WEEKLY COLUMNS (ARCHIVE)

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by Brunello Rosa

19 August 2024

The Democratic National Convention will take place in Chicago next week. The DNC will return to Chicago for the first time since 1968. The number of similarities with that period are striking. 

First, of course, there was a Democratic president in the White House at that time as well, Lyndon B. Johnson. Second, that president had decided not to run for a second term, the same as Biden today. In that case, Johnson initially had sought to run for re-election; however, following disappointing results in the New Hampshire primary he withdrew his candidacy. Third, the Democratic party was divided in the support for the war that its president had intensified: in that case, the “surge” in Vietnam, these days the wars in Ukraine and the Middle East. 

Fourth, just like today, universities were in revolt against those wars. The Chicago police had a very hard time containing the protests, and had to resort to violent methods, which further antagonised Democratic opinion. Fifth, the country as a whole was highly divided at the time, following the assassination of John F. Kennedy in November 1963 in Dallas. Sixth, the Republican party was featuring the return of a highly divisive figure as its frontrunner, in that case Richard Nixon, who had lost the presidential race in 1960 against the young Kennedy, after Kennedy had been better at using the new medium of the day, namely television. (The famous first-ever US presidential debate, between Nixon and Kennedy, was held – again – in Chicago, on September 26th, 1960). 

Needless to say, the Democrats hope that the result of this year’s election will be different from that of 1968, when Nixon defeated the Democratic candidate Hubert Humphrey. And hopefully everybody hopes that, unlike in 1968, when the leading Democratic candidate Robert Kennedy was killed by Sirhan Sirhan, a supporter of the Palestinian cause, there will not be any further act of political violence in this campaign, after the attempted assassination of Trump in early July. 

As we discussed in previous columns, this has already been one of the most surprising campaigns in American presidential races. This includes the fact that, for the first time in history, a women of color is running for the highest office in the US. But the tension between the two sides of the political spectrum is as high as ever, as proven by the recent interview by Elon Musk with Donald Trump, held on Twitter/X (to which Trump was re-admitted by Musk himself in November 2022, after the tech entrepreneur bought the platform in 2022). Musk said he has committed USD 45m a month to support Trump’s campaign. Musk’s co-investor in Paypal, Peter Thiel, has sponsored the political ascent of JD Vance, Trump’s running mate. 

Our hope is that, after the DNC, this heated campaign will return to more normal standards, with candidates speaking about their economic programs and their view for the US in the world. But, as we discussed many times before, our fear is that the stakes are too high, and this will remain a heated campaign until November 5th. But the recent riots in the UK should serve as a warning signal of what may occur in the US, if tensions do not abate before that day. 

by Brunello Rosa

12 August 2024

Global markets have been shaken by large and sudden moves during the last few days, to an extent unseen since the pandemic crisis (2020-21), global financial crisis (GFC, in 2008-09) or even earlier than that. On Monday August 7th, for example, Japan’s Nikkei 225 index dropped by 12.4%, its sharpest one-day decline since the 1987 Black Monday selloff. US equity markets fell by a similar amount: in particular, the Nasdaq composite fell by 13% since last month’s peak. European markets, which had lagged behind in the market run-up, have declined less, so far. Conversely, recession fears resulted in lower rates across the US curve: the 2-year US Treasury yields fell to 3.8%, causing the gap against the effective federal funds rate of 5-5.25% to widen by a greater amount than at any time since the GFC.

There are four main causes for this global repricing. First, recession fears in the US. These were sparked by an NFP reading of 114k in July that was well below expectations and recent averages, and by an increase in the unemployment rate from 4.1% to 4.3%. This increase in the unemployment rate has triggered the so-called Sahm Rule recession indicator. This rule “posits that a recession has begun once the three-month moving average of the unemployment rate exceeds its low from the prior year (2023) by at least half a percentage point.” 

Second, there have been disappointing earnings from the tech sector. As reports suggest, the US “magnificent seven” high-tech stocks, including Nvidia and Apple, have accounted for most of the market price gains over the past year or so, significantly stretching their market valuations. Their recent disappointing earnings reports have triggered the correction, shedding nine hundred billion dollars in market value.”

Third, central banks’ pivot. In our latest column, titled “The World’s Major Central Banks Are At A Turning Point”, we discussed how the Bank of England had cut rates in August, the ECB had signalled a further cut in September, and the Fed signalled its readiness to beginning to cut its Fed funds rate in September. All this, while the Bank of Japan had increased its policy rate for the second time this year (after the hike in March from -0.1% to 0-0.1%), reaching “around 0.25%” (as the BoJ put it) for the first time since the GFC. The increase in Japanese rates coupled with the fall in DM – and EM – market yields implied an unwinding of the so-called Yen carry trade. The BIS estimated the “upper bound” of the yen carry trades conducted “on-balance sheet” to be JPY 40 trillion (around USD 270bn). The largest “victims” of this un-winding have been the Mexican and the Colombian pesos. 

Compounding macro-financial reasons, the fourth cause is the rise in geopolitical tensions in the Middle East after the assassination of Hamas leader Ismail Haniyeh in Tehran, which Iran blames on Israel; there are increasing concerns of the extension of the conflict at regional level. 

What has seemed like a global market rout in the last few days has been a healthy repricing of market valuations, the result of some changes to the fundamentals of the economy (US possibly headed for a recession), company earnings (in particular in the frothy tech sector), and central bank future moves. We believe that upcoming rate cuts in the US, Eurozone and BoE will further help stabilise the situation in coming weeks.

by Brunello Rosa

5 August 2024

In the last couple of weeks, the world's major central banks have met and taken important decisions or made crucial announcements regarding their future decisions. Going in chronological order, the European Central Bank (ECB) in mid-July decided to keep its key policy rates unchanged, after the 25-bps cut it deliberated in June. This was due to the fact that macroeconomic conditions did not warrant a back-to-back reduction in policy rates, considering that economic activity has actually picked up recently, while inflation has remained above the ECB’s target. Nonetheless, during the press conference, President Christine Lagarde said that the possibility of an additional measure of monetary easing (another 25bps cut) in September is “wide open”, and we expect the Eurozone’s central bank to cut rates on that occasion. 

Last week, the US Federal Reserve, the UK’s Bank of England, and the Bank of Japan met for their last meetings before the summer break, all making important decisions and announcements. 

The Federal Reserve left its policy stance unchanged, as inflation remains above the central bank’s target, and economic activity, including job creation, remains solid. However, during the press conference, Chair Jay Powell said that the FOMC has increased in confidence that inflation will durably return to target after a series of positive readings in Q2, which offset the negative readings (i.e. rises) recorded in Q1. On the back of that, Powell said that if the economy continues to perform in line with current developments, the Fed would be prepared to finally cut its benchmark Fed funds rate by a quarter of a point in September, thus marking the end of one of the steepest tightening cycles in recent history. 

The Bank of England left the market to wonder until the very last minutes about its intention, with market participants split in half between those (including us) who expected the BoE to cut rates in August and those who thought the Bank would wait until September. Eventually, the Bank decided, with a razor-thin majority of 5-4, to cut rates in August, with Chief Economist Huw Pill joining the “usual” dissenters, recording a dissent compared to Governor Andrew Bailey, and his boss Claire Lombardelli, the newly-appointed Deputy Governor for Monetary Affairs. In September, the Bank of England will release its plan for its Quantitative Tightening (QT) program for the September 2024-August 2025 period. 

Finally, the Bank of Japan held its meeting at the end of July, after announcing in June that it would reduce the pace of its asset purchases, without specifying the parameters for such a move. So, at its July meeting the BoJ announced that it would reduce the purchase of JGBs by about a half over time, from JPY 6tn yen a month to around JPY 3tn yen. Alongside this announced decision, the BoJ decided to increase its policy rate by about 15bps to “around 25%”, a second increase after that decided in March. This signals increased confidence on the part of the BoJ that inflation will remain durably above the 2% target, after years of dis-inflation or deflation. 

Overall, this set of decisions or announcements signals the will by the world’s major central banks to put their respective houses in order before the summer break, to be ready to resume their activities in the autumn with a bang.

by Brunello Rosa

29 July 2024

At the end of last week, we published a report titled “A Month of Political Shocks in U.S. Elections: Trump’s Nomination, Biden’s Withdrawal And Harris’ Endorsement.” In this report we discussed the political shocks that have affected US politics in the last few weeks.

First, former President Donald Trump suffered an attempted assassination that left him wounded. A few days after the attack, he was confirmed as the official nominee of the Republican Party for the race to the White House that will take place of November 5th. On that occasion he chose JD Vance as his pick for Vice President. Ironically, a few years ago, JD Vance called Trump “America’s Hitler.” He must have changed his mind, or perhaps become increasingly similar to Trump in the meantime. 

For example, three years ago Vance said that people with children should be given more voting power than those without kids. The idea is that, supposedly, parents have more of a vested interest in the future of the country than those without. Apart from the wobbly logic behind that idea, this a direct attack on the 1776 Declaration of Independence of the US, which starts by saying that “all men are created equal,” without saying that “parents are more equal than others.” What we know now is that Trump has found somebody with views as radical and outrageous as his own. It is fair to assume that if Trump wins the election on November 5th, the pair will start a swift implementation of Project 2025, as confirmed by JD Vance itself. The grab of power from the pair would be so “ruthless” (to use Vance’s words), than in four years “Americans won’t have to vote again.” 

The second shock was the decision by President Joe Biden to drop out of the race for the White House, for the greater good of the “country and the party.” Biden knew that without the fundamental support of the party, and its donors, he would not stand a chance to win against Trump. In the days preceding the announcement, a number of party grandees had increased their pressure on Biden to convince him to withdraw from the race. He will now focus on completing his mandate as President, and likely preserve his legacy: 15 million jobs created since the beginning of his presidency, milestone legislation passed (such as the Inflation Reduction Act), and unwavering support provided to Ukraine in its attempt to resist the brutal aggression by Russia, just to name a few of his accomplishments. 

The third element in recent weeks was the endorsement Biden gave to Kamala Harris, his Vice President, to replace him in the Presidential race. Harris has quickly gathered the endorsement of some key party members such as the governor of California (Gavin Newsom, who could have aspired to run himself, but will now have to wait) as well as Josh Shapiro, the governor of Pennsylvania, and Roy Cooper, the governor of North Carolina. Finally, and most importantly, Kamala Harris gathered the support of the Clintons and especially of the Obamas. She will now have to face an uphill battle, as some polls show she is neck and neck with Trump, or slightly behind him. Apart from her undoubtful merits, is a country that shows such a strong support to Trump ready to elect a woman, and even a black woman, to the White House? 

After these three shocks, the presidential race is now re-opened, and any result is possible. We continue to think this will be the most consequential election in recent US history, in which its liberal democracy is at stake.

by Brunello Rosa

22 July 2024

On Thurs 18 July, Ursula von der Layen, the recently re-appointed EU Commission president, received the necessary vote of confidence from the EU parliament that will allow her new Commission to be formed and begin operating. The new Commissioners will also have to be confirmed by the EU parliament; there have been cases in the past in which some appointed Commissioners were voted down. The final score in parliament, where MEPs voted with a secret ballot, recorded 401 votes in favour, 284 against and 22 blank or invalid votes.

Who voted for her? Officially, the European People’s Party (EPP), the Socialists and Democrats (S&D), the Liberals and the Greens. According to the official group sizes (see picture above), she could have counted on 454 votes, which means that – as usually occurs – dissenters likely emerged in all groups. In any event, she had a large safety margin compared to the 360 MEP majority needed to win the vote. On the other hand, the European Conservative and Reformist (ECR) group, led by Italian Prime Minister Giorgia Meloni, voted against, even if the vote was only declared after the result was announced. While it is obvious that von der Leyen got what she wanted, we believe that both “Ursula” and “Giorgia” have made a mistake in their respective strategies. Let’s see why. 

In the run up to the vote, “Ursula” had been trying to enlarge her majority beyond the traditional tri-party bloc of Socialist, Christian Democrats and Liberals. She has approached the Greens (to the left) and the ECR (to the right). Eventually, she understood that only the Greens could be trusted to provide a positive vote, which they did mostly to block the mounting right-wing parties, and so she opted for them. In her speech, she promised the “Green Deal” (“clean industrial deal”) to be approved within the first 100 days. While securing a larger and probably more cohesive coalition, she has moved the political axis of the future Commission to the left. 

This could prove to be a fatal mistake. In the last few elections for the EU parliament (2014, 2019 and 2024), right-wing parties have increased their relevance in terms of votes and seats. The three right-wing groups (ECR, the Patriots recently formed by Hungarian PM Victor Orban and led by France’s Jordan Bardella, and the new Europe of Sovereign Nations - ESN, where the German AfD resides) now control 25% of the seats in the EU Parliament.

While the continent was moving to the right, the Commission has shifted to the left in an attempt to isolate the rising anti-European, pro-Russian parties. But this has fed the sense of frustration of large swathes of the European electorate, those tired of the Euro-bureaucracy of Brussels and its policies that are perceived to be as elitist, such as the “green deal.” Further ignoring these demands, and doubling down on these policies, will further feed anti-European sentiment. Five years from now, the right-wing parties that are now in opposition may take the lead in the European parliament, especially if Marine Le Pen becomes French President in the meantime.

But “Giorgia” also made a mistake. Reasoning as leader of the ECR, she said she was “coherent” with her declared intention of never mixing her votes with those of the Socialists and the Greens. But by doing so she has completely nullified the results of the European elections in Italy, where she had a resounding success. In fact, she was not consulted for the top jobs of the EU institutions, and now – being in opposition – Italy will have to give up one of the positions of the Executive Vice President, and most likely also a heavy Commissioner role for Raffaele Fitto (or other politicians from her coalition). 

Meloni said that the “weight” of the Commissioner will depend only on the relative weight of Italy within the EU, as its third largest economy and second largest manufacturing country behind Germany. But things don’t work like this in politics: Why should von der Leyen give an important portfolio to the Commissioner of a country whose PM has voted against her Commission, when she already enjoys a massive margin above the needed majority? Meloni should have seized the opportunity to enter the big games of EU politics and continue her march towards the centre, and to a possible convergence with the EPP at some point. The moves she made instead will leave Italy isolated and under-represented. 

Unfortunately, both mistakes will be paid for by future generations.  

by Brunello Rosa

15 July 2024

Last Saturday, an attempted assassination of Republican candidate Donald Trump took place at one of his electoral rallies in Butler, Pennsylvania. Donald Trump was injured in an ear, but survived. The shooter, Thomas Matthew Crooks, a Republican-registered voter, was shot dead. This event is likely to impact the future of this already very tense electoral campaign, for the following reasons. 

In the Democratic camp, there are already numerous party grandees, including former House Speaker Nancy Pelosi, as well as key donors, who are reportedly asking US President Joe Biden to step aside. Former President Barack Obama, who’s been silent in recent days, is reportedly considering to ask Biden to leave the race. Biden’s mishaps in public speeches are not helping. At a recent NATO summit, he called Volodymir Zelensky “President Putin” and Kamala Harris “Vice-President Trump.”

No-one in his camp doubts the extraordinary merits of his presidency, epitomised by the creation of 15 million jobs and the return of inflation to near target levels (helped by the Fed’s restrictive stance). But it is precisely to preserve that legacy that they would prefer Biden not to run against Trump. Potential replacements are Vice-President Kamala Harris and Gretchen Whitmer, the governor of Michigan, a key swing state. (Despite Whitmer having ruled out running even if Biden stepped aside). Though polls don’t show that these candidates would do any better than Biden against Trump, and they would of course lose the advantage of being an incumbent. 

The attempted assassination could do to Trump what a similar attempted murder did to Jair Bolsonaro in Brazil: propel him to the final victory. Trump will certainly use the episode to continue depicting himself as a victim of the system that he wants to so radically change. And his adversaries will have a harder time addressing Trump with equally aggressive terms, because doing so now would likely antagonise an already divided electorate. 

The failures of the secret service, and the local police, in preventing the shooting – witnesses said they had alerted the police about the suspicious presence of a potentially harmful person at the campaign event – will raise the question of the reliability of the “deep state”, and the purported hatred it would have against the candidate (Trump) that has repeatedly said he will do a “clean-up” – by being a “dictator” for one day – of the system. 

The blueprint for this overhaul of the deep state is contained in the so-called Project 2025. This report has been published by the Heritage Foundation and other smaller organisations, providing a step-by-step guide for how to transform the US into a nationalistic Christian state.

This guide is not just a catalogue of ultra-conservative policies (including a complete ban of abortion and the increase of carbon-emitting energy sources) but provides also a database of tens of thousands individuals that would be ready to replace current staff in the administration. Moreover, thanks to the re-instatement of “Schedule F” envisaged by Project 2025, these newly-appointed bureaucrats would swear allegiance not to the Constitution, but to the President, becoming the operation arm for implementing his policies. Thanks to the recent decision by the Supreme Court, this president would also be immune for all acts conducted in the exercise of presidential functions. 

For these reasons, many believe that Project 2025 is the blueprint for how to transform the US into an authoritarian state, potentially a dictatorship. We have discussed several times how we believe the re-election of Trump would represent the end of US liberal democracy. The recent events in Butler may catapult Trump into the position of changing the nature of the US system forever. 

by Brunello Rosa

8 July 2024

The last few days have witnessed political turmoil in major countries, starting last Sunday when the results of the second round of the French legislative round began to emerge. French President Emmanuel Macron, who had already lost his parliamentary majority in 2022, has further reduced its parliamentary base. A hung parliament has resulted from the surge of the extreme right and extreme left, which will make it even harder to form a government in coming weeks. 

Also in Europe, Victor Orbán, the PM of Hungary, which holds the rotating presidency of the EU, visited both Volodymir Zelensky in Kiev and Vladimir Putin in Moscow. Orban is reportedly seeking a diplomatic solution, but his visit to Moscow allowed Putin to say that the EU is trying to re-establish a dialogue with Russia, which is by no means the EU’s official position. The outgoing President of the EU Council, Charles Michel, said that Orbán has “no mandate” from the EU to open a diplomatic channel with Russia, and that the EU needs to show “unity” not “cracks” in its unwavering support for Ukraine. 

Yet these cracks are already emerging, and they are likely to intensify in the coming months. Marine Le Pen said that if the RN reaches power, it will withdraw its authorisation to use the long-distance weapons France has supplied to Ukraine, a move that will certainly please Putin. Putin himself was also pleased to hear that US presidential candidate Donald Trump “sincerely” intends to reach an agreement between the two sides by allowing Russia to remain in Ukraine’s territory, and by promising that Ukraine will never join NATO. More than a compromise, that would seem like a capitulation to Putin’s pretences.

These “cracks” could eventually lead to an internal division within the EU, with the creation by Victor Orbán of a new group of “Patriots” within the EU parliament, which has already attracted the participation of Spain’s Vox, Italy’s’ Lega, Czechia’s ANO, and Austria’s FPÖ.

Where is the US in all this? The race for the November 5th presidential election continues, but both camps seem in trouble. The Democrats – and especially their powerful donors – are actively considering replacing Joe Biden as their nominee, on the back of the disastrous showing by him in the CNN debate with Trump. But Biden reiterated he will remain in the race, running on the real achievements of his government, including the massive job creation: on Friday, the June Non-Farm Payroll showed an increase of 206K jobs, above market expectations of a 190K figure.

The Republican camp is well presided over by Trump, who is certain to win the nomination by the party in a few days. But two major scandals are emerging. First is Trump’s alleged potential involvement in Jeffrey Epstein’s organisation, as hs emerged by the de-classification of official documents. Second, there is the emergence of his links with the authors of Project 2025, a sort of guide to establish an autocratic regime in the US starting from the inauguration of Trump in January 2025, with around 20,000 people reportedly on call to replace the employees of the current administration, in order to make the “deep state” loyal to Trumpism. 

In all this chaos, which could lead to any outcome, the UK, which completely changed its political colour following its general election last week, with a massive defeat of the Tories and a resounding victory by Labour, led by Keir Starmer, seems to be an island of peace and stability, considering the orderly and civilised transition of power that occurred between outgoing PM Sunak and incoming PM Starmer. 

by Brunello Rosa

1 July 2024

Last week the world moved another inch close to chaos. In the first US presidential debate, President Biden and Donald Trump staged one of the worst performances in American political history, with allegations and counter-allegations on personal matters and little space for policy discussion. 

Joe Biden looked confused and weak, and even the press that is closer to the Democrats could not defend his appearance. Many voices emerged asking him to step down from the race, or else for the Democratic Convention, which is scheduled to take place in Chicago on 19-22 August, to replace him. Biden responded that he will carry on with the race. Donald Trump, who on stage performed better than Biden, still did not have much more substance to add to his usual rhetoric. The vast majority of polled people thought that Trump won the debate, and his chances of being re-elected have meaningfully increased since the debate. 

In Europe, the EU sped up the process of appointing its top representatives on Thursday, with an agreement being reached on Ursula von der Leyen getting a second mandate as Commission president, Antonio Costa, the former Portuguese prime minister, being the next EU Council president, and Kaja Kallas, former prime minister of Estonia, becoming the High Representative for Foreign Affairs and Security Policy. Maltese Roberta Metsola is confirmed as President of the EU Parliament. The Council, with the opposition of Italy’s Giorgia Meloni and Hungary’s Victor Orban, wanted to make sure that all these appointments were made before the first round of the French legislative election, which took place during the weekend. This is because the Council did not want to negotiate these matters with Marine Le Pen calling the shots from the heavy chair of France. 

In France, as discussed in our trip report, Le Pen’s party, Ressemblement National, is set to gain power for its first time in history, either with an absolute majority in parliament or a plurality just shy of a majority which can be reached with the addition of 10-20 MPs from other right-wing parties. In our opinion this will set the scene for her victory in the presidential election of April 2027, or earlier than that in the event that Emmanuel Macron resigns.

This turn of events could effectively lead to a situation in which Trump returns as US president and Le Pen controls the French political system until her ascent to power in 2027. Two right-wing populist leaders at the helm of two of the oldest liberal democracies in the world, at the same time as Putin, Xi, and a series of other autocratic leaders are already in power. Even the “moderate” Giorgia Meloni, who already displays autocratic tendencies, would likely show her true colours in such a mutated international context, likely returning to her radical right-wing ideas of the past. And we need to wait to see what happens in Germany, where the neo-nazi party AfD is already second behind the CDU, and first in many Eastern states. 

Needless to say, a world in which Trump, Le Pen, Meloni, possibly the AfD in some form, plus Xi, Putin and many other autocrats are all in power at the same time, does not look terribly good in terms of international security and domestic defense of liberal democratic values, including the independence of the judiciary and the freedom of the press. 

by Brunello Rosa

24  June 2024

In the last few weeks, a flurry of reports announced that Saudi Arabia had quietly let its 50-year petrodollar agreement with the United States expire without renewal, causing rumours to spread about the possibility of an official end to the petrodollar system and, with it, the wider US dollar hegemony. Other media reports suggested this was just “fake news”, that nothing has actually changed. In this column we will try to make sense of this story, which we explore in much greater detail in a forthcoming article. 

The context here is the end of the USD convertibility into gold decided by Nixon in 1971, which led major currencies to begin to free float by 1973, and the first oil shock, with its 4-fold increase in the price of oil and OPEC oil embargo. In 1974, two separate agreements were signed as a result of this. One, signed on June 8th, 1974, established the “U.S.-Saudi Arabian Joint Commission on Economic Cooperation” to “fosters closer political ties between the two countries through economic cooperation; assists Saudi industrialization and development while recycling petrodollars.” The second agreement was secretly signed later in 1974, in which the U.S. promised military aid and equipment in exchange for the Kingdom investing billions of dollars of its oil-sale proceeds in U.S. Treasurys. 

While most press reports are suggesting that it was the first of these two agreements that was not renewed earlier this June, in reality it is the second, which remained secret for decades, that gets closer to the “military security in exchange for petrodollar recycling into U.S. Treasuries” deal that people refer to. 

Whether a formal agreement as opposed to an established practice existed, the petrodollar system has developed over the decades and has helped in establishing the USD as the global reserve currency. From this perspective, regardless of whether or not an agreement was formally renewed, in practice nothing substantial will change until an equally large and liquid market and widespread currency replaces those of the U.S., and this does not seem to be on the horizon. Some oil transactions will occur in local currencies, in Chinese yuan, etc. but this will not undermine the role of the USD as the global reserve currency. 

However, there is an element that makes this story even more intriguing, which cannot be easily dismissed. Just a couple of days prior to the supposed expiry of the “petrodollar deal,” on 6 June 2024, the Saudi Central Bank confirmed it was joining the mBridge multi-CBDC (Central Bank Digital Currency) project as a full participant, as the initiative moved from the production phase to the ‘minimum viable product’ phase. Saudi Arabia’s joining the China’s dominated “new rails” for cross-border payments may be interpreted as a signal that Saudi Arabia is ready to shift away from the U.S.-dominated financial architecture. The potential for Saudi Arabia to embrace CBDCs, and, by extension, the financial architecture championed by China and the BRICS, would pose an unprecedented challenge to the existing U.S.-led global financial order. In effect, it would mark a watershed moment for the US dollar’s unchallenged supremacy as the global reserve currency.

by Brunello Rosa

17  June 2024

Elections for the European parliament took place last week. When reading the results, two main elements appeared quite clearly. First, the majority that had controlled the previous EU parliament, made up of Christian Democrats (EPP), Socialists and Democrats (S&D) and Liberals (Renew Europe), will continue to control the newly elected parliament. The three parties will hold 406 seats together; well above the required 361 seat majority, with a safety margin of 45 seats that should be large enough to contain the potential dissenters in each group (which always materialise when there is a secret vote). Given the numbers, no other majority is possible. More specifically, the right-wing majority that some leaders were hoping to build, comprised of the EPP, European Conservatives and Reformist (ECR) and Identity and Democracy (ID), won only 324 seats, and so is far away from the minimum number of seats required to hold a majority in parliament. 

Second, the left-wing parties (S&D and Greens) as well as the Liberals have lost seats (-44 in total) in favour of the EPP (+ 14), the radical Left (+2), and especially the radical right-wing parties (ECR +7) and (ID +9). 

In sum, while it is undoubtable that there has been a shift to the right in this EU parliament, if we look at the numbers only, the cataclysmic effect of the rise of right-wing parties has failed to materialise. Things look different however when one looks at the national repercussions of the vote, especially in France and Germany. 

In Germany, the largest party in the governing coalition, the SPD, finished in third place, behind the resurgent CDU and the rising AfD in these European elections. The radical right party AfD, in particular, has surged in Eastern Germany, where it has reached 30% of the votes in some instances. While this is not going to have immediate implications, the CDU has already started to discuss whether an alliance with the AfD may be considered possible, thus breaking a taboo that had seemed impossible to consider.

But the largest effect has been felt in France, where President Macron dissolved parliament and called for a parliamentary election on June 30-July 7, which may have momentous consequences for Europe. 

In our recent trip reports from France we had highlighted how Macron had failed to leave a legacy in terms of policies, and most importantly had failed to build a clear succession plan. Now these failures risk deflagrating in the most consequential manner. Especially if we consider that the head of the neo-Gaullist party (Les Républicains - LR) has also infringed the so-called “pact républicaine” that has remained in place since the beginning of the Fifth Republic; that is, to leave the National Front (the post-fascist party founded by Jean Marie Le Pen) out of government at all costs. In fact, Mr Éric Ciotti has made an opening towards forming an alliance with Marine Le Pen at the next elections, thus causing a revolt in his own party, but breaking a taboo similar to that prevailing in Germany. 

Even without a pact between the Rassémblement National (RN) and LR, the polls show damning numbers for Macron, considering that the radical left and the radical right are ahead in virtually all constituencies. At this point, it is very likely that Macron will be forced into a co-habitation with a prime minister of a different political colour. This may be Jordan Bardella, from the RN.

What would be the consequences of such an outcome? In theory, Macron could show what the RN could do negatively once in power, while still having a massive power of interference in government policies, and with foreign policy remaining as it does in the hands of the President of the Republic. His gamble is that the French people will not want to give the RN full powers by electing Marine Le Pen as President in 2027. But things may go differently: Bardella may prove to be moderate and mainstream while constrained by the presence of Macron, and then reveal his true colours once Le Pen becomes President.

Through all of this, the market is very nervous, and has sold OATs since the announcement, with the 10y OAT - Bund spread having reached 83bps recently. 

Markets believe that the future Bardella's government will be less fiscally responsible than the current Attal's executive. In case of a victory by Macron, the OAT yield will retrace. In case of a victory by the RN it will initially widen, and two scenarios may then play out: either the RN proves as destructive as feared, in which case the spread will continue to widen further, or the RN proves to be more moderate than is feared, in which case the OAT-bund spread will shrink in coming months. 

by Brunello Rosa

10  June 2024

Last week there were celebrations for the 80thanniversary of the D-Day, the arrival of allied troops in Normandy on 6 June 1944, which marked the beginning of the last phase of World War 2. Far from being a rhetorical exercise, the celebrations were the catalyst for reflecting on some of the most pressing issues of the moment.

First and foremost, on D-Day we are celebrating the victory of democracy over authoritarianism; in that specific case, the Nazi-fascist dictatorships that were plaguing Europe. We have discussed in the past why we consider it to be absolutely essential that the US remains a liberal democracy, with an independent judiciary and a free press. Imagine if it had not been so in the 1930s: who would have come to the rescue of Europe? What would have happened then, in a world in which in the Soviet Union there was another form of authoritarianism, and with China about to see the birth of the Communist party? 

For this reason, we consider the upcoming US Presidential elections a fundamental moment. The conviction of Donald Trump in his first trial (over hush money he paid during an election), a first for a former US President, marks a historical moment. During the trial, Trump was spared some of the measures that would have been adopted towards any other convicted defendant, given his repeated violations of Court orders. On July 11th, Trump may be spared jailtime, and be sentenced only with probation or a fine. So, Trump has already proven that not all citizens are the same in the US judicial system. If Trump manages to win the nomination of the Republican party and the presidential race in November, this would prove that a man is “above the law,” and this would mark the end of the US liberal democracy. 

During the D-Day celebrations, it appeared – once again – how elderly Joe Biden is. However, Biden is old enough to remember WW2, and this gives him the conviction he has shown in fighting the Russian invasion of Ukraine. In fact, during the celebration, the analogy was made between the fight against the Nazis with today’s fight against Russia’s imperialist plan. One cannot put Adolf Hitler and Vladimir Putin in the same basket, but the amount of unnecessary suffering that Russia in creating at the moment is reminiscent of the darkest periods in European history. This is the reason why French president Emmanuel Macron, at the forefront of the celebrations, confirmed that French “trainers” have been sent to Ukraine to help the country build a stronger army.

On this occasion, UK PM Rishi Sunak’s decision not to attend the celebration, to record a TV interview set to be broadcast next week, was a grave mistake, and not just from a historical perspective. A Tory minister said it was a big favour made to Reform, the party that is challenging the Conservatives from the right.

These celebrations are occurring during the same days that the European elections are being held. As we discussed last week, extremist right-wing parties are re-emerging in European and may gain seats in the next EU Parliament. It is now more important than ever to remember that, if we can have this kind of election (a pipe dream for generations of euro-philes), it is exactly because the US liberal democracy prevailed over the odious European dictatorships. 

by Brunello Rosa

3 June 2024

This week, elections for the European Parliament will take place all across the continent, on different days. (This will however be a small undertaking when compared to the complexity of the 7 stages of the ongoing Indian elections). While the EU parliament still has limited powers compared to national parliaments, it does have the power to approve or reject the next EU Commission President. The EU Commission proposes, together with the Council, the vast majority of the legislation in place in EU member states. A rejection by the EU parliament therefore provides a strong political signal to national governments, potentially influencing their negotiations for the composition of the EU executive branch. 

The European political landscape is slightly less fragmented than are those of its national components. Parties are required to gather MEPs from at least seven countries in order to form a political group in the EU parliament. This forces MEPs to make compromises in order to be part of a group. In the EU parliament, MEPs belong to one of the following groups: radical left (the Left), Socialists and Democrats (S&D), Greens, Liberals, Christian Democrats (EPP), Conservatives and Reformists (ECR), and radical right (Identity and Democracy, ID). Traditionally, the governing coalition derives from a cohabitation of the EPP and S&D. In 2019, the coalition was enlarged to include the Liberals (Renew Europe) led by Macron. 

For the next parliament, the big political bet is the attempt by right-wing parties to form a centre-right coalition with the EPP, pushing S&D and Liberals into the opposition. According to the latest polls, this seems unachievable; it is much more likely that we will see a repetition of the previous coalition with EPP, S&D and Liberals. 

After the election Ursula Von Der Leyen herself became Commission President instead of Manfred Weber, the Spitzenkandidat of the EPP back then. Who is going to be the president of the Commission that will grant this political equilibrium? According to the method of the Spitzenkandidaten, the leader of the party that gets the most votes in European Parliament become the Commission President. So in theory it should be Ursula Von Der Leyen again. However, in 2019 things didn’t go that way. 

However, the EPP would like to re-balance the coalition towards the right side of the political spectrum, to make sure that the next Commission does not become hostage of the votes of the Greens and the extreme Left. For this reason, Von Der Leyen would like to receive the votes from at lest one component of the ECR, the one led by Giorgia Meloni, the Italian Prime Minister. A valid argument the EPP is making is the following: while the European parliament is moving progressively towards the right, the majority expressed by this parliament has been increasingly “progressive”, because the right-wing parties (led by Marine Le Pen, Matteo Salvini, Santiago Abascal, etc.) are considered “unelectable” for their extreme and anti-European views. This fracture between the “will of the people” who elected those right-wing leaders, and representation at the EU level, risks becoming pathological, and it will eventually lead to a deep political and institutional crisis.

However, French President Macron and German Chancellor Scholz have warned Von Der Leyen that if she insists on seeking votes from right-wing parties, she may not get re-appointed as Commission President, and she may suffer the same fate that Weber faced five years ago. A possibility therefore is that Von Der Leyen will get re-appointed but then her Commission will be voted down by the EU parliament, opening a political crisis of vast proportions that could lead to new political scenarios difficult to imagine at this stage. 

In any case, it is obvious that the EU, with two wars at its doorstep, is about to face an existential challenge. The result of the next EU parliamentary elections could be the trigger for it.

by Brunello Rosa

27 May 2024

On Wednesday 22 May, in what is likely to be remembered as one of the most disastrous announcements in UK politics from a communication perspective, PM Rishi Sunak announced that Parliament was dissolved and general elections were being called for July 4th. This was also the day on which the latest inflation figures were released: CPI inflation had fallen to 2.3% y/y, from 3.2% previously. 

The inflation figures allowed Sunak to claim that he kept one of the promises made in the past, namely that he would reduce inflation back to more “normal” levels. The merit for this should however go mostly to the Bank of England, which increased its policy rates by 500bps in the space of about 18 months. Given the polls showing the Tory party trailing the Labour party by 22 points, a heavy defeat for the Tory party is likely. Sunak therefore had to choose the moment in which the Tory party could flag a victory, hoping to minimize the damage. 

In a country with a first-past-the-post electoral system, the real question is how a lead in the polls will translate into a parliamentary majority. In a 650 seat House of Commons, the numerical majority is 326 MPs. As Peter Kellner reminded his readers in a recent article for The Times, Sunak may also win with 315 seats, if the Democratic Unionist Party (DUP) agreed to enter into a coalition with him, as they did with Theresa May in 2017 – and assuming that the Sinn Fein’s MPs continue to boycott the UK Parliament. 

For Labour’s Keir Starmer, forming an anti-Tory coalition is easier. Depending on how many MPs are elected by the Liberal Democrats, Scottish National Party, the Welsh Plaid Cymru, Greens, and Northern Ireland’s parties, Starmer may be asked to form a government with as little as 270 Labour MPs. But how long would such a minority, or coalition, government last? 

The truth is that Labour will need at least 340 seats to make sure it can stay in power for five years. Some pollsters expect a landslide victory for Labour, similar to the one that catapulted Tony Blair to N.10 Downing Street in 1997. This may not necessarily be good news. Given the tradition of in-fighting and splintering by left-wing parties, especially during periods of war, a “too-large” parliamentary group may convince the fringes to break up with the rest of the party, putting Labour’s parliamentary majority at risk. 

In terms of policies, Labour has recently launched the idea of “Securonomics,” which was recently presented at Chatham House by the Shadow Chancellor Rachel Reeves and the Shadow Foreign Secretary, David Lammy, taking inspiration from Joe Biden’s administration. 

"Securonomics" is a political strategy seeking a synergy between economic and foreign policy to make sure the UK will be resilient to future economic and geopolitical shocks. Lammy has spoken of putting economic prosperity and resilience at the centre of the FCDO’s objectives, if he were to take that role, within a foreign policy doctrine that he labelled “progressive realism.” 

The Tories have very little to defend, in terms of legacy. Their major contribution has been “Get Brexit Done,” as the slogan by Boris Johnson said. But the number of people in the UK that believe that Brexit was a mistake reached 55% recently, with only 31% thinking it was a good idea, thus signalling that it is not going to be a very popular electoral campaign argument. Sunak’s decision to re-instate compulsory national service was not well received by his fellow party members either. This electoral campaign should be aimed at damage control for the Tory party. 

by Brunello Rosa

20 May 2024

The war in Ukraine started in February 2022; it has lasted for 815 days thus far. There have been ups and downs, as there are in any long-lasting conflict, but two elements seem quite clear. First, the counter-offensive attempted by Ukraine, which was carried out in the spring-autumn period of 2023, largely failed to achieve its objectives. Second, the Russian army has made advances since the end of the Ukrainian counter-offensive, as epitomised by the fall of Kharkiv region back into the hands of the Russian army. Ukrainian President Volodymyr Zelenskyy, commenting on this development, said he now fears that the new Russian offensive is only “the first wave” in what will be a brutal summer.

Given the situation, can “the West” (i.e. the US and its European allies) win this war? If by winning one means pushing back the Russian army outside of where the borders of Ukraine were before February 2022, and – even more so – out of Crimea, which was occupied in 2014, this seems to be very unlikely. Especially if the West continues to consistently invest many fewer resources into the war than Russia is doing. 

