will want to keep all options open until well into 2020, to consider how events unfold in coming months.
But keeping all options open will also come at a huge economic cost. The option value of waiting for a resolution to US-China negotiations is leading many big businesses to a sort of “investment strike”, which is already weighing on economic performances in the largest, most advanced economies, such as the US, Germany and Japan.
The ongoing balkanization of global supply chains will have an impact on companies’ cost structure irrespective of whether a trade deal will eventually be reached or not. As such, the real risk is that the damage that will be inflicted upon the US and world economy by this Cold War 2 and its various components (the trade war, technological competition, disruption of supply chains) is larger than is currently being estimated, and that a few cuts by proactive central banks will therefore not be able to prevent a global recession from occurring in 2020-21.
Thus, even if after the G20 meeting a few people around the world breathe a sigh of relief, the reality is that the underlying problems that exist between the two countries remain mostly unresolved. As fiscal policy remains largely constrained, once again[js1] central banks will have to be the first line of defence against the ongoing synchronised global economic slowdown.
By Brunello Rosa
24 June 2019
Last week, Facebook unveiled its plan to introduce a new means of payment for small transactions, called Libra. Although many of the details about it have yet to be revealed, some comments seem warranted based on what we know already. As far as we know, Libra, which will be backed by existing centralised payment systems such as Visa, Mastercard and PayPal, is not a crypto-currency. Facebook itself labelled it a “stable-coin” for this reason. Additionally, as persuasively argued by Nouriel Roubini and other leading economists, crypto-currencies are not currencies insofar as the volatility of their exchange rates with conventional currencies such as the US dollar does not make them a safe store of value, which is one of the key characteristics of money. At most, crypto-currencies can be considered as highly speculative, crypto assets.
It is unclear for now how “regular” money will be transferred into Libra wallets, at what rate of exchange such transfers will occur at, or whether consumers will be charged a fee whenever they do so. But let us assume that at some point all 1.7bn people on Facebook will have a Libra wallet. That would be a momentous feat, at least in terms of the scale of such an operation. And it would be just the latest arrival with in an increasingly crowded space, in which non-financial corporations are entering en masse into the traditional space occupied by financial companies. Other examples of this include Apple Pay, Ali-Pay, We Chat Pay, and Amazon’s loans to sellers on its own platform.
It is now time to take stock of these developments, and assess some of the potential risks that could come along with some of the purported advantages for the consumer, such as reduced fees for small transactions. The fact that the private sector creates money is not cause for concern, nor is it anything new. Most of the money we use – which, incidentally, is already largely electronic, even if not “digital” – is created independently by commercial banks rather than by central banks, the latter of which maintain the monopoly to issue high-power money (the so-called monetary base).
Banks creating money via their loans are however subject to strict prudential regulations, which establish that there needs to be a relationship between the deposit held and money created. Banks have a lender of last resort, the central bank itself, which has its own international lender of last resort, the Bank For International Settlements (BIS). Deposits at commercial banks enjoy a public guarantee (in Europe, it is up to EUR 100,000 per current account), and banks enjoy an implicit backstop by their sovereign (hence the too-big-to-fail problem, when the individual financial institution is much larger than the sovereign that is supposed to provide the backstop for it). None of these implicit and explicit guarantees will be available for Libra and other forms of digital currency. Who is going to police against fraud, or against money laundering activities, for example? If something goes terribly bad, who will be the ultimate lender of last resort?
We are entering a dangerous territory here from the perspective of financial stability. For these reasons, leading regulators such as the BIS itself have started to give their warnings about the subject. As Mark Carney, Governor of the Bank of England and former President of the Financial Stability Board, reportedly said, If Libra is successful in attracting users it would “instantly become systemic and will have to be subject to the highest standards of regulation.”
We are registering here the dramatic increase of offers of new forms of money, means of payments, etc., by private-sector participants, more often than not from non-financial corporations, clearly aimed at disintermediating the traditional channels dominated by banks. This is nothing new: during the eighteenth and nineteenth centuries, plenty of corporations issued their own private forms of payment. That proliferation was at the origin of some of the worst scams and financial instability episodes (for a collection of which, read “Manias, Panics, and Crashes”, the masterpiece written by Charles Kindleberger). The final users of such products, excited by what seem to be “innovations,” should remember these historical precedents when embracing these newly offered means of payment.
By Brunello Rosa
17 June 2019
In our latest Market Update and Outlook, published last week ahead of the upcoming quarterly asset allocation, we reviewed the major macroeconomic, political, geopolitical and market events of the last six months. We then provided an outlook for the next six and next twelve months, as well as further ahead in the future.
From a macroeconomic perspective, the last six months have seen a synchronised deceleration of the global economy, starting from its three main regions (US, Eurozone and China), in spite of upward surprises in Q1 GDP growth. The ongoing trade and tech war between US and China, which is likely the beginning of a new Cold War, which we called Cold War II, is taking its toll on the global economy. The US and China (ahead of a possible truce, yet short of a full deal that would resolve their economic disputes) are importing less from each other, which is likely to benefit only a few select economies, such as Vietnam, Taiwan, Chile, Malaysia and Argentina. In our recent analysis we discussed why we believe that a controlled escalation, or contained commercial warfare, is more likely for the time being than a full-scale trade war or a full deal being reached between the two countries.
But trade wars, tech wars and the disruption to global supply chains is not the only factor affecting the global economy. Geopolitical tensions are on the rise irrespective of trade tensions (with the US still being the instigator of these tensions). We discussed the risk of miscalculations and accidents taking place in the US-Iran standoff, and last week there was indeed an attack on two oil tankers in the Gulf of Oman, the gateway for over a third of the world’s shipped oil. Even if the situation in the region is set to remain tense for some time, oil prices still fell on a weekly basis, in response to the slowdown in the global economy. Also in the Middle East, the Turkish government confirmed its S-400 arms deal with Russia, after Turkey’s Defense Minister stated that “the language used in a letter sent by the US regarding Turkey’s removal from the F-35 fighter jet program does not suit the spirit of alliance".
Finally, the regional geopolitical mess that is Brexit, with its potential global implications (the Fed quoted it among the most relevant cross-currents recently weighing on market sentiment), could deteriorate further, if the UK were to go for a no-deal exit following the arrival of the country’s new prime minister (Boris Johnson is the frontrunner). In fact, last week the House of Commons rejected (with a 309-298 vote) a motion designed by the opposition intended to block a “no-deal” exit on October 31st.
