WEEKLY COLUMNS (ARCHIVE)

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by Brunello Rosa

31 August 2020

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

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

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

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

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

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

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

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

by Brunello Rosa

24 August 2020

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

Mike Pence has officially begun. 

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

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

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

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

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

by Brunello Rosa

17 August 2020

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

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

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

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

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

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

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

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

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

 by Brunello Rosa

10 August 2020

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

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

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

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

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

Who is benefiting from this situation in financial markets? 

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

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

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

by Brunello Rosa

6 July 2020

A few weeks ago we warned that the world will look very different after Covid from how things were at the end of 2019. Some of the changes we envisioned are already occurring. 

We mentioned how China would try to use the crisis to make geo-strategic gains relative to its rivals, primarily the US and, more broadly, the Anglosphere. In this respect, the new more assertive geopolitical stance taken by China was visible in the military exchange that occurred between China and India in the disputed territories of the Himalayas.  This direct military confrontation risks pushing India more towards the US sphere of influence, at a time when US President Trump has already expressed sympathy towards authoritarian or nationalistic leaders like Narendra Modi. 

But the geopolitical confrontation between China and the Anglosphere is occurring on other fronts as well. As we discussed in a recent column, the blame game over the origin of the Covid-19 pandemic must be interpreted as part of a wider containment strategy with regard to China, a strategy which also includes the probable decision by the UK government to gradually phase out Huawei from its 5G network, following similar steps already taken by both the US and Australia. 

Meanwhile, the US is still mired in the middle of a surge in Covid-19 cases, with  erratic management of the crisis by US President Trump. The US now has about one quarter of the 11 millioncases of Covid recorded worldwide. As a result, the EU, which has just re-opened its external borders, has excluded the US from the list of countries from which citizens can arrive without having to undergo a period of quarantine. The US is about to enter one of the most heated presidential elections in its history, with Trump already openly speaking of “rigged” elections, alleging irregular vote-by-mail schemes and ballots printed by foreign countries. 

There is even the risk that, unless the Democratic candidate Joe Biden obtains a large majority in the electoral college, the president will refuse to accept the result of the election and will not leave the White House in January 2021.  

In the middle of the US and China, there is always Europe, which is trying to overcome its many contradictions. As we discussed in our recent in-depth analysis, the EU is in the middle of a difficult negotiation regarding the Recovery and Resilience Fund, with the Frugal Four (Sweden, Denmark, Austria and Netherlands) asking for much stricter conditionality attached to any funds sent to the countries that have been most impacted by the crisis, primarily Italy and Spain. In a recent interview, Greek PM Kyriakos Mitsotakis said that he will not accept the approval of a recovery instrument with too much additional conditionality compared to regular fiscal coordination and surveillance. 

In our analysis we also discussed the national implications of such a deal, in particular in France. There, President Emmanuel Macron decided to sack Prime Minister Edouard Philippe, following the defeat of the president’s party in the local elections last week. He substituted Philippe, who had become more popular than the president for his good management of the Covid emergency, with Jean Castex, another “Enarque” who advised the president on the re-opening of the economy post-lockdown. 

These movements, apparently simple domestic politics, are of the greatest importance ahead of the 2022 Presidential election. As we have said many times before, if Macron does not win a second mandate, the entire European integration project could be in serious jeopardy. 

by Brunello Rosa

29 June 2020

Last week, equity indices suffered despite a rebound in economic activity in some key economies. This occurred as a rise in COVID-19 cases, especially in the US and Brazil, as well as fresh warnings over the global growth outlook and the Fed’s warning of a cap to ‘shareholder payouts’ all weighed on market sentiment. 

On a weekly basis, global equity indices fell (MSCI ACWI, -0.6%, to 524), driven by the US (S&P 500, -0.5% to 3,084) and the EZ (Eurostoxx 50, -1.5% to 3,219). From the beginning of the year, the S&P 500 index is down 7%, Eurostoxx 50 is down nearly 15%, the UK’s FTSE 100 is down 18% and Nikkey 225 5%. These figures are very much in line with what we  predicted a few months ago, perhaps with the only exception of NASDAQ, which has surprised us as well as market participants with a more positive than expected performance. The NASDAQ is up 9% year-to-date, mostly due to the fact that pandemic has further boosted the use of technology for business continuity.

Have these depressed valuations re-aligned equity indices with economic fundamentals? We don’t think so. Last week, the IMF released a revision of its World Economic Outlook (WEO), which featured a significant further downward revision of expected global growth, from the -3% predicted in April to -4.9% predicted now. US growth is  expected to be -8.0% in 2020 (a 2.1% downward revision as compared to April’s prediction), the UK -10.2% (a -3.7% downward revision as compared to April’s), and the Eurozone at -10.2% (a -2.7% downward revision). These new forecasts are now more aligned with our own more pessimistic estimates made in April. This week, we will publish our revised forecasts alongside the Strategic Asset Allocation.  

Recently, the OECD went even further than this economic outlook of the IMF. In its June forecasts, the OECD foresees a 6% contraction in global GDP (if no “second wave” of the pandemic occurs – the so called “single-hit scenario”), and -7.6% contraction in case of a second wave (the “double-hit scenario”).  It expects the US to lose roughly 7.3%/8.5% of GDP in 2020 (depending on whether or not a second wave occurs), the Eurozone 9.1/11.5%, and the UK a staggering 11.5/14%. So, either these growth forecasts are too grim, or else market valuations are too optimistic.

At the beginning of the year, we warned that there was a large discrepancy between risk asset valuations, especially equities, and economic fundamentals. The collapse in valuations following the global outbreak of Covid-19, which marked the beginning of the fastest bear market in recent history, had temporarily solved that discrepancy, by bringing valuations closer in line with economic fundamentals. But the rapid recovery in equity indices (pushed by central bank liquidity) led also to the manifestation of the shortest bear market in recent history, with valuations departing again from economic fundamentals. 

In our recent analysis, we warned about the possibility that a U-shaped (or W-shaped) recovery could be accompanied by a V-shaped rally in financial markets. However, our recent in-depth analysis shows that equity valuations seem to be mis-aligned not just with macroeconomic fundamentals, but also with microeconomic variables that serve as an input for equity valuation models, such as expected earnings per share. There is also a mis-alignment with the signals from the credit market, in particular the expected default rates. What is underpinning high valuations seems to be only low interest rates (both current interest rates and expected future interest rates), which is a purely circular argument. Clearly, central bank liquidity has been underpinning valuations for a long time now. It is perhaps to break the virtuous (but also vicious) circle that, after the easing spree of March/April, most global central banks are now adopting a more cautious stance, with a partial withdrawal of some of the extraordinary measures introduced in the last few weeks. 

In any case, the evolution of the pandemic and the global economy remain highly uncertain, and so “prudence” should be the buzzword for market participants at this time.  

by Brunello Rosa

22 June 2020

Last week, China announced that a number of boroughs in Beijing had to be locked down as a result of a new localised outbreak of Covid-19 in the city, possibly originating from another food market. The Chinese authorities said that investigations concluded that the coronavirus strain detected at the Xinfadi market in Beijing came from Europe, even if they admitted that this particular strain “has existed longer than the current coronavirus strain circulating in Europe.”

So, it appears that China is now making accusations of other countries and regions for the possible second wave of pandemic it might be suffering. This is, of course, similar to the way most countries have accused China for having caused the pandemic in the first place, whether “naturally” (if the virus spread out the wet market in Wuhan), or “artificially” (either intentionally, or by accident, given the presence of the notorious research lab in Wuhan itself). What then should we make of this blame game between China and the rest of the world?

One should not be confused by the exchanges of allegations between politicians and even heads of state and governments. In most cases, these allegations are made to assuage the domestic opinion more than to attack the foreign entity, in order to distract attention and divert responsibility away from themselves. This is a usual game in politics. However, there is also something deeper going on now, which makes the current situation different from those which typically exist. 

As we discussed a few weeks ago, we believe that after this pandemic, and after the containment measures that have been adopted to counter this pandemic, the world will look very different from how it was until the end of 2019. In particular, the economic or political power ranking of countries and regions could change on a global scale. 

For certain, the economic and political “distance” between the major global players will be very different: for example, China will be able to reduce the gap with the US on a number of dimensions. The US, with its erratic response to the pandemic, and its inability thus far to rein in the pandemic, will most likely lose ground versus China, whose response to the virus having been much more rapid and forceful. Europe is still debating which policies to adopt to recover from it. 

The US and its closest allies in the Anglosphere (the so-called “Five Eyes”: the USA, UK, Canada, Australia and New Zealand) are trying to respond this evolution of events. Clearly, the first point of attack is about the origin of the crisis, which is undoubtably in China; emphasizing this fact also serves to diminish the relevance of Beijing’s strong response. For the first time in history, countries or state entities (such as Missouri and Mississippi) have expressed their intention to ask for “compensation” or “reparations” in non-war related circumstances, and this will continue to put pressure on China. 

But there are other open fronts as well. As we know, the new Cold War between US and China has several components, one of which is the very relevant technological competition. Recently, the US imposed further restrictions on Chinese tech giant Huawei (which were subsequently partly eased). 

Countries in America’s inner circle, such as Australia, have taken similar measures. This has meant a sharp deterioration in the bilateral relationships between Beijing and Canberra, even despite the fact that China has been the main importer of Australia’s iron ore and coal in the last few years. But in the “new world order” of disrupted global supply chains, geopolitical considerations will trump economic cost/benefit analysis. This is an unfortunate evolution. It will eventually hurt the end consumer globally, as it will lead to a reduced choice of products and higher prices. 

by Brunello Rosa

15 June 2020

In this world of de-materialised data, where the control of the cyber space and the most advanced communication and information technologies seems necessary to gain a strategic advantage versus the geo-political rivals, it is quite dystonic to learn how global and regional powers still consider the control of the sea as a key factor for assert dominance over a geographical area.

We have discussed many times how the new Cold War between US and China was increasingly driven by the technological competition between the two world’s super-powers, in particular in the fields of artificial intelligence, big data and 5G technologies, with the US trying to at least slow down China’s Agenda 2025, foreseeing the Asian giant becoming the world’s first country in the most technologically advanced sectors of the future. More recently, we have discussed how Russia, the world leader in cyberwarfare techniques, was using the Covid-induced crisis to make geo-strategic advances by using its competitive advantage in the field. 

But exactly when all the advanced world is making the greatest use of online technologies to carry on its economic activities and circumvent the restrictions imposed by the lockdowns, we learn how the good old control of key maritime routes and straits, or the acquisition of naval basis is still considered a key ingredient for asserting geo-strategic dominance. 