As Russian dissident Mikhail Khodorkovsky said in a recent post, Russia invests more than 5% of GDP in military expenses related to the war in Ukraine. Indeed, as we discussed in a recent column, Putin has transformed Russia into a war economy. Europe’s aid to Russia amounts to EUR 88bn, or 0.25% of EU’s GDP. When taking into account the US contribution, Russia still outpaces the West by a ratio of 2.5 to 1. In the many months that it took US Congress to approve the USD 61bn aid package to Ukraine, this ratio jumped to 4 to 1. As we discuss in our recent report, this “foreign aid” security package aimed at helping Ukraine, Israel and Taiwan is in fact a massive expenditure package in favour of the US military industry. Only USD 8bn out of the total 95bn will go “abroad” – the rest will be spent domestically to build weapons that will eventually be exported

The situation is even worse if one considers that, while Western support for Ukraine is wavering in many countries, the Chinese support being given to Russia seems to be consolidating. China’s President Xi recently warmly welcomed President Putin in Beijing, in what seems to be a periodic appointment to confirm and reinforce the “limitless cooperation” between the two countries. This happened just a few days after Xi visited Europe, in an attempt to divide and conquer the EU.

Last but not least, Putin and Xi can still count on the option value of waiting for a potential success by Donald Trump in the US presidential election in November, which would further divide the Western front and further weaken the support being given to Ukraine. Political scientist Ian Bremmer recently summarised all this by saying: “Ukraine is going to be partitioned. The best-case scenario is that they lose a significant amount of their territory, but at least they can defend the rest with help from the Europeans and Americans, and they can join the EU and get security guarantees and rebuild their country. That’s the best-case scenario. The worst-case scenario is a lot worse than that.” 

by Brunello Rosa

13 May 2024

The Bank of England concluded the April-May cycle of major central bank meetings last week, confirming that a new phase is about to begin. Already in March, the Swiss National Bank (SNB) was the first to cut rates in developed markets in this cycle, from 1.75% to 1.5%. Last week the Swedish Riksbank followed the SNB, cutting its repo rate from 4.0% to 3.75%. 

As we discussed in our review, the Bank of England has already opened the door to a cut in its Bank Rate in June, although such a move cannot yet be considered a done deal. As governor Bailey said, it’s neither a “fait accompli”, nor an event that can be “ruled out.” A key issue will be the inflation and labour market data of the next two months; two full sets of data will be available before the 20th of June, with the second inflation release being scheduled for May 19th, the day before the MPC meeting. In May, the April CPI inflation figures will show a large drop from the current 3.2% due to base effects, but the May figure released in June may show an upward surprise that could convince the MPC to wait until August before announcing the first rate cut of this cycle. Additionally, Bailey may want to achieve a larger consensus and prefer to wait six more weeks rather than push through the MPC a decision with a razor-thin majority.

Also in Europe, as we discussed in our recent review, the ECB is considering its first 25bps rate cut a fait accompli, and it is clear that all the discussion within the Governing Council (CG) at the moment is about the Bank’s next moves. The doves within the GC would prefer to cut rates at every meeting until December, to bring the deposit rate to 2.75%.  

On the other hand, the hawks would rather reduce the number of rate cuts to a minimum, perhaps to only two by the end of the year. As usual, a compromise will be reached, and three cuts by the end of the year are likely warranted. Data will tell if there is space for an additional rate cut in the next seven months. 

On the other side of the pond, the US Federal Reserve has instead made clear that this is still no time to start cutting rates. The domestic economy in the US is still too strong, in spite of its recent deceleration, and its labour market too is robust (in spite of the recent relative softening) to begin an easing phase. We are now looking at the second half of the year to see the Fed start to cut rates, which it may do twice before the end of the year. On the other hand, we believe that the view that foresees the Fed hiking rates, instead of cutting them, is unfounded. 

Finally, finishing our tour of the major central banks with a jump to the other side of the Pacific, the Bank of Japan is in a totally different phase compared to those of Europe or North America. After having ended its negative deposit rate facility and its Yield Curve Control policy, it is now in its tightening phase. The market would have expected more action from the Bank to have taken place since March, but instead the BoJ has remained prudent about its next moves; it is still unconvinced about the sustainability of inflation above the 2% target over the medium term. This has caused the Yen to depreciate further since the policy action took place, forcing the Ministry of Finance to supposedl) intervene in the market, so far unsuccessfully. Only a real change in tack in the policy stance (relative to the Fed’s) could convince market participants that the Yen will not depreciate further.

by Brunello Rosa

7 May 2024

This week, Chinese President Xi Jinping returns to Europe after five years of absence. There have been several interpretations about his trip, but this gives us the occasion to step back and make a broader assessment about China and its position in the world. In fact, in the last few years, the rise of China has been a dominant theme in geopolitical and macroeconomic debates. According to the calculations by Angus Maddison, since the 1990s China has been returning towards its historical average of generating 25-30% of global GDP. Already in 2014, China became the largest economy in the world (albeit not the “richest” in terms of per capita GDP), surpassing the US in PPP terms. 

Economic dominance has always been associated with geopolitical influence, and for this reason, there is an ongoing “Cold War” between the incumbent power, the US, and the rising challenger, China. Harvard scholar Graham Allison has wondered whether the US and China will fall into a “Thucydides Trap,” i.e. whether they are “destined for war” and will eventually have to clash militarily, as has occurred in 12 out of the 16 historical cases of rising powers analysed by Allison. 

This succession of countries taking the leadership of the world is not new. German philosopher Georg Wilhelm Friedrich Hegel, in the 19th century, said that dominant countries, from a “civilisational” standpoint, passed one another what he called the “Weltgeist,” or “world spirit.” In effect, almost 5000 years ago, the Chinese civilisation was the most developed in the world, from a technical and political organisation standpoint. The Weltgeist then moved to the Middle East, with the Mesopotamian civilisations, and then to the Egyptians. The Greeks and the Romans followed, in ancient history. 

In more modern history, the UK took over France and the Netherland’s leadership in the 17th century, and kept it until the dawn of the 20thcentury, when the US had to intervene twice in the European affairs to save the continent from German domination. Around 100 years later, a new country seems ready to take the helm again, and this would mark the return of the Weltgeist to the far East. There is a peculiarity in this passage that we want to explore in this column. 

First, the US is certainly in the declining phase of its leadership. In functions, the first derivative indicates the direction (“growth” vs “decline”) while the second derivative indicates the speed (“acceleration” vs “deceleration”). As we discussed in a previous column, if Trump were to win, this would mark in our opinion the end of the US liberal-democracy, and therefore an acceleration in the declining process. Generally speaking, rising powers take over old powers with both first and second positive derivative, indicating the fact that they are in the accelerating phase of their ascent.

From a demographic as well as socio-political perspective China is already in a decelerating phase of its own ascent. The decision by Xi to change the Constitution to remain in power for life marks an involution, rather than an evolution of the political system, and the beginning a negative second derivative of “China’s rise” function. It is very peculiar for a declining power to give up leadership to a country that is close to peaking in terms of economic and social organisation. This could make China the leader of its “portion” of the world, rather than a global hegemon. 

This leads us to the second point. A world in which there may be a series of regional, rather than global, hegemons, is not – as some optimistically point out – poly-centric, but rather is chaotic. In the history of humanity, the passages of the Weltgeist from one hegemon to the next have caused wars and instability. In a multi-polar world, the chances for conflict may increase exponentially. 

by Brunello Rosa

29 April 2024

In the middle of WW2, a series of international conferences posed the basis for the economic and geopolitical post-war period: Tehran (December 1943), Bretton Woods (July 1944), Yalta (February 1945) and Potsdam (July 1945). Less known, but equally important, are two treaties that delivered the international security architecture that has lasted until today. On 4 March 1947 France and the UK signed the Dunkirk treaty of mutual military assistance, for cases of aggression from external forces (with Germany or the Soviet Union being top of the list). And, crucially, the Western Union treaty was signed in Brussels on 17 March 1948, between the UK, France, Belgium, the Netherlands and Luxembourg. 

The Brussels treaty, scheduled to remain in force for 50 years, established cooperation amongst its five signatories in the military, economic, social and cultural spheres. The Brussels treaty is the embryo of the subsequent North Atlantic Treaty Organisation (NATO), of April 1949, with the US joining the alliance and its expansion to other European countries as well as Canada. While the US has always had a predominant role in NATO, its embryonic form dates back to the Brussels treaty and its mastermind was Ernest Bevin, the UK foreign secretary, so one can credibly argue that the US in fact “joined” the organisation, which still today is based in Brussels and has always been led by European leaders. 

Following the birth of NATO, the global security equilibrium has been based on the credibility of its “Article 5,” which stipulates that an aggression against any NATO country would entail the response of all the others, in particular the US (which had guaranteed its nuclear umbrella). Just as the US fought on two fronts during WW2, so NATO has “stabilised” the trans-Atlantic front, while the nascent QUAD is replicating the same approach towards the Pacific. For this reason, the US has de-facto extended “Article 5” to the Pacific, with the promise that if China invaded Taiwan, this would trigger a US response (in spite of the official “One China Policy”).

This long background analysis is necessary in order to make two assertions. First, the threat that the US may “leave” NATO is a credible one, if a US president were to decide to pursue it. Clearly, from a practical standpoint, if the US were to leave NATO, this would mark the end of the alliance, which would not have the means to support its aims, considering that the US spends in defence as much as the next 10 largest-spending countries summed together, including China, Russia, India and Saudi Arabia. But from a legal standpoint, the US may leave NATO, thus forcing all the other countries to multiply by a large factor their military spending. 

Second, the credibilityof Article 5, even more than its existence, is the cornerstone of the global security equilibria, both in trans-Atlantic and trans-Pacific terms. If the US were no longer perceived as ready to intervene to defend a European country under attack, or to defend Taiwan in case of a Chinese invasion, then the geopolitical rivals of the US would easily “catch their prey.” There is even a cross-reading between the two sides: the US cannot credibly be said to be willing and able to defend Taiwan at any cost on the Pacific front if it does not demonstrate a willingness to defend a European country within its sphere of influence from Russian aggression, with Ukraine being the example at hand. Hence, the inevitability of the approval of the latest USD 95bn military assistance package deliberated by the US Congress, despite months of posturing. 

In this way, isolationism in the US is not compatible with the responsibility of being the ultimate guarantor of the world’s geopolitical equilibria.  

by Brunello Rosa

15 April 2024

Last week, the 2024 IMF-World Bank Spring Meetings took place in Washington, DC. The meetings occurred at a time of heightened geopolitical tensions, with the counter-attack by Iran into Israeli territory for the first time in history taking place just before the meetings began, and the retaliatory response by Israel, with the bombing of a military base near the central city of Isfahan, carried out on Friday morning on the last day of the meetings. 

On the other hot geopolitical front, the US House of Representatives has finally approved a USD 60.1bn financial and military aid to Ukraine (as part of a broader USD 95bn military aid package, which includes Israel and the Indo-Pacific) that has been blocked for months by the opposition of the Republican party. This comes at the same time as the Biden administration has proposed a compromise solution about seizing Russian assets to finance Ukraine’s resistance, as we discussed in our column last week. 

During these same days, the US decided to re-impose sanctions on Venezuela, albeit with some important carve-outs, given the lack of progress, or even backtracking, of President Nicolas Maduro in organising “free and fair” elections, in which candidates of the opposition had at least the theoretical chance to win. 

On the macroeconomic front, the IMF certified that the global economy is, basically, “Steady But Slow” with “Resilience Amid Divergence.” The latest edition of the World Economic Outlook (WEO) kept the forecast for global growth in 2024 unchanged at the disappointing level of 3.2%, the same as in 2023 and as expected again in 2025. The US economy is seen accelerating in 2024 to 2.7% compared to the 2023 growth rate of 2.6%. The Euro area is also seen accelerating from 0.4% in 2023 to 0.8% 2024, but this still represents less than a third of the US’ speed. Further confirming this divergence is the deceleration that the IMF sees for the largest EM economies, China (from 5.2% in 2023 to 4.6% in 2024), India (from 7.8% in 2023 to 6.8% in 2024), Brazil (from 2.9% in 2023 to 2.2% in 2024), Russia (from 3.6% in 2023 to 3.2% in 2024) and Mexico (from 3.2% in 2023 to 2.4% in 2024). 

Inflation is clearly on a downward trend globally, but the recent rise in oil prices due to increased geopolitical tensions in the Middle East risks creating another bump in the descending dynamics of headline inflation. So the real question is: will central banks “look through” this potentially “temporary” increase in inflation, or will they fear that this may represent a stop in its positive trajectory? Theoretically speaking, if other shocks are not added to this one, the major central banks may conclude that a short-lived revitalisation of inflation does not fundamentally change the picture, and they may carry on with their intention of starting to reduce some of the monetary restrictions that have been introduced in the last couple of years. 

Given all of this, markets may find some reason not to be too scared. Some monetary easing is on the way, although probably less than had been anticipated at the beginning of the year. Lower short- and longer-term yields should provide some relief to both fixed-income products and equity prices over the spring-summer period.

by Brunello Rosa

15 April 2024

Press reports suggest that during the upcoming IMF/World Bank meeting a new proposal will be made by the US administration regarding the potential use of Russia’s frozen assets to finance Ukraine’s resistance. Let’s recap the current position. 

On the one hand, according to the US, the roughly USD 300bn in frozen Russian assets should be seized and used to finance Ukraine’s military efforts. This could be particularly relevant as the House of Representatives, now led by the pro-Trump Speaker Mike Johnson, is refusing to ratify the new financial aid approved by the Senate, where the Democratic Party still holds a majority. Even the UK foreign minister David Cameron has flown to the US to try and convince the Republicans, including the de-facto presidential candidate Donald Trump, to unlock these funds, which could prove vital for the survival of Ukraine. 

So, according to this line of thought, considering Russia’s illegal invasion of Ukraine, the US and its allies (let’s call them “the West”) should simply seize the assets, then use the proceeds from the potential sale to buy the weapons Ukraine so desperately needs to resist the spring-summer 2024 offensive that Russia is about to launch to get as close as possible to Odesa and Transnistria. Opponents of this view fear that if the West reacts to an illegal action by Russia with an equally illegal action such as the arbitrary seizure of Russian frozen assets, the West would lose its purported moral superiority, which is necessary for the US to continue to be an effective global financial centre led by the rule of law. 

On the other hand, there are the Europeans. Most of the frozen Russian assets are in the EU, including roughly EUR 190bn of Russia’s central bank assets that are held at Euroclear, a central securities depository based in Brussels. These assets have generated EUR 3.85bn in profits since the beginning of the war in Ukraine. 

EU countries had been discussing the possibility of deploying these profits to support Ukraine. The Europeans believe that authorities should not seize the entirety of the assets, but only the returns deriving from them. This is to avoid breaking international law and confidence in Western financial markets.

As a potential solution, the Biden administration is proposing a compromise. The West would only seize the profits from the assets, but will be able to collect the discounted Net Present Value of these profits through financial instruments such as loans that will be repaid over the next 15-20 years. This would allow them to respect international law, while “super-sizing” the value of these income flows over time. The US administration hopes to put this proposal on the table at the upcoming IMF/World Bank meetings that will be starting this week in DC, and to get a final approval by the G7 meeting in Italy in June. 

Apart from the technicalities, the West needs to be wary about arbitrarily seizing Russian assets. No one denies that the aggression on Ukraine, apart from being brutal, is also illegal and unjustified. But the West has the responsibility of keeping a world order that is rational, just, and governed by the rule of law, not the whims of a dictator, as occurs in Russia or the China-led bloc. In particular, at a time when the de-dollarisation process is in full swing, the West needs to show that assets held in the West are safe and cannot be arbitrarily seized. Otherwise, the West may win a battle, but ultimately lose the war over which economic and financial system should prevail in the medium term. 

by Brunello Rosa

8 April 2024

The 35th edition of the Ambrosetti Forum, discussing “The Outlook for The Economy and Finance” took place on the shores of Lake Como last week. As usual, this was an occasion for policymakers, market participants, academics, advisors and pundits to discuss the most pressing issues of the global economy, in terms of macroeconomic scenarios as well as technological and geopolitical developments. The key takeaways of this edition of the forum were the following.

First, from a macroeconomic perspective, the global economy is more stable than was feared a year ago, when a recession in a number of key developed markets and emerging economies seemed inevitable. The US managed to achieve the sought-after soft landing; it could even be said that the US economy continues to fly, and so remains in a “no-landing” zone, as we called it in our 2024 Global Outlook. The Eurozone economy meanwhile is very weak, and has experienced a technical recession in some countries, such as Germany, and yet one could characterise the current cyclical phase as stagnation rather than recession. In non-Eurozone Europe, such as in the UK, there was a technical recession at the end of last year, but the much-feared five consecutive quarters of economic contraction that were predicted by the Bank of England to occur in 2023-24 did not materialise. 

Among the largest economic areas, China is the one that poses the most cause for concern. In 2023, the economy expanded 5.2%, just a tad higher than the 5% targeted by the government, however its potential growth continues to decline. This is due to the bust in the real estate sector, which represents almost a quarter of the economy and could lead to what Richard Koo calls a “balance sheet recession,” possibly resulting in a decade of stagnation while economic agents repair their balance sheets (similar to what Japan suffered in the 1990s). If the government continues to refuse to provide fiscal stimulus, the economy will likely continue to face the Middle Income Trap, as recently discussed by Nouriel Roubini on his return from China Development Forum. 

Second, inflation is falling everywhere, and only a recent increase in oil prices could lead to a rise in headline inflation. As long as central banks consider this to be a truly “temporary” phenomenon, they could look through it and proceed with the beginning of their monetary policy easing cycles. In the US, the recent encouraging data from the labour market (with 303K new jobs added in March alone) suggest that the Fed may need to wait longer before cutting rates. The ECB seems on track to begin its easing cycle in June. The Bank of England is still facing persistent inflation, and therefore the first rate cut is “some way off.”

Third, in spite of this relatively benign macroeconomic backdrop, geopolitical risks continue to abound, and could pose a threat to the durability of such a moderate economic scenario. The two open wars, in Ukraine and Gaza, are nowhere near their end. Russia, which just launched the recruitment of 150,000 additional soldiers, will likely launch a large-scale offensive in Ukraine in the spring/summer. In Israel, the current operation against Hamas will not change tack until PM Netanyahu is ousted, something that seems to be easier said that done. Other risks that participants feared were the re-election of Trump as US president, an intensification of the attacks by the Houthis in the Red Sea, and the re-opening of the skirmishes in the Strait of Taiwan.

In September, the 50thedition of the summer version of the Ambrosetti Forum, discussing the “Intelligence on the World, Europe, and Italy” will take place, and that will be an occasion to re-evaluate these assessments regarding the macroeconomic environment and geopolitical risks. 

by Brunello Rosa

2 April 2024

In our latest column we discussed how Russia is becoming a “war economy” under the influence of its “czar,” the newly re-elected president Vladimir Putin. We also said that the recent terrorist attacks in Moscow will accelerate this process. This week, we want to discuss in detail this key link between these two events and other European countries’ reaction to them. 

On March 22nd, a group of gunmen perpetrated an attack at the Crocus City Hall theatre, in the outskirts of Moscow, where at least 139 people were killed. This episode resembles a similar attack perpetrated in Paris in November 2015, at the Bataclan music venue. The massacre was claimed by a cell of ISIS-K, a segment of the wider ISIS/ISIL organisation, which we discussed in our recent article on Iran and its neighbours. This group draws some inspiration from the revanchist sentiment prevailing in the South-Western region of Russia, deriving from the wars that Putin carried out in the early 2000s against the separatist groups in Chechnya. 

Every nation subject to similar attack would naturally increase its domestic security defenses (as happened in the US post-9/11 and in France during the Hollande presidency), which in itself would contribute to the re-militarisation of that country, which is already underway given the ongoing war in Ukraine. 

For most leaders, this would be enough, but not for Putin. While the paternity of the attacks was clear –the arrested gunmen were all from Tajikistan, and ISIS-K was vary vocal in claiming the attack – Putin wanted to make sure to blame Ukraine and its Western allies, and so he and his “leadership team” openly said that the attack was orchestrated by the US and British secret services in collaboration with Ukraine. 

Western countries dismissed the ludicrous claim, but also fear that Putin is looking for pretexts to launch an offensive, possibly on NATO countries. Press reports suggest that Biden fears for a possible attack on one of the Baltic countries, such as Lithuania, which is one of the countries bordering on Russia’s Kaliningrad enclave, near Danzig. As a result, the leaders of Estonia and Latvia, the two other Baltic countries and former Soviet Union republics, said that national military conscription should be re-instated in Europe. 

This is coming at a time when France, with its president Macron, is being very vocal about the necessity of NATO deploying its soldiers in Ukraine while also leaving some diplomatic channels with Putin open. And when the long-waited F-16 fighter jets are being cautiously given to Ukraine, starting with the first six planes (out of 45 approved), which are to be delivered in coming weeks. This is also coming at a time when the EU is discussing the issuance of euro-bonds to finance a joint defence budget. 

It seems that the rise of a common “enemy at the gates” is finally pushing the European countries to start acting as a unified political entity. Paradoxically, after having already achieved the unintended consequence of revitalising NATO and increasing its membership to include historically neutral, neighbouring countries such as Sweden and Finland, Russsia may now also be unifying Europe around a joint cause, instead of destroying it from within with the usual tactics of “divide and conquer.”

by Brunello Rosa

25 March 2024

On 15-17 March, presidential elections were held in Russia. As we have discussed on numerous occasions, the Russian elections were one of the three key elections taking place in 2024 in Emerging Markets. As discussed in previous columns, elections need to be closely watched even in electoral autocracies such as Russia, because they may reveal important insights regarding the state of the autocracy itself. 

For example, in our column of 19 February we said that the following four elements deserved close scrutiny: (a) the turnout: on this occasion it was 77.5%, almost 10% higher than in 2018. This is a very high percentage by any standard, and certainly it was “incentivised” by the Kremlin; (b) the number of contenders: after the killing of the real opponent Aleksej Navalny, and the disqualification of the anti-war candidate Boris Nadezhdin, the only other candidate was Nikolay Kharitonov, from the Communist party, who gathered a meagre 4.4% of votes. 

Also, (c) the actual result: Vladimir Putin collected an astonishing 88.5% of votes, which again is very elevated by any standards. The use of the electronic vote for the first time in a presidential election must also have contributed to the result, as it adds a layer of opacity; finally, (d) the regularity of the electoral process: This is where we know for sure that this election was rigged: there were widespread and clearly visible reports of all sorts of irregularities, from armed guards entering voting booths with electors inside, to packs of pre-voted ballots clearly visible at the bottom of the transparent ballot boxes.

What have we learnt from all these elements? First, Putin’s regime is solid, and aims at remaining in place for at least six more years, if not twelve (if Putin runs again in 2030, something he can do after the change to the Constitution he made). 

At the same time, Putin is also scared that the situation may get unexpectedly out of hand: the killing of Navalny and the disqualification of Nadezhdin showed that the regime did not want to take any chance regarding the re-election of Putin, which had to be a plebiscite. 

At the end of the day, Putin achieved what he wanted: being re-elected as supreme leader of Russia for at least six more years, and claiming that this occurred thanks to popular support. What is he going to do with such a corroborated power?

In his latest speeches, Putin and his accolades have made it clear that Russia is preparing for a long war, not just with Ukraine, but with the wider EU community. For example, Defence Minister Sergei Shoigu has outlined the efforts recently made to increase Russia’s conventional military capabilities, with the aim of forming two armies, 14 divisions and 16 brigades by the end of 2024. So, the next phase of Putin’s presidency will be transforming the country into a “war economy,” which is also the only way to prop up economic activity when economic sanctions are biting. The terrorist attack by ISIS-K that hit Moscow last Friday will reinforce Putin’s intention to increase “militarise” the country. 

The combined effect of Russia’s transformation into a war economy and the possibility of Trump winning the US presidential race, and therefore de-facto ditching NATO’s nuclear umbrella over Europe, is pushing European countries to further push for a common defence, and to dedicate more resources to military expenditures. As Spanish newspaper El Pais said: Europe gets ready for war. 

by Brunello Rosa

18 March 2024

Towards the end of 2023, it appeared clear that the world’s major central banks were changing their tone. After increasing rates at an unprecedented pace over the previous year, in a de-facto coordinated fashion, the US Federal Reserve, the Bank of England, and the Eurozone’s ECB started to signal that additional interest rate increases may not necessarily be justified. 

The Federal Reserve, for example, “skipped” its rate increases in September and November, thus signalling that its “fast and furious” tightening cycle could afford at least a pause. Similarly, the ECB managed to “slot in” another 25-bps rate increase in September, in a decision that clearly divided the Governing Council, while saying that further hikes would be subject to additional scrutiny. The Bank of England instead skipped September, and in effect began its long pause in its tightening cycle, thus implementing what the Bank’s chief economist Huw Pill had labelled a “table mountain approach.” 

Subsequently, between January and February all three central banks removed their tightening bias, and started to signal that the next move will not necessarily be a rate hike. At the same time, they all warned that rates will need to be kept on hold for quite some time before a rate cut could be considered. As the market tends to get ahead of itself, it has started to price in an aggressive policy easing cycle, for example by suggesting that the Fed may be cutting rates six or even seven times in 2024 – way more than the three cuts suggested by the Fed’s dot plot – and the ECB at least five times. We warned that these aggressive expectations were not justified either by data or by central bank communication. 

In the last few weeks, the market seems to have come to terms with the reality that central banks will stick to what they had been saying for some time, namely that policy rates will need to be kept “high for longer.” In particular, the European Central Bank said last week that it will want to see more data on wage growth before making a decision on cutting rates, and that the bulk of those data will become available after the April meeting, making June the more likely time for the beginning of the easing bias. 

The Federal Reserve and the Bank of England will meet this week. As we have written in our preview, the Bank of England will likely take into serious consideration what its Chief Economist Huw Pill has said, i.e. that the beginning of the easing cycle could still be “some way off.” The market has interpreted these words by pushing back the time of the first rate cut to August 2024. The Federal Reserve faces a quite persistent inflation pressure deriving from a strong economy and a robust labour market, which could also imply a delay of the first rate cut. 

Among the major central banks, the BoJ remains the usual outlier: while all others are thinking to cut rates, it is now preparing the ground for finally exiting its extraordinary easy stance. That might occur as early as in April this year. 

by Brunello Rosa

11 March 2024

We have written several times about the upcoming US elections in the last few months. First and foremost, it is by far the most important and consequential of the several elections that will take place in 2024, “the biggest election year in history.”

We have discussed how difficult it is to replace Biden as the leading candidate for the Democratic camp, in spite of the several calls coming from different directions asking him to step down given (a) old age, (b) health-related concerns, and (c) the fact that he is trailing in the polls. For the time being he will remain the candidate of that party, unless the DNC finds a solid argument to impose an alternative at the Democratic Convention that will take place in August in Chicago.

On the Republican front, after Super Tuesday, in which 10 out of 11 states have chosen Trump and Nikki Haley stepped down as a contender, the former president has become the de-facto candidate of the Republican party to run the presidential race, which will be officially sanctioned by the Republican Convention that will take place in July in Milwaukee. 

So, it seems that the presidential race of 2024 will be a re-match of the 2020 electoral campaign. But is that really the case? For sure, unless the two leading candidates are substituted by others, for a variety of reasons, the two names are the same. But both candidates would act quite differently from how they have in the past, if re-elected. And both of them are likely to further radicalise their policy stance. 

Biden, if re-elected, would feel less constrained and – for example – would likely act more decisively on Israel, to stop PM Netanyahu and his massacre in the Gaza strip. Trump would further accentuate his isolationist positions, on both economic matters (epitomised by his “America First” approach) and geo-strategic issues (de-funding NATO and asking the Europeans to step up).  On the domestic front, Trump would “take no prisoners” and would likely conduct a total wipe-out of the much-hated “deep state,” in his “one day” of self-proclaimed “dictatorship.” 

So, both candidates would radicalise their differences, which are very evident in economic matters and geopolitics. While both candidates want to preserve the US role as centre of the international system, Trump wants to promote an autarkic approach based on “buy American, hire American.” Conversely, Biden’s Inflation Reduction Act promotes subsidies for companies from other countries (in particular, from Europe) that are willing to invest in the US. It is a de-facto subsidisation of energy and manufacturing exports not dissimilar to what the US does with NATO on the defence front. 

In geo-strategic terms, Trump pulled out of TPP, JCPOA and the Paris Agreement on Climate Change, while Biden has indirectly engaged NATO in the war in Ukraine as a prominent objective. When people say that “under Trump there were no wars,” they forget the wars that have emerged as a result of Trump’s decisions. For example, pulling out of the JCPOA has meant dis-engagement with Iran, in favour of separate agreements between Israel and selected Arab countries under the Abraham Accords. But this has made the rapprochement between Saudi Arabia and Israel, that the Biden administration was negotiating, subject to the whims of the Iranians. Unsurprisingly, with Iran out of the equation, the Hamas attack on Israel on 7 October 2023, and the Houthis’ attacks in the Red Sea, have taken place. 

It is hard therefore to imagine a more consequential election than the US presidential race of 2024, which can hardly be described as a mere re-match between Biden and Trump. 

by Brunello Rosa

4 March 2024

As we discussed in our article on 2024’s elections in Developed Markets, one of the major events of this year’s political landscape is parliamentary elections in the UK. After being in power uninterrupted since 2010, the Tory party now seems on the verge of ceding power to the Labour Party, led by Keir Starmer. 

The Conservatives have faced a rollercoaster over the past 15 years. First they had to enter a coalition with the Liberal Democrats led by Nick Clegg, as they did not have a majority in Westminster. Then they faced the Scottish independence referendum in 2014, which was narrowly won. At the end of the coalition parliament, they won the 2015 election with an unexpectedly large majority, which caused more harm than good. Prime Minister David Cameron had promised a referendum on EU participation in case of victory, because he thought that a coalition with the LibDems would be needed to have a majority in parliament as had been the case 5 years prior, and would prevent him from calling any such referendum. 

After obtaining a victory with a large majority for the Tory party, Cameron had to make good of his promise, and called the Brexit referendum, which resulted in a victory for the “Leave” camp, in June 2016. Since Cameron had campaigned for the UK to “remain” in the EU, he resigned, and was replaced by Theresa May. She called an election in June 2017, which turned out to be disastrous. Instead of increasing her majority in parliament, she was forced to enter a coalition with Northern Ireland’s DUP party. Her majority wobbled to the point that eventually Boris Johnson replaced her, and led the Tory party to a landslide victory in December 2019, to “get Brexit done.” Johnson himself was destabilised by the Covid crisis, and had to resign in 2023, when he was replaced by Liz Truss, the shortest-serving UK Prime Minister in British history, who caused a bond market rout in the space of 2 months after taking office. She was replaced by Rishi Sunak, Johnson’s Chancellor of the Exchequer, who has never been particularly popular. 

Meanwhile, the Labour Party has changed its face, and after shifting massively to the left, and recording the worst defeat since 1935 in 2019, has now moved back to the centre under the leadership of Keir Starmer, and is around 15-20 points ahead of the Tory party in the polls. The Conservatives will announce the budget on March 6th, and are ready to provide some fiscal giveaways such as a reduction in the income tax or a reduction in national insurance contributions. This will be the case even if Chancellor Hunt says that the UK will still need to wait before seeing a substantial easing of its fiscal stance. Press reports suggest that the Tory party is ready to “steal” some of the key policies of the rising Labour Party (such as a reform of the resident, non-domiciled fiscal regime) to finance these fiscal giveaways. Some speculate that a “sweet” budget may pave the way for an early election, possibly in May. 

Meanwhile the Bank of England is facing the dilemma of a slowing economy and a persistent inflation rate, which remains at 4%. For this reason, the MPC has recently voted with a three-way split, with some members voting for a hike, while other preferred a cut, with the majority imposing another month of “no change.” The BoE’s Chief Economist Huw Pill said that in his opinion rate cuts are still “some way off.” So, both monetary and fiscal policies cannot be as easy as is desirable, while policy uncertainty and political noise will keep investors wary of UK assets. 

by Brunello Rosa

26 February 2024

On 24 February 2022, Russian troops formally begun the invasion of Ukraine, eight years after the illegal annexation of Crimea, which had been “approved” by a manipulated referendum among the local population. Vladimir Putin wrongly thought that this could be a “blitzkrieg,” perhaps forgetting that even the German “original” in the 1940s didn’t work. In fact, the attempt to conquer Kiev and decapitate the Ukrainian government within days – and likely eliminate its president Vladimir Zelensky, in what was labelled at the time as “operation Z” – miserably failed. 

The resistance of the Ukrainian troops, who were better prepared than their Russian counterparts and had immediate support from Western countries, was able to push back the initial Russian offensive. Within months, Russia had to change its objectives, and focus only on the south-eastern regions of Donetsk, Luhansk, Zaporizhzhia, and Kherson, which were formally annexed to the Russian Federation after fake referendums.

In the spring and summer 2023, the long-awaited Ukrainian counter-offensive began, but its results have been underwhelming. The Ukrainian troops managed to push back the Russian army only to a limited extent, while in effect giving it time to re-trench and further in-trench in the southern-eastern regions where it was already present. In November 2023, the Ukrainian general Valerii Zaluzhnyi had to admit that the war was a "stalemate". The last couple of months, in which winter has led to a relative pause in the fighting, have seen Russian troops making some progress, for example conquering the strategic city of Avdiivka, after the Ukrainian army “withdrew to preserve soldiers’ lives.” 

Western support to Ukraine has been large, and unprecedented for a non-NATO country to receive. The largest contributors have been the US (USD 74bn in total, including military, financial and humanitarian aid), the EU (with over EUR 82bn in overall aid, especially financial) and the UK, with GBP 12 billion pledged, of which GBP 7.1 is military assistance. 

The EU has recently approved another package of €50 billion of reliable financial support for Ukraine until 2027, although the gap between EU commitments and allocations remains very large (€144 billion committed vs. €77 billion allocated). Among the Eurozone countries, Germany has been by far the largest donor, with over EUR 20bn in aid approved. A few days ago, the US Senate has approved an additional USD 60bn package for Ukraine, but this still needs to receive approval from the House of Representatives, where the majority is controlled by sceptical Republicans. 

Where do we go from here? In theory, given the stalemate, this could be a favourable period for an agreement between the two sides. Like any agreement, it would be costly for both Russia and Ukraine, but could be effective. Ukraine would have to give up the 17% of the territory that Russia has conquered, and from which Russian troops would be hard to remove. In exchange, Ukraine would enter NATO immediately, and possibly also the EU. That way, Putin will have no incentive to re-start the war a couple of years from now, as he would likely do if an interim agreement was signed but Ukraine were not to enter NATO. 

However, Putin has the option of waiting. If, in November 2024, Donald Trump is re-elected President, Putin knows that he will not provide further military aid to Ukraine, thus allowing Russian troops to “finish the job.” Given Trump’s recent declarations on NATO – namely that the US may withdraw from it, or would not assist countries that don’t pay their 2% of GDP contribution – even if Ukraine were to enter NATO in exchange for part of its territory, this may not represent a stable equilibrium. Given these premises, the war is likely to last for at least another year.  

by Brunello Rosa

19 February 2024

In July 2023, we began a series of articles about the upcoming year of elections, to be held in 2024. Among the key emerging market elections we identified those in Taiwan, Russia and India as the most relevant ones. While the Taiwanese elections were clearly at the forefront of public attention, given the escalating tension in the Taiwan Strait as a exemplification of the Cold War II between the US and China, few people thought that the Russian election deserved any attention. “We already know who’s going to win, right?” was the typical objection. We took a radically different view. 

As V-Dem authoritatively states, there are four classified forms of government: liberal democracies (e.g. the UK), where elections are held, the press is free and the judiciary independent; electoral democracies (e.g. Turkey), in which elections are held, but the judiciary and the press are not free and independent; electoral autocracies (e.g. Russia), in which decisions are made by a restricted group of people that only formally is legitimised by non-free elections; and closed autocracies (e.g. China), in which elections are not held and decisions are made by a very restricted number of people who operate in a system in which powers are not divided and there is no freedom of information. 

In electoral autocracies such as Russia, elections are still a very important moment to watch, even if the result is known a-priori. They worth being scrutinised to ascertain: (a) the turnout: 50% is different from 90%, and tells a lot about the legitimacy of the autocrat; (b) the number of contenders: how many people dare to defy the incumbent autocrat? Are they real opposition leaders, or simply puppet candidates that are running only mask the charade? (c) the actual result: does the autocrat win with a plebiscite (90-95%) or with a lower majority? (d) regularity of the electoral process: how many “tricks” (incarcerations – or worse – of opposition leaders; electoral fraud; etc.), does the autocrat need to pull out in order to obtain the intended outcome? So, there is a lot of information that can be gathered about the state of an electoral autocracy from the election moment, even if the result is known ex-ante. 

In the specific case of Russia, it is known that Vladimir Putin will win the election. With the change in constitution he imposed to the Duma, which was later “legitimised” by a popular vote, this will allow him to remain in power for six more years, and then for another six years if he gets re-elected in 2030. Ahead of the March 15-17th presidential election, it was still unclear how many people would run against him, and whether they will be real opposition leaders. With the death of Alexei Navalny, we now know that there won’t be any real challenge to Putin’s regime. 

Navalny was a courageous leader who wanted to put an end to Putin’s autocratic rule. As such, he was already a victim of an attempted poisoning in August 2020, which he survived thanks to the healthcare he received in Germany. But in our opinion, he may have made a miscalculation. He thought that Putin was reaching the end of his road, and that the war in Ukraine would be the classic last straw that broke the camel’s back. As such, he decided to return to Russia where he was sure he would be incarcerated (in electoral autocracies, the judiciary is not independent from the executive power), given the number of trials awaiting him. 