With all of this taking place, and as fiscal policy remains constrained, central banks are already on the move. Joining the Fed, ECB, PBoC and BOJ, the Swiss National Bank (SNB) also claimed last week to have room to further ease its policy stance, and, also for this purpose, introduced its own SNB Policy Rate, in substitution of the 3m Libor target range. This week, the Fed will provide further indication as to whether or not it wants to proceed with its precautionary cuts, which the market now considers certain to be implemented by year end, considering the various cyclical and structural factors dampening upward pressures on US inflation. At the same time, Norges Bank will likely confirm that it will remain at odds with all other G10 central banks, and will likely proceed with its pre-announced 25bps increase in its policy rate.
After a very volatile semester, the price of risky assets (primarily equities) and the price of long-dated government bonds are supported by this renewed dovishness of central banks. However, if the damage to the global economy proves to be larger than is currently estimated, central banks will have to do much more than a few insurance-based cuts to prevent a recession and severe market correction in the next few months.
By Brunello Rosa
10 June 2019
The global economy is now in the middle of an asynchronous slowdown, which is occurring mostly as a result of prolonged, intensifying trade tensions, rising geopolitical risks, and tightness in the labour market in a number of countries. Let us briefly examine the three major economic regions of the global economy.
In the US, Q1 GDP growth was surprisingly positive, but domestic demand weakened substantially, providing little comfort for the economy’s future performance. The non-farm payrolls figures for May 2019, released last week, were weaker than expected; only 75,000 jobs were added, as opposed to the consensus expectation of 185,000 jobs or the previous reading of 224,000 jobs. This weaker figure was accompanied by slower growth in average hourly earnings: 3.1% y/y, versus a consensus expectation and previous reading of 3.2%. In a recent interview, Fed’s Vice-Chair Richard Clarida said that tariffs are expected to have a one-off effect on price levels, but a more lasting impact on economic activity. Therefore, if trade tensions do not subside, the negative demand shock to the economy from those tensions will eventually be larger than the negative shock to supply.
In the Eurozone, Q1 GDP also surprised mildly to the upside, but the latest ECB projections suggest that economic activity will decelerate in Q2 and Q3, so the much-hoped for rebound in Q2 is unlikely to materialise. This is mostly because the largest European economy, Germany, is fighting to exit a prolonged period of stagnation (it has been flirting with recession), while the third largest Eurozone economy, Italy, has temporarily exited its technical recession in Q1 but risks entering a new one in Q2 2019. For the time being, France and Spain are the main drivers of economic growth in the Eurozone.
In China, the policy stimulus of 2018 allowed the economy to also surprise to the upside in Q1, but the reignition of trade tensions this year have meant a new slowdown, which the authorities are fighting with fiscal, monetary and regulatory stimulus. Going forward, US tariffs are expected to continue weighing on exports and push inflation higher. All other regions in the world closely depend on developments from these three economic and geo-strategic giants, so economic activity is likely to decelerate globally.
Facing this situation, and waiting for fiscal policy to provide a larger counter-cyclical contribution (even as most government are busy “fixing their fiscal roof” now that “the sun is still shining”), central banks have already begun to act. In a number of jurisdictions, monetary policy, which had at least had a tightening bias, has now become neutral if not overtly more accommodative. In developed markets, last week the Reserve Bank of Australia cut (after a long debate) its main policy rate to a record low of 1.25%, following the neighbouring RBNZ by a month.
During its latest press conference, President Draghi said that the ECB’s Governing Council has discussed possible easing measures. While the BoJ has never abandoned its accommodative stance, the elephant in the room is clearly the Fed. The markets now price in the likelihood, indeed almost the certainty, that the Fed will cut rates in coming months. In Emerging Markets, central banks have been even more proactive. In China, the PBoC Governor announced “there is tremendous room to adjust monetary policy if the trade war deepens.” In India, a marked slowdown in the economy led the Reserve Bank of India to cut interest rates by 25bps (to 5.75%) for a third time this year, and suggest further cuts are in the pipeline. The central banks of the Philippines and Malaysia also recently cut their policy rates by 25bps, to 4.5% and 3% respectively.
By Brunello Rosa
3 June 2019
From the beginning, the ill-designed Brexit referendum has intoxicated the UK’s political system and introduced an element of uncertainty into the country’s constitutional arrangements. In a parliament-centred political system such as the British possess, the source of legitimacy for political decisions rests squarely with Westminster (notwithstanding a strong role for the Prime Minister). From a purely procedural standpoint, then, simply labelling the Brexit referendum as “advisory” and non-binding might have saved the day. Unfortunately, since the day after the referendum its result has been considered politically binding on both sides of the political spectrum, which has committed to “deliver Brexit.”
The inability or unwillingness by Parliament to ratify the Withdrawal Agreement negotiated by Theresa May with the EU has made manifest the constitutional short-circuit that has taken place, as the primary source of legal and political legitimacy is now countervailing the “will of people” as expressed in the referendum.
The birth of the Brexit party led by Nigel Farage, and its first-place finish in the European election held on May 23rd, is a response to this inability by Britain’s parliament to deliver Brexit. The Tory party will try to respond to the rise of the Brexit party by choosing its new leader from the camp of Brexiteers, with different degrees of radicalism ranging from Boris Johnson to Dominic Raab and Michael Gove. At the same time, Farage might be tempted to “finish the job”, forcing a split in the Conservative party between pro-Europeans and Brexiteers and becoming the leader of the right-wing of Britain’s political spectrum.
The British results of the European election has other implications as well. First, both parties entangled in negotiations (Tory and Labour) lost a large portion of their votes. Second, those parties in favour of Remain (chiefly the Lib Dems and the Greens) did very well, and if we sum their votes, they represent a larger proportion of the electorate than does the Brexit party.
Moreover, a recent poll by YouGov shows that the Lib Dems would be the leading party in the UK if an election were to be held today, ahead of the Brexit party, the Conservatives, Labour and the Greens. If that poll is correct, Brexit would have made the unthinkable happen: a traditional two-party system governed by a first-past-the-post electoral law would become a messy four-party system with the major parties having only between 19% and 24 of the votes. Elections would become completely unpredictable, unless the four major parties coalesced ex ante into pairs (Labour-Lib Dem; Tories-Brexit). Alternatively, all parties might eventually break up and allow a new centrist formation to emerge and take control of parliament and the Brexit process. Such an outcome could lead, potentially, to the Brexit decision being reversed.