In the G2 heightening rivalry between US and China, the disputes over the east and south China sea have acquired absolute prominence in determining how the rivalry will evolve, including regarding the still unresolved trade dispute. As discussed in our recent report, roughly $5 trillion of trade passes through the South China Sea (SCS) each year, including oil and natural gas. It’s clear that controlling SCS enables China to potentially choke off these routes and severely impair neighboring economies and global trade.

Press reports suggest that Beijing has steadily fortified seven islands or reefs, equipping them with military bases, airfields and weapons systems. This means, that while US President Donald Trump might be trying to apply the Art of The Deal in the negotiations, China might be applying the Art of War by general Sun Tzu, implying that any comprehensive trade deal with China might need to include a resolution of SCS sovereignty issues, potentially an unachievable result. 

Clearly, China’s difficulty in projecting its geopolitical influence by controlling the seas is a massive constraint, compared to the US historical prevalence over the Atlantic and Pacific oceans. The Belt and Road Initiative (where the “Road” is a maritime route) is a way for China to break that constraint disguised behind commercial interests. 

In other reports, we have discussed how the control of the strait of Hormuz was considered by Iran as a key to re-assert its authority in the Persian/Arabian gulf, potentially impairing global trade of oil from the region. 

Finally, in our recent report, we have discussed how geopolitical tension was rising in the Mediterranean sea, with two open fronts in Syria and Libya, where regional powers are playing their chess game. Turkey and Russia seem now close to reach an agreement on the two fronts, with Tukey having completed its “Open Sea Training” operations (thus extending its maritime influence from the Dardanelles to Cyrenaica), and Russia getting closer to achieve its most cherished goal: naval bases in the west Mediterranean sea (in Bengasi – together with the air base in Al Jufra), to complement its historical posts in Latakia and Tartus in Syria. Controlling what the Romans called Mare Nostrum(“Our Sea”) seems to be, two thousand years later, still a desirable strategic objective.

by Brunello Rosa

11 May 2020

According to the most recent statistics, the UK is now third in the ranking of countries most affected by Coronavirus, after the US and Spain. It is second (after the US) in terms of number of deaths, with around 32,000 reported victims. Given the severity of the situation, the government, after initial hesitation, launched a complete lockdown of the country and its economy on March 23rd. Now, the government seems ready to relax some of these rules (for example, on daily exercise), while also tightening boarder controls (e.g. imposing a 14-day quarantine on anybody arriving in the UK). The central government – but not, for example, the devolved government in Scotland – is ready to move from the slogans “Stay Home/Protect the NHS/Save Lives” to “Stay Alert/Control The Virus/Save Lives”.

The impact of the pandemic and lockdown on the UK economy was recently estimated by the Bank of England, in the “illustrative scenario” described in its May Monetary Policy Report. The Bank estimated a 14% drop in the UK’s economic activity in 2020, followed by a V-shaped recovery of 15% in 2021. This estimate takes into consideration the overall policy response, namely a massive fiscal stimulus accompanied by a large monetary easing package, including rate cuts, increased QE and credit easing measures. The fiscal stimulus includes the innovative Job-Retention Scheme, by which the government will pay 80% of the salary of “furloughed” employees (up to GBP 2,500 a month) as long as their companies do not fire them, until June 30. The monetary stimulus includes a form of direct fiscal deficit, with the re-activation of the Bank’s “Ways and Means”, i.e. the Treasury account at the BoE.

While the pandemic and containment measures take their toll on the UK economy, the other major chapter of the UK’s political economy, Brexit negotiations, has re-started. As we have discussed in our previous analysis, the UK has no intention to seek another extension to the implementation period beyond December 2020. 

The EU now seems to have accepted this position, which initially was motivated by the UK’s intention not to repeat the experience of requesting multiple extensions as occurred during the prime ministership of Theresa May, which led to political chaos. But now there are two additional motivations, which we consider to be even stronger. 

First, as we explained in our analysis, “no deal” Brxit is the only logical conclusion of the approach brought forward by Johnson and his political side of the Conservative party, which won in a resounding way at the December 2019 elections. Second, the economic damage caused by the pandemic and the containment measures will easily mask any economic damage deriving from “no-deal” Brexit. The most visible aspect, namely travel restrictions and border controls, would be implemented anyway due to Covid. 

Thus for now the UK government has all the advantages of not seeking for an extension by June 30 while knowing that it can always get one at the very last minute). It will make “no deal” more likely, thereby strengthening its negotiating position at the table. And if a hard Brexit does occur, it is probably what hard-Brexiteers such as Boris Johnson and his chief advisor Dominic Cummings, Dominic Raab (currently foreign minister and senior secretary of state) and Michael Gove (in charge of Brexit planning) ultimately want. 

What happens if a no-deal, hard Brexit eventually occurs as a result of this tough negotiating approach? Well, the economic damage deriving from leaving the customs union and the single market without a deal, as well as increased border controls and customs checks, will likely be attributed by the government to the pandemic and the lockdown, rather than to the hard Brexit. The UK will also be free to respond to the additional economic shock by completely dis-aligning itself from the EU in terms of taxation, regulation, as well as product and labour standards. In the post-Covid world, where every country will try to do as much as possible just to remain afloat, the UK position might even not be perceived particularly at odds with that of other European countries, including those who will remain in the EU. 

by Brunello Rosa

27 April 2020

We have discussed the macroeconomic impact of Coronavirus in several recent columns and research pieces. It is clear that we have already started witnessing large falls in economic activity around the globe in Q1. In some countries, GDP had fallen already 4-5% on a quarterly basis, and the collapse of real GDP growth will be in double digits in Q2. As a result, oil prices have collapsed into negative territory for the first time ever. Unemployment rates are soaring everywhere, with the US having witnessed a 30mn rise in initial jobless claims in the last six weeks, wiping out the gains made over the past several years. 

Governments and central banks are coming to the rescue with large stimulus packages, but these will still struggle to reach small and medium sized enterprises (SMEs) and the self-employed, which will be decimated by the crisis. Helicopter money works only if money reaches every corner of the system, without remaining concentrated in the hands of a lucky few and without remaining concentrated in intermediary institutions such as banks. 

When economies and societies do re-open, nothing will be like it was before. We will have to live together with the virus for so many months, potentially for another year until a vaccine becomes available on a large scale for most of the global population. Until that time social distancing will remain the mantra in most work and business environments.

Teams might need to work on alternate days or weeks. Open-space offices will remain unfilled for the months to come. In the aviation industry, planes will fly half empty and airports will devote much larger spaces to passengers. 

In the hospitality industry, restaurants will have to find ways to serve food while complying with social distancing regulations, and hotels will remain half empty at best.    

In such an environment, what is the right strategy to adopt in order for your business to survive? Well, during the financial crisis, Richard Koo’s theory of “balance sheet recession” got a lot of attention. It was based on the fact that, in a financial crisis, private sector agents are trying to deleverage, and therefore the only entity able to increase its debts is the government. In such an environment, private sector agents switch from being profit-maximisers to become debt-minimizers, to regain financial viability.

In this crisis, unless private-sector agents receive grants from public authorities, they will need to take loans, which banks will offer at a very cheap rate and with favourable conditions as a result of central bank’s credit-easing measures. In this crisis, therefore, private-sector agents cannot afford to be debt-minimizers. Also, especially companies should forget about being profit maximisers, in order to avoid frustration and disappointment. In an environment such as the one described above, they will be forced to run at half-capacity at best and therefore they will surely suffer losses.

Since losses will come no matter what, the ideal business strategy to adopt is to minimize such losses, without regretting too much the lost revenues and profits. Most of those losses, especially in public services, will likely be subsidised by the government. In some cases, subsidization will not be possible, and so the aim should be to develop enough internal efficiencies to minimise future losses. The development of the various forms of remote working point exactly in that direction.  

by Brunello Rosa

30 March 2020

In our column of March 16th, titled “The World Is Likely To Be Radically Different After The Coronavirus Crisis” we mentioned that the Coronavirus is posing an existential threat to the survival of the EU. In this column, we want to further elaborate on this issue, following the EU Council meeting on March 26, in which the heads of state and governments failed to reach a deal for a common strategy to fight the crisis.

The underlying principle behind the EU integration process is the solidarity that member states should display towards one another on all matters of common interest, after centuries of inter-European conflict. For this reason, the first embryo of the EU was the European Coal and Steel Community, coal and steel representing the key ingredients for the economic recovery in the post-War period. Once solidarity ceases to exist, there is no reason for the Union to exist either. In spite of the initial, delusional hope that COVID-19 was an asymmetric shock to Italy rather than a generalized crisis across the region, and could therefore be addressed by the activation of article 122.2 of the EU Treaty (i.e. grants to the country “seriously threatened with severe difficulties caused by … exceptional circumstances beyond its control”), it is now clear that is a symmetric shock to every country of the EU. 

This means that the EU as a whole should react to it, with common instruments, rather than by simply adopting a coordinated approach of national policies by individual member states. Instead, so far national selfishness has prevailed, and countries have reacted by adopting a series of policies based on their individual circumstances. For example, at the fiscal level, Germany has announced a plan of EUR 550bn of fiscal easing (of which EUR 156 will be fresh expenditures), France a EUR 300bn plan, and Italy, given its more stringent budget constraints, only a first EUR 25bn plan followed by another EUR 25bn likely to be announced in April. Virtually all countries have re-instated national borders and suspended the Schengen agreement.

At the EU level, there has thus far been only a partial and temporary suspension of the Growth and Stability Pact (GSP) and an easing of the discipline regarding state aid to private-sector companies. Even the ECB was initially reluctant to engage in its mandatory spread-compression activities, until finally the EUR 750bn PEPP was launched, with the inclusion of Greece and the suspension of the issuer limits. But this is still too little compared to what the EU could and should do to face the existential crisis before it. 

With Brexit underway, and the UK initially threatening to deviate from the continental practices of social distancing to follow a chimeric and flawed herd immunity approach; with Schengen and the GSP suspended; with every country following its own approach to COVID, from para-military lockdowns (in Italy, for example) to minimal social distancing rules (e.g. in Sweden), the risk is that re-converging when the crisis is finished will become virtually impossible, as every country will find it more convenient to pursue its national strategies and interests. A country might, for example, bitterly and understandably decline to pursue European reintegration because it felt that it was neglected during the crisis.

