by Brunello Rosa
16 November 2020
Last week, Pfizer reported initial results of the tests of its anti-Covid vaccine, exhibiting a 90% efficacy rate. The news sparked optimism among global investors, with equity markets rallying (MSCI was up 2.2% on the week). This occurred while a number of European countries started to enter national lockdowns (as we discussed last week), as the infection rates soared again, posing a risk that national health systems will be overwhelmed. This second round of lockdowns will have dramatic effects on societies and their economies. A double-dip recession has now become the baseline scenario for European economies, as Q4 is likely to be another quarter of negative growth.
In the US, daily infection rates have reached 180,000, the highest level on record. Nonetheless, in spite of some localised restrictions, state governors are still reluctant to declare the total closure of economic activities. In this respect, the US presidential election might represent a slightly more positive direction being taken. With 306 votes in the electoral college, Joe Biden has won the presidential race. As we discussed in our in-depth analysis of the results, Donald Trump will try to launch a series of legal challenges to this outcome, but they are unlikely to succeed.
With a 36-vote advantage in the electoral college, Joe Biden may afford to judicially lose a couple of relatively large states, and yet remain president elect. This means that, in spite of the short-term noise and the difficulty in the transition process, this huge element of political uncertainty has been removed for investors. A divided Congress (if the Senate remains, as it seems likely, controlled by the Republicans) means that the fiscal stimulus is likely to be smaller than would otherwise be the case had the Democrats won, but this means the Fed may be required to do a bit more.
As we discuss in our “Brexit Endgame” preview, the Brexit saga is likely to enter its final crunch week. An agreed text needs to emerge at the end of the EU Summit on November 19 for a no-deal Brexit to be avoided on January 1st, 2021. A skinny FTA is likely to emerge this week or in coming days, as the government cannot conceal Brexit behind Covid anymore, as Covid has proved to be a national disaster anyway.
Countervailing these events, a new round of monetary and fiscal stimulus is likely to be adopted by national governments and central banks. Central banks in particular are reacting. The ECB has already announced an expansion of its programs in December. The Bank of England (BoE) has approved a new increase in its APF facility by deliberating an increase of GBP 150bn in asset purchases until the end of 2021. The Reserve Bank of New Zealand (RBNZ) has launched a new credit-easing facility (a Funding For Lending Programme). Both the BoE and the RBNZ have contemplated the possibility of introducing negative policy rates, although the actual implementation of such a program may be postponed well into 2021.
During all of this, equity markets have been continuing to make a timid comeback following the slump of early 2020, while remaining vulnerable to the series of corporate defaults that may follow the peak of the Covid-induced crisis. The only real winners seem to be the tech companies (well represented by NASDAQ), which can take advantage of the massive increase in digital application due to widespread lockdowns
by Brunello Rosa
9 November 2020
As we discussed in our recent publications, a number of countries, especially in Europe, have decided to enter a new phase of general lockdowns. France, for example, after adopting a curfew policy that proved ineffective, started to implement a general lockdown from October 30 to December 1st. Germany, which during the first phase of the pandemic witnessed an infection rate markedly lower than other countries (the result of more effective testing measures and a larger number of intensive care units) is also introducing a sort of semi-lockdown now, from November 2 to November 30. Italy is adopting a three-tiered restriction system which might easily morph into a national lockdown in coming days. The UK, which adopted a tiering system earlier on, switched to full lockdown on November 5, which for now is set to last until December 2nd. Other countries, such as Greece, Belgium and Spain, are adopting similar measures.
These generalised lockdowns have been decided upon as the second wave of the pandemic hit following the reprieve that occurred during the summer (as we discussed in our recent column). Studies have shown that this second wave originated from a virus mutation that occurred in Spain during the summer. As Spain – together with France – decided to adopt an open-door policy during the summer holidays in order to save the tourism season, this mutated version of the virus has spread across Europe this autumn. Most governments seem to be flirting with the idea that a full lockdown in November will allow countries to reopen for Christmas, but this strategy seems self-defeating in the light of the Spanish example above: any sacrifices made during these weeks in November would likely be nullified by a reopening of shops and a restarting of domestic and international flights for the holiday season.
The question is on what basis these new generalised closures were decided. Most governments got scared, and seemed frankly unprepared to this second wave, as the number of new cases soared in recent weeks (see map above). Some governments decided to adopt new lockdowns after a certain threshold of new daily cases was reached (a threshold that would purportedly translate into a relatively predictable percentage of hospitalisations, intubations and – eventually – deaths).
But these metrics seem highly questionable. In a pandemic generated by an airborne virus, to reach “heard immunity” it is obvious that the number of cases will have to increase. Over a relatively short period of time, a vast proportion of the population will in theory have to get infected (even without necessarily being symptomatic) in order for herd immunity to be achieved. For the same reason, even the apparently more sophisticated metric of the percentage of positive cases as a share of the overall number of tests (a metric which should control for the increase in the number of tests), appears to be wrong. Over time, as we reach heard immunity, that percentage will have to increase towards 70-80% without necessarily being a cause for alarm.
In that case, what metrics should actually be used? Well, first of all, in order to get a sense of the speed at which the virus is spreading, governments should compare the actual rate of infection with the theoretical rate of infection as calculated by epidemiologists.
A natural progression of the virus’ spread should not lead to generalised closures of the economy, whereas a faster-than-expected spreading should prompt the adoption of increasingly severe restrictions. The second metrics should be based on the hospitalisation rate (and within it, the intubation rate), so as to make sure health systems are not overwhelmed. This is because the unfortunate statistic of Covid is that only 50% of those entering intensive care actually make it out alive (rendering intubation effectively a coin toss). But again, the solution to this problem is building more intensive care units (ICUs) and adopting more effective treatments, not adopting new lockdowns. Most governments did not increase their ICU capacity between the first and the second waves of the virus, in spite of the fact that the coming of the second wave was highly predictable.
In fact, it seems anachronistic that social distancing, a medieval solution against pandemics, remains today the most effective way of stopping the virus, in the era of massive technological and medical advancement. The case of Donald Trump may serve as an example. He was hospitalised and then released within 3-4 days, after receiving innovative (indeed, almost experimental) cures, including a mix of remdesivir, an antiviral drug, with polyclonal anti-bodies and other substances. This example proves that an extremely effective treatment for the disease does exists, but is clearly not available to the vast majority of the population.
Finding an effective cure might prove even more promising than developing a vaccine. The three most advanced products under trial (in phase three) won’t be ready before March 2021 at the earliest and won’t be available for the wider population before Q3-Q4 2021 at best. Additionally, the effectiveness of these vaccines may prove elusive, if the virus mutates. Recently, the WHO has identified a new variant of the virus deriving from farmed minks in Denmark. If this new variant were to spread further, the vaccines currently under development may prove to be not very effective, and new vaccine trials may need to start from scratch.
Clearly the solution to this pandemic must be a mix of social distancing, better treatments, and the development and usage of vaccines, with lockdowns being the extrema ratio. Perhaps the emphasis should now be put on treatments rather than vaccines, as countries needto reopen. Economies and societies cannot tolerate this “stop and go” approach, whereby total closures are followed by partial re-openings, for too long. The long-term economic, social and political consequences of such an approach could be devastating.
Companies are now unable to plan and invest without any certainty about the near future, and workers are continuing to increase their levels of precautionary savings and are under-consuming out of the fear of joblessness as a result of the pandemic. Mental illnesses are also becoming endemic, as a mix of fear, anxiety, and stress is faced by individuals around the globe. Entire sectors, for example the hospitality and transportation sectors, are on their knees and struggling to survive as their business models simply cannot cope with pandemics. The political consequences of pandemics should never be under-estimated either. In 1919, Benito Mussolini formed the Fasci di Combattimento (the predecessor of the Fascist Party) not only immediately after World War 1, but also following the 1918-19 Spanish flu pandemic. It is not out of the question that political radicalisation could similarly follow Covid-19.
by Brunello Rosa
2 November 2020
This week investors’ attention will be focused on the US presidential election, which will take place on November 3rd. In reality, as of Wednesday last week, 75 million people have already voted, either in person or by post. This represents around 54% of the total turnout recorded in 2016. So, it is quite likely that this year the turnout will be higher than in the last election, even if the number of people who will physically vote on Tuesday is lower than usual, as it probably will be due to the Coronavirus pandemic.
As we discussed in our preview, the Covid-19 pandemic - its economic and social effects, and the way it was managed - will clearly represent a determining factor of the final outcome of the election. According to the latest statistics, the US, with its 9.2 million reported cases (out of 46.2 millions worldwide) and 230,000 deaths (out of 1.2 millions globally), has had a very unfavourable track record. Despite being just 4.3% of the world’s population, the US has had almost 20% of reported cases and deaths. This means that something has gone wrong in the way the pandemic was managed, or the way the US healthcare system is organised. We know both elements are true: President Trump’s management of the crisis has been erratic at best, and large parts of the population are still not covered by public or private healthcare.
Having said that, the US is not alone in this crisis. A number of countries, especially in Europe, are facing the second wave of the pandemic after re-opening their economies during the summer. As a result, new total or partial lockdowns (of at least one month) have been carried out by Germany, France, and the UK, and likely will soon be by Italy as well.
The economic impact of these new restrictions will be large, and therefore the V-shaped recovery that some policymakers were fantasising about will not materialise (as early as March we have been saying that such a recovery was unlikely to happen). A long, uneven, bumpy U- or W-shaped recovery will likely take place instead.
Given all this, central banks have re-started their engines of monetary easing to complement fiscal stimulus. Last week, the European Central Bank explicitly said that in December it will recalibrate all its instruments, the Bank of Japan reiterated that it stands ready to act, and the Bank of Canada began a sort of semi-twist in its asset purchases to increase the effectiveness of QE. This week, we expect the Bank of England and the Reserve Bank of Australia to actually deliver more monetary stimulus with a combination of increased asset purchases, rate cuts, enhanced forward guidance and additional credit easing.
This is the climate in which the US election will take place. In our previous comments, we discussed the successes and the failures of Trump’s presidency. In our preview we discussed how we believe that election night will likely be followed by a nasty legal battle by Trump, who has been saying for months that the postal vote (which Democrat voters prefer) is rigged. He might be trying to claim victory after a possible advantage deriving from the in-person voting during election night, but for the US television networks it will be hard to declare the winner in each state with 50% of the votes still to be counted. The only way the result will not be severely contested is if Biden wins a large majority in the electoral college, something could happen if he were to win a large state such as Florida.
Eventually, we still expect Biden to emerge as the final winner, perhaps even leading a “blue sweep”, with the Democrats taking control of the Senate as well. However, a word of caution is needed. As Michael Moore - the movie director who predicted Trump’s victory in 2016 - said, “Trump electors are always undercounted in polls.” A surprise victory by Trump cannot be ruled out.
by Brunello Rosa
26 October 2020
Months ago, UK PM Boris Johnson said that unless an agreement between the UK and the EU was found by the October 15th EU Summit, both sides should start preparing for a “no deal” scenario at the end of the transition period on 31 December 2020. The EU Summit ended without such an agreement, and Johnson said that negotiations will be over unless the EU becomes ready for a “fundamental change” in perspective. In effect, the UK government has been repeatedly telling companies and individuals to prepare for a no-deal environment.
After a few more days of back-and-forth declarations from the two sides, negotiations have in fact re-started in London in “submarine mode”, i.e. with sherpas from the two sides aiming at preparing a joint text, without consulting with their political stakeholders and without briefing the press as to the level of progress they have made. At the end of this “tunnel phase” of the negotiations, a joint text agreed by the two sides may emerge.
There are three main areas of contention here: fisheries, state aid and dynamic regulatory alignment. Regarding fisheries, the EU would want EU boats (mostly from France, Spain and Ireland) to continue fishing in British waters, whereas the UK wants exclusive access. Regarding state aid, the UK wants to be able to subsidise its industries, which will need to adjust (sometimes heavily) post Brexit, whereas the EU wants the UK government to follow EU rules that forbid countries (outside of the current Covid-19 emergency) to provide state aid to private companies, so as not to distort the existing “level playing field”. For the same reason, the EU wants the UK to continue aligning also in the future (i.e. “dynamically”) with EU regulations even after the end of the transition period, something the UK will resist as much as possible as it attempts to reap the benefits of Brexit.
At the same time as these talks proceed, a number of other major events are occurring that could have an effect on the positions of Britain and the EU. In the US, the presidential race is entering its last phase ahead of the November 3rd vote.
As discussed in our preview, we currently expect Joe Biden to win the race, even if perhaps after a nasty legal battle. If Biden wins, Johnson’s negotiating strategy might fail, as he needs the support of Donal Trump to show that the UK has a viable alternative to trading with the EU (however credible the threat of severing trade ties with Europe might actually be).
Meanwhile the UK has managed to strike a trade deal with Japan, which – according to the UK government – will be able to “secure additional benefits beyond the EU-Japan trade deal, giving UK companies exporting to Japan a competitive advantage in a number of areas… The deal is also an important step towards joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).”
Given this background, the EU and the UK will now have to
decide whether to make at least a “skinny deal” in order to avoid a cliff edge at the end of December, without which major disruptions could possibly occur in the financial industry, in transportation and trade. Room for compromise exists: the UK can give in on fisheries and state aid in exchange for the freedom to diverge from the EU from a regulatory standpoint. Indeed, the UK will never be able to absorb all the fish available in its seas with its small domestic market, and has never been particularly keen on state aid since the Thatcher’s liberal revolution.
At the same time, for Brexit to be a success, obtaining regulatory divergence over time (especially on new areas such as data collection, management and protection) is absolutely essential for the UK. The EU might accept this trade-off, as long as the UK does not become a de facto offshore financial centre and does not engage in savage regulatory competition. If such a compromise does eventually emerge, it will still be “hard Brexit,” but perhaps less hard than it otherwise could be.
by Brunello Rosa
19 October 2020
As the second wave of the pandemic is in full swing, its economic impact is becoming increasingly evident. The rapid increase of new daily Covid cases in Europe, which have recently surpassed those of the US, is forcing a number of European countries to implement renewed restrictions, such as partial lockdowns, or tiered systems such as those adopted by the UK. If the experience of the Spanish flu is of any guidance, the world might even experience a third wave in spring 2021, before a combination of incipient herd immunity, better treatment and availability of vaccines finally manage to tame the pandemic in H2 2021.
As a result of a longer than expected pandemic and more restrictive measures, the economic impact of Covid-19 is likely to be larger and longer than initially estimated.
According to the latest estimates of the IMF, although global growth should fall less this year than had been expected in June (by 4.4% in 2020, with a 0.8% upward revision) the rebound after that is also expected to be shallower (5.2% in 2021, vs the 5.4% that had been expected in June). So, the IMF too is getting closer to the idea that the recovery will be U-, rather than V-shaped. But we consider even these projections to be too optimistic.
If that is the case, it means that policy support is likely be larger and more prolonged than had been initially envisioned. During the IMF meeting a message emerged clearly: fiscal stimulus needs to be at the forefront of the policy response, with monetary policy either complementing fiscal policy or – bluntly said – simply monetising the ballooning fiscal deficits and debts.
In fact, according to the latest forecasts in the IMF’s fiscal monitor, the US will reach a deficit of 18.7% of GDP, the UK of 16.5%, and the euro area of 10.1% in 2020, with France 10.8% and Italy at 13%. In terms of gross public debt in percentage of GDP, the IMF estimates the US to reach 131.2% in 2020, the UK 108%, the Euro area 101.1, with France at 118.7% and Italy at 161.8%.
As a result of these ballooning levels of public deficits and debts, rating agencies are starting to re-evaluate the sustainability of public finances, and starting to take action accordingly. During the last week end, Morningstar DBRS downgraded France from AAA to AA, with the outlook moved from negative to stable. Equally, Moody’s has downgraded the UK from Aa2 to Aa3, also changing the outlook from negative to stable. The downgrades of these solid sovereign issuers will have little market impact, especially because the respective interest rate curves in those countries remain historically low. But for other countries, rating actions might have a larger impact.
For example, the Italian rating will be reviewed by S&P Global, DBRS and Moody’s between October 23rd and November 6th. After the recent downgrades of more solid sovereigns such as the UK and France, a downgrade of the Italian rating becomes more likely. However, Italy’s position is more precarious as the country is already at the bottom of the investment grade grid, being Baa3 for Moody’s, BBB for S&P, BBB- for Fitch and BBBh for DBRS. A downgrade by Moody’s and Fitch would make Italy one of the most significant “fallen angels” of this crisis.
In terms of immediate impact, the effects of a potential downgrade have been partially softened by the ECB, which has already said that “fallen angels” will continue to be used as collateral in refinancing operations or in PELTROs. However, asset managers following indices may need to start rebalancing their portfolios as a result of a downgrade. All this is to say that Covid-19 not only can attack the human body in unexpected ways, but may have larger economic repercussions than was initially envisaged.
by Brunello Rosa
12 October 2020
This week, the annual meetings of the International Monetary Fund (IMF) and the World Bank will begin. Though large component of the scheduled events will take place virtually, the IMF will still be releasing the latest edition of its World Economic Outlook (WEO), which includes updated estimates of growth and inflation for the vast majority of the economies of the world. According to the Brookings – FT tracking index, the recovery will remain fragile and patchy. This is in line with the column we published on 28 September, titled “Covid’s Second Wave Threatens Economic Recovery and Market Stability.”
This is also in line with our latest Global Outlook Update - Market Views - Q4-2020 Strategic Asset Allocation, titled “Volatility To Create Opportunities, While Investors Keep Focus On The Long Term”. In that report we discussed how the Covid pandemic was likely to come in at least two, if not three, waves, the same way the “Spanish flu” pandemic did in 1918-19. In our analysis, we discussed how the second wave was the most deadly of the three waves during that pandemic a century ago. Given the rise in cases registered globally in the last few weeks, it is clear we are at the beginning of the second wave of the current pandemic. We cannot rule out there being a third wave in the months ahead, if the vaccine is not found before Q1 2021 (as we assume in the baseline scenario of our Global Outlook Update).
Our report also discusses how we expect global growth to be worse than had been estimated by the IMF in June (we expect -5.3% growth, vs the -4.9% the IMF estimated), with the rebound in 2021 more anaemic as well. As a result, monetary and fiscal accommodation will still be required.
In terms of fiscal policy, most governments will continue to provide protection to companies and individuals, but, as UK Chancellor of the Exchequer Rishi Sunak said in parliament at the end of September governments will not be able to save every company and every job. In Europe, where the institutional setting remains more fragmented, the approval and implementation process of the Next Generation EU plan is now encountering some difficulties, which might delay the arrival of its funds further into 2021.
For this reason, monetary policy needs to remain highly accommodative. Following the Fed’s de facto promise of keeping rates extremely low for a much longerperiod of time, all other central banks are reacting, both in developed and emerging markets. In the G10 sphere, we expect imminent moves (in November) from the Bank of England, the Reserve Bank of Australia and the Reserve Bank of New Zealand, featuring a combination of rates cuts, revised forward guidance, larger asset purchases and new credit-easing facilities. Negative policy rates have started to enter the radar screen of the central banks in the so-called Anglosphere (the US, UK, Canada, Australia, and New Zealand), which so far have been the most reluctant to adopt them.
Through all of this, markets remain volatile, with equity markets having just experienced the second week of a rebound after four weeks of market losses. Meanwhile we are entering the most delicate part of the US electoral campaign, which could culminate in a 10% correction in equity markets in case of a highly contested result. In this volatile environment, strategic asset allocators should focus on longer-term investment horizon.
Picture source: Taubenberger JK, MorensDM. 1918 Influenza: the Mother of All Pandemics. Emerg Infect Dis. 2006;12(1):15-22.
by Brunello Rosa
5 October 2020
Last week US President Donald Trump tested positive with the SARS-CoV-2 (Covid-19) infection, together with a number of members of his family, his inner circle and White House staff. Press reports suggest that he might have contracted the virus from his senior advisor Hope Hicks (former director of strategic communications at the White House) or, possibly, during what was defined as a “super-spreader” event, held at the White House on September 26th, just a few days before he tested positive.
The first obvious concern is whether, how and when the US President will fully recover from the disease, for which he was hospitalised and treated with innovative (indeed, almost experimental) cures, including a mix of remdesivir, an antiviral drug, with polyclonal anti-bodies and other substances. In a recent message from the hospital, Trump declared himself to be in good shape and on his way to recovery.
The second concern is what type of impact this event could have on the US Presidential race. Since the first debate between Trump and the Democratic nominee Joe Biden took place on September 29th, it is not impossible that Joe Biden also contracted the virus, possibly from Trump, Trump’s family, or his inner circle, members of which were not wearing a facemask at the debate. If both candidates were to have Covid, it is possible that at least one, if not both of the subsequent debates (currently scheduled for October 15th and October 22nd) will be cancelled. This would be a real novelty for US Presidential elections; the American public has been able to watch televised presidential debates since 1960.
Another issue is that Trump’s infection might fundamentally alter his political strategy. Clearly, most of his bold communication was centred around his attempt to downplay the significance of the virus.
This was an attitude that he shared with all of the other major Covid-sceptics, such as UK Prime Minister Boris Johnson and Brazil’s President Jair Bolsonaro, both of whom have also fallen ill with Coronavirus in the last few months.
Having contracted the virus himself, and being hospitalised (in a military facility), it will be hard for Trump to continue downplaying the significance of the pandemic and its impact on public health, the economy and society in general. There have now been almost 210,000 cases directly attributed to Covidin the United States.
Additionally, given Biden’s advantage in the polls, it was clear that Trump was getting ready for a nasty legal battle following the night of the vote on November 3rd. Trump thought the election result could reach the Supreme Court, as it did in 2000 in the contested election of George W. Bush and Al Gore. That partially explained the heist with which he appointed Amy Coney Barrett as his Supreme Court pick in substitution of the late Ruth Bader Ginsburg, who died on September 19th. If Trump (and – a fortiori – if both Trump and Biden) were still to be in hospital in November, would that strategy still pay off?
Finally, and most importantly, will Trump’s infection fundamentally alter the American voters’ perception of how Trump handled the pandemic? The obvious narrative from the Democrats would be that, the same way that Trump didn’t care for his own health (and his family’s and inner circle’s health), he was way too nonchalant on his approach to the pandemic for the country, ultimately allowing the virus to spread out of control and result in a death toll much higher than what would have been the case had he had adopted more stringent containment measures.
The Republican response is likely to be based on Trump’s recovery: a fast and full recovery would be used as an argument to say that the significance of the virus and the pandemic is vastly over-stated. This would help Trump’s light-touch approach to appear be justified. The voters will ultimately decide whose narrative gets more traction.
by Brunello Rosa
28 September 2020
In many countries in Europe, a second wave of Covid-19 infections is materialising. According to the European Centre for Disease Prevention and Control, recent developments in Spain, France and the UK seem to be particularly serious. Unlike during the first wave, Italy is less exposed this time. The 14-day cumulative number of Covid-19 cases for 100,000 inhabitants is 320 in Spain, 230 in France, 96 in the UK and 32 in Italy. For reference, the same figure is 30 for Germany, which has responded best to the epidemic among large countries in Europe.
As the map above shows, in Spain the situation already seems to be close to critical, with Intensive-Care Units (ICUs) on their way of being filled up again like they had during the first wave from March to June. In France, the situation is also alarming, with large portions of the country reporting some of the highest infection rates in Europe. In these two cases, the recurrence of the virus seems to be connected to the relaxation of social distancing policies during the summer, which had been adopted to at least partially save the tourism season.
In Italy, the rules have remained as stringent as they had been before (although people became more relaxed in implementing them, as was the case in Sardinia), but the severity of the initial lockdown seems to be having beneficial long-term effects. In the UK, the situation is also becoming increasingly critical, as the government openly incentivised people to return to work and go out for dinner, with the scheme Go Out To Help Out.
The idea that the situation is more severe in the UK than in Germany and Italy because “British people love freedom,” as declared by UK PM Boring Johnson during his recent Question Time, is simply laughable. [Italy’s President Mattarella’s response that “also Italians love freedom, as well as seriousness” was impeccable]. In all cases, the re-opening of schools is constituting, at the very least, an amplifying factor in the spread of the virus.
As a result of this second wave of infections, governments are imposing new sets of restrictions. In particular, in the UK the government extended the emergency state for six more months and has taken a U-turn on public exercises (bars and restaurants must close by 10pm) and on business policies (once again suggesting people to work from home whenever possible). It seems to be a repeat of what happened in March-April, when the government declared a total lockdown after a series of initial restrictions. Press reports suggest that a total lockdown could be declared in coincidence with the two-week school holidays at the end of October.