During his visit to the UK, US President Donald Trump could not resist the temptation to make things even more complicated, with his suggestions that Boris Johnson should be the new Tory leader, Nigel Farage should be involved in negotiations with the EU, and the UK should throw out the deal agreed to by Theresa May with the EU and aim instead for a hard Brexit, without paying the GBP 39bn owed to the EU in the coming years. Trump might not have considered that the UK is much smaller than the US is, and that the EU has so far had the upper hand in negotiation, in part because Article 50 is designed to punish the leavers.
by Brunello Rosa
27 May 2019
Last week we discussed the European election, which took place between Thursday 23 and Sunday 26 May. The voter turnout for the election, at above 50 percent, was the highest in the last 20 years, testifying to this election’s importance. According to the preliminary results, most of the predictions made in advance of the election (by us and by others) are proving to be correct. The European People’s Party (EPP), will remain the largest group in the European parliament, with around 180 seats, but will lose more than 40 MEPs compared to its results in the previous election in 2014. The Socialist and Democratic (S&D) Party will be the second largest group, with around 150 seats; it too will have close to 40 fewer MEPs than it had in 2014. Conversely, the Liberals of ALDE and the Greens will both gain seats, going from 68 to more than 100 and from 52 to around 70 respectively. This means that in order to form a 376-strong majority, the EPP and the S&D will have to coalesce with the Liberals. (The Greens seem not to be necessary at this stage).
What about the “national-populist” parties? The ENF group of Italy’s Salvini and France’s Le Pen will increase the number of its MEPs from 37 to around 60. The EFDD group of Farage’s Brexit Party and Italy’s Five Star will also rise, from 41 to around 60 seats. The ECR’s group of UK Tories, Poland’s PiS, Germany’s AfD and Finland’s True Finns will fall from 75 to around 60, mostly because of the UK Tories’ debacle. These groups together will not yet be big enough to make an offer to the EPP, but they will increase their influence in future decision-making processes.
The press and most “mainstream” policymakers will probably take an unwarranted sight of relief following this election, as they will think that the “national-populist” parties have been kept at bay. We believe this view might prove to be incorrect, for two reasons.
First, these elections are forcing increasingly unnatural alliances to be made at the European level. The fact that the Liberals may now be in the same camp as the EPP and S&D means that they will all be jointly blamed for anything that can and probably will go wrong in coming years, thereby leaving the national-populist parties (and perhaps the Greens) as the only remaining alternative.
Second, some of the individual national-populist parties actually fared exceptionally well in these elections. In Germany, the CDU and SPD combined lost more than 18% of the vote, in favour of Greens (now Germany’s second largest party) and AfD (now its fourth largest party). In France, Le Pen’s National Rally Party has reportedly overtaken President Macron’s En Marcheparty. In Italy’s Salvini’s Lega is the first party with 34% of votes having overtaken the Five Star (collapsed to 17%). In the UK, the Brexit Party has gathered around 32% of votes, is the largest party in this election and will certainly campaign for an eventual hard-Brexit solution. In Poland and Hungary, PiS and Fidesz respectively remain the parties that received the most votes.
Elsewhere, in Greece, New Democracy has reportedly overtaken PM Tsipras’ SYRIZA, and is getting ready to get back into power with the national elections of June 30th.
Thus, the parties forming what we have labelled the “Populist International” are still gaining ground. They know that the race to political power is a marathon, not a sprint. From their new, more powerful positions in EU politics, they will strongly influence the process of appointing the new heads of the EU Parliament, Commission, Council and, above all, the ECB. They will also be likely to have a greater say regarding the overall fiscal and monetary policy stance taken at the EU level. Overall, then, we continue to think that 2019 will be a crucial year for European politics. This EU election is likely to prove an inflection, if not a turning point, in the region’s affairs.
by Brunello Rosa
20 May 2019
All EU states will hold elections for the European Parliament this week, between Thursday May 23rd and Sunday May 26th. The EU Parliament will be completely renewed, with all 750 seats up for grabs. Because the UK will still take part in this election, the number of MEPs elected will not fall to 705, as had been planned to occur until the UK asked for its first extension to the Article 50 process in late March.
We have already discussed the importance of this election in a number of publications, particularly as a result of the increase in the share of seats that “populist” parties are expected to win. In our paper on the rise of the Populist International, we anticipated how these populist parties might eventually increase their power during this parliamentary term if an economic and financial crisis were to shatter the alliance between the European People’s Party (EPP), Socialists, Liberals, and, perhaps, the Greens, which is expected to emerge following the elections this week. In order to achieve that, the populist parties will have to make an agreement with the EPP, as, for example, has occurred in Austria, where the EPP’s Chancellor Sebastian Kurz is allied with FPÖ’s Heinz-Christian Strache. They would do this by making use of the presence of populist, authoritarian, or nationalistic parties within the EPP, such as Victor Orban’s Fidesz (which has been temporarily suspended from the EPP for its anti-Juncker campaign in Hungary).
In this respect, there have been very interesting developments, recently. A couple of weeks ago, Orban himself declared several weeks ago that he will not support the EPP’s candidate for the European Commission presidency (so-called Spitzenkandidat) Manfred Weber. This could be a signal of an initial rupture between Fidesz and the EPP, which would have the effect of making the EPP smaller yet less “compromised” by populist parties. On the other hand, a rupture of this kind would also make the group of populist parties larger in the new EU Parliament. This week, the Austrian government itself collapsed after the release of a video showing Strache dealing with supposed intermediators of Russian interests.
So, the future of the EU is at stake in this election. But the election’s importance is not only limited to its historical and geo-strategic significance. The implications for future European policymaking have been discussed at length in a series of papers we wrote about the ongoing European musical chairs game, in which all the most important EU positions will be filled in coming months, including the presidencies of the EU Commission, Council and Parliament and, most importantly for financial markets, the ECB.
The choice of who heads these institutions will make it clear what fiscal policy stance the EU will take; crucially, at a time when tensions over Italy’s deficit and debt are re-emerging. Consequently, this will determine what the ECB will be asked to do to support the fragile and uneven expansion of the Eurozone economy (which is now slowing down) or to save the euro area from a possible breakup when the next crisis hits (as the ECB did previously during the crisis of 2011-2012).
As usual, these European elections will also be read with a domestic lens within all of the EU countries. In Germany, they could mark the end of Angela Merkel’s tenure as Chancellor (in favour of her successor as CDU leader Annegret Kramp-Karrenbauer), especially if Merkel decides to lead the EU Council. In France, Macron will need to convince his electorate that he can still win more votes than Marine Le Pen’s party (now re-named Rassémblement National).