Take Italy, for example. In 2011-12 Italy was brought to the verge of default because of the slow and flawed response (by moral hazard considerations) from the EU/EZ to the Greek crisis. Italy, which participated in the rescue packages for Greece, Ireland, Portugal and Spain, came under speculative attack because it was perceived as being part of the PIIGS grouping of economies. Only Draghi’s “whatever it takes” pledge and the consequent OMT avoided the disaster. In 2015, during the migrant crisis, Italy was then left alone facing the arrival of ships landing on the southern shores of Europe. In 2020, after the symmetric exogenous shock deriving from COVID, the implicit message from the EU was: “deal with it by yourself, we’ll be lenient on your fiscal position, ex-post.” It is not clear where solidarity is in all this, and we should not be surprised if, at the end of the crisis, the levels of EU-scepticism will be at historical highs. Other countries are in similar positions, and if the EU fails to rise to the historical task it is now facing, it might end up being the largest, institutional victim of Coronavirus. 

So, while Merkel and Von Der Leyen declared their opposition to Eurobonds/Coronabonds being used  to finance a pan-European recovery plan, the Eurogroup has been tasked with coming up with technical proposal on the feasibility of risk-sharing instruments. Hopefully, it will come up with some serious proposals in the next couple of weeks, and these approaches will be adopted by the EU Council. But other roads are possible, such as the possibility of activating ESM loans with virtually zero interest rates and null or very limited conditionality. That, in turn, could open up the possibility of using the OMT to fight unwarranted widening of sovereign yield spreads within the EZ. 

by Brunello Rosa

23 March 2020

We have discussed Coronavirus in a series of columns in our weekly Viewsletter this year. Discussing the virus is inevitable, considering the importance the COVID-19 will have on all aspects of life for a large part of the world population – with its health, economic conditions and financial repercussions. Our first column on COVID dates from February 3rd, when China was starting to impose some of its most draconian measures while all other countries were ignoring the risk or happily living in denial. On that occasion we warned that “Coronavirus Poses a Downside Risk To The Global Economy.”

One month later, on March 2nd, we commented on how financial markets had finally caught up with reality of the virus, saying that markets “Belatedly Correct on Coronavirus Concerns.” The week after that, we discussed how central banks had tried to come to the rescue with more of the same “medicine” (i.e. rate cuts and a limited increase in asset purchases). Finally, last week, we took a longer-term view that the world will look radically different a year from now. 

This week, we are discussing how central banks and governments have finally realised the magnitude of the shock and the therapy needed to mitigate its impact. As we discussed in Part 1 of our Global Outlook Update, we now expect the global economy to experience a global recession in 2020, as our baseline scenario. In downside scenarios, the economic contraction could be much more pronounced and prolonged. As most countries are now realizing what was, in our opinion, self-evident, namely  that Italy has simply been a leading indicator of what could happen if they do not contain the spreading of the virus early on, the policy decisions deriving from this “epiphany” are now finally starting to appear on the horizon.

As we discuss in Part 2 of the Global Outlook Update, most countries are now adopting monetary and fiscal expansion measures to limit the damage to the economy deriving from the draconian measures adopted to contain the virus. These draconian measures which include the partial or total lockdown of the country, suspension of all international travel, re-instatement of borders, even within the EU with the suspension of Schengen, etc. In the US, the Fed has brought its policy rate to zero and re-started QE, and the government has presented to the Senate a USD 1.6tn fiscal easing package, potentially including forms of cash directly sent to households. The UK government has announced a GBP 330bn fiscal easing package, while the BOE slashed rates to virtually zero and re-started QE. In France, President Macron has announced a EUR 300bn fiscal package, while Germany has finally thrown its ridiculous “schwarz null” policy out of the window and pledged EUR 550bn of fiscal stimulus (including loans and credit guarantees), of which EUR 156bn will be fresh money expenditures. The ECB, following the initial mishap by President Lagarde, has staged its “Whatever it Takes – 2” moment, launching its new PEPP plan of EUR 750bn of asset purchases. 

The next stage in this process is increased coordination between the monetary and fiscal responses, both of which are needed for the overall response to the crisis to be effective. This will likely translate into forms of direct or indirect debt and deficit monetisation, which has been variously labelled as People’s QE, MMT or helicopter drops of money. It is with some relief that we finally see these “helicopters” taking off to fight the effects of COVID on the economy and financial markets.

by Brunello Rosa

16 March 2020

Now that the new Coronavirus (COVID-19) has officially been declared a pandemic by the WHO, an increasing number of countries are adopting measures to counter its spreading. Financial markets have collapsed as a result; it is clear that we are facing a serious health, economic and financial crisis. This is likely to be more serious than that in 2008-09, which was a banking, demand, and confidence crisis. This is a demand, supply, and confidence crisis, in which banks have not yet played a major role. In 2008-09 there was the element of uncertainty as to how low housing and asset prices would fall before finding a floor. Today, in contrast, there is a much larger element of uncertainty: How long will this crisis last? 

In fact, the re-opening of economies even after the number of new cases is dropped to zero will remain gradual at best. Until a vaccine becomes available, the virus can always come back and force the authorities to close their economies all over again to stop the contagion. So, let us make the assumption that not until 12-18 months from now, if a vaccine then becomes available to everybody, will the end of the health emergency occur. For the sake of the argument, let us assume that we will be able to expedite the production of a vaccine to only 12 months from now. The world would then be in some form of emergency until Q1 2021.

What will the world be like that will emerge from this crisis? We believe that the world in 2021 will be radically different from that which exists today.

In China , there will be two opposing forces. On the one hand, there will be the conviction that the regime was able to contain the virus in three months of very hard work, which in turn gave much of the rest of the world the template to use when attempting to contain the virus themselves. The regime could use this to strengthen its grip on society, and on any form of dissent, or against any emerging appreciation for Western values such as “privacy”. On the other hand, the regime will at the same time be blamed for hiding the real nature of this pandemic for too long, causing the damage at global level that now plainly exists. Chinese society might also have to rethink some of its millennial traditions (including food and hygienic standards) that make China the origin of virtually every new flu strain. Overall, we believe China will come out stronger and even more modernised from this experience, even if its regime might need to make further strides to regain legitimacy and trust among the wider populace. 

On the other side of the Pacific, there is the US, where the political leadership is held by a person, President Trump, who embodies of the polar-opposite attitude that led the Chinese to a rapid victory against the virus: indecisiveness, mis-representation of facts, open criticism of scientifically-proven theories in favour of his gut feelings, under-reaction followed by over-reactions.  There is enough to make many people re-think the idea that a large and complex country like the US can be governed by virtually anybody so long as the “deep state” and its institutions are alive and well. Given its initial mistakes, the US will take much longer to rein in the disease. Perhaps the worst economic impact will be felt just before the November election, and therefore COVID could easily cost Trump the re-election. But the country will be shaken in its preference for relatively low personal and corporation tax levels at the cost of many public goods such as a universal healthcare system and good-quality education. The US has lost its supremacy in many domains versus China; this crisis will further shake its position as the world’s leading country.

In between these two countries, there is the EU, which will face its most serious existential crisis since its foundation. The uncoordinated health and fiscal response to the virus, plus the arbitrary and unilateral closures of the borders (i.e. suspending the Schengen agreement) have, once again, shown the fragility of the European construct and the possibility of its collapse. The only truly pan-European institution has missed this opportunity to show leadership, as it did during its previous existential crisis, the Euro crisis, in 2012. The package of measures adopted last week was borderline adequate given the stage of the threat, considering that the package could be further expanded in coming months. But the ECB cannot afford mishaps such as that which was made by President Lagarde, when she said that “it’s not the ECB’s job to close the spreads within the EZ sovereign bond yields.” In the absence of Eurobonds or EZ safe assets, it is precisely the ECB’s job to ensure that the spreads remain compressed, in order to ensure the smooth transmission of monetary policy. Additionally, the ECB has a facility (OMT) specifically designed to close widening spreads unwarranted by market fundamentals. In addition, because most countries will move into forms of fiscal-monetary coordination, the EU, with its 27 fiscal regimes and several central banks, will have much harder time than the ECB would at implementing a similarly coordinated response to the crisis. 

In conclusion, we believe that all the three main areas of the world will face serious crises of political legitimacy and, in the case of the EU, existential threats. Other countries and regimes will equally come under severe stress and could collapse as a result of this crisis. The rankings of countries at the global level will change drastically after this crisis, in many dimensions. We should prepare to see debt/GDP ratios approaching 150-200%, as often occurs during wartime. Global supply chains will be further disrupted; the tendency towards de-globalisation will be reinforced. Returning to the “new normal” will be another enormous task of world leaders in 2021; at least, for those leaders who will have politically survived.   

by Brunello Rosa

9 March 2020

The latest news from the COVID-19 front is a mixed bag. In China, following the draconian measures of containment the country adopted during the last few weeks, the official number of new cases is close to zero. A number of existing cases still need to be resolved, but there are not new infections occurring that would aggravate the situation. In the rest of the world, however, the situation is starting to become increasingly bad. In Italy, which has been the country with the second highest number fatalities (almost 370), the daily percentage increase of new cases is still around 20-25%, which means that the number of reported cases doubles every 4-5 days. Thus the diffusion of the infection is still in its exponential phase. And the number of cases is increasing in other countries too, including Germany and the UK and, of course, the US. 

Albeit slowly, authorities in Germany, the UKand at EU level are awakening to the fact that COVID-19 is not going to remain a phenomenon limited to Italy, a conviction some European leaders have deluded themselves with for too long. This means that, in time, a larger response will be put in place. In the US, it seems that we are still in the delusional phase in which COVID-19 will remain primarily limited to China and Europe, with only a limited spread in the US. The response has therefore been limited and insufficient so far. The number of swab tests being carried out is still ridiculously low, and the official number of infected people is being kept artificially low by the fact that they are not being detected. 

But the story of this virus always shows the same news cycle. 

Initially, politicians delude themselves that the problem will remain limited to other countries. As soon as the first person dies in that country as a result of COVID-19, this delusion is no longer tenable, and so the initial timid admission and response occurs. When the number of deaths increases, one can easily infer the total number of infected people by knowing that the mortality rate at global level is around 3.4%. When the number of cases reaches the thousands, the response then becomes forceful. In Italy, the entire region of Lombardy has been quarantined, as have other provinces from neighbouring regions: people cannot get in or out. 

As the disease spreads, the economic damage worsens. In our upcoming updated outlook, we will show how we expect global growth to be closer to 2% in 2020 than 3%. This means that in some countries, such as Italy and Japan, there will be a recession this year. Other countries could be equally badly affected – Germany might also fall into a recession, and US growth is likely to be around half of what was expected back in December. To prevent the economic downturn from becoming too large, policy makers are coming to the rescue. Fiscal authorities are trying to design targeted relief plans, in particular to support solvent but illiquid small and medium sized enterprises. 