He probably thought that this was a necessary step to become the next Russian leader, once Putin’s regime had collapsed. He probably had in mind the examples of Nelson Mandela, who spent his life in prison before being elected president when the apartheid was abolished in South Africa. And to some extent also the example of Deng Xiao Ping, who had been exiled by Mao during the Cultural Revolution, before returning as supreme leader when Mao’s generation of leaders disappeared. Obviously, things have turned out to be different in Navalny’s case.

Navalny’s death clearly shows that Putin’s grip on power in Russia is solid and unchallenged. But to some extent it also shows the fragility of the regime, which did not want to take any chance of allowing Navalny (or anybody else from his movement) to run against Putin, and start the coalescing a politically organised opposition movement. 

by Brunello Rosa

12 February 2024

The US electoral campaign for the US presidential election is starting to enter its crucial phase. In the Democratic camp, Joe Biden is so far the only candidate, being the incumbent president. In spite of this, a number of questions have been raised about his ability to effectively discharge his duties, given his age and mental state. The report of the special counsel Robert Hur, in charge of the investigation on the handling of confidential information at the time Biden was vice president under Barack Obama, defines Biden as a “sympathetic, well-meaning, elderly man, with a poor memory.”

Clearly, a younger and more energetic candidate would serve better the cause of the Democratic party, however changing the horse race nine months before the election day is an exceptionally high risk. Building a credible candidate in such a short period of time is a very complicated proposition. Having anybody running againstor even after Biden would be equivalent to admitting that Biden was not a good president, thus destroying his legacy; with all possible caveats, a strong economy with a robust labour market and the courageous handling of the war in Ukraine are certainly good feathers in Biden’s cap, even if the electorate seems reluctant to give him credit for that. 

Kamala Harris is not a viable option, for reasons already discussed. Some are suggesting that if Michelle Obama were to run instead of Kamala Harris for vice president, that could have a positive impact in the Democratic camp. Yet it would increase the suspicion that the Democrats are run by dynasties. So, the politics of changing Biden as Democratic candidate is more complicated than one might think prima facie.

The Republican camp is not necessarily in better shape. A clear winner of the primary election campaign is emerging, Donald Trump, but this may not lead to a final victory. For reasons discussed in greater detail below, Trump may be able to mobilise the base of the party, but he is also a candidate that scares the centrist component of the Republican electorate, the one that ultimately decides the vote in the general election. For this reason, the Democrats believe that Trump is the best candidate to run against, as he can convince even reluctant centrist Republicans to vote for Biden. 

Biden, having realised that Bidenomics is not a good argument to run on in order to win the sympathy of the median voter, has decided to transform the election in a referendum on the survival of the US democracy. We believe there is quite a bit of merit in this approach, for the following reasons. 

The US Constitution has evolved in the last two centuries to prevent leaders with autocratic tendencies from winning power and transforming the system from the inside to perpetuate their rule beyond the limits established by the Constitution itself. The 14th amendment, which prevents people who have supported insurrections from holding office, is a case in point. The Constitution does not want leaders with an organised militia to gain power and transform the US democracy into an autocracy, or even into a dictatorship. This amendment has been utilised in Colorado and in Maine to strike Trump out of the primary election ballot, and now this decision is being challenged in the Supreme Court. The case started on February 8th. 

This is only one of the many legal obstacles that Trump will have to overcome to win the primary election and eventually the run-off against Biden. If Trump manages to overcome all of them and to be elected president again, he already said he will be “dictator for one day”. But the reality is that he would radically transform the US political system from within, marking the end of the US liberal democracy. 

by Brunello Rosa

5 February 2024

Two different headlines appeared at the end of last week, coming from two sides of the world, seemingly unrelated to one another but in reality sharing a solid point in common. 

The Financial Times reported Donald Trump saying he would replace the Federal Reserve’s Chairman Jay Powell if he is elected President in November. He accuses Powell of being “too political”, and of planning to make a move that would help the Democrats ahead of the elections, i.e. cutting rates. As we discussed in our recent review of the January 2024 FOMC meeting, rate cuts are probably coming this year, as was already signalled in December, but this has nothing to do with political motivations. As we discussed in our global outlook, the US economy, while remaining resilient with a still-strong labour market, has started to feel the effects of the monetary tightening of the past 22 months, and therefore it’s about time for the Federal Reserve to start to ease its policy stance. 

But clearly Trump is trying to bully Powell as he did in 2018, when he was saying that Powell was keeping rates unnecessarily high. At that time, Powell resisted for as long as he could, but in 2019 the FOMC implemented 3 “precautionary cuts” as it thought that the US’ economic momentum was weakening. The intention of replacing Powell as central bank governor must be part of his plan of being “dictator on day one,” as he emphatically announced in December (thankfully he added “only on day one...”).  Given the US spoils system, this was the announcement of his intention to replace all the civil servants from the hated “deep state” that could potentially oppose his intention of ruling without constraints.  These intentions clearly signal Trump’s inclination to bend the US liberal democracy into an electoral democracy at best, and potentially into in an electoral autocracy, if he has enough time and energy to do so.

Examples of this behaviour are abundant. As the headlines from Turkey show, the recently-appointed central bank governor of the CBRT, the Turkish central bank, had to resign following a defamatory media campaign that lasted for weeks. Hafize Gaye Erkan, the bank governor, had increased rates from 8.5% in June last year to 45% recently, to prevent a further slide of the Turkish lira and attempt to stop the further increase of Turkey’s inflation, which had overcome the 80% mark only a few months ago, and now is above 60%, after briefly touching 40%. This must has sounded ridiculous to President Recep Tayyip Erdoğan, whose bizarre economic theory, dubbed Erdonomics, suggests that interest rate hikes cause a rise in inflation. Erkan will be replaced by deputy governor Fatih Karahan, a former Federal Reserve economist; he will be Erdoğan’s sixth central bank governor in five years.

These examples, coming from two different areas of the world, one in the developed Americas, the other from emerging Europe, show that autocrats, or wannabe autocrats, behave the same way no matter where they are found: they have little tolerance for critics and for independent authorities that could seemingly pose obstacles to their unconstrained rule. 

by Brunello Rosa

29 January 2024

In the middle of the January round of major central bank policy meetings, we can start making some preliminary conclusions. 

In Asia, the Bank of Japan has once again left its policy stance unchanged, providing no indication that a change in policy stance is imminent. Clearly the Bank’s new governor Kazuo Ueda and its MPC would like to eventually exit from the extraordinary easing measures introduced in the last few years, including Quantitative and Qualitative Easing (QQE) and Yield Curve Control (YCC) and negative rates. But inflation, which had finally gone above target in 2022 as a result of the pandemic, the war in Ukraine and the energy crisis, still does not provide enough reassurances of being able to remain close to target on a sustainable basis in coming years. 

In Europe, the European Central Bank has left its key policy rates unchanged, as well as its forward guidance and balance sheet policy. During its press conference President Lagarde said that the Governing Council found a consensus around the fact that it was “premature” to discuss rate cuts at this stage, when key figures around wage growth are not available yet. It may be premature to make public what its internal discussions are, but the reality is that the discussion has been ongoing for some time. 

The two extreme positions here are represented by Mario Centeno, governor of the Central Bank of Portugal, who would likely be in favour of a rate cut already in March, but could wait until April. On the other side of the spectrum, there’s Robert Holzmann, Governor of the Austrian central bank, who thinks that policy rates should not be cut in 2024. The consensus of the GC is likely in the middle of these extremes; as Lagarde hinted recently, probably favouring a rate cut in the summer. The market still attributes around 70% probability of a first rate cut taking place in April. We believe that Q2 is the correct compromise, possibly in April, almost certainly by June.

The Bank of England will hold its policy meeting this week. It is likely to keep its stance unchanged in February, but will likely need to change its forward guidance to show that the next move will likely be a cut in interest rates and/or a tapering of its balance sheet reduction plans. The updated forecast of the latest Monetary Policy Report will provide assistance to this process.

Finishing this world tour in America, the US Federal Reserve will also keep its policy stance unchanged at the FOMC meeting this week. But with inflation now back in check, the FOMC will need to start to remove its still-existing tightening bias. This could occur with a signal on rates with a change in forward guidance, or with a tapering of the balance sheet reduction.

From these preliminary considerations, it is clear that the unchanged policy stances of the various central banks are hiding heated discussion over their next moves, which we expect to occur broadly speaking mostly in Q2 this year, as we also discussed in our recently-published global outlook.

by Brunello Rosa

22 January 2024

Last week, the annual meeting of the World Economic Forum (WEF) was held in Davos, Switzerland. The meeting was convened under the theme “Rebuilding Trust,” and it brought together more than 300 public figures, including over 60 heads of state and government, as well as leaders from business, civil society, academia and media. The meeting addressed the most pressing issues facing the world, such as climate change, cybersecurity, artificial intelligence, global cooperation and economic growth.

During the proceedings, the WEF released its Global Risks Report 2024, which identified the five biggest risks facing the world in the next two years: extreme weather events, cyberattacks, social unrest, biodiversity loss and geopolitical tensions. The report called for urgent action to mitigate these risks and strengthen the global system of cooperation and governance. In our view, the four themes that featured highest on the agenda were: artificial intelligence, climate change, political and geopolitical risk, and central banks’ next moves. 

Regarding the first theme, artificial intelligence, the WEF launched the AI Governance Alliance during the forum, a global initiative to promote ethical and responsible use of artificial intelligence in various sectors and domains. The alliance aims to foster collaboration among stakeholders, develop common standards and frameworks, and support innovation and inclusion in AI development and deployment. This comes only a few weeks after the November’s meeting at Bletchley park in England, in which AI heads of state and government met to agree on a “responsible development” of AI. It also comes just a few months after the tumultuous exit and re-entry of Sam Altman from and then back into Open AI.

Partly related to this theme, the WEF published its “Future of Jobs Report 2024,” which analysed the impact of technology, automation and COVID-19 on the labour market and skills demand. The report projected that by 2025, 85 million jobs may be displaced by machines, while 97 million new roles may emerge that are more adapted to the new division of labour between humans and machines. The report highlighted the need for reskilling and upskilling workers in order to ensure a smooth transition to this new reality, and promote inclusive growth.

On the second theme, the WEF hosted several sessions on climate change, nature, and energy. The sessions focused on the implementation of the Paris Agreement, the transition to net-zero emissions, the protection of biodiversity and ecosystems, and the promotion of clean and renewable energy sources. As part of this and other efforts, the WEF also announced the creation of a “Global Resilience Network,” a platform to enhance the preparedness and response capabilities of countries and communities to cope with natural disasters, pandemics, conflicts and other shocks. The network will leverage data, technology, partnerships and best practices to build resilience across multiple dimensions, such as health, infrastructure, economy and society.

Regarding political risk, clearly everybody’s attention was focused on the result of the Taiwanese elections, which had just taken place the weekend before the meetings, and also on the upcoming elections that will be taking place through 2024, with the US elections featuring high on people’s concerns, for a potential return of Donald Trump to the White House. For geopolitics, there was a distinct sense of fear among the Forum’s participants about a potential extension of the Israel-Hamas to the entire Middle East. 

Regarding central banks’ next moves, the declarations by ECB President Lagarde regarding a possible rate cut in the summer took centre stage among market participants. But questions also arose about the timing of the first interest rate cut by all other major central banks. There was a broad consensus that Q2 2024 could be a reasonable compromise for both the Federal Reserve and the Bank of England. 

by Brunello Rosa

15 January 2024

In the long-awaited elections in the Republic of China (Taiwan), the ruling Democratic Progressive Party (DPP) won an unprecedented third term in office. Tsai Ing-wen, the incumbent President of Taiwan, was ineligible to seek re-election after serving two terms. Lai Ching-te, the current vice-President, will become President on May 20th. Lai’s running mate for the vice-Presidency was Hsiao Bi-khim, who is currently Taiwan’s representative to the United States. Lai gathered 40% of the votes, versus 33.5% for Hou Yu-ih from the Kuomintang (KMT), and 26.5% for Ko Wen-je from the Taiwan People's Party (TPP). 

At the legislative level, the results were less clear. Members were elected by parallel voting. 73 members were elected by first-past-the-post, 6 were reserved for indigenous candidates by single non-transferable vote, and 34 were elected via party-list proportional representation. The KMT won the largest number of seats (52), 14 more than in 2020, versus 51 for the DPP (down 11 seats from 2020) and 8 for the TPP (up 3 additional seats from 2020). No party has reached the 57 seats needed for a majority, so the DPP will be forced to either form a minority government and make compromises with the other two parties in parliament, or else to create a coalition with the TPP. 

As we discussed in our preview, the most relevant issue at stake was Taiwan’s relationship with China. China would have preferred a victory by the KMT, which is perceived as the party that pushes for the closer relationship with the “motherland” (somewhat surprisingly, considering that the Republic of China was formed in Formosa by Mao’s fiercest opposed, Chiang Kai-Shek, founder of and for decades the leader of the KMT). The incumber president Tsai Ing-wen has been a staunch defender of Taiwan’s autonomy and self-determination rights. 

For that reason, Chinese representatives said the result “shows that the DPP does not represent majority public opinion on the island,” given the lack of a majority for the DPP both at the presidential and parliamentary level. Additionally, the Taiwan Affairs Office, the Chinese government department that implements the Taiwan policy, said that both sides should “promote the great cause of the reunification of the motherland.” Just before the election, in his year-end speech, Chinese President Xi said that “the reunification of the motherland is a historical inevitability,” and that “China will surely be reunified,” to put pressure on the Taiwanese electorate.

What’s going to happen now? The fact that Lai won’t have a parliamentary majority means that any major re-armament plan will need to be agreed upon with other political parties, making any such plan less likely. China will not have any incentive to pursue aggressive moves (which we have always considered a tail risk event), but rather will continue with its strategy of destabilisation, which it is likely to intensify in coming months and years. 

Overall, this result keeps the status quo relatively intact. Given the alternative, this should be considered a positive outcome at this stage. 

by Brunello Rosa

8 January 2024

On October 7th, 2023, the world witnessed the massacre conducted by Hamas militias in Israel, in what was labelled “Operation Al-Aqsa Flood.” In subsequent weeks, the atrocities, including a number of gender-based crimes, committed by the Hamas militias emerged in the recounts of the surviving victims. After an initial hesitation, and after various attempts by world leaders, including the US president, to dissuade Israel’s prime minister, Israeli troops entered the Gaza strip in early November and began their land operations, aimed at – possibly – eradicating Hamas.

At that point, the conflict remained confined to Israel, with Hezbollah from Lebanon not joining Hamas in its attack into Israel. Behind an incendiary rhetoric, Hezbollah leader Hassan Nasrallah remained vague and refused to engage in what he described as a “Palestinian” action. We noted the risk that Russia could enter the conflict with a mediation role, pretending to be the only actor that could convince Iran (which finances both Hamas and Hezbollah) not to enter the conflict. At that point, the conflict seemed to remain localised, and unlikely to escalate even at the regional level .

However, in the last few days, a series of events occurred that made an extension of the conflict in Gaza between Israel and Hamas more likely. First of all was the assassination of Saleh al-Arouri, a key figure in the Izzedine al-Qassam Brigades, Hamas's armed wing, and a close ally of Ismail Haniyeh, the Hamas leader and considered to be his deputing political leader. Arouri was killed in a “surgical strike” in Lebanon, in a Hezbollah stronghold in the southern Beirut suburbs, where he had been acting as a connection between his group and Hezbollah.

Following this assassination, the response by Nasrallah was stronger than previously. He reportedly said: “If the enemy thinks of waging a war on Lebanon, we will fight without restraint, without rules, without limits and without restrictions.” At the same time, he kept some room for caution, when he said: “For now we are fighting on the frontline following meticulous calculations.”

 This speech had been pre-planned to commemorate the fourth anniversary of the death of Iran’s Islamic Revolutionary Guards Corp general Qassem Soleimani. But that occurrence did not go as planned. In fact, on the occasion of the fourth anniversary of the assassination of General Soleimani – who had been touted to become Iran’s next Supreme Leader – by a US drone strike in Iraq in 2020, a terrorist attack was carried out by ISIS in Kerman in southern Iran. The attack caused 84 deaths and several more wounded people. In this case too the subsequent speech by Iran's Supreme Leader Ayatollah Ali Khamenei was filled with hard rhetoric, as he vowed a "harsh response" to this attack, which was initially blamed on Israel and/or the US. 

These events follow air strikes by US and Israeli forces in Iraq and Syria, which took place at the end of 2023, which resulted in the death of over 30 militants including a senior commander of the Nujaba Movement, Mushtaq Talib al-Saidi. These strikes were a response to a series of 115 coordinated attacks launched by Iran-backed militias on U.S. military bases and assets in Syria and Iraq, which began on 17 October.

In our view, the fact that other countries (Iraq, Iran, Syria, Lebanon) started being involved in terrorist attacks or episodes of war testifies that the risk of a further escalation of the conflict to a regional scale has increased in recent weeks. It could potentially expand beyond the region as well, considering that US, Russia and China are all somehow involved or interested in this dispute. As we discussed in our recent trip report from the region, the next few months will clarify whether this expansion of the conflict will become a reality or not. 

by Brunello Rosa

2 January 2024

In July 2023, we wrote a column titled “Elections in 2024: The Year That Can Change The Fate of The World.” It was based on two pieces of research, one on developed markets and one on emerging markets. We pointed out the risks deriving from six key elections, in the US, the UK and the EU, and in Russia, India, and Taiwan. But other elections will be taking place as well, in Mexico in June and in Ukraine in March (if they are not postponed by the application of martial law), or in Venezuela. This election in Caracas could be of particular interest given the territorial dispute it has opened with Guyana, which we will discuss in an upcoming piece of research. 

Six months after we published that column, all the most relevant journals and magazines are now identifying the same risk. Chatham House’s The World Today speaks about “The Power in The Voters’ Hands.” The Economist labels 2024 as “the biggest election year in history,” with 4.2bn people that will be asked to cast their vote to choose the leaders they want to be governed by. Almost all free press considers 2024 as the year in which a sort of referendum between “democracy” and “autocracy” will be held. As The Economist puts it, “there is more to democracy than voting.”

The V-Dem (Variety of Democracy”) project says that only a few countries can be labelled as “liberal democracies,” in which both the judiciary and the press are fully independent from the executive power. Most countries are now “electoral democracies,” in which elections are held, but the leader of the country can influence the press and the judiciary and overrule decisions made by other branches of government. (Turkey being an example) of this. On the other side of the spectrum, there are electoral autocracies (e.g. Russia), in which the leader is elected, but elections are not free. And there are closed autocracies (such as China), in which elections are not held, and most civil liberties (freedom of association, the press, etc.) are suppressed.

Overall, we remain of the view that the six elections we chose as the most significant ones for next year will be the critical ones, starting with the election in Taiwan. As discussed in our recent in-depth analysis, the greatest risk is not that of a ground invasion by China, which is quite unrealistic in our view, but rather the beginning of an intensified phase of destabilisation that may eventually lead to China taking over the control of the political system of the island, as it has done with Hong Kong in the past. The year-end speech by Chinese President Xi, in which he said that “the reunification of the motherland is a historical inevitability,” and that “China will surely be reunified” reinforces this impression.

In Europe, the biggest risk is of a massive success of the populist and anti-European parties, with the AfD doing very well in Germany, Le Pen’s Rassémblement National doing very well in France and Meloni’s Brothers of Italy confirming its undiscussed leadership over the Italian political system. And then there’s the “biggie”, the US presidential election. All other elections until November may go “in the right direction” of confirming democracy as the centerpiece of modern society and statehood, but if in November Donald Trump wins, all this would be irrelevant. 

Conversely, even if all five of the other elections before November go “in the wrong direction”, of showing an advancement of autocracies, so long as Trump is not elected one can always hope that democracy will have another chance to reaffirm itself. 

by Brunello Rosa

27 December 2023

At a time when populist parties are once again on the rise, globally but in the EU in particular, as testified by the recent victory by Geert Wilders in the latest Dutch general election, the EU has decided to respond with two major reforms. 

First, the gathering of the Finance Ministers of EU countries, Ecofin, approved the reform of the Stability and Growth Pact last week, which encompasses the fiscal rules for EU member states. Given the impact of the crises of the pandemic and the war in Ukraine, with its associated energy crisis, the fiscal position of many countries has become precarious, with high fiscal deficits and public (and private) debts. In January, the old and stringent fiscal rules – summarised in the so call “Fiscal Compact”- were supposed to return in place. Instead, EU member states have agreed to a new set of fiscal rules. 

The agreement, spearheaded by Germany and France, foresees the adoption of bilateral agreements between the EU Commission and each member state for a sustainable reduction of fiscal deficits and public debts over a period of 4 to 7 years. The old parameters (deficits no higher than 3% of GDP, debt no higher than 60% of GDP) remain in place, with additional safeguards. Countries with high debt levels (above 90% of GDP) and in “excessive deficit procedure” will have to reduce their deficit by 0.5% a year and debt by 1% a year. 

Additionally, they will have to keep a “fiscal buffer” equal to 1.5% of GDP – i.e. they will have to bring their deficit to 1.5% of GDP. France (and to some extent Italy) have obtained that for the first three years (2025-27), their debt-servicing costs will not be included in the calculation of the so-called “structural deficit,” so as to reduce the amount of fiscal adjustment needed to be made. Apart from this, it is quite obvious that Germany won the battle, while allowing some additional flexibility to other member states. 

On the other front, the EU has also revised its immigration rules, at a time when immigration into Europe is causing political troubles to several countries including France, Italy and the UK. In France, a new immigration law has led to the resignation of a minister of Macron’s government, since Le Pen’s party has also approved the new measures. Italy and the UK seem to be allied in the fight against illegal immigration, with solutions being externalised to Albania and Rwanda respectively, during a time when legal immigration is reaching an all-time high. 

The new Pact on Migration and Asylum will keep the archaic Dublin rules in place, but foresees compensation mechanisms for those countries that refuse to host their quota of migrants who are temporarily placed in countries of first arrival (typically Greece, Italy, and Spain). They will have to pay up to 20,000 EUR for every migrant who they are not accepting to be relocated in their territory. The EU will establish new sites, located in the outskirts of the Union, in which migrants will be placed while waiting for an evaluation of their refugee status (which will be completed in 12 weeks). These new rules are not the panacea that Metsola and Von Der Layen are flagging, but are a step forward compared to the old regime. 

These are two concrete examples of how the 27-member elephant that is the EU can still move when required, to react to the existential threats that it is still facing.

by Brunello Rosa

18 December 2023

Three major banks met for their policy meetings last week. All of them have de-facto abandoned their tightening biases in favour of a neutral stance, and are ready to adopt an easing bias in coming weeks. But they had to push back against market expectations that they would prematurely cut policy rates. Let’s discuss each of these central banks in the chronological order in which they made their decisions.

On December 13th, the US Federal Reserve announced its decision to keep its policy rates unchanged for the third consecutive time, after the September and November “skips.” More than that, the new Summary of Economic Projections (SEP) showed that FOMC participants expect three 25-bps cuts in 2024, four cuts in 2025 and three more in 2027, which would bring Fed funds rate from 5.25-5.50% to 2.75-3.00% at the end of the forecast period. That is still above the longer-term level of 2.5%, which is considered a sort of short-term neutral rate (whose value is likely to be higher, by now). Having said all this, in determining the need and extent of “any additional policy firming”, the FOMC will continue to monitor incoming data on economic activity and financial conditions. As Chair Powell explained during the press conference, the inclusion of this sentence was necessary to make sure that the possibility of further rate hikes was not completely removed. In spite of this caveat, financial markets celebrated with a fall in market yields, a weaker dollar, and higher equity prices.

The following day, the Monetary Policy Committee of the Bank of England also announced its decision to keep the Bank Rate unchanged at 5.25%, with a 6-3 split in favour of the decision. Three MPC members (J. Haskel, M. Greene and K.L. Mann) voted for a 0.25% increase in the Bank Rate in consideration of the still-elevated level of headline and core inflation (respectively at 4.6% and 5.7%) and a still-resilient labour market, in spite of the weakening economy.

During the press conference, central bank governor Andrew Bailey specifically had to say that it was too early for the MPC to start contemplating possible rate cuts, even if the market is pricing them in starting from May/June 2024. Of the three major central banks, this was the strongest pushback against market expectations of rate cuts, taken in consideration of the still-elevated level of inflation. 

Also on Thursday, the European Central Bank announced its unchanged policy stance. With its updated forecasts, it revised its growth and inflation forecasts lower. The ECB, the descendant of the German Bundesbank, also said that rates will have to remain at “sufficiently restrictive levels for a sufficiently long period of time”, to allow inflation to fall to target levels over the forecast horizon. Given the deceleration of Eurozone economy, the ECB could have indicated more clearly that rate cuts are on the horizon, as the Fed did, but instead it decided to send a relatively hawkish signal. Actually, the ECB also decided to taper, from H2 2024, the reinvestment of the principal proceeding of PEPP bonds, which in itself is a tightening move. In spite of this, markets were still digesting the news from the Fed and continued to celebrate the perceived pivot by central banks. 

While all three central banks have remained on hold in December, they all reiterated that it is too early to declare victory against inflation. In spite of this, market participants are now looking at incoming easing cycles, which they expect to begin in the first half of 2024. The skirmishes between markets and central banks are set to continue for a few more weeks. 

by Brunello Rosa

4 December 2023

A few days ago, Robert Kagan, editor at large at The Washington Post, wrote an article titled: “A Trump dictatorship is increasingly inevitable. We should stop pretending.” In this article, the main claims of which are discussed below, Kagan warns that the US is sleepwalking into a dictatorship, which would become effective once Trump is elected for the second time, in November 2024. To avoid this outcome, a number of decisive political actions should be taken now, by both the Democrats and the Republicans, who are currently pretending or hoping that this eventuality will not materialise. 

Robert Kagan is not some neo-Bolshevik who despises Trump a-priori for ideological reasons. Robert Kagan is a neo-conservative Republican, in favour of military interventionism and nation-building, and co-founder of the think tank “Project for the New American Century.” He served in the George W. Bush administration, with foreign policy hawks such as Dick Cheney, Donald Rumsfeld, and Paul Wolfowitz. During the 2008 presidential campaign he served as foreign policy advisor to John McCain, the Republican Party's nominee. In the same year, Kagan wrote an article titled "Neocon Nation: Neoconservatism, c. 1776" for World Affairs Journal, describing the main components of American neoconservatism “as a belief in the rectitude of applying US moralism to the world stage.” 

So, Kagan is a 24-carat conservative Republican, who in 2016 left the party due to its nomination of Donald Trump. He must have thought that populist Trump represented a deviation from the traditional mandate of the Republican party, that of defending US moralism and inspiring liberal democracies with a conservative tendency around the globe. Now that he sees Trump potentially winning again, he is warning that it could lead the US to become a dictatorship. 

Kagan believes that Trump will use the trials against him to prove that he is superior to the judiciary, which has already been bent in his favour with his appointment of three of the nine Supreme Court judges. He will then use the power of the executive branch to organize an extensive spoils system and replace the top- and medium-level bureaucrats of the much-hated “deep state” with his own loyalists. His Republican party will likely control the two branches of Congress, and he will effectively keep them hostage, vetoing any law that he does not like. He may run again, for a third term, ignoring the 22ndamendment of the US Constitution. If Trump loses, as in 2020, he will stage a coup, finishing the job left incomplete on January 6th, 2020, when Trump endorsed the sedition and the assault to Capitol Hill by his supporters, on the day Congress was meeting to ratify the election of Joe Biden as President of the US.

How likely is this to happen? Well, as we discussed in a previous column, Trump is now by far the leading candidate to win the nomination for the Republican party for the November 2024 presidential election. He has a 47-point lead versus the runner-up, Ron DeSantis, and a 27-point lead versus all the other candidates, combined. He is ahead of Biden in almost all polls conducted at national level, and ahead in key swing states. So, Trump may well win in 2024, and the trials against him are unlikely to prevent that from happening. Actually, he will probably use them as a platform to run his technically revolutionary campaign, and to show that he is above the judiciary, which will not be able to contain him. 

We have repeatedly discussed how the number of liberal democracies is diminishing in favour of electoral democracies and authoritarian regimes. The US may be on the verge of embarking on such a journey.

by Brunello Rosa

4 December 2023

The 28th Conference of the Parties (COP 28) began in Dubai, in the United Arab Emirates, last week, with 197 countries being represented there. It is set to continue its proceedings until December 12. The hope of the attendees, policymakers, activists, NGOs, and other representatives at the conference is that COP 28 will manage to deliver tangible results needed to arrest the global warming and climate change that is affecting our planet. According to the latest estimates, 2023 has been the warmest year on record, with temperatures averaging 1.43 degrees Celsius above the 1850-1900 pre-industrial period, and 0.1% higher than the averages recorded in 2016, the warmest year on record until now.

So far, some initial agreements have started to emerge from the conference. The UAE intends to leverage its position as host to engage participating delegations in oil and gas agreements with 15 different nations. For example, oil producing giants such as Exxon, Aramco, Occidental and others pledged to stop adding to planet-warming gases by 2050. Additionally, 22 nations, including the UK, France, and the US, have committed to tripling their nuclear capacity in a concerted effort to reduce reliance on fossil fuels.

Finally, and perhaps most importantly, a “loss-and-damage” fund that will provide essential finance to countries most impacted by climate change has attracted more than USD 400 million in pledges. According to press reports, the UAE and Germany have pledged USD 100 million each to the fund; other EU members have together promised USD 125 million, and the UK around USD 50 million. The United States pledged USD 17.5 million and Japan USD 10 million. The fund will be administered from the World Bank in Washington DC until a more permanent host country and institutions is found.

This is certainly a positive start to the conference, but one wonders whether more concrete results will be achieved, for example by signing legally binding deals, such as the Paris Agreement signed in 2015, which was a binding international treaty which aims at limiting the global temperature increase by 2030 to 1.5 degrees Celsius compared to pre-industrial levels. We are a bit sceptical that agreements of this kind will be made. As we discussed in our recent column, while US President Biden and Chinese President Xi Jinping made some loose agreements on climate during their recent bilateral meeting at the APEC in San Francisco, neither of them will attend the COP 28 in Dubai. No international agreement on climate change can be effective if the two major, and most polluting, countries in the world don’t commit to it.

And this is where the long-term issue of climate change also becomes intertwined with short-term political dynamics. In fact, after the 2016 US Presidential election, when Donald Trump was elected president, one of his first acts was withdrawing his countries from the Paris Agreement. In June 2017, Trump then announced that the United States would cease all participation in the 2015 Paris Agreement on climate change mitigation, contending that the agreement would "undermine" the US economy and put the US "at a permanent disadvantage." Conversely, one of the first actions by President Biden was to re-join the Paris Agreement, in February 2021. Needless to say, if Trump were to be elected president in November 2024, it is well possible that he would withdraw the US from that agreement again. The US presidential race will certainly be fought on environmental issues and their implications for the US economy, among other issues.

by Brunello Rosa

27 November 2023

In a series of articles published last summer, we identified 2024 as the year that could change the fate of the world. In Developed Markets, there will be elections in the US, EU and the UK, and in Emerging Markets there will be elections in India, Russia and Taiwan, to name only a few. We discussed how, with two wars still ongoing in Ukraine and Israel, a third front may be opening in Taiwan, with the window between the Taiwanese elections and the US elections representing an opportunity for China to continue destabilising its breakaway “province.” With just over a month to go before the beginning of 2024, 2023 is providing electoral results that may impact sentiment in the new year.

In Argentina, Javier “El Loco” Milei has been elected President, interrupting the long dominance of Peronist leaders that have governed the country in the last few years (with the brief interval of the moderate conservative government of Mauricio Macri). In our preview, we discussed the electoral platform of the newly elected president, and of its political movement, La Libertad Avanza (LLA). Milei is considered a political leader who is between former Brazilian President Jair Bolsonaro and former US President Donald Trump, and in effect his proposals have a populist bent that is hard to ignore.

Here we would like to focus on just one of these proposals: the abolition of the Argentine Central Bank (Banco Central De La República Argentina, BCRA), to be replaced by the full dollarisation of the economy. The project does not make economic sense and is unfeasible, but it attracted the favour of voters, who are exasperated by levels of inflation that has reached 140% recently, and has been above 20% since 2015. 

The project makes no economic sense because the monetary policy decisions that have been widely criticised by the Argentinian people, which are the basis of the request of the abolition of the BCRA, would instead now be made by another central bank, the US Federal Reserve, over which Argentinians would have no control. Moreover, the Fed is there to make decisions for the US, not for Argentina: the US is an expanding economy with a falling level of inflation, while Argentina is a contracting economy with rampant inflation. It’s hard to see how the Fed could make decisions that are good for the US and Argentina at the same time.

The project is unfeasible because Argentina is not a small country at the doorstep of a large continental economy, as Ecuador could be for the US or Montenegro is for the EU, two examples of countries that have chosen to adopt the currency of the much larger economic neighbour, which their economies are dependent on. Argentina is a large economy with 46 million people: there aren’t enough US dollars in circulation to accommodate that request, and the Fed is not going to print them just to please Milei. Yet these nonsensical economic proposals managed to attract the majority of voters and propel Milei to the Presidency. Luckily, the limited presence of LLA in Congress (only 35 deputies out of 257) will make them harder to implement, but one can be sure that a few years of Milei in government will produce a permanent economic and social damage to the country. 

In the Netherlands, the nationalist and populist leader Geert Wilders won the election held last week, with his PVV collecting 23.6% of votes (much more than the socialist and conservative opposing parties, which are stuck at 15%), thus electing 37 MPs in the 150-seat House of Representatives. Wilder’s populist anti-Islamic and anti-immigration slogans have convinced a large segment of the Dutch population to give him a chance to govern. The other parties may coalesce to keep him out of power, but this would make his party even stronger at the next election.

In a recent column, we discussed the victory by Robert Fico in Slovakia, who ran on a populist anti-EU and pro-Russia platform. 

These examples are not a good harbinger for the coming elections in 2024. If populist leaders still manage to be so attractive for the electorates of developed and sophisticated nations, the return of Trump as president in the US one year from now is becoming increasingly likely, with polls showing that he is getting a lead over Biden since the beginning of the war in Israel. And if Trump wins again, the macroeconomic and geopolitical implications would be profound. 

by Brunello Rosa

20 November 2023

US President Biden and Chinese President Xi met in the sidelines of the Asia Pacific Economic Cooperation (APEC) Leaders' Meeting in San Francisco last week. This was a highly anticipated and hoped-for meeting, which we discussed in previous columns. The meeting took place at a time when two major wars are taking place, i.e. the war in Ukraine and the war in Israel (which may be connectedwith one another) and when the Sino-American relations are at one of the lowest points in recent history. 

Very high on the agenda was the US request to re-establish military-to-military communications, which were interrupted by China after the visit of former US House of Representative Speaker Nancy Pelosi to Taiwan in August 2022. Tension had further increased after the discovery of the Chinese spy balloon, which led to the cancellation of the trip by US Secretary of State Anthony Blinken to Beijing earlier this year. The visit eventually took place in June, but Blinken failed to re-open the interrupted military lines. Finally, one of the positive outcomes of this meeting was that the military-to-military communications were re-opened.

Other tangible results were an in-principle agreement to fight climate change, ahead of the COP28 conference in Dubai later this month, and the joint effort to stop fentanyl trafficking. The two presidents also agreed to continue talking on a bilateral basis to avoid miscommunication and misunderstandings, and Xi agreed to send more pandas to the US zoos, a symbolic gesture akin to holding out an olive branch. 

So far so good. But here is the less good news. The re-opening of military lines is a very positive step, but it was also unavoidable, considering the number of incidents that have occurred in the Taiwan Strait in the last few months, which had led to a near collision between US and Chinese vessels. The re-opening of communications may also be indicative of a possible intensification of the disputes, before the beginning of year 2024, which will open with the elections in Taiwan and will close with the US presidential election – a time window during which Chinese pressures on Taiwan are set to increase. Second, the commitment on climate change is as positive as it is vague, lacking as it is in any serious joint target and enforcement mechanism. Third, when explicitly asked, President Biden did not refrain from repeating that Xi is a “dictator,” causing much disappointment to his Secretary of State. 

Additionally, in spite of the meeting, Cold War 2 remains in full swing: China is putting no pressure on Russia to stop its brutal invasion of Ukraine. Regarding the Middle East, the BRICS group has just expanded to Iran, Saudi Arabia, Egypt and the UAE, among other countries. Perhaps it could exert some pressure on those countries to induce them to find a solution for the Israeli-Palestinian perennial conflict. 

Finally, President Xi reportedly said: “Earth is big enough for both our countries to succeed,” which recalls the 007 movie “The World is Not Enough.” But what lies beneath that sentence is the suggestion to “partition” the world into spheres of influence led by the US and China respectively, which can grow and prosper at the same time instead of cooperating for the management of global emergencies. The growth of spheres of influence is what defined Cold War 1, and is likely to be the main characteristic of Cold War 2 as well. 

by Brunello Rosa

13 November 2023

On November 5th, 2024, the US presidential election will close a busy electoral year that will begin on January 13th, with the presidential election in Taiwan, and which will continue with the Russian presidential election in March-April, the Indian general election in April-May, the European parliamentary election on June 6th-9th, and the UK general election at some point between November and December. 

So far the polls have shown the following results. First, Trump is clearly ahead in the primary race for the Republican party, gathering 58% of voting intentions, thus displaying a 40 percentage point advantage as compared with his closest contender, Ron DeSantis. Second, Trump does not enjoy the favourable opinion of the majority of Americans, with 54.8% expressing an unfavourable opinion and only 40% exhibiting a favourable opinion. Third, President Biden finds himself in a similar position to Trump, since 55% of Americans disapprove his actions, versus 38.7% approval. Fourth, in a rematch of the 2020 race, Biden and Trump are neck and neck, with polls showing a small advantage alternatively for either candidate. And fifth, consensus polls show that the Senate may return to being in the hands of the GOP, which already controls the House of Representative. 