In Italy, this election will be a referendum on Salvini’s leadership, and could mark the collapse of the fragile M5S-Lega coalition. In the UK, where the participation in this election is considered a national humiliation, these elections will probably mark the departure of Theresa May from Number 10 Downing Street in the coming weeks, whether Brexit is delivered or not.
by Brunello Rosa
13 May 2019
Last week we discussed the renewed trade tensions between China and the US. We feared that President Trump’s threat to increase the tariffs imposed on all goods imported from China to 25% would eventually materialise (reportedly due to China backtracking on a number of commitments made in previous stages of the negotiations) – as in fact did occur. These trade skirmishes might still lead to an eventual agreement, but we might also witness a repeat of what happened during the US negotiations with North Korea, which were also abruptly interrupted by Trump. There is now no deal in sight in that case, Kim Jon Un having reportedly started a new series of tests of tactical weapons. In the case of the trade negotiations with China, it is similarly not clear now how or when a deal could be reached. For the time being China will test whether or not President Trump is courageous enough to open a second front of his trade wars by imposing tariffs on the EU, and in partic
ular, on Germany, in the auto sector.
According to one line of thought, this interruption in the negotiations was a result of Trump’s decision to use the window of opportunity he has to create new international tensions; a window being provided by a combination of the strong US economy, tight labour market, low inflation and buoyant equity markets thanks to the Fed’s pivot. Other analysts believe instead that it was China that misread Trump’s call for a 100bps cut to Fed funds rate, seeing it as a sign of weakness of the US economy, thereby inducing an unwarrantedly tougher Chinese stance in the final stage of the negotiations. Whatever the reason, a deal that seemed at hand fell apart last week.
These types of miscalculations also seem to be taking place in the renewed tensions between the US and Iran. Iran has announced a partial withdrawal from the nuclear deal in response to the US decision to withdraw from the JCPOA months ago. In a typical tit-for-tat strategy reaction, the US has deployed the aircraft carrier Lincoln in the Middle East, further destabilising the region (where currency pegs to the USD have come under severe stress).
All this is occurring while Turkey’s fragility is again becoming more prominent, the Lira having risen above 6 versus the US dollar, in spite of the central bank’s increase in policy rates from 24% to 25.5%, as international investors doubt the real firepower of the country to defend its currency in the event of a speculative attack.
Some believe that Trump’s trademark ability is making deals, which might well be the case. Nevertheless, politics is more complicated than business, and the examples above show that the potential for geopolitical miscalculation is huge, as is the possibility of starting a conflict by accident. As historian Christopher Clark masterfully wrote, Europe “sleepwalked” its way into World War I.
These geopolitical tensions and lack of international coordination is leading to higher oil prices, which are contributing the global macro-economic environment becoming volatile and uneven, with some regions growing robustly with rising inflation, while others are weakening. To counter these developments, fiscal policy has been relaxed in the US, EU and China. Central bankers, observing this uneven scenario (which is leading to market volatility) are responding in different ways, depending on domestic circumstances.
Within the G10 some central banks followed the Fed and turned dovish: the ECB, the BOJ, the BOC, the Riksbank, the Reserve Bank of Australiaand the Reserve Bank of New Zealand, the latter of these becoming, in the past week, the first G10 central bank to cut its policy rate during this cycle. On the other side of the spectrum there is the BOE, and above all Norges Bank, which last week increased its degree of hawkishness by pre-announcing a rate hike in June; this is likely to be indicative of an acceleration in its rate normalisation process.
by Brunello Rosa
7 May 2019
The decision by US President Donald Trump to present China with the threat of imposing a 25% tariff on all Chinese imported goods as of Friday 10th of May marks yet another twist in this seemingly endless saga of US-China trade relations. The decision led to immediate heavy losses in global equity markets (in Asia, Europe and the US) and shows that Trump is willing to sacrifice positive momentum in financial markets in order to pursue his “art of the deal.” Analysts believe this is just another tactical move to force the Chinese to sign a deal on less favourable terms, and that an eventual agreement will be reached in the next few weeks. Still, the move is risky for a number of reasons.
First, this episode could end up like the recent failure at the summit with North Korea in Vietnam. After proclaiming with great fanfare that a deal with North Korea was at hand, Trump ended up leaving the negotiating table, accusing Kim of unreasonable requests. It is not clear when the two sides will meet again. In the meantime, Russia’s Putin has entered the scene and complicated an already difficult negotiation process. So, breaking off discussions with China now could imply that a long pause will take place before China and the US continue negotiating.
Second, by May 18th the US will have to decide whether or not start imposing tariffs on auto sector trade with European countries, most notably Germany. It is possible that the Chinese were delaying any agreement to see whether or not Trump would have the nerve to start a trade war on two fronts at the same time. But the effects of today’s decisions on financial markets show that the first victim of any delay in reaching a deal is China itself (and other Asian markets by extension) – and Trump knows it.
If Trump were to open the European trade front while the Chinese front is still open, it could result in a severe hit to confidence in financial markets and economies in general. Trump has certainly shown that he is willing to sacrifice a few percentage points of equity valuations to pursue his negotiating strategies.
Even if China and the US were to return to the negotiating table and reach a deal quickly, today’s episode shows that the relationship between the two sides remains fundamentally fraught. The strategic rivalry between China and the US on a number of dimensions (military, security, economic, investment, technology) is in full swing and will not be assuaged by any short-term trade deal. We have discussed how the trade conflict is only the most visible component of a much wider geo-strategic rivalry that amounts to a new Cold War, which we can call Cold War II.
It is quite likely that, as during the Cold War between the US and the Soviet Union, there will be a series of “truces” that will allow the two contending nations to gather their energy for subsequent returns to outright competition, instead of the two being able to reach any sort of comprehensive compromise that would more permanently end such competition. With a Cold War II, we risk returning to a two-bloc system in which de-globalization would occur, implying a massive reversal of the previous global integration in trade, investment, supply chains, technology and data transfers. This potential fragmentation of the world economy would have significant economic, financial and political implications. Like its predecessor, Cold War II is likely to be won by the richer, faster-growing, and larger economy. Only this time the winning country might not be the US.
by Brunello Rosa
29 April 2019
A couple of weeks ago, we reported our impressions of the IMF meetings in Washington. The April edition of the World Economic Outlook put an official seal on the ongoing synchronised global economic slowdown, though with a hoped-for rebound in H2 this year. Within that context, some differentiations are starting to emerge. In China, the monetary, regulatory and fiscal stimulus provided by the authorities in response to the growth slowdown that occurred in H2 last year has managed to stabilise economic activity, with growth in Q1 coming out at 6.4% y/y, slightly stronger than the 6.3% anticipated by consensus expectations. As the economy shows signs of recovery, last week the PBoC offered banks USD 39.8bn of “lower profile, more targeted medium-term loans,” signalling a shift away from broad-based easing. The stabilisation of Chinese growth is among the factors underpinning the risk-on sentiment prevailing in financial markets, with equity valuation close to their historical highs.