Central banks can also act faster to support market sentiment. A number of them have cut rates in the last few days: the Federal Reserve by 50bps to 1.00-1.25% (intra-meeting), the RBA by 25bps to 0.50%, the BoC by 50bps to 1.25%. Elsewhere, the central banks of Hong Kong and Malaysia cut their interest rates by 50bps (to 1.50%) and by 25bps (to 2.50%), respectively. These interventions are necessary to support market sentiment but will do little to solve the problem generally. The market understands all this, and therefore the selloff in equities continues. Equities will continue to adjust until market participants believe that the virus has been successfully contained at the global level. Even in the best-case scenario, this could take at least a couple of quarters. If the US delays its response to the virus in order to keep the economy strong during an electoral year, the process will be severely delayed, with the result being that immense damage to global health and economic activity could ensue.  

by Brunello Rosa

17 February 2020

During the weekend, the annual Munich Security Conference was held in the capital of Bavaria, Germany’s richest state. Media outlets extensively reported on the key proceedings of the conference, which this year focused on the concept of “Westlessness”; i.e., on whether the world has become less Western. This is a concept they also studied in depth in their annual report. As long as the “West” is defined by the alliance between North America and Europe, along with the key additions of Australia and New Zealand (part of the so-called Five Eyes), clearly the last few years have observed a marked deterioration in this relationship, and in particular of NATO, the military alliance underpinning it. 

US Secretary of State Mike Pompeo came to Munich to reassure those present that NATO is alive and well, and that it is ready to deploy its benefits to its constituent countries. Pompeo specifically said that he was “happy to report that the death of the transatlantic alliance is grossly exaggerated. The West is winning, and we’re winning together.” However, only in November 2019, Pompeo himself warned that NATO was risking extinction unless it adapted itself to reality. This happened at the same time as French President Emmanuel Macron was reported as saying that NATO was brain-dead. So, what’s the current state of the transatlantic alliance, in reality?

It is true that NATO is still alive, but its cohesion has been severely tested recently. Trump has just approved a series of tariffs on the Europeans, following the WTO ruling on EU’s aid to Airbus in that company’s long dispute with Boeing. (Italy, which does not belong to the Airbus consortium, got exempted from these tariffs, thanks to their own successful bilateral negotiations). Other tariffs aimed at the auto sector are also being considered by the Trump administration at the moment, after being delayed by six months in May 2019. 

In a few months, when the WTO will likely rule in favour of Airbus and the Europeans will be able to impose retaliatory tariffs on the US, we might be at the beginning of another tit-for-tat trade war, similar to that we have been observing between US and China in the last three years. 

Within Europe, the situation is, at best, fluid. The UK has just left the EU, imposing a severe level of damage onto the geopolitical standing of the continental bloc, as discussed by John Hulsman in his recent analysis. PM Johnson is now mostly committed to establish his leadership within Whitehall, as the recent reshuffling of his government proves. What is left of the EU is in flux. In Germany, the decision by Annegret Kramp Karrembauer not to run for Chancellor at the next federal election has completely ruined Angela Merkel’s succession plans. As we discussed in our analysis of the German political scene, under certain circumstances, this might eventually lead to a desirable outcome, for example a Green-Black coalition. On the other hand, it might make Germany even more inward-looking and undecided as to how to exert its leadership on the continent. And Germany is absolutely needed by French President Macron if he wants any of his grandiose plans for the future of Europe to ever become a reality. As we discussed in our recent trip report, both the social and political opposition to Macron are weak or weakening, paving the way to his re-election in 2022 (bar a global economic crisis occurring in the meantime). But without its German dance partner, there is very little France will be able to do. 

So, the West might be still in the position of taking on China, weakened by the impact that the Coronavirus might have on the Chinese economy and on the legitimacy of its regime. But the West needs to find a new sense of unity if it wants to win the battle for the geo-strategic hegemony of the future. At a time when China is trying to reach out to the Europeans, to convince them to break ranks with their historical US ally, and with Trump not hiding his distaste for the EU concept, this might be easier said than done.

by Brunello Rosa

10 February 2020

Two crucial regional elections took place in Italy a couple of weeks ago, one in Emilia-Romagna (in northern Italy) and the other in Calabria (in southern Italy). Lega’s leader Matteo Salvini greatly increased the significance of the election in Emilia-Romagna, a region that has been a stronghold of the Democratic Party (PD), making the election appear, in effect, as a referendum on the government. As we discussed in our in-depth analysis following the election, if Lega’s candidate Lucia Borgonzoni had won with a relatively ample margin, this could have led to the resignation of Nicola Zingaretti from the leadership of the PD. Since Di Maio had already resigned from his national leadership role in the Five Star Movement, a resignation by Zingaretti could have led to the collapse of the government altogether. Since Borgonzoni did not win, however, and since her opponent, the incumbent leader Stefano Bonaccini, won with a 7-point difference in the regional election, this scenario did not happen. So, Giuseppe Conte and his government could relax for the moment. Still, this respite might prove short-lived. 

In fact, theoretically speaking, if the governing coalition manages to survive the additional round of elections in May/June 2020, the possibility for this parliament to last until 2022 (after the election of the new president), could be quite high, either with the current governing coalition or with a slightly different one. Elections in 2020 would become extremely unlikely and, if the coalition were to stick together for six more months from January to June 2021, then in September President Mattarella would lose his power to dissolve parliament. Thus the only theoretical window for an election would be between March and June 2021. 

In reality, things might prove more complicated than this. Matteo Renzi is restless in his attempt to force a change of the Prime Minister, and is now using a parliamentary battle over the reform to the statute of limitations in criminal trials to re-launch his assault. An already fragile majority is vulnerable to defections in parliament, and the possible support from MPs from other parties (for example, from Forza Italia), would not be reassuring for PM Giuseppe Conte. He could become hostage to all sorts of vetoes. If MPs from a new party were to vote in favour of the government in a confidence vote, President Mattarella might call Conte for an update on parliamentary developments, and send him back to the Chambers for a new confidence vote, to re-assess the “perimeter” of the coalition supporting the government. The reality is that the Italian government remains fragile, and could collapse as a result of a parliamentary incident at any time.  

What is the centre-right doing during all this? Salvini’s Lega continues to poll above 30%, and Meloni’s Fratelli D’Italia has now reached 10% in the polls, well ahead of Berlusconi’s Forza Italia, which now struggles to get to 6%. Altogether, the centre-right coalition polls around 50%. Salvini’s popularity remains very high, but not as high as it was previously. The belief in his infallibility has been now severely hit by two consecutive mistakes: his decision to make the Conte-1 government collapse in August 2019, and his decision to transform the regional election in Emilia-Romagna into a referendum on the government. He will soon face a vote in the Senate, which will decide whether or not he will have to stand a trial for “kidnapping” the migrants of the Gregoretti ship. And he will probably lose the constitutional referendum over making a cut to the number of MPs, which will take place in March. Investigations into “Moscow-gate” are continuing, meanwhile. 

Can Salvini stage a comeback through all this, and so ascend to power in the coming months or years? Theoretically speaking, yes, he can, especially if the governing coalition proves incapable of sticking together. Polls suggest that Italians still seem inclined to give Salvini a chance to prove himself as PM. But the biggest obstacle to his final ascent to power is… himself. The recent re-organisation of Salvini’s party shows that he might have understood the underlying problem that has led him to all the mistakes mentioned above. During his period in government, when he was gaining popularity, he managed to antagonise the US allies (his trip to Washington was reportedly a disaster), the Europeans (his preferred target), the Chinese (by not signing the MoU on the silk-road) and the Russians (with Moscow-gate). In addition, he antagonised the vast majority of the global economic and financial establishment, which fears a breakup of the Eurozone following a potential decision by Italy, led by Salvini, to leave the euro area. It will take time for Salvini to gain credibility within all these powerful circles. 

So, somewhat ironically, the centre-right led by Salvini needs time to become a credible governing coalition. And the centre-left hopes to stay in power for as long as possible. These two converging tendencies might keep this parliament alive for longer than is currently believed, even if it remains true that an accident could occur that would bring down the government at any time.    

by Brunello Rosa

3 February 2020

In the last couple of weeks, the world has witnessed the outbreak of the Coronavirus (2019-nCov) infection, and its global diffusion. According to the most recent statistics, there are 14,500 people reported as infected in Asia, more than 9000 of whom are in China. The virus has been detected in at least 24 countries. Even then, it is likely that the number of infected people has been under-reported. So far, 305 people have died, with the first victim reported being located outside of China, in the Philippines. 

It is understood that the virus originated in Wuhan, a city of 11 million people in central China. It was initially reported that the origin of the virus was the seafood and poultry market in Wuhan. However, the origin remains disputed. A study published on Lancet says that the Wuhan market might not be the origin of the virus. According to some theories (bordering on conspiracy theories), the virus might have originated from a biosafety laboratory – also based in Wuhan – housing some of the world's most deadly illnesses. The lab, opened after the outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003, is used to study class four pathogens (P4), referring to the most virulent viruses which pose a high risk of “aerosol-transmitted person-to-person infections,” according to a press release. It is possible that we will not be able to establish for certain the origin of this virus, but we cannot exclude a-priori that the virus originated from lab experiments. 

Plenty of comparisons have been made with the SARS episode, which in 2002-03 infected more than 8,000 people, killing around 700 of them. Some studies have also analysed the economic costs of SARS (estimated to be around USD 13bn). According to initial statistics conducted on the first 99 patients at a hospital in Wuhan, the Coronavirus has a case-fatality rate (the percent of deaths among those infected) of 11%. Initial estimates show that the virus has an R0 of 2.2, meaning each case patient could infect more than 2 other people. If those statistic prove accurate, this virus would be more infectious than the 1918 “Spanish-Flu” pandemic virus, which had an R0 of 1.80. 

Based on current statistics, Coronavirus is definitely more infectious and deadly than SARS, and possibly also than the Spanish Flu of 1918-19, which infected more than half a billion people and killed an estimated 20-50 million (statistics were not very accurate in that case, in part because of World War I). At the same time, to most people’s surprise, the Coronavirus is less severe than the usual seasonal flu. Just to give an example, seasonal influenza epidemics cause 3 to 5 million severe cases and kill up to 650,000 people every year, according to the World Health Organization. So far in this season, there have been an estimated 19 million cases of flu, 180,000 hospitalizations and 10,000 deaths in the US alone, according to the Centers for Disease Control and Prevention.