Needless to say, these new restrictions will take their toll on economic activity in Q4, making the materialisation of the so-called V-shaped recovery even less likely to occur. The big hope of having a vaccine ready by this winter seems to be vanishing rapidly, leaving us all no other option than co-existing with the virus for a few more months, perhaps until the summer of 2021. Financial markets will react to this new situation with further corrections in equity valuations and, given the continued accommodative stance by central banks, with a further fall in sovereign bond yields.
by Brunello Rosa
21 September 2020
The Abraham Accords Peace Agreement, signedbetween United Arab Emirates, Bahrain and Israel in Washington last week, is aimed at the normalisation of the former two countries’ diplomatic relations with Israel. It marks the shift towards various new geo-strategic equilibria being reached in the Middle East.
This process had begun in 2011, when the Obama administration started to withdraw US troops from Iraq. It continued in 2014, with the end of the US fighting mission in Afghanistan, and was then epitomised in 2015 by the Joint Comprehensive Plan of Action (JCPOA) signed between Iran and the five permanent members of the UN Security Council, plus Germany and the EU. Obama’s aim, following Metternich’s and (more recently) Kissinger’s example, was that of creating a “balance of power” among the major countries in the region, to allow a gradual withdrawal of the US from the Middle East, which had become less strategically important since the beginning of the shale oil and gas revolution. To achieve that goal, Obama aimed at creating a balance of power between NATO (represented by Turkey), Sunni Muslims (Saudi Arabia), Jews (Israel) and Shia Muslims (hence the JCPOA with Iran).
The plan failed for two main reasons. First, as soon as the US started to withdraw from the region, Russia entered it with full force, becoming a decisive player. Second, the new US administration led by Trump reneged on the JCPOA and marginalised Iran in favour of the traditional US alliances with Israel and Saudi Arabia. This has led to an escalation of tensions with Iran, culminating in the assassination of General Suleimani by the US at the beginning of 2020.
Between 2016 and 2020, the only two countries that managed to make serious advances in the region were Russia and Turkey, the two deciding in effect to partition between themselves spheres of influence in Syria, Libya and the Easter Mediterranean.
The Abraham Agreement marks the beginning of a new phase. First of all, the notion that in order to achieve a durable peace in the region, the Palestinian question needs to be addressed first, with the creation of two states between the Jordan River and the sea (deriving from the 1993 agreements in Oslo) has been wiped out. The logical order has been seemingly inverted. Rather than Palestinian statehood being a prerequisite to Sunni Arab states recognizing Israel, Sunni countries of the region will instead start normalising their relationship with Israel first, and this normalisation might eventually lead to the creation of a proper Palestinian state in the future.
Second, the fact that the US administration was actively involved in the mediation process via its secretary of State Mike Pompeo, and the fact that the agreement was signed in Washington, means that the US is still actively engaged in the process. In other words, only when a new geo-strategic regional equilibrium is reached the US may start to dis-engage. The Democratic candidate Joe Biden has committed to continuity of this approach as well.
Third, Turkey, as a NATO member, will be less able to play its own game in the region, having to abide by the superior interests of the US and of the alliance generally.
Fourth, for the first time since 2015, Russia has been placed on the backfoot, and could not dictate its conditions.
Finally, as it seems that many other countries in the region are now aiming at normalising their relationship with Israel as well, it is possible that this new, more pragmatic approach to a seemingly unsolvable problem might have the ability to lead to a new geo-strategic equilibrium being reached in the Middle East.
by Brunello Rosa
14 September 2020
Last week the UK government presented a bill to regulate the smooth functioning of the internal market following the withdrawal of the UK from the EU on January 31st, 2020, which will exert its full effects starting from January 1st, 2021, at the end of the so-called transition period. As has been widely reported by the media, many clauses of the internal market bill override the provision of the so-called Northern Ireland (NI) protocol, which was signed between the EU and the UK alongside the Withdrawal Agreement (WA) in order to ensure that a physical border between Northern Ireland and the Republic of Ireland does not return following the UK’s departure from the EU.
As was clear from the very beginning, the implementation of the so-called Irish backstop would have effectively put a customs and regulatory border in the Irish sea, de-facto breaking the “union” of the Kingdom, while leaving Northern Ireland within the EU customs union. For that reason, Theresa May repeatedly refused to accept that option, considering that “no UK prime minister could ever accept” such a condition. Boris Johnson instead revitalised the plan, and that was the key to unblocking the negotiations with the EU in November 2019, perhaps knowing that he would have reneged that pact less than a year later.
The UK government has explicitly said in parliament that the internal market bill would break international law and that the government’s intention was in fact that of overriding the Withdrawal Agreement with domestic legislation. Top EU officials (starting with the leaders of the Council and the Commission, Charles Michel and Ursula von der Leyen, respectively) have called on the UK to respect the pacts signed with the Withdrawal Agreement and the Northern Ireland protocol (pacta sunt servanda, tweeted von der Leyen).
Where does all this leave the ongoing UK-EU negotiations?The two sides agreed that any deal would need to be reached by the EU Council by October 15th, to give enough time for EU parliament and national parliaments to ratify the treaties. For this reason, the EU sent the UK the ultimatum of either withdrawing the internal market bill or making it compatible with the Withdrawal Agreement and NI protocols by the end of September 2020, in order to have at least 15 days to make a final attempt to strike a skinny free-trade agreement (FTA).
This FTA would be even less ambitious than the one the EU recently signed with Canada (the so-called Canada-minus FTA). But it is self-evident that, given the tight schedule, the risk of a no-deal scenario has returned with a vengeance.
Is this just hard-ball negotiation tactics by Boris Johnson? One could suspect that, with deadlines approaching, the two sides are trying to play chicken to see who gives up first. That’s a possibility. However, Boris Johnson is on the record saying that for him a no-deal scenario is a perfectly legitimate and desirable outcome. Also, “no deal” is the only logically consistent end-point of his entire Brexit campaign.
Finally, no deal is the only way the UK would have a proper and final clean break from the rest of the EU, allowing maximum freedom in terms of state aid, taxation and regulatory divergence. It would be the final and cherished prize to secure in return for all the hardship of Brexit. Therefore, we do not think that this is just negotiation tactics. If the final outcome is no-deal, Johnson would sell it as his personal victory.
What’s wrong with a “no-deal” outcome? While the UK can gain something in the short term from reneging on the pact with the EU that was signed just a few months back, doing so would represent a terrible precedent. For a country aiming at “striking trade deals around the world” (such as the one it recently signed with Japan) as the “Leave” propaganda said, being perceived as a counterparty that not only does not respect its word, but does not even respect the treaties it signs, would be a terrible signal to send to other countries that could be potentially interested in striking a deal with the UK.
The UK has taken hundreds of years to move from encouraging piracy to providing one of the most reliable legal systems in the world. If Boris Johnson decides to go down that route, it could cause severe damage to the country’s international reputation. With the UK already being one of the countries hardest-hit by the economic repercussions of Covid, its PM needs to be careful in inflicting more damage from the effects of a no-deal Brexit, even if (as we discussed in our column of May 11th) he could get away with it in the short run by blaming Covid for the economic consequences of a disorderly exit from the EU.
by Brunello Rosa
7 September 2020
During the latest Jackson Hole symposium of central bankers and academics, which was held for the first time in a virtual format and, therefore, was open to the broader public, Chairman of the US Federal Reserve Jerome Powell provided the main conclusions reached in the Review of the Fed’s Strategy, Tools and Communication. In our recent analysis, we provide all the details of that decision.
In a nutshell, the Fed decided to introduce what has been labelled as Average Inflation Targeting (AIT), which means that the Fed will allow inflation to overshoot the 2% target for brief periods (by a limited amount), in order to make up for the lost price level during periods of target-undershooting. This system is clearly designed for the present period, during which the Fed has been undershooting the inflation target for a very long time. The new framework will therefore allow the Fed to keep rates low for longer, and to look through potential inflation spikes that may arise due to Covid-induced supply-side constraints.
Clearly, a potential side effect of this approach (typical of all “averaging” or “level-based” regimes) is what happens when there is a persistent period of above-target inflation. In theory, the Fed should then keep policy rates higher than they otherwise would, to send inflation below target for some time. In turn, that would possibly induce a marked slowdown or recession (as occurred during Paul Volcker’s experience to combat spiralling inflation in the 1970-80s). Although now that seems a distant problem, it might occur at some point if stagflationary pressures were to emerge. The Fed will likely cross that bridge only when the time comes to do so.
In any case, the immediate policy implication is that the Fed will likely keep interest rates at record lows for longer than previously thought, as now the Fed can wait for inflation to be above target before increasing rates, rather than start raising rate as soon as inflation starts moving, consistently and convincingly, towards the target level.
This has clear market implications for bond and equity prices (likely to be supported by the lower rates), credit spreads (likely to remain more compressed than would otherwise be the case) and for the US dollar, which will likely stay as weak as it currently is, and remain so in the future as well. Long-term yields have briefly edged up on the announcement of the Fed’s approach, as the implied breakeven inflation level embedded into them rose, together with inflation expectations.
The real question is how all other central banks (in the G10, but also in EMs), will react to this move by the Fed. They will not be able to afford staying put: when the “mothership” that is the US Federal Reserve moves, all others will have to react, and move in the very same direction. The real risk is therefore that a new race to the bottom will now ensue, of interest rates and other accommodative monetary policies. Such a process may be additionally likely as the other central banks seek to prevent their own currencies appreciating versus the dollar, in the middle of the most severe economic contraction since the Great Depression.
The first G10 central bank to meet after the Fed announcement was the Reserve Bank of Australia (RBA). As discussed in our review of the policy meeting, the RBA decided to leave its policy rates unchanged, but did increase the size of its credit easing facilities. This week, the Governing Councils of the ECB and of the Bank of Canada will each meet. As discussed in our previews, we expect both central banks to keep their policy stances broadly unchanged, while keeping a clear easing bias and adding a dovish twist as a response to the Fed’s policy review.
In the next few months, these and other central banks will meet. The risk is that another significant round of policy easing, carried out by a number of central banks, is just around the corner.
by Brunello Rosa
31 August 2020
Japanese PM Abe Shinzo resigned at the end of last week, suffering as he is from a pathology (ulcerative colitis) that had already previously caused him to resign in September 2007, back when he had only been in office for one year. This institutional crisis could not come at a worse time for Japan, which is facing a second wave of Covid and is in the middle of the worst economic contraction in decades, with GDP having fallen by 7.8% q/q in Q2, the third consecutive quarterly drop in the country’s GDP.
Abe’s second term in office started in December 2012, with the resounding victory in the general election that led to a solid majority for his party, with 328 MPs out of 480 in the House of Representatives of the Diet. With the support of a strong cabinet featuring former Prime Minister Tarō Asō as Deputy Prime Minister and Finance Minister, Yoshihide Suga as Chief Cabinet Secretary and Akira Amari as Economy Minister, Abe launched his celebrated Abenomics, consisting of three “arrows”: ultra-loose monetary policy, initial fiscal stimulus followed by fiscal consolidation, and structural reform.
As generally happens, the policy package started with the lower-hanging fruits, i.e. massive monetary easing in 2013, which led to the adoption of QQE (quantitative and qualitative easing), followed by the introduction of various forms of forward guidance, credit easing, negative policy rates and (last but not least) yield curve control. All these monetary innovations led to the weakening of the JPY, and the massive rise in Japanese equity valuations (Nikkei and Topix), with Japanese companies recording record profits, often hoarded abroad.
The other two arrows proved less successful: following an initial JPY 10tn stimulus package, fiscal consolidation came with the rise in the consumption sales tax, from 5% to 8% in April 2014. That fiscal tightening led to the Japanese economy to a stall and, eventually, a recession in Q2 and Q3 of that year, which plagued Abe’s second term in office. The decision to proceed with the planned second hike in the sales tax rate (from 8% to 10%) in 2019 led to similar results, with the ongoing recession aggravated by the arrival of Covid. The pandemic has also forced the government to postpone the flagship event with which Abe wanted to conclude his period in office: the Olympic games in Tokyo. They will now have to wait until 2021 at least.
The pandemic has also forced the government to postpone the flagship event with which Abe wanted to conclude his period in office: the Olympic games in Tokyo. They will now have to wait until 2021 at least.
The third arrow has been even less successful, as the planned and implemented structural reforms were watered down and ineffective at best, in a country where the population is rapidly ageing and shrinking (from almost 130 million today to around 100 million only a few decades from now, barring a significant change in birth rates or immigration). As a result of all this, the overarching aim of bringing the deflationary period to an end after almost thirty years has miserably failed, with inflation struggling to remain above zero. Other notable failures of Abe’s second term in power were the attempt to hold a referendum to change article 9 of the constitution in order to allow Japan to re-arm, and the failure to settle an old territorial dispute with Russia.
However, Abe’s period in office also saw some important successes, such as his ability to remain in power for 7 years in a row, ending the endemic instability of Japanese governments that had defined the decades before Abe’s ascent. The re-vitalisation of the Trans-Pacific Partnership (TPP) after Trump ditched it in 2016 was another success (it has been relabelled the Comprehensive and Progressive Agreement for Trans-Pacific Partnership). One could also classify as a success Abe’s ability to forge a good working and personal relationship with US President Trump, which may have helped lead the US to engage with North Korea, and stop North Korea’s missile tests of rockets sent over the Japanese territory.
What lies ahead for Japan? Next year, the general election was supposed to bring a new LDP leader and PM to power; now the process is accelerated. The race has begun, with credible contenders being Fumio Kishida (LDP’s head of policy), Shigeru Ishiba (former defence minister), Yoshihide Suga and the old Tarō Asō, who would not mind a final stint in power before retiring. More than their personalities, it is Japan’s policies that will matter. Assuming that for the time being monetary and fiscal policies will remain amply accommodative, one needs to understand how Japan will position itself strategically in international affairs, at a time when the US election is as uncertain as ever and China has become more assertive than ever. The next few months will determine the path Japan will follow in coming years.
by Brunello Rosa
24 August 2020
The Democratic National Convention (DNC) was held in Milwaukee last week – mostly in virtual format, given Covid-19 – with the nomination of Joe Biden as the Democratic candidate for the US presidential election on November 3rd. On August 11th, Biden chose Kamala Harris as his running mate and candidate for the Vice-Presidency of the United States. With Harris’ appointment and Biden’s nomination by the Democrats, the race for the White House against the incumbent Republican President Donald Trump and his VP
Mike Pence has officially begun.
Donald Trump is currently under attack for his management of the Covid-19 crisis, with the number of infected people in the US having reached 5.6 million people and the number of deaths 175,000, the highest number of confirmed cases and reported deaths in the world. This has led to the sharpest contraction of the economy since the Great Depression of the 1930s (-32.9% SAAR in Q2), with a rise in the number of unemployed people, which reached in 14.7% of the workforcein April 2020, before falling to the current level of 10.2%. The successful management of the pandemic and the economic track record will not be arguments that Trump will be able to credibly run on during the electoral campaign. Equally, the divisive and polarising nature of his presidency, including the rise of “white supremacist” movements across the US, will make Trump’s re-election harder.
At the same time, the incumbent President always enjoys a special status, which gives him a slight head start in the race. Policies, including further tax cuts and fiscal stimuli, can be adopted between now and the day of the election in an attempt to swing voters in his favour. Some further “successes” in foreign policy such as the recent agreement between the UAE and Israel, or the continued implementation of the Phase-1 deal with China can be used as “weapons of mass distraction”. So, in spite of his recent difficulties, it would be wrong to write Trump off at this stage.
In the opposite camp, Biden has emerged as the obvious centrist choice to fight against a polarising figure such as Trump. He can enjoy the support of former presidents Obama and Clinton (whereas Trump faces the disapproval of former presidents such as G.W. Bush and other GOP grandees), and Trump’s mistakes on Covid and the economy are defining the campaign for him. The choice of Harris as running mate is supposed to bring on board the votes of ethnic minorities and socially disadvantaged groups, in an attempt to win back crucial votes in swing states that in 2016 allowed Trump to win the race even with nearly 3 million fewer votes than Hillary Clinton.
At the same time, some of the Republican votes that might have gone for Biden just to get rid of Trump could be put off by Biden’s choice of a VP – a VP who could potentially become President, if Biden became “unavailable” for whatever reason during his first term in office. Additionally, Harris’ centrist approach might not be enough to win back the votes of the party’s left wing, represented by Bernie Sanders and Alexandria Ocasio-Cortez.
Pollsters are divided as to what the eventual outcome of the election will be. Recent national polls suggest that Biden is ahead, but we know that what really matters is the distribution of votes in key swing states. Those using sophisticated statistical methods that managed to predict Trump’s surprising victory in 2016 are also divided. The outcome is still uncertain at this stage, therefore. There are however three things we can be sure about: 1) The campaign will be acrimonious, and full of ruthless accusations thrown by both sides at their adversary. 2) In the event of a narrow defeat in the electoral college, Trump will fight hard not to leave the While House. 3) The US will emerge more divided than ever after this campaign, and a lot of effort will need to be made by whoever wins to unite the country behind the President.
by Brunello Rosa
17 August 2020
During the 20th century Europe was been plagued by dictatorships. The most known where those in Germany, Italy, Spain, and Portugal. Adolf Hitler and Benito Mussolini were removed from power at the end of World War II, when Germany and Italy returned to democracy; Portugal’s António Salazar lasted until 1968 (and his authoritarian government remained until 1974) and Francisco Franco until 1975, the year of his death. But somewhat incredibly, dictatorship remained a viable option in many other parts of Europe for much longer than this.
In Greece, the dictatorships of the colonels (τὸ καθεστώς τῶν Συνταγματαρχών), also known as the Junta (η Χούντα), lasted from 1967 until 1974. In Jugoslavia, the regime by Colonel Josip Tito lasted for a decade beyond the year of his death (1980), until the division of the country and Balkan wars of the 1990s. In Eastern Europe various forms of authoritarian regimes stayed in place until 1991, when the Soviet Union collapsed. Since then, the progressive expansion of the European Union and of NATO has gone together with an expansion of democratic regimes in the region.
In some cases, such as in the Baltic countries (Estonia, Latvia, and Lithuania), the adoption of the Euro has also meant a consistent transition to democracy and political freedom.
Other countries, such as Poland and Hungary, have backtracked on their progress towards democracy, with the arrival of the Kaczyński brothers and Viktor Orban, respectively. For this reason, both countries are now under the procedure foreseen by Article 7 of the EU Treaty for violating basic principles of the EU, including academic freedom, freedom of expression (particularly freedom of the media), and the independence of the judiciary. In other cases, such as in the Czech Republic, right-wing populist leaders threaten the existing democratic regime.
The two most remarkable cases in Europe remain Ukraine and Belarus. Ukraine has gone through a very complicated transition, including having to deal with the annexation of Crimea by Russia in 2014. The election of Volodymyr Zelensky in 2019 seems to have normalised the situation – or at least frozen the status quo, for the time being. Clearly, Ukraine remains in a situation that is less than ideal, as half of the country (especially its easternmost regions) remains under the heavy influence of Russia, and no real progress seems to be taking place in the negotiations for the association of Ukraine with the EU.
The second case, Belarus, has come back to the fore in the last few days, with the recent re-election of incumbent president Aljaksandr Lukashenko, who has been in power without interruption since 1994. The election was officially won by Lukashenko with 80.1% of votes, versus 10.1% for his only remaining rival, Svjatlana Tikhanovskaya. But the EU and the US have not recognised the result the elections, and are now discussing possible sanctions on Belarus. As violent riots occurred in the capital Minsk as well as in other parts of the country, Tikhanovskaya had to flee the country in order to avoid being arrested, and will now have to continue her fight from Lithuania. The question is whether Lukashenko will manage to stay in power for a long time yet, and eventually pass the baton to his young son (as he has planned for a long time) or if he will be ousted from power. The answer to this question probably lies in Moscow.
For decades the fragile Belarus economy counted on subsidies coming from Russia, assuring it full employment, rising wages, and the well-being of its population. But as Russia itself ran into economic difficulties following the collapse in oil prices in 2014, its economic help started to wane, and with it, political support for Lukashenko’s regime. The president cannot last unless Putin and Russia support him. So, Putin will have to decide what to do; that is the reason for the recent phone conversation held between the two presidents. Lukashenko warned Putin that the riots pose a threat to the stability of Russia as well. In a a not-so-veiled request for help, he claimed that if the riots do not get stopped in Belarus, they will spread to Russia as well. That’s why a military intervention by Russia in Belarus cannot be ruled out at this stage.
For some time, the idea has existed that the president of Russia would also become president of Belarus, in something akin to a new confederation being formed between the two states. This seemed to be one of the options that Putin was considering to extend further his own mandate within Russia. However, now that Putin has managed to change the Russian constitution, allowing him to remain in power until 2036, this option seems to be less palatable, considering the lack of support among the people in Belarus for a sort-of “annexation” of their country by Russia. At the same time, a nationalistic approach, in which Belarus would try to re-assert its independence from Moscow, is not particularly popular among the wider populace either.
So, perhaps the only option remaining on the table for Putin is to keep Lukashenko in power for longer and increase economic and financial support for the country. But this solution may prove to be more temporary than either of the two presidents desire, exposing them to further revolts.
by Brunello Rosa
10 August 2020
After the disastrous collapse in economic activity recorded in Q2, with real GDP falling by double digit percentage points in many economies, including in the most advanced ones, the global economy is attempting a timid rebound in Q3. The re-opening of economies after months of widespread lockdown, when 1/3 to half of the world population was estimated to be subject to more or less draconian restrictions, is facilitating a comeback in economic activity. However, this rebound is uneven and uncertain at best. In its latest statement, the US Federal Reserve’s FOMC warned about a slowdown in this timid rebound, as signalled by many leading and contingent indicators.
Governments remain alert and active in their plans to stimulate economic activity. Among others The US is preparing its third fiscal stimulus package, the EU has just adopted the new Recovery and Resilience Facility, and the UK has prorogued its furlough schemes (together with other forms of fiscal support).
Central banks remain fully accommodative after having launched what we called “Covid-related forward guidance”. In fact, in August the Reserve Bank of Australia (RBA), in deciding to re-start QE after the lockdown in the state of Victoria, joined the Fedand the ECB in explicitly linking the duration of its monetary stimulus to developments of the virus.
After the so-called “time-limited” and “state-contingent” forms of forward guidance, in which the central bank will continue to provide monetary stimulus until a certain date arrives or a pre-set economic condition materialises, some central banks seem to have decided to launch a new form of state-contingent forward guidance, in which the condition to be met to reduce the stimulus is fully exogenous. Specifically, central banks will continue to keep policy rates low (or lower) or make asset purchases until there is convincing evidence that the virus has been durably and credibly contained.
Considering that the number of cases is still accelerating in very large parts of the world, such as in the US, Brazil and India, this means that central banks will keep the tap of liquidity open for the foreseeable future. Most central banks, when showing their implicitly expected path of policy rates, do not show any sign of tightening over the forecast horizon.
Who is benefiting from this situation in financial markets?
Clearly risk asset prices have been the ones that have benefited from the combination of monetary and fiscal stimulus (sometimes coordinated in “helicopter money” fashion). But there is plenty of evidence that both equity and credit markets valuations are stretched, as they are under-pricing the risk of the chain of defaults and bankruptcies which is likely to manifest itself in coming months. Perhaps also because of this reason, the clear winner so far seems to have been gold.
The yellow precious metal has in fact reached and recently overcome the 2000$ per troy ounce for the first time since the Global Financial Crisis. Gold was trading at just over $250 in the early 2000, before starting a glorious rally that brought it to $1750 (monthly prices) during the Euro crisis in 2011-12. After retracing and falling to just over $1000 in 2015, the rally re-started with some conviction in mid-2019 (when the Fed started to implement its “insurance cuts”) with a serious acceleration in the last few months.
As discussed in our recent in-depth analysis, there are multiple reasons for this rally. Gold is perceived to be a good hedge against inflation, but also deflation (as it is a physical asset, but nobody’s liability, unlike government bonds). It is a store of intrinsic value and is also perceived to be a store of US dollar value, during a time when political uncertainty and turmoil in the US, ahead of the Presidential election in November, is making many investors nervous about the greenback.
by Brunello Rosa
3 August 2020
Last week, the US Bureau of Economic Analysis released its first estimate of the performance of the US economy in Q2 2020. After the 5% q/q drop in Q1 (a seasonally-adjusted annualised rate, SAAR), in Q2 the economy contracted by 32.9% q/q SAAR. This was slightly less than anticipated (34.1%), but still the largest contraction on record. This quarterly contraction of 8-9% (32.9% divided by four) is in line with the fall in income recorded by other major economies. It is explained, of course, by the adoption of lockdown measures that were introduced in order to slow down the spread of Covid-19.