A recent set of polls show that Trump is gaining an advantage versus Biden. In particular, a New York Times/Siena poll found Biden was behind Trump in five of the six most important battleground states, fuelled by doubts about his handling of the economy, questions about his age, and discontent on other issues such as the Israel-Hamas conflict. Younger, black, and Hispanic constituencies don’t agree with Biden’s conduct on this issue. Biden would lose to Trump by margins of 3-10% in Arizona, Georgia, Michigan, Nevada, and Pennsylvania. Biden is ahead in Wisconsin by a 2% margin. Yet he carried all of these crucial swing states in the successful 2020 race. Voters said they trusted Trump over Biden on the economy by 59% to 37%, the widest gap on record. Across the electorate Trump got better marks on the economy, regardless of gender, age, education or income level. A CBS News poll also showed that more voters thought they would be better off financially if Trump were to win in 2024, and that Biden has failed to win over Democrats in the way that Trump has convinced Republicans. 

Another factor complicating Biden’s hopes for re-election is the proliferation of independent candidates that could take away more votes from him than from Trump. Robert Kennedy Jr, a nephew of the late former president John F. Kennedy, has been running for president as an independent for several months. Last week Jill Stein, a leftwing activist, said she will run again for the Green party in the 2024 presidential race. In addition, Joe Manchin, the centrist Democratic senator from West Virginia, announced he would not seek a new term in Congress and may run for the White House. Manchin could be backed by No Labels, a centrist organisation led by former Democratic senator Joe Lieberman and former Maryland Republican governor Larry Hogan.

Independent candidates may subtract voters from either candidate. In 1992, Ross Perot prevented incumbent president George Bush from being re-elected. In 2000, the few votes gathered by Ralph Nader were sufficient to prevent Al Gore from being elected president. In 2016, Jill Stein gathered more votes than the difference between Hillary Clinton and Donald Trump in key swing states. The fact that Joe Lieberman, the candidate for the Vice-President position during the unsuccessful race by Al Gore in 2000, is the leader of No Labels really does not bode well for the incumbent president. 

In the UK, the 5th of November is celebrated as Guy Fawkes day, from the name of the person who tried to kill King James I, along with his parliament, in 1605. Since that day, the anniversary is celebrated as a national holiday with bonfires (“Remember, Remember the 5thof November”). Time will tell if the 5th of November 2024 will also be remembered in the US as the beginning of a new era, when the US stopped being the beacon of democracy in the world. 

by Brunello Rosa

6 November 2023

A few days ago, it emerged that some of the leaders of Hamas went to Moscow, to speak with high-ranking officials at the Kremlin. Considering of the two ongoing wars in Ukraine and Israel, this news clearly could not go unnoticed. It raises a number of questions. 

Let’s recap the positions “on the field”, so to speak. There’s an ongoing war in Ukraine due to Russia’s unjustified invasion of the south-eastern regions of that country. Russia managed to conquer around 17% of Ukrainian territory, after the Ukrainian army won back some of the land that had initially been lost. Ukraine’s widely anticipated counter-offensive took place during the spring and summer of 2023, and it did achieve some results, though likely more modest ones than were anticipated at the outset. The arrival of the winter probably will mark another pause ahead of a new offensive by the Russians or a new counter-offensive by the Ukrainians starting from spring next year. At the moment, there is a stall on the ground, relatively speaking, which may favour a crystallisation of the conflict for the near future. 

In the Middle East, there is a composite situation, which could be simplified as follows. The traditional division is between the Sunni Muslims, spearheaded by Saudi Arabia, and Shia Muslims, led by Iran. The two countries have been arch-enemies for decades, but recently marked a rapprochement by signing an agreement in Beijing, the content of which remains unclear. Virtually all countries in the Middle East are against Israel, which is not officially recognised by the vast majority of them. Currently, Iran provides financing to the operations of Hamas in Gaza and Hezbollah in Lebanon. Hamas has been tolerated by Israel until now because its aims run contrary to the “two peoples, two states” solution for Israel and Palestine. 

During the Obama presidency, the Joint Comprehensive Plan of Action was signed by several countries with Iran, to provide an environment that would favour a gradual re-entering of the country into the international community. But Trump pulled the US out of it, in effect killing the agreement. At the same time, during the Trump Presidency, the Abraham Accords were signed between Israel, Bahrain, Morocco, the United Arab Emirates, and Sudan. As we have discussed in recent columns, there was an attempt by President Biden to favour a rapprochement between Israel and Saudi Arabia. The missing piece was clearly Iran.

Russia has strong ties with Iran and Syria, whose dictator/leader Assad is protected by both Moscow and Tehran. Russia has also made advancements in Africa, in particular in Libya and the Sahel. 

The war in Israel may expand and become regional if Hezbollah directly enters the conflict. Last week’s declaration by Hezbollah’s leader Hassan Nasrallah remains vague: it affirms that Hezbollah is already fighting Israel but refuses to endorse Hamas’ action, attributing their full responsibilities to “the Palestinians.” Hezbollah can be unleashed only by Iran. Was the trip to Moscow by Hamas leaders perhaps meant to convince the Kremlin to put pressure on Iran to unleash Hezbollah? It is a fact that, on the same days that Hamas leaders were in Moscow, a deputy foreign minister of Iran was also in Moscow, meeting with his Russian counterpart.

Clearly Russia could put itself in the middle of the game with an offer of mediation, to attempt to convince the international community that it holds the key for the de-escalation or the containment of the conflict in the Middle East. If it was able to do this, Moscow would then for sure want to have a “free hand” on Ukraine, in exchange for convincing Iran not to unleash Hezbollah, or in any case, for Iran not to join the conflict. This would make Ukraine’s situation almost intractable. On the back of all this, last week EU Commission President Von Der Leyen flew to Kiev to discuss Ukraine’s accession to the EU, to reassure the invaded country about its prospects. The real question is: what portion of Ukraine would eventually join the EU, in this scenario? 

by Brunello Rosa

30 October 2023

General elections took place in Poland on October 15th. The turnout was 74.4%, the largest since the country’s return to democracy in 1989. At the general elections in 1989, when the country refused Soviet rule, turnout was 63%. Since the exit pollscame in, it has appeared that the ruling Law and Justice (PiS) party, led by Jarosław Kaczyński, gas remained the largest party, but that it will be unable to form a governing coalition. Instead, the Civic Coalition led by Donald Tusk could be at the centre of a three-party pact to form a new government. 

The official ballot announced by the National Electoral Commission confirmed the exit polls. PiS won 35.4% of votes, and 194 seats (down from the 43.6% of votes and 235 seats it received in the 2019 election). The Civic Platform (CO) received 30.7% of votes and 157 seats; the left-wing Lewica gathered 8.6% and 26; the Third Way (Trzecia Droga, a political alliance formed in April 2023 between Poland 2050 and Polish People's Party, to provide an alternative to both the PiS and Civic Platform) reached 14.4% and 65 seats, and the nationalistic, right-wing Confederation got 7.2% and 18 seats. In the upper house, which maintains some limited power in the legislative process, the new winning coalition secured 66 votes, versus 34 that went to PiS.

Even if PiS were to coalesce with the Confederation, it could count at most on 212 seats, versus the 231 needed for a majority. On the other hand, the coalition between CO, Third Way and Left could reach a comfortable majority of 248 seats in the lower house (Sejm). 

President Andrzej Duda, coming from PiS, called for the new parliament to convene on November 13th, for its first meeting. Following that, he will appoint the new PM. Duda recently declared that there are two credible candidates for the job: incumbent PM Mateusz Morawiecki, and CO leader Donald Tusk. Tusk has previously been PM during the period 2007–2014, before becoming EU Commission President between 2014 and 2019. In theory, Duda may ask Morawiecki to form a government, and wait for him to fail before asking Tusk to do the same; similar to what has happened in Spain recently, when King Felipe IV asked first Alberto Nunez Feijoo, the numerical winner of an election, and then incumbent PM Sanchez, the political winner, to form a government. 

But this would be just a tactical move to show his allegiance to PiS’s leader Kaczyński. But that move could antagonize the new coalition, with which he will have to work anyway. In the background, there are the 2025 Presidential elections approaching: PiS’s chances of electing one of their potential candidates, including Morawiecki, impinge on the way Duda will behave and the choices he could make in the next few weeks. Tusk has gained the possibility of being re-appointed PM after being subject to all sorts of attacks during the electoral campaign, when his adversaries tried to depict him as a puppet in the hands of the Germans, the Americans, or – alternatively – the Russians: allegations that the general public clearly considered baseless.

If Tusk becomes Poland’s PM, he will have several issues to fix. On the domestic front, he will have to reduce his public deficit, which runs around 4% of GDP, while re-affirming the importance of military spending, which is around 3% of GDP (and well above the NATO-mandated 2%). On the international front, he will have to try to close the Article 7 procedure that the EU has opened against Poland for violation of the rule of law (given the PiS influence over the judiciary and the press, in particular over Poland’s state-owned TV channels), which has resulted in the freezing of EUR 75bn of EU funds, of which 25bn are in grants. On the Russia-Ukraine front, Tusk will have to reassure the European and American allies about Poland’s willingness to continue providing ammunitions and logistical support to Ukraine. In general, Tusk will have to rebuild all the relationships with Poland’s traditional allies that had gone sour after many years of PiS’s rule. 

As we noted recently in the aftermath of the victory of Robert Fico in Slovakia, the Viségrad group is now more divided than ever, with Slovakia and Hungary still insisting on their populist, right-wing, nationalistic and pro-Russian positions, while Czechia and Poland have re-embraced a pro-European stance. But while Slovakia is a small country, Poland, with more than 40 million people, is the fifth largest country of the EU, after Germany, France, Italy and Spain. So, the fact that Poland has returned to a pro-European stance definitely revives the hopes of further integration at the EU level.

by Brunello Rosa

23 October 2023

In a series of interviews made recently, both US President Joe Biden and Secretary to the Treasury Janet Yellen affirmed and confirmed that the US is in the position of fighting two wars at the same time: that both Ukraine and Israel can be supported against their aggressors, Russia and Hamas respectively. Biden said “We’re the United States of America for God’s sake, the most powerful nation in the history — not in the world, in the history of the world. … We can take care of both of these and still maintain our overall international defense.” So, he justified his answer by re-affirming the USA’s geopolitical dominance at global level. Janet Yellen, providing an answer more centred on the fiscal sustainability of the military efforts, said that the USA’s weakened fiscal position does not constitute an obstacle to the support of these two countries in difficult positions. 

Is it really the case that the US can afford to fight two wars at the same time? It is certainly true that, historically, it has been able to do so. Just to mention contemporary history, during World War 2 the US obviously did fight on two fronts at the same time. In Europe the US was fighting the Nazi-fascist bloc in Germany and Italy, with the decisive help of France, the UK and the Soviet Union. In the Pacific, it was fighting a parallel war against Japan, which ended up with nuclear bombs being dropped on Hiroshima and Nagasaki. 

In the post-WW2 period, the US was fighting the “cold” war with the Soviet Union (1947-1991), but this did not prevent the US from fighting “hot” wars in Korea (1950-1953) and subsequently in Vietnam (1955-1975), just to give two examples. More recently, the US found itself embroiled in two separate wars at the same time, in Iraq (2003-2011) and Afghanistan (2001-21), and they managed to conduct these simultaneously, although the results in both cases were highly questionable. 

So, Yellen is correct in responding “absolutely” to the question of whether the US can afford to fight two wars at the same time. But a different issue is the implication of all this for the US fiscal and monetary position and the overall global financial order. In fact, it is not a mystery that the collapse of the Bretton Woods monetary system was the result of the excessive military expenses the US had encountered to fight the war in Vietnam. When France asked to convert their US dollar reserves into gold, US President Nixon was forced to declare the end of the convertibility of the US dollar into gold. 

Financing wars has huge fiscal and monetary implications. Central banks - and their predecessors - were originally created to finance the wars of the kings. They certainly were not initially created to carry out banking supervision, or be lenders of last resort and monopolists of currency issuance, let alone to conduct monetary policy, as is the case today. 

Are financial worries of this kind emerging these days? Certainly, they are emerging in the form of a rapid increase in long-term US Treasury yields, those which are more closely linked to weaker fiscal positions and higher inflation expectations. The 10y UST yield has recently reached 4.91%, and the 30y UST yield 5.08%, levels not seen since the period prior to the Global Financial Crisis in 2007-09. This testifies to the fact that investors are worried about the long-term sustainability of the US fiscal deficit (now 5.8% of US GDP) and of the US public debt (now 129% of GDP), in spite of the “exorbitant privilege” that the US enjoys in printing the global reserve currency, the US dollar. The example of the Vietnam war shows that even the most consolidated US-centric regimes end, and that new international monetary frameworks can emerge as a result. 

by Brunello Rosa

16 October 2023

Last week, the annual meetings of the International Monetary Fund (IMF) and the World Bank took place in Marrakech, Morocco. The mood of the meeting was sober to begin with, as the meetings took place just over a month after the country was shaken by a devastating earthquake less than 100 km away from Marrakech. Additionally, during the weekend before the meetings began, the news broke of the attack by Hamas to Israel, which left thousands of people dead, and many wounded or captured as hostages. 

It is within this very sombre environment that the IMF released its latest forecasts, which did not bring much better news. The latest estimates of the IMF’s World Economic Outlook show a downward revision to the 2024 growth forecast, from 3.0% previously down to 2.9%, marking a further deceleration from the 3.0% that had been expected in 2023, and well below the 3.8% average of the last few years pre-pandemic. The projection would have been even worse if it wasn’t for an upward revision to the US growth forecasts for 2023 and 2024 (by 0.3% to 2.1% and by 0.5% to 1.5%, respectively). The projections for other key countries and regions such as China and the Eurozone were revised lower, however. This is why the IMF says that the “resilient global economy is limping along, with growing divergences.”

Inflation is expected to remain well above the targets of central banks; for example at4.1% and 2.8% in 2023 and 2024 in the US, at 5.6% and 3.3% respectively in the Eurozone, and 5.0% and 2.9% in other advanced economies. The IMF says that “global inflation is forecast to decline steadily, from 8.7 percent in 2022 to 6.9 percent in 2023 and 5.8 percent in 2024, due to tighter monetary policy aided by lower international commodity prices. Core inflation is generally projected to decline more gradually, and inflation is not expected to return to target until 2025 in most cases.” So, a sort of stagflationary scenario of weakening growth, coupled with persistent inflation, continues to characterize large segments of the global economy. 

What can policy do to address this? The IMF says that “monetary policy actions and frameworks are key at the current juncture to keep inflation expectations anchored […] Chapter 2…emphasizes the complementary role of monetary policy frameworks, including communication strategies, in helping achieve disinflation at a lower cost to output through managing agents’ inflation expectations.” All this has been translated by the world’s major central banks with the formula “higher for longer,” referring to policy rates being set at higher levels, for longer than the market expects. 

But the question has emerged as to whether central banks should actually raise their policy rates further, given the ongoing slowdown in economic activity and the increased uncertainty due to the recent terrorist attacks in Israel, which are leading the country to conduct a land campaign in the Gaza Strip. If central banks were to come to the conclusion that rates won’t need to be raised further, then the formula should be changed to “high for longer” than the market expects. But since, when economists meet, all possibilities must be explored, two additional combinations can be considered. One would be “higher for long”, implying that central banks would be prepared to continue increasing rates for a prolonged period of time. The other would be “high for long,” in which case rates would be kept at current levels for a protracted period of time. 

The policy meetings of the Federal Reserve, Bank of England and the European Central Bank that will take place in coming weeks will tell which of these four combinations will be chosen by each central bank. 

by Brunello Rosa

9 October 2023

On Saturday, the “Islamic Resistance Movement” Hamas, the political and paramilitary Palestinian organisation based in the Gaza strip, launched a multi-pronged attack on Israel, with thousands of rockets fired at several Israeli cities, and incursions by its militias into the Israeli territory via land, sea, and sky with the use of paragliders. Hundreds of victims and injured people can already be counted, together with dozens of hostages being taken. 

Benjamin Netanyahu, the Israeli Prime Minister, said immediately after the attack that Israel was “at war”, and this wasn’t simply an “operation” by the Palestinian organisation. He later added that “Israel should prepare for a long and difficult war.” As a result, the retaliation by Israel started immediately; as press reports suggest, at least 300 people have been killed, more than 2,000 wounded and 100 taken hostage in the Gaza strip during Israel’s retaliation.

This attack occurred during Shabbat, the weekly day of rest for Jewish people, and during the Jewish holiday of Simchat Torah, which marks the completion of the annual reading of this section of the Bible. Additionally, and perhaps more significantly, the attack occurred on the 50thanniversary of the Yom Kippur War of 1973, when Israeli troops were also caught by surprise by the military operation initiated by the surrounding Arab countries. 

In particular, this attack occurs at a time during which talks were gathering pace for a possible agreement between Saudi Arabia, the US and Israel, which would have led to the beginning of formal diplomatic relationships between Saudi Arabia and Israel. As we discussed in a recent column, the potential agreement could have led to the stabilisation of the region for decades, yet was ridden with obstacles. Saudi Arabia would have asked for a formal recognition of the Palestinian institutions, to further progress towards the “two states” solution. 

What are the implications of this attack? First, the Saudi-Israeli-US deal will be much more difficult to be achieved, as Israel is “at war” with the state-like organisation that would benefit from a formal recognition. As has always occurred in previous occasions, every time there is the chance of a détente between Israel and Palestine, the extreme factions of either side carry out attacks that block the rapprochement process. Hamas said that Iran gave support for the organisation of the strike, and in effect Hezbollah, the Iranian-backed organisation in Lebanon, has launched rockets in the North of Israel. It is possible that Iran is opposed to the potential Saudi-Israeli-US deal, from which it would be excluded. 

Secondly, the legitimacy of PM Netanyahu will increase, as always happens during crisis periods, and particularly during wars, when populations are scared and seek protection from the incumbent government, whatever its colour. This happens at the time in which Netanyahu’s popularity was at its lowest point, given the corruption charges against him and the widespread protests against his ill-conceived reform of the judiciary. 

True, his government will be widely criticized for the lack of intelligence that was needed to pre-empt the attack, which has clearly been planned for months, and which was timed for the 50th anniversary of the Yom Kippur war. But Netanyahu could actually seize the chance of ditching his right-wing parliamentary allies, which have allowed the birth of the most-rightwing government in Israeli history. He could instead form a national unity government that many of his political opponents, starting from Yair Lapid, would likely support. This would probably allow him to remain in power for longer than he could with the current coalition. 

One could even hope that such a national unity government may actually be the one that will be able to negotiate the deal with Saudi Arabia and the US, which clearly now is more needed than ever. But as mentioned above, the war between Israel (led by whatever government) and Hamas makes it even harder to achieve any such deal. 

by Brunello Rosa

2 October 2023

Last week, Smer SSD, the party of the former Slovak prime minister Robert Fico, won the general election held in the country, with nearly 23% of votes. It finished ahead of Progressive Slovakia, the pro-European party led by the young leader Michal Šimečka (with 18% of votes), and ahead of the social-democratic party Hlas–SD, led by Peter Pellegrini (with 14%; the party was born after splintering from Smer). Smaller parties received 5% and 9% of votes, respectively. In terms of seats, Fico will have to form a coalition, as his 42 MPs are far from the 76 seats needed for a majority in a the 150-seat National Council. 

Fico’s comeback is astonishing for two reasons. First, Fico has been in power almost un-interruptedly between 2006 and 2018, when the killing of Jan Kuciak, an investigative journalist, cast a shadow on the Slovak government, as Kuciak had been writing articles about the relationships between Fico’s closest aides and the Calabrian mafia ‘Ndrangheta. A few months after that tragic event, Fico resigned and did not return to power, until now. Second, Fico’s party won the election with an openly anti-Ukrainian and pro-Russian campaign, in which he promised to stop sending weapons to Ukraine. 

What are the implications of this victory? First of all, this is likely to break the unity of the European front in the unconditional support for Ukraine. Even Hungary, under Victor Orban, has not been able to achieve this goal. Now, Ukraine without the unwavering support of the US and the EU will not be able to stop the Russian aggression. Considering how many decisions need to be taken with a unanimous vote at the EU level, Fico’s victory represents a problem in this respect, at a time when Joe Biden is having a hard time passing fiscal legislation – including financial support for Ukraine – through Congress, under the Damocles’ sword of the US government shutdown. 

Secondly, Fico’s return to power, with a pro-Russian stance, also risks breaking the unity of NATO against Russia, at a time when Turkish President Erdogan is asking Sweden further “concrete steps” against extremist organisations supposedly being harboured by the Scandinavian country, in return for removing the veto that Erdogan is holding against Sweden’s access to NATO. Again, for the US which is trying to re-organise the Western front for the long-lasting Cold War 2 against China, having rebellious pro-Russian partners in Europe and within NATO does not help. This is happening just as Lars-Hendrik Röller, the key economic adviser to to Angela Merkel when Merkel was German Chancellor, admitted that she left Germany too reliant on Russian gas. 

The only positive piece of news for the pro-European parties in Europe is that the so-called Viségrad group, comprising Poland, Hungary, Czechia and Slovakia, is now more divided than ever. Poland and Hungary are under the procedure of Article 7 of the EU Treaties, for violation of key principles of the Union, including the rule of law and the independence of the judiciary. But while Poland is resolutely pro-Ukraine, Hungary and Slovakia have a more nuanced position. Czechia, which was leaning towards Russia under former PM Andrej Babis, has recently returned towards a more pro-European position under the leadership of President Petr Pavel. 

All this shows that European political equilibria are continuously shifting and cannot be taken for granted. The situation may further evolve in coming years, especially if Marine Le Pen were to become the next French president in 2027. 

by Brunello Rosa

25 September 2023

Last week, a 12-person working group(the so-called Group of Twelve), set up by the German and French ministers for Europe Anna Lührmann and Laurence Boone, presented a report on the possible reform of the EU’s architecture ahead of a possible enlargement to the Union that would take place in coming years. The report presents various options to change the Treaties that govern how the EU functions, as well as different solutions to make the EU decision-making process fit for the future, even in the case of it consisting of a growing number of countries. 

In a nutshell, the main aim of the reform is to overcome the unanimity vote that is required for the most relevant decisions made by the EU, and to increase the instances in which qualified majorities or even simple majorities may instead be sufficient. The EU has previously experienced the implications of “enlarging” before “reforming”, after several new member states from Central and Eastern Europe were admitted in the EU in 2004. Giving the veto power to new entrants, including smaller countries, has implied a significant slowdown in the decision-making process of the EU, which in some cases closely resembles sclerosis and paralysis. 

In the not-so-distant future, the EU may need to enlarge further, for example to allow the accession of Ukraine, or of some West Balkans states. The accession of Ukraine would be a life-changing experience for the EU. Almost all development funds would be re-directed from the EU periphery (the South as well as the Centre-Eastern part of the EU) to Ukraine. All agricultural subsidies, which are a large component of the EU budget, would be absorbed by Ukraine. We saw in recent days an example of the conflict that could emerge as a result, when Poland threatened to suspend its supply of weapons to Ukraine because its farmers thought that they were being damaged by the import of grains from Ukraine. 

So, the EU needs to reform to be fit for purpose in the future also. One way it would enlarge would be by re-arranging the various forms of association within the European continent into four concentric – or overlapping - circles (see picture above). The inner circle would be represented by the eurozone, plus other “coalitions of the willing” that may want further integration in specific areas, for example through forms of “enhanced cooperation”. The second circle would be the EU. 

The third circle, and the first circle to be outside of the EU (called “Associate Membership”), would be represented by nations such as “EEA countries, Switzerland or even the UK,” which have strong ties with the EU but “would not be bound to ‘ever closer union’ and further integration, nor would they participate in deeper political integration in other policy areas such as Justice and Home Affairs or EU citizenship.” Beyond this third circle, there would also be an outer circle of countries belonging to a reformed European Political Community (so-called “EPC 2.0”), which “would not include any form of integration with binding EU law or specific rule of law requirements and would not allow access to the single market,” so beyond what the report calls the “rule of law border” that would stop with the third circle. We have discussed the relevance of this EPC grouping in our column of June 5th, 2023. 

These proposals recall very closely what we discussed in our column of May 2ndm 2022, titled “The War In Ukraine Resurrects The Idea Of Organizing Europe In Concentric Circles,” which in turn was based on several publications I wrote several years ago (including here and here). My outer circle “Common European Space” is divided in the Group of Twelve’s report into the two outer circles “Associate Membership” and “EPC 2.0,” but – in substance – the division of concentric circles remains the same.

Most importantly, the re-grouping into concentric circles is fundamentally different from the idea of a “multi-speed” Europe. With multiple speeds, the various countries were to aim at reaching the same end-point (an “ever closer union”) at different times. With concentric circles, not only the speed, but especially the destination of countries would be different. Some countries would never join the EU, let alone the Eurozone, while remaining either closely or loosely associated with the EU; for example the UK and – say – Azerbaijan, respectively. Reforming and enlarging the EU according to the proposal of this report seems essential for the survival of the EU in the long run.

by Brunello Rosa

18 September 2023

In 2013, China launched its One Belt One Road (OBOR) project, later rebranded Belt and Road Initiative (BRI). Taking the cue from Marco Polo’s “Silk Roads,” the BRI’s initial intention was that of allowing China to export its excess capacity to neighbouring and allied countries in South-East Asia, Central Asia, the Middle East, and eventually up to Europe. The terrestrial “Belt” was accompanied by a crucial maritime “Road,” which was also aimed at breaking China’s straitjacket represented by its inability to project its influence over the seas. 

In fact, the US is totally unconstrained in its dominance of the seas, the same way the British empire was, and has made its maritime superiority a key geo-strategic lever. Conversely China needs to break the maritime constraints posed by the presence of many other countries off its coasts: Japan, North and South Korea, the Philippines, only to name a few. Opening a commercial road, through various ports purchased or built in key countries along the BRI, allowed China to also establish a military presence over the seas, at the very least to defend its legitimate commercial interests. 

The US reacted to that move by establishing the TPP, the Trans-Pacific Partnership, which was conceived by the Obama administration, subsequently abandoned by the Trump administration, and eventually revived by Japan – without the US – under the name of Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Meanwhile, the BRI became an instrument to impose “slave contracts” to adhering countries, that found themselves in a debt trap with China (e.g. Sri Lanka). The BRI was also used by China to export (and impose) its technology to the countries along the way via the so-called “Digital Silk Road Initiative,” launched in 2015. 

With an inexcusable delay of around ten years, the G7 countries reacted to China’s BRI by launching their Partnership for Global Infrastructure and Investment (PGII), a USD 600bn investment plan, that is supposed to offer an alternative to China’s BRI and its associated debt traps. Last week, at the G20 meeting in New Delhi, the G7 agreed to create a logistical counterparty to the PGII, i.e. the so-called “India-Middle East-Europe Economic Corridor,” i.e. a railway network designed to provide reliable and cost-effective cross-border ship-to-rail transit, complementing existing maritime and road transport routes passing through India, the UAE, Saudi Arabia, Jordan, Israel, Italy, France and Germany.

This new strategic corridor excludes Turkey, a country that is between Europe and the Middle East, is a NATO member while being closer to Russia even after the invasion of Ukraine and has sided with China in its “space race” against the US. For this reason, Turkey is now proposing an alternative corridor, the Iraq Development Road, which foresees the participation of Kuwait, Iraq, Qatar and the UAE, together with Turkey. Besides all these corridors, there’s also the so-called “North-South Transport Corridor,” signed between India, Iran, Azerbaijan and Russia in September 2020, and which connects these three countries. 

All these initiatives show the importance of establishing new “corridors” to make sure that goods and technology will continue to be efficiently transported and exported even in presence of balkanised supply and value chains, which are a distinctive feature of the ongoing Cold War 2 between US and China. 

by Brunello Rosa

11 September 2023

Last week, a G20 meeting was hosted by India in New Delhi. The heads of state and government of the countries representing 80% of the world's GDP gathered to discuss the most relevant issues affecting the global economy – with the notable exception of China’s Xi Jinping, who did not attend the meeting.

We have discussed in previous articles how the multilateral institutions in charge of what can be called “global governance”, in particular the G20 and the UN Security Council (UNSC), have been affected by the ongoing Cold War 2 between the US and China. These fora have become polarised, in some cases balkanised, and, therefore, ineffective. The polarisation of positions within the G20 was such that severe doubts emerged ahead of the meeting as to whether a joint statement could be released at the end of the meeting.

In reality, the leaders did manage to issue a joint statement, summarizing the conclusions of the work undertaken by the various sectoral components of the G20 on issues of global growth, health, the green transition, debt financing, technological transformation, international taxation, gender equality, etc. But, as one can imagine, a compromise solution implied a watered-down version of the communique. In particular, it is extremely disappointing to note that the final texts make no explicit mention of “Russia’s unjustified invasion of Ukraine” (the wording that even the European Central Bank uses to describe it). It only says that “all states must refrain from the threat or use of force to seek territorial acquisition against the territorial integrity and sovereignty or political independence of any state. The use or threat of use of nuclear weapons is inadmissible.”

In spite of all this, some important results were delivered by the meeting. In our opinion the most relevant are the following. First, the leaders of countries including India, the United States, Saudi Arabia, the United Arab Emirates, France, Germany, and Italy, as well the European Union, have signed a Memorandum of Understanding (MoU) that establishes the “India-Middle East-Europe Economic Corridor,”a “railway network designed to provide reliable and cost-effective cross-border ship-to-rail transit, complementing existing maritime and road transport routes.” 

This network, passing through India, the UAE, Saudi Arabia, Jordan, Israel, Italy, France and Germany, will provide the logistical support to the Partnership for Global Infrastructure and Investment (PGII), and will represent the “Western” alternative to China’s Belt and Road Initiative (BRI), on its tenth anniversary. Needless to say, US President Biden pushed hard for the creation of this corridor. 

Second, India and the US cemented their “close and enduring partnership” and reinforced the conclusions of the meeting held in Washington in June, wherein the US will support India’s bid for a permanent seat in the UNSC and will invest in semiconductors facilities in India, while providing US-made armed drones to the country. Biden also agreed to return to New Delhi in 2024 for a leadership meeting of the Quad, the Quadrilateral strategic pact with Japan and Australia (the democracies of the Indo-Pacific, aimed at “containing” China). This seems to reinforce the impression that India, in this Cold War 2, may decide to eventually side with the US rather than with China and Russia. 

Finally, it has emerged that Italy, in a meeting between Italian PM Meloni and Chinese PM Li Qiang, has decided not to renew the memorandum of understanding regarding Italy’s participation to the BRI, which had caused severe concerns in Washington and Brussels in 2019. Italy instead will revive the “Global Strategic Partnership” it signed with China in 2004, which will be “the beacon for the advancement of friendship and cooperation ... in every area of common interest", according to the statement released after the meeting. 

All in all, it seems that this meeting that Xi Jinping deserted (after his diplomatic success of the BRICS enlargement) in order to weaken Modi’s leadership, marked a series of successes for the US-led front, alongside China’s victory of not explicitly mentioning Russia’s invasion of Ukraine.

by Brunello Rosa

4 September 2023

At the end of August, the meeting of the BRICS countries (Brazil, Russia, India, China, and South Africa) in Johannesburg decided upon the admission of six new member states into the club: Argentina, Saudi Arabia, Iran, Ethiopia, the UAE and Egypt. This enlargement marks a diplomatic victory for China, which had urged the other BRICS countries to transform the club into a geopolitical rival to the G7 gathering, which is dominated by the US and Europe. In previous columns, we have discussed how the BRICS were morphing into an emeging markets G7; the enlargement of the group seems to confirm this trajectory. 

The BRICS enlargement will create an even more heterogeneous group, with internally diverging strategic interests and geopolitical ambitions. All the same, it certainly strengthens China’s position as a broker of international affairs. In fact, it would have never been possible without a preliminary rapprochement between Saudi Arabia and Iran, which was sanctioned by the pact signed between the two countries in Beijing in April. 

While it is perfectly legitimate for China to try to leverage the BRICS grouping to project more geopolitical influence in various areas of the global economy, doing so will also create further problems for global governance. As we discussed previously, international fora for the resolution of conflicts, or for the tackling of transnational issues such as climate change and pandemics, are becoming increasingly ineffective. Indeed with Cold War 2 between US and China gathering pace, these international fora are becoming increasingly balkanised; they are being divided into factions, each of them loyal to either the US or China. 

The UN Security Council is clearly divided, with a fault-line separating the US, UK and France on the one hand and China and Russia on the other. The G20 is even more dramatically being divided between the allies of China and those of the US. When the G20 meeting was hosted by Indonesia in Bali in November 2022, it was almost a miracle that the various countries agreed on a joint communique. For the upcoming G20 meeting in India, they might not even be able to do so. 

In fact, Chinese leader Xi Jinping confirmed that he will not attend the G20 meeting; instead he will send his right-hand man, premier Li Qiang. Russia’s president Vladimir Putin will also not attend, because an arrest warrant by the International Criminal Court is still hanging over his head. These absences will clearly reduce the influence of the gathering and its ability to address the numerous global issues currently on the table. It is also possible that other heads of states and government will decide to send their own number twos, knowing that Xi will not be there, and so further reducing the impact of the meeting. 

In our view, Xi’s decision to stay home is a deliberate decision by China to boycott the G20 as a gathering for the resolution of international disputes, to the clear advantage of more limited groupings such as the G7 and the enlarged BRICS. This will reinforce the polarisation of global economy and the geopolitical order.

by Brunello Rosa

29 August 2023

The Biden administration has made important, and unexpected, moves in the last few weeks, moves that could reshape global geopolitics for decades to come, putting the US on a much stronger footing in Cold War 2, its global competition with China for world supremacy.

Earlier in August, it emerged that a potential breakthrough occurred in Biden’s attempt to normalise the relationship between Saudi Arabia and Israel. The two countries do not have formal diplomatic relationship but, informally, they co-operate on key security issues, having a mutual enemy in common, Iran. If these diplomatic efforts are successful, the two countries would begin their own formal diplomatic relationships; Riyadh would open an embassy in Tel Aviv, for example. The hope is that other Muslim countries would then follow suit, and also that Israel and Saudi Arabia would step up their security cooperation with one another. In exchange, Riyadh would secure more US defence support and assistance for its own civil nuclear programme. Additionally, Saudi Arabia would also want Israel to make concessions on the Palestinians’ state.

 If this diplomatic effort succeeds, it would be the strongest response by the US administration to China’s advances in the region, and in particular to its successful brokering of the pact between Saudi Arabia and Iran, signed in Beijing in April. But there are still enormous obstacles to overcome before either side can declare victory. For example, Saudi Arabia’s military requests may prove difficult for the US to negotiate, as they would need approval from a sceptical Congress. Israel may be unwilling to make concessions to Palestinian aspirations.  

Additionally, with US presidential elections looming, the three countries may prefer to wait for the results before concluding any agreement that may be overturned by a new president. However, if a pact is in fact struck between the three sides, it would have the effect of stabilising the region for decades to come. 

Looking to another part of the world, the US administration has also managed to secure a deal, signed in Camp David, between Japan and South Korea, whose relationships have been tense for decades, following the Japanese occupation of Korea during the first half of the twentieth century. At a time when China is announcing further military drills in the Strait of Taiwan, Japan and South Korea realised that it was important to show an united front against China’s threats and economic coercion. The agreement foresees “annual summits between US, Korean and Japanese foreign and defence officials; establishes joint military exercises; and creates new lines of communication to collaborate on threats posed by North Korea and China”, according to press reports.

US President Biden is clearly trying to leave a lasting footprint in US foreign policy before the end of his first mandate, not knowing if he will still be in the White House after January 2024. He is also putting the US on a much stronger footing in Cold War 2, by strengthening its alliances in East Asia, as well as in the Middle East where China and Russia have made tremendous strides in the last few years. 

by Brunello Rosa

21 August 2023

Last week, Evergrande, the largest Chinese property group with 1300 ongoing projects in 280 Chinese cities, filed for bankruptcy protection in New York, using the so-called Chapter 15 process for foreign companies seeking recognition of their restructuring in the US. According to the petition, Evergrande is also pursuing parallel “schemes of arrangement” and restructuring, in the Cayman Islands, Hong Kong and in British Virgin Islands. This follows losses nearing 600bn yuan, i.e. around USD 80bn over the last two years, after having accumulated debt of around USD 330bn. 

Evergrande has been in trouble for years. In December 2021, it defaulted on its offshore debt, causing a liquidity crisis across China's real estate sector. That incident dragged down home prices, and that put further pressure on struggling developers, putting them at risk of default. Over the last couple of years, many of these developers have gone bankrupt. One of the groups that has been put at risk is Country Garden, the largest private-sector property development group. Country Garden said it may lose around USD 8bn in the next six months. 

 The difficulties of the real-estate sector have forced the People’s Bank of China (PBOC), the Chinese central bank, to cut interest rates for the second time in three months. Last week, the PBOC lowered the rate on 401 billion yuan (USD 55.25 billion) worth of one-year medium-term lending facility loans to some financial institutions to 2.50%, from 2.65% previously.  This could be the precursor to a cut of the 5-year loan prime rate, the rate on medium-term loans that is particularly relevant for real estate institutions, which most analysts are expecting this week. The central bank also injected 204 billion yuan through seven-day reverse repos, while cutting borrowing costs to 1.80%, from 1.90% previously.

China’s real-estate troubles are reverberating through its economy, putting at serious risk the 5% GDP growth objective set by the CPP at the October 2022 congress, which was believed to be an “easy target” for the new premier Li Qiang for his first year on the job. A weakening of the Chinese economy would have impact on growth both in Asia and on the global economy. In Europe, for example, two export powerhouses, Germany and the Netherlands, have already experienced two consecutive quarters of negative growth, entering a technical recession. 