So, what is making the Coronavirus so special, and worthy of attention, to the point that every major central banker (e.g. Fed’s Powell, BoE’s Carney and ECB’s Lagarde) had to answer a question about its impact? The point is that the panic that the outbreak has created, and the defensive reactions to it, might be causing quite a severe level of damage to the global economy (even if perhaps only temporarily, in which case the losses might be mostly recouped in the following quarters). A number of airline companies have completely interrupted all of their flights in an out from China; British Airways, which has cancelled every flight until March, being only a very notable example of this. Most importantly, the US has barred entrance to any foreigner travelling from mainland China. A number of other countries, such as Australia, have followed the US’ example. China has reacted with anger to the measures adopted by the US and other countries. China risks being isolated by the rest of the world, a position that is politically and economically difficult for Beijing to tolerate, especially as the trade and tech negotiations with the US are still ongoing, following the Phase-1 deal between the two countries.

So, more than the virus per se, it is the various countries’ reactions to the virus which pose serious downside risks to the global economy. Indeed, the global economy risks another year of stagnation, following a disappointing 2019. If that happens, central banks and fiscal authorities will likely have to do their part to support aggregate demand in the various countries directly or indirectly hit by the outbreak.  

by Brunello Rosa

27 January 2020

We have discussed several times the importance of climate change and the repercussions it may have for the economies of various countries and the global geopolitical order as a whole. Among other things, climate change causes increased desertification in areas such as Sub-Saharan Africa, the Middle East and Latin America, inducing millions of people to migrate in search for a chance to live. This in turn has helped lead to the rise of populist leaders trying to block the arrival of undesired migrants. Lately, the devastating fires in Australia show what an extraordinarily hot summer can mean for the environment, here and now, not just in some distant future. 

More recently, climate change has risen to the top of the agenda for institutions that were previously considered quite removed from this issue, such as the International Monetary Fund with the arrival of Kristalina Georgieva at its helm, the European Commission with Ursula Von der Leyen’s “Green Deal”, and central banks, with Christine Lagarde’s ECB and Mark Carney’s Bank of England leading the way. Not surprisingly, this issue were given high priority at this year’s meetings in Davos, even if it still remains unclear how and when governments and multinationals will finally decide to seriously tackle this crucial issue. Many hopes now rest on the result of the COP26 Conference in Glasgow, to be held at the end of this year. But the experience with previous COP conferences suggests that there is a need to keep expectations at a realistic level. 

In any case, it is extremely important that the level of awareness of the climate issue has finally increased, and that climate change now features very high in the agenda of policy makers.   

The European Union has decided to become a world leader in this regard, and to shape a large component of its future choices on environmental sustainability. The “Green Deal” recently launched has the potential to unlock up to EUR 1tn of public and private investments, generating hundreds of thousands of job opportunities. The Bank of England has already asked financial institutions to stress-test their resilience to climate change, considering that (as the BIS recently stated) climate change could be a cause of financial instability, if a “green swan” materialises. 

Among the various initiatives mentioned during her latest press conference, Christine Lagarde said that the ECB will make sure that its corporate bond portfolio will be designed to incentivise environmental sustainability. In Germany, the rise of the Green Party in opinion polls is constant, and in Austria the Greens joined the new conservative government formed by Sebastian Kurz.

While the US seems still to be missing in action, the key risk identified by some is the so-called “greenwashing” process, whereby anything that seems socially acceptable or politically advantageous is promoted as being a “green” initiative. Some key policy figures, such as Bundesbank President Jen Weidmann, recently made the point that central banks cannot replace good environmental policies decided by democratically elected political leaders. Others fear that good old-fashioned counter-cyclical fiscal stimulus might be masked by “green investment” to stimulate aggregate demand, thus producing good results in the short run, but no effects in the future.

As it often happens, “in medio stat virtus”. Climate change will need to be front and centre of policy makers’ agendas. But abusing the term for marketing reasons might eventually damage the cause rather than support it.    

By Brunello Rosa

23 December 2019  

Last week we published our Global Outlook and Strategic Asset Allocation for 2020. We discussed our growth, inflation, policy and market forecasts for the year that is about to begin, with baseline, downside and upside scenarios. We also discussed the main macroeconomic and market themes for 2020, with their implications for market and asset allocation. 

In our global overview, we mentioned how 2019 was characterised by a synchronized global economic slowdown, but with a strong rally of risky assets, such as US and global equities. The slowdown was driven by a number of geopolitical risks, such as the escalating trade and tech war between the US and China, the risks of a hard Brexit, and increasing tensions in the Middle East. These helped lead to a recession in the manufacturing sector. Now, in our baseline scenario for 2020, we expect this slowdown and stagnation of the major developed market economies to continue. We are less convinced however by the global reflation story that other research houses, especially in the sell-side of the financial industry, are pushing these days. 

Equally, we consider a global recession in 2020 to be a risk scenario, at this stage. In a series of articles published in the second half of 2018 we discussed the possibility of a severe market correction and a global recession occurring as early as in 2020, and we outlined the ten factors that could lead to such an outcome. At the same time, in a more in-depth analysis, we discussed the ten reasons why a milder scenario could materialise, in spite of those threats. 

Chief among these ten reasons were an accommodation in the global monetary policy stance and a containment of the geopolitical risks, both of which have occurred since then, thereby reducing the probability of a global recession in 2020. Nevertheless, geopolitical and domestic political tensions, an increase in trade wars, disruption of global supply chains, tighter financial conditions, and market valuations disconnected from underlying macro fundamentals could still cause sudden market corrections: investors need to remain aware of these risks in the year ahead. 

Given this background, the current environment calls for a moderately ‘risk-on’ position in 2020. There is a high probability that trade and political tensions will de-escalate. A more balanced policy mix is expected to emerge. Variants of “helicopter money” policies could eventually be introduced when the next economic recession and severe market downturn finally occur. From an asset allocation perspective, over the next few years, the investment environment remains challenging, because central bank liquidity and geopolitical risks are likely to matter more than fundamentals and market volatility is likely to rise, hampering portfolio performances and increasing the likelihood of corrections and, eventually, bear markets. As a result, “expected returns” are likely to be lower than in the pre-2008 crisis period. Investors, over a multi-year horizon, will therefore have to accept lower expected returns in exchange for lower volatility, and while riding the liquidity wave remain aware of the risks mentioned above.    

By Brunello Rosa

16 December 2019  

As we discussed in our in-depth analysis, the UK general election resulted in a historic victory for the Tory Party, which will now gain the largest parliamentary majority of any British government since 1987, under PM Thatcher. It was also the worst electoral defeat for the Labour Party since 1935. The Conservatives gained 48 seats (for a total of 365) compared to their performance in the 2017 general election.  The Scottish National Party gained 13 seats (for a total of 48), while Labour lost 59 seats (bringing it down to 202) and the Liberal Democrats lost 1 (it now has 11). Still, the Conservative victory was unquestionable only in England, where Labour now remains strong only in urban areas. Regional parties won their respective nations: Plaid Cymru in Wales, Sinn Fein and DUP in Northern Ireland, and especially the SNP in Scotland. 

As of now, we believe that the main political consequences of the vote will be the following: (1) Boris Johnson remains prime minister and, as discussed below, will carry on with his Brexit plan; (2) Jeremy Corbyn, who already said that he will not lead the Labour party at the next general election, will likely resign from his position as party leader in the next few weeks; Labour will now face a harsh leadership contest between the so-called “True Corbynistas”, such as Rebecca Long-Bailey, currently the shadow business secretary, and moderate left-wing figures such as Keir Starmer, the shadow Brexit secretary. If the party does not want to disappear, it will likely shift back to the centre in coming years, following the disastrous results of Corbyn’s attempt to bring Marxism back into the UK political system; (3) Jo Swinson, the Lib-Dem leader who lost her seat in favour of a SNP MP, will also likely resign her position as party leader in the next few days. She carries the responsibility for having forced Labour to accept this snap election that has led to the largest Tory victory in recent history; (4) Nicola Sturgeon, whose SNP party has won 48 out of the 59 seats in Scotland, will press further for a second referendum on Scottish independence.

At this point, Brexit will happen for certain, most likely by January 31st, as is currently planned. This does not automatically mean the end of the Brexit uncertainty. Boris Johnson has promised to conclude a trade deal with the EU by 31 December 2020, a virtually impossible task unless by reaching a deal he means merely an agreement in principle, or only a sort of UK version of the “Phase-1 deal” from the US-China trade dispute. A renewed phase of uncertainty might therefore occur towards the end of the year, when a no-deal Brexit could once again become a possibility if the transition period is not postponed to 2022. The decision must be made by 30 June 2020, and given the ample majority that will now exist in parliament, and the government’s strong negotiating position deriving from the large popular mandate the election has given it, it is unlikely as of now that Johnson will request such an extension in the summer. 

Most importantly, if Johnson’s deal is finally approved by parliament, Northern Ireland will become a very special zone. It will be part of both the UK and the EU customs unions, a privileged position that Scotland especially would aspire to have. As in the case of Spain, where the Catalans ask to have the same privileges of the Basque Country in return for giving up their quest for independence, Scotland will probably ask to obtain the same status as Northern Ireland in return for giving up its intention to ask for a second independence referendum. 

To conclude, while this election has removed some of the Brexit-related uncertainty and all of the Corbyn-related fears, the road ahead for the UK remains bumpy and winding. For this reason, it is likely that fiscal policy will be more growth-friendly, and monetary policy will remain supportive. As such, the election-induced GBP rally might prove to be more short-lived than is currently thought.     

By Brunello Rosa

9 December 2019  

After a few weeks during which G10 central banks did not make any major decisions, in December nearly all ten of them will hold their policy meetings. Last week, the boards of both the Bank of Canada (BoC) and the Reserve Bank of Australia (RBA) met to decide the course of their respective monetary policies for the coming months. The BoC left its policy rate unchanged at 1.75%, as had been expected it would. It is the highest such rate among the G10 countries. The BoC’s position is, broadly speaking, “neutral”: the Bank’s statement did not express any particular bias towards either raising rates further or cutting them in the near term. The Bank can enjoy Canada’s inflation being on target and growth being not too distant from its potential level, and so can afford to wait longer before deciding what to do. Clearly, the most relevant factor will be the outcome of the trade negotiations between China and US, given that the Canadian economy is highly dependent on both those economies. It will also depend on oil prices, which tend to move in tandem with global growth. 

If the US and China manage to agree to at least the Phase-1 deal (as we expect they will), the Bank of Canada will be able to stay on hold for longer, hoping that a pickup in global growth does not  eventually lead to cutting its policy rates. 

On the other side of the world, in Australia, the RBA also kept its rate unchanged at 0.75%, but in this case after having already cut rates three times this year, for a cumulative amount of 75bps. Like Canada, the Australian economy is highly dependent on the US, China, global growth and the commodity cycle, which is why the RBA has already also started to explore which unconventional measures it might use if and when its policy rate reaches the effective lower bound of 0.25%. Governor Lowe said that the RBA would be ready to start a QE program of purchases of sovereign bonds in case extra easing is needed, also thanks the additional supply of bonds deriving from the expected fiscal stimulus. So, while the BoC’s position was effectively neutral, in the case of the RBA we can see there exists a clear easing bias. 