As the Federal Reserve Chairman Jerome Powell said during the press conference following the FOMC decision to leave the central bank’s policy stance unchanged in July, this is the largest shock the US has had to endure in recent history. After an unexpected rebound in May and June, the recovery of economic activity since July has slowed down, as has been revealed by non-standard, high-frequency indicators, such as hotel occupancy and credit card use. In its latest statement, the Federal Reserve decided to establish a clear link between the expected path of economic activity and the likely evolution of the pandemic.
Following the release of the quarterly GDP figures, US President Donald Trump released a tweet in which he wondered whether the US election could be delayed “until people can vote properly, securely and safely.” Even if it is not in the president’s power to decide on the date of the election, this tweet created an outcry in the media and the Democratic party, where it was often viewed as a confirmation of Trump’s authoritarian tendencies and an attempt to undercut the US democracy. Since the power to postpone the date of the election has resided with Congress since 1845, Trump’s tweet must be read as a signal of how he is ready to contest any result that would not see him as the victor in the US presidential race in November, as we discussed in our column on April 20.
But the economy is not the only preoccupation of President Trump at the moment. After putting the popular video-sharing social medium Tik Tok under scrutiny for representing a possible threat to national security, Donald Trump said he was ready to ban its operations in the US, where it counts around 50 million users. The company responded that the data it collects is stored in US-based servers (confirming once again how relevant the concept of digital sovereignty is becoming), with limited and controlled access from its employees. Some read Trump’s move as a way of either jeopardising the potential sale of the US arm of Tik Tok to Microsoft, or as an attempt to reduce Tik Tok’s price.
This is yet another confirmation that one of the main battlefields of the ongoing Cold War 2 between US and China is the tech race between the two superpowers. In a separate, but related field, our recent report on the “stunning” alliance between China and Iran discusses how Cold War 2 is taking shape in the more traditional domain of strategic alliances.
While all of this is going on, the Democratic contender in the November race, Joe Biden, will soon announce the choice of his running mate. Many see this as a potential turning point in the campaign. Biden is set to choose a candidate who, unlike himself, is not old, or male, or white, and for this reason the most credited contenders for the position are Susan Rice and Kamala Harris. But this choice must be considered in the broader context of the US presidency.
Biden, if elected would at 77 years old be the oldest US president in history at the time of his inauguration. He already hinted at the possibility of running for only one term, making his VP the natural candidate for succession in 2024. There is also a possibility that Biden could resig duringhis first term, which would of course would directly make his VP ascend to the presidency. Knowing all this, any Republican voters or swing voters who might be inclined to vote for Biden just to make sure that Trump is not re-elected in November, might want to be reassured that Biden’s running mate is as mainstream a politician as possible.
by Brunello Rosa
27 July 2020
We have often discussed how a key component of the ongoing Cold War II is a technological conflict between the incumbent dominant power (the US) and the rising star (China). Last week, US microchip producer Intel, for decades the undisputed leader in its sector, announced that it had fallen behind its development plans by at least one year, thus leaving its main competitor, TSMC a Taiwan-based company, as the leader in its field. This has been read by some analysts as the latest confirmation of the US losing its dominant position in technology, an area that for decades was the ultimate key to American success.
But this is only the last episode of a much wider saga. In particular, the battle for the distribution of 5G technology represents a significant front in the ongoing tech wars. Recently, the UK has also joined its fellow countries of the Five Eyes (US, Canada, Australia and New Zealand) in the broader Anglosphere, with the decision to gradually phase out Huawei in the provision of technology for the 5G British network. This was a decision that came after repeated and heavy pressures were placed on PM Boris Johnson by the US.
In this raging tech war, we must note the impetus that the Coronavirus pandemic has given to cyber-wars, as we discussed in our recent two-part report on the subject. Part 1 of that report focused on US and international developments, Part 2 focused on national developments in Russia, EU, Israel and China. The rapid increase in digital technologies that has occurred in order to provide business continuity during the long months of widespread lockdowns has made most countries, institutions and companies much more vulnerable to cyber attacks than was already the case before the pandemic began.
In the future, we will have to assume that the failure of diplomatic avenues in any serious dispute between countries could result in one of those countries carrying out a cyber attack. Such attacks will, perhaps, be launched by non-state entities at the behest of a state, in order to provide that state with “plausible deniability”.
These technological developments will certainly impact traditional areas of finance as well, such as banking. As we have discussed in our recent in-depth report on the future of the banking industry, traditional lending institutions already find themselves under siege by fin-tech developments coming from the private sector. On the other side of the spectrum, central bank digital currencies (CBDCs) developed by the public sector will pose an additional threat to the traditional business model of financial institutions.
Both sides will continue to squeeze banks in the middle.
Given the widespread use of digital technologies, fin-tech developments will continue unabated in their aim of increasing efficiency and granting access of financial services to larger segments of the population which otherwise have little exposure to financial services. Central banks (with China and Sweden leading the race) will continue their journey to the eventual adoption of CBDCs, which are seen as the key to solving the next systemic crisis.
Traditional banks will have to adapt their modus operandi to fit this radically changed environment. As we discuss in our report, the key elements of their new business model will have to be digitalisation, a consumer-centricity, and further specialisation regarding local needs. This will be a process that will surely lead to further consolidation in the industry, with fewer players left on the battleground afterwards.
by Brunello Rosa
20 July 2020
Since last Friday, the special EU summit to decide on the implementation of the Recovery and Resilience Facility is taking place in Brussels, with European leaders meeting in person for the first time after months of video conferences.
The summit started with a great distance between the positions of the so-called Frugal Four (Austria, Netherlands, Denmark and Sweden) – which became Frugal Five when Finland joined the group – and those of the Mediterranean front of Italy and Spain (which is supported by France). The former group wants a reduction of the overall package proposed by the EU Commission, namely EUR 500bn in transfers and EUR 250bn in loans, and a significant reduction in the amount made up by transfers. Within this group, the most aggressive position is expressed by the Netherlands, whose PM Mark Rutte seeks to win a majority in his country’s parliamentary election next spring. The Netherlands, for a change, is not simply the “bad cop” of the duo with Germany. Rather, the two countries entered this meeting with two different strategic objectives. The second group of countries wants the overall size of the program to be left unchanged, and wants transfers to remain the bulk of it.
There is also a third front at the table, representing the nations of the so-called Viségrad group (Czechia, Slovakia, Hungary and Poland). Those countries, among the largest beneficiaries of EU funds (Poland in particular) want to make sure that their quota of funds in the new Multiannual Financial Framework (MFF) remains intact.
Alliances across regions (North/South, East/West) and political families (People’s party, Socialists and Democrats, Liberals) are variable, and subject to change opportunistically.
In the middle of these different positions is Germany, with Angela Merkel trying to broker a historic deal during the period in which Germany holds the rotating EU presidency, to make sure that the eventual result is acceptable to everybody. Germany is doubly putting its face on this deal.
The EU Commission that made the initial proposal discussed at the summit is led by Ursula Von der Leyen, the former German defence minister and protégé of Angela Merkel. In addition, Merkel herself is looking to complete her long period in service with an agreement that could prove historical. Merkel’s goal is passing the EU to the next generation of European leaders, with some of the elements of solidarity that characterised the initial project still intact. So, Germany cannot risk that this summit ends with no results.
Given such distance between the positions of various blocs of countries to begin with, the sessions on Friday, Saturday and Sunday not surprisingly finished in acrimonious discord.
Various proposals have been presented by EU Council President Charles Michel to reduce the overall size of the package and the share of that package made up by transfers rather than loans, to make the deal more acceptable to the Frugal Five. The latest proposal foresees EUR 390bn of grants and will be discussed starting from Monday afternoon. We expect that, eventually, a compromise will emerge, if not at this meeting, at a new one later in July.
by Brunello Rosa
13 July 2020
The number of Covid-19 cases worldwide is increasing. It has now nearly reached the 13 million mark, causing almost 600,000 reported deaths. Some countries, especially in Europe and Asia, are experiencing an increase in new cases, though only to a limited extent so far, after re-opening their societies following long periods of lockdown. In other countries, such as the US and Brazil, the situation is worse; according to some experts, infection rates may already be out of control in these countries. In the US in particular, where the number of cases has now reached 3.2 million, the spread of the virus is still increasing exponentially, suggesting that the adoption of new social-distancing measures is likely to occur during the next few weeks.
As lockdown measures have eased, economic activity has been picking up, recovering from the lows touched in Q1 and Q2. Unless restrictions are re-imposed to the same extent as occurred during the first part of the year, or new restrictions imposed upon large economies such as the US have massive spillovers to the rest of the global economy, Q3 GDP growth should show a positive figure in many countries, given base effects.
In spite of the recovery in economic activity, the support of economic policy remains essential. As far as fiscal policy is concerned, most governments are still providing stimulus by way of new or renewed packages. In the US, a third fiscal easing package is underway. In the UK, the Chancellor of the Exchequer has just announced a new set of measures to support economic activity, such as the temporary reduction of VAT on certain products and services and of the stamp duty on certain real-estate transactions.
In the EU, this week there will be another summit to make progress towards the approval of the EU Recovery and Resilience fund, which should support the economies most hit by the Covid pandemic, such as Italy and Spain.
In all this, central banks are taking a breather. In recent weeks, after the massive monetary easing programs announced during H1, most central banks are adopting a wait-and-see approach. Some of them, such as the Reserve Bank of Australia, have even started to reduce their intervention in markets as the economy stabilises. This week, there will be the monetary policy meetings of the European Central Bank (ECB), Bank of Japan (BOJ) and Bank of Canada (BOC). The BoC will release its first set of forecasts since the pandemic begun, and the BoJ will update its economic outlook. As we have written in our preview, we expect them not to change their policy stance, while remaining ready to add monetary stimulus should economic and financial conditions deteriorate in coming weeks.
Central banks, which have been at the forefront of the policy response during the global financial crisis, have already used most of their conventional and unconventional arsenal. At this point, they prefer fiscal policy, and regulation, to be in the driving seat. At the end of July, the FOMC of the Federal Reserve, which sets the tone for most central banks with its decisions, will meet. It is likely to adopt a similarly cautious approach, although with the worsening healthcare conditions in the US discussed above, the meeting might result in the decision to further increase its stimulus, for example by widening the depth and spectrum of its credit-easing facilities.
by Brunello Rosa
6 July 2020
A few weeks ago we warned that the world will look very different after Covid from how things were at the end of 2019. Some of the changes we envisioned are already occurring.
We mentioned how China would try to use the crisis to make geo-strategic gains relative to its rivals, primarily the US and, more broadly, the Anglosphere. In this respect, the new more assertive geopolitical stance taken by China was visible in the military exchange that occurred between China and India in the disputed territories of the Himalayas. This direct military confrontation risks pushing India more towards the US sphere of influence, at a time when US President Trump has already expressed sympathy towards authoritarian or nationalistic leaders like Narendra Modi.
But the geopolitical confrontation between China and the Anglosphere is occurring on other fronts as well. As we discussed in a recent column, the blame game over the origin of the Covid-19 pandemic must be interpreted as part of a wider containment strategy with regard to China, a strategy which also includes the probable decision by the UK government to gradually phase out Huawei from its 5G network, following similar steps already taken by both the US and Australia.
Meanwhile, the US is still mired in the middle of a surge in Covid-19 cases, with erratic management of the crisis by US President Trump. The US now has about one quarter of the 11 millioncases of Covid recorded worldwide. As a result, the EU, which has just re-opened its external borders, has excluded the US from the list of countries from which citizens can arrive without having to undergo a period of quarantine. The US is about to enter one of the most heated presidential elections in its history, with Trump already openly speaking of “rigged” elections, alleging irregular vote-by-mail schemes and ballots printed by foreign countries.
There is even the risk that, unless the Democratic candidate Joe Biden obtains a large majority in the electoral college, the president will refuse to accept the result of the election and will not leave the White House in January 2021.
In the middle of the US and China, there is always Europe, which is trying to overcome its many contradictions. As we discussed in our recent in-depth analysis, the EU is in the middle of a difficult negotiation regarding the Recovery and Resilience Fund, with the Frugal Four (Sweden, Denmark, Austria and Netherlands) asking for much stricter conditionality attached to any funds sent to the countries that have been most impacted by the crisis, primarily Italy and Spain. In a recent interview, Greek PM Kyriakos Mitsotakis said that he will not accept the approval of a recovery instrument with too much additional conditionality compared to regular fiscal coordination and surveillance.
In our analysis we also discussed the national implications of such a deal, in particular in France. There, President Emmanuel Macron decided to sack Prime Minister Edouard Philippe, following the defeat of the president’s party in the local elections last week. He substituted Philippe, who had become more popular than the president for his good management of the Covid emergency, with Jean Castex, another “Enarque” who advised the president on the re-opening of the economy post-lockdown.
These movements, apparently simple domestic politics, are of the greatest importance ahead of the 2022 Presidential election. As we have said many times before, if Macron does not win a second mandate, the entire European integration project could be in serious jeopardy.
by Brunello Rosa
29 June 2020
Last week, equity indices suffered despite a rebound in economic activity in some key economies. This occurred as a rise in COVID-19 cases, especially in the US and Brazil, as well as fresh warnings over the global growth outlook and the Fed’s warning of a cap to ‘shareholder payouts’ all weighed on market sentiment.
On a weekly basis, global equity indices fell (MSCI ACWI, -0.6%, to 524), driven by the US (S&P 500, -0.5% to 3,084) and the EZ (Eurostoxx 50, -1.5% to 3,219). From the beginning of the year, the S&P 500 index is down 7%, Eurostoxx 50 is down nearly 15%, the UK’s FTSE 100 is down 18% and Nikkey 225 5%. These figures are very much in line with what we predicted a few months ago, perhaps with the only exception of NASDAQ, which has surprised us as well as market participants with a more positive than expected performance. The NASDAQ is up 9% year-to-date, mostly due to the fact that pandemic has further boosted the use of technology for business continuity.
Have these depressed valuations re-aligned equity indices with economic fundamentals? We don’t think so. Last week, the IMF released a revision of its World Economic Outlook (WEO), which featured a significant further downward revision of expected global growth, from the -3% predicted in April to -4.9% predicted now. US growth is expected to be -8.0% in 2020 (a 2.1% downward revision as compared to April’s prediction), the UK -10.2% (a -3.7% downward revision as compared to April’s), and the Eurozone at -10.2% (a -2.7% downward revision). These new forecasts are now more aligned with our own more pessimistic estimates made in April. This week, we will publish our revised forecasts alongside the Strategic Asset Allocation.
Recently, the OECD went even further than this economic outlook of the IMF. In its June forecasts, the OECD foresees a 6% contraction in global GDP (if no “second wave” of the pandemic occurs – the so called “single-hit scenario”), and -7.6% contraction in case of a second wave (the “double-hit scenario”). It expects the US to lose roughly 7.3%/8.5% of GDP in 2020 (depending on whether or not a second wave occurs), the Eurozone 9.1/11.5%, and the UK a staggering 11.5/14%. So, either these growth forecasts are too grim, or else market valuations are too optimistic.
At the beginning of the year, we warned that there was a large discrepancy between risk asset valuations, especially equities, and economic fundamentals. The collapse in valuations following the global outbreak of Covid-19, which marked the beginning of the fastest bear market in recent history, had temporarily solved that discrepancy, by bringing valuations closer in line with economic fundamentals. But the rapid recovery in equity indices (pushed by central bank liquidity) led also to the manifestation of the shortest bear market in recent history, with valuations departing again from economic fundamentals.
In our recent analysis, we warned about the possibility that a U-shaped (or W-shaped) recovery could be accompanied by a V-shaped rally in financial markets. However, our recent in-depth analysis shows that equity valuations seem to be mis-aligned not just with macroeconomic fundamentals, but also with microeconomic variables that serve as an input for equity valuation models, such as expected earnings per share. There is also a mis-alignment with the signals from the credit market, in particular the expected default rates. What is underpinning high valuations seems to be only low interest rates (both current interest rates and expected future interest rates), which is a purely circular argument. Clearly, central bank liquidity has been underpinning valuations for a long time now. It is perhaps to break the virtuous (but also vicious) circle that, after the easing spree of March/April, most global central banks are now adopting a more cautious stance, with a partial withdrawal of some of the extraordinary measures introduced in the last few weeks.
In any case, the evolution of the pandemic and the global economy remain highly uncertain, and so “prudence” should be the buzzword for market participants at this time.
by Brunello Rosa
22 June 2020
Last week, China announced that a number of boroughs in Beijing had to be locked down as a result of a new localised outbreak of Covid-19 in the city, possibly originating from another food market. The Chinese authorities said that investigations concluded that the coronavirus strain detected at the Xinfadi market in Beijing came from Europe, even if they admitted that this particular strain “has existed longer than the current coronavirus strain circulating in Europe.”
So, it appears that China is now making accusations of other countries and regions for the possible second wave of pandemic it might be suffering. This is, of course, similar to the way most countries have accused China for having caused the pandemic in the first place, whether “naturally” (if the virus spread out the wet market in Wuhan), or “artificially” (either intentionally, or by accident, given the presence of the notorious research lab in Wuhan itself). What then should we make of this blame game between China and the rest of the world?
One should not be confused by the exchanges of allegations between politicians and even heads of state and governments. In most cases, these allegations are made to assuage the domestic opinion more than to attack the foreign entity, in order to distract attention and divert responsibility away from themselves. This is a usual game in politics. However, there is also something deeper going on now, which makes the current situation different from those which typically exist.
As we discussed a few weeks ago, we believe that after this pandemic, and after the containment measures that have been adopted to counter this pandemic, the world will look very different from how it was until the end of 2019. In particular, the economic or political power ranking of countries and regions could change on a global scale.
For certain, the economic and political “distance” between the major global players will be very different: for example, China will be able to reduce the gap with the US on a number of dimensions. The US, with its erratic response to the pandemic, and its inability thus far to rein in the pandemic, will most likely lose ground versus China, whose response to the virus having been much more rapid and forceful. Europe is still debating which policies to adopt to recover from it.
The US and its closest allies in the Anglosphere (the so-called “Five Eyes”: the USA, UK, Canada, Australia and New Zealand) are trying to respond this evolution of events. Clearly, the first point of attack is about the origin of the crisis, which is undoubtably in China; emphasizing this fact also serves to diminish the relevance of Beijing’s strong response. For the first time in history, countries or state entities (such as Missouri and Mississippi) have expressed their intention to ask for “compensation” or “reparations” in non-war related circumstances, and this will continue to put pressure on China.
But there are other open fronts as well. As we know, the new Cold War between US and China has several components, one of which is the very relevant technological competition. Recently, the US imposed further restrictions on Chinese tech giant Huawei (which were subsequently partly eased).
Countries in America’s inner circle, such as Australia, have taken similar measures. This has meant a sharp deterioration in the bilateral relationships between Beijing and Canberra, even despite the fact that China has been the main importer of Australia’s iron ore and coal in the last few years. But in the “new world order” of disrupted global supply chains, geopolitical considerations will trump economic cost/benefit analysis. This is an unfortunate evolution. It will eventually hurt the end consumer globally, as it will lead to a reduced choice of products and higher prices.
by Brunello Rosa
15 June 2020
In this world of de-materialised data, where the control of the cyber space and the most advanced communication and information technologies seems necessary to gain a strategic advantage versus the geo-political rivals, it is quite dystonic to learn how global and regional powers still consider the control of the sea as a key factor for assert dominance over a geographical area.
We have discussed many times how the new Cold War between US and China was increasingly driven by the technological competition between the two world’s super-powers, in particular in the fields of artificial intelligence, big data and 5G technologies, with the US trying to at least slow down China’s Agenda 2025, foreseeing the Asian giant becoming the world’s first country in the most technologically advanced sectors of the future. More recently, we have discussed how Russia, the world leader in cyberwarfare techniques, was using the Covid-induced crisis to make geo-strategic advances by using its competitive advantage in the field.
But exactly when all the advanced world is making the greatest use of online technologies to carry on its economic activities and circumvent the restrictions imposed by the lockdowns, we learn how the good old control of key maritime routes and straits, or the acquisition of naval basis is still considered a key ingredient for asserting geo-strategic dominance.
In the G2 heightening rivalry between US and China, the disputes over the east and south China sea have acquired absolute prominence in determining how the rivalry will evolve, including regarding the still unresolved trade dispute. As discussed in our recent report, roughly $5 trillion of trade passes through the South China Sea (SCS) each year, including oil and natural gas. It’s clear that controlling SCS enables China to potentially choke off these routes and severely impair neighboring economies and global trade.
Press reports suggest that Beijing has steadily fortified seven islands or reefs, equipping them with military bases, airfields and weapons systems. This means, that while US President Donald Trump might be trying to apply the Art of The Deal in the negotiations, China might be applying the Art of War by general Sun Tzu, implying that any comprehensive trade deal with China might need to include a resolution of SCS sovereignty issues, potentially an unachievable result.
Clearly, China’s difficulty in projecting its geopolitical influence by controlling the seas is a massive constraint, compared to the US historical prevalence over the Atlantic and Pacific oceans. The Belt and Road Initiative (where the “Road” is a maritime route) is a way for China to break that constraint disguised behind commercial interests.
In other reports, we have discussed how the control of the strait of Hormuz was considered by Iran as a key to re-assert its authority in the Persian/Arabian gulf, potentially impairing global trade of oil from the region.
Finally, in our recent report, we have discussed how geopolitical tension was rising in the Mediterranean sea, with two open fronts in Syria and Libya, where regional powers are playing their chess game. Turkey and Russia seem now close to reach an agreement on the two fronts, with Tukey having completed its “Open Sea Training” operations (thus extending its maritime influence from the Dardanelles to Cyrenaica), and Russia getting closer to achieve its most cherished goal: naval bases in the west Mediterranean sea (in Bengasi – together with the air base in Al Jufra), to complement its historical posts in Latakia and Tartus in Syria. Controlling what the Romans called Mare Nostrum(“Our Sea”) seems to be, two thousand years later, still a desirable strategic objective.
by Brunello Rosa
8 June 2020
In our column in October of 2018, following Jair Bolsonaro’s victory in the first round of Brazil’s presidential election, we asked: “Will The World’s Next Strongman Come From Brazil?”. Bolsonaro, who had been an underdog in the election until he was stabbed at a campaign event only one month before the vote took place, had already been displaying all of the characteristics of the strongmen who were already populating the globe at that time (Trump, Putin, Xi Jinping, Orbán, Kaczynski, Erdoğan, Duterte, Modi, etc.), including a passion for (or in his case, a past within) the military, an admiration for non-democratic regimes, and a preference for the use of force to solve international and domestic disputes.
Fast forward almost two years later to today, and, taking into account the natural tendency of Covid-induced economic restrictions to strengthen autocratic behaviours, here we are: Bolsonaro is not only proving to be the world leader who is most reluctant to adopt containment measures against the spreading of Covid-19, a reluctance which has made Brazil the new epicentre of the pandemic, together with the US, but a judge from the country’s Supreme Court has also accused Bolsonaro of wanting to abolish democracy in Brazil in order to establish an “abject dictatorship”. Justice Celso de Mello, in a WhatsApp message leaked to the media, reportedly said: “We must resist the destruction of the democratic order to avoid what happened in the Weimar Republic when Hitler, after he was elected by popular vote, did not hesitate to annul the constitution and impose a totalitarian system in 1933.”
These allegations came after Bolsonaro attended a rally at which demonstrators, wearing paramilitary uniforms, called for Brazil’s parliament and supreme court to be shut down and be replaced with military rule, and after Bolsonaro’s Minister of Culture was forced to resign after quoting Joseph Goebbels, the Nazi minister of propaganda. This should not be surprising, given that Bolsonaro packed his government with more than 100 current and retired military officers, including his vice-president and at least 6 cabinet ministers.
In a recent in-depth analysis by John Hulsman, we discussed Bolsonaro’s record in government, showing how the president of Brazil has been out of his depth over myriad issues hamstringing his erratic presidency. In particular, we noted how three C’shave been plaguing the populist leader: (lack of) Competence, (lack of) Competition within the right-wing camp, and Corruption; and how these have dramatically morphed together into an existential threat to Bolsonaro’s continued rule.
At the same time, we also noted the three B’s that could lead to his political salvation: Beef (Agribusiness), Bullets (the Military), and the Bible (the growing number of Brazilian Evangelical Christians). In fact, much of the President’s enduring and loyal political base is clustered around these three groups. These constituencies could help Bolsonaro politically survive, or even thrive, for a continued period of time. Indeed, we concluded our analysis of Bolsonaro’s political record by noting that although Bolsonaro is embattled, he is probably in no immediate danger of impeachment.