Throughout all this, only the US economy seems to still be enjoying a robust performance, with a 2.4% annualised rate of growth in Q2 2023, faster than the 2.0% recorded in Q1. US growth is being fuelled by consumer spending and resilient investment. While a deceleration is expected in the second half of the year, the US economy, in the absence of further shocks, may still experience the sort of “soft landing” that the US Federal Reserve has been pursuing for the last year and a half, during which time policy rates have been increased by over 5%. A shock from China may put at risk the performance not just of the US, but of the entire global economy.

by Brunello Rosa

14 August 2023

Last week, Russia launched its Luna-25 robotic probe with a Sojuz 2.1b rocket, in an ideal continuation of the lunar programme interrupted 47 years ago. The Russian aim is to achieve the first successful landing on the southern polar region of the moon, a location believed to contain valuable deposits of water ice. This is only a piece of the much larger jigsaw that constitutes the ongoing second race to the moon, after the one that occurred in the 1960s-70s, which culminated in the moon landing of Neil Armstrong and Buzz Aldrin on 20 July 1969. 

Like the first moon race, this second is occurring in parallel with a much wider Cold War between two of the world’s super-powers. In the 1960-70s, these were the US and the Soviet Union. In that instance, the Soviets managed to make initial advances with the first satellite in orbit (Sputnik), the first animal in space (the dog Laika) and the first man in space (Yuri Gagarin). The US only later caught up, with the moon landing. This time, Cold War 2 is between US and China, and this moon race is also being led by these two countries. 

The two contenders share the same aim: establishing a monopoly in certain areas of the moon, in order to be able to claim the resources deriving from them (in particular, rare materials that are necessary to building semiconductors). With the same aim in mind, the US and China will follow two very different approaches. The US is involving the private sector in the race, with both Blue Origin sponsored by Jeff Bezos and Space X by Elon Musk aiming to provide a rocket for the mission (the Blue Moon and Starship rockets, respectively). On the other hand, the Chinese government will keep a monopoly over its mission, while seeking inputs from its allies. China has already established a presence on the moon with Yutu-2, a rover that has been sending precious data from “the dark side of the moon” in the last few years. 

In terms of alliances, there are 27 countries on the US side that have signed the Artemis Accords, including France, Italy, Spain, and the UK from Europe, and also Canada, Japan, Brazil, and Israel. Initially even Russia was part of it: its space agency Roscosmos in 2017 signed an agreement with NASA to build an orbiting space station called Lunar Gateway. But as time passe, Russia started siding with China, and in 2021 it signed an agreement to build the International Lunar Research Station, an embryonic colony. China can also count on the collaboration of Pakistan, Bangladesh, Iran, Mongolia, Peru, Thailand and other countries from the Asia-Pacific Space Cooperation Organization. 

These alliances tend to replicate the groupings that we generally see in the Cold War 2 disputes, with three notable exceptions. First, Turkey, a NATO member, has signed an agreement with China for this space race. Second, the United Arab Emirates has signed both the Artemis Accords and an agreement with China. (Holding both positions like this seem untenable in the long run, as the US will likely soon demand these countries to make a choice, following the logic of “you’re either with me or against me”). And third, most importantly, India, which in Cold War 2 is hedging its bets and maintaining a non-aligned position, in this case has decided to sign the Artemis Accords and side with the US.  

by Brunello Rosa

07 August 2023

In the last few weeks, a number of extreme climate-related episodes have occurred around the globe. In June, New York was engulfed by the smoke from wildfires in Canada. In the Mediterranean Sea, the Greek islands of Corfu, Rhodes and Eviaand the Italian island of Sicily, as well as Cascais in Portugal and Dubrovnik in Croatia were also battered by wildfires, caused by the extreme temperatures reached in July and August (up to 48 degrees Celsius). In some parts of Latin America, temperatures reached 40 degrees Celsius, in spite of it being winter there. And the temperature of the oceans, at almost 21 degrees, has been the highest on record, as the El Niño phenomenon re-appeared this year.

Northern Europe has also been characterised by severe weather conditions, with floods in Northern Italy, Austria and Slovenia. In some parts of the Dolomites, it snowed in early August. As it did earlier this year in Sierra Nevada in California, which had previously been characterised by severe droughts during the last few years. 

What’s going on? Well, according one view, all these are phenomena related to climate change, due to so-called global warming. According to NASA, the 15 warmest years on record have been registered since 2005, and the last 8 years have been the hottest 8 years on record. A 2021 report by Cornell University found that 99.9% of more than 88,000 climate change studies agree that humans have accelerated the phenomenon, largely due to carbon emissions. This is the so-called “anthropogenic theory” of climate change, according to which global warming has been created by the carbon emitted by humans in the last couple of centuries, since industrialisation begun. Recently, the movement Fridays for Future launched by Greta Tunberg were among the most vocal activists. But there are also many other groups, such as “Last Generation,” Greenpeace, WWF, etc. They are well represented by the Intergovernmental Panel on Climate Change, which was awarded, together with Al Gore, the Nobel Peace Prize in 2007.  

While one may think this is an undisputed theory, in reality there is an entire army of negationists that are organising themselves, in order to push the opposite view. Recently, a document supposedly signed by scientists and academics, under the title “World Climate Declaration” says that “There is no climate emergency,” as planet earth has gone through cycles of warming and cooling. The most organised group is called Clintel (Climate Intelligence) Foundation, a Netherlands-based climate science denial group founded in 2019 by retired professor of geophysics Guus Berkhout and journalist Marcel Crok. According to independent review, a large percentage of the supporters of Clintel are linked to the fossil fuel industry.

Recent events show, in our opinion unequivocally, that these extreme weather events are related to climate change caused by global warming. But it’s notable that an opposite camp of climate negationists is emerging and becoming organised. This is not a new phenomenon. During the recent Covid pandemic for example a movement of anti-vaxxers got organised and became vocal. Not to mention that the prevailing evolutionist theory about the origin of the species (deriving from Darwin’s seminal works) got challenged by the “creationists.” Interestingly, in the US state of Texas, this second approach is taught in public schools as a plausible alternative to the prevailing scientific theory. 

While we believe that the arguments are overwhelmingly in favour of the climate change theory, we also believe that an organised negationist movement, which finds its political references mostly in right-wing parties around the globe, and is supported by the fossil fuel industry, will manage to stop or delay the adoption of the climate-mitigation measures that are needed to prevent global warming from becoming irreversible.

The number of disasters related to a weather, climate or water hazard has increased by a factor of five over a 50-year period, driven by climate change, more extreme weather and improved reporting. According to the WMO Atlas of Mortality and Economic Losses from Weather, Climate and Water Extremes (1970 – 2019), there were more than 11 000 reported disasters attributed to these hazards globally, with just over 2 million deaths and US$ 3.64 trillion in losses. 

by Brunello Rosa

31 July 2023

On July 23rd, the Spanish general election took place. As we will discuss in greater detail in our upcoming review, the election result was inconclusive. The Partido Popular (PP) led by Alberto Núñez Feijóo won the most votes (33%) and seats (137), but the Partido Socialista Obrador de España (PSOE) led by Prime Minister Pedro Sanchez performed better than expected, with 32% of the vote and 121 seats, two more seats than his party had won in the previous election. Vox, the right-wing party with controversial positions on immigration and civil rights, did not gain votes as initially it had been expected to, but instead lost votes and seats. Its seat count declined to 33, 19 less than it won in the last election. Sumar, however, the coalition of left-wing movements led by Yolanda Diaz, which inherited the position of the populist party Podemos, staged an excellent performance, receiving more than 3 million votes and 31 seats. Regional parties meanwhile more or less held steady their share of votes and seats; they may once again prove decisive in the formation of a coalition government. 

The distribution of seats In parliament could make it difficult for any major party to form a working majority. A coalition between PP and Vox could only count on 170 seats, 6 less than the 176 majority required to install a prime minister. Theoretically speaking, a new edition of the coalition led by Sanchez, between PSOE, Sumar and regional parties could lead to a new mandate for the incumbent prime minister, if the Catalan party of Junts por Catalunya (JxCat) were to abstain in the parliamentary vote to elect the Prime Minster – or to vote for Sanchez’s coalition. The problem is that on July 24th the Spanish state prosecutor’s office — Fiscalía — asked Supreme Court judge Pablo Llarena to issue a new European arrest warrant for the JxCat’s leader, Carles Puigdemont, who has lived in exile in Brussels during the past few years after having held an illegal referendum for Catalonia’s independence in 2017. This is not going to make the solution of this intricate political situation any easier. One cannot rule out that new elections will be called soon, especially if Sanchez remains prime minister. 

However, there is a more relevant political consideration that is worth taking account of in our view. We have discussed in previous columns and in a dedicated report how there is an ongoing attempt within the EU to build a coalition between the European People’s Party (EPP) and centre-right parties, such as the European Conservative and Reformists and even Democracy and Identity, as an alternative to the usual grand coalition between the EPP and the Socialists and Democrats (S&D). The Spanish vote shows how difficult it will be to build such an alternative scenario. The PP belongs to the EPP and Vox to ECR. In a country that is moving its political axis to the right, voters rejected the possibility of a national alliance of the two parties to form a government, by punishing the more extremist of the two (Vox). 

The leader of the ECR in Europe is Italy’s Prime Minister Giorgia Meloni. Italy’s exemplifies well the divisions of the right-wing side of the political spectrum. In fact, she governs in Italy with Forza Italia (which belongs to the EPP) and Lega (which is part of Democracy and Identity, together with Marine Le Pen’s Rassémblement National – RN – and Germany’s Alternative fur Deutschland – AfD). Lega’s leader Salvini has already said that the only way for a right-wing coalition to emerge in Europe would be to include Democracy and Identity, but the idea of coalescing with the extremists of the RN in France and AfD in Germany is highly unpalatable for the majority of EPP party leaders, who remember how autocratic governments emerged in Europe in the 1930s when centrist parties coalesced with the Nazis in Germany and the Fascists in Italy. The next few months will tell us whether this attempt at forming a right-wing coalition to elect the next EU Commission President after the European election of 2024 may still survive, or is already dead.

by Brunello Rosa

24 July 2023

Last week we discussed how it will be difficult for central banks to achieve their inflation targets. A series of factors will likely keep core inflation, and eventually headline inflation, higher on average than in previous decades. Central banks will do as much as they can to bring inflation down to their targets, which tend to be around 2% in developed markets. But when inflation is between 3% and 4%, they will have to make a difficult judgment call. We also expect the ECB to increase rates twice more this year, probably in July and September. If inflation surprises to the upside significantly, we cannot rule out a further increase by the year’s end, possibly in December. 

Finally, on Friday the BoJ will announce its own decision. In Japan inflation has been much better behaved than in other advanced economies; the country had after all been facing three decades of deflation. But recently inflation has been higher in Japan than in the US, for the first time in eight years. In spite of this, we do not expect the BoJ to make any meaningful change to its policy stance, though it might start to tweak the language in its policy statement to suggest that, in coming months, the Bank may be ready to phase out its flagship yield curve control (YCC) policy. 

The following week, on 4 August, it will be the BoE’s turn to decide on its policy stance. After the surprise increase, by 50bps, that it carried out in June, following upon an unexpectedly sticky inflation reading, we expect the BoE to increase its Bank Rate by only 25bps, as inflation has in fact fallen to 7.9% from 8.7% the month before, more than the market had been expecting. The BoE remains the central bank in the most precarious position, considering how sticky inflation is in Britain when compared to other jurisdictions. This is also, in part, the result of the self-inflicted wound that was Brexit. 

As we discussed last week, the other message that all central banks will try to give to market participants is that, once their terminal rate will be reached, they will keep rates high for longer than the market currently expects them to, so as to make sure that inflation has been tamed for good.

Should they try to make an extra effort to bring inflation down to 2%, while causing a major loss of output, an increase in the unemployment rate, and potentially causing financial instability episodes? Or should they give up their targets in order to preserve economic and financial stability as well as social cohesion? Each central bank will choose for itself, but we believe that, on average, most central banks will choose the first option.

While mulling over what to do in the medium term, the world’s major central banks are all meeting this week and next. They will start on Wednesday, when the US Federal Reserve will announce the outcome of its two-days FOMC meeting. As we discuss in our preview, we expect the Fed to increase its Fed funds target range by 25bps, as is widely expected by the market and has been signalled by Powell in previews weeks. This is likely to be the penultimate rate increase of the year, with the final one to be delivered between September and November, depending on how aggressive the Fed wants to be. 

On Thursday it will be the ECB’s turn. The Governing Council will likely agree, unanimously, on a 25bps increase, which has been amply publicised in advance by ECB President Christine Lagarde. The ECB started its tightening cycle one year ago, four months after the Fed, and from a lower base than the Fed (the ECB’s deposit rate was -0.5%). 

by Brunello Rosa

17 July 2023

There is a lively debate over how long central banks will continue to increase their policy rates. Clearly lots of ground has been covered by the world’s major central banks in order to rein in inflation, but there is the widespread expectation that more needs to be done to ensure that inflation will remain low, and as close as possible to their pre-pandemic and pre-war target levels. Let’s look at the three major central banks, knowing well that other G10 central banks have followed and will continue to follow a similar pattern.

The US Federal Reserve has started its tightening cycle sooner than any other developed economy’s central bank (though after some key emerging market central banks, which moved in anticipation of the Fed’s decision in order to avoid a repetition of the “taper tantrum” of 2013-14). The Fed started to increase rates in March 2022, and has brought their Fed funds target range from 0-0.25% to 5.00-5.25%. This tightening cycle has had some effect, as both headline and core inflation have dropped, according to various gauges. For example CPI is now at 3.0% and core-CPI is at 4.8%. But as the labour market remains resilient and wage growth quite dynamic, the Fed has signalled that it intends to increase rates at least another couple of times before year end, with July being the first of such occasions.

The ECB started increasing rates later than the Fed and from a lower starting point, as the deposit rate was -0.5% at the beginning of the campaign. Now the deposit rate is at 3.5% and the ECB has already announced that it intends to hike rates again in July. With headline inflation at 5.5% and core inflation at 5.4 % the ECB will likely continue increasing rates into the autumn, and possibly winter. September remains a possible time for a rate increase.

The Bank of England continues to be in the most complicated situation, as inflation remains stubbornly high, a result not just of the Ukrainian war-induced energy shoc, but also of the self-inflicted Brexit, which now a large part of the population is regretting. Headline inflation is at 8.7% and core inflation 7.1%. In June, when headline inflation remained at 8.7% instead of falling to 8.4% as expected, the Bank of England decided to increase rates by 50bps instead of the 25bps anticipated by market participants. Now it’s clear that the BoE will increase rates again in H2 2023, starting from August, and a cumulative increase of Bank Rate to 6% is almost certain by year-end.

So, all major central banks will increase rates further in coming months, and - after having reached their “terminal rates” - they will keep rates at a high level for a period of time longer than the market currently expects, just to make sure that they have finished the job of killing this sort of inflation, which has proven to be much stickier than was initially anticipated.

But the real question is: will central banks manage to bring inflation down to their original targets, on a sustained basis? Central banks can certainly temporarily bring inflation down, possibly to even below their targets, especially when base effects work in their favour. But in the medium term, inflation is likely to remain higher than initially thought, and certainly higher than pre-pandemic and pre-war levels, for the various reasons we have discussed on previous occasions (such as the tech and ecological transition, de-globalisation, the balkanisation of global supply chains, and the re-distribution of income from capital to labour). And so the question is whether central banks will make an extra effort to bring inflation down from 3-4% to their target of 2%.

We do not think it is the case that they will, as the price in terms of loss of output and increase in unemployment is too high for any central bank to bear, however independent they may be. Even if they are politically independent, central banks do not want to be responsible for adding further fuel to the electoral competitiveness of populist parties, which thrive from this combination of high inflation and sluggish growth.

This does not mean that central banks will ask for an upward revision of their inflation targets. Nor will governments rush to do so, as they do not want to be accused of having failed on their promise of reining in inflation. They will likely de-facto accept an above target inflation, patiently waiting for the system to adjust to the new price level and hoping that this will remain a one-off adjustment process, rather than a continued feature of the next few years.

by Brunello Rosa

10 July 2023

In 2024 there will be elections held in several key countries or regions, each of which has the ability of change the fate of the world for the foreseeable future. Three of these will be held in developed countries and regions, namely, the US, the European Union, and the UK; three will be held in the developing world, in Russia, India and Taiwan. We will discuss these elections in two upcoming pieces of research.

Starting with the developed countries, the US presidential election in November 2024 is likely to be as contested, and possibly even more heated, than the 2020 election that led Joe Biden to become US president. In spite of 13.2 million jobs having been created during his presidency, and the US having led – so far rather successfully – the anti-Russia coalition in Ukraine, Biden’s popularity remains low (at 41%), and polls show that another run-off against Donald Trump would be as tight as it was last time. Needless to say, if Trump were to win the race to the White House, the entire geopolitical landscape at global level would change.

In June 2024, the European election will be held. Formally speaking, this is the election of the European Parliament, which is still much less powerful than the national parliaments of the EU member states. However, the result of the election will be key for the choice of the EU Commission, which is the executive body (together with the Council) of the EU. There is an ongoing attempt by the right-wing groups, such as the European Conservative and Reformists, to re-balance the political barycentre of the governing coalition, which is currently composed of the Socialists and Democrats, European People’s Party (EPP) and the liberals. Other even more extremist groups, such as Identity and Democracy of Marine Le Pen and Matteo Salvini, will try to create a right-wing bloc with the EPP, which might be capable of substituting for the grand coalition between Socialists and EPP.

In the UK, elections may also take place in November. A victory of the Labour party is widely expected, but the real question is whether Labour will have a working majority in parliament or will instead be forced to form a minority government or enter into coalitions. Even after Brexit, the UK is crucial for European affairs, given its international alliances (including NATO) and its strenuous anti-Russian position in the war in Ukraine. A Labour victory may change some of these equilibria.

Moving on to the developing countries, in April and May 2024 there will be elections to decide the members of the 18th Lok Sabha, India’s lower house. As we have discussed in our recent report, a large coalition has been put together to defeat Narendra Modi, the “most popular leader in the world,” who has recently shown a more nationalistic and autocratic posture. But as in the case of Turkey, a large but heterogeneous coalition may not be enough to defeat the incumbent leader. We have often discussed India’s ability not to choose side between the US and China in Cold War 2. But if a change of leadership were to occur, the balance may move one way or the other

In January 2024, there will be presidential elections in Taiwan. As usual, the key issue will be the position of the next president vis-àvis China. But this year, there are reasons to believe the contest will be even more heated than usual. This could be the case not just because of the increasing disputes regarding Taiwan, but also because some analysts believe that China may take advantage of the electoral year in both the US and Taiwan to increase its destabilisations tactics against the island. Some even fear there is a potential window for an invasion (though this is a risk scenario, at this stage). 

Finally, but no less importantly, in March 2024 there will be presidential elections in Russia. Prior to the war in Ukraine, these would be considered marginal events, with a predetermined outcome, the re-election of Putin. However, there are now rumours that Putin may not even be in a physical condition to actually run the next election, which if true would dramatically change the entire global geopolitical landscape, as much as would a victory by Trump in November 2024 would do.

by Brunello Rosa

3 July 2023

An EU Council was held last week, with several items on the agenda. The first item to discuss was clearly the developments in Russia after the near-coup attempted by the Wagner division, which ended up with its leader Yevgeny Prigozhin exiled to Belarus. EU leaders agreed on continued military support for Ukraine and a further increase of the financial ceiling of the European Peace Facility. The second item on the agenda was a strategic discussion about the EU’s relationship with China. The EU reiterated its intention of “pursuing constructive and stable relations” with China, while following a strategy of de-risking, i.e. diversifying supply chains. 

The third point on the agenda was a discussion of the EU’s migration policy. On this issue, the Council could not find consensus for the opposition of the leaders of Poland and Hungary. In theory, the Council was supposed to approve a text that would meet Mateusz Morawiecki’s and Viktor Orbán’s desire to make it difficult for migrants to leave for Europe from countries such as Tunisia. But Poland and Hungary were still upset about the conclusions of the Justice and Home Affairs Council, which in early June approved the asylum and migration management regulation and the asylum procedure regulation. The asylum procedures regulation (APR) establishes a common procedure across the EU that member states need to follow when migrants are seeking international protection. The asylum and migration management regulation (AMMR) meanwhile should replace the current Dublin regulation. 

The combination of these two pieces of legislation de-facto establishes that all EU countries need to provide assistance to the countries of first arrival of migrants. That includes Poland for example in the case of Ukrainian refugees, but also Italy and Greece for migrants coming across the Mediterranean Sea. Given the opposition of Poland and Hungary, the EU’s final communique says that “President Michel took further note that Poland and Hungary declared that, in the context of the ongoing work on the pact on migration and asylum, there is a need to find consensus on an effective migration and asylum policy. The European Council will keep this work under review.”

This matters a lot for future European politics, ahead of next year’s elections. Giorgia Meloni’s dream is to bring the European group she leads, the European Conservatives and Reformists, into the majority that will elect the next EU Commission President, potentially Ursula Von Der Leyen again. But the veto posed by Poland and Hungary to the EU Council’s conclusions on migration will make it much harder for the European Conservatives and Reformists (ECR) to join the European People’s Party (EPP), socialists and liberals in the next majority. Mainstream leaders asked Meloni to make a last-minute attempt to convince Morawiecki and Orbán to withhold their opposition, but she failed to do so.

Another item about which Meloni is trying to put pressure on her European colleagues is the ratification of the reform of the European Stability Mechanism (ESM). Italy is the only country that has not yet ratified the treaty, even though it is the third largest contributor to the fund. According to Meloni, Italy should only ratify the ESM reform together with the approval of the new rules of the stability and growth pact (SGP), which will come into force as of 2024, in a sort of “package deal.” However, this position is only creating frustration among Italy’s European partners, and some incredulity, since Italy would be the most relevant beneficiary of the fund, in case of a banking crisis.

These last few episodes are starting to expose the challenges that Meloni faces in Europe, at a time when the EU has not yet sent out the third instalment of the Recovery funds. She has surprised many to the upside, by taking a rather mainstream and cautious approach. But these episodes will test her real ability to drive her agenda through Europe.

by Brunello Rosa

26 June 2023

Last week, US Secretary of State Antony Blinken visited Beijing, where he met with his counterpart Qin Gang and - after a long wait - with President Xi Jinping. As we discussed in our review, Blinken failed in his main objective, which was re-opening the direct communication lines between the militaries of the US and China, to make sure that a conflict doesn’t start between the world’s two superpowers by mistake.

This attempt by the US’ top diplomat was made to ease some of the tensions that have developed in the last few years between the two countries. Perhaps irritated by the limited success of his envoy, Biden subsequently had a slip of tongue and called the Chinese President “a dictator,” specifying however that he was ready to meet with him, and is hoping to see Xi in November in San Francisco at the APEC meeting.

After the failed attempt with China, Biden tried to make inroads with India, by inviting PM Narendra Modi to a state visit to DC, where Modi also addressed the US Congress for the second time. This visit was a resounding success. First, the US and India agreed on a series of technological and strategic partnerships, including in the crucial areas of semiconductors and satellite industries. More importantly, India agreed to purchase (and the US agreed to sell) military equipment, in particular armed MQ-9B SeaGuardian drones, which are produced by US defence contractor General Atomics.

This visit was particularly important because it marks a clear attempt by the US to detach India from China in the global rivalry between the world’s two superpowers that we called Cold War 2. In fact, as we have discussed on several occasions, India is trying to maintain a neutral and non-aligned position between the US and China, in the hope of extracting value from both relationships. But both China and the US do not like this neutrality.

The US is trying to keep India geo-strategically engaged via their participation to the Quadrilateral security dialogue. The US and India both also have democratic political systems, at a time in which many Asian countries are switching to autocracy. Finally, the US is aware of the territorial disputes between India and China, along their 3500 km of shared borders, which culminated in a military exchange between the two countries in May 2022 in the Himalayas.

China meanwhile counts on India’s participation in the BRICS club, and on the fact that Modi has shown several signals of his penchant for nationalistic politics, with some authoritarian aspects, especially in regard to India’s religious minorities, such as Muslims and Christians.

All this is happening while, at a finance summit in Paris, which is being attended by BRICS delegations as well as by the US Secretary to the Treasury, other BRICS countries re-asserted their intention to diminish the role of the US dollar as the world’s reserve currency. (This included South Africa and Brazil, via the attendance of presidents Cyril Ramaphosa and Ignacio Lula, respectively). The BRICS would aim to use their own currencies, rather than the dollar - or else a future “common” currency - for their commercial exchanges, as China and Russia have already done, especially after the international community (led by the US) froze USD 300bn of Russian central-bank assets following Russia’s invasion of Ukraine.

As we discussed on previous occasions, these are all examples of the ongoing competition between the G7 bloc and the BRICS bloc to establish their economic and geopolitical hegemony on the world’s stage. This competition, a further derivative of Cold War II, is destined to remain with us for decades to come.

by Brunello Rosa

19 June 2023

Three major central banks held their policy meetings last week. The FOMC of the Federal Reserve met on Tuesday, and on Wednesday it revealed the decision (which had largely been anticipated by the market) to “skip” the June meeting as part of its tightening cycle. During the press conference, Chairman Powell said he did not want to elaborate on the difference between a “skip” (which could be considered a one-off event) and a “pause” (which could be a prelude to a more prolonged period of no action). 

But with some key inflation indicators, such as the PCE and core PCE indices which are the Fed’s preferred gauges of inflation, having recently risen, it is hard for the FOMC to declare victory, so long as inflation remains more than double the target level. For this reason, the Fed has indicated, in its quarterly projections, that the FOMC expects two more 25bps increases to be deliberated in H2 2023. That will begin in July, which will be a “live” meeting, suggesting that a rate increase is more likely than not.

The Governing Council of the ECB meanwhile met on Thursday and announced, through its President Madame Lagarde, an increase in all its policy rates by 25bps. More importantly the ECB announced during the press conference that it is very likely that rates will be increased further in July, and possibly in coming months, as there is still “ground to cover,” given that inflation remains persistently high. The ECB is doubling its tightening efforts by completely stopping reinvesting the proceeds of its maturing bonds under the APP facility. 

The day after the ECB came the BoJ’s turn. The BoJ has been the outlier of this tightening cycle, having maintained its policy rates – and all the other elements of its policy stance – at an unchanged level throughout this period. It did so in spite of headline and core inflation now being above the bank’s 2% target, for the first time in a very long time. Clearly, Kazuo Ueda, the new governor of the central bank, has not been able to form a majority within the MPC to change the BoJ’s stance.

This week, it will be the Bank of England that has to decide whether or not to raise rates. The MPC will meet on Wednesday, and on Thursday it will likely deliver yet another 25bps increase, which will bring Bank Rate to 4.75%, a level not seen since prior the global financial crisis. More than the decision, which is widely expected, the market will focus on the language accompanying it, to see how many rate increases are still in the pipeline. 

All of the above suggests that rate increases are likely not over yet in many jurisdictions. Inflation proves to be stickier than initially anticipated. And inflation is more persistent than had been anticipated because of the various structural factors that we have been discussing in several pieces of analysis.

by Brunello Rosa

05 June 2023

We have often written about Turkey in the last few weeks. The catalyst for this has been the presidential and parliamentary elections that took place in May, the first round held on the 14thand the second round on the 28th. In our initial preview, we asserted that a period of change, and potentially instability, could emerge during the election period. That would have been exacerbated by a potential victory for the leader of the wide-ranging coalition that opposed incumbent president Recep Tayyip Erdoğan, which was led by Kemal Kılıçdaroğlu. 

In our review, we discussed how Erdoğan managed to win his third mandate, and his third decade in power, with a narrow (52%-48%) victory over his opponent in the presidential race. Erdoğan maintained a comfortable majority with his nationalistic allies of the MHP, further indicating what might be lying ahead for Turkey, in terms of the country’s policies. Finally, in our column for last week’s ViewsLetter, we discussed the appointment of  Mehmet Şimşek as the new finance minister. Turkey is again in the news this week, for the appointment by Erdoğan of the new central bank governor. 

Turkey is an important country to watch, for a number of reasons. First, from a geopolitical perspective, Turkey has long tried to become the intermediary to broker a Russia-Ukraine conflict. Being a NATO country, Turkey can reassure Ukraine that Russia will be opposed in its most outrageous territorial requests. At the same time, Erdoğan has attempted to keep an open relationship with Vladimir Putin, even after the beginning of the war. Long gone are the days in which the two leaders were at loggerheads over the issue of the Russian fighter jet downed by a Turkish warplane, back in 2015. 

Erdoğan instead brokered a U.N-backed deal on grain exports from Ukrainewhen the risk existed of a devastating food crisis in emerging markets, especially in Africa. 

Second, Turkey sits at the boarder of several political fault-lines. It is the gateway between Europe and the Middle East and Asia, being an Islamic country but with secular institutions established by Mustafa Kemal Atatürk – the first Turkish president. At the same time, it is also a primary example of the ongoing phenomenon of the “autocratization” of democracies, with Erdoğan having also brought back the respect for Islamic rules in public affairs, though short of re-establishing the Shari'a. 

Finally, Turkey is at the centre of attention of financial markets, given the sharp depreciation of the Turkish lira observed in the last few years. The USD/TRY exchange rate moved from 1.18 to 23.4 between 2008 and 2023. This is the end result of the un-orthodox economic policies introduced by Erdoğan over the last few years, which have been branded “Erdonomics.” The most notorious and controversial of these has been the reduction of interest rates carries out in the last few months, which have led to a sharp increase in inflation, which has reached 85.5% y/y recently (before “easing” back to 40%). Erdoğan was in fact convinced that an increase in interest rates would lead to an increasein inflation rather than a reduction, as economics textbooks would traditionally say. (Erdoğan’s rationale being that, when the inflation basket is dominated by administered prices, an increase in rates would lead to an increase in these administered prices). 

During his years as president, Erdoğan has appointed several central bank governors, including five in the last four years, until he found someone willing to follow his lead on these policies. At the same time, in the past he appointed his son-in-law Berat Albayrak as Finance Minister, to replace the well-respected Mehmet Şimşek. The result of this has been fiddling economic growth, rampant inflation, a large current account deficit (4.5% of GDP) and a collapsing currency. The failed attempts to prop up the currency have resulted in the depletion of foreign exchange reserves, and the explosion of bank deposits protected against TRY devaluation (which reached USD 92bn in April 2023), which is a clever way to mask foreign currency debt. This is the recipe for a financial crisis to occur sooner rather than later. 

Facing that, Erdoğan has decided to change tack, at least on economic policies, soon after his re-election as president at the end of May. As we discussed last week, he re-appointed Mehmet Şimşek as Finance Minister, who promised transparency and accountability. Last week, he appointed Hafize Gaye Erkan as the new central bank governor. Ms Erkan is a well-respected figure in financial circles, having worked for several years at Goldman Sachs after graduating from Princeton, and recently as Deputy CEO in charge of risk management (her specialisation) at First Republic, the now-disgraced American bank that was once considered innovative. Her last stint at First Republic, which failed because – among other reasons – of inadequate risk-management practices and a poor business model, clearly makes her appointment controversial. At first sight investors are likely to approve of the move, however. 

In fact, more than the presence of these two figureheads that can reassure markets, the real question is whether they will be left with the freedom to adopt the orthodox policies the country needs to avert a financial crisis in short order. If so, we should soon observe a re-appreciation of the TRY. But if instead they are asked to continue following unorthodox policies, a financial crisis appearing on the horizon will be more likely than not.

by Brunello Rosa

05 June 2023

Lat week,  deal – however temporary – for the US debt ceiling was reached between the two sides of the aisle in the US congress. This will avoid a catastrophic default, which could have had unforeseen consequences on international markets. Meanwhile, the Non-Farm Payroll figure for May 2023 showed an astonishing 339,000 increase in the number of jobs, well above the 190,000 that had been estimated by the market, a further proof of the US job market resilience. In the past, these events would have been more than enough to determine investors’ sentiment in the market. But these days are different. 

Clearly, macro-financial conditions still have a large impact on market sentiment and behaviour. But in this period, geopolitics seems to reign supreme for investors’ moods, and for market dynamics. In this respect, several items have been on the agenda over the last few days. First is the OPEC+ summit, which is trying to agree on another cut to oil production in order to prop up oil prices. Saudi Arabia is reportedly in favour of a cut, while other countries seem more reluctant. The decision by OPEC on oil production is the traditional “transmission mechanism” between geopolitics and the global economy. But in this period, geopolitics tends to have a much more direct impact on investor sentiment. 

In Europe, at the end of last week, a meeting of the European Political Community (EPC) took place in Mimi Castle in Bulboaca, Moldova. The EPC gathers around the table the 27 EU countries, plus 18 additional non-EU European countries to discuss security and energy-related issues. The choice of Moldova was not casual. Moldova has a region, Transnistria, which is already controlled by the Russians, and many fear that the country could follow a fate similar to that of Ukraine. Clearly the EU countries wanted to make it known that they will stand beside Moldova, as well any other country that could be threatened by Russia (including Armenia, Azerbaijan, and Georgia, all of which were present at the meeting). On the sidelines of the meeting, French President Emmanuel Macron backed Ukraine’s NATO membership, in a U-turn that follows that of Henry Kissinger, which we discussed last week.

Surprisingly enough, Turkey was not invited to the meeting, despite having applied for EU membership several years ago and clearly being the gateway between Europe and the Middle East. In Turkey, President Erdogan began his third mandate, and his third decade in power. In a move that has pleasantly surprised market participants, Erdogan has appointed as new Finance Minister Mehmet Şimşek, a former Merrill Lynch bond strategist who served as Finance Minister and Deputy Prime Minister in one of Erdogan’s previous administrations, until 2018, when he was replaced by Erdogan’s son-in-law Berat Albayrak. The hope by the industry is that Turkey will return to more orthodox policies, after the deviations of so-called Erdonomics, which brought inflation to nearly 50% per annum. Reportedly, Şimşek promised to adopt “transparency, consistency, predictability and compliance with international norms” as the “basic principles in achieving the goal of raising social welfare.”

In Asia, tensions are instead increasing between the US and China. At the Shangri-La Dialogue in Singapore, US defence secretary Lloyd Austin “criticised China for conducting dangerous aerial intercepts over the South China Sea,” according to the FT. This happened just a few hours before a Chinese warship nearly collided with a Canadian frigate in the international waters of the Taiwan Strait, in what the Canadians called “an unsafe maritime interaction.” The risk of unintended incidents that quickly escalate into a direct military confrontation is increasing fast in the Indo-Pacific. If anything closer to such a confrontation were to happen, the repercussions on financial markets would be immediate and significant. 

by Brunello Rosa

30 May 2023

Henry Kissinger, the former US Secretary of State and National Security Advisor under President Richard Nixon, and advisor to other presidents, including John F. Kennedy, turned 100 last week. The press was full of articles recollecting his achievements as top US diplomat, in particular his ability to begin the so-called détente between US and China in the early 1970s, and his negotiations that led to a ceasefire during the war in Vietnam. For these and other results, he was awarded the Nobel Peace Prize in 1973. Kissinger was considered able to reach impossible compromises among belligerent parties. 

Being still active in media, Kissinger has expressed his views on the war in Ukraine, and how it could end. Recently, he changed his mind regarding Ukraine’s NATO membership. Initially, he thought it would be read by Russia as a further provocation, and so opposed Ukraine’s membership. But now he believes that Volodymyr Zelensky is an “extraordinary leader,” who is wise in accepting China’s diplomatic efforts, and that NATO members should allow Ukraine to join the club sooner rather than later. 

Clearly, in these highly confused times, another Kissinger able to negotiate a peace plan between Russia and Ukraine would be neeeded. We believe there is still a long way to go before this can ever happen. Ukrainian troops have just announced the beginning of their long-waited Spring counter-offensive, with the aim of winning back some of the territories currently occupied by the Russians. Ukrainian sources are saying that they expect some form of “massive incident”, a “provocation” by the Russians at the nuclear power station of Zaporizhzhia, currently controlled by the Russians, reportedly to justify their reaction. 

Despite this, perhaps the first elements of a possible path to peace are starting to emerge. There are several pieces to this jigsaw puzzle. First, Russia has said that China – which has its special envoy for Eurasian affairs, Li Hui – would reportedly be in favour of Russia keeping the territories that it is currently controlling. Ukraine, and the West, do not consider this acceptable, although some of the allies would be open to leaving Crimea to Russia. Second, Sir Jeremy Fleming, the head of the UK cyber-intelligence at CGHQ, said that President Xi cares that his ally Putin should not end this conflict with a humiliation, implying that some sort of compromise that allows him to save face would be necessary.

Third, the Vatican has opened its diplomatic channels, and Pope Francis has nominated Cardinal Zuppi as the Holy See’s envoy to the region, the same way that in 2003 Pope Wojtyla appointed Cardinal Etchegaray as his envoy to Bagdad, at the time of the war in Iraq. Moscow seems in favour of the Vatican’s mission, while Ukraine is much more sceptical. Fourth, Brazilian president Lula said that he is ready to negotiate with Russia, together with India, Indonesia and China, to find a peaceful compromise to end the war. 

 These are still very preliminary steps, but perhaps they could be the initial elements towards a possible, compromise solution.

by Brunello Rosa

22 May 2023   

Last week we discussed the main themes of the G7 Summit in Japan. The final communiquereleased at the summit reflected those themes, in particular the commitment by G7 countries to a) support Ukraine “for as long as it takes” against Russia’s “illegal war of aggression;” b) strengthen nuclear “disarmament and non-proliferation efforts;” c) enhance economic resilience and security that is based on diversifying supply chains via “de-risking, not de-coupling” from China;” d) drive the transition to cleaner energy economies; e) launch the Hiroshima Action Statement for Resilient Global Food Security; and f) deliver the goal of mobilizing $600 billion in financing for quality infrastructure through the Partnership for Global Infrastructure Investment (PGII), i.e. the Western equivalent of China’s BRI. 

The summit was dominated by the presence of Ukrainian president Volodymyr Zelensky, as well as other leaders who have recently expressed a more neutral position towards the war in Ukraine, such as Brazilian president Ignacio Lula da Silva and Indian Prime Minister Narendra Modi. In the past, India processed Russian crude oil and diamonds, while Brazil refused to sell ammunition to Germany as it could be used to help Ukraine. The FT reported that Zelensky directly confronted these leaders, asking them to more forcefully condemn the Russian invasion of Ukraine. 