In the week ahead, the two largest central banks will meet: the Fed and the ECB. As we will discuss in our forthcoming preview, the Fed, which has officially declared itself to be “on pause”, will have to calibrate this message in order not to be pushed around further by President Trump during the coming election year, Trump wanting rates to be cut even more. The ECB’s job is equally challenging. Its policy stance is currently on some sort of auto pilot: open-ended QE, full reinvestment of proceeds, easing bias on rates, and reserve tiering for core-EZ banks and TLTROIII for periphery-EZ banks. But the arrival of a new president at the helm of the institution – namely, Lagarde replacing Draghi – marks the beginning of a transition period that could last a few months. The announced review of policy strategy is a double-edged sword. On the one hand, Lagarde my end up taking ownership of the current policy stance; on the other hand, the review could be the beginning of a reversal of some policy tools. Also this week, the central bank of Switzerland (the SNB) will meet, but as we will discuss in our forthcoming preview we do not expect major changes in its policy stance to be made. 

The following week, on Thursday, there will be a number of important central bank meetings: the BoJ, the BoE, Norway’s Norges Bank and Sweden’s Riksbank. The BoE is unlikely to do anything just a week after the general election: it remains to be seen whether the dissenters within the Monetary Policy Commitee will keep or change their vote to “no change”. Norges Bank has already reached “pause” levels, and we do not expect them to do anything at this meeting. More interesting will be to see what the BoJ will do, since the government has finally launched a supplementary budget  (which includes a larger-than-expected USD 121bn stimulus package), as the Bank had been clearly demanding it do. Finally, and perhaps surprisingly, the Riksbank is likely to increase its policy rate, as we mentioned in our latest review. It may take its repo rate from -0.25 percent to zero, before entering what will likely be a long period of pause.    

By Brunello Rosa

2 December 2019  

Two important events shook Germany’s political landscape this past weekend. On the left, the Social-Democratic Party (SPD) chose the radical couple Norbert Walter-Borjans and Saskia Esken as new co-leaders of the party, instead of finance minister Olaf Scholz and Klara Geywitz who they defeated in the party’s leadership race. Scholz and Geywitz were perceived as champions of the status quo, which basically means the SPD remaining in the grand coalition with Angela Merkel’s CDU. Walter-Borjans and Esken however have proposed a more radical platform, which requires the re-negotiation of the “coalition contract” and foresees the rupture of the grand coalition as a possibility. 

At the opposite side of the political spectrum, Alternative für Deutschland (AfD) chose a relatively moderate (by AfD standards) ticket to lead the party, after the unifying figure of Alexander Gauland decided not to run again for the party’s leadership in order to allow a generational changeover to occur (Gauland is 78 years old). The party, which already holds 94 seats in the German Bundestag (out of 709) and is the third largest party after the CDU and the SPD, chose as co-leaders Tino Chrupalla and Joerg Meuthen. Chrupalla is a legislator from Saxony, who will represent the former communist states of the East where AfD surged in three elections this year. Meuthen is a professor of economics in the industrial south-western state of Baden-Wuerttemberg. Contrary to the SPD’s decision to choose a leadership ticket that may distance itself from Merkel’s CDU, the unusually moderate choice by the AfD was specifically made to allow the AfD to become a potential ally of the CDU, at least at the local and state government levels. 

The selection of these new leaders of the SPD and the AfD occured just over a week after the CDU confirmed Annegret Kramp-Karrenbauer (AKK) as leader of the CDU. Where do these events leave Germany, and what implications might they have for the broader European integration process?

From a domestic standpoint, Germany’s political instability is now clearly on the rise. If the SPD does pull the plug on the government, Merkel might either lead a minority government, or try to strike another coalition deal, or call a snap election. In such an election, the Greens would likely emerge as the first party of the left, which would open up three options (assuming that no party has enough seats to govern alone): 1) A CDU-Green grand coalition, if the CDU emerges as the first party in the election. (But, such an outcome might not be the case if AKK remains as CDU party leader, as she might not be able to guarantee that the CDU will end up as the first party in the election); 2) A new attempt of the Jamaica coalition (CDU-Greens-Liberals); and 3) an alt-left coalition between the Greens, the SPD and the Linke. That is, assuming the three parties together have enough seats, and assuming the Linke compromises on key policies such as Germany’s participation in NATO. In any case, it is clear that the myth of Germany’s political stability is now a relic of the past. 

For the broader European integration process (now that Ursula Von Der Leyen has been confirmed as president of the EU Commission) these political events could be either positive or negative. They might be positive if the ongoing political tsunami in Germany were to bring to power the Greens in a relatively stable coalition (a “grand” coalition with the CDU, a leftist coalition with the SPD and Linke, or the “Jamaican” coalition). The Greens are undoubtedly pro-Europeans even if in favour of fiscal discipline, and are advocates of the “green” new deal that in Europe is likely to become the proxy for much-needed fiscal stimulus. German politics might be negative for European integration, on the other hand,  if the country’s political instability were to lead to a stalemate within its own decision-making process: Germany remains the largest, richest and most influential country in Europe, without which no decisions are made. The events of the next few weeks will determine which of these outcomes will ultimately prevail.    

By Brunello Rosa

28 October 2019  

Argentina and Uruguay went to the polls yesterday to elect new presidents, at the same time as a wave of protests has been hitting Latina America. Argentina elected a Peronist president again: Alberto Fernández, who will have as his Vice President Cristina Fernández de Kirchner, the former president of Argentina from 2007 to 2015. This is coming after the failure of the Macri presidency to implement liberal reforms and bring Argentina back to international capital markets. When Mauricio Macri was elected president of Argentina in 2015, his campaign was based on the motto “Argentina is open for business.” Macri’s plan was to definitively end the preceding Peronist era, in which Argentina had experienced a very volatile economic performance, rising public subsidies and inflation, and endless disputes with international investors over bonds restructured after the 2001 default.

Things seemed to be going in the right direction until early 2018, when a drought hit the country and a series of policy mistakes led markets to massively short the peso. The subsequent collapse in economic activity, the rise in inflation (55% y/y, the highest in the world after Venezuela and Zimbabwe) and a shortage of reserves led Macri to go back, cap in hand, to the IMF to ask for a bailout. The IMF granted the bailout: USD 57bn, the largest loan in the IMF’s history. This gave Fernández a formidable argument against Macri in the recent election campaign. He was able to say that the 2018 bailout was brought about by the Macri government’s adoption of the IMF-inspired liberal reforms (just like how the 2001 default was caused in part by the collapse of the “currency board” inspired by the “Chicago school”). In other words, instead of opening the country for business, liberal reforms have led it to default. The obvious conclusion (Fernández’ argument goes) is that only Peronism can work in Argentina. This argument has clearly been accepted by Argentina’s population in 2019. 

At this point, the key question is what type of policies Fernández will adopt once he is elected. As we discussed in our recent in-depth analysis, Fernández is likely to opt for a middle ground between an orthodox approach and a fully populist approach. He knows Argentina needs a constructive dialogue with the IMF, as it will likely need more financial support in coming months. The IMF too knows that a constructive dialogue with Argentina is necessary: having already disbursed USD 44bn, it will need to keep the relationship healthy and intact if it wants to have a chance of seeing this debt repaid at some point.   

Argentina might be a special case, but other LatAm countries are undergoing a difficult transition period as well. As mentioned above, Uruguay also went to the polls yesterday, to elect a successor to President Tabaré Vásquez, who could not run again due to constitutional term limits. Polls were held in the middle of a surge in crime (specifically, of murders and burglaries), which some attribute to the liberalisation of cannabis adopted by the government. Bolivia just had its presidential election, meanwhile, the result of which was that Evo Morales managed to win a second term, which led to disputes about transparency and protests against claims of alleged fraud in the election results. 

Besides the basket case of Venezuela and the yet-to-be-confirmed hopes in AMLO’s Mexico, the two most worrying cases in the region of late are Ecuador and Chile. In Ecuador, protests recently erupted as Lenín Moreno, who in 2017 succeeded Rafael Correa (from the same party), in practice made a U-turn on a number of the government’s previous policies, for example by handing back a US military base that had previously been confisca­ted by Correa, and by steering the country back toward austerity and neoliberal reforms. In Chile, President Sebastian Piñera has reshuffled his entire cabinet as a result of the widespread protests that were triggered by an increase in transportation costs and the more general rise in inequality. 

All this has been occurring while, in Colombia, President Iván Duque Márquez is trying to secure a final peace arrangement with the FARC, and in Brazil President Bolsonaro is passing a controversial pension reform in parliament.  

By Brunello Rosa

21 October 2019  

The IMF/World Bank meetings that just concluded in Washington DC were an occasion for policy makers, market participants, academics and other observers to take stock of the current worldwide macroeconomic, financial and geo-political environment. In its latest edition of the World Economic Outlook, the IMF warned about the synchronised global slowdown now taking place - the opposite of the global synchronised expansion that occurred in 2017-18. The outlook for the global economy has been downgraded, with the forecasts for growth in a number of key economies being revised downwards. The downgrade could have been even larger if it was not for the large positive contribution to growth from countries such as Brazil, Iran and Turkey (whose economy have stabilised after a severe recession). All this is happening at a time when policy makers’ fears of a global recession are increasing.

In this precarious global economic environment, some of the tail risks that could have tipped this global slowdown into a global recession seems have been diminishing in the last few weeks. Just to focus on the four economic collision courses recently identified by Nouriel Roubini, we can say that the risk that such collisions actually materialise is, for the time being, slightly lower than had been the case until recently. In the US-China trade dispute, there now seems to be at least a “Phase 1” agreement, which should be finalised by the APEC meeting in November. If such finalisation does indeed occur, then perhaps the feared increase in tariffs on consumer goods that would have come into effect in mid-December is not going to occur. That would certainly help provide a respite to the global economy. 

Regarding Brexit, it seems that the new deal signed between the UK and the EUlast week should eventually lead - even if only at the end of a tortuous path - to an outcome that does not include a hard Brexit. In the Middle East, the tensions between the US, Saudi Arabia and Iran persist, but seem unlikely to escalate further into an open military confrontation. As the decision to pull out of Syriashows, the US seems inclined to disengage further from the region, rather than engaging in a new conflict that could mean putting US boots on Middle Eastern ground yet again. Thus for now the US seems inclined to resist the temptation to respond to Iranian provocations.   