But while the three B’s are protecting Bolsonaro from impeachment, and while his power base is holding for the present, none of the three C’s have been even remotely dealt with. As time passes, and these structural problems turn increasingly septic, what seems now to be a slow unspooling of the Brazilian president may suddenly become a torrent that washes away “The Trump of the Tropics” for good.
Before this happens, though, the risk remains that Bolsonaro will officially or unofficially suspend democracy in Brazil, bringing a return of the dictatorship that the country abandoned in 1985.
Picture Credit: Julio Cortez/AP
by Brunello Rosa
1 June 2020
In the last few days, the streets of Minneapolis and other major US cities have been filled by people protesting the treatment of George Floyd, who died while in policy custody. The facts are sadly well known, and the fact that the police officer Derek Chauvin has been arrested did not placate the ire of the African-American community or the wider population. Protests have become violent in the last couple of days, as they have in previous similar occasions, most notably in Los Angeles in 1992, after a trial jury acquitted LAPD officers’ accused usage of excessive force in the arrest and beating of Rodney King.
So, this type of episode is unfortunately not new, and it will likely happen again in future. What makes this episode peculiar and particularly noticeable in this period is that it is happening as social tensions are clearly on the rise, with a number of protests being staged in various parts of the US against the lockdown measures introduced in many states. The most worrying of these took place outside the Michigan Capitol building in Lansing on April 30, when a number of protesters showed up equipped with firearms.
This is quite concerning, considering this is a year in which one of the most tense presidential elections in US history will take place. The election will be tense not just because of the logistical difficulties resulting from Coronavirus, or from the fact that the margin between the two contenders is likely to be small, but also because there is widespread concern that if Trump were to lose, he might not accept the result – even were it to come in the form of a verdict from the Supreme Court – and will instead refuse to leave the White House.
These episodes are taking place in the US, but other parts of the world are not immune from this same sort of situation. Protests against lockdown measures are happening in many different countries: the UK, Germany, Australia, Belgium, Italy, Poland, etc. At this stage, most of these protests are motivated by social anger against the restrictions that have been placed on personal liberties. In some cases, they have also been motivated by dissatisfaction regarding the economic impact of the measures being adopted to stop the spread of the virus. But even if the lockdown measures were to be alleviated in coming months, social tension might not ebb.
In fact, the real economic impact of the anti-Covid measures will be felt in the autumn. In Q2, there was an immediate impact deriving from the closure of economic activities. But those companies that could remain open used these months to process the orders arrived until the end of Q1 2020. But in Q3/Q4 2020 it will be clearer how many businesses have in fact survived, and how many new orders will have arrived.
The risk is that the collapse in economic activity of Q1/Q2 will have a long-lasting impact on economic systems, with serious repercussions on employment and, therefore, on social cohesion. This is the reason why governments around the world are trying to gradually re-open their economic systems, and why support in the form of government policy will need to remain abundant for the foreseeable future.
by Brunello Rosa
26 May 2020
We have been following the vicissitudes of the EU integration process for years now. To recap the milestones of our view, we have been saying that unless the EU changes tack, it will be very hard for the incomplete federalisation process of Europe to survive in a new world in which continental economies (the US, China, and India) will make the most relevant geo-strategic and economic decisions. Covid will make this new world come sooner than anticipated, even if the relative ranking of countries will be different than would have otherwise been the case.
The EU is currently an incomplete transfer union, in which resources (human, physical and financial capital) move from the periphery to the centre. The two main poles of attraction have been the UK (within the EU) and Germany (within the euro area). Somewhat ironically, one of the greatest beneficiaries of these influxes, namely the UK, has decided to leave, because the influx of migrants became politically unsustainable (or so the Leave campaign sold it as being). Brexit has proved us right, that the EU dis-integration process has begun.
The optimists believe that without the UK a more cohesive union will emerge, and therefore the integration process will finally be able to proceed. This is likely to be an over-estimate of what will actually take place. The presence of the UK was the excuse all other reluctant countries were using not to proceed further with the integration process. Was the UK blocking the completion of the euro-area banking union with the adoption of EDIS (the European Deposit Insurance Scheme)? Of course not. It was Germany that was doing so.
With the rise of populist parties in all major EU countries(Germany, France, Italy, Spain, and Poland) and also in smaller countries (Hungary, Czech Republic, etc,), it was clear that, a soon as any severe crisis would arrive, it would constitute an existential threat to the EU.
And, at that point, the EU would reveal whether or not it was up to the game, by completing its integration process, or else accelerate the ongoing dis-integration process. The shock has now arrived, of course, with the Coronavirus. We wondered whether the EU would finally face its “Hamilton moment” (i.e. finish its integration process) or, instead, its “Jefferson moment” (return to some form of Confederation, with limited sharing of sovereignty).
Facing the abyss, France and Germany have tried to come up with a proposal to mitigate the devastating effects of Covid and lockdowns on the economy of the continent. In an interview, German Finance Minister Olaf Scholz has called it Europe’s “Hamilton moment.” We wish that was true. The proposal has merits, and is in line with our previewfor how the EU would respond to the Covid crisis.
But some of the details reveal that we are still quite far from any form of debt mutualisation, and the distrust that exists between the Northern “frugal four” (Finland, Denmark, Austria, Sweden) and the “profligate” Southern countries (Italy, Spain, Greece, etc.) remains high. We will see what the Commission proposal looks like on May 27, and what compromise the Council will be able to make in June and the following months.
Our suspicion is that we will merely witness another round of the eternal “muddle through” that seems to characterise recent European history. To some extent, this would be better than the immediate collapse of the EU project, as any such collapse would have enormous economic, social and political costs. On the other hand, we doubt that any “more of the same” approach will equip Europe to succeed in the post-Covid world.
by Brunello Rosa
18 May 2020
We have discussed several times how serious the Coronavirus-induced economic crisis is. The lockdown measures introduced by many countries to mitigate the spreading of the virus have created a collapse in economic activity, on the order of 20-40% on a quarterly basis. This could result in a fall in real GDP of about 7-10% in many developed economies, with a rebound next year that will be mushy and uneven at best.
To mitigate the economic impact of Covid-19, a number of countries have adopted large stimulus packages consisting of fiscal expansion and monetary easing, in most cases in a coordinated fashion that closely resembles helicopter-money drops. Financial markets have, as usual, anticipated economic developments – equity prices collapsed around the world at the end of February/beginning of March, sending most of them into bear-market territory (-30% from their peak). Other segments of the market have given clear signs of dislocation. As discussed in our recent outlook, oil prices turned negative for the first time in history on April 20, as the collapse in global demand more than offset the cut to production that was decided upon by OPEC+ (including Russia) on April 12th.
Since the lows reached on March 23rd, equity markets have tried to rebound, but have done so with varying degrees of success. In the US, the S&P500 has recovered around half of the losses; it is now only down 11% year-to-date. The NASDAQ has managed an even more astonishing rebound, being at par year-to-date, thanks to the even more widespread use of technology during the lockdown. The Dow Jones, in contrast, which represent more traditional industries, is down 17% year-to-date.
In Europe, where the pandemic has led to harsher forms of lockdown (which are now being relaxed), the situation is less rosy, with the exceptions of Switzerland and Sweden. Equity markets remain down 25%-30% year-to-date. All these developments are in line with what we expected in our global outlook update.
As we previously discussed, a sustained recovery in market valuations could only occur when a durable solution (a vaccine or medication) to the healthcare crisis is in sight. Until then, market valuations will remain subject to downside risks. Nevertheless, as markets are leading indicators of economic activity, they will start to recover much sooner than the real economy. Conversely, the unemployment rate, which is a lagging indicator, will take much longer to normalise than economic activity in general. In the US, where unemployment insurance schemes and other similar automatic stabilisers are less widespread than in Europe, initial jobless claims reached 36 million in the first 7 week of the crisis. Non-farm payrolls dropped by 20.5mn in April, the largest monthly drop on record, with the country’s unemployment rate reaching 14.7%, up from the historically low 3.5% rate just a couple of months earlier.
Public authorities are coming to the rescue: the Fed has just launched a Main Street program of credit easing. But the reality remains the same as it has been since the Global Financial Crisis: the liquidity injections by central banks tend to translate into asset price reflation, which mostly helps Wall Street, while other measures, even those akin to helicopter drops of money, leave Main Street in the doldrums. Again, this could be the result of the difference between leading and lagging indicators of economic activity, with equity prices rising much more quickly than unemployment rates in the wake of a serious crisis. But perhaps it could also signal the need to refocus the aim of the stimulus packages in the first place.
by Brunello Rosa
11 May 2020
According to the most recent statistics, the UK is now third in the ranking of countries most affected by Coronavirus, after the US and Spain. It is second (after the US) in terms of number of deaths, with around 32,000 reported victims. Given the severity of the situation, the government, after initial hesitation, launched a complete lockdown of the country and its economy on March 23rd. Now, the government seems ready to relax some of these rules (for example, on daily exercise), while also tightening boarder controls (e.g. imposing a 14-day quarantine on anybody arriving in the UK). The central government – but not, for example, the devolved government in Scotland – is ready to move from the slogans “Stay Home/Protect the NHS/Save Lives” to “Stay Alert/Control The Virus/Save Lives”.
The impact of the pandemic and lockdown on the UK economy was recently estimated by the Bank of England, in the “illustrative scenario” described in its May Monetary Policy Report. The Bank estimated a 14% drop in the UK’s economic activity in 2020, followed by a V-shaped recovery of 15% in 2021. This estimate takes into consideration the overall policy response, namely a massive fiscal stimulus accompanied by a large monetary easing package, including rate cuts, increased QE and credit easing measures. The fiscal stimulus includes the innovative Job-Retention Scheme, by which the government will pay 80% of the salary of “furloughed” employees (up to GBP 2,500 a month) as long as their companies do not fire them, until June 30. The monetary stimulus includes a form of direct fiscal deficit, with the re-activation of the Bank’s “Ways and Means”, i.e. the Treasury account at the BoE.
While the pandemic and containment measures take their toll on the UK economy, the other major chapter of the UK’s political economy, Brexit negotiations, has re-started. As we have discussed in our previous analysis, the UK has no intention to seek another extension to the implementation period beyond December 2020.
The EU now seems to have accepted this position, which initially was motivated by the UK’s intention not to repeat the experience of requesting multiple extensions as occurred during the prime ministership of Theresa May, which led to political chaos. But now there are two additional motivations, which we consider to be even stronger.
First, as we explained in our analysis, “no deal” Brxit is the only logical conclusion of the approach brought forward by Johnson and his political side of the Conservative party, which won in a resounding way at the December 2019 elections. Second, the economic damage caused by the pandemic and the containment measures will easily mask any economic damage deriving from “no-deal” Brexit. The most visible aspect, namely travel restrictions and border controls, would be implemented anyway due to Covid.
Thus for now the UK government has all the advantages of not seeking for an extension by June 30 while knowing that it can always get one at the very last minute). It will make “no deal” more likely, thereby strengthening its negotiating position at the table. And if a hard Brexit does occur, it is probably what hard-Brexiteers such as Boris Johnson and his chief advisor Dominic Cummings, Dominic Raab (currently foreign minister and senior secretary of state) and Michael Gove (in charge of Brexit planning) ultimately want.
What happens if a no-deal, hard Brexit eventually occurs as a result of this tough negotiating approach? Well, the economic damage deriving from leaving the customs union and the single market without a deal, as well as increased border controls and customs checks, will likely be attributed by the government to the pandemic and the lockdown, rather than to the hard Brexit. The UK will also be free to respond to the additional economic shock by completely dis-aligning itself from the EU in terms of taxation, regulation, as well as product and labour standards. In the post-Covid world, where every country will try to do as much as possible just to remain afloat, the UK position might even not be perceived particularly at odds with that of other European countries, including those who will remain in the EU.
by Brunello Rosa
27 April 2020
We have discussed the macroeconomic impact of Coronavirus in several recent columns and research pieces. It is clear that we have already started witnessing large falls in economic activity around the globe in Q1. In some countries, GDP had fallen already 4-5% on a quarterly basis, and the collapse of real GDP growth will be in double digits in Q2. As a result, oil prices have collapsed into negative territory for the first time ever. Unemployment rates are soaring everywhere, with the US having witnessed a 30mn rise in initial jobless claims in the last six weeks, wiping out the gains made over the past several years.
Governments and central banks are coming to the rescue with large stimulus packages, but these will still struggle to reach small and medium sized enterprises (SMEs) and the self-employed, which will be decimated by the crisis. Helicopter money works only if money reaches every corner of the system, without remaining concentrated in the hands of a lucky few and without remaining concentrated in intermediary institutions such as banks.
When economies and societies do re-open, nothing will be like it was before. We will have to live together with the virus for so many months, potentially for another year until a vaccine becomes available on a large scale for most of the global population. Until that time social distancing will remain the mantra in most work and business environments.
Teams might need to work on alternate days or weeks. Open-space offices will remain unfilled for the months to come. In the aviation industry, planes will fly half empty and airports will devote much larger spaces to passengers.
In the hospitality industry, restaurants will have to find ways to serve food while complying with social distancing regulations, and hotels will remain half empty at best.
In such an environment, what is the right strategy to adopt in order for your business to survive? Well, during the financial crisis, Richard Koo’s theory of “balance sheet recession” got a lot of attention. It was based on the fact that, in a financial crisis, private sector agents are trying to deleverage, and therefore the only entity able to increase its debts is the government. In such an environment, private sector agents switch from being profit-maximisers to become debt-minimizers, to regain financial viability.
In this crisis, unless private-sector agents receive grants from public authorities, they will need to take loans, which banks will offer at a very cheap rate and with favourable conditions as a result of central bank’s credit-easing measures. In this crisis, therefore, private-sector agents cannot afford to be debt-minimizers. Also, especially companies should forget about being profit maximisers, in order to avoid frustration and disappointment. In an environment such as the one described above, they will be forced to run at half-capacity at best and therefore they will surely suffer losses.
Since losses will come no matter what, the ideal business strategy to adopt is to minimize such losses, without regretting too much the lost revenues and profits. Most of those losses, especially in public services, will likely be subsidised by the government. In some cases, subsidization will not be possible, and so the aim should be to develop enough internal efficiencies to minimise future losses. The development of the various forms of remote working point exactly in that direction.
by Brunello Rosa
27 April 2020
Last week, we analysed some of the ongoing issues that risk being overlooked as a result of the Covid-induced crisis. One of these issues was the impact of the crisis on carbon emissions. According to recent estimates, with 28 countries in the world having adopted full or partial lockdowns, the movements of a third of the world population are now enduring some form of restriction as a result of social distancing. Economic activity has been severely reduced because of this; the IMF is estimating a contraction of real GDP in 2020 of approximately 3% (but we expect it to be closer to 4%). Some sectors have completely shut down, and international travel, especially via planes, has collapsed. Statistics show that commercial air traffic has shrunk 41% below 2019 levels in the last two weeks of March. The situation since then has likely worsened even more, as more countries have adopted some form of lockdown.
As a result of this collapse in economic and travel activity, air pollution has collapsed, and greenhouse gas emissions have been dramatically reduced. According to the United Nations, since lockdowns and shutdowns begun, CO2 emissions have dropped by 6%. By the time the year ends, there will be an estimated 0.5%-2.2% reduction in CO2 emissions due to Covid (or even 5%, according to some experts), depending on the model adopted to predict the pick-up in economic activity in Q3 and Q4 2020. This could be the first reduction in global emissions since the 2008-2009 Global Financial Crisis.
To some extent, the Covid-induced lockdowns have provided an unexpected, yet welcome, massive natural experiment as to the impact that a reduction on human economic activity can have on greenhouse gas emissions that are responsible for global warming (the rise in the earth’s temperature, estimated to be around 0.2˚ C every decade). This hopefully will resolve once and for all the vexata quaestio of whether global warming is caused by human activity or other unrelated factors.
However, the UN warns, this temporary reduction in emissions will not stop climate change, which derives from the accumulation of the effects of many decades of human activity. Especially if the solution to this crisis will be the implementation of public infrastructure projects that have a significant environmental impact.
While having gone silent in the last couple of months, climate change activists have gained a number of arguments in their favour. Not just on the impact that a reduction of economic activity might have on pollution and global warming, but also on the need for international coordination and cooperation to achieve that result. There is, however, another argument that will likely get traction. As the chart above shows, carbon emissions have increased in tandem with world population, which has risen from the 3 billion people of 1960 to the 7.6bn of 2018 (more than doubling in two generations). The UN estimates that there will be 11.2bn people in 2100, and if greenhouse gas emissions continue to be correlated with world population, the world’s temperature will rise well above any target being discussed in the various Conferences of The Parties (COP) rounds.
Pandemics, if the virus is natural and not man made, may be partly a reaction to overpopulation (and therefore pollution). It is a clear signal the planet is sending that it may not have enough natural resources for all its inhabitants, at least not if resources are so unequally distributed. If the world does keep on increasing its human population without significantly changing its development model, pandemics will become more frequent and deadly in the future.
If, then, we want to learn some lessons from the immense tragedy represented by Covid, they might include the following: 1) human beings are for the most part responsible for the catastrophes that befall them; 2) if the world’s development model does not radically change in favour of sustainability and renewable resources, extreme weather events will continue to affect the planet and pandemics will plague its human (and more generally, animal) population; and 3) only a coordinated and cooperative international approach can provide the solution to these historical issues.
by Brunello Rosa
20 April 2020
We have lately been discussing four fundamental dimensions of COVID: healthcare, economics, policy, and market implications. On the healthcare front, advancements have been made that increase intensive-care capacity (with field hospitals and other logistical arrangements) as well as testing, treatment and progress towards a vaccine. On the economics front, we have just released our latest estimates of the macroeconomic impact of lockdowns around the world. We have often also discussed the policy reaction (fiscal, monetary and regulatory) that will be needed to mitigate the effects of the macroeconomic impact and market implications of all these factors.
Besides these four fundamental dimensions of COVID, we have also analysed what could be the long-term geopolitical implications of this crisis. Namely, China is set to gain the most from a strategic perspective, at the expense of the US, while the EU faces yet another existential crisis.
In this column, we want to discuss some of the events that are now occurring which risk being overlooked because of the pervasiveness of the news regarding the main dimensions of the crisis discussed above. We might call these the collateral effects of COVID. They too could have serious consequences, and perhaps even represent a turning point in the world’s history.
On the one hand, as we have recently discussed in our in-depth analysis, there is the progress that is still being made by various countries in technologies such as artificial intelligence, which could provide a massive geo-strategic advantage to those who master them first. Russia, for example, is certainly using this period to make gains vis-a-vis its international competitors, by making large use of AI, and not just to find a cure for COVID-19. Russia is certainly not alone in this game, but it has a historical head-start over most other countries where cyberwarfare is concerned.
On the other hand, the US is about to enter one of its more turbulent periods in recent history. The US is already the country in the world with the largest number of confirmed cases and deaths, and yet partisanship regarding how to face this pandemic still prevails, with science being regularly questioned by populist political leaders and media. The US will soon have to face an election in a time of the pandemic, the result of which (as we discussed in our recent analysis) is now too-close-to call. There are those who suggest that if Trump were to lose by a small margin and the vote were to be contested, he would not accept the verdict of the Supreme Court, like Al Gore did when he run and lost against George W. Bush in 2000. The requests on Twitter made by President Trump to “LIBERATE” a number of states that are being governed by Democratic governors who are imposing COVID-related restrictions, and the gathering of armed militias to protest those restrictions, do not bode well for the future.
Around the world, authoritarian leaders are using the excuse of lockdowns to increase their grip on power and leave even less freedom to opposition parties and the press. This is happening even in Europe, within the European Union, ostensibly the most advanced defender of civil and political liberties in the world, where Hungary’s PM Victor Orban has created a de-facto dictatorship.
On a larger scale, the fight against climate change has gone incredibly silent in the last few weeks. Clearly there is an even more imminent threat to deal with, but at the same time, the arguments made by those fighting against climate change have been made even stronger by the COVID crisis. The virus, if natural and not man made, is certainly a reaction of overpopulation and pollution. With lockdowns imposed in most countries, the world has just carried out its largest natural experiment as to how pollution can be greatly contained if human activities are drastically reduced. At the same time, the opponents of those advocating against climate change will say that the top priority now is re-starting the world’s economic engine, rather than worrying about the side effects such as pollution and climate change.
All these example show that even as we follow the news about the COVID crisis, we should not lose sight of what else is happening in the world, which could have long-lasting consequences that will become apparent only when the current emergency is ended.
by Brunello Rosa
6 April 2020
The Covid pandemic has now led to more than a 1.2 million people being infected around the world, and 68,000 confirmed deaths. It is now clearly understood that the economic impact of this crisis will be far worse than was the 2008-09 financial crisis, and maybe as bad as that of the Great Depression in the 1930s. It could, potentially, be even worse than the Great Depression (as Nouriel Roubini calls it, a Greater Depression).
After initial hesitations, in particular in the US, UK, Brazil and Sweden, the pandemic has now generated a policy response that is broadly homogeneous around the globe. From a healthcare perspective, partial or total lockdowns have been imposed by several countries, with severe restrictions that can be slightly less draconian in those countries which have a population historically used to self-discipline, such as the UK. Of the largest countries, only the US is still reluctant to adopt serious measures of suppression, preferring forms of light mitigation instead. This is a mistake that will cost dearly down the line.
In terms of fiscal policy, virtually every economy has launched schemes aimed at guaranteeing liquidity and credit to large, medium and small enterprises, and fiscal support to workers, without much distinction between protected salaried workers and unprotected self-employed ones. In terms of monetary policy, almost all central banks in the world have adopted a combination of cuts to policy rates, increasing asset purchases, funding for lending schemes, longer-term refinancing operations against wider collateral, easier access to emergency lending, FX intervention and swap lines. Regulators have relaxed capital and liquidity requirements for financial institutionsto increase their lending capacity.
Despite all this, stock prices in equity markets, sovereign yields of reserve currency countries and oil prices continue to fall. Why? The answer is simple: there is still no light at the end of the COVID-19 tunnel. Even if policy makers throw the kitchen sink at the crisis, they will not resolve the underlying issue, which is the containment of (or the cure for) the virus.
Only medical experts and scientists, in this occasion, hold the key to solving the crisis. The measures introduced so far and discussed above only aim at buying time for scientists to find a solution. Initially, they are intended to flatten the curve of contagion, reduce the influx of patients into hospitals requiring expensive intensive-care units (ICUs), and increase their ICU capacity, perhaps by building field hospitals.
Following these necessary initial measures, progress needs to be made in the other three directions that will lead to the eventual “victory” over the virus. First, testing needs to become available on a much larger scale, in order to trace the diffusion of contagion. And, more so than the current antigenic testing (which tells if somebody is currently infected), the development of reliable forms of antibody tests will be crucial, to easily determine who had been infected and has developed immunity (even if such immunity is only temporary) and could therefore – for example – return to work. Secondly, if a treatment is found that alleviates the symptoms and reduces the need for ICUs, this would mark a major change in people’s perceptions of the virus. It will help people calculate the risk of living in a world where the virus is still prevalent, which is likely to become necessary at some point unless we are willing to keep the world shut for the next 18 months.
Finally, there is the goal of developing a vaccine that would allow people to develop antibodies and return to work. On this front, there might be some promising progress that could speed up the process compared to the 12-18 months currently being estimated. Even still, we are talking about a timeline of several months before the fastest vaccine could possibly become available to millions of people.
Only when some breakthrough on a combination of these fronts occurs will it become possible to realistically say that there is some light that can be seen at the end of the tunnel. At that point, equity prices will find credible reason to rebound. The bad news is that we do not know when these breakthroughs might occur. The good news is that they could happen at any point in time during the next few weeks.
by Brunello Rosa
14 April 2020
As we discussed last week, the impact on economic activity and markets from Covid depends crucially on medical advancements made in the fight against the virus. When progress on the medical front is considered sufficient by market participants, it is likely that risky asset prices will then start to recover (certainly, they will do so before economic activity itself stabilises). The impact of the virus on economic activity could also become smaller if enough advancement is made on the medical front.
While China is facing its second mini-wave of contagion, deriving mostly from people returning home from abroad, there are reports that Spain is tentatively starting to re-open some of its non-essential activities, such as factories and some offices. Italy has started to plan a gradual re-opening, aimed at May 4th, and a task force led by former Vodafone CEO Vittorio Colao has been appointed by the government to plan a gradual re-opening of the economy. An undersecretary of Conte’s government even ventured to say that Italy’s beaches could be open this summer, if social distancing measures are in place.