In Europe, 75,000-80,000 people have participated in Moldovan president Maia Sandu’s rally in Chisinau in favour of an expedited accession to the EU, to prevent further Russia interference in the Moldovan region of Transnistria, which borders with Ukraine and is already controlled by the Russian army. All this is happening while the Russians announced that, after months of conflict, their troops managed to conquer Bakhmut, which was considered a strategic position. President Zelensky admitted that the city is now only in the “hearts of the Ukrainians.”

Meanwhile, the G7 issued its strongest condemnation to date of China’s position regarding the war. They asked China to intervene with Moscow for a withdrawal of troops from Ukraine. They also criticised Beijing for its militarisation of the South and East China seas, and for its economic coercion of South-East Asian countries. G7 leaders also called for a peaceful solution to tensions across the strait of Taiwan. 

Perhaps in response to all this, China has decided to ban the products by Micron, the US largest micro-processor producer, from key infrastructure projects, citing a national security risk. This is the mirror image of what the US has done in the past to semi-conductors produced by Chinese companies such Huawei and ZTE. 

All of this suggests that the hot war between Ukraine and Russia, which in our opinion is the first proxy conflict of the new Cold War between US and China, will continue unrelentingly, with all its open fronts: the trade war, the tech conflict with its various battlefields (big data, AI, cyberwarfare, Regulatory Technology and Central Bank Digital Currencies) and the balkanisation of global supply chains. 

In the absence of an effective forum for global governance (the UN Security Council and the G20 are both polarised between US and China), regional fora such as the G7 (for the advanced economies) and the BRICS+ (for emerging markets) are the only occasions in which these issues can be discussed at a global level. 

by Brunello Rosa

15 May 2023   

There will be a G7 summit in Hiroshima this week, where world leaders will meet to discuss the most topical issues of the moment. There is no shortage of subject matters for them to focus on. The elections in Turkey have shaken the political, and perhaps institutional, system of one of the world’s pivotal countries: an electoral democracy flirting with autocracy, a Muslim country at the gateway between Christian Europe and the Islamic Middle East, a NATO country with a “special relationship” with Russia, which would like to be a mediator in the conflict between Russia and Ukraine. 

The war between Russia and Ukraine itself is entering a decisive state, with Ukraine having possibly begun its counter-offensive, perhaps making progress on the Bakhmut front. Ukrainian President Volodymir Zelensky is currently in Rome to meet with President Sergio Mattarella, Prime Minister Giorgia Meloni, and Pope Francis, who is himself committed to a “secret” peace effort through the diplomatic channels of the Vatican. 

On the financial front, the ongoing banking crises in the US and in Europe, and the approaching deadline for the increase in the debt ceiling in the US in order to avoid a default, will certainly be part of the discussions at the G7 summit as well. 

Underlying all this, there will be the overarching theme of the incipient Cold War between the US and China, which, in diplomatic circles goes under the name of “decoupling”, between the two world’s super-powers. 

There is no better place to discuss this issue than Japan, and in particular Hiroshima. Japan is currently the closest ally of the US in the Indo-Pacific, part of the Quadrilateral Security Dialogue with US, India and Australia. It has a strong economic relationship with China, but at the same time it has a territorial dispute over islands in the East-China Sea. This comes as a result of a reversal in the alliances that existed during WWII. 

Then, the US was allied with China to defeat Japan, which of course was acheived following the atom bombs dropped on Hiroshima and Nagasaki in 1945. 

The visits by German Chancellor Scholz and French President Macron to China in the last couple of months represented an attempt to re-build diplomatic and commercial ties between European countries and China. But, as we discussed in our column, the head of the European Commission Ursula Von Der Leyen marked a different tone during her visit to China together with Macron. She spoke about “de-risking”, referring to European countries needing to reduce their dependency on China-dominated supply chains. 

Press reports suggest that Germany may be tempted to adopt the theme of “smart de-risking” and include it in the final communique at the G7 summit, while excluding the idea of more fully decoupling from China. That may well occur, but we believe that de-risking may be just the initial phase of a more profound decoupling that will take place in coming decades. Clearly, it is also not in China’s interest to break its economic ties with the West too soon, as South-East Asia, Africa and Latin America are not yet wealthy enough to be able to substitute the US and Europe as China’s preferred destination for its exports. 

That is also the reason why China is itself increasing its efforts to end the war between Russia and Ukraine, by way of diplomatic, rather than belligerent, means. This is the reason why China is sending a special envoy to Ukraine and Russia to try to find some common ground, and why Xi finally made his long-awaited telephone call to Zelensky at the end of April. 

by Brunello Rosa

8 May 2023        

The US Federal Reserve held its FOMC meeting last week. As we discussed in our review, the Fed increased its Fed funds target rate by 25bps, to 5.00%-5.25%. We – as well the consensus opinion – consider this to be the last increase before a pause that is likely to last at least until the autumn. The Fed is also continuing its policy of reducing its balance sheet, according to the criteria it established in May 2022. 

As we discussed in our review, the Fed retained a hawkish bias with this decision. It made it clear that it could further increase its rates if the economy proves to be more resilient, the labour market tighter, and inflation stickier than is currently expected. A condition for this to happen is the absence of further negative surprises from the banking sector. This cannot be taken for granted at this stage, as regional banks remain vulnerable to a downturn in residential as well as commercial real estate, and all banks remain exposed to much higher interest rates. In spite of the Fed’s hawkish bias, the market celebrated with a relief rally, especially in bonds. It has been perceived as the end of the hiking cycle – at least for a while. 

Also last week, the ECB held its Governing Council (GC) meeting, and decided a 25bps increase in its policy rates. It also decided to accelerate the shrinking of its balance sheet, given the end of the re-investment of maturing bonds from July 2023. Unlike the Fed, the ECB has signaled that further hikes will likely be necessary to tame inflation, which remains stubbornly high at three times the ECB’s target level. But with a couple of more hikes in June and July, the ECB too will likely have finished its initial hiking phase. 

The Reserve Bank of Australia meanwhile carried out a surprise rate increase of 25bps, to 3.85%, because inflation, at 7%, is still too high compared to its target, even if it has passed its peak. 

This week, it will be the Bank of England’s turn to increase its Bank Rate, again by 25bps, to 4.25%, to try to bring inflation down to single digit levels. Inflation remains above 10% in the UK, impacted not just by the re-opening of the economy and the energy shock, but also by the effects of Brexit on British supply chains. 

In spite of the different jurisdictions, it is clear that central banks, especially in the developed world, have now reached, or are about to reach, a local peak in their increases of interest rates. The Fed has increased rates by 500bps in a little more than a year. The hiking cycle has been rapid, large and coordinated, to an extent unseen in recent decades. 

The side effects of this massive tightening in policy rates conducted at global level has started to appear in terms of financial instability, with banks suffering a level of interest rates that may be beyond what the Fed has called a “financial (in)stability rate.” Central banks will now have to try a difficult balancing act between slowing growth, persistently high inflation, and incipient financial instability. Not an easy job, surely.

by Brunello Rosa

1 May 2023        

A few weeks ago, a series of banks across the Atlantic fell into trouble. In the US, as we discussed in our previous column, the Silicon Valley Bank went into receivership as the rise in policy and market rates made the simple, poorly managed business model of the bank (namely, gathering cash deposits and investing them in long-term Treasury bonds) miserably fail. Last week, the Fed released a report on this failure and blamed both the poor risk-management of the bank, which did not hedge against the interest rate risk and maturity mismatch, as well as the too-soft supervisory oversight by regulators. According to the Fed, the regulators’ action was weakened by the reforms made during Trump era, which had called for a less intrusive approach. 

The other US banks that were in trouble were Silvergate and, in particular, First Republic Bank. In the latter case, a group of 11 banks pooled resources to put together a rescue plan worth around $30 billion, in an attempt to stop the slide on the banks’ equity prices, which had collapsed by 90% from their peak of $219, reached at the end of 2021. As we said in our column, “It is not yet clear whether this rescue plan will be effective, as the fall in the banks’ equity prices has not yet stopped.” Now we know it has not worked, because the Fed has asked other financial institutions, including JP Morgan and PNC, to express an interest in the acquisition of the bank.

In Europe, Credit Suisse was acquired by UBS with a “burden-sharing” approach that left everybody unhappy, apart from the management of Credit Suisse which got away with some form of a golden parachute. Most importantly, the market quickly turned its eyes against what was perceived to be the next weakest link, Deutsche Bank, which underwent severe stress when a small bet on its credit default swaps (CDS) hit the market. 

Second, as I argued at the recent G30 meeting in Washington, the apparatuses that have been put in place after the GFC to avoid a repetition of the serial banking failures of that period may not be proving fit for purpose. The return of blanket guarantees on deposits and the fact that regulators, instead of resolving troubled banks, always try to sell them to larger willing institutions, suggest that the instruments devised to resolve crises may have not worked when tested against reality. In this respect, it is scary to note that the total assets held by the twoFDIC-insured banks that have failed in 2023 (at USD 319bn) are almost as large as the combined assets of all failed banks in 2008.

Third, as a consequence of the first two points, the risk remains that an episode similar to what happened to Deutsche Bank a few weeks ago may repeat itself. If it does, the government might then panic and announce that ALL deposits will be guaranteed. In 2008, this was the beginning of the end for Ireland, which first announced a blanket guarantee on deposits. This put the government in a very precarious position, from which it was rescued only by the ECB activating an ELAand the government issuing a promissory note. This was the beginning of the doom loop between government debt and banking debt that worsened the Euro crisis and proved hard to break. If a government were to do that again - and a simple line during the evening news such as “all deposits will be guaranteed by the government” may be enough for it to happen - we may see a return of the “doom loop.” At that point, central banks, even if they are busy fighting inflation, would need to reconsider their stance and prioritise the solvency of the government and the banking system over the fight against inflation. They might need to cut rates and re-start QE. 

As we have said, during the 2007-2008 financial crisis, it took one year between the Northern Rock bank run and the collapse of Lehman Brothers. This is the reason why it is essential that regulators, in the year ahead, will try to “fix the roof until the sun shines”, as Christine Lagarde used to say when she was the head of the IMF, and adopt the necessary reforms to prevent the isolated cases of recent days from becoming systemic events in one year’s time. 

For this reason, Michael Barr, the Fed’s bank-supervision chief, called for an overhaul of how the Fed oversees US financial firms. The Fed will revisit the various rules that apply to institutions with more than USD 100 billion in assets, including stress-testing and liquidity requirements. Regulators could require additional capital or liquidity, or limit share buybacks, dividend payments, or executive compensation when firms exhibit inadequate capital planning and poor risk management.

Regulators across the board are trying to say that these are idiosyncratic cases, which do not necessarily need to be precursors of a more systemic financial instability episode. We dissent from this interpretation, for the following reasons. 

First, all banks have been subject to the same shock, which was the rapid, large, coordinated increase in interest rates across the globe. Up to a certain point, for well-managed banks, higher rates are a bonanza, as banks can charge more for the money lent, while being slow in adjusting the remuneration of their deposit, in the absence of real competition. But above a certain level (that the Fed named r**), higher rates are detrimental because of their impact on overall financial conditions and on the strength of the economy, which is the most relevant factor in determining the ability of borrowers to repay their debt. 

by Brunello Rosa

24 April 2023    

Brazilian President Luiz Inacio “Lula” Da Silva visited China last week, and reportedly he and Chinese President Xi Jinping discussed possible solutions to end the war in Ukraine. The two sides discussed the possibility of creating a group of countries that are not involved with the Russia-Ukraine war, to broker peace between the two belligerent countries. On his way back to Brazil, in Abu Dhabi, the Brazilian president made comments in which he suggested that Western countries should stop providing weapons to Ukraine, because doing so has been “prolonging the war.” 

Unsurprisingly, these comments caused much resentment and outcry in the U.S. and Europe, while being lauded by Russia. Lula partly backtracked from his comments by condemning the “violation of Ukraine’s territorial integrity” by Russia, and again called for mediation to end the war. He avoided further criticism of the U.S. and European role in the war during his visit to Portugal this past weekend.

Why did Lula come up with such comments? There are several reasons. 

First, Lula has been re-elected with a much more left-wing platform than in the past, as he needed to differentiate himself from his predecessor Jair Bolsonaro. Part of this platform consists in being less pro-American than his right-wing predecessor, who was considered the “Trump of Latin America.” So Lula has to some extent re-vitalised the traditional non-aligned and pacifistic position of Brazil, by distancing himself from the US. 

Second, Brazil belongs to the BRICS, the group of emerging markets that is creating a new EM-G7, together with Saudi Arabia, Argentina, and perhaps other countries as well. 

So, Russia Brazil is already keen to listen to both China and Russia, which belong to the same grouping, and are currently allied in the Russia-Ukraine conflict. One cannot be surprised therefore if Brazil echoes some of China’s and Russia’s opinions. China has already acquired several Latin American countries in its Belt and Road Initiative (BRI), i.e. Venezuela, Ecuador, Peru, Bolivia, Chile, Argentina, and Uruguay. China is increasing its influence in South America, either via its BRICS grouping or its BRI initiative. 

Third, and perhaps more importantly, China has massively increased its appeal as a potential broker for international affairs. Apart from attempting to become a mediator for the conflict in Ukraine, which will be difficult given its support to Russia, it has recently brokered a historic agreement between Saudi Arabia and Iran, which at least on paper may freeze the conflict between the two Middle Eastern powers after decades of overt or covert conflict. For this reason, China has become a reference point for a diverse (and often conflicting) set of countries, such as Iran, Saudi Arabia and Israel, as well as Pakistan, India and North Korea. 

China’s role as an international peacemaker will still require time to be built, and it is unlikely to happen until China will be involved directly in some major conflict, as it happened to the U.S. after WW2. But the country has already made huge strides in that direction, and it is obvious that the role of the U.S. as the world’s only superpower, brokering international affairs with diplomatic as well as military means, is now over.

by Brunello Rosa

17 April 2023  

The IMF’s Spring Meetings took place in Washington, DC last week. This was the occasion for policymakers, academics, practitioners and market participants to meet after the financial instability episodes of the last few months, at a time when the fears of a global recession are not totally dissipated. 

The atmosphere in DC was relatively relaxed, with policymakers taking a sigh of relief as they saw inflation start to abate, recession fears becoming severely diminished, and some potentially devastating financial crises having been averted. There was no sense of urgency, but rather a sense of suspension, with the knowledge that something unpleasant may happen down the line, but that this “something” has not materialized yet. This sense of suspension may however easily morph into complacency, given the downside risks that still affect the global economy. In our opinion, complacency abounded at these Spring Meetings. And here is why.

First, inflation may be going down, but it is unlikely to return consistently to 2% (apart from potentially undershooting the target for a period of time, due to base effects). More likely it will remain around 4-5% in the medium term, for structural reasons we have discussed several times. 

Second, in terms of financial stability, it is true that potentially dangerous spillovers have been averted on both sides of the Atlantic, by containing the SVB and Credit Suisse crises. But at what costs? In the US there is a return of some form of blanket guarantee to all deposits; in Switzerland, there was a de-facto inversion of the pecking order, with AT1 bond-holders being bailed-in before shareholders were wiped out. 

Third, the major economies may have escaped a full-fledged recession, but only because household consumption has been supported by reducing the excess savings deriving from generous monetary policy and profligate fiscal policy. Once these excess savings run out, and the full extent of the monetary policy tightening will be felt, the economy will remain prone to contraction. 

This period resembles the early stages of the Global Financial Crisis (GFC). In November 2006, BNP announced that it would not allow the redemption of some funds. In February 2007, the first shakeup to the system let several institutions, including UK’s Northern Rock and Germany’s IKB, run into trouble. In September 2007, there was the bank run on Northern Rock, but it took more than one year for the collapse of Lehman Brothers to materialize. Until September 2008, it wasn’t immediately clear that what was described as a localised banking crisis was about to become the Global Financial Crisis of 2007-09.

Banks around the world are all subject to a synchronized and abrupt increase in policy rates, whose effects, after “long and variable lags” will be felt by the real economy. Initially, higher interest rates are good for banks, as long-term rates rise, and the yield curve bear-steepens. But, after a threshold, higher interest rates may become problematic for banks, especially if badly run, as the yield curve inverts. The market has targeted the weakest links in a systematic way: SVB first, Credit Suisse afterwards, and then it tested the solidity of Deutsche Bank. Short-term fixes have been applied, but long-term solutions are far from being deployed. In the US, a blanket guarantee on all deposits is not fiscally sustainable. In Switzerland, a gigantic single institution has been created, with a balance sheet much larger than that of the state. 

In Germany, there is a risk that a new attack on Deutsche Bank may result in the withdrawal of deposits, which may force a panicking government to promise a blanket guarantee on all deposit, and a suspension of the bail-in rules. This would re-activate the doom loop between banks and government bonds, with a potential fragmentation of the regulatory environment and of the transmission mechanism, and with amplified effects on the government bonds of the most indebted countries, Italy first and foremost.

So far, irresponsible bankers have learned that their mismanagement won’t be punished, and that depositors will be backed by taxpayers’ money. It is the return of the moral hazard, which regulators were believed to have dismantled in the aftermath of the GFC. It is sad to note that, so far, moral hazard has always paid off. Especially when regulators have been too complacent, and too slow in recognising emerging risks.

by Brunello Rosa

11 April 2023  

Last week, French President Emmanuel Macron went to China to meet Chinese President Xi Jinping. This was the first visit of France’s president since the beginning of the war in Ukraine, and it follows the visit German Chancellor Olaf Scholz made to China in early March. That visit caused much discontent in Europe, as Scholz seemed to be breaking from the West’s ranks in the war against Russia in order to pursue the commercial interests of Germany. 

For this reason, Emmanuel Macron was accompanied by EU Commission President Ursula von der Leyen, to show that he was trying to advance the interests of the entire EU and not solely those of France. In particular, they reportedly asked Xi to “bring Russia back to reason.” Nevertheless, Macron was accompanied by plenty of French business leaders on his trip to Beijing - and subsequently to Guangzhou – who were in search for contracts to be signed. Additionally, it seemed that the French President and the EU Commission President released quite diverging messages regarding the purpose of their trip. 

While von der Leyen has tried to portray a sense of unity in the European front, including that of its alliance with the US and other NATO countries, Macron has shocked policy observers and allies with the declarations he made after his tea with Xi Jinping. These declarations by Macron contained the following three messages.

First, that the EU needs to build the “strategic autonomy” that the French President has spoken about since his first months in office in 2017. Second, that this strategic autonomy will serve the purpose of not making European countries vassal states of the US. And third, that the EU should as a result not be embroiled in all the geo-strategic disputes of the US that are not pertinent to the EU’s own objectives. 

All this is happening while the US is trying to build a united front against China in what we have called Cold War 2. We assume that these declarations won’t make the US president particularly happy, as they clearly undermine his own efforts. 

Especially as they are coming at a time when China is flexing its muscles against its “rebel province” of Taiwan. This week China started a military exercise against Taiwan, reportedly with live ammunition, in response to which the US has sent a military ship. We have discussed several times how we think that China will try to destabilise Taiwan with a series of provocations that will eventually aim at overthrowing the fragile democracy of the island, following a tactic not too dissimilar to that which it used to regain control of Hong Kong. 

French President Macron has tried to revive the dream of Europe’s strategic autonomy. But in this polarising world, in which countries have to side either with China or the US, this may prove much harder than he currently predicts.

by Brunello Rosa

3 April 2023  

The indictment of Donald Trump took place last week. The former US president will have to surrender to the New York judiciary on Tuesday, two weeks after he had anticipated to occur. He is accused of having used electoral campaign funds to buy the silence of “Stormy Daniels,” a porn-star, regarding an affair they had at the time when Trump was married to Melania, and she was expecting their only child, Barron. Daniels’ silence may have also altered the course of the electoral campaign that led to Trump’s victory in November 2016.

Trump will likely use this scandal as proof of the establishment’s attempt to keep him out of power, against the will of the “true Americans” he purportedly represents. This will make the 2024 electoral campaign even more tense than one could have anticipated, and the risk of civil unrest will increase dramatically, both before the election - to prevent voting from taking place - and after it, if Trump again loses and claims the results were fraudulent. 

Western countries, and even G7 countries, have already experienced similar situations, the most similar being Italy under Berlusconi. But the US is the beacon for Western democracies and cannot afford to stage such a depressing “show.”

But the US is not the only Western country that is exhibiting a worrying collapse in the quality of its political leaders. In the UK, the populist leadership under Boris Johnson led the country to implement the referendum on Brexit with a “hard-leave”, a rare example of a self-inflicted wound that will be felt for generations, and will be hard to undo. Luckily, the Tory leadership is now in the safer hands of Rishi Sunak, after the disastrous interregnum of Liz Truss and Kwasi Kwarteng.

In Germany, after the fall of Merkel, a clear successor in terms of charisma has not yet emerged in any party. On the right side of the political spectrum, Friedrich Merz is facing the challenge of unifying the CDU behind his liberal positions. On the left, Olaf Scholz is having a hard time exerting leadership over his coalition, in which Christian Lindner is facing the possibility for his Liberal party not to re-enter parliament. The Greens meanwhile are busy with a leadership clash between their two co-leaders, Annalena Baerbock and Robert Habeck.

In France, it is unclear what happens after the presidency of Macron. Macron was a product of the French elites, but he has not yet built a credible legacy in terms of enacting policies or facilitating the emergence of credible successors. His controversial pension reform, which was approved through the Article 49.3, which allows the government to circumvent parliament, has not made him more popular. In 2027, a possible victory by Marine Le Pen is considered to be the central scenario. And Marine Le Pen has not yet built a credible profile as a good administrator of France’s domestic and international affairs. 

In Italy, prime minister Meloni is avoiding making huge mistakes, but the different weight Italy is considered to have on decision-making processes after the Mario Draghi’s era has been abundantly noted. Meloni herself believes that it is Macron who is keeping her out of the most relevant decision tables within European politics. At the same time, Italy’s difficulties in spending the money coming from the EU’s Recovery Fund is not helping to improve the country’s image in terms of its efficiency and effectiveness.

Especially at a time when the West is committed in a war against Russia, and indirectly against China (which is the champion of all existing and potential autocracies), it cannot afford to be presenting itself with such un-inspiring political leadership. The survival of democracy itself is at stake.

by Brunello Rosa

27 March 2023  

In the past few weeks many events have occurred that have made the world a more dangerous place. In mid-March, a MQ-9 Reaper reconnaissance drone collided with two Russian Su-27 fighter jets and fell into the Black Sea. This is the first official “military exchange” between Russian and NATO forces over the conflict in Ukraine; albeit an indirect one, as the drone was un-armed and the Russian jets did not aim to shoot it down. 

Subsequently, the state visit by Xi Jinping to Moscow made the “limitless cooperation” between China and Russia even stronger than it already was. And Xi can no longer credibly say that Putin misled him regarding his intentions on Ukraine. After one year of war, with dozens of thousands of deaths, it is perfectly clear what Putin’s intentions are, and it is also clear that Xi will not try to dissuade him from reaching his aims, at least not yet. (Apart from the fig leaf that is the purported “Chinese Peace Plan”). This comes after the International Criminal Court issued an arrest warrant against Putin for war crimes, in particular for the deportation of Ukrainian children to Russia. 

Russia has now started to use the Chinese yuan as its international reserve currency, in a sign of subjugation to its stronger ally. It is yet to be seen whether China will start openly selling weapons to Russia for its “special operation” in Ukraine. That would mark a definite escalation of the conflict, and its official transformation into a proxy war between the US and China. 

Finally, Russia has declared that it will deploy tactical nuclear weapons to Belarus, in an extreme attempt at dissuading NATO countries (chiefly the Baltics and Poland) from providing further military assistance to Ukraine. Putin has also said that NATO and his allies are now akin to the Nazi alliance that Russia fought during WWII, which in Russia was called the “Great Patriotic War.” NATO responded that Russia’s deployment of nuclear weapons to Belarus is “dangerous and irresponsible.” 

One could give further examples, but the story here is clear. The rhetoric coming from the two sides is hardening, instead of softening, and their actions are also escalating, in terms of NATO providing support to Ukraine and China helping Russia. Contemplating a nuclear attack in Ukraine has now become part of the central scenario, rather than a tail or even a risk scenario. It is understood that NATO would not react to a Russian nuclear attack with a nuclear response, but rather with a conventional retaliation of devastating proportions, to obliterate the Russian army in Ukraine, potentially including in Crimea.

World leaders seem to be sleepwalking into a nuclear Armageddon that could lead to World War 3. This is the reason why incidents such as the contact between the Russian jets and the US drone may be much more consequential than they could appear prima facie. One can imagine that in a situation of even higher tension between the two sides, a collision of this kind could easily be construed as the pretext for the beginning of direct military exchange between NATO and Russia, similar in nature to the killing of Archduke Ferdinand in Sarajevo, which of course marked the beginning of WWI. 

by Brunello Rosa

20 March 2023  

The ongoing banking crisis claimed more victims last week. The parent company of SVB filed for bankruptcy under chapter 11 rules in order to protect its assets from creditors. Meanwhile, Silvergate has gone under, and First Republic bank is also under stress. A group of 11 banks pooled resources to put together a rescue plan worth around $30 billion, in an attempt to stop the slide on the banks’ equity prices, which had collapsed by 90% from their peak of $219 reached at the end of 2021. It is not yet clear weather this rescue plan will be effective, as the fall in the banks’ equity prices has not yet stopped.

Much more significantly, on the other side of the Atlantic, one of the major European lenders, Credit Suisse, also got into trouble. Credit Suisse’s troubles started years ago, with very poor investment decisions, the most recent and insignificant of which have been the financing given to Greensill and to Archegos, both of which resulted in heavy losses for the bank.

Credit Suisse also had to apply for public rescue, with the Swiss National Bank providing emergency funds to it to the tune of €50 billion. During the weekend, the acquisition of Credit Suisse in its entirety by its historical rival, UBS will likely put an initial end to this story. Its investment bank operations, which were supposed to be shut down anyway, remain the most problematic part of the sale, as they may conceal hidden losses. 

The cases of SVB and Credit Suisse are very different. SVB had engaged in a very conservative business model, based on re-investing in safe US Treasury bonds; its collapse was caused by the lack of basic risk management practices. Credit Suisse meanwhile had engaged in a series of risky operations, the losses from which ultimately eroded the bank’s capital.

While this episode of financial instability was unfolding, central banks had to decide whether or not to continue their tightening cycles in order to a combat still-elevated inflation rate. As we discussed in our review, the European Central Bank decided to carry on with its pre-announced 50 basis point increase in interest rates, in part to address inflation but also to send a signal that the European banking system was solid and not involved in the ongoing banking crisis affecting US and Swiss banks. 

This week, it will be the US Federal Reserve and Bank of England’s turn to decide on their respective interest rates. As discussed in our previews, we expect both central banks to increase their policy rates by 25 basis points, unless new financial instability episodes emerge before their policy meetings take place.

But the genie is out on the box: it has become patently clear that a conflict exists between pursuing price stability and financial stability goals. We had discussed this at length in our 2023 Global Outlook, long before these episodes manifested themselves. During her press conference, Christine Lagarde attempted to provide assurances that such a conflict does not exist, as the ECB will use its interest rates primarily to fight inflation, and its liquidity tools to prevent financial instability from spreading. But the reality is likely to be much more difficult. 

Central banks may need to stop their tightening cycles, and perhaps even start cutting rates or resuming QE, to make sure that the financial system is not in danger. The next few weeks will show whether or not central banks will have to resort to these kinds of measures to prevent further financial instability episodes.

by Brunello Rosa

13 March 2023

At the end of last week, the Silicon Valley Bank (SVB) collapsed, just a few days after a much smaller lender, Silvergate, announced a plan to wind down its operations. The bank had USD 212bn in assets, a market valuation of around USD 16bn as recently as Wednesday last week, and a valuation of USD 44bn less than 18 months ago. At the end of December 2022, SVB had USD 173bn in deposits. However, on Thursday the bank suffered a USD 42bn withdrawal of deposits, after losing USD 1.8bn in a USD 21bn sale of part of its bond portfolio (made up of Treasuries and mortgage-backed securities). 

SVB tried to make a final, desperate attempt to shore up its capital by issuing USD 1.25bn of its common stock, plus USD 0.5bn of mandatory convertible preferred shares (which are slightly less dilutive to existing shareholders), while private equity (PE) firm General Atlantic had previously agreed to buy 0.5bn of SBV’s common stock in a separate private transaction. But this last attempt failed, and the bank was shut down by the Federal Deposit Insurance Corporation (FDIC), the US regulator that guarantees bank deposits of up to USD 250,000. Following that, the Bank of England put the UK arm of SVB into insolvency as well.

Why did the bank fail? Being exposed to crypto trading (Circle, the operator of one of the world’s largest stablecoins, said that USD 3.3bn of its reserves were held at SVB) and start-ups, including in the healthcare sector, one could think that the bank failed given the collapse in tech and crypto assets valuations over the last year. But the reality is much simpler, and to a certain extent is even more alarming. 

The business model of SVB was surprisingly “conservative”. The bank would receive large deposits from tech and crypto companies that had raised their funds through venture capitalists and PE firms. These deposits were reinvested into ultra-safe bonds – in particular Treasuries and mortgage-backed securities, both of them held in massive quantities by the Federal Reserve – and also foreign government bonds. As of the end of 2022, the bank had $26.1bn in available-for-sale securities and around $91bn of securities in a held-to-maturity portfolio. 

This business model would make money as long as policy interest rates were low, such that the cost of deposits would be minimal and the value of the bond portfolio would remain high. But as the Fed increased its policy rates by around 5% in one year, the cost of deposits rose from 0.14% to 2.33% in the same time-span, while the value of the bond portfolio declined. For this reason, the bank had reported a loss of USD 15bn at the end of last year. 

So, the bank didn’t fail because it had invested in assets that were too speculative, or followed a business model that was too risky. It collapsed because the most basic risk management practices were not followed. Banks tend to have a diversified depositor base, with a number of small – fully insured – depositors. They would not run at the first bad news. But the vast majority of SVB’s depositors were not insured, so they wanted their money out as soon as they perceived an increased default risk. Furthermore, banks would normally invests in floating rate notes, which gain in value if interest rates go up, or they would enter into swap agreements to insure against rising interest rates. This didn’t happen. 

So, why this is scary? We discussed how recently the New York Fed had defined an r** rate, a rate over which financial stability episodes could emerge. If r** was below the neutral interest rate, r*, or in any case if it was below the terminal rate, the central bank may be forced to stop its tightening cycle in order to prevent further episodes from emerging So, as Hyman Minsky predicted in his Financial Instability Hypothesis, downturns in financial markets occur when interest rates go up. SVB was a fragile bank, from a Minskian perspective, for the reasons exposed above. But other lenders may fall from similar difficulties if interest rates continue to increase at this speed. And all this is happening just days before the next FOMC meeting, in which the Fed may decide to ratchet up the pace of its tightening cycle again, by 50bps, in response to the positive news from the labour market and the stubbornly high inflation rate.  

by Brunello Rosa

27 February 2023  

On February 24th, 2023, the one-year anniversary of Russia’s invasion of Ukraine took place. As we discussed in various columns on this theme, this date also marks the end of the post-WW2 equilibria, the official end of this phase of the globalisation process, and an acceleration to the polarisation of the world between the spheres of influence of the US and China, as part of the broader Cold War 2 between the world’s super-powers. 

On February 4th, 2022, Russia’s President Vladimir Putin and China’s President Xi Jinping met in Beijing and issued a joint declaration that called for the beginning of a “limitless cooperation” between the two countries. That declaration, intended to be the first step toward the establishment of a new, multipolar world order, represented the de-facto green light given by China to the Russian invasion of Ukraine. 

Subsequently, press reports were released in which Xi expressed his irritation for not being fully informed by Putin about his intentions prior to the invasion. (Indeed, even Russia’s own Foreign Minister Sergei Lavrov said he was informed about Putin’s decision only after the invasion had started). But the reality is that the recent European tour by China’s plenipotentiary Wang Yi concluded in Moscow, with a meeting with Putin, and – according to press reports – Xi himself is expected to visit Putin soon. 

Whatever the recollection of events may be, the fact remains that the relationships between Russia and China remain “rock solid”, and now the world has polarised between the US and its allies, primarily in Europe (which has given up any dream of “strategic autonomy”) on the one hand, and China and its allies on the other. Only a bunch of countries can afford not to choose between these two sides and remain non-aligned; primarily, India. But India has joined China in not approving the UN resolution that condemns Russia’s invasion of Ukraine last week (141 voted in favour, 32 countries abstained - including India and China – and 7 voted against, i.e. Belarus, Nicaragua, Russia, Syria, North Korea, Eritrea and Mali.) 

In our view, many countries in Africa and Latin America will likely become battlefields of proxy wars between the US and China, as happened during the Cold War between the US and Soviet Union (and in fact, many of those same countries abstained in the UN resolution asking Russia to leave Ukraine). In our opinion, the war in Ukraine is already the first of these proxy wars between the US and China, fought by Ukraine and Russia, notwithstanding the ongoing rivalry between these two countries, which of course dates back a long time before Cold War 2 clearly emerged. 

And precisely because this is already a proxy war between US and China, we believe that China’s 12-point peace plan (“position paper”) to achieve a political solution to the Ukrainian crisis is destined to fail. The US will never accept that its main contender will become the peacemaker in a conflict in which the US is so largely invested. 

Considering all this, it is hard to be optimistic about the duration and intensity of this war. What could be considered a “natural equilibrium” for Putin (a result after which he could claim full victory), i.e. the occupation – besides Crimea – of the four “annexed provinces” such as Luhansk and Donetsk, plus Odessa’s region up to Transnistria in Moldova, is totally unacceptable for the international community, and certainly to Ukraine. It would be hard enough to convince Ukrainian president Volodymir Zelensky to give up Crimea as part of a broader peace plan, and for Putin merely stabilising the position of Crimea alone after such a costly war would be considered a severe defeat. 

This means that a diplomatic solution to this conflict is not in sight; but a victory of either of the two sides on the ground is also very unlikely, as US generals have admitted. The conflict will therefore continue, along with its dire humanitarian, social, economic and financial consequences. And with the risk of a nuclear escalation having in fact increased, rather than decreased, in recent weeks, as testified by Russia’s decision to suspend the application of the NEW START treaty on nuclear non-proliferation). The international community will need to continue working hard to find any solution that avoids such a catastrophic eventuality.

by Brunello Rosa

20 February 2023  

In a column a few weeks ago, we asked ourselves whether China was ready to make a broader U-turn after the massive change of direction it had taken regarding its Zero-Covid policy. A symbol of that potential change was the arrival of Qin Gang, a former ambassador to Washington, as foreign minister, replacing Wang Yi. We also mentioned how Xi Jinping himself had started to make speeches in favour of private initiatives, after years of carrying out witch-hunts against the private sector, in particular the tech sector. 

Now things seem to have moved further in that direction. Wang  ascended to the Politburo after the October Congress of the CPP that confirmed Xi as party leader for the third time, and has replaced Yang Jiechi as the Director of Central Foreign Affairs Commission, the highest diplomatic position in China. Wang has recently started a “charm offensive” in Europe, beginning from Paris where he met French President Macron ahead of the Munich security conference. The messages that Wang is trying to pass to his European counterparts are twofold: 1) that China is open for business; and that 2) China is willing to find a diplomatic solution to the war in Ukraine. 

Regarding the first point, this seems almost a foregone conclusion. China has observed an acceleration in the process of global polarisation and a separation from the US and, to a lesser extent, from European countries, a process which is clearly premature. China is rightly betting on the growth of South-East Asia and Africa in the next 20-30 years, and believes that the countries from these regions of the global economy will eventually replace the US and Europe as China’s largest “customers” (i.e. importers of its products). That is the reason why the vast majority of the signatories of the BRI are from these two regions of the global economy. But these countries are not large enough to replace Europe and the US just yet and – crucially – they do not possess the technology that the EU and US are able to provide to China, in terms of materials, semi-conductors, etc. 

On the second point (namely, finding a diplomatic solution to the war in Ukraine), facts tell a different story than words or intentions. Recent press reports from the Wall Street Journal and other US newspapers show that trade between China and Russia has massively increased since the beginning of the war in Ukraine, both in terms of commodities and manufactured goods and in terms of technology that can be used for civilian and military purposes. Between March and September 2022, trade between the two countries has grown by USD 27bn, and touched USD 100bn. Russia has become even more dependent on Chinese imports, which now represent 36% of Russia’s total. More generally, Russian trade with China has allowed it to cicumvent the tech embargo imposed by the US, and its purchases of foreign-made semi-conductors has increased by 34% in 2022, with the lion’s share coming from China.

On the back of these considerations, the following preliminary conclusions may be drawn. First, it is extremely positive that China has realised how damaging for its own reputation and economic activity some of its policies have been, including the Zero-Covid policy and the support to Russia for the war in Ukraine. Secondly, building on this realisation, and considering its purported intention to change tack, China now needs to show actions that are consistent with its words. Thirdly, even in the most favourable scenario, in which China manages to at least marginally re-orient its policy choices, we remain convinced that a Cold War between the US and China is ongoing, and will develop further in coming decades. But its intensity and speed do matter a lot for the well-being of the global economy and the geopolitical environment. So, any softening on this front will always be welcome. 

by Brunello Rosa

6 February 2023  

A number of major central banks held their policy meetings last week, to decide what course of action to take for the beginning of the year. 2023 was widely expected to be a year of recession for a number of countries. At the beginning of January, the head of the IMF Kristalina Georgieva said that the IMF expected one third of the global economy to be in a recession during the year. 

Subsequently, the IMF released the January update of its World Economic Outlook, initially released in October 2022, titled “Inflation Peaking Amid Low Growth”. In effect, the January update showed an upward revision to the growth forecasts made for a number of countries, and for the global economy as a whole. 

