WEEKLY COLUMNS (ARCHIVE)

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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

4 March 2019  

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

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

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

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

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

by Brunello Rosa

25 February 2019  

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

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

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

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

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

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

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

by Brunello Rosa

18 February 2019  

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

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

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

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

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

Picture from the “Populism Research Group” at Loughborough University 

by Brunello Rosa

11 February 2019

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

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

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

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

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

by Brunello Rosa

4 February 2019  

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

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

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

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

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

by Brunello Rosa

28 January 2019  

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

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

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

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

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

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

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

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

(Picture by Associated Press, from www.ilsole24ore.com)

by Brunello Rosa

10 December 2018  

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

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

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

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

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

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

by Brunello Rosa

3 December 2018

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

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

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

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

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

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

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

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

by Brunello Rosa

26 November 2018

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

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

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

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

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

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

by Brunello Rosa

19 November 2018

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

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

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

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

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

by Brunello Rosa

12 November 2018

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

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

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

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

by Brunello Rosa

5 November 2018

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

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

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

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

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