The situation is very different in the UK, the US and Sweden, which have been late to adopt social distancing measures, and are still in the fast-accelerating part of the contagion curve. In particular, in the UK, the country has been following a path not too dissimilar from that of Italy, and its Prime Minister Boris Johnson admitted that he could have died of Covid-19 during his stay in the hospital. In the US, the scenes of public burials in New York has shocked people around the globe. In Sweden, PM Stefan Lofven had to apologise for being too slow and timid in adopting social distancing measures.
However, some glimmers of hope are starting to emerge from the medical front, which, as we said last week, consists of four sub-fronts. On the increase in intensive-care capacity, a lot of progress has been made worldwide, with the construction of field hospitals. This should help manage the expected increase in the number in patients admitted to hospitals in the most-hit countries.
On testing, the availability of antibody tests (which can tell if somebody had been infected and has developed some form of immunity to the virus) has increased massively, and the Lombardy region, one of the areas most affected by the epidemic, has stated that soon a large-scale distribution of what will be considered “Covid-19 health passports” will begin. On the other two medical sub-fronts, namely treatment and vaccine, plenty of progress has been made as well.
As to a possible cure for the virus, doctors have identified the three phases of infection. Against the first phase, when the virus starts to attack cells, at least two medicines have proved to be effective, Cloroquineand L-Asparaginase. If a virus still manages to infect the body, anti-inflammatory medicines (such as steroids that reduce inflammation and the immune response) can reduce the impact on the affected person.
In the third phase, when infection becomes serious, the virus causes an over-production of antibodies that clog the lungs and create small thrombus that start circulating throughout the body, causing multiple organ failure and eventually death. Against this, a group of doctors in various hospitals in Italy have started to test the efficacy of a traditional anticoagulant, the heparin, which prevents the formation of thrombus. Initial clinical tests show that this cure is effective and, if heparin is given early enough, patients might not need to be hospitalised. From this mix of cures, it is likely that very soon a clinical protocol to treat patients in the various phases of the disease will become standardised, thus reducing the need for intensive-care units. The good news is that most of these medicines are quite common and therefore not very expensive.
On the final front, the vaccine, good progress has also being made. Besides the progress that has been made in Pittsburgh, which we mentioned last week, another team of researchers, based in Italy in collaboration with Oxford University, has found a methodology that will be tested by the end of the month, which could result in a vaccine being ready by September (in small samples).
All this is to say that much effort is being made to reduce the impact of the virus on the health of people and on economic activity. While we need to remain vigilant against second and third waves of the virus (which could be more deadly than the first), three strains of which have already been identified, it is encouraging that some progress is being made on the medical front.
by Brunello Rosa
30 March 2020
In our column of March 16th, titled “The World Is Likely To Be Radically Different After The Coronavirus Crisis” we mentioned that the Coronavirus is posing an existential threat to the survival of the EU. In this column, we want to further elaborate on this issue, following the EU Council meeting on March 26, in which the heads of state and governments failed to reach a deal for a common strategy to fight the crisis.
The underlying principle behind the EU integration process is the solidarity that member states should display towards one another on all matters of common interest, after centuries of inter-European conflict. For this reason, the first embryo of the EU was the European Coal and Steel Community, coal and steel representing the key ingredients for the economic recovery in the post-War period. Once solidarity ceases to exist, there is no reason for the Union to exist either. In spite of the initial, delusional hope that COVID-19 was an asymmetric shock to Italy rather than a generalized crisis across the region, and could therefore be addressed by the activation of article 122.2 of the EU Treaty (i.e. grants to the country “seriously threatened with severe difficulties caused by … exceptional circumstances beyond its control”), it is now clear that is a symmetric shock to every country of the EU.
This means that the EU as a whole should react to it, with common instruments, rather than by simply adopting a coordinated approach of national policies by individual member states. Instead, so far national selfishness has prevailed, and countries have reacted by adopting a series of policies based on their individual circumstances. For example, at the fiscal level, Germany has announced a plan of EUR 550bn of fiscal easing (of which EUR 156 will be fresh expenditures), France a EUR 300bn plan, and Italy, given its more stringent budget constraints, only a first EUR 25bn plan followed by another EUR 25bn likely to be announced in April. Virtually all countries have re-instated national borders and suspended the Schengen agreement.
At the EU level, there has thus far been only a partial and temporary suspension of the Growth and Stability Pact (GSP) and an easing of the discipline regarding state aid to private-sector companies. Even the ECB was initially reluctant to engage in its mandatory spread-compression activities, until finally the EUR 750bn PEPP was launched, with the inclusion of Greece and the suspension of the issuer limits. But this is still too little compared to what the EU could and should do to face the existential crisis before it.
With Brexit underway, and the UK initially threatening to deviate from the continental practices of social distancing to follow a chimeric and flawed herd immunity approach; with Schengen and the GSP suspended; with every country following its own approach to COVID, from para-military lockdowns (in Italy, for example) to minimal social distancing rules (e.g. in Sweden), the risk is that re-converging when the crisis is finished will become virtually impossible, as every country will find it more convenient to pursue its national strategies and interests. A country might, for example, bitterly and understandably decline to pursue European reintegration because it felt that it was neglected during the crisis.
Take Italy, for example. In 2011-12 Italy was brought to the verge of default because of the slow and flawed response (by moral hazard considerations) from the EU/EZ to the Greek crisis. Italy, which participated in the rescue packages for Greece, Ireland, Portugal and Spain, came under speculative attack because it was perceived as being part of the PIIGS grouping of economies. Only Draghi’s “whatever it takes” pledge and the consequent OMT avoided the disaster. In 2015, during the migrant crisis, Italy was then left alone facing the arrival of ships landing on the southern shores of Europe. In 2020, after the symmetric exogenous shock deriving from COVID, the implicit message from the EU was: “deal with it by yourself, we’ll be lenient on your fiscal position, ex-post.” It is not clear where solidarity is in all this, and we should not be surprised if, at the end of the crisis, the levels of EU-scepticism will be at historical highs. Other countries are in similar positions, and if the EU fails to rise to the historical task it is now facing, it might end up being the largest, institutional victim of Coronavirus.
So, while Merkel and Von Der Leyen declared their opposition to Eurobonds/Coronabonds being used to finance a pan-European recovery plan, the Eurogroup has been tasked with coming up with technical proposal on the feasibility of risk-sharing instruments. Hopefully, it will come up with some serious proposals in the next couple of weeks, and these approaches will be adopted by the EU Council. But other roads are possible, such as the possibility of activating ESM loans with virtually zero interest rates and null or very limited conditionality. That, in turn, could open up the possibility of using the OMT to fight unwarranted widening of sovereign yield spreads within the EZ.
by Brunello Rosa
23 March 2020
We have discussed Coronavirus in a series of columns in our weekly Viewsletter this year. Discussing the virus is inevitable, considering the importance the COVID-19 will have on all aspects of life for a large part of the world population – with its health, economic conditions and financial repercussions. Our first column on COVID dates from February 3rd, when China was starting to impose some of its most draconian measures while all other countries were ignoring the risk or happily living in denial. On that occasion we warned that “Coronavirus Poses a Downside Risk To The Global Economy.”
One month later, on March 2nd, we commented on how financial markets had finally caught up with reality of the virus, saying that markets “Belatedly Correct on Coronavirus Concerns.” The week after that, we discussed how central banks had tried to come to the rescue with more of the same “medicine” (i.e. rate cuts and a limited increase in asset purchases). Finally, last week, we took a longer-term view that the world will look radically different a year from now.
This week, we are discussing how central banks and governments have finally realised the magnitude of the shock and the therapy needed to mitigate its impact. As we discussed in Part 1 of our Global Outlook Update, we now expect the global economy to experience a global recession in 2020, as our baseline scenario. In downside scenarios, the economic contraction could be much more pronounced and prolonged. As most countries are now realizing what was, in our opinion, self-evident, namely that Italy has simply been a leading indicator of what could happen if they do not contain the spreading of the virus early on, the policy decisions deriving from this “epiphany” are now finally starting to appear on the horizon.
As we discuss in Part 2 of the Global Outlook Update, most countries are now adopting monetary and fiscal expansion measures to limit the damage to the economy deriving from the draconian measures adopted to contain the virus. These draconian measures which include the partial or total lockdown of the country, suspension of all international travel, re-instatement of borders, even within the EU with the suspension of Schengen, etc. In the US, the Fed has brought its policy rate to zero and re-started QE, and the government has presented to the Senate a USD 1.6tn fiscal easing package, potentially including forms of cash directly sent to households. The UK government has announced a GBP 330bn fiscal easing package, while the BOE slashed rates to virtually zero and re-started QE. In France, President Macron has announced a EUR 300bn fiscal package, while Germany has finally thrown its ridiculous “schwarz null” policy out of the window and pledged EUR 550bn of fiscal stimulus (including loans and credit guarantees), of which EUR 156bn will be fresh money expenditures. The ECB, following the initial mishap by President Lagarde, has staged its “Whatever it Takes – 2” moment, launching its new PEPP plan of EUR 750bn of asset purchases.
The next stage in this process is increased coordination between the monetary and fiscal responses, both of which are needed for the overall response to the crisis to be effective. This will likely translate into forms of direct or indirect debt and deficit monetisation, which has been variously labelled as People’s QE, MMT or helicopter drops of money. It is with some relief that we finally see these “helicopters” taking off to fight the effects of COVID on the economy and financial markets.
by Brunello Rosa
16 March 2020
Now that the new Coronavirus (COVID-19) has officially been declared a pandemic by the WHO, an increasing number of countries are adopting measures to counter its spreading. Financial markets have collapsed as a result; it is clear that we are facing a serious health, economic and financial crisis. This is likely to be more serious than that in 2008-09, which was a banking, demand, and confidence crisis. This is a demand, supply, and confidence crisis, in which banks have not yet played a major role. In 2008-09 there was the element of uncertainty as to how low housing and asset prices would fall before finding a floor. Today, in contrast, there is a much larger element of uncertainty: How long will this crisis last?
In fact, the re-opening of economies even after the number of new cases is dropped to zero will remain gradual at best. Until a vaccine becomes available, the virus can always come back and force the authorities to close their economies all over again to stop the contagion. So, let us make the assumption that not until 12-18 months from now, if a vaccine then becomes available to everybody, will the end of the health emergency occur. For the sake of the argument, let us assume that we will be able to expedite the production of a vaccine to only 12 months from now. The world would then be in some form of emergency until Q1 2021.
What will the world be like that will emerge from this crisis? We believe that the world in 2021 will be radically different from that which exists today.
In China , there will be two opposing forces. On the one hand, there will be the conviction that the regime was able to contain the virus in three months of very hard work, which in turn gave much of the rest of the world the template to use when attempting to contain the virus themselves. The regime could use this to strengthen its grip on society, and on any form of dissent, or against any emerging appreciation for Western values such as “privacy”. On the other hand, the regime will at the same time be blamed for hiding the real nature of this pandemic for too long, causing the damage at global level that now plainly exists. Chinese society might also have to rethink some of its millennial traditions (including food and hygienic standards) that make China the origin of virtually every new flu strain. Overall, we believe China will come out stronger and even more modernised from this experience, even if its regime might need to make further strides to regain legitimacy and trust among the wider populace.
On the other side of the Pacific, there is the US, where the political leadership is held by a person, President Trump, who embodies of the polar-opposite attitude that led the Chinese to a rapid victory against the virus: indecisiveness, mis-representation of facts, open criticism of scientifically-proven theories in favour of his gut feelings, under-reaction followed by over-reactions. There is enough to make many people re-think the idea that a large and complex country like the US can be governed by virtually anybody so long as the “deep state” and its institutions are alive and well. Given its initial mistakes, the US will take much longer to rein in the disease. Perhaps the worst economic impact will be felt just before the November election, and therefore COVID could easily cost Trump the re-election. But the country will be shaken in its preference for relatively low personal and corporation tax levels at the cost of many public goods such as a universal healthcare system and good-quality education. The US has lost its supremacy in many domains versus China; this crisis will further shake its position as the world’s leading country.
In between these two countries, there is the EU, which will face its most serious existential crisis since its foundation. The uncoordinated health and fiscal response to the virus, plus the arbitrary and unilateral closures of the borders (i.e. suspending the Schengen agreement) have, once again, shown the fragility of the European construct and the possibility of its collapse. The only truly pan-European institution has missed this opportunity to show leadership, as it did during its previous existential crisis, the Euro crisis, in 2012. The package of measures adopted last week was borderline adequate given the stage of the threat, considering that the package could be further expanded in coming months. But the ECB cannot afford mishaps such as that which was made by President Lagarde, when she said that “it’s not the ECB’s job to close the spreads within the EZ sovereign bond yields.” In the absence of Eurobonds or EZ safe assets, it is precisely the ECB’s job to ensure that the spreads remain compressed, in order to ensure the smooth transmission of monetary policy. Additionally, the ECB has a facility (OMT) specifically designed to close widening spreads unwarranted by market fundamentals. In addition, because most countries will move into forms of fiscal-monetary coordination, the EU, with its 27 fiscal regimes and several central banks, will have much harder time than the ECB would at implementing a similarly coordinated response to the crisis.
In conclusion, we believe that all the three main areas of the world will face serious crises of political legitimacy and, in the case of the EU, existential threats. Other countries and regimes will equally come under severe stress and could collapse as a result of this crisis. The rankings of countries at the global level will change drastically after this crisis, in many dimensions. We should prepare to see debt/GDP ratios approaching 150-200%, as often occurs during wartime. Global supply chains will be further disrupted; the tendency towards de-globalisation will be reinforced. Returning to the “new normal” will be another enormous task of world leaders in 2021; at least, for those leaders who will have politically survived.
by Brunello Rosa
9 March 2020
The latest news from the COVID-19 front is a mixed bag. In China, following the draconian measures of containment the country adopted during the last few weeks, the official number of new cases is close to zero. A number of existing cases still need to be resolved, but there are not new infections occurring that would aggravate the situation. In the rest of the world, however, the situation is starting to become increasingly bad. In Italy, which has been the country with the second highest number fatalities (almost 370), the daily percentage increase of new cases is still around 20-25%, which means that the number of reported cases doubles every 4-5 days. Thus the diffusion of the infection is still in its exponential phase. And the number of cases is increasing in other countries too, including Germany and the UK and, of course, the US.
Albeit slowly, authorities in Germany, the UKand at EU level are awakening to the fact that COVID-19 is not going to remain a phenomenon limited to Italy, a conviction some European leaders have deluded themselves with for too long. This means that, in time, a larger response will be put in place. In the US, it seems that we are still in the delusional phase in which COVID-19 will remain primarily limited to China and Europe, with only a limited spread in the US. The response has therefore been limited and insufficient so far. The number of swab tests being carried out is still ridiculously low, and the official number of infected people is being kept artificially low by the fact that they are not being detected.
But the story of this virus always shows the same news cycle.
Initially, politicians delude themselves that the problem will remain limited to other countries. As soon as the first person dies in that country as a result of COVID-19, this delusion is no longer tenable, and so the initial timid admission and response occurs. When the number of deaths increases, one can easily infer the total number of infected people by knowing that the mortality rate at global level is around 3.4%. When the number of cases reaches the thousands, the response then becomes forceful. In Italy, the entire region of Lombardy has been quarantined, as have other provinces from neighbouring regions: people cannot get in or out.
As the disease spreads, the economic damage worsens. In our upcoming updated outlook, we will show how we expect global growth to be closer to 2% in 2020 than 3%. This means that in some countries, such as Italy and Japan, there will be a recession this year. Other countries could be equally badly affected – Germany might also fall into a recession, and US growth is likely to be around half of what was expected back in December. To prevent the economic downturn from becoming too large, policy makers are coming to the rescue. Fiscal authorities are trying to design targeted relief plans, in particular to support solvent but illiquid small and medium sized enterprises.
Central banks can also act faster to support market sentiment. A number of them have cut rates in the last few days: the Federal Reserve by 50bps to 1.00-1.25% (intra-meeting), the RBA by 25bps to 0.50%, the BoC by 50bps to 1.25%. Elsewhere, the central banks of Hong Kong and Malaysia cut their interest rates by 50bps (to 1.50%) and by 25bps (to 2.50%), respectively. These interventions are necessary to support market sentiment but will do little to solve the problem generally. The market understands all this, and therefore the selloff in equities continues. Equities will continue to adjust until market participants believe that the virus has been successfully contained at the global level. Even in the best-case scenario, this could take at least a couple of quarters. If the US delays its response to the virus in order to keep the economy strong during an electoral year, the process will be severely delayed, with the result being that immense damage to global health and economic activity could ensue.
by Brunello Rosa
2 March 2020
At very long last, financial markets caught up with the reality of the coronavirus, selling off last week in the worst market performance since the Global Financial Crisis of 2008. As the Financial Times reported, “mounting concerns at the rapid spread of the coronavirus caused one of the quickest market corrections in the benchmark US S&P 500 since the Great Depression in the 1930s.”
As we have written in our in-depth report on the subject, market participants are finally realising the impact that COVID-19 could have on the economic performance of the countries that have been most affected by the disease. In our column on the potential impact of COVID-19 (which we published a month ago already), we warned that the downside risks posed to the global economy by the public reaction to the virus could be huge, possibly greater even than the virus itself. In effect, last week market participants staged a panic reaction to the news coming from Italy, where entire cities were quarantined in the country’s northern region, which is the industrial powerhouse of the country, with Milan, the financial capital of the country, being the epicentre.
Since then, the situation has not improved: the number of infected people and fatalities worldwide have risen (albeit at a slower rate than in previous weeks), surpassing 85,000 and 3,000 respectively. At the same time, the number of people who have recovered from the disease has also increased, surpassing 42,000. Most importantly, the US has suffered its first fatality from COVID-19 (near Seattle). This could mark the beginning of a new phase in the crisis. In fact, as we have already said, unless the pathogen mutates suddenly in coming months, the mortality rate will remain relatively low, around 2% globally of those who become infected with it.
Nevertheless, the economic impact of the virus will derive from the reaction of governments to the news about it. No politician wants to be blamed for not having taken sufficient action in response to the virus. The first reaction from the US was the suspension of certain flights from the US to Northern Italy. As the number of cases and deaths increases in the US, however, so too will the escalation in the counter-measures the government takes. The economic impact of severe counter-measures in the US would take the economic impact of COVID-19 to a different order of magnitude, and would have a global economic impact. A global recession in 2020 is now becoming a real possibility.
The countries that have experienced the largest number of cases of infection show that the economic impact of the virus could be large, and might not necessarily be V-shaped as had been optimistically assumed by some commentators until just a few days ago. In China, the manufacturing PMI has collapsed to 35.7 in February, down from 50 in January, marking a new all-time low. Any figure below 42 in China signals an outright contraction in activity. The GDP in China, Japan, South Korea and Italy will contract sharply in Q1, and perhaps also in Q2. Fiscal packages to ease the sharp fall in economic activity are in the process of being approved in those countries. The latest is the EUR 3.6bn package announced by Italy on Sunday. These measures will help to a certain extent, but ultimately will not be able to achieve much. In particular, monetary policy, which will likely become more expansionary at the global level pretty soon, is likely to prove impotent against a supply-side shock.
Considering all of this, it is clear that market participants should brace themselves for more volatility and corrections in the weeks and months ahead. The impact of Coronavirus on global economic activity will be large and persistent. The policy response will be slower, smaller and less effective than expected. This will necessarily have to be reflected in the valuation of risky asset classes. Fasten your seatbelts.
by Brunello Rosa
24 February 2020
After entering the Democratic primary late, Michael Bloomberg is trying to establish himself as the only Democratic candidate who can defeat Trump in November. His strategy might prove to have been well-calculated. By not entering the race before the caucuses in Iowa and New Hampshire were held, he knew that by the time Super Tuesday takes place on 3 March one of the left-wing contenders (either Bernie Sanders or Elizabeth Warren) would be ahead in the game – an that would scare the median voter, financial markets, and also the Democratic leadership into preferring a candidate like himself. The result of the latest primary election, in Nevada, where Sanders once again finished ahead of centrist candidates such as Joe Biden and Pete Buttigieg, confirmed this trend (which can also be seen at a national level, according to recent polls), and thereby the validity of Bloomberg’s strategy.
Michael Bloomberg might have thought that, after scaring markets and centrist voters with the advancement of radical left-wing candidates (notably, of Bernie Sanders, who self-defines himself as a socialist), the democratic leadership would come to him, begging him to unify the party and lead it in the race against Trump in November. However, things might not work out as Bloomberg may have planned.
In the first televised debate in which he appeared against the other Democratic candidates, Bloomberg was frontally attacked by the left-wing contenders, in particular by Elizabeth Warren. He did not come across as particularly friendly in this exchange. A highly curated video clip of the debate, in which Bloomberg asks the other candidates who else has founded a successful business, did not do him great credit either. While he had a point, since he is indeed the only one among the remaining Democratic candidates with that achievement, the entire scene lasted no more than a couple of seconds on live television, while the video made it look much more dramatic than it had been in reality.
Also troubling the Bloomberg campaign is a series of NDAs signed by women who were allegedly mis-treated when working at Bloomberg LLC.. So, even if Bloomberg may be the only candidate who can defeat Trump in November, he still faces an uphill battle to win the Democratic nomination.
In particular, Bloomberg will have to mobilize a portion of the Democratic electorate – African-Americans, other ethnic minorities, women – that is essential to win the nomination and, eventually, the general election. Some fights with the black community when he was mayor of New York will not help him in this battle. Additionally, his profile might not be particularly attractive to this key portion of the Democratic electorate. While being a truly self-made man (unlike Donald Trump, who inherited his fortune from his father), Bloomberg is still the sort of New York-style billionaire who does not necessarily attract the sympathy of minorities and other traditional segments of the Democratic electorate. Also, the story of the women-related NDAs risks sticking to him much more than to Trump, who the electorate seems willing to forgive almost anything. (Certainly, the number and depth of allegations against Trump is much larger than those against Bloomberg).
Bloomberg, therefore, might not be the white knight he was presumably hoping to become. The race for the Democratic nomination remains open. The simple truth is that the Democratic party has not been able thus far to converge towards a candidate who can truly represent a credible threat to Trump in the coming general election. The president will present as victories his trade and tech wars with China, his hard-line on Iran, and other high-profile battles that could ultimately damage the international reputation of the US and its economy. His electorate might accept this narrative, securing his re-election in November. If the Dems want to avoid this, they better start getting their act together, and fast.
by Brunello Rosa
17 February 2020
During the weekend, the annual Munich Security Conference was held in the capital of Bavaria, Germany’s richest state. Media outlets extensively reported on the key proceedings of the conference, which this year focused on the concept of “Westlessness”; i.e., on whether the world has become less Western. This is a concept they also studied in depth in their annual report. As long as the “West” is defined by the alliance between North America and Europe, along with the key additions of Australia and New Zealand (part of the so-called Five Eyes), clearly the last few years have observed a marked deterioration in this relationship, and in particular of NATO, the military alliance underpinning it.
US Secretary of State Mike Pompeo came to Munich to reassure those present that NATO is alive and well, and that it is ready to deploy its benefits to its constituent countries. Pompeo specifically said that he was “happy to report that the death of the transatlantic alliance is grossly exaggerated. The West is winning, and we’re winning together.” However, only in November 2019, Pompeo himself warned that NATO was risking extinction unless it adapted itself to reality. This happened at the same time as French President Emmanuel Macron was reported as saying that NATO was brain-dead. So, what’s the current state of the transatlantic alliance, in reality?
It is true that NATO is still alive, but its cohesion has been severely tested recently. Trump has just approved a series of tariffs on the Europeans, following the WTO ruling on EU’s aid to Airbus in that company’s long dispute with Boeing. (Italy, which does not belong to the Airbus consortium, got exempted from these tariffs, thanks to their own successful bilateral negotiations). Other tariffs aimed at the auto sector are also being considered by the Trump administration at the moment, after being delayed by six months in May 2019.
In a few months, when the WTO will likely rule in favour of Airbus and the Europeans will be able to impose retaliatory tariffs on the US, we might be at the beginning of another tit-for-tat trade war, similar to that we have been observing between US and China in the last three years.
Within Europe, the situation is, at best, fluid. The UK has just left the EU, imposing a severe level of damage onto the geopolitical standing of the continental bloc, as discussed by John Hulsman in his recent analysis. PM Johnson is now mostly committed to establish his leadership within Whitehall, as the recent reshuffling of his government proves. What is left of the EU is in flux. In Germany, the decision by Annegret Kramp Karrembauer not to run for Chancellor at the next federal election has completely ruined Angela Merkel’s succession plans. As we discussed in our analysis of the German political scene, under certain circumstances, this might eventually lead to a desirable outcome, for example a Green-Black coalition. On the other hand, it might make Germany even more inward-looking and undecided as to how to exert its leadership on the continent. And Germany is absolutely needed by French President Macron if he wants any of his grandiose plans for the future of Europe to ever become a reality. As we discussed in our recent trip report, both the social and political opposition to Macron are weak or weakening, paving the way to his re-election in 2022 (bar a global economic crisis occurring in the meantime). But without its German dance partner, there is very little France will be able to do.