Meanwhile, inflation seems to have peaked in some key economies, such as the US (where inflation decreased from 9.1% in June 2022 to 6.5% recently), the Eurozone (from 10.6% in October 2022 to 8.5%), the UK (from 11.1% in October 2022, to 10.5%) and Canada (from 8.1% in June 2022, to 6.3%). 

So, this year of stagflation, as we described in our 2023 outlook, appears to be a bit milder than initially anticipated, with slightly higher growth and slightly lower inflation. Still, one needs to remain vigilant about some ongoing risks, for example that of a new Russian offensive in Ukraine, which could bring the global economy to a standstill once again. 

How have central banks reacted to this updated macroeconomic environment? The Bank of Canada was the first to announce the outcome of its policy meeting at the end of January. The Bank increased its policy rate by 25bps to 4.5%, while continuing its Quantitative Tightening program. But, most importantly, it announced that “[the] Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases”. In a nutshell, it announced a pause in its tightening cycle.

Last week, it was the turn of the Federal Reserve, the Bank of England and the European Central Bank to decide upon their own courses of action. The Fed announced another 25bps increase of its target range, to 4.5-4.75%, and two more rate increases in March and May. As discussed in our in-depth review, during the press conference Chair Jay Powell sounded as hawkish as one can be given the circumstances, saying that the dis-inflation period has just begun and that there is still “a long way to go,” among other messages. The market totally disregarded the hawkish components of Powell’s press release, and celebrated the fact that the end of the tightening cycle is finally in sight. Funnily enough, the market had disregarded the same message for months; it had ignored the message that the peak of the cycle was in fact near, focusing instead only on the further rate increases and the rise in the terminal rate expected by the Fed. 

A similar fate occurred for the ECB, which increased its deposit rate by 50bps to 2.50% and announced another 50bps hike in March, while further specifying the criteria for its QT starting in March. Lagarde also said that there is still ground to cover and that further hikes are likely after March. But the market celebrated the statement in which the ECB says that, after March, it will “evaluate the subsequent path of its monetary policy”, as this future re-evaluation was already the end of the tightening cycle. 

The Bank of England chose an approach similar to the Bank of Canada’s. It raised its repo rate by 50bps to 4.0%, but then indicated what seems to be a likely pause for the months ahead, without making further mentions of the QT program. Again, this generated euphoria in the market. 

To conclude, it seems that the macroeconomic outlook is less malign than initially anticipated, and central banks are announcing a pause, or signalling an imminent end of, their tightening cycles. This clearly makes market participants very happy. Hopefully bad news will not intervene too soon to interrupt this moment of relief.

by Brunello Rosa

30 January 2023  

We have discussed on several occasions that we believe there is an ongoing Cold War between the US and China, which is being fought on the fields of trade, technology, and supply chains. For example, on the tech side, the Netherlands and Japan have recently joined the US in restricting chip exports to China. According to Harvard scholar Graham Allison, there may be a chance that this Cold War will escalate into a “hot war”, with an open military exchange between the US and China taking place. In our in-depth analysis of Nancy Pelosi’s visit to Taiwan, we also discussed how Taiwan may become the detonator of such a military exchange. 

Today, the news emerged of a memo written by General Mike Minihan, head of US Air Mobility Command, in which the general said that he has a gut feeling that “the two military powers were likely to end up at war” by 2025, according to the FT. In fact, in 2024 there will be the US presidential election, which will distract the US administration and population. There will be also presidential elections in Taiwan. The uncertainty created by these two occurrences may favour a Chinese attempt to take over Taiwan. 

The US had historically kept so-called “strategic ambiguity” as to whether they will intervene in defence of Taiwan, but recently Biden has been more vocal about the fact that the US will in fact intervene. This is supposed to deter China from taking that step. That is the reason why China is watching very closely the US position vis-à-vis the war in Ukraine. In the joint declaration of 4thFebruary 2022 between Chinese President Xi and Russian President Putin, the “Russian side reaffirm[ed] its support for the One-China principle, confirm[ed] that Taiwan is an inalienable part of China, and oppose[d] any forms of independence of Taiwan.”

So, how is the situation progressing in Ukraine? Last week, we discussed the hesitation by Germany in sending its Leopard 2 tanks to Ukraine. Eventually, the German Chancellor decided to send 14 tanks, and allow other European countries to do so. Also, the US approved another aid package for Ukraine, which includes the possibility of sending 31 M1 Abram tanks. The US and Germany are the two largest providers of weapons to Ukraine, followed by the UK. Meanwhile, Lockheed Martin said it is ready to provide F-16 fighter jets to Ukraine, if necessary. 

On the back of this news, the FT wondered if Ukraine was getting ready to resist the likely assault by the Russian troops that is expected to take place in the spring. Or rather, whether Ukraine is ready to launch its own offensive. Italian defence minister Guido Crosetto said that, if Russian tanks come back to Kyiv, World War 3 would ensue. That cannot be taken for granted. But clearly a direct military exchange between US and China over Taiwan would likely lead to what will undoubtedly be labelled by future historians as the beginning of World War 3. 

Is this scenario avoidable? In theory, yes, even if it seems to be that we are sleepwalking into it. On the positive side, after Pelosi’s provocatory trip to Taiwan, there is the scheduled trip of US secretary of state Antony Blinken to China in a week’s time; Blinken will be the first cabinet secretary from President Joe Biden’s administration to visit China. 

Additionally, President Xi will visit the US in November for the APEC meeting, which will be held in San Francisco. One hopes that these will be occasions for the two super-powers to clarify their respective positions and re-start a constructive dialogue, instead of being occasions on which ultimatums are launched. 

by Brunello Rosa

23 January 2023  

A few weeks ago, we discussed how the geopolitical landscape was in flux, with the re-organisation of international alliances and a new world order emerging as a result of the war in Ukraine. In particular, with Russia siding with China in a Cold War II between the US and China, a polarisation of the world has emerged. 

As part of this broader re-arrangement of the world order, we discussed how a new gathering of seven countries, formed around the BRICS group, emerged; we labelled this the EM G7. Besides China, Russia, India, Brazil and South Africa, two additional countries were invited as observers. One is Saudi Arabia, with which China has just formed a new strategic partnership, as we discussed in our recent column. 

The other country is Argentina. As discussed in our recent in-depth analysis of the country, Argentina is undergoing a difficult macroeconomic period, characterised by slow growth, high inflation and high interest rates, with political turmoil on the horizon given the presidential election occurring at the end of the year. 

As we said, the main reason to have Argentina in the group is because Argentina has recently joined China’s Belt and Road Initiative (BRI). With Argentina in the BRI and Brazil in the BRICS, China has extended its influence over the entire Latin American region, through its two largest countries. Among others, Chile and Peru are also part of the BRI, giving China influence over the entire west coast of South America. 

Now Brazil and Argentina have announced that they intend to enter a currency union, by creating an additional currency that would run in parallel to the Brazilian real and the Argentinian peso. According to estimates by the Financial Times, this would be the second largest currency union (representing around 5% of the world GDP) after the Euro (14% of the world’s GDP), and ahead of the France’s inspired CFA franc, which is shared by several African countries and is pegged to the euro. The new currency would be yet another attempt by countries that are not totally aligned with the US to reduce their dependence on the US dollar.

All of the factors above suggest that the polarisation of the world continues and was accelerated by the war in Ukraine. Some countries are backtracking from their previously held positions. As we discussed last week, China is shifting from some of its recent positions, first on the zero-Covid policy, then on distancing itself somewhat from some of the most extreme positions of Russia, and finally on re-opening a dialogue with the private sector, after the witch-hunting of the country’s tech companies and private-led education that took place during the last couple of years.

On the other side of the equation, Germany has announced that before sending more of its Leopard tanks to Ukraine, it will want to run a full analysis of its inventory. This is a way of buying time and sending a signal to Russia that it does not want to espouse the most extreme position of NATO countries. So, while China puts some distance between itself and Russia, Germany gets a bit closer to Russia, or at least reduces its distance.  

These are all proofs that the geopolitical environment is in flux, but is solidifying towards a polarisation of the world, symbolised by the ongoing Cold War II between the US and China.

by Brunello Rosa

16 January 2023  

Last week we discussed how authoritarian or populist leaders are on the rise in various parts of the world. A possible precursor to this phenomenon has been the emergence of Chinese President Xi Jinping. In 2018 Xi changed the country’s constitution to allow the President to remain in power for life, instead of stepping down after 10 years like his predecessors Hu Jintao and Jiang Zemin. Last October, he was elected leader of the Chinese Communist Party (CCP) for the third time in a row, something his predecessors did not dare to do. 

When elected leader, Xi changed the composition of the Politburo and of its Standing Committee, replenishing it with party members loyal to him who would not challenge his views or, most importantly, his policies. This move was clearly intended as a method of consolidating power in his hands. 

This was happening at the same time that China was forging its “limitless cooperation” – i.e. strategic alliance – with Russia, another state whose leader, Vladimir Putin, had also changed the constitution to allow himself to remain in power potentially until 2036. Russia was conducting its unjustified invasion of Ukraine, with China supporting (perhaps reluctantly) the “special military operation”, possibly in order to establish a precedent in case of a future invasion of Taiwan. 

Just when all the power seemed consolidated in Xi’s hands, the inevitable happened: protests emerged against the ruthlessness of the Xi-mandated Zero-Covid Policy (as we discussed in our preview columns). These protests, for the first time, were not simply against local leaders, as has happened in the past. They were also against the CCP, and its leader as well. 

Xi’s foreign minister, Qin Gang, a former Chinese ambassador in Washington, may be the expression of this potential rethinking of the overt confrontation of China with the West. If there were to be a rapprochement between the US and China, potentially sealed at the APEC meeting in San Francisco this coming November, when Xi is expected to visit the US, it would be welcome news.

The Politburo has since allowed cities to ease the Covid restrictions, in a move that was intended to be a soft, and less visible, U-turn in policy. Official data from China now admit there have been 60,000 deaths as a result of the re-opening of the economy and the consequent re-spreading of the virus, at a time when China still has not vaccinated large part of the population. Many countries introduced restrictions for Chinese travellers, against which the Chinese government threatened “retaliation” – without considering the severe and unilateral quarantine measures the government itself has been imposing on foreign travellers for the last two years. 

Meanwhile, the FT reported that doubts have emerged about China’s “limitless cooperation” with Russia. In a previous column, we have already talked about the first cracks emerging. But now it seems that irritation is mounting in Beijing on the way Putin is conducting Russia’s military campaign in Ukraine, which is causing severe damage to the global economy, including for China, which depends on foreign growth for its exports. Additionally, it seems that on the famous meeting between Xi and Putin on 4th February 2022, Putin hid his invasion plans from Xi, only saying Russia “would not rule out taking whatever measures possible if eastern Ukrainian separatists attack Russian territory and cause humanitarian disasters.” 

Our fear however is that any such rapprochement may be merely a tactical move, to ease the tension on Xi’s leadership and on the global economy. The broader context of Cold War II seems to us to still be intact, and likely to remain in place for the foreseeable future.

by Brunello Rosa

09 January 2023  

The supporters of former Brazilian President Jair Bolsonaro assaulted and occupied the Brazilian parliament and other federal institutional buildings at the end of last week, to protest against the election of Ignazio Lula da Silva as the new President of Brazil (his third mandate). This episode is closely reminiscent of Trump’s supporters’ assault on Capitol Hill in January 2021, on the occasion of the election of Joe Biden to the presidency of the US. As we discussed in numerous articles, Bolsonaro was widely seen as a leader that would have transformed Brazil into yet another autocracy, had he been re-elected. 

Meanwhile, in Israel, Benjamin Netanyahu was re-elected as Prime Minister of the country, following the short parenthesis of Naftali Bennet and Yair Lapid. Netanyahu has formed a government that is widely regarded as the most right-wing in Israeli history. The new government has proposed a reform of the judiciary, which will give the government a say in the appointment of judges. The political and civil society opposition has labelled the move as the “end of democracy” in the country. 

In Italy, the September 25th general election resulted in the appointment of Giorgia Meloni, leader of the right-wing party Brothers of Italy, as Prime Minister. As we discussed in our recent trip report, Meloni has adopted a moderate approach, but some of the choices of her government confirms the radical right-wing approach of her coalition. Additionally, she still has not changed the symbol of her party, which contains the flame emanating from Benito Mussolini’s grave. 

Also in Rome, but on the other side of the Tiber river, the death of the ultra-conservative former pope Joseph Ratzinger has led the orthodox component of the curia to making an attack on the progressive Pope Francis, who is seen as too open vis a vis the issues of modern society. Ratzinger’s presence was keeping this conservative fringe component at bay, as he did not want to be perceived as an anti-pope. But now the war for the succession of Francis has begun, and it is very unlikely that another equally progressive pope will be elected. 

In France, as we discussed in our recent trip report, the election of right-wing Marine Le Pen in 2027 is now considered a central scenario rather than a risk scenario. Marine Le Pen could stage “a Meloni” and pretend to moderate and move to the centre for some time, but her radical positions, especially on immigration and civil rights, would likely emerge before long. Also, she may heavily impact the EU integration process, in a way that Italy will never be able to. 

These are only recent examples of a much larger swing that is occurring at the global level, in which right-wing movements are coming to power. In other cases, populist leaders, of the right and the left, are being voted in. Especially in Latin America, populist leaders from the left are contributing to the so-called “Pink Tide”. This goes hand in hand with a broader phenomenon, whereby even democratically elected leaders are becoming autocratic or nationalistic leaders, such as in Turkey and in India. We have discussed in our previous columns this tendency of autocratic leaders to emerge in the last few years. 

All these phenomena are contributing to the even broader trend of the decline of liberal democracies in favour of electoral autocracies, as testified by the studies of the V-Dem project and several academic papers. 

by Brunello Rosa

03 January 2023  

Last week, we discussed how 2023 will be a year of stagflation from a macroeconomic perspective. We discussed how the global slowdown, which will translate in outright recessions in several countries (a third of the global economy, according to the IMF) will be accompanied by still-high inflation. Inflation may fall for cyclical reasons (including the fall in energy prices recorded in the last few months), but will remain sticky and elevated for a series of structural reasons discussed in our 2023 Global Outlook and mentioned in our latest column. This week, we discuss the implications of this macroeconomic outlook for policy and markets. Regarding policy, we discuss fiscal and monetary policy in turn. 

Fiscal policies will be inflationary in the next few years, including 2023, as governments will have to fight “wars” on at least five fronts. 1) Hot and cold wars lead to larger budget deficits that are eventually monetized and tend to cause higher inflation. 2) The war against global climate change will be very expensive as countries transitions to new form of energy consumption. 3) The war to prevent the next global pandemic will be very expensive ex ante or ex-post if we don’t prevent it and end up with another costly Covid-style pandemic. 4) The war to prevent social strife in face of rising inequality will be expensive as social spending, transfers and lower taxes for workers and left-behind households. 5) The tech war in which AI, robotics and automation will lead to job losses that require stronger social safety nets for those experiencing permanent tech or trade-related unemployment. 

All these five “wars” over the next decade will lead to greater public spending, transfer and lower taxes for the those “left behind”, while the ability to raise taxes is constrained by politics and economics. Thus, higher budget deficits that will crowd out growth if financed with debt; and the eventual monetization of such deficits as a “debt trap” will force central banks to wimp out and blink.

Regarding monetary policy, with inflation much more persistent than central banks currently expect in 2023, central banks will have to either hike much more than they currently signal, thus triggering a more severe hard landing and financial markets distress; or they will need to blink and wimp out, in which case inflation expectations get de-anchored, price-wage spirals ensue and higher inflation persists. We believe that central banks will be pressured to stop tightening or even easing if there is a hard landing; and in presence of negative supply shocks and a wage-price spiral even a hard landing may not push inflation low enough towards target. 

So monetary policy and fiscal policy risk being inconsistent one another, and this will cause plenty of headaches to policymakers. Additionally, central banks will face a dilemma of countering price instability (with higher rates) or financial instability (potentially, by continuing or resuming asset purchases). 

What are the implications for markets? In our global outlook we discuss several scenarios, depending on how the macroeconomy and policy evolve. In a nutshell, in our baseline we expect equity prices to continue their descent, as inflation proves stickier than expected, and central banks are forced to keep rates high for longer. As a result, we also expect higher short- and long-term rates in all major jurisdictions. In the currency space, we expect the USD to weaken against its major currencies as their central banks catch up with the Fed in terms of policy tightening. As inflation remains elevated, and interest rates high, we expect alternative investments (private equity, crypto, real estate) to continue suffering. On the other hand, we expect digital infrastructure investments to continue doing well in coming years.

by Brunello Rosa

28 December 2022

2022 was a year of rising inflation and slowing economic growth; it was a year in which the conventional wisdom of central banks, sell-side research, and consensual forecasts turned out to be mostly wrong about key economic, policy and market views. In particular, consensus forecasts got the inflation outlook wrong: the rise in inflation proved to be persistent and permanent, rather than transitory and temporary. 

The consensus view was also that the rise in inflation was mostly driven by excessively loose monetary, fiscal and credit policies. But, in addition to these bad policies there was also plain bad luck, with a series of negative aggregate supply shocks taking place. These included the initial impact of Covid-19 on the supply of goods and services, and on the supply of labor and global supply chains; the impacts of the Russian invasion of Ukraine regarding energy and other commodities prices; and the impact of the continuation – until recently – of China’s Zero Covid Policy on global supply chains. 

Another opinion held by the consensus was that central banks, as they were phasing out QE and credit easing and raising policy rates, would be able to achieve a “soft landing”: a fall in inflation to the 2% target without a recession or rise in the unemployment rate. That turned out to be incorrect, as now the UK and Eurozone economies are already entering into a recession, and even the Fed expects that a soft landing will be “very challenging”, and thus expects a “softish” landing and some serious “pain”. 

Now the new conventional wisdom is that we will experience a “short and shallow” recession (rather than a severe one) that will trigger a sharp drop of inflation and allow central banks to ease by H2 of 2023. The consensus also argues that – consistent with such a mild recession – central banks will remain committed to achieving their 2% inflation target. We continue to have views different from the consensus in these last two debates, after having been correct in the previous debates of 2021-22. 

We believe that a hard landing is more likely than a short and shallow recession. Why? First, we argue that although inflation has peaked in most advanced economies, and has started to fall, it will nevertheless remain more sticky than central banks and consensus opinion expects, and thus central banks will be forced to hike more than currently predicted, if they want to push inflation closer to target. 

The argument for stickier inflation is based on several points: the war in Ukraine will continue and get uglier, rather than be resolved; the supply bottlenecks in China will remain in spite of the phase out of Zero-Covid Policy, as China will continue its stop-and-go policies towards Covid and a full phase out of the policy will lead to a spike in cases and reduce the available labor supply of healthy workers; even if stronger growth were to resume in China – not our baseline scenario – its impact on commodities demand and prices would be sharper. Commodities prices have declined in the last few months in spite of their spike during H1, mostly because of expectations of lower demand – given the expected global economic contraction – rather than because of much higher supply. Next year commodity prices – and not just in energy – are likely to spike, as many years of under-investment in new capacity will lead to a shortfall in supply, even if demand falls as well. 

Secondly, geopolitical factors will continue weighing on economic activity. The war in Ukraine will continue for much longer than people expect. One cannot rule out a military strike by Israel against Iran – that is effectively now a threshold nuclear star – that would lead to a dramatic spike in energy prices. An outright confrontation (not our baseline scenario now) between US and China over Taiwan – where 50% of all computer chips and 80% of high end chips are produced – would be another massive stagflationary shock.

by Brunello Rosa

03 January 2023  

Last week, we discussed how 2023 will be a year of stagflation from a macroeconomic perspective. We discussed how the global slowdown, which will translate in outright recessions in several countries (a third of the global economy, according to the IMF) will be accompanied by still-high inflation. Inflation may fall for cyclical reasons (including the fall in energy prices recorded in the last few months), but will remain sticky and elevated for a series of structural reasons discussed in our 2023 Global Outlook and mentioned in our latest column. This week, we discuss the implications of this macroeconomic outlook for policy and markets. Regarding policy, we discuss fiscal and monetary policy in turn. 

Fiscal policies will be inflationary in the next few years, including 2023, as governments will have to fight “wars” on at least five fronts. 1) Hot and cold wars lead to larger budget deficits that are eventually monetized and tend to cause higher inflation. 2) The war against global climate change will be very expensive as countries transitions to new form of energy consumption. 3) The war to prevent the next global pandemic will be very expensive ex ante or ex-post if we don’t prevent it and end up with another costly Covid-style pandemic. 4) The war to prevent social strife in face of rising inequality will be expensive as social spending, transfers and lower taxes for workers and left-behind households. 5) The tech war in which AI, robotics and automation will lead to job losses that require stronger social safety nets for those experiencing permanent tech or trade-related unemployment. 

All these five “wars” over the next decade will lead to greater public spending, transfer and lower taxes for the those “left behind”, while the ability to raise taxes is constrained by politics and economics. Thus, higher budget deficits that will crowd out growth if financed with debt; and the eventual monetization of such deficits as a “debt trap” will force central banks to wimp out and blink.

Regarding monetary policy, with inflation much more persistent than central banks currently expect in 2023, central banks will have to either hike much more than they currently signal, thus triggering a more severe hard landing and financial markets distress; or they will need to blink and wimp out, in which case inflation expectations get de-anchored, price-wage spirals ensue and higher inflation persists. We believe that central banks will be pressured to stop tightening or even easing if there is a hard landing; and in presence of negative supply shocks and a wage-price spiral even a hard landing may not push inflation low enough towards target. 

So monetary policy and fiscal policy risk being inconsistent one another, and this will cause plenty of headaches to policymakers. Additionally, central banks will face a dilemma of countering price instability (with higher rates) or financial instability (potentially, by continuing or resuming asset purchases). 

What are the implications for markets? In our global outlook we discuss several scenarios, depending on how the macroeconomy and policy evolve. In a nutshell, in our baseline we expect equity prices to continue their descent, as inflation proves stickier than expected, and central banks are forced to keep rates high for longer. As a result, we also expect higher short- and long-term rates in all major jurisdictions. In the currency space, we expect the USD to weaken against its major currencies as their central banks catch up with the Fed in terms of policy tightening. As inflation remains elevated, and interest rates high, we expect alternative investments (private equity, crypto, real estate) to continue suffering. On the other hand, we expect digital infrastructure investments to continue doing well in coming years.

by Brunello Rosa

19 December 2022

The global economy is clearly decelerating, as certified by the latest IMF forecasts, while inflation seems on the verge of peaking as energy prices have fallen in recent months. The world remains gripped by the stagflationary shock that has been caused by the pandemic and then by the war in Ukraine. But the effects of the numerous interest rate increases carried out by several central banks around the world is starting to be felt. Most economies are showing signs of deceleration, and inflation has started to turn in some countries, notably in the US. It seems also to be on the verge of peaking in other economies, such as in the Eurozone and the UK. 

Last week, there was a slew of central bank decisions that were made (which we discussed in our numerous previous and reviews) to take stock of these developments and adjust policy stances accordingly. To focus our discussion on just the major central banks, on Wednesday last week the Fed increased its Fed funds rate by 50bps, thereby reducing the pace of tightening compared to the 75bps rate hikes that had been introduced in previous FOMC meetings. On the other hand, the Fed has also increased its estimate of the terminal Fed funds rate again, something it has repeatedly done in the past. The market was expecting this pivot, but perhaps it was less significant than expected. 

On Thursday, the Bank of England (BOE) also delivered a 50bps hike, lower than the 75bps hike in November. This also came on the back of a slight deceleration of inflation, but in particular at the beginning of the recession that the BOE estimates to last a couple of years. 

Also on Thursday, the ECB raised its benchmark rates by 50bps, again lowering the pace from the previous 75bps. But at the same time it announced the beginning of its QT plan. This has sent shockwaves to the market, leading to a widening of intra-EMU spreads, particularly for Italy. Norges Bank, which in September 2021 was the first G10 central bank to start increasing rates in this policy cycle, increased its policy rate by 25bps, and announced that at least one further hike may be needed in 2023. To finish the day, the Swiss National Bank also increased its policy rate by 50bps,again lower than the 75bps decided upon in September. For the record, the SNB was the central bank with the lowest policy interest rate in the world (-0.75%) for a number of years, amid the deflationary fears led by the strong franc. 

All these actions show that central banks have now made a lot of progress in normalising their policy stances, and are moving into restrictive territory with a more cautious approach. They are doing this to make sure that their policy tightening does not transform what may be a relatively short and shallow recession into a prolonged and deeper contraction. 

The MPC was split in the decision, with some members voting for an unchanged rate, and another member voting for a larger rate increase. The BOE decisions are complementing those made by Sunak and Hunt in fiscal policy, which is expected to be highly restrictive in coming months. 

by Brunello Rosa

12 December 2022

Last week, during a three-day state visit to the Kingdom of Saudi Arabia, Chinese President Xi Jinping and Saudi Arabia’s de-facto ruler Mohammed Bin Salman (MBS) signed a Comprehensive Strategic Partnership Agreement (CSPA), in which the two countries are committing to support each other’s “core interests, sovereignty and territorial integrity, and to defend the principle of non-interference in the internal affairs of states.”

The CSPA is comprised of 35 memorandums of understanding, including deals worth USD 30 billion. It foresees cooperation between the two countries in the following areas: the automotive industry, supply chains, logistics, water desalination, infrastructure, manufacturing, mining, the financial sector, communications and artificial intelligence, and digital and space economies and technologies. China and Saudi Arabia stressed the importance of stability in oil markets, and “agreed to explore common investment opportunities in petrochemicals, and to enhance cooperation in solar, wind, and other sources of renewable energy.” They also agreed to cooperate on hydrocarbons, energy efficiency, and localization of energy sector components and supply chains, in addition to the peaceful uses of nuclear energy.

Besides these specific areas of cooperation, China and Saudi Arabia welcomed the signing of a “harmonization plan” between the Kingdom’s Vision 2030 social reform and economic diversification agenda and China’s Belt and Road Initiative, making use of the Kingdom’s location as a regional center.

In a recent report, we discussed how India was sitting on the fence in its decision to join either the Western camp led by the US, or a China-led camp. We also said that India would be eventually be forced to choose, and that even Brazil would have a hard time remaining in the list of non-aligned countries. In a press conference at the conclusion of Xi’s visit, Prince Faisal bin Farhan, the Saudi minister of foreign affairs, said that the deepening of relations between Saudi Arabia and China did not mean the Kingdom was turning its back on the US and other Western allies. But the impression we are left with is exactly the opposite. 

We also discussed how a new EM-G7 was emerging around the BRICS grouping, expanded to include Saudi Arabia and Argentina. With the signing of this CSPA between China and Saudi Arabia, another important step has been made towards the creation of this grouping of countries as an alternative to the G7. It includes some of the largest, fastest growing, or most resource-rich economies in the world. 

In a world in which the Americans say to their potential allies “you are either with me or against me”, this CSPA must be read as a slap in the face from Saudi Arabia to the US, irrespective of the reassurances given by the Kingdom’s foreign secretary. With its vast oil reserves, Saudi Arabia represents a key ally to have during Cold War II, and it seems that Saudi Arabia has decided to side with China at the moment, and be less close to the US. The harmonization between two landmark reform plans such as China’s BRI and the Kingdom’s Vision 2030 clearly signals that this is not just a tactical, trade-based agreement, but rather – as the title says – the beginning of a strategic partnership. 

This CSPA seems to be less far reaching than the “limitless cooperation” between China and Russia that was declared in Beijing on February 4th 2022. But it still represents good news for China and its allies, and bad news for the US and American allies. 

by Brunello Rosa

5 December 2022

In the last few days, news about protests taking place in China were widely reported by media outlets in both the Western world and in China itself. The focal point was the civil unrest that occurred in the city of Urumqi following an apartment fire that killed 10 people, who apparently could not escape the building they were trapped in because of the Covid-related restrictions. 

Various forms of civil unrest erupted nationwide, with protesters clearly criticizing the national government, the Communist Party, and its leader, Xi Jinping. This is a novelty for China, where protests have taken place in recent years but have targeted local leaders for their lack of action or mistakes made over local issues, such as environmental or transportation disasters. Not since the Tiananmen square protests of April-June 1989 has the authority of the Chinese Communist Party (CCP) been  directly challenged. On that occasion, the repression was ferocious, resulting in a massacre of the protesters.

The lesson from Tiananmen was that the CPP can repress any form of protest. But the CPP learnt a lesson as well, namely that it cannot govern indefinitely without popular support. For this reason, media outlets are now saying that the CPP is allowing various Chinese cities to ease the Covid-related restrictions. 

This does not represent a fundamental change in the official zero-Covid policy just yet, as Xi himself championed the policy and cannot lose face by carrying out an explicit U-turn. However, it is an important shift towards pursuing zero-deaths, rather than zero cases, which was a totally unrealistic objective in a country with relatively low vaccination rates among the elderly and a vaccine – the Sinovac – that is not as effective as those developed by Western countries. 

China should admit its failure in achieving this goal and start purchasing vaccines from the West, in particular those based on m-RNA technology that China has not yet developed. But in the context of Cold War II, this is clearly not possible, so it will still take time before China will fully re-open and the global economy can finally start breathing again. In fact, the global economy and financial markets will not be able to fully recover until China fully re-opens, resolving once and for all the supply bottlenecks that have plagued global value chains for the last three years.

What are the lessons from this entire story? First, that even in the most autocratic regimes, governments still need the explicit or implicit approval of their populations. History teaches us that autocratic regimes seem very stable until they collapse. Second, that even the most autocratic regimes cannot refuse to respond to their people’s needs. But here is where things may subtly start going wrong. 

In their joint declaration of February 4th 2022, on the sidelines of the Beijing Winter Olympics, Russian President Putin and Chinese President Xi said: “democracy is a universal human value, rather than a privilege of a limited number of States, and that its promotion and protection is a common responsibility of the entire world community.” As we discussed in our column of June 6th, this is clearly an attempt by Russia and China to re-define what democracy is. 

According to these autocratic leaders, democracy should not be intended as the electoral process by which people vote in their preferred leaders. Rather it should be the process by which governments, whether they are chosen via free elections or not, provide public goods to their people and keep them content. The number of democratic countries in the world is already dwindling. If this new concept of democracy takes place, dark days await us in the years ahead. 

by Brunello Rosa

28 November 2022

At the end of October, the presidential election in Brazil saw the narrow victory of Luiz Inácio Lula da Silva over the incumbent president Jair Bolsonaro. In so many respects, Lula was considered to be the antithesis if Bolsonaro, but last week the news emerged that there may be an element of continuity between the two leaders. President Lula announced that although Brazil continues to condemn Russia’s invasion of Ukraine, it does not intend to apply the sanctions that the West has activated against Putin’s regime. 

The reasons behind this choice are fundamentally economic, but possibly also geo-strategic. From an economic perspective, Russia and Brazil share cooperation in key sectors such as space and military technology, and telecommunication. For example, in 2012, after a state visit by Brazilian President Dilma Rousseff to Russia, Brazil signed an agreement to buy Russian anti-aircraft systems. At the same time, the state-owned Russian Technologies State Corporation (Rostec) and the Brazilian Odebrecht Defence and Technology signed a memorandum on technical cooperation, committing to the establishment of a joint venture for production of helicopters, air defence weapons, and naval vehicles. 

Additionally, Brazil is of the main suppliers of commodities to China, including but not exclusively in agriculture, and China in turn has been one of the main allies of Russia during this period of Russia’s international isolation, since its invasion of Ukraine. In November, the Chinese authorities updated their list of approved Brazilian corn exporters, making it easier for Brazil to export its corn to China, at a time when China’s imports from the US and Ukraine have been disrupted by geopolitical tensions. 

But, from a geo-strategic perspective, Brazil may be willing to follow the path of India. As discussed in depth in our recent report, India has so far decided not to choose between US and China in the dispute between the two economic superpowers that is now polarising the world. During the Cold War between the US and the Soviet Union, India tended to side with the Soviets. 

But now Russia is on the same side as China, and tensions between China and India have increased recently, especially after the recent military exchange in the Himalayas. India is also part of the Quadrilateral security Dialogue (the Quad), together with the US, Japan and Australia, but at the same time is part of the BRICS gatherings together with China, Russia, Brazil, and South Africa, and it has recently struck favourable oil deals with Russia. So, India has resurrected his traditional non-aligned position, which it can afford given the size of its economy, and especially given the size of its population. During Cold War 1, India was one of the promoters of the so-called non-aligned movement, which was born after the Bandung Conference in 1955 and the Belgrade Conference of 1961.

Could Brazil do the same? Brazil certainly does not have the size of India’s economy (USD 1.6tn vs USD 3.1tn), nor India’s population (0.2bn vs 1.4bn). It is not part of a security dialogue like the Quad, and its ties with the US have been variable over time. At the same time it is part of BRICS meetings as India is, and it certainly wants to keep a good relationship with China and Russia. So, the  far left-wing Lula will likely follow the path of far right-wing Bolsonaro in keeping Brazil out of the polarisation process that is dividing the world between the friends of China on the one hand and US allies on the other. 

However, Brazil may not have the luxury to remain non-aligned for as long as India can afford. It may be forced to choose sooner rather than later. China will not want to lose its outpost in Latin America, but the US will not easily let go of the next largest country within its “backyard” of the Western hemisphere. As we discussed previously, like many other Latin American and African countries, Brazil may end up being a battlefield for a proxy conflict in this ongoing Cold War II between the US and China.  

by Brunello Rosa

21 November 2022

Last week, the news emerged that the Republicans have finally conquered a slim majority in the House of Representatives at the mid-term elections. This came after the Democrats celebrated the fact that they retained control of the Senate, with at least 50 senators. If the Democrats win the run-off election in Georgia in early December, they may even increase their majority compared to the results they achieved in 2020. The youth and pro-abortion vote proved essential for the Democrats to win in many constituencies, in a polarised society in which yet another shooting (in this case against the LGBTQ community) took place last week.

The Republicans were hoping to get control of both branches of Congress to launch an impeachment process against Biden, his management of the Ukraine war and the relationships of his son Hunter in that country before the conflict exploded. Now they can try and pass the articles of impeachment in the House - that will already be hard enough, as some moderate Republicans will likely oppose it - but it will be almost impossible to win the battle for impeachment in the Democratic-controlled Senate. 

The big question now is whether Joe Biden will run again for President in 2024. The “victory” in the mid-term election, as a red wave failed to materialise, would suggest he will, but he will make an official announcement only in January. Meanwhile, his competitor in the 2020 election Donald Trump has already announced that he will run again in 2024. Trump’s abrasive rhetoric, and the choice of “negationist” candidates who denied Biden’s victory in 2022 and then failed to win their seats in the mid-terms, was condemned by the Republicans as the reason for their defeat. So, he will again face an uphill battle to win the Republican nomination. 

Trump’s candidacy will likely freeze most of the trials against him, for tax evasion, for his responsibility in the January 6th 2021 assault to Capitol Hill, and for having illegally collected secret documents from the White House when he moved out. An independent special prosecutor will need to be appointed to continue the investigations. The Democrat-led Department of Justice was very prudent in continuing the investigation, as it would be the first time in history that a former President is criminally investigated. 

Now the paradox is that the Democrats seem willing to have Trump as their contender in 2024, as they consider him easier to beat. Whereas the Republicans would like to accelerate the trials, so that an indictment would prevent him from running for office and dividing the Republican camp once again. Meanwhile, Elon Musk, the new owner of Twitter, decided to re-open Trump’s profile, which had been banned in the aftermath of the assault on Capitol Hill, after a quick referendum with the users. 

As usual, US domestic politics has international ramifications. In particular, the Russian army decided to withdraw from Kherson and all territories west of the Dnieper river as soon as they realised that Biden will not become a lame duck. If Trump had become the most likely successor to Biden, the Russian calculus regarding the war in Ukraine would have probably changed. 

In the next couple of years, US domestic politics will return centre stage with the primary election for the presidential election of November 2024. We will continue to follow that closely, given their international implications.

by Brunello Rosa

14 November 2022

The news of the last few days seems to suggest that a bubble is bursting in the tech sector. After completing a USD 44bn acquisition of Twitter, the new owner and boss Elon Musk fired half of the company's workforce in an attempt to increase efficiency and restore profitability. A few days later, Mark Zuckerberg, the head of Meta, fired 11,000 Facebook employeeswith a simple email. During the same few days FTX, one of the major crypto exchanges, collapsed, after its arch-rival Binance pulled out of a possible attempt to rescue its competitor. All this happens as Nasdaq (the equity index specialised in tech) has been severely underperforming its more general counterpartssince the beginning of the year: Nasdaq is down 28% y-t-d, while the S&P is down 16% and the Dow Jones 7%. 

Given this background, it has been quite obvious to ask whether a bubble has burst in the tech sector. Our view is that the reports of the tech sector’s death are being greatly exaggerated, for a series of reasons. 

First of all, the recent fall in tech valuations has followed a period of massive out-performance, coinciding with the pandemic, when widespread lockdowns implied a massive use of technologies to satisfy even the most basic needs, such as the purchase of groceries. So a post-pandemic adjustment seemed inevitable. Clearly this adjustment is adding to the re-evaluation of general indices, leading to the above-mentioned underperformance. 

Secondly, this is not the first time the sector has undergone a major re-alignment of market valuations with economic fundamentals. 

The dot-com bubble burst in 2000 wiped out a large chunk of the value of the tech companies at that time, but also represented the opportunity to identify those companies that really deserved to survive. Some of them, such as Amazon, and the like, are the champions of today’s tech scene and are among the largest companies in the world by market capitalisation. As we are moving toward the so-called Web 3, it is only healthy that the champions of Web 2undergo a reality check.

Thirdly, a new wave of technological innovation is about to come online, from fin-tech, to med-tech, bio-tech, and so on. For example in the financial domain, central banks are about the enter cyber-space with central bank digital currencies(CBDCs), and cyberwarfare is now a standard companion of traditional war methodologies. This will require plenty of investment in “digital infrastructure” (servers, cables, mainframes, etc.), which will likely boost tech valuations as soon as this bear market ends. 