In the US, recent data are more of a mixed bag. Q1 GDP growth came out at 3.2% quarterly annualised, much stronger than the 2.3% that had been expected. However, this unexpected strong performance came more from net exports and a build-up in inventories, with underlying consumption remaining weak (final sales to private domestic purchasers decelerated). This week, the April Non-Farm Payroll figures (with 180K additional jobs expected, compared to 196K in March) will show whether the deceleration in economic activity will start to have an impact on the labour market. The Fed will also hold its April FOMC meeting, and the language of the statement and the press conference by Chair Jay Powell will clarify what the most recent take of the central bank is regarding the current economic and financial situation in the US.
Japan and Europe are providing a less reassuring picture. In Japan, given the deterioration in trade and manufacturing indicators (with April industrial production falling more than the expected -4.6% y/y), Q1 growth is expected at 0% y/y. While inflation (Tokyo CPI) has recently risen to its highest rate in four years, it remains well below the 2% target, so the BOJ has re-affirmed its commitment to low rates at least until the spring of 2020, and tweaked its policy tools to signal that more easing is possible should economic conditions worsen further.
In Europe, Q1 GDP growth (at 0.3% q/q, 1.1% y/y) is expected to remain broadly in line with Q4 2018 readings, but the economic and political landscape continues to provide worrying signals. In Germany, the March IFO business expectations sub-index declined to 95.2 from 95.6, sending the 10y bund yield back into negative territory. For the time being, talks of the possible merger between Deutsche Bank and Commerzbank have collapsed. The deceleration in economic activity and the need to invest is reportedly prompting a shift in economic thinking, with a possible relaxation of the stringent fiscal rules. In France, President Macron’s list of promised actions resulting from “Le Grand Débat National” might be read as an act of defiance by the Gilets Jaunes. In Italy, political instability and budget uncertainty are putting BTPs under renewed stress, with the 10y BTP-bund spread returning to 270bps recently. In Spain, the election has failed once again to provide a majority to support a government in parliament, where the alt-right movement Vox has entered for the first time with 24 seats. The UK remains mired in its Brexit mess.
Given this background, all the G10 central banks apart from Norges Bank have turned dovish, following January’s pivot by the Fed. In Sweden, the Riksbank has returned towards its traditionally dovish positions. In Canada, the BOC has announced a long pause in its normalisation process. In Australia, following a collapse of inflation in March, the RBA might cut rates in May. While for now rate cuts are off the table in the US, the market-derived probability of a Fed rate-cut in 2019 has increased this week to 74%, versus 43% last week.
In a recent study, we discussed whether the US could decouple from Europe if the EZ ended up in recession, and established that they can, so long as the EZ shock is mild. But if the shock to the EZ is large, even the US will not be able to escape it.
by Brunello Rosa
23 April 2019
On Sunday, Spain will go to the polls to elect a new Congreso De Los Diputados and decide 208 of the 266 seats of the Senate. As we discussed in our recent analysis, the Socialist Party (PSOE), led by incumbent Prime Minister Pedro Sanchez, is leading the polls, with support from roughly 30% of the electorate. It is ahead of the People’s Party led by the new leader Pablo Casado, which has around 20% support. Domestically, the most relevant aspect of this election is the fact that the Spanish political system, which used to be solidly bi-polar until a few years ago, has now become a 5-party system. In addition to the Socialists and the People’s Party, Podemos, Ciudadanos, and the new alt-right Vox party are the other three parties looking to win significant numbers of seats. Even if Sanchez were to win this election, he might have a difficult time forming a government.
In our analysis of this week’s elections we explore all the possible parliamentary coalitions that could support a government (there are a number of these as the Spanish system allows minority governments, even minority-coalition governments, to survive in parliament for the entire political term). Sanchez’ Socialists might need to form a coalition with Podemos and other regional parties in order to remain in power, which would make the government particularly fragile and exposed to opposing demands from different parties. On the other hand, while the Socialist Party might win the most seats, the People’s Party might be tempted to repeat at the national level the experiment that has been carried out in Andalusia, where a right-wing coalition was formed with Ciudadanos and Vox. In any case, political instability and fragmentation has reached the shores of Spain, and will stay there for some time yet.
At the international level, the election in Spain will be followed a few weeks later by the European elections of May 23-26. Populist parties are expected to do very well in those elections, and, if the UK takes part in them, those parties might receive a further boost from the newly-formed Brexit Party, led by Nigel Farage, the pro-Brexit leader who left politics temporarily after achieving his historical goal of setting the UK on a course to leave the EU (with the referendum in 2016). Currently, the Brexit party is leading the polls with around 27% support. Of course, the other big question mark is whether the UK will also hold a snap election ahead of the new October 31st “Halloween” Brexit deadline.
After the European elections, Portugal will go to the polls on October 6th for a national election. Portugal’s PM Antonio Costa (leader of its Socialist Party) will try to repeat the “miracle” of 2015 when, even though his party ended up in second place, behind the Social Democratic Party, he managed to become Prime Minister by putting together what seemed initially a very unlikely coalition with the communists and the radical left. Not only did this coalition survive, it also managed to put an end to the European-imposed austerity that had fatigued the country and increased its poverty and inequality. This coalition government has also allowed the Portuguese economy to recover, and re-balance the country’s fiscal budget. For these outstanding results, former German Finance Minister Wolfgang Schaeuble said that Mario Centeno (the former Finance Minister of Costa’s government, now head of the Eurogroup) was the “Cristiano Ronaldo of the Ecofin.”
Within this European landscape, the big unknown remains Italy. Will the expected large victory by Salvini’s Lega, at the expense of Di Maio’s Five Star, lead to new elections being held in the autumn? Some press reports suggest this might be the case, but one still needs to consider that President Mattarella might be unwilling to dissolve parliament during the autumn’s budget season. At this stage, all options remain on the table.
by Brunello Rosa
15 April 2019
The IMF has just published its April edition of the World Economic Outlook (WEO) entitled “Growth Slowdown, Precarious Recovery”. The WEO notes that after a synchronised expansion in 2017 and the first half of 2018, the world has entered a synchronised slowdown, with all three of the world’s major markets are now facing economic headwinds. In the US, the effects of the fiscal stimulus that was approved at the end of 2017 are fading, and the fist fight between Democrats and President Trump over the budget, which led to the longest government shutdown on record earlier this year, are having a negative impact on the economy. So too are trade tensions and the tightening financial conditions deriving from the Fed’s policy normalisation.