So, the West might be still in the position of taking on China, weakened by the impact that the Coronavirus might have on the Chinese economy and on the legitimacy of its regime. But the West needs to find a new sense of unity if it wants to win the battle for the geo-strategic hegemony of the future. At a time when China is trying to reach out to the Europeans, to convince them to break ranks with their historical US ally, and with Trump not hiding his distaste for the EU concept, this might be easier said than done.
by Brunello Rosa
10 February 2020
Two crucial regional elections took place in Italy a couple of weeks ago, one in Emilia-Romagna (in northern Italy) and the other in Calabria (in southern Italy). Lega’s leader Matteo Salvini greatly increased the significance of the election in Emilia-Romagna, a region that has been a stronghold of the Democratic Party (PD), making the election appear, in effect, as a referendum on the government. As we discussed in our in-depth analysis following the election, if Lega’s candidate Lucia Borgonzoni had won with a relatively ample margin, this could have led to the resignation of Nicola Zingaretti from the leadership of the PD. Since Di Maio had already resigned from his national leadership role in the Five Star Movement, a resignation by Zingaretti could have led to the collapse of the government altogether. Since Borgonzoni did not win, however, and since her opponent, the incumbent leader Stefano Bonaccini, won with a 7-point difference in the regional election, this scenario did not happen. So, Giuseppe Conte and his government could relax for the moment. Still, this respite might prove short-lived.
In fact, theoretically speaking, if the governing coalition manages to survive the additional round of elections in May/June 2020, the possibility for this parliament to last until 2022 (after the election of the new president), could be quite high, either with the current governing coalition or with a slightly different one. Elections in 2020 would become extremely unlikely and, if the coalition were to stick together for six more months from January to June 2021, then in September President Mattarella would lose his power to dissolve parliament. Thus the only theoretical window for an election would be between March and June 2021.
In reality, things might prove more complicated than this. Matteo Renzi is restless in his attempt to force a change of the Prime Minister, and is now using a parliamentary battle over the reform to the statute of limitations in criminal trials to re-launch his assault. An already fragile majority is vulnerable to defections in parliament, and the possible support from MPs from other parties (for example, from Forza Italia), would not be reassuring for PM Giuseppe Conte. He could become hostage to all sorts of vetoes. If MPs from a new party were to vote in favour of the government in a confidence vote, President Mattarella might call Conte for an update on parliamentary developments, and send him back to the Chambers for a new confidence vote, to re-assess the “perimeter” of the coalition supporting the government. The reality is that the Italian government remains fragile, and could collapse as a result of a parliamentary incident at any time.
What is the centre-right doing during all this? Salvini’s Lega continues to poll above 30%, and Meloni’s Fratelli D’Italia has now reached 10% in the polls, well ahead of Berlusconi’s Forza Italia, which now struggles to get to 6%. Altogether, the centre-right coalition polls around 50%. Salvini’s popularity remains very high, but not as high as it was previously. The belief in his infallibility has been now severely hit by two consecutive mistakes: his decision to make the Conte-1 government collapse in August 2019, and his decision to transform the regional election in Emilia-Romagna into a referendum on the government. He will soon face a vote in the Senate, which will decide whether or not he will have to stand a trial for “kidnapping” the migrants of the Gregoretti ship. And he will probably lose the constitutional referendum over making a cut to the number of MPs, which will take place in March. Investigations into “Moscow-gate” are continuing, meanwhile.
Can Salvini stage a comeback through all this, and so ascend to power in the coming months or years? Theoretically speaking, yes, he can, especially if the governing coalition proves incapable of sticking together. Polls suggest that Italians still seem inclined to give Salvini a chance to prove himself as PM. But the biggest obstacle to his final ascent to power is… himself. The recent re-organisation of Salvini’s party shows that he might have understood the underlying problem that has led him to all the mistakes mentioned above. During his period in government, when he was gaining popularity, he managed to antagonise the US allies (his trip to Washington was reportedly a disaster), the Europeans (his preferred target), the Chinese (by not signing the MoU on the silk-road) and the Russians (with Moscow-gate). In addition, he antagonised the vast majority of the global economic and financial establishment, which fears a breakup of the Eurozone following a potential decision by Italy, led by Salvini, to leave the euro area. It will take time for Salvini to gain credibility within all these powerful circles.
So, somewhat ironically, the centre-right led by Salvini needs time to become a credible governing coalition. And the centre-left hopes to stay in power for as long as possible. These two converging tendencies might keep this parliament alive for longer than is currently believed, even if it remains true that an accident could occur that would bring down the government at any time.
by Brunello Rosa
3 February 2020
In the last couple of weeks, the world has witnessed the outbreak of the Coronavirus (2019-nCov) infection, and its global diffusion. According to the most recent statistics, there are 14,500 people reported as infected in Asia, more than 9000 of whom are in China. The virus has been detected in at least 24 countries. Even then, it is likely that the number of infected people has been under-reported. So far, 305 people have died, with the first victim reported being located outside of China, in the Philippines.
It is understood that the virus originated in Wuhan, a city of 11 million people in central China. It was initially reported that the origin of the virus was the seafood and poultry market in Wuhan. However, the origin remains disputed. A study published on Lancet says that the Wuhan market might not be the origin of the virus. According to some theories (bordering on conspiracy theories), the virus might have originated from a biosafety laboratory – also based in Wuhan – housing some of the world's most deadly illnesses. The lab, opened after the outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003, is used to study class four pathogens (P4), referring to the most virulent viruses which pose a high risk of “aerosol-transmitted person-to-person infections,” according to a press release. It is possible that we will not be able to establish for certain the origin of this virus, but we cannot exclude a-priori that the virus originated from lab experiments.
Plenty of comparisons have been made with the SARS episode, which in 2002-03 infected more than 8,000 people, killing around 700 of them. Some studies have also analysed the economic costs of SARS (estimated to be around USD 13bn). According to initial statistics conducted on the first 99 patients at a hospital in Wuhan, the Coronavirus has a case-fatality rate (the percent of deaths among those infected) of 11%. Initial estimates show that the virus has an R0 of 2.2, meaning each case patient could infect more than 2 other people. If those statistic prove accurate, this virus would be more infectious than the 1918 “Spanish-Flu” pandemic virus, which had an R0 of 1.80.
Based on current statistics, Coronavirus is definitely more infectious and deadly than SARS, and possibly also than the Spanish Flu of 1918-19, which infected more than half a billion people and killed an estimated 20-50 million (statistics were not very accurate in that case, in part because of World War I). At the same time, to most people’s surprise, the Coronavirus is less severe than the usual seasonal flu. Just to give an example, seasonal influenza epidemics cause 3 to 5 million severe cases and kill up to 650,000 people every year, according to the World Health Organization. So far in this season, there have been an estimated 19 million cases of flu, 180,000 hospitalizations and 10,000 deaths in the US alone, according to the Centers for Disease Control and Prevention.
So, what is making the Coronavirus so special, and worthy of attention, to the point that every major central banker (e.g. Fed’s Powell, BoE’s Carney and ECB’s Lagarde) had to answer a question about its impact? The point is that the panic that the outbreak has created, and the defensive reactions to it, might be causing quite a severe level of damage to the global economy (even if perhaps only temporarily, in which case the losses might be mostly recouped in the following quarters). A number of airline companies have completely interrupted all of their flights in an out from China; British Airways, which has cancelled every flight until March, being only a very notable example of this. Most importantly, the US has barred entrance to any foreigner travelling from mainland China. A number of other countries, such as Australia, have followed the US’ example. China has reacted with anger to the measures adopted by the US and other countries. China risks being isolated by the rest of the world, a position that is politically and economically difficult for Beijing to tolerate, especially as the trade and tech negotiations with the US are still ongoing, following the Phase-1 deal between the two countries.
So, more than the virus per se, it is the various countries’ reactions to the virus which pose serious downside risks to the global economy. Indeed, the global economy risks another year of stagnation, following a disappointing 2019. If that happens, central banks and fiscal authorities will likely have to do their part to support aggregate demand in the various countries directly or indirectly hit by the outbreak.
by Brunello Rosa
27 January 2020
We have discussed several times the importance of climate change and the repercussions it may have for the economies of various countries and the global geopolitical order as a whole. Among other things, climate change causes increased desertification in areas such as Sub-Saharan Africa, the Middle East and Latin America, inducing millions of people to migrate in search for a chance to live. This in turn has helped lead to the rise of populist leaders trying to block the arrival of undesired migrants. Lately, the devastating fires in Australia show what an extraordinarily hot summer can mean for the environment, here and now, not just in some distant future.
More recently, climate change has risen to the top of the agenda for institutions that were previously considered quite removed from this issue, such as the International Monetary Fund with the arrival of Kristalina Georgieva at its helm, the European Commission with Ursula Von der Leyen’s “Green Deal”, and central banks, with Christine Lagarde’s ECB and Mark Carney’s Bank of England leading the way. Not surprisingly, this issue were given high priority at this year’s meetings in Davos, even if it still remains unclear how and when governments and multinationals will finally decide to seriously tackle this crucial issue. Many hopes now rest on the result of the COP26 Conference in Glasgow, to be held at the end of this year. But the experience with previous COP conferences suggests that there is a need to keep expectations at a realistic level.
In any case, it is extremely important that the level of awareness of the climate issue has finally increased, and that climate change now features very high in the agenda of policy makers.
The European Union has decided to become a world leader in this regard, and to shape a large component of its future choices on environmental sustainability. The “Green Deal” recently launched has the potential to unlock up to EUR 1tn of public and private investments, generating hundreds of thousands of job opportunities. The Bank of England has already asked financial institutions to stress-test their resilience to climate change, considering that (as the BIS recently stated) climate change could be a cause of financial instability, if a “green swan” materialises.
Among the various initiatives mentioned during her latest press conference, Christine Lagarde said that the ECB will make sure that its corporate bond portfolio will be designed to incentivise environmental sustainability. In Germany, the rise of the Green Party in opinion polls is constant, and in Austria the Greens joined the new conservative government formed by Sebastian Kurz.
While the US seems still to be missing in action, the key risk identified by some is the so-called “greenwashing” process, whereby anything that seems socially acceptable or politically advantageous is promoted as being a “green” initiative. Some key policy figures, such as Bundesbank President Jen Weidmann, recently made the point that central banks cannot replace good environmental policies decided by democratically elected political leaders. Others fear that good old-fashioned counter-cyclical fiscal stimulus might be masked by “green investment” to stimulate aggregate demand, thus producing good results in the short run, but no effects in the future.
As it often happens, “in medio stat virtus”. Climate change will need to be front and centre of policy makers’ agendas. But abusing the term for marketing reasons might eventually damage the cause rather than support it.
by Brunello Rosa
20 January 2020
At the end of last year, in our paper on the six Grey Swans facing the global economy, and in our 2020 Global Economic Outlook, we said that geopolitical instability was set to increase during the US election year ahead. The strategic calculus by Trump to secure his re-election, going into 2020, was to make sure that the US economy was as strong as possible (perhaps with a bit of help from the three insurance rate cuts “independently” delivered by the Fed in 2019, which came after plenty of pressure was put on the Fed by the President), while closing some of the open geopolitical fronts, in particular the trade dispute with China.
In fact, Trump’s “art of the deal” consists of brutally shaking his counterpart before inviting it to the negotiation table and concluding a deal on more favourable terms for himself. Following this paradigm, Trump had a window of opportunity from the mid-term elections until 2020 to unsettle the system and shake his opponents, in order to then use 2020 as the period to reach compromises with his negotiating partners that he could “sell” as victories to the US public during the electoral campaign. But, as we mentioned in previous analysis, while this tactics might work in the corporate sector, where an aggressively confrontational approach could lead the counterpart to the brink of bankruptcy and therefore make it more willing to accept the harsh terms that Trump offers, in public affairs things are not that simple. States do not go bankrupt that easily, and opponents can react in unexpected ways.
So, while Trump’s preferred choice could have been that of having a strong economy and some tail risks reduced (risks such Brexit; during Trump’s intrusion in the recent electoral campaign in the UK, he basically “ordered” Nigel Farage to step back and allow Johnson’s victory), his opponents saw a clear opportunity in 2020 to “mess things up” in order to jeopardise Trump’s re-election. Domestically, the Democrats have launched an impeachment trial, which is unlikely to succeed but will still keep Trump on his toes and will expose him on a number of fronts.
The delay in sending the impeachment article to the Senate, while being borderline acceptable, has prevented Trump from having the news on the impeachment obfuscated by escalating tensions with Iran that would have otherwise occurred at the same time as one another.
Internationally, Iran is clearly at the forefront of the historical foes that would like to see Trump go, hoping to get a Democratic president to deal with instead. This is the reason why we believe that Iran will do much more in coming months to retaliate against the killing of Qassem Suleimani, and why we believe the market is under-pricing the risk of a further escalation down the line, closer to the election date.
According to press reports, Kim Jong UN sacked its “moderate” foreign minister Ri Yong Ho, replacing him with the more hawkish Ri Son Gwon. This is seen by the intelligence community as a signal that a season of testing of ballistic missiles (launching them over key regional allies such as Japan) is about to re-start, after a period of pause.
China remains the big unknown: signing the Phase-1 deal certainly gives Trump a trophy to show during the electoral campaign, and gives China the much needed break in the escalation of tariffs. At the same time, it is clear that the trade, technological and geo-strategic dispute between the two countries will continue. One possible interpretation is that China, instead of wanting to see Trump leave office, might prefer having him remain for a second term, given the damage he is doing to the US and their international relations.
All this is to say that the historical foes of the US will use the opportunity of this electoral year and Trump’s impeachment trial to take advantage of the difficulty Trump will face in providing anything other a constrained response to any moves they may make. If Trump goes from disputes to battles to open wars, he would tip the economy into recession, thus jeopardising his re-election. As such, his options this year will be relatively limited. 2020 will be most likely “a year lived dangerously” for the world.
by Brunello Rosa
13 January 2020
Financial markets became excited at the end of last week, by signals that some of the most feared tail risks hanging over the global economy could be diminishing. On a weekly basis, global stock indices rose (MSCI ACWI rose by +0.6%, to 570), driven by DM equities (S&P 500 +0.9% to 3,265; Eurostoxx 50 +0.4% to 3,790). EM indices also rose (MSCI EMs +0.9% to 1,134), and, as markets rallied, volatility fell (VIX S&P 500 fell by -1.4 points to 12.6, below its annual average of 15.0).
Regarding tensions between US and Iran, the “measured” retaliation by Iran to the killing of Quassem Soleimani, in which rockets were fired at two US military bases in Iraq without causing casualties and major damages, and the decision by the US not to respond to that attack, was interpreted by market participants as a signal of de-escalation. Some might even hope that, after a period of increased tension, the status quo ante between the two countries might return. While it is certainly a positive development that Iran’s retaliation was not followed by further US counter-attacks, we would be much more cautious before considering the events of the last few days to be merely isolated incidents that are now effectively concluded.
In our scenario analysis, we discussed how events might still develop less favourably than markets currently imply they will be and Nouriel Roubini argued that financial markets are still seriously under-pricing the possible future evolution of events. This is true for a number of reasons. First, Iran’s Supreme Leader Khamenei said that the initial attack on US bases was just the beginning of the retaliation, and that much more will occur in coming weeks. Secondly, President Trump’s invitation to the UK, France and Germany to also abandon the Joint Comprehensive Plan of Action (JCPOA) means that tensions will remain elevated for some time. Third, Iran would benefit from striking closer to the November Presidential elections, when mis-calculations could lead to Trump’s defeat. Fourth, the US has in any case launched a new series of sanctions against Iran, which could eventually lead to a further reaction by Tehran.
And finally, the unintentional downing of the Ukrainian plan by Iran on the night of the retaliation show how things can go wrong even when there is no intention to kill. In his upcoming Geopolitical Corner, John Hulsman will discuss how the Iranian story is intertwined with the electoral campaign and Trump’s impeachment process.
The second piece of good news that excited market participants was that the market the announcement by the US President that he is “ready for the Phase-1 trade deal with China to be signed on January 15th at the White House”. Trump also said he would “sign the deal with high-level representatives of China”, and that he would later “travel to Beijing to begin talks for the next phase”. The market believes that this might signal the end of the saga that rattled the global economy during the past couple of years. But again, reality might be slightly harsher than what is being hoped for. Until the deal is actually signed, anything can happen, and time is on China’s side. Why should the Chinese government provide Trump with the argument that he succeeded in containing China’s trade mis-practices ahead of the election?
Moreover, even if the trade tensions do ease, the geo-strategic rivalry between the two countries will continue, with its impact on global supply chains and technological developments. In any event, once the China issue is finally considered to be done with, Trump will then simply be ready to start a fight with Europe, over various issues such as Airbus versus Boeing, auto sector trade, digital taxes, etc. So, trade tensions worldwide could very well continue going forward.
Finally, the UK parliament has at last approved the PM’s Brexit deal, opening the gates to an orderly Brexit on January 31st, if the House of Lords does not object. At the same time, a series of cliff-edges are likely to present themselves in the next 11 months, especially now that the possibility of extending the transition period beyond 31 December 2020 has been excluded by law.
All this is to say that, while some tail risks have not materialised so far, market participants should remain aware of their presence and remember the stretched valuations that now exist in most asset classes.
by Brunello Rosa
6 January 2020
The year has just begun, and geopolitical and political events are already accumulating. From a geopolitical perspective, the most relevant development has been the escalation of tensions in the Middle East, with the US and Iran likely to begin some form of direct and indirect military confrontation following the killing of Iranian general Quassem Soleimani in Baghdad. US President Trump reportedly ordered the attack as a retaliation for an Iran-backed militia’s attack of the US embassy in Iraq, and for the killing of a US civilian contractor on an Iraqi military base in Kirkuk. These events followed months of provocations from Iran to which the US has not responded, including a drone attack on Aramco’s refinery facilities in Saudi Arabia. Tensions between the US and Iran have been on the rise since President Trump decided to pull out of the JCPOA , the agreement between Iran and six international counterparts to limit the development of its nuclear program. That agreement was negotiated by Trump’s predecessor Barack Obama in 2015. We have discussed the run-up to these events in previous papers and scenario analyses, and shortly we will publish an updated scenario analysis, with its implications for oil prices.
From a political risk perspective, these developments have a clear bearing on the US political environment. As discussed in our recent 2020 global outlook, 2020 will be an election year in the US, and most of the macroeconomic and policy events will be driven by the developments in the US presidential race. To make things even more complicated, the US President was impeached by the House of Representatives at the end of December, and his “trial” in the Senate will start soon. As we discussed in our analysis of September 2018, regarding the risk of a global recession materialising in 2020, Trump might be tempted to “wag the dog” with military operations during his campaign for re-election, with Iran being the most likely designated target. The recent developments in the Middle East will surely help Trump obfuscate the news about his impeachment trial. He might also hope that the country will rally behind him in the event an overt conflict takes place, as it often does to presidents is similar circumstances. However, the political spectrum has thus far been divided by Trump’s decision, which reportedly was not discussed and agreed to in advance with other political leaders.
In Europe, there are interesting political developments taking place in Spain and in Austria. In Spain, Pedro Sanchez seems on the verge of being confirmed Prime Minister, with a second vote for his “investidura” on January 7th. He managed to strike a deal not just with Podemos, but also with the independentist parties of Catalonia and the Basque Country. This solution is fraught with risks. The leader of the Esquerra Republicana de Catalunya(ERC), Oriol Junqueras, has spent the last couple of years in prison, and has been ordered to be released only recently, given his election to the European Parliament. Depending on the votes of ERC is clearly a gamble for Sanchez, considering that his government fell precisely because the Catalan parties did not support his budget. On the other hand, having both the Catalan and the Basque pro-independence parties in government could mean that a peaceful solution to Spain’s domestic conflict is likely, considering that the Catalans have always asked to be given at least the same powers and autonomy granted to the Basque Country in return for dropping their quest for independence.
In Austria, following months of negotiations, the Chancellor Sebastian Kurz managed to strike a deal to form a government with the leader of the Greens, Werner Kogler. This coalition between the conservative Austrian People's Party (ÖVP), which belongs to the European People’s Party (EPP), and the Greens, could provide the model for the next German coalition government, if the next general election (scheduled for 2021) were to result in yet another hung parliament. Such a solution could stabilise Germany’s political landscape, and provide the platform to push further European integration and stop the ongoing process of European dis-integration. European political risk was another factor discussed in our September 2018 paper on the risk of a global recession in 2020. As the recent examples from Spain and Austria show, the news from this front is mixed, and worth following in coming months.
by Brunello Rosa
30 December 2019
In our column last week, we discussed some of the key points of our Global Economic Outlook and Strategic Asset Allocation for 2020. This week we want to focus on what we can expect from a policy perspective in the year ahead, and on policy’s implications for markets.
A number of key equity indices in the US have reached their all-time highs during the past few days. The NASDAQ, for example, touched the 9,000 mark for the first time ever on Friday 27th December. The question is whether this rally in risky asset prices is being driven by fundamentals, or whether it is being driven rather by policy intervention (or the anticipation policy intervention), in particular the large liquidity injections made by both the Fed (with the re-increase in the Fed’s balance sheet to stabilise the repo market, which some have labelled QE-4) and the ECB (which has recently re-started its own QE program).
In our Outlook we discussed how, from the monetary policy side of the equation, after the three “insurance cuts” implemented by the Fed in 2019, we now expect the US central bank to remain on hold during the 2020 electoral year, remaining open to further easing only if the economy materially worsens. We also discussed how the ECB is now undertaking open-ended QE and has an easing bias on policy rates (but its strategic review might induce a less accommodative stance). The BOJ will remain extremely accommodative; it might even add a further level of modest accommodation to accompany Japan’s fiscal stimulus. The BoE will react to Brexit developments, but is mulling over the possibility of rate cuts. The PBOC is likely to continue to provide modest monetary stimulus to cushion the Chinese economy, given trade frictions and disruptions in global supply chains.
On the other hand, fiscal policy remains constrained but is becoming modestly expansionary. In the US, the divided Congress means that no fiscal stimulus is likely in 2020; in the Eurozone some additional fiscal flexibility is underway, especially to accompany its “green deal” and “energy transition” plans that may be attempted. Japan has approved a large fiscal stimulus (as a headline figure), which could be the basis for an effective initial version of “helicopter money”. China will keep providing some additional fiscal stimulus, despite its high fiscal deficits.
Given these considerations, we believe that in 2020 there will likely be a moderately ‘risk-on’ environment, given the improving chances that growth will stabilize, inflation will remain under control, and monetary and fiscal policies will be supportive, as well as the fact that some significant tail risks have diminished recently. Additionally, the anticipation by market participants that “helicopter drop” policies could eventually be introduced when the next economic recession and severe market downturns occur (a situation that we have labelled a “helicopter put”) is keeping the markets happy for the time being, and even frothy in some instances.
At the same time, we warned how geopolitical and domestic political tensions, a possible re-intensification of trade wars, the continued disruption of global supply chains, tighter financial conditions, and market valuations disconnected from underlying macro fundamentals could cause sudden market corrections that investors should be wary of during the new year ahead.
By Brunello Rosa
23 December 2019
Last week we published our Global Outlook and Strategic Asset Allocation for 2020. We discussed our growth, inflation, policy and market forecasts for the year that is about to begin, with baseline, downside and upside scenarios. We also discussed the main macroeconomic and market themes for 2020, with their implications for market and asset allocation.
In our global overview, we mentioned how 2019 was characterised by a synchronized global economic slowdown, but with a strong rally of risky assets, such as US and global equities. The slowdown was driven by a number of geopolitical risks, such as the escalating trade and tech war between the US and China, the risks of a hard Brexit, and increasing tensions in the Middle East. These helped lead to a recession in the manufacturing sector. Now, in our baseline scenario for 2020, we expect this slowdown and stagnation of the major developed market economies to continue. We are less convinced however by the global reflation story that other research houses, especially in the sell-side of the financial industry, are pushing these days.
Equally, we consider a global recession in 2020 to be a risk scenario, at this stage. In a series of articles published in the second half of 2018 we discussed the possibility of a severe market correction and a global recession occurring as early as in 2020, and we outlined the ten factors that could lead to such an outcome. At the same time, in a more in-depth analysis, we discussed the ten reasons why a milder scenario could materialise, in spite of those threats.