Finally, as far as Argentina is concerned, it seems that Alberto Fernandez, the Peronist candidate supported by Cristina Kirchner, is aware of the need to constructively engage in a conversation with the IMF, rather than put up a fight which could lead to a nasty outcome for all sides involved. If all four of these tail risks are reduced – US-China negotiations, Brexit, the Middle East, and Argentina – the danger coming from some of these potential triggers of a global recession would be lessened as a result. 

Clearly, if these four fronts become less dangerous, new ones might open up. For example, by November 17th the US administration will have to decide whether or not to start imposing tariffs on the European auto sector. Such tariffs could have a large economic impact on the European economy. For the time being, it seems that the US administration will postpone the decision for a bit longer, as the Chinese front has not closed yet. Germany’s grand coalition could collapse as a result of new local elections or the change of leadership at the helm of the SPD. Older risks could resurface as well, for example if the Italian government were to collapse sooner than expected as a result of the continued tensions within its majority.

Reducing the likelihood of some of these triggers is as important as deploying a policy response to them. In this respect, the Fed and the ECB (and a number of smaller central banks, such as RBA and RBNZ) have started to do their part. More needs to be done, especially in terms of fiscal policy, but at least policy makers are alerted about the need to be vigilant and responsive, even if they are incapable of being proactive. At the same time, the IMF will begin a formal review of the effects of the unconventional monetary measures adopted by several central banks around the world, which hopefully will not lead to a sudden abandonment of such measures. In Europe, the ECB will carry out its own review of strategy, tools and communication, with the arrival of Christine Lagarde at the helm.

Given this background, risk in financial markets seems to be on rather than off. Risky asset prices are still close to their highs, long-term yields are low and credit spreads are tight. The IMF’s Global Financial Stability Report, also published last week, warns about the risks posed by a mounting level of corporate debt of dubious quality. The Financial Stability Board says that it is alerted to this, but is not yet alarmed by it; early in 2020 it will publish a report where is likely to acknowledge this. At the same time, market sentiment remains vulnerable to any swings in economic, geopolitical and policy developments. 

By Brunello Rosa

14 October 2019  

During a week in which the Nobel Peace Prize was granted to Ethiopia’s Prime Minister Abiy Ahmed Ali, for his “efforts to achieve peace and international cooperation, and in particular for his decisive initiative to resolve the border conflict with neighbouring Eritrea," still another new conflict is starting in the Middle East. After Donald Trump’s decision to withdraw US troops from the north-eastern corner of Syria, Turkey decided to occupy a strip of 20km inside that region to create a buffer zone. The occupation has two declared goals: to make it easier for the Turkish army to defend Turkey’s borders, and to relocate to Syria a portion of the 3.6m Syrian refugees currently living in Turkey. 

As part of this offensive (somehow ironically named “Operation Peace Spring”) Turkish troops have launched a series of airstrikes and artillery bombardment against the Syrian Democratic Forces (SDF), forces which have helped the US-led coalition in Syria to fight ISIS, but which Erdoğan considers effectively a terrorist organisation. This is because the SDF are led by the Kurdish People's Protection Units (YPG), which Turkey considers a terrorist group. So, this “Operation Peace Spring” will be directed mainly against the Kurdish ethnic groups, which Erdoğan has long considered a threat to Turkey’s national unity and security. 

The US position on this issue is contradictory at best. The US Department of Defense was reportedly against the abandonment of Northern Syria by US troops, and even Lindsey Graham, an ally of President Trump, said he would seek to introduce a bi-partisan resolution in the US Senate to reverse the decision and punish Turkey, if Turkey decides to attack the SDF. Trump himself, after giving green light to the Turkish invasion of Northern Syria, said that he would “obliterate” the Turkish economy if its actions were to be “off-limits”, or “inhumane.” In a spectacular U-turn, US Secretary of State Mike Pompeo said that the US did not give green light to the Turkish offensive in Syria, even as the official press statement following the phone call between Trump and Erdoğan states that “Turkey will soon be moving forward with its long-planned operation into Northern Syria”. 

Europe’s reaction has, for a change, been to unanimously condemn this brutal military operation. But it has also, as usual, been ineffective. This is because the EU is in no position to tell Erdoğan what to do, after making a treaty with him on 18 March 2016, the result of which has been that the EU has paid Turkey EUR 6bn for two years in return for keeping the Syrian refugees on Turkish territory. Ahead of the renegotiation of this atrocious deal in 2020, Erdoğan is now threatening to open the gates of its refugee camps and flood Europe with migrants, as happened in 2015. Then, Angela Merkel decided to accept 1.1 million refugees in Germany (and, in so doing, marked the beginning of her own political decline) and Italy and Greece also dealt with hundreds of thousands of migrants coming from (or through) the Middle East by land and sea, while Hungary and other countries closed their borders.

If Erdoğan were to do what he is threatening to do – a scenario we do not expect to happen – the EU would not now be able to cope with such a migration crisis the same way it did in 2015. Germany would be unwilling and unable to accept more migrants, since the CDU has been severely punished for that humanitarian decision by Merkel in 2015. Italy, after the “security decrees” by Salvini (which are still active), has closed its ports to the ships rescuing migrants. Greece is now governed by a centre-right government much tougher on migration than Syriza’s far-left positions were. The Viségrad group (Poland, Hungary, Czechia and Slovakia) remains resolutely against any re-distribution of migrants within the EU (even as they continue to collect, financially, the “solidarity contributions” from larger EU countries). The EU Commission is in the middle of a difficult transition from Juncker’s presidency to Von Der Leyen’s, preventing it from making any big decisions. So, another migration crisis would most likely destabilize Europe, sending it close to collapse. A dis-integration of Europe would have large economic, financial and social consequences. 

This means that Erdoğan’s threat is credible. Unfortunately, the likely conclusion to all this is that the EU will renew its deal with Turkey, and receive only a somewhat less “inhumane” war in Northern Syria than would otherwise occur.  

By Brunello Rosa

7 October 2019  

Following a number of warning signals, a European front in the global trade wars has now been opened by the World Trade Organisation (WTO). In a recent ruling on a 15-year old dispute, the WTO ruled that the US is authorised to apply tariffs worth USD 7.5 billion annually on the UK, France, Germany, and Spain (the “Airbus nations”), as well as on the wider EU, as a compensation for the subsidies that the EU has allegedly given to Airbus, providing the company with an unfair advantage against its US rival Boeing. Similarly, in a separate ruling that is expected in the months ahead, the EU is likely to be authorised to impose tariffs (likely billions of dollars worth) on EU imports of US goods, due to the subsidies that the US government has provided to Boeing. This could mark the beginning of a tit-for-tat escalation between the EU and US, which could prove damaging for both sides. 

Ironically, it is the WTO, an international body devoted to the resolution of trade disputes, that is risking opening this new front in the ongoing international trade wars. As discussed in our previous analysis, US President Trump has opened a number of fronts for his country’s trade wars: he began by withdrawing the US from the TPP, then continued with a worldwide tariff increase on steel and aluminium (even imposing such tariffs on its close allies Canada, Europe and Japan, albeit with selective exemptions), then moved to the re-write of NAFTA with Canadaand Mexico, and finally finished in style with China, subjecting it to several rounds of tariff increases as well as technological disputes. When it seemed that on the Chinese front a deal could finally be reached, Trump was ready to wage war to Europe and the European car industry. 

The procrastination of the negotiations with the Chinese therefore meant that this European leg of the dispute has repeatedly been postponed. Now, however, the European front is officially open.     

The list of goods impacted as a result is very large: French wine, Italian cheese and olives, whisky, and cashmere sweaters, among other items. This cannot be good for Europe: its economy is already in stagnation, with some of its largest economies (such as Germanyand Italy) flirting with a recession.  In particular, while Franceand Germany have at least benefited from the positive impact of the aerospace industry to their economies, Italy, which does not belong to the Airbus consortium, would be hit by new tariffs without ever having directly or greatly benefited from the subsidies the company is alleged to have received. 

Neither will the US economy remain immune from the expected counter-ruling by the WTO, nor from any retaliatory tariffs that the EU might decide to implement. The American economy is decelerating as the effects of tax cuts are fading out, and the Fed is not following Trump’s game of forcing the central bank to provide monetary stimulus as an (imperfect) offset of the tariffs on various countries that the US government has imposed.

This new European chapter of the American trade war is unlikely to have a happy ending, especially as the most likely outcome for the US-China front of the trade war is not a fully-fledged deal or a total breakdown in negotiations, but rather a continuation of the “controlled escalation” that has been taking place. Unfortunately, the world economy will have to deal with the effects of these disputes for years to come, forcing policy makers to provide fiscal and monetary stimulus, and keeping markets unnecessarily volatile. 

By Brunello Rosa

2 September 2019 

This week will be a crucial one for determining the fate of governments in Italy and the UK. In Italy, Giuseppe Conte will come back to President Mattarella to announce whether or not he has been able to form a coalition between the Five Star Movement, the Democratic Party, and other smaller parties. As we discussed in our scenario analysis, there are a number of unresolved issues between Five Star and the Democratic Party, including as to what their government’s program and composition would be. Di Maio’s tough speech last Friday(“either the PD accepts these 20 points, or better to vote. And I may add: the sooner, the better”), was widely regarded as an obstacle to eventual solving of the crisis (hence the fall in equity markets and the spike in the BTP/Bund spread). Additionally, there is a Damocles’ sword hanging over the coalition deal; that is, the vote on Five Star’s online platform Rousseau to ratify such a decision. 

Nonetheless, in our baseline scenario, we expect Conte to be able to positively resolve the “reservation” with which he accepted the charge of forming the government. The government would initially be very fragile, as Conte will have a strong political and social opposition to face, as well as a difficult economic condition (GDP contracted in Q2, among other concerns). At the same time, such a government could also count on some powerful allies. The US President openly hoped for Conte to be confirmed as PM. The outgoing European Commission, even with one of its most hawkish representatives (Guenther Oettinger) said it welcomes the possible formation of a pro-European parliament in Italy.  

The new Commission led by Ursula Von Der Leyen made Conte understand that Brussels will close an eye regarding the budget, so long as Italy remains fiscally prudent and moves in the right direction (even if not at the ideal speed). Even the Vatican showed sign of sympathy for the new government, with a short meeting between the Pope and Conte on Friday. So, while the navigation could be bumpy, the government’s ship does not necessarily need to sink if the coalition partners do not fight too much amongst themselves.  