China meanwhile has been affected by its trade tensions with the US, as well as by what the IMF calls “regulatory tightening to rein in shadow banking.” And the Eurozone has lost momentum as two of the largest economies, Germany and Italy, have significantly slowed down. Germany’s economy, which narrowly avoided a recession in Q4, has slowed because of the impact of new emission standards on car manufacturing. Italy’s , which did in fact enter a technical recession in Q4, has slowed because of the higher sovereign spread’s impact on business investment and consumer confidence, and the impact of Germany’s slowdown. Elsewhere in the world, Japan’s economy too has been affected by global trade tensions, as well as by natural disasters, and emerging markets have been affected by capital outflows deriving from Fed tightening and USD strength.
The current narrative from the IMF and the World Bank is that these headwinds will be transitory, and that the economic outlook will improve in H2 2019. This improvement is also expected to occur because of the important contribution of central banks, almost all of which have turned dovish since the Fed’s U-Turn in January, and because of the use of some of the fiscal space that is available in certain countries. The mood prevailing among market participants and policy makers attending the IMF and World Bank Spring Meetings also seems to be aligned with this narrative. Nevertheless, some of the risks we have identified in our recent research are still present, putting the recovery in danger and making it “precarious”.
First is the US trade dispute with China: while it seems that a deal is at hand, it has not been reached yet. Press reports suggest that China might be waiting to see if the US will launch another offensive on Europe over trade in the auto sector before signing anything. China knows that Trump cannot afford to open multiple fronts on trade, and so might be strategically delaying any deal to make it harder for Trump to lunch another offensive against it.
Second, even the new USMCA trade deal has not been ratified yet, and the threat of the US unilaterally withdrawing from NAFTA still exists.
Third, the Chinese economy is stabilising thanks to policy stimulus, but new episodes of slowing activity are always possible if this stimulus proves insufficient. In Europe, Germany’s recovery is not fully secured yet, and Italy seems on the verge of starting a new fight with Europe over the introduction of further measures of fiscal easing (such as the introduction of the flat tax) it cannot afford. In the UK, Brexit has been postponed, but lingering uncertainty continues to weigh on business investment and consumer spending.
Thus far central banks have come to the rescue, making markets happy. There might be further room for this rally in risky asset prices to continue if the headwinds cited above dissipate over time. However investors should be aware that, if any of the risks mentioned above were to materialise, new risk-off episodes would be likely to occur in the months ahead.
by Brunello Rosa
8 April 2019
Since the Fed’s sudden U-turn at the January 2019 FOMC meeting, when the institution led by Jay Powell delivered a surprisingly dovish
statement suggesting that it could enter a prolonged pause in its tightening cycle, all of the G10 central banks have followed the Fed’s lead, modifying their policy stances and becoming more dovish. The only exception to this has been Norway’s Norges Bank.
Within the G4, the Bank of England, in coincidence the release of its February Inflation Report, mimicked the Fed by indicating its own shallower tightening cycle, with potentially longer intervals likely to take place between successive rate hikes. In any case, the BOE will have to wait for the result of Brexit negotiations before doing anything.
The ECB even overtook the Fed in terms of dovishness, in a sense. Instead of simply indicating that there will be a longer period before it can start increasing rates, it decided to add policy stimulus by modifying its forward guidance and announcing a new round of TLTROs. This week the ECB will hold the April meeting of its Governing Council, which could shed more light on the details of its current policy stance. The decision to provide more policy stimulus moved the ECB closer to what the BOJ’s policy stance has been. The BOJ remains extremely accommodative – and there is as yet no end in sight to such a stance, so long as core-core inflation remains this low.
Moving now to the smaller central banks in Europe, the Swiss National Bank (SNB) is the one that is most closely following the ECB. It might have a hard time if more monetary stimulus is needed to counter a new downturn. The Danish National Bank shadows the ECB via the currency peg, and so far has not changed its policy stance. The Scandinavian central banks have been among the most hawkish recently. The Riksbank slotted in a rate hike in December (somehow unexpectedly), a hike which seemed to be ill-timed and is probably now regretted by the Executive Board.
The SEK has remained weaker than it would have been in the past, but the renewed ECB accommodation might result in lower EUR/SEK, with an impact on inflation. The Riksbank has suggested that a new hike could come in H2 this year, but we see an increasing chance that this might not happen. As mentioned above, Norges Bank is the most hawkish among G10 central banks and is the only one that has not changed its stance towards a more dovish position. It recently delivered a rate hike and, in line with our view, indicated that more tightening is coming in H2.
Moving to Oceania, in February (following the Fed) the RBA altered its policy stance and moved from a tightening bias to a neutral position, joining the RBNZ which had instead decided to stay put on that occasion. In March, the RBNZ altered its position in line with the Fed and indicated that its next move is likely to be a rate cut. In our view, this move put pressure on the RBA to also shift the balance of risks of its neutral stance to the downside. Indeed this is what happened in April, when central bank governor Philip Lowe changed a few words of the policy statement accompanying the decision to keep rate unchanged, to suggest that the RBA could be considering rate cuts much more closely than it has done so far.
The Fed’s move has also had an impact on EM central banks. As we discussed in our recent Strategic Asset Allocation update, the more dovish stance taken by the Fed opens up policy space for shallower tightening cycles or even rate cuts by central banks that are less concerned about their currencies weakening relative to the USD. The recent decision by the Reserve Bank of India to cut its policy rate from 6.25% to 6% (the second cut in three months) is an example of this already beginning to take place.
by Brunello Rosa
1 April 2019
A growing number of policy and macroeconomic uncertainties are weighing on household and business confidence and, by extension, are weighing on global economic activity. Between the world’s major superpowers (US and China) there is a trade dispute that remains unresolved, and the two sides admit that it might take months before a deal that can satisfy both sides is finally struck. Meanwhile Italy is making side deals with China regarding China’s Belt and Road Initiative, a move that has infuriated its American and European partners alike. In Europe, the Brexit saga is getting more and more complicated, with Britain’s parliament having rejected for a third time the deal its prime minister negotiated with the EU. There are less than two weeks left before the UK crashes out of the EU without any formal arrangement; EU Council President Donald Tusk has called an extraordinary summit for April 10th. Theresa May is likely to try to push her deal through parliament for a fourth time before giving up. If she fails to do so, then a further extension of Article 50, snap elections, or a new referendum cannot be ruled out.