Chief among these ten reasons were an accommodation in the global monetary policy stance and a containment of the geopolitical risks, both of which have occurred since then, thereby reducing the probability of a global recession in 2020. Nevertheless, geopolitical and domestic political tensions, an increase in trade wars, disruption of global supply chains, tighter financial conditions, and market valuations disconnected from underlying macro fundamentals could still cause sudden market corrections: investors need to remain aware of these risks in the year ahead.
Given this background, the current environment calls for a moderately ‘risk-on’ position in 2020. There is a high probability that trade and political tensions will de-escalate. A more balanced policy mix is expected to emerge. Variants of “helicopter money” policies could eventually be introduced when the next economic recession and severe market downturn finally occur. From an asset allocation perspective, over the next few years, the investment environment remains challenging, because central bank liquidity and geopolitical risks are likely to matter more than fundamentals and market volatility is likely to rise, hampering portfolio performances and increasing the likelihood of corrections and, eventually, bear markets. As a result, “expected returns” are likely to be lower than in the pre-2008 crisis period. Investors, over a multi-year horizon, will therefore have to accept lower expected returns in exchange for lower volatility, and while riding the liquidity wave remain aware of the risks mentioned above.
By Brunello Rosa
16 December 2019
As we discussed in our in-depth analysis, the UK general election resulted in a historic victory for the Tory Party, which will now gain the largest parliamentary majority of any British government since 1987, under PM Thatcher. It was also the worst electoral defeat for the Labour Party since 1935. The Conservatives gained 48 seats (for a total of 365) compared to their performance in the 2017 general election. The Scottish National Party gained 13 seats (for a total of 48), while Labour lost 59 seats (bringing it down to 202) and the Liberal Democrats lost 1 (it now has 11). Still, the Conservative victory was unquestionable only in England, where Labour now remains strong only in urban areas. Regional parties won their respective nations: Plaid Cymru in Wales, Sinn Fein and DUP in Northern Ireland, and especially the SNP in Scotland.
As of now, we believe that the main political consequences of the vote will be the following: (1) Boris Johnson remains prime minister and, as discussed below, will carry on with his Brexit plan; (2) Jeremy Corbyn, who already said that he will not lead the Labour party at the next general election, will likely resign from his position as party leader in the next few weeks; Labour will now face a harsh leadership contest between the so-called “True Corbynistas”, such as Rebecca Long-Bailey, currently the shadow business secretary, and moderate left-wing figures such as Keir Starmer, the shadow Brexit secretary. If the party does not want to disappear, it will likely shift back to the centre in coming years, following the disastrous results of Corbyn’s attempt to bring Marxism back into the UK political system; (3) Jo Swinson, the Lib-Dem leader who lost her seat in favour of a SNP MP, will also likely resign her position as party leader in the next few days. She carries the responsibility for having forced Labour to accept this snap election that has led to the largest Tory victory in recent history; (4) Nicola Sturgeon, whose SNP party has won 48 out of the 59 seats in Scotland, will press further for a second referendum on Scottish independence.
At this point, Brexit will happen for certain, most likely by January 31st, as is currently planned. This does not automatically mean the end of the Brexit uncertainty. Boris Johnson has promised to conclude a trade deal with the EU by 31 December 2020, a virtually impossible task unless by reaching a deal he means merely an agreement in principle, or only a sort of UK version of the “Phase-1 deal” from the US-China trade dispute. A renewed phase of uncertainty might therefore occur towards the end of the year, when a no-deal Brexit could once again become a possibility if the transition period is not postponed to 2022. The decision must be made by 30 June 2020, and given the ample majority that will now exist in parliament, and the government’s strong negotiating position deriving from the large popular mandate the election has given it, it is unlikely as of now that Johnson will request such an extension in the summer.
Most importantly, if Johnson’s deal is finally approved by parliament, Northern Ireland will become a very special zone. It will be part of both the UK and the EU customs unions, a privileged position that Scotland especially would aspire to have. As in the case of Spain, where the Catalans ask to have the same privileges of the Basque Country in return for giving up their quest for independence, Scotland will probably ask to obtain the same status as Northern Ireland in return for giving up its intention to ask for a second independence referendum.
To conclude, while this election has removed some of the Brexit-related uncertainty and all of the Corbyn-related fears, the road ahead for the UK remains bumpy and winding. For this reason, it is likely that fiscal policy will be more growth-friendly, and monetary policy will remain supportive. As such, the election-induced GBP rally might prove to be more short-lived than is currently thought.
By Brunello Rosa
9 December 2019
After a few weeks during which G10 central banks did not make any major decisions, in December nearly all ten of them will hold their policy meetings. Last week, the boards of both the Bank of Canada (BoC) and the Reserve Bank of Australia (RBA) met to decide the course of their respective monetary policies for the coming months. The BoC left its policy rate unchanged at 1.75%, as had been expected it would. It is the highest such rate among the G10 countries. The BoC’s position is, broadly speaking, “neutral”: the Bank’s statement did not express any particular bias towards either raising rates further or cutting them in the near term. The Bank can enjoy Canada’s inflation being on target and growth being not too distant from its potential level, and so can afford to wait longer before deciding what to do. Clearly, the most relevant factor will be the outcome of the trade negotiations between China and US, given that the Canadian economy is highly dependent on both those economies. It will also depend on oil prices, which tend to move in tandem with global growth.
If the US and China manage to agree to at least the Phase-1 deal (as we expect they will), the Bank of Canada will be able to stay on hold for longer, hoping that a pickup in global growth does not eventually lead to cutting its policy rates.
On the other side of the world, in Australia, the RBA also kept its rate unchanged at 0.75%, but in this case after having already cut rates three times this year, for a cumulative amount of 75bps. Like Canada, the Australian economy is highly dependent on the US, China, global growth and the commodity cycle, which is why the RBA has already also started to explore which unconventional measures it might use if and when its policy rate reaches the effective lower bound of 0.25%. Governor Lowe said that the RBA would be ready to start a QE program of purchases of sovereign bonds in case extra easing is needed, also thanks the additional supply of bonds deriving from the expected fiscal stimulus. So, while the BoC’s position was effectively neutral, in the case of the RBA we can see there exists a clear easing bias.
In the week ahead, the two largest central banks will meet: the Fed and the ECB. As we will discuss in our forthcoming preview, the Fed, which has officially declared itself to be “on pause”, will have to calibrate this message in order not to be pushed around further by President Trump during the coming election year, Trump wanting rates to be cut even more. The ECB’s job is equally challenging. Its policy stance is currently on some sort of auto pilot: open-ended QE, full reinvestment of proceeds, easing bias on rates, and reserve tiering for core-EZ banks and TLTROIII for periphery-EZ banks. But the arrival of a new president at the helm of the institution – namely, Lagarde replacing Draghi – marks the beginning of a transition period that could last a few months. The announced review of policy strategy is a double-edged sword. On the one hand, Lagarde my end up taking ownership of the current policy stance; on the other hand, the review could be the beginning of a reversal of some policy tools. Also this week, the central bank of Switzerland (the SNB) will meet, but as we will discuss in our forthcoming preview we do not expect major changes in its policy stance to be made.
The following week, on Thursday, there will be a number of important central bank meetings: the BoJ, the BoE, Norway’s Norges Bank and Sweden’s Riksbank. The BoE is unlikely to do anything just a week after the general election: it remains to be seen whether the dissenters within the Monetary Policy Commitee will keep or change their vote to “no change”. Norges Bank has already reached “pause” levels, and we do not expect them to do anything at this meeting. More interesting will be to see what the BoJ will do, since the government has finally launched a supplementary budget (which includes a larger-than-expected USD 121bn stimulus package), as the Bank had been clearly demanding it do. Finally, and perhaps surprisingly, the Riksbank is likely to increase its policy rate, as we mentioned in our latest review. It may take its repo rate from -0.25 percent to zero, before entering what will likely be a long period of pause.
By Brunello Rosa
2 December 2019
Two important events shook Germany’s political landscape this past weekend. On the left, the Social-Democratic Party (SPD) chose the radical couple Norbert Walter-Borjans and Saskia Esken as new co-leaders of the party, instead of finance minister Olaf Scholz and Klara Geywitz who they defeated in the party’s leadership race. Scholz and Geywitz were perceived as champions of the status quo, which basically means the SPD remaining in the grand coalition with Angela Merkel’s CDU. Walter-Borjans and Esken however have proposed a more radical platform, which requires the re-negotiation of the “coalition contract” and foresees the rupture of the grand coalition as a possibility.
At the opposite side of the political spectrum, Alternative für Deutschland (AfD) chose a relatively moderate (by AfD standards) ticket to lead the party, after the unifying figure of Alexander Gauland decided not to run again for the party’s leadership in order to allow a generational changeover to occur (Gauland is 78 years old). The party, which already holds 94 seats in the German Bundestag (out of 709) and is the third largest party after the CDU and the SPD, chose as co-leaders Tino Chrupalla and Joerg Meuthen. Chrupalla is a legislator from Saxony, who will represent the former communist states of the East where AfD surged in three elections this year. Meuthen is a professor of economics in the industrial south-western state of Baden-Wuerttemberg. Contrary to the SPD’s decision to choose a leadership ticket that may distance itself from Merkel’s CDU, the unusually moderate choice by the AfD was specifically made to allow the AfD to become a potential ally of the CDU, at least at the local and state government levels.
The selection of these new leaders of the SPD and the AfD occured just over a week after the CDU confirmed Annegret Kramp-Karrenbauer (AKK) as leader of the CDU. Where do these events leave Germany, and what implications might they have for the broader European integration process?
From a domestic standpoint, Germany’s political instability is now clearly on the rise. If the SPD does pull the plug on the government, Merkel might either lead a minority government, or try to strike another coalition deal, or call a snap election. In such an election, the Greens would likely emerge as the first party of the left, which would open up three options (assuming that no party has enough seats to govern alone): 1) A CDU-Green grand coalition, if the CDU emerges as the first party in the election. (But, such an outcome might not be the case if AKK remains as CDU party leader, as she might not be able to guarantee that the CDU will end up as the first party in the election); 2) A new attempt of the Jamaica coalition (CDU-Greens-Liberals); and 3) an alt-left coalition between the Greens, the SPD and the Linke. That is, assuming the three parties together have enough seats, and assuming the Linke compromises on key policies such as Germany’s participation in NATO. In any case, it is clear that the myth of Germany’s political stability is now a relic of the past.
For the broader European integration process (now that Ursula Von Der Leyen has been confirmed as president of the EU Commission) these political events could be either positive or negative. They might be positive if the ongoing political tsunami in Germany were to bring to power the Greens in a relatively stable coalition (a “grand” coalition with the CDU, a leftist coalition with the SPD and Linke, or the “Jamaican” coalition). The Greens are undoubtedly pro-Europeans even if in favour of fiscal discipline, and are advocates of the “green” new deal that in Europe is likely to become the proxy for much-needed fiscal stimulus. German politics might be negative for European integration, on the other hand, if the country’s political instability were to lead to a stalemate within its own decision-making process: Germany remains the largest, richest and most influential country in Europe, without which no decisions are made. The events of the next few weeks will determine which of these outcomes will ultimately prevail.
By Brunello Rosa
25 November 2019
For better or worse, 2020 will be characterised by the US Presidential race, which will not end until November 3, the day the election will be held. President Trump has made all possible efforts to make this election a referendum on himself and his style of being president. He has polarised the US political landscape like very few presidents before him ever have, with his abrasive conduct of government affairs, partly inherited from his business days when he was using his “art of the deal” to get things done.
In politics, and especially in foreign policy, his approach of hitting counterparts as hard as possible before inviting them to the negotiating table has not always worked. Sovereign institutions are not businesses that can be brought to the brink of bankruptcy to soften their negotiating positions. Hence the failed negotiations with the North Korean dictator over that country’s nuclear program, the standstill with the Iranians over the nuclear deal and Middle East policy in general, and the protracted negotiations with China over trade and tech arrangements, which have so far produced at most a “Phase-1” informal agreement.
Regarding the US domestic agenda, President Trump is trying to show that he continues to side with the deprived working class in urban areas and with under-privileged populations in rural areas. For some reason, the president’s narrative is still popular in the country, even though the reality is that some of these domestic issues are actually bi-partisan. For example, every president, Republican or Democratic, would have had to start taking on China and its trade surplus vis-a-vis the US, as well as its unfair tech and IP practices. Perhaps Trump’s unorthodox style and abrasive approach make his positions less acceptable to many who would otherwise support such positions if it were a more conventional politician who was championing them.
Indeed, to some extent Trump may have actually surprised to the upside in his policy stances, by being less trigger happy than what could have been expected from him, especially after surrounding himself with very hawkish advisers and officials such as John Bolton and Mike Pompeo. For example, he did not respond to the provocations of North Korea and Iran in the last couple of years, and has not directly intervened in Venezuela as some of his predecessors would perhaps have done. Trump might turn out to be just another isolationist Republican president.
In any event, the electoral campaign is beginning to heat up. The impeachment hearings are turning awry for Trump, with the testimony of people close to the president such as Gordon Sondland, the US ambassador to the EU, and Fiona Hill, a senior National Security Council official. For now, the baseline scenario will continue to be that President Trump is likely to be impeached in the House, but not convicted in the Senate, where 20 Republican votes are needed to reach the necessary two-third majority of 67 votes.
However, the more embarrassing the hearings become for the Trump administration, the more Republican senators might decide to turn their back on the president if and when an impeachment vote is held. If the president’s position weakens as a result, he might induce some of his external enemies, like China, Iran, or North Korea, to scale up the level of provocations during the electoral year, to see whether a more tense international environment make Trump lose enough votes in the key swing states he will need to win a second term.
What about Trump’s Democratic opponents? As we discussed in our recent analysis, the frontrunner Joe Biden has been damaged by “Kyiv-gate” more than Trump has so far, so much so that Pete Buttigieg now seems to be leading the race in Iowa and New Hampshire, which are the first states that will hold primary elections. To counterbalance the rise of Elizabeth Warren, a left-wing candidate who has spooked the market with her radical reforms made up of universal healthcare coverage and wealth taxes, Michael Bloomberg, the former mayor of New York, has now launched his own campaign to win the Democratic nomination. His presence will make the race in the Democratic camp more uncertain. If he wins the nomination, we would then see two New York billionaires running against each other to become, or in Trump’s case, to remain, President of the United States in November.
By Brunello Rosa
18 November 2019
A number of economists and commentators are discussing the question of what the most effective fiscal and monetary policy response to the next global financial and economic downturn will be. There seems to be a consensus forming that, with global interest rates as low as they currently are (in some regions, nominal policy rates are negative), some form of fiscal and monetary coordination will be needed when the next crisis hits. Most recently, Gavyn Davies has discussed the role of automatic stabilisers, like indirect taxes and forms of unemployment insurance, in such a context, highlighting how this form of automatic support to aggregate demand is weaker in the US than in Europe, for example.
In our recent analysis, we discussed in depth what form this monetary/fiscal cooperation could take, citing the examples of “helicopter drops of money,” “People’s QE”, “Modern Monetary Theory” and other more mainstream forms of fiscal-monetary coordination such as that which was recently proposed by former Fed’s Vice Chairman Stanley Fisher and former SNB chief Philipp Hildebrand, and describing their pros and cons. Our impression is that this idea of monetising fiscal deficits, far from being new (let alone “modern”), is actually becoming mainstream, and will likely provide the theoretical foundation for the policy response to the next economic and financial downturn, especially if the next downturn is severe.
This discussion is already having a very positive impact on financial markets. As we discussed in our column two weeks ago, markets are already celebrating the reduction of tail risks (US-China trade tensions, Brexit, the IMF-Argentina confrontation, etc.) and the additional monetary stimulus (such as that which was delivered by the Fed at the end of October) that are accompanying the stabilisation of key macroeconomic indicators such as manufacturing PMIs (which seem to be bottoming out, while remaining in contractionary territory). We concluded that column by saying that markets are already pricing in some form of fiscal and monetary backstop that they expect to be provided when the next crisis hits. This is like counting on a massive “fiscal and monetary put” available at the global level.
In this imaginary bridge between where we are now (a synchronised global slowdown) and where we are likely to be in a few quarters from now (a recovery phase driven by a coordinated fiscal and monetary policy response at the global level) the question is what will take place in between. For certain, monetary authorities will be prudent, and policy rates will be kept lower than what they would have been if this recovery had taken place pre-2008 crisis. Hence, policy rates are likely to be kept low, if not lower than they are now, for longer.
This might not be enough to prevent a sudden reversal in the imbalances that are building up and will continue to build up, in part even as a result of this very prudent monetary policy. For example, in H1-2019, global debt rose above USD 250tn, with China and the US accounting for more than 60% of new borrowing (with worrisome levels in the corporate debt sector). As such, a “non-linear” event in the middle of the bridge between the current global slowdown and future global recovery seems hard to avoid at some point. A coordinated fiscal-monetary action will then occur, providing the necessary policy response.
By Brunello Rosa
11 November 2019
Spain’s general election has resulted in yet another hung parliament. The final results suggest that the Socialist Party (PSOE) of the incumbent Prime Minister Pedro Sanchez has obtained a plurality of votes (around 28%), but very far from a level that would allow Sanchez to obtain a majority of seats in the Congreso De Los Diputados, the country’s main legislature at the national level. The Socialist Party will have 120 seats, out of the possible 350. Pablo Iglesias’ Unidas Podemos has collapsed, meanwhile, receiving only around 13% of votes and 35 seats. Podemos probably paid a political price for the intransigent position they had taken during the negotiations that followed the April 2019 election, which had failed to lead to the formation of a new Sanchez government. The new party born to the left of PSOE, Mas Pais, obtained 2.4% of votes (most likely from both PSOE and Podemos) and 3 seats.
On the right of the political spectrum, the Ciudadanos party led by Albert Rivera has also collapsed in these elections, from 16% of votes and 57 seats to 6.8%of votes and 10 seats.
Critics are saying the party has run out of “marketable” political material. It is also true that Ciudadanos’ intransigent position regarding the Catalan separatists had already paid off, with the incarceration and severe sentences of the leaders of the “rebellion”, and that its outlook is in any case well represented by the even tougher positions taken by the rising Vox party.
Vox, led by the controversial figure Santiago Abascal, has staged the best performance of all, rising from 24 seats in the previous legislature to 52 in the new one. It received 15.1% of all votes, which despite being only around half as many as the Socialists, is nevertheless a 30% increase from the votes Vox had received in April 2019. This is yet another confirmation that nationalist-populist parties are still strong in Europe, and still represent a serious threat to the European integration process. The People’s Party (PP), led by Pablo Casado, has also increased its votes (+4.1% to 20.8%) and seats (+22 to 88). Other parties, including regional ones from Catalonia and the Basque Country, gained a combined 42 seats.
Where will Spain go from here? As we discussed in our in-depth election preview, Spain’s political stability is long gone, as the fact that this was its fourth general election in four years clearly shows. At the same time, Spain’s two traditional parties, PSOE and PP, plus the newer parties from the left (Podemos) and the right (Ciudadanos), cannot afford not to be able to form a government after this election. If they do not manage to form a government, there is a risk that the protest vote will rally around the newest party on the political scene, Vox, which has the potential to wipe out both Podemos and Ciudadanos and drain further votes from PP and PSOE. As such, we believe that these parties will do all it takes to form a government this time.
Given the number of seats available, Sanchez is very likely to be given the first chance to form a government. He will probably go back to Podemos and try to form a majority with them and some of the other left-wing parties (such as Mas Pais) and regional parties, or if not a majority than at least a parliamentary bloc large enough to form a minority coalition government. If this attempt were to fail, the three right-wing parties (PP, Ciudadanos and Vox) might try to form a coalition – the same grouping that took over the Andalusian regional parliament in December 2018, following decades of unrivalled Socialist rule in that region.
If neither of these two relatively “natural” solutions work out, Spain might instead try to form, for the first time in its recent history, a German-style “grand coalition” between PSOE and PP, which together would command a comfortable majority. A weaker form of this grand coalition could be a PSOE-only minority government, which can be formed thanks to the abstention of the PP (which, in this way, would “return the favour” that the PSOE did to Rajoy in 2016). But the risks deriving from this type of solution are well-known in those countries that have experienced them (chiefly, in Germany, Austria and, more recently, Italy). Grand coalitions tend to reinforce support for extremist parties, especially those on the right side of the political spectrum (AfD, FPÖ, and Lega, respectively). With Vox already on the rise, a PSOE-PP coalition is therefore a solution we believe will be attempted only at the very end, if all else has failed.
By Brunello Rosa
4 November 2019
In our column two weeks ago, we discussed how several key tail risks that were weighing on the global economy were in the process of being reduced, and how that could prove beneficial for risky asset prices. In particular, we noted the following: how the risk of hard Brexit was diminished since Boris Johnson had obtained a new deal from the EU and managed to obtain early elections; US-China trade tensions were lower after the Phase 1 agreement was reached between President Trump and Chinese Vice Premier Liu He; the risk of an open confrontation in the Middle East involving Iran, Saudi Arabia and the US currently seems to be relatively low; the risk of a collision course between Argentina and the IMF seems contained for now, even after the victory of Alberto Fernández in recent presidential elections.
Together with these reduced tail risks, there have been also some positive surprises from the real economy, in particular in the US. Last week, the advanced reading of Q3 US GDP showed a smaller deceleration of growth than initially feared (from 2.0% to 1.9% SAAR, versus 1.6% expected), and October’s Non-Farm Payroll increase was 128,000 (versus 89,000 expected), with September’s data upwardly revised from 136,000 to 180,000. Other positive figures from the US labour market were a small increase in average hourly earnings (3.0%) and an increase in the labour force participation rate (to 63.3%, versus an expected decrease to 63.1%, from September’s 63.2%), which partially justify the uptick seen in the unemployment rate, from 3.5% to 3.6%.
Finally, the Federal Reserve provided an additional kick, with its third back-to-back insurance cut last week, which brought the Fed funds target range to 1.50%-1.75%. The impact on financial markets was powerful, with global equity indices rising substantially: MSCI ACWI was up +1.3% on a weekly basis, driven by strong performance in both DMs (MSCI World, +1.3% w-o-w and S&P 500, +1.5% w-o-w, to 3,067, its all-time high) and EMs (MSCI EMs, +1.3% w-o-w).
Some analysts even wondered whether the easing the Fed has provided since July 2019 (and the interrupting of its tightening cycle since last December) were actually necessary. In our view the answer is yes, the easing was necessary. The manufacturing recession is still ongoing; on Monday the manufacturing ISM rose less than expected to 48.3, still well below the 50 mark, which separates expansion from contraction. Consumer and business sentiment remains fragile, and the risk of an increase in consumer tariffs on December 15th remains present, albeit diminished. So, most likely a mid-cycle policy adjustment was warranted, especially considering a reduced neutral real rate (r*), as was mentioned by Chair Powell during his latest press conference.
Where do we go from here? The Fed has already clearly signalled a period of long pause, which would require dramatic changes in economic and financial conditions in either direction to be interrupted. Indeed, it would likely require either a sharp and persistent increase in inflation above the 2% target, or a consistent deterioration in economic growth, for this pause to be ended. Other central banks are taking a cue from the Fed, meanwhile. The Bank of Canada left its policy rates unchanged (even if with a clear easing bias) in October. The Bank of Japan bought more time before providing more stimulus. The Riksbank even signalled its intention to increase its policy rate (and “normalise” it to 0%) before entering a long pause. This week, the Reserve Bank of Australia is expected to pause its easing cycle (after three 25-bps cuts this year). The Bank of England will remain on hold ahead of the December 12th general election.
As a result, some of the euphoria currently observed in financial markets might be tamed in coming weeks. But don’t worry: in due course, when the situation will have deteriorated enough, central banks will be ready to deploy “helicopter money” to support the global economy and financial markets.
By Brunello Rosa
28 October 2019
Argentina and Uruguay went to the polls yesterday to elect new presidents, at the same time as a wave of protests has been hitting Latina America. Argentina elected a Peronist president again: Alberto Fernández, who will have as his Vice President Cristina Fernández de Kirchner, the former president of Argentina from 2007 to 2015. This is coming after the failure of the Macri presidency to implement liberal reforms and bring Argentina back to international capital markets. When Mauricio Macri was elected president of Argentina in 2015, his campaign was based on the motto “Argentina is open for business.” Macri’s plan was to definitively end the preceding Peronist era, in which Argentina had experienced a very volatile economic performance, rising public subsidies and inflation, and endless disputes with international investors over bonds restructured after the 2001 default.