Market concerns are now actually higher for the government in the UK than for Italy, for a change. During the past week PM Boris Johnson obtained from the Queen the possibility to suspend parliamentfor five weeks between September 9th -12th and October 14th, ahead of a new Queen’s speech. As discussed in our analysis, Johnson claims that this is a normal procedure to allow the new government to focus on its new legislative agenda. But the reality is that the decision was made to prevent opponents of Brexit (or at least, opponents of a no-deal Brexit), who are a majority in parliament, to undertake the legislative actions that would prevent a no-deal Brexit from occurring. When parliament reconvenes on September 3rd, after the summer recess, it will now only have 6 days, and even fewer working days, to try and react to this move. 

Though legal challenges have been made against Johnson’s decision, including from the former leader of the Tory party Sir John Major, the possibility that the Labour party will table a no-confidence vote to oust Johnson during this week are much higher now. It is yet to be seen whether this will be a feasible initiative and, if so, whether it will be a successful one. For the time being, markets are skeptical and the pound sterling is reaching all-time lows.  

By Brunello Rosa

27 August 2019  

In spite of the hot weather and the summer holiday season, policy events are in full swing. In the US, the traditional summer meeting of central bankers in Jackson Hole was closely watched, observers attempting to detect signs that would indicate whether the Fed’s insurance cuts could become the beginning of a more prolonged and deeper easing cycle. The words of the Fed’s Chair Jerome Powell were scrutinised, the prevailing impression of them being that Powell remained cautious about providing precise indications as to what the Fed would do in September and beyond. President Trump, considering these words not dovish enough, even asked on Twitter, “who is our bigger enemy, Jay Powell or Chairman Xi?”.  

This question was motivated by the intensification of the trade war between the US and China, with China first announcing tariffs on USD 75bn of imports from the US (itself a retaliation to Trump’s decision to impose additional tariffs starting from September 1st), to which the US responded with a further retaliation. President Trump tweeted that tariffs on the USD 250 billion of imports already in place would be raised to 30% from 25% on October 1, and that the remaining USD 300 billion of imports set to become effective on September 1stwould be taxed at 15%, rather than 10% as had initially been announced.

Another front of the many US confrontations now taking place is Iran. On this front, there might be marginally positive news coming from the recently concluded G7 meeting in Biarritz. Iran’s Foreign Minister Javad Zarif was invited to the side-lines of that meeting. Though President Trump did not meet with Zarif, we can consider it positive news that a channel of communication was opened between the two sides (thanks to French President Macron, who organised the meeting).   

Other items on the agenda of the G7 meeting besides trade wars and tension with Iran included the digital tax that Macron wants to impose on US tech giants in France, and emergency measures to combat the fires in the Amazon forest.  The Amazon represents another very sensitive front in international relations, of course. Brazil’s President Jair Bolsonaro is insisting that Brazil’s portion of the rainforest belongs unequivocally to Brazil – but the rest of the world is claiming that the forest is the “global lungs”. 

Around the table in Biarritz there were key players in two other critical political developments that were cited by Powell as global risks; namely, “the collapse of the Italian government and Brexit”. Italy’s PM Conte – who resigned last week – is waiting to see whether he will be reconfirmed as prime minister in a new coalition government between Five Star and the Democratic Party.  Italy’s President Mattarella will hold a second round of consultations on Tuesday and Wednesday this week. If at the end of this round the possibility of forming a new government is not clear, the President will dissolve parliament to hold early elections, which will most likely take place on November 3rd or November 10th. 

UK PM Boris Johnson made his debut at the G7 in Biarritz meanwhile, and there had the chance to meet again with French President Macron and German Chancellor Merkel, together with EU President Donald Tusk. Johnson re-affirmed his tough stance on Brexit, threatening not to pay the GBP 39bn Theresa May had pledged to pay as part of the Withdrawal Agreement. He is facing a tough return to Britain. When parliament re-opens, he will have to face a no-confidence vote, which could bring down his newly formed government and allow for the formation of a caretaker government that would postpone Brexit and prevent a no-deal scenario from materialising. In response to this threat, Johnson has asked legal advice on whether he can shut down parliament (or, technically speaking obtain a “prorogation”) for five weeks, so as to make sure that no-deal Brexit cannot be blocked by parliament. The EU partners have given the UK the onus to come back to the negotiating table within 30 days with examples of “alternative arrangements” to the Irish backstop, for a deal to be signed. We are clearly going to have to wait until the last moment to find out whether or not a deal is reached. 

By Brunello Rosa

19 August 2019  

We have written several times about the rise of populism at global level, and its repercussion on the political, economic, and financial developments of the countries in which the populist phenomenon is strongest. We have also discussed the potential repercussions for the liberal order and its institutions, such as the European Union, that were created after Word War II as a response to the damage caused by the nationalistic and populist movements of the first half of the 20th century. 

Plenty of studies have been published that discuss the origin of this new wave of populism. A useful taxonomy is one in which contemporary populists have been classified into three categories: those who reached power for cultural or “identity-related” reasons (e.g. Brexit); those who claim to be anti-establishment (e.g. Donald Trump), and finally, those who came to power as a result of a widespread socio-economic malaise (e.g. Five Star and Lega in Italy). In this column we want to focus on the underlying causes of the last of these three categories: socio-economic populism. At the core of any economic malaise there is under-development and lack of opportunity, especially in emerging markets. In developed economies, however, where per capita income is much higher, it is the uneven or unfair distribution of income and wealth that seems to be the driving force behind the rise of populist forces in recent years. 

As discussed in our recent in-depth analysis, income and wealth inequality (or lack of “inclusion”, to use the expression of the IMF/World Bank) is one of the main causes of subdued growth and historically low real interest rates. As the IMF said in its 2018 Annual Report, “reducing inequality can open doors to growth and stability.” Yet by causing subdued and uneven growth, inequality is also a primary origin of protest movements that want to rectify this situation, which sometimes are or have been classified as “populist.”   

In our analysis we discuss how income inequality has been increasing since the 1970s, when the primary distribution of income began to become skewed more towards profits, interests and rents and less to labour.  

At the same time, the neo-liberist revolution of Ronald Reagan and Margaret Thatcher also made the redistribution of income via taxation and subsidies less effective, on the back of what was labelled as trickle-down economics. Many years of increased globalisation, with its inherently deflationary forces (including on wages), reduced labour share of income in the most advanced economies (and parallel increase in the profit and interest share of income), diminished power of trade unions, mass privatisation of public goods, and inability of taxation and subsidies to redistribute income in a fairer way, have led to the current situation. Workers in many countries feel deprived, and are therefore willing to give a chance to political leaders who claim to be on their side, however inconsistent with this claim those leaders’ biographies might be. 

The policy solution to this problem seems quite straightforward: a more active role of fiscal policy, to promote income redistribution, increased public expenditure in infrastructure and education, the provision of job opportunities to younger generations by the public and private sectors. Some of these solutions are becoming popular even among the US electorate, with the rise of political leaders such as Bernie Sanders and Alexandria Ocasio-Cortez, who are not afraid of being labelled “socialists,” a description which just a few years ago would have killed any political career. Nevertheless these solutions are easier said than done. Once in power, even their proponents realise how difficult implementing such policies tends to be, given binding budget constraints. 

Wealth inequality is even harder to assess than is income inequality, as it is often a legacy issue (as wealth is accumulated over generations), and as it is the result of the cumulative effect of income inequality over a long period of time. A group of economists has suggested the adoption of a “wealth tax” as a solution to this issue. This might well be a solution, but the political economy of adopting such a tax would be complicated, and so might ultimately prove to be counter-productive. 

All this is to say that income and wealth inequality are here to stay for the time being, and will continue to feed populist movements around the globe. Policy solutions are available, but their implementation is complicated and sometimes politically toxic. This means that probably things will have to get worse before they can get better.   

By Brunello Rosa

12 August 2019  

Last week, we observed that political risk has been rising again, especially in Europe. In Italy, following months of indecision, Lega’s leader Matteo Salvini decided to pull the plug on Conte’s government by tabling a no-confidence motion in the Senate. As we discussed in our flash update last week, that officially marked the beginning of a government crisis which is expected to lead to a snap election being held in late October. If that election takes place, Salvini – who has asked the Italian voters to given him “full powers” – could become Italy’s Prime Minister by the end of the year. Salvini’s budget plans are certainly not in line with Italy’s budget discipline of the last few years, and therefore Italy is likely to soon be on a collision course with the EU Commission (again!). Markets are already reflecting these developments, with the 10y BTP-bund spread back to 240bps, and equity prices having fallen by 2.5% last Friday. Also on Friday, Fitch kept Italy’s rating at BBB, with a negative outlook, clarifying that a government collapse in H2 2019 was already part of their baseline. As we discussed in our medium-term scenario analysis in October 2018, Italy is now choosing what we labelled an Austro-Hungarian path. This could eventually lead the country to become an “illiberal democracy,” as theorised by Salvini’s maestro, Hungary’s Prime Minister Victor Orban. 

Italy is not the only country to be experiencing a political drama. In the UK, PM Johnson has confirmed that the country is ready to leave the EU with “no ifs and no buts” by October 31st, with or without a deal. He might have been lured into doing so by US assurances that the Trump administration will be at the UK’s doorsteps “pen in hand” to sign a free-trade agreement with the country. 

In fact, such a deal might be difficult to achieve: a number of US politicians with Irish roots would reportedly be very reluctant to ratify any trade deal that risks endangering the provisions of the Good Friday Agreement for Ireland, and in particular the existence of an open border between the two sides of the island. 

Also, former US Secretary to the Treasury Larry Summers said that any trade deal signed with the US after a “no-deal” Brexit would be particularly advantageous for the US (for example, health insurance companies could try to replace the NHS), but very dis-advantageous for the UK, given that the UK may be in a desperate position after crashing out of the EU. (Brexit uncertainty has already caused UK’s GDP to fall in Q2 2019). As a result of all of this, a new standoff between the UK and the EU Commission is likely to begin soon, which might lead to new elections. Press reports suggest these might take place immediately after Brexit, possibly even on November 1st. The effects of the no-deal would then not yet be immediately visible or able to influence voters’ opinion. 

All these domestic political risks are resurfacing at a time when geopolitical risks are also on the rise, and as the global economy is particularly fragile. As we will discuss in greater detail in John Hulsman’s Geopolitical Corner later this week, a few days ago India’s PM Modi reduced Kashmir’s autonomy, and by doing so inflamed a region that is geopolitically one of the hottest in the world (especially given that both India and Pakistan have nuclear military capabilities). Meanwhile the US has decided to rebrand China as a currency manipulator after many years, following the depreciation of the RMB to above 7 US dollars for the first time since 2008. (The RMB depreciation was caused by the threat of new US tariffs on Chinese imports, which we discussed last week). With this move by the US, the risk of a currency war has been added to the ongoing trade and tech wars between China and the US. It should not come as a surprise that all these political and geopolitical risks are taking a tolls on the global economy.