All of this is occurring just a few months before crucial EU elections will take place, elections in which populist parties are expected to do very well an could potentially bring about a radical shift in the European policymaking. Perhaps a small sign of hope came last week, with the election of a pro-European, anti-corruption candidate, Zuzana Caputova, as president of Slovakia, breaking for the first time the unity of the fiercely anti-European Viségrad group (the group of countries that includes Poland, Hungary, Slovakia and Czechia).
In emerging markets, local elections in Turkey were held yesterday at a time of renewed tensions for the Lira. The central bank in effect increased the policy rate to 25.5% by suspending the regular 1-week repo auctions (priced at 24%), thereby forcing banks to borrow through the O/N lending facility. In Ukraine, the first round of a presidential election could result in the victory of the comedian Volodymyr Zelensky, who has almost no political experience to oversee the ongoing results of the tragic developments that have taken place in the country during the last few years.
This is just a sampling of events currently weighing on investor and consumer confidence, as economic growth is slowing down globally and inflation is falling back below central bank targets. Where some policy space is available (and sometimes even where it is not), governments are trying to cushion economic activity with fiscal support. Equally, central banks have all turned dovish, have paused their tightening cycles, or are prepared to cut rates again if necessary, at the same time as yield curves are (chiefly in the US) becoming inverted. As we discussed in our recent analysis, the Fed might even amend its inflation targeting regime to make sure that lost inflation does not become foregone (sometimes called bygone) inflation.
The ECB recently provided more accommodation, and, at its recent Watchers conference in Frankfurt, confirmed that it is looking at measures to protect bank profitability from rates being low for a longer period of time. The BOE again left its rates unchanged at its MPC meeting in March, knowing that the key driver of any future move will be the outcome of the Brexit process. The RBNZ has just updated its forward guidance and indicated that its next move is likely to be a cut, putting pressure on the RBA to move the balance of risks to the downside. In EMs, central banks have less pressure to defend their currencies from an appreciating dollar, given the recent dovish U-turn by the Fed. Some of them are ready to cut rates in coming months, as inflation has generally fallen within a manageable 5-10% range.
As we discussed in our latest Strategic Asset Allocation and Market Update, risky asset prices will be supported by reduced liquidity withdrawal by central banks, even as these asset prices remain vulnerable to bouts of volatility. In such an environment, investors will likely maintain a defensive risk profile, and continue to focus on and prioritize capital preservation above other investment goals.
Sources: NDRC, Commerce Ministry, Digital Silk Road Project, IMF, http://www.silk-road.com/artl/marcopolo.shtml
by Brunello Rosa
25 March 2019
China’s President Xi Jinping and Italy’s Prime Minister Giuseppe Conte were present at a ceremony in Rome on Friday, in which 29 protocols of a “non-binding” Memorandum of Understanding (MoU) were signed by several members of their two governments. The protocols cover areas including agriculture, e-commerce, satellites, beef and pork imports, media, culture, banking, natural gas, steel, science and innovation. They also set up a dialogue mechanism between the two countries’ respective finance ministers. Among the various deals signed between China and Italy were two port management agreements between China Communications Construction and the ports of Trieste (which is situated in the northern Adriatic Sea) and Genoa, which is Italy’s biggest seaport. Luigi Di Maio, Italy’s deputy prime minister, said that the value of the various deals is around EUR2.5bn, with the potential of rising to EUR 20bn over time, if and as Italy succeeds in its intention to rebalance the trade deficit it has with China by increasing Italian exports to China as well as Chinese investment in Italy.
This Memorandum of Understanding has raised more than one eyebrow in Europe and in Washington, as Italy is the first G7 country and the largest country in the EU and Eurozone to have yet signed up for China’s flagship Belt and Road Initiative (BRI). The EU has re-affirmed that China is a “strategic rival” of the EU, and the US fears that Rome might be weakening its traditional Western ties with NATO, the EU and the Eurozone. Press reports preceding Xi’s trip to Rome suggested that Italy’s top-ranking officials had discussed with their Chinese counterparts the possibility of China buying Italian sovereign debt (which is the third largest amount of sovereign debt in the world). Italy’s European partners have warned the country not to fall into a “debt trap” in which its strategic decisions would eventually be made by the owner of its sovereign debt rather than decided upon by the Italian government.
The reason for China to sign such a deal is obvious: Xi will be able to show, both domestically and to his strategic rivals (particularly the US), that he managed to bring a large G7, NATO and EU member country to China’s side in the BRI, which is regarded as the most important Chinese geostrategic initiative. The level of commercial commitment China is making with this deal is minimal (as its effects will only be produced over a long period of time), while the political prize of the deal (prestige, which is being realized immediately) is huge. When Xi will get to Paris this week, the tune will be different. France, Germany and Brussels are worried about China scooping up strategic European assets, so they are likely to impose restrictions – albeit less draconian than the US ones – to Chinese takeovers of strategic European assets. France and Germany are also trying to build European champions to avoid US and China dominate key industries.
Now, why would Italy sign such a memorandum? There are several explanations. First, historically the starting point of the Silk Road (or its terminus, depending on which direction you were travelling) was Venice, the city from which the explorer and merchant Marco Polo departed to discover China, in what President Xi labelled as the first contact between China and Western civilisation. So, one cannot be surprised if China views Trieste’s port (near Venice) as the end of a modern “sea road”. Trieste is strategically important for China because it offers a connection from the Mediterranean to landlocked countries such as Austria, Hungary, the Czech Republic, Slovakia and Serbia, all of which are markets China hopes to reach through its BRI.
Secondly, Italy has been known for decades for its ability to have friendly relationships with strategic rivals: the USA and the Soviet Union, Iran and Iraq, Israel and the Palestinians, etc. (This is a reason why often Italian troops are used in peace-keeping operations by the United Nations). Italy could very much remain a loyal member of the Western alliance while also doing business and even signing deals of this kind with China. (Indeed, the US itself, while remaining the cornerstone of the Western alliance, is seeking to sign an MoU with China to end the ongoing trade war. And the largest holder of US sovereign debt is China). Third, a stagnating economy like Italy needs to show it is “open for business” if it wants to attract foreign investment, including from China.