Things seemed to be going in the right direction until early 2018, when a drought hit the country and a series of policy mistakes led markets to massively short the peso. The subsequent collapse in economic activity, the rise in inflation (55% y/y, the highest in the world after Venezuela and Zimbabwe) and a shortage of reserves led Macri to go back, cap in hand, to the IMF to ask for a bailout. The IMF granted the bailout: USD 57bn, the largest loan in the IMF’s history. This gave Fernández a formidable argument against Macri in the recent election campaign. He was able to say that the 2018 bailout was brought about by the Macri government’s adoption of the IMF-inspired liberal reforms (just like how the 2001 default was caused in part by the collapse of the “currency board” inspired by the “Chicago school”). In other words, instead of opening the country for business, liberal reforms have led it to default. The obvious conclusion (Fernández’ argument goes) is that only Peronism can work in Argentina. This argument has clearly been accepted by Argentina’s population in 2019.
At this point, the key question is what type of policies Fernández will adopt once he is elected. As we discussed in our recent in-depth analysis, Fernández is likely to opt for a middle ground between an orthodox approach and a fully populist approach. He knows Argentina needs a constructive dialogue with the IMF, as it will likely need more financial support in coming months. The IMF too knows that a constructive dialogue with Argentina is necessary: having already disbursed USD 44bn, it will need to keep the relationship healthy and intact if it wants to have a chance of seeing this debt repaid at some point.
Argentina might be a special case, but other LatAm countries are undergoing a difficult transition period as well. As mentioned above, Uruguay also went to the polls yesterday, to elect a successor to President Tabaré Vásquez, who could not run again due to constitutional term limits. Polls were held in the middle of a surge in crime (specifically, of murders and burglaries), which some attribute to the liberalisation of cannabis adopted by the government. Bolivia just had its presidential election, meanwhile, the result of which was that Evo Morales managed to win a second term, which led to disputes about transparency and protests against claims of alleged fraud in the election results.
Besides the basket case of Venezuela and the yet-to-be-confirmed hopes in AMLO’s Mexico, the two most worrying cases in the region of late are Ecuador and Chile. In Ecuador, protests recently erupted as Lenín Moreno, who in 2017 succeeded Rafael Correa (from the same party), in practice made a U-turn on a number of the government’s previous policies, for example by handing back a US military base that had previously been confiscated by Correa, and by steering the country back toward austerity and neoliberal reforms. In Chile, President Sebastian Piñera has reshuffled his entire cabinet as a result of the widespread protests that were triggered by an increase in transportation costs and the more general rise in inequality.
All this has been occurring while, in Colombia, President Iván Duque Márquez is trying to secure a final peace arrangement with the FARC, and in Brazil President Bolsonaro is passing a controversial pension reform in parliament.
By Brunello Rosa
21 October 2019
The IMF/World Bank meetings that just concluded in Washington DC were an occasion for policy makers, market participants, academics and other observers to take stock of the current worldwide macroeconomic, financial and geo-political environment. In its latest edition of the World Economic Outlook, the IMF warned about the synchronised global slowdown now taking place - the opposite of the global synchronised expansion that occurred in 2017-18. The outlook for the global economy has been downgraded, with the forecasts for growth in a number of key economies being revised downwards. The downgrade could have been even larger if it was not for the large positive contribution to growth from countries such as Brazil, Iran and Turkey (whose economy have stabilised after a severe recession). All this is happening at a time when policy makers’ fears of a global recession are increasing.
In this precarious global economic environment, some of the tail risks that could have tipped this global slowdown into a global recession seems have been diminishing in the last few weeks. Just to focus on the four economic collision courses recently identified by Nouriel Roubini, we can say that the risk that such collisions actually materialise is, for the time being, slightly lower than had been the case until recently. In the US-China trade dispute, there now seems to be at least a “Phase 1” agreement, which should be finalised by the APEC meeting in November. If such finalisation does indeed occur, then perhaps the feared increase in tariffs on consumer goods that would have come into effect in mid-December is not going to occur. That would certainly help provide a respite to the global economy.
Regarding Brexit, it seems that the new deal signed between the UK and the EUlast week should eventually lead - even if only at the end of a tortuous path - to an outcome that does not include a hard Brexit. In the Middle East, the tensions between the US, Saudi Arabia and Iran persist, but seem unlikely to escalate further into an open military confrontation. As the decision to pull out of Syriashows, the US seems inclined to disengage further from the region, rather than engaging in a new conflict that could mean putting US boots on Middle Eastern ground yet again. Thus for now the US seems inclined to resist the temptation to respond to Iranian provocations.
Finally, as far as Argentina is concerned, it seems that Alberto Fernandez, the Peronist candidate supported by Cristina Kirchner, is aware of the need to constructively engage in a conversation with the IMF, rather than put up a fight which could lead to a nasty outcome for all sides involved. If all four of these tail risks are reduced – US-China negotiations, Brexit, the Middle East, and Argentina – the danger coming from some of these potential triggers of a global recession would be lessened as a result.
Clearly, if these four fronts become less dangerous, new ones might open up. For example, by November 17th the US administration will have to decide whether or not to start imposing tariffs on the European auto sector. Such tariffs could have a large economic impact on the European economy. For the time being, it seems that the US administration will postpone the decision for a bit longer, as the Chinese front has not closed yet. Germany’s grand coalition could collapse as a result of new local elections or the change of leadership at the helm of the SPD. Older risks could resurface as well, for example if the Italian government were to collapse sooner than expected as a result of the continued tensions within its majority.
Reducing the likelihood of some of these triggers is as important as deploying a policy response to them. In this respect, the Fed and the ECB (and a number of smaller central banks, such as RBA and RBNZ) have started to do their part. More needs to be done, especially in terms of fiscal policy, but at least policy makers are alerted about the need to be vigilant and responsive, even if they are incapable of being proactive. At the same time, the IMF will begin a formal review of the effects of the unconventional monetary measures adopted by several central banks around the world, which hopefully will not lead to a sudden abandonment of such measures. In Europe, the ECB will carry out its own review of strategy, tools and communication, with the arrival of Christine Lagarde at the helm.
Given this background, risk in financial markets seems to be on rather than off. Risky asset prices are still close to their highs, long-term yields are low and credit spreads are tight. The IMF’s Global Financial Stability Report, also published last week, warns about the risks posed by a mounting level of corporate debt of dubious quality. The Financial Stability Board says that it is alerted to this, but is not yet alarmed by it; early in 2020 it will publish a report where is likely to acknowledge this. At the same time, market sentiment remains vulnerable to any swings in economic, geopolitical and policy developments.
By Brunello Rosa
14 October 2019
During a week in which the Nobel Peace Prize was granted to Ethiopia’s Prime Minister Abiy Ahmed Ali, for his “efforts to achieve peace and international cooperation, and in particular for his decisive initiative to resolve the border conflict with neighbouring Eritrea," still another new conflict is starting in the Middle East. After Donald Trump’s decision to withdraw US troops from the north-eastern corner of Syria, Turkey decided to occupy a strip of 20km inside that region to create a buffer zone. The occupation has two declared goals: to make it easier for the Turkish army to defend Turkey’s borders, and to relocate to Syria a portion of the 3.6m Syrian refugees currently living in Turkey.
As part of this offensive (somehow ironically named “Operation Peace Spring”) Turkish troops have launched a series of airstrikes and artillery bombardment against the Syrian Democratic Forces (SDF), forces which have helped the US-led coalition in Syria to fight ISIS, but which Erdoğan considers effectively a terrorist organisation. This is because the SDF are led by the Kurdish People's Protection Units (YPG), which Turkey considers a terrorist group. So, this “Operation Peace Spring” will be directed mainly against the Kurdish ethnic groups, which Erdoğan has long considered a threat to Turkey’s national unity and security.
The US position on this issue is contradictory at best. The US Department of Defense was reportedly against the abandonment of Northern Syria by US troops, and even Lindsey Graham, an ally of President Trump, said he would seek to introduce a bi-partisan resolution in the US Senate to reverse the decision and punish Turkey, if Turkey decides to attack the SDF. Trump himself, after giving green light to the Turkish invasion of Northern Syria, said that he would “obliterate” the Turkish economy if its actions were to be “off-limits”, or “inhumane.” In a spectacular U-turn, US Secretary of State Mike Pompeo said that the US did not give green light to the Turkish offensive in Syria, even as the official press statement following the phone call between Trump and Erdoğan states that “Turkey will soon be moving forward with its long-planned operation into Northern Syria”.
Europe’s reaction has, for a change, been to unanimously condemn this brutal military operation. But it has also, as usual, been ineffective. This is because the EU is in no position to tell Erdoğan what to do, after making a treaty with him on 18 March 2016, the result of which has been that the EU has paid Turkey EUR 6bn for two years in return for keeping the Syrian refugees on Turkish territory. Ahead of the renegotiation of this atrocious deal in 2020, Erdoğan is now threatening to open the gates of its refugee camps and flood Europe with migrants, as happened in 2015. Then, Angela Merkel decided to accept 1.1 million refugees in Germany (and, in so doing, marked the beginning of her own political decline) and Italy and Greece also dealt with hundreds of thousands of migrants coming from (or through) the Middle East by land and sea, while Hungary and other countries closed their borders.
If Erdoğan were to do what he is threatening to do – a scenario we do not expect to happen – the EU would not now be able to cope with such a migration crisis the same way it did in 2015. Germany would be unwilling and unable to accept more migrants, since the CDU has been severely punished for that humanitarian decision by Merkel in 2015. Italy, after the “security decrees” by Salvini (which are still active), has closed its ports to the ships rescuing migrants. Greece is now governed by a centre-right government much tougher on migration than Syriza’s far-left positions were. The Viségrad group (Poland, Hungary, Czechia and Slovakia) remains resolutely against any re-distribution of migrants within the EU (even as they continue to collect, financially, the “solidarity contributions” from larger EU countries). The EU Commission is in the middle of a difficult transition from Juncker’s presidency to Von Der Leyen’s, preventing it from making any big decisions. So, another migration crisis would most likely destabilize Europe, sending it close to collapse. A dis-integration of Europe would have large economic, financial and social consequences.
This means that Erdoğan’s threat is credible. Unfortunately, the likely conclusion to all this is that the EU will renew its deal with Turkey, and receive only a somewhat less “inhumane” war in Northern Syria than would otherwise occur.
By Brunello Rosa
7 October 2019
Following a number of warning signals, a European front in the global trade wars has now been opened by the World Trade Organisation (WTO). In a recent ruling on a 15-year old dispute, the WTO ruled that the US is authorised to apply tariffs worth USD 7.5 billion annually on the UK, France, Germany, and Spain (the “Airbus nations”), as well as on the wider EU, as a compensation for the subsidies that the EU has allegedly given to Airbus, providing the company with an unfair advantage against its US rival Boeing. Similarly, in a separate ruling that is expected in the months ahead, the EU is likely to be authorised to impose tariffs (likely billions of dollars worth) on EU imports of US goods, due to the subsidies that the US government has provided to Boeing. This could mark the beginning of a tit-for-tat escalation between the EU and US, which could prove damaging for both sides.
Ironically, it is the WTO, an international body devoted to the resolution of trade disputes, that is risking opening this new front in the ongoing international trade wars. As discussed in our previous analysis, US President Trump has opened a number of fronts for his country’s trade wars: he began by withdrawing the US from the TPP, then continued with a worldwide tariff increase on steel and aluminium (even imposing such tariffs on its close allies Canada, Europe and Japan, albeit with selective exemptions), then moved to the re-write of NAFTA with Canadaand Mexico, and finally finished in style with China, subjecting it to several rounds of tariff increases as well as technological disputes. When it seemed that on the Chinese front a deal could finally be reached, Trump was ready to wage war to Europe and the European car industry.
The procrastination of the negotiations with the Chinese therefore meant that this European leg of the dispute has repeatedly been postponed. Now, however, the European front is officially open.
The list of goods impacted as a result is very large: French wine, Italian cheese and olives, whisky, and cashmere sweaters, among other items. This cannot be good for Europe: its economy is already in stagnation, with some of its largest economies (such as Germanyand Italy) flirting with a recession. In particular, while Franceand Germany have at least benefited from the positive impact of the aerospace industry to their economies, Italy, which does not belong to the Airbus consortium, would be hit by new tariffs without ever having directly or greatly benefited from the subsidies the company is alleged to have received.
Neither will the US economy remain immune from the expected counter-ruling by the WTO, nor from any retaliatory tariffs that the EU might decide to implement. The American economy is decelerating as the effects of tax cuts are fading out, and the Fed is not following Trump’s game of forcing the central bank to provide monetary stimulus as an (imperfect) offset of the tariffs on various countries that the US government has imposed.
This new European chapter of the American trade war is unlikely to have a happy ending, especially as the most likely outcome for the US-China front of the trade war is not a fully-fledged deal or a total breakdown in negotiations, but rather a continuation of the “controlled escalation” that has been taking place. Unfortunately, the world economy will have to deal with the effects of these disputes for years to come, forcing policy makers to provide fiscal and monetary stimulus, and keeping markets unnecessarily volatile.
By Brunello Rosa
30 September 2019
In the beginning there was Minsky. According to Hyman Minsky’s financial instability hypothesis, during the expansionary phases of business cycles, the financial position of economic agents – companies, households, sometimes even governments – becomes increasingly fragile, as they move from relatively secure “hedge” positions towards speculative or, in extreme cases, “ultra-speculative” positions; the latter not dissimilar from infamous Ponzi schemes. In a more fragile environment, even a small shock to the system, such as a small increase in interest rates, has the potential to render the most exposed positions illiquid or even insolvent. This eventually leads to a downturn in the financial cycle, not dissimilar to the debt-deflation spiral described by Irving Fisher. In turn, this collapse of financial positions triggers a downturn in the business cycle, which moves from expansion to slowdown and eventually into contraction. From a Shumpeterian perspective, this period of “creative destruction” is very healthy, as this process of selection and “survival of the fittest” allows the system to restore itself, shedding previous excesses that existed and therefore readying itself for the subsequent economic recovery.
The particular segment of the business cycle when the cycle turns as a result of a financial shock has been popularised with the name “Minsky moment.” This is considered a real pity by those who are actuallyscholars of the great post-Keynesian economist, as the term completely misses the fact that Minsky’s analysis is a theory of the business cycle: its most interesting part is not the “moment” of shock, but rather is the recovery phase of the cycle, when the financial fragility of the system increases, completely undetected, thus preparing the ground for the later, inevitable downturn. Economic analysis has preferred to focus on the conditions (including shocks) that could trigger these “Minsky moments.” For example, Nassim Nicholas Taleb has written convincingly about “black swans”, extremely rare events that could trigger major changes in prevailing economic, financial and social conditions.
Moving from theory to practice, press reports recently reported that market participants currently fear many black swans, with a potential spike in oil prices deriving from the US-Iran-Saudi Arabia tensions adding itself to a list that already included a possible collapse in US-China trade talks or UK-EU negotiations regarding Brexit. In his latest column for Project Syndicate, Nouriel Roubini spoke about four collision courses that could derail the global economy, adding to this list the victory by Alberto Fernandez in Argentina’s primary presidential election, which has triggered yet another debt restructuring by the Latin American country.
But the list of these potential triggers could be expanded even further. in the US, an impeachment of Trump ahead of the 2020 presidential race could lead, under certain circumstances, to a severe market correction. In Europe, Germany’s recession could deepen, potentially leading to a government collapse and further political fragmentation. In Italy, Matteo Renzi’s newly formed party could pull the plug on Conte’s government, paving the way for a return of Salvini to power. In Asia, an increase in the Japanese consumption tax could lead to an economic contraction, deepening the global slowdown. And other examples could be made for Brazil, China, Russia, etc.
What about the policy response? In the recent decision by the Fed to adopt “insurance cuts” there is a reminiscence of Minsky’s theory, insofar as the central bank decided not to increase rates further at a time when the economic and financial system seemed already to be fragile – to avoid providing a shock that might have triggered a downturn. After years of experimenting with monetary policy, there is now a great consensus among economists that fiscal policy should take up the responsibility of being the main counter-cyclical policy instrument. In effect, in Minsky’s theory, the policy prescription could be simplified with the expression “Big Government” – in other words, making sure that public expenditure is a large component of national income, so as to stabilize business cycles. As Richard Koo convincingly argued, in a balance sheet recession following a debt-deflation episode, the system needs at least one large borrower that can compensate for the deleveraging of the private sector, and that must be the government.
By Brunello Rosa
23 September 2019
There have been a number of rallies around the world this
past week, mostly of young people gathering to protest about the inaction of the global élites regarding the devastating phenomenon that is climate change. Rallies were held in 150 cities, according to event organisers. These took place at the same time as the intervention at the United Nations by Greta Thunberg, one of the moral leaders of this global movement.
We have already previously written,in our column in August 2018, about the impact that climate change (or, more appropriately, global warming) could have on a number of economic, financial, political and geopolitical fronts.
Last year we focused our attention on the existing link between climate change and migration flows, as immigration was and still is one of the most divisive political issues in both the US (where President Trump was suggesting to build a wall along the border with Mexico) and in Europe (where the support for populist parties was increasing as a result of the rise of immigration). In this respect, in 2019 the UN has made a giant leap forward in our view, by introducing the concept of “climate migrants”, a term that will be even broader in scope than the initial category of “climate refugees”.
The introduction of this new concept might eventually have very practical political consequences. In their recent meeting in Rome, French President Macron (who is preoccupied by the rise of Marine Le Pen’s Rassémblement National) promised Italy’s PM Conte (who needs to contain Salvini’s propaganda about there being a “migrant invasion”) to automatically redistribute only the asylum-seeker refugees arriving on Italy’s shores, but not the “economic migrants.” But if – in the not-too-distant future – the EU accepted the idea that those who are now considered “economic migrants” (i.e. people supposedly looking for a better life) are in fact “climate refugees” (i.e. people escaping the effects of climate change) then the number of people subject to automatic re-distribution would increase dramatically, making migration an EU-wide phenomenon as opposed to just a “law-and-order” issue for Greece and Italy to address on their own. The sooner this happens, the better.
Turkey’s Erdogan, who pocketed EUR 6bn from the EU to keep the Syrian refugees in his camps, has threatened to “open the gates” of migrants to Europe, unless the EU gives him more money to deal with this phenomenon. A new wave of migrants to Europe, similar to the 1.1mn people that Germany absorbed in 2015, could destabilise the EU and eventually lead to its implosion.
In this respect, French President Macron is very active, and put climate change as one of the key agenda points of the G7 meeting in Biarritz. Macron suggested to provide financial resources (USD 20mn) to Brazil to help the government led by Bolsonaro to deal with the Amazon wildfires. The two had a lively exchange of views, which unfortunately has not led to a solution. Also in Europe, Germany’s government unveiled a EUR 40bn investment plan in “climate protection measures,” which is thought to be Germany’s vehicle to provide fiscal stimulus to its ailing economy, which contracted by 0.1% in Q2 2019.
But the fight for climate change will involve also key actors from the financial industry. While the US continues to be on the side-lines of this fight, given Trump’s scepticism over the scientific foundations of global warming, Christine Lagarde (former IMF Managing Director) pledged to “paint the ECB green” in her inaugural audition before the EU parliament as ECB President. As Lagarde said, the “discussion on whether, and if so how, central banks and banking supervisors can contribute to mitigating climate change is at an early stage but should be seen as a priority.” In effect one of the pioneers of evaluating the impact of climate change for central banking is BOE Governor Mark Carney.
How to combine economic efficiency and productivity growth with the transition of major economic systems towards more sustainable sources of energy should be a key aspect of the new form of capitalism that thought leaders such as Martin Wolfbelieve should start to emerge in coming years, if liberal democracies want to survive.
By Brunello Rosa
16 September 2019
The world’s major central banks are taking to centre stage again. As we discussed in our review, last week the ECB kicked off the process by announcing a new stimulus plan, consisting of a cut to the deposit rate (accompanied by the introduction of tiered reserves to protect bank profitability), easier conditions for the new TLTRO long-term loans, a promise to keep interest rates at current or lower levels until inflation is closer to target, and new asset purchases that will last until shortly before rates start to be increased. While market participants expected a larger package in some ways, the ECB surprised to the upside by announcing an open-ended version of this easing program: the stimulus will continue until inflation stabilises at a level closer to target.
This coming week, two other major central banks will hold their policy meetings: the Federal Reserve and the Bank of Japan (BoJ). The Federal Reserve is widely expected to cut its Fed funds target rate further, as part of the insurance cuts it started in July. The real question is what the Fed will say about future rate cuts. The market expects these insurance cuts to be just the beginning of a prolonged easing cycle. President Trump is putting as much pressure as possible on Fed Chair Jay Powell to make sure this is indeed the case. However, the Fed is trying to resist any political interference, including the pressure to cut rates to respond to the increases in tariffs unilaterally decided upon by the White House. The clash between the two is intensifying; the former President of the New York Fed William Dudley openly advised the Fed not to fall into this political game, which only serves the purpose of ensuring Trump’s re-election in November 2020.
On Thursday, it will be the BoJ’s turn: analysts are split as to what the BoJ could do in September, just a couple of weeks before Japan’s planned sales tax increase from 8% to 10%. The BoJ might want to keep some of its ammunition for rainy days, but on the other hand it will not want to fall excessively behind the Fed and ECB in their easing cycles. In Europe, the Swiss National Bank and Norges Bank will also hold their policy meetings this week. Their policy decisions too will be greatly influenced by what the ECB and the Fed have done.
The Bank of England’s MPC, also meeting on Thursday, is also widely expected to remain on hold, waiting for Brexit developments.
In spite of all of the best efforts to reduce their relevance over time, the contribution of central banks remains absolutely crucial to countries’ policymaking. There is a lot of talk about the possibility of greater monetary-fiscal cooperation, if not explicit coordination. Some are even suggesting that the next step should be “helicopter money”, whereby central banks provide monetary instruments directly to the general public, thus circumventing the banking system. (Recently, key contributions in this direction have been given by Stanley Fisher, Philip Hildebrand, and others). Draghi himself, during his press conference last week, said that “government with fiscal space should act in an effective and timely manner.” But the reality on the ground, so far, is that fiscal policy is constrained, and monetary policy still remains, by and large, the only game in town when it comes to supporting economic activity during the ongoing slowdown.
By Brunello Rosa
9 September 2019
The level of recklessness existing in politics has increased remarkably during the past few years. This recklessness has produced unexpected outcomes and dangerous side effects that will impact certain countries for years to come. Examples of this phenomenon can be seen in most of the regions of the world.
Let’s start with the UK. In 2016, PM David Cameron launched a referendum on the UK’s participation in the EU. He made this decision as a way of solving the internal debate taking place within the Conservative party, which had been divided for years over this issue (and still is!). The referendum, only the fourth held in the country in 40 years, did not include any precautionary mechanism that could prevent a small majority from deciding the fate of the entire country and its four constituent nations. One could have included a minimum threshold in the referendum (e.g. requiring at least 55% of votes to validate the outcome), or a provision that would have required a majority vote to be achieved in the referendum within each of England, Scotland, Wales, and Northern Ireland. Instead, the Leave camp won by a narrow 52-48% majority, and the Brexit process was initiated in March of 2017.
In the two and a half years since then, the issue has still not been resolved.
Partisanship in the country’s political debate has reached levels not seen in decades. The new Prime Minister Boris Johnson is further radicalising this clash, shutting down parliament and threatening further constitutional stretches in coming days. All this just to increase the stakes in the UK’s negotiations with the EU, to threaten the 27 with a no-deal scenario. This is yet another example of lack of a prudence being taken in contemporary politics.
Moving over to Italy now, we can see that other notable examples of political recklessness have emerged as well, in recent years. In 2016, Matteo Renzi launched a referendum on his plan for constitutional reform, which was very controversial. As if that was not enough, Renzi said that his political career depended on the outcome of that referendum, thus raising the stakes to the point of risking his entire government. The referendum did not pass. Years of discussions over how to change the country’s constitution were wasted in a single day, and the government collapsed as well, paving the way to the Five Star and Lega victory in 2018.
Lega’s Matteo Salvini made the same mistake in 2019: he pulled the plug on a government that was extremely popular at the national level (even if internally divided and quarrelsome).
He bet everything on the fact that the PD and the Five Star would not make a deal with one another, and that the President would call early elections right in the middle of the budget season, thereby risking budget prorogation and market turmoil. All this did not occur, and so he lost power. In this case, this actually removed a risk factor from the political landscape; namely the possibility for Italy to leave the euro area. Nonetheless, the political calculus behind Salvini’s gamble was not prudent, and could have cost the country dearly.
On the other side of the Atlantic, President Trump was after running a very divisive campaign, a campaign which radicalised the political landscape in the US and reduced the space available for cooperation between the two parties in Congress. After that, Trump started applying his “art of the deal” approach, consisting of assertive moves, veiled and not