So, if the current episode does not represent the bursting of a tech bubble, how can we explain it? We believe that the current episode can be explained by two theories. First of all, as Hyman Minsky’s financial instability hypothesis suggests, when central banks increase interest rates, the most fragile, speculative positions tend to fail, thus determining the equity market re-pricing that we are observing in this period. Additionally, the sector is undergoing the process of creative destruction described by Joseph Schumpeteras one of the key drivers of capitalism. After this clean-up, the tech sector will be ready to re-start even stronger than before. 

by Brunello Rosa

7 November 2022

Last week, the October-November round of major central bank meetings came to an end. As discussed in our previews and reviews, the Federal Reserve increased its policy target range by 75bps, as had widely been expected. Market participants were exposed to mixed signals from the Fed. On the one hand, the Fed reassured them that, in December, a discussion would start within the FOMC regarding whether and when to reduce the pace of tightening, taking into account the cumulative actions that have been taken since March 2022. On the other hand, the FOMC statement suggested that the terminal rate would be higher than previously had been expected by market participants. The market reacted with a see-saw price action, with a net effect of there being losses in equity and bond prices. 

The Bank of England also had to provide mixed signals to the market, while increasing the Bank Rate by 75bps as well. It re-started QT and promised more rate hikes, but also said that the terminal rate would be lower than currently expected by the market. Again, market prices were volatile following the release of news by the central bank. 

These are only two examples of how policy news has been buffeting financial markets in the last few months. More specifically, the UK staged an example of how monetary and fiscal policy may end up on a collision course, with the result of causing a financial market rout, around the time of the Truss-Kwarteng mini-budget and the LDI debacle. 

But there is a more subtle inconsistency within monetary policy itself that is causing trouble for central bankers all around the world, namely the potential conflict between price stability and financial stability. 

Virtually all central banks around the world, perhaps with the exception of the Bank of Japan, are fighting inflation to restore price stability, with a combination of higher policy rates, balance sheet policies (such as Quantitative Tightening) and to a certain extent forward guidance (provided by the forecasts of terminal policy rates, for example). 

At the same time, rising rates and tightening financial conditions risk causing financial instability episodes, which would force central banks to stop their policy normalisation cycles, or even to stop their tightening cycles. In a sort of unofficial way, most central banks are now heading towards a division of labour between interest rates (devoted to price stability) and balance sheet policies (aimed at financial stability). The ECB offers the perfect example of this: while increasing interest rates, the ECB continues to provide a backstop to the eurozone bond market by re-investing the proceeds of maturing bonds in full. And even when the ECB does start its QT program, the TPI facility will ensure that bonds can be selectively purchased in order to avoid financial instability episodes emerging. 

The Federal Reserve has recently formalised this trade-off between price stability and financial stability with the introduction of a new theoretical framework. In this framework, a new rate (called r**, the rate above which a financial instability episode may be triggered) is defined besides the traditional r* (the rate at which monetary policy is neither stimulating nor restricting economic growth). If r** is lower than r*, the central banks will need to stop its pursuit of price stability sooner than its desired neutral level, in order to avoid financial instability. But even if r** is above r*, the central bank may need to stop its tightening cycle, if its desired terminal rate is above the neutral rate. 

These examples show how policy inconsistencies are here to stay, and that they will continue to determine market dynamics in coming months.

by Brunello Rosa

31 October 2022

Last week, Ukrainian forces struck the Russian fleet in the Bleak Sea with a massive drone attack in Sevastopol. The Russians are accusing the British army and intelligence services of having contributed to the planning of the attack. They have retaliated by suspending the agreement on grains, which allowed Ukrainian crops to be distributed globally. So, tensions are clearly on the rise in the Russian-Ukraine war, and the risk of a further escalation exists. 

Recently Russian President Putin said that the use of nuclear weapons is not necessary in the war in Ukraine, and that Russia is now ready to negotiate. To which US President Biden responded that his Russian counterpart is only posturing. In effect, Russian foreign minister Sergej Lavrov recently repeated what he had already said already in April 2022, namely that the current situation is as severe as the Cuban missile crisis of 1962, when the US and the Soviet Union got closest to a possible nuclear exchange during the entire Cold War. 

The real question therefore is how close we are to a potential nuclear conflict in Ukraine, and which countries such a conflict would involve. The answer to this question is quite disturbing, in the sense that of course nobody can predict with any degree of certainty how close we really are to an actual nuclear attack. By definition of using nuclear bombs as a deterrent, one country needs to use the threat to the fullest possible extent to extract as many concessions as possible from its rival, even if the nuclear weapon is never actually deployed. 

At the same time, the impression is that we may not be very far from an exchange that will include nuclear weapons. In particular, the more the Ukrainian army regains control of the provinces that were illegally annexed by Russia in recent weeks (especially in Kherson), the more likely it becomes that Putin will see no alternative other than using a nuclear device to defend the “territorial integrity of Russia.” This was the main motivation for Russia’s speeding up the annexation process of the four provinces.

The Russians are accusing the Ukrainians of wanting to prepare the use of a “dirty” bomb, i.e. a conventional bomb with some nuclear component (e.g. uranium from nuclear power plants). If that were to happen, this would certainly constitute a pretext for the Russians to use their “tactical” nuclear devices. As discussed in our previous column, these tactical devices would serve a double purpose. First, they would be intended to annihilate the morale of the Ukrainian army. Second, they would potentially inflict an irreparable wound to the continuity of the Ukrainian government.

How would the West then react? The US and NATO are not officially involved in the conflict, and certainly they are not directly involved, even though it is clear to all that the most recent advancements by the Ukrainian forces have been possible only because of the military technology provided by NATO, and especially by the US and the UK. Hence, the US cannot directly react with another nuclear strike: doing so would be the beginning of an escalation that would quickly bring to the beginning of World War III, and the end of the world as we currently know it.

So, the Americans may stage a brutal reaction which may involve weapons that may not be fully known to the Russians, or to other NATO allies, weapons that could be deployed as a one-off response to end the conflict with Russia, bringing it to a sort of perennial standstill. The questions within  US policy circles are: should they keep these cards close to the chest, so to maximise the surprise effect if and when Putin has launched its nuclear attack? Or should they publicise to the fullest extent what reaction they are ready to stage in case of a Russian nuclear attack, so as to dissuade Putin from launching it in the first place? 

A shared line has not yet emerged, but rather a sort of mixed approach, with former CIA director and US general David Petraeus saying that the US would wipe out all Russian forces in Ukraine in case of a Russian nuclear attack, but without specifying how and over what time horizon doing so would be accomplished.  Our hope is that Putin may in fact be dissuaded from launching a tactical nuclear attack by knowing that the US reaction would be ferocious. But our hope does not necessarily coincide entirely with our expectation.  

by Brunello Rosa

24 October 2022

Last week, the drama surrounding the British government came to a sudden conclusion. After sacking her finance minister Kwasi Kwarteng in an extreme attempt to save her job, Prime Minister Liz Truss had to give in and hand her resignation in as head of the Conservative party, less than two months after winning its leadership contest. As with Boris Johnson before her, she will remain as Prime Minister until a successor is found, ideally by the end of this week. 

The hope by the conservative leaders is that, if there are multiple candidates vying to replace Truss, one of the last two remaining candidates will withdraw from the race in order to avoid the choice being left to the base membership of the party, which would imply a longer process. At one point it seemed that Boris Johnson would enter the race in an attempt at staging an unexpected comeback, just a few months after leaving his position as Tory leader, but then he withdrew from the competition. At this stage, Rishi Sunak is the frontrunner of the competition.

What led to this sudden conclusion? First, Liz Truss replaced Kwasi Kwarteng with Jeremy Hunt, who is perceived to be a much safer pair of hands than Kwarteng was. From that position, Hunt performed a U-turn on the fiscal policies introduced by Truss and Kwarteng in the so-called mini-budget presented earlier in October, which we labelled as an “economic gamble.” Instead of promising GBP 45bn of unfunded tax cuts, Hunt presented a plan of GBP 41bn of spending cuts. With these moves, Hunt appeared to be the de-facto Prime Minister, overshadowing Truss and her flagship economic program. 

Second, Truss’s attempts at manoeuvring within the UK political scene proved to be totally ineffective vis-à-vis the market reaction to her economic plans. The market continued to be sceptical of her plans, and of what may have been presented in the actual budget. As a result, the GBP continued to be under the cosh, reaching almost parity with the USD. Long-term rates also continued to face upward pressure, especially after the Bank of England stopped its emergency bond-purchases program. 

The third factor behind the conclusion of these political events was the conflict between price stability and financial stability that caught fiscal policy in the middle (even if fiscal policy ended up being the trigger for the financial stability episode). In the UK, like in any other major country, central banks are focused on fighting rampant post-pandemic inflation by increasing rates frequently and in large step. By doing so, they risk triggering financial stability episodes in a fragile system, as the Financial Instability Hypothesis by Hyman Minsky would suggest. 

In this case, the episode was triggered by reckless fiscal plans that led to an increase in interest rates in the leveraged system of pension funds performing LDIs. When these funds received margin calls to cover their derivatives position, they had to sell the most liquid assets, i.e. gilts, to get the cash they needed, thus triggering a further increase in rates, until the BoE stepped in to save the day. 

The clear lesson of this entire saga is that market discipline still works, and that even those countries that pride themselves of being financially advanced, such as the UK, are subject to it. This is good news, because the market will induce governments to adopt sounder fiscal policies, at a time when they may be the only source of support to dwindling economic activity, which is at risk of soon entering a recession.

by Brunello Rosa

17 October 2022

The annual IMF meetings took place last week, and they were held in an in-person format for the first time in three years. At the centre of attention in these meetings there were of course the geopolitical developments that – as we discussed in our latest column – are having such a large impact on key macroeconomic variables, such as GDP and inflation, as well as on financial markets. 

As usual, the IMF released its updated World Economic Outlook, titled “Countering The Cost-Of-Living Crisis”. It foresaw a revision of the key macroeconomic variables consistent with a stagflationary shock: an upward revision in the inflation profile and a downward revision in the growth outlook. Global growth is now forecast to be 3.2% in 2022 and 2.7% in 2023, compared to the 3.2% and 2.9% expected in July 2022.

Another element that was clearly present at the IMF meeting was the sense of policy uncertainty that is prevailing among policymakers. In March this year, in our article titled “Is There An Optimal Policy Mix To Get The Global Economy Out Of The Current Difficult Conjuncture?” we discussed how it is very hard to reach all policy goals that policymakers are setting for themselves (i.e., higher growth, lower inflation, low long-term interest rates and to severely punish Russia for its illegal invasion of Ukraine) with the instruments at their disposal, namely monetary and fiscal policy and sanctions. In particular, we noted how monetary policy and fiscal policy risked entering into a conflict with one another: fiscal easing would be inflationary whereas monetary tightening would depress economic activity. 

Our conclusion was that policymakers would only have two solutions: either a) give up at least one of their goals, to focus instead on the others; or b) give up a bit of all goals, and achieve a sub-optimal result on all fronts. In all cases, in these circumstances policymakers cannot aim at finding an optimal policy mix, bur rather can only minimize the effects of the inevitable policy errors that they will make. 

In the last few weeks, the UK provided a live case of the point we made: reckless fiscal policy (what we called a “gamble” in our column), uncoordinated with monetary policy or even with the forecasts of the Office for Budget Responsibility, led to a collapse in the value of GBP, and a spike in long-term rates that risked bankrupting the private pension system (undertaking LDIs – Liability Driven Investment). The Bank of England had to step in to bail-out the pension system by committing to re-open asset purchases for the sake of financial stability rather than price stability. Events unfolded further, with Liz Truss forced to sack the Chancellor Kwasi Kwarteng and replace himwith the much safer Jeremy Hunt. 

The UK case made clear what had already started to become visible on the horizon: central banks can increase short-term interest rates to fight inflation and also buy long-term government bonds to ensure the financial stability of the smooth transition of monetary policy (e.g. the ECB’s TPI). This seemed unconceivable until a few months ago, as it would have represented a policy inconsistency within monetary policy, given the mixed signals that this would send to market participants. 

But in this word of policy uncertainty and absence of an optimal policy mix, we need to get used to policy inconsistencies, policy mistakes and even conflicts between the various areas of policymaking.

by Brunello Rosa

10 October 2022

This past week has been another very eventful one, from a geopolitical perspective. First, besides the ongoing cyberwarfare between the two sides, which we discussed in our recent analysis, the threat of a possible nuclear escalation in the Russia-Ukraine conflict has become even more vivid. Initially, Russian President Vladimir Putin promoted referenda in four Ukrainian provinces which he claims are under control of the Russian army: Donetsk, Luhansk, Kherson and Zaporizhzhia. Then he ratified the results in favour of the annexation of these provinces, which the international community is not recognizing. 

This was the crucial step to saying that any attack on those regions would imply a direct attack on Russia. According to the Russian doctrine for the use of nuclear weapon, any threat to the security of the Russian territory - not necessarily an actual attack, but rather any threat considered “imminent” - would justify the use of the nuclear arsenal. 

There is a lot of talk about the use of “tactical” nuclear weapons, which have a smaller radius of action. Commentators and the wider public opinion are even starting to consider the use of those weapons similar to that of conventional artillery. But they are not. Their use would still represent the beginning of a nuclear holocaust, not too dissimilar to what happened in the Japanese cities of Hiroshima and Nagasaki at the end of WWII. Hiroshima and Nagasaki have been in fact quoted many times by the Russian government in their rhetoric, to justify the use of Russia’s nuclear arsenal. This is the reason why US President Biden spoke about a potential Armageddon that would derive from such a possible move from the Russians. 

We need to hope that the nuclear escalation does not progress further, as it is unclear how it would end. The bombing of the Kerch bridge that connects the Russian mainland to Crimea meanwhile might represent another starting point for further escalation, which is the reason now nobody wants to claim to be the author of that attack. 

Also taking place this past week, the OPEC+ cartel decided to cut oil production by around 2m barrels a day, in order to support falling oil prices and keep the price close to 100$pb. The move clearly benefits Russia at this difficult juncture in its war with Ukraine, and it could have never been adopted without the decisive input of Saudi Arabia, the major stakeholder of OPEC. 

This confirms what we discussed in our column of a few weeks ago: the emergence of a new bloc of countries, established around the BRICS gathering and now including Saudi Arabia as well  and that is in direct competition with the G7, which is centred around the US. In one of our recent papers, we discussed how Saudi Arabia was re-gaining centre stage in the more multipolar world that is currently emerging.

This is the reason why both President Biden and US Treasury Secretary Yellen complained about the cut to oil production inspired by Saudi Arabia, which risks tipping the global economy into a recession. And all this while the EU struggles to find a unified position around the proposal of a price cap for oil and gas imports from Russia.

These are just some of the examples that show that geopolitics remains at the centre stage in world affairs, and is one of the main determinants of key macro-financial variables, including oil prices (a crucial input for headline inflation) and GDP.

by Brunello Rosa

3 October 2022

Last week the UK went through one of the most dramatic periods of its recent history. The events started with the not so-mini-budget that was presented on Friday, September 23rdby the Chancellor of the Exchequer Kwasi Kwarteng, which we discussed at length in our previous column and subsequent podcast.  

As we argued in our column, the fiscal measures introduced by the Chancellor represent an economic gamble, as they consist of unfunded tax cuts worth GBP 45bn, to be added to the roughly GBP 100bn of measures that were adopted to cushion the effects of the energy crisis on households and companies. This would imply an additional GBP 150bn of borrowing by the government; i.e. gilts to be issued by the Treasury and presumably absorbed by the market. All this, without any forecast on economic growth and related fiscal deficit projections by the Office for Budget Responsibility (OBR), which generally accompany the issuance of the budget.

The results of these decisions have been disastrous. Investors have started to ask for higher yields to absorb the upcoming extra borrowing planned by the UK Treasury. Pension funds have been caught in margin calls, which forced them to sell even more gilts to get hold of cash to close these margins. This has made the price of gilts collapse and their yields rise rapidly. To stop this vicious circle, the Bank of England had to step in and launch an emergency program of GBP 65bn of purchases of gilts to be carried out over the following fortnight. Meanwhile, the GBP collapsed to its lowest level in recent history. Tory MPs threatened a no-confidence vote on Truss just weeks after having chosen her as their new party leader. Truss and Kwarteng had to meet with the OBR in order to inject confidence into the market, even though the meeting did not end with any sign of a policy U-turn by the government. 

The question we are asking ourselves is the following: is there any lesson that Giorgia Meloni, likely to be appointed PM in Italy, may learn from Liz Truss? After all, Liz Truss, in spite of all her shortcomings in communicating her policy intentions to the public, is an experienced politician and member of government, who studied Philosophy, Politics and Economics, the famous PPE course of the University of Oxford attended by many prime ministers before her. And Kwasi Kwarteng, after studying at Eton, has obtained various degrees, including a PhD at Cambridge University. In spite of these prestigious pedigrees, they made a mess of their first few days at the helm of the government.

Giorgia Meloni and her closest aids lack the academic background of her UK counterparts, so she may seemingly be starting at a disadvantage. Yet she may be able to learn a few lessons from what happened to Truss and so avoid making the same mistakes. The first lesson to learn is that being a person of conviction only buys you some time and credibility: it is the test with reality that makes the difference, especially if one is extremely convinced about the wrong ideas. The second lesson is to always be surrounded by the best people you can find, not just by acolytes and minions. Finally, never challenge the markets if you have a large amount of debt to refinance. You may end up needing to  ask for the intervention of the central bank. In the case of Italy, this is now mediated by the eligibility for TPI, which is subject to a high degree of discretion by the ECB.  

As we said in our preview, we do not expect Giorgia Meloni to start her period of PM with bellicose intentions. However, as Liz Truss shows, a couple of wrong moves may transform the honeymoon phase into a debacle. Giorgia Meloni may end up being on a collision course with the markets and European authorities before show knows it.

by Brunello Rosa

26 September 2022

Last week was an eventful one. On Wednesday, the US Federal Reserve increased its policy target range by additional 75bps, to 3-3.25%. On Thursday, the Bank of England increased its policy rate by 50bps to 2.25% in order to tackle rampant inflation. And on Sunday general elections were held in Italy. Russian President Vladimir Putin meanwhile announced the partial mobilisation of Russians of fighting age, which most commentators interpreted as an escalation of the war. 

While these events were taking place, on Friday the new UK Chancellor of the Exchequer, Kwasi Kwarteng announced its Growth Plan for the UK, which, according to its proponents, represents the “biggest package of tax cuts in generations.” The fiscal package, which is larger than a regular budget, will be comprised the following measures:

For households, a) the basic rate of income tax will be cut to 19% in April 2023, one year earlier than planned; b) the 45% additional rate of income tax will be abolished; and c) there will be changes made to the Stamp Duty regime for homebuyers, with 200,000 people expected not to pay the tax altogether each year. This comes a day after the government announced that the Health and Social Care Levy (HSCL) of 1.25%, due to be introduced from April‌‌‌ ‌‌2023, will not be implemented, and that the 1.25% increase in National Insurance contributions (NICs) rates that was introduced in April 2022 will end on 6‌‌‌ ‌‌November 2022.

For companies there are planned tax cuts as well, in particular: a) the cancellation of the planned increase to the Corporation Tax (CT) main rate from 19% to 25%, with changes made to the dividend tax rate; b) the cancellation of the planned increase in the rate of Diverted Profits Tax from 25% to 31%, and the planned reduction in the Corporate Tax surcharge rate for banking companies, both of which are expected to take effect from 1‌‌‌ ‌‌April 2023; and c) the introduction of new investment zones around the UK where enhanced tax reliefs will be offered for Stamp Duty Land Tax (SDLT), Enhanced Capital Allowances, Structures and Buildings Allowance and Employer National Insurance contributions.

The government expects these tax cuts to increase the UK’s growth potential from 1.75% to 2.5%, and to increase productivity and wages over time. Considering as well the measures that were introduced in previous weeks, in particular the Energy Price Guarantee that was made in response to the large increases in gas prices that are being experienced by households and companies, how credible are these promises? 

The Bank of England, in its latest statement, said that it will assess the overall impact of these measures on growth and inflation, and their implications for monetary policy, in the November 2022 Monetary Policy Report. In its preliminary assessment the BoE announced that by increasing disposable income the energy price cap may induce stronger spending, which could be inflationary. 

Therein lies the real risk, which we discussed in previous analysis. Monetary policy and fiscal policy are not working in the same direction anymore. To the contrary: fiscal easing to support economic activity tends to be inflationary, whereas monetary tightening to combat inflation tends to be recessionary. The monetary-fiscal coordination that worked so well during the pandemic is now a distant memory. And the biggest problem is that an optimal policy mix does not even exist. 

The UK government does not seem to have understood this point. It has introduced a massive plan of tax cuts as it was operating in isolation, without considering the potential inflationary impact, at the same time as the BoE is trying to tame inflation with higher rates and QT. Moreover, these tax cuts imply much larger borrowing, which may also result in higher long-term rates, which in turn tend to depress economic activity. 

Markets have been fast to provide their response, with the GBP sinking versus the USD to one of its lowest points on record. Voters in the UK seem to have expressed their view as well, with polls showing a solid Labour lead (42% versus 33%, with LibDems, SNP and Greens – all potential allies of Labour – polling at 20% collectively). Liz Truss should learn from Margaret Thatcher, whom she considers to be her role model. Thatcher did increase taxes, including the hated VAT, before cutting taxes. And her government collapsed on the proposed introduction of the poll tax, intended to finance local governments. 

by Brunello Rosa

19 September 2022

Italy will hold a general election this Sunday, to elect its 19th parliament since the return of democracy in 1948. This will be an early election, called after the resignation of Mario Draghi in July following the de-facto loss of confidence by parliament in Draghi’s government. The no-confidence process was started by M5S’s leader Giuseppe Conte, but ultimately it was Berlusconi’s Forza Italia and Salvini’s Lega that pulled the plug, leaving only Enrico Letta’s PD to support the government.  

This election will be peculiar mainly for two reasons. Institutionally, following the 2020 constitutional referendum, the number of MPs has been drastically reduced, from 630 to 400 Deputies for the Chamber, and from 315 to 200 Senators for the Senate. This also has a political implication, since the constituencies have also been re-designed, with more weight now being given to peripheral areas and suburbs, and less to city centres where the centre-left is traditionally stronger. 

Politically, the general election is widely expected to result in a landslide victory by the centre-right, led by Giorgia Meloni of the Fratelli D’Italia (FdI). This is due to the fact that FdI was the only party officially in opposition to Draghi’s government in parliament. After the fall of Draghi’s government, she therefore emerged as the only credible alternative to the status quo. Also, the decision by centre-left parties (the PD, the M5S and the so-called Terzo Polo of Azione + Italia Viva, both of which splintered from the PD during this parliament) not to run in a coalition will likely allow the centre-right to win all the first-past-the-post seats, which are around 1/3 of the total number of seats (the rest are elected with a proportional representation system), likely leading to a massive defeat. 

On the other side of the political spectrum, FdI is likely to be by far the most voted for party in the centre-right coalition, which should imply that Meloni becomes the most obvious candidate to become Italy’s next prime minister. Things may change depending on the overall electoral results, and, in particular, on the results within the centre-right, and the distance between the first and second party in their coalition.

The latest available poll shows that FdI is at 25.3% of voting intentions, PD at 23.3%, Lega at 12.3%, M5S (12%), Forza Italia 6.7%, Azione + Italia Viva 6.4%, and the Greens and Left together 4.1%. If the eventual outcome of the election is similar to these polls, with FdI having a number of MPs almost double than that of its immediate follower, Lega, then Meloni can legitimately claim to become Italy’s next PM. 

What would a Meloni government do? In our opinion, there are two scenarios to consider here. If the centre-right wins enough votes to be able to change the Constitution without requiring a confirmative referendum – it will need a two-thirds majority in each chamber of parliament in order to do so – then we believe the centre-right coalition will devote most of its energy to changing the Constitution towards a presidential or semi-presidential system in which the head of state is elected directly by the people. 

If instead the centre-right wins “only” a simple majority, it will devote most of its energy on the economic front. It will likely review the recovery plan (PNRR) and pursue a tax reform to introduce elements of a flat tax. 

In any case, markets seem relatively relaxed at this stage, in spite of Italy’s large debt/GDP ratio. Partly this is because growth has lately surprised on the upside, and the fiscal deficit on the downside. But things may change rapidly if Meloni, unwisely, decides to set Italy on a collision course with the EU on economic or rule-of-law themes.

by Brunello Rosa

12 September 2022

Last week, Elizabeth II, Queen of the United Kingdom and other Commonwealth realms, died at the age of 96. Her kingdom lasted 70 years, making her the longest-serving monarch in British history. Only months ago the country celebrated the platinum jubilee of her accession to the throne, which took place on 6 February 1952, when she was just 25 years old. During her life, Queen Elizabeth has appointed 15 prime ministers, the first one being Winston Churchill, the last being Liz Truss.

The world has changed around her during her time as Queen. The first US President she met was Harry Truman, who succeeded Franklin D. Roosevelt; the last one was Joe Biden. In between these, she met with diverse characters such as John F. Kennedy, Richard Nixon, and Barack Obama. The UK has gone through tragedies and humiliations such as the Suez Crisis in 1956, and triumphs such as the Falklands war in 1982. During her kingdom, the UK entered the EU (in 1973) and later exited it (2020), and London has become the world’s foremost financial centre.

Overall, during this long span of time, the UK has certainly increased its influence and prestige at the global level. 

Domestically, the UK has gone through difficult periods, such as the troubles in Northern Ireland, which ended only in 1997 with the Good Friday agreement. In 2014, the UK survived an independence referendum by Scotland. So, one can say that, during the second Elizabethan era, the UK has strengthened domestically and on the global stage. Elizabeth leaves a heavy legacy for her successors in this regard. 

King Charles III will have to begin from where his mother left. His name is a difficult one. Charles I was the first king executed in European modern history (in 1649, more than a century before the French Revolution). Charles II was forced to live in exile during the rule of Oliver Cromwell as Lord Protector of the UK, and was able to return only at the death of the dictator. Charles III will be confronted with phenomenal secession pressures, from Northern Ireland and from Scotland. 

As we discussed in our previous column, the victory of the Sinn Fein on the two sides of the isle of Ireland makes a re-unification referendum for the island more likely. On that occasion we said that such a referendum would not take place while the Queen was alive. But now the clock is ticking, and it will take some serious effort by Charles to convince Northern Ireland that they are better off inside the UK rather than within the EU. This task will become even harder, as Liz Truss has declared her intention to re-discuss the Northern Ireland protocol with the EU. Meanwhile, regarding Scotland, First Minister Nicola Sturgeon has also said that it intends to launch a new independence referendum by 2023. Anow that the UK is out of the EU, pro-European Scotland may opt for the independence route. 

Domestically, Charles will likely oversee an autumn and winter of severe discontent among the UK population, given the cost-of-living crisis originating from the rise in energy prices. 

For all these reasons, a very steady hand will be needed to keep the country together and drive it out of this current difficult situation. This is the reason why Charles has immediately appointed his son William as Prince of Wales, making him a de-facto right hand to the throne, in the hope that this “duumvirate” will help Britain navigate the new few difficult years. 

by Brunello Rosa

5 September 2022

At the and the end of last week, the figures for US Non-Farm Payrolls (NFP) were released. The US Bureau of Labour Statistics reported that the US economy added 315K jobs in August of 2022, compared to a downwardly revised 526K in July (p. 528), but above market expectation of 300K and pointing to broad-based hiring across many sectors. Even if the unemployment rate rose slightly from 3.5% to 3.7%, non-farm employment is now 240K higher than its pre-pandemic level in February 2020. 

On the basis of these figures, even if employment figures are a lagging indicator of economic activity, it may be correct to say that the US economy is not in a recession, not even a technical one, in spite of two consecutive quarters of contraction. This seems to be confirmed by a cross-check through the lense of the so-called Okun’s law, which links unemployment and GDP changes. According to a recent analysis, the US economy may have actually been growing in H1. This is crucial in determining what the Fed, and other major central banks, will do in coming months. 

Regarding the Fed, at its traditional gathering in Jackson Hole Chair Powell surprised the market with unexpectedly hawkish remarks. Powell said that the US economy remains strong and the world economy resilient in the face of the ongoing energy crisis deriving from the war in Ukraine, and therefore the FOMC will continue tightening its policy stance.  The FOMC will continue aiming for a “soft landing” of the economy, but the Committee priority is now to bring inflation (which is still running at 8.5% y/y) back to target. Commentators and markets read this as an anticipation that another 75bps rate increase will be delivered in September. In July, Powell clarified that the Fed will not provide as much forward guidance as before, as the FOMC has become data dependent, but this seems now a reasonable assumption. 

But more than the decisions that the Fed makes in any given meeting, what matters is the cumulative amount of tightening that takes place. In this respect, the Fed has recently reached neutral territory with its policy rate (2.50%), and it is ready to enter restrictive territory with the next rate increase, to reach and overcome the 3-3.25% expected at year-end according to its SEP dots. However, one should note that with inflation at 8.5% and a policy rate at even 3.5%, policy rates would still be negative in real terms, meaning that in real terms the Fed’s policy stance remains highly accommodative. To bring inflation down to 2%, much more tightening may be needed. 

Regarding the ECB, next week another 50bps rate increase is expected, but perhaps a surprise 75bps hike cannot be ruled out. This follows the remarks by ECB Board Member Isabel Schnabel, who said that the ECB may need to make further “sacrifices” (i.e. rate increases) as the inflation outlook has not improved. Additionally, the ECB’s policy stance cannot remain too distant from that of the Fed, at a time when the EUR has already fallen below parity versus the USD. A weaker currency contributes to higher inflation rates, at a time when the ECB is trying to bring inflation back to target. 

by Brunello Rosa

29 August 2022

A few weeks ago, after Boris Johnson resigned as UK Prime Minister, we published a column titled “Johnson’s Resignation Opens The Gate To A Real Post-Brexit Britain.” In that column we discussed the possible contenders for the leadership race, indicating Rishi Sunak and Liz Truss as the clear frontrunners. We also warned that, once that Brexit was “done” by Boris Johnson, the new Tory party leader and future PM will have to deliver on what Brexit will really mean for the country; in particular, by showing what benefits it could derive from leaving the EU. 

This week, the leadership race will come to an end, with the election of Johnson’s successor by 161,000 Tory party members on September 5th. Liz Truss is widely expected to win the race. Sunak has been one of the most popular ministers in Johnson’s cabinet, widely praised for his sensible approach to the pandemic, which was epitomised in the furlough scheme that was launched to make sure that millions of people did not lose their jobs. But Truss has been a party member far longer than Sunak, and she is clearly favoured by the party grandees, as well as by the base. She comes from the party ranks, and can probably speak to the belly of the country better than Sunak can. 

In spite of the humble origins of his family, Sunak would seem an elitist choice, considering his business studies at Stanford and his marriage with the daughter of one of the richest men in India. The fact that his wife was caught using a legal scheme to pay less taxes in the UK did not help. Sunak would speak to Britain’s minds. But in a period in which populism is still in vogue, speaking to the belly of the country goes a longer way than speaking to the mind. This is the reason Liz Truss will likely win the race. 

We have already discussed the differences in policies between Sunak and Truss; a further comparison between the two can be found here. But there is an aspect of the difference between them that it is worth discussing in greater depth. Let us assume that Liz Truss wins the race. She is considered to be a die-hard Brexiter, with a level of zealotry that only “the converted” have (she voted to remain in the EU in 2016). 

Truss reportedly wants to transform the UK in a sort of Singapore-on-Thames, with a super low tax rate. Hence, her proposal of reducing taxes by GBP 30bn from “day one” in office. She also wants to reduce the regulatory burden, to take advantage of the divergence in standards with the EU that the UK has gained from Brexit. She also wants to revisit the Northern Ireland protocol, which regulates the relationship between UK and the rest of the EU at the Irish border. In terms of economic policy, she is clearly in favour of tax cuts over “cash handouts.” But even Margaret Thatcher increased taxes (for example VAT), before announcing tax cuts, years later. 

Some commentators say that “Liz Truss can do a lot of damage before she’s thrown out, as she will be, in 2024.” Others believe that, “If she wins, and enacts her promise of immediate tax cuts, the only safe prediction is that sterling will crash.” While we are somewhat concerned by her proposed policy, we believe that Truss is likely to show to the UK what Brexit really means, in both a positive and a negative sense.

by Brunello Rosa

22 August 2022

Since mid-June 2022, the S&P 500 equity index has risen more than 15%, reaching 4228 points at the end of last week. This rally has helped the index (and similar indices around the globe) exit bear market territory, defined as a fall in equity prices of at least 20% from its recent peak, which it entered in June just before this rally begun. 

The index is still down 11% year-to-date, but only 5% from one year ago. It is actually up 45% over the last three years, and an astonishing 500% since March 2009, when the post-Global Financial Crisis (GFC) rally begun. The index has been one of the major beneficiaries of the massive liquidity injections made by central banks around the world in the last 14 years, with various round of QE to combat the various shocks the global economy underwent in the period, and in particular the GFC and the Covid-19 pandemic.

This introductory background serves the purpose of providing some context for one of the hottest debates among market participants in this period; namely, will this mid-summer market rally last, at least until the autumn, and possibly beyond? As we know, market participants tend to have a short-term horizon for their decisions. But putting things into context here may help to provide an answer. 

We discussed recently about the asynchronous nature of financial and business cycles, with financial cycles typically anticipating the developments of the real economy. In this context, we warned that we could see markets rallying when the economy was entering a recession, having fallen in advance, before the economic cycle turned downward. In this case, the key indicators that markets are watching are inflation data and the response of central banks. If inflation starts showing signs of peaking and central banks signal that they can stop their tightening cycle soon, markets would be ready to rally. 

This is what has fuelled the mid-summer rally so far. Inflation has shown some (mixed) signals of peaking, and the Fed, at its July FOMC meetings, said that it is now data dependent, and not on a pre-set course of action. 

What about the future? The real economy shows further signs of deceleration globally, starting in China and Europe, and a contraction in economic activity taking place at the end of this year cannot be ruled out. The US has already exhibited two consecutive quarters of negative growth meanwhile, but various one-off factors seem to convince policymakers that this still does not represent even a technical recession. 

On the other hand, labour markets remain tight, on both sides of the Atlantic. And with unemployment rates still at historical lows, wage growth remains strong, pushing up domestically generated inflation. In the UK, for example, inflation has surprised on the upside again, and market participants now expect another 50bps rate increase in September by the Bank of England. 

Central banks will not stop increasing rates until they are sure that inflation is tamed, even if this implies a strong deceleration, and potentially even a contraction in economic activity (to some extent, this is in fact what central banks are trying to engineer). Central banks, which have a longer time horizon than market participants, know that markets can suffer some additional losses (precisely because some equity indices have rallied 500% since the QE experiment began), if such losses are the price needed to pay for reining in inflation. So, the mid-summer rally may come to an abrupt halt when central bank activity resumes in September. 

The real puzzling piece in this jigsaw is the following: if a debt crisis accompanies the upcoming economic downturn, the reaction function by central banks may change, and they may instead be more inclined to safeguard the integrity of the overall financial system rather than rapidly bringing inflation down to target levels. But in that case, more wealth destruction in the equity and sovereign and corporate bond markets would be assured, even with less hawkish – or even accommodating – central banks.

by Brunello Rosa

15 August 2022

The visit to Taiwan by US Speaker of the House Nancy Pelosi on August 2nd, and the reaction to that visit by the Chinese authorities, were widely reported upon by all media outlets. Pelosi had programmed her visit for April 2022, the first trip by a senior US lawmaker since House Speaker Newt Gingrich’s visit in 1997; but her trip was cancelled due to Covid-19. Already at that time, the Chinese Ministry of Foreign Affairs said that the visit was a “malicious provocation” and that the People’s Republic of China (PRC) would “take strong and resolute measures to thwart any interference by external forces”.

In effect, the reaction by the Chinese authorities was resolute. On 1st August, the PRC announced a military exercise opposite Taiwan. A military build-up was also seen in cities and on beaches directly opposite Taiwan. The Chinese military has also continuously sent fighter aircraft and naval ships over the median line and into the Taiwanese Air Defence Identification Zone (ADIZ). These drills have also been planned for areas east of Taiwan. During Pelosi’s stay, various Taiwanese government sites were hit by DDoS attacks, bringing down the Office of the President’s website, the Ministry of Defence website as well as the website of the Taoyuan International Airport. 

Since the Russian invasion of Ukraine, many commentators said that China was keen to establish a new, privileged relationship with Putin’s country because this invasion would legitimise, at some point, the Chinese invasion of Taiwan. But things are a bit more complicated than this. 

First, already in July 2021, six months before Russia’s invasion of Ukraine, we said that China would aim at taking back the “rebellious province” of Taiwan over the next 5 to 10 years, initially with a series of destabilising actions and provocations. The Chinese government will likely use a tactic not dissimilar from the one it adopted to take back control of Hong Kong. 

Secondly, we said that China would not make such a move this year, as many had expected, simply because Chinese President Xi Jinping’s energy is devoted to being re-elected as party leader for the third time (effectively paving the way to a lifelong tenure as Chinese leader, irrespective of the official title) during the upcoming 20th Congress of the Chinese Communist Party (CCP). A war with Taiwan, which may have unpredictable consequences, would likely cause more harm than good to Xi’s hopes of re-election, paving the way for a victory of the opposing factions within the CCP, and in particular the faction led by Prime Minister Li Keqiang. 

Third, and perhaps most importantly, when geopolitics is in flux, unexpected events may develop which make “mechanical inferences” less obvious than they would seem to be, prima facie. For example, recently Putin – the arch-enemy of the enlarging NATO alliance – and Erdogan, the President of Turkey, a long-time NATO member, decided to deepen the economic ties between their respective countries. Initially Erdogan established himself as the mediator between Russia and the West to free the grain stuck in Ukrainian ports (chiefly Odesa) besieged by the Russian army.