Yet there are also risks involved in signing this deal. Foremost of these would be China gaining a level of geo-strategic influence in Europe much greater than the acquisition of Greece’s port of Piraeus allowed it at the end of the Greek economic crisis in 2015. Another risk is that, with Italy already taking an ambiguous stance vis-à-vis its position versus the EU and Russia, Italy risks not being considered a loyal partner to Europe, and instead is perceived to be, in effect, “up for sale” to the highest bidder, no matter who that might be.
Third, this entire story shows – once again – how weak the European construction is when it is comes to defending common European interests. In a world that is increasingly becoming bi-polar, wherein countries have to pledge their alliance to either the US or China, the EU could play a vital role in presenting itself as a global actor pushing for peace, prosperity, the welfare state, democracy and environmental protection. Yet when EU countries do not work together, they have little leverage to advance even their own positions. Unless the EU completes its transition towards becoming a cohesive political entity, it will not be able to play a positive global role in coming years. Sources: NDRC, Commerce Ministry, Digital Silk Road Project, IMF, http://www.silk-road.com/artl/marcopolo.shtml
by Brunello Rosa
18 March 2019
With US-China trade negotiations being granted a deadline extension by President Trump on March 1st, it seems that an agreement between China and the US on their long-lasting trade disputes could finally be at hand. What might the elements of the deal include? In brief, the deal could include a commitment by China to increase its import from the US, while the US is granted increased access to the Chinese market, more protection for its intellectual property, reduced technology transfer via obligatory joint ventures, and other similar guarantees. If we only focus on the quantitative aspects of such an agreement, we could brutally summarise it as follows: China would commit to buy more stuff from the US and the US will be able to sell more stuff to China. (That is, after all, the way to reduce the US’ trade deficit with China, which recently reached an all-time high).
Now, would this be a good deal for the world economy? On the one hand, reduced trade tensions would mean less volatility in markets, which could be beneficial for developed economies and emerging markets (EMs) both. Less protectionism would also imply a reduced drag on global growth, which in turn might also imply higher prices for certain commodities, another factor that could be beneficial for commodity-exporting Ems. (Moreover, so long as commodity prices do not increase too much, this would not necessarily impact DMs too negatively). As part of the trade deal China might also commit to stabilizing its trade-weighted exchange rate and allowing more transparency regarding its reserves and reserve policy. Trade-weighted currency stabilization would be better for Europe than China pegging to the US dollar alone, which tends to hurt the Eurozone at times when the dollar is weak.
On the other hand, not all that shines is gold. Even if a temporary agreement were to be agreed on between China and the US, the cold war between the two global geopolitical superpowers will continue. The sub-components of this wider rivalry, such as the technological competition between them and the balkanisation of the global supply chains, will also continue, and, as the recent row around Italy’s memorandum with China on the Belt and Road Initiative may show, other countries and regions will be forced to choose sides between either the US or China.
In addition, there might be direct losers from a US-China deal of this sort. If China commits to buying more goods from the US, other countries’ exports to China might suffer, especially countries or regions which have economies that are export-led, such as Japan and the Eurozone. If China also commits to buying more US goods such as soybeans, fossil fuels, and other commodities, exporting EMs may suffer as well. Thirdly, as we discussed in a recent column, if the US and China come to an agreement , Trump will then be able to devote his full attention to an attack on Germany and its car industry (another popular bipartisan subject in the US), threatening to slap tariffs on US car imports in order to strongarm the Germans into taking a deal that is advantageous to the US.
As we discussed in recent reports, both Japan and Europe are now undergoing a severe economic slowdown, which is having important political repercussions. Germany’s slowdown means that other countries in its supply chain, such as Italy, are already in a recession. EMs are stabilising after a difficult 2018 thanks to the Fed’s more dovish stance. If those economies were to suffer again, possibly falling into a recession, the world economy as a whole would be affected, being then able to rely only on the US and China, both of which are also slowing down economically.
Germany could seize the opportunity to rethink its business model and become less dependent on foreign demand. But that would mean revitalising its domestic demand and promoting the transformation of the EU and the Eurozone into full-fledged transfer unions (perhaps organised in concentric circles), with a vibrant internal market like the US. However, as we discussed in our recent Europe Update this seems very unlikely to happen in the near future. This will leave Europe, Japan, EMs and the world vulnerable to the volatile mood of the US president.
by Brunello Rosa
11 March 2019
This will be one of the most crucial weeks yet in the entire Brexit process: On Tuesday March 12th there will be a second “meaningful” vote on Theresa May’s deal. The aim of the government is to present a revised version of the deal, on which the UK and EU have worked over the weekend. The UK is seeking legally binding reassurances that the backstop solution for Northern Ireland will be temporary. The EU has made it clear that it cannot re-open negotiations for the withdrawal treaty, yet seems willing to compromise. If the vote is in favour of May’s deal, the UK will leave the EU on March 29th as planned, but am “implementation” period lasting until December 2020 will ensure a smooth transition and allow the UK to reach a final arrangement with the EU. Theresa May is pledging resources for the constituencies in which current Labour MPs might be willing to vote in favour of her deal. As discussed in our recent update, if Labour decides to allow some defectors within its own party to vote in favour of May’s deal, this strategy could pay off.
If the result of this vote goes against the deal like the previous vote did, yet another vote will take place on Wednesday March 13, as the UK parliament will have to decide whether or not it is in favour of exiting the EU with no deal whatsoever. We expect the UK parliament to reject the possibility of the no-deal Brexit that the hardline Brexiteers want. There does not seem to be a majority in favour of it. On the same day, the UK Chancellor of the Exchequer will make its Spring Statement (i.e. a budget update), where revised growth and inflation forecasts will determine whether the UK’s fiscal trajectory is still in line with the October budget. Chancellor Philip Hammond will reiterate that the UK has plenty of fiscal resources to counter a potential no-deal scenario and cushion the economy against a possible crash. If for any reason the UK were to crash out of the EU without a deal, the figures of the Spring Statement update would quickly be thrown out of the window and a fresh, emergency budget would need to be passed.
On Thursday March 14th, the UK parliament will vote to authorise a possible extension of Article 50, which would be the logical course of action in the event that its elected officials vote to reject May’s deal on Tuesday and then vote against a no-deal Brexit on Wednesday. The EU is ready to provide a short (2 or 3 month) extension, but wants to be sure that the UK parliament will spend that time trying to converge towards a definite solution, so this cannot be taken for granted at this stage. The UK might also be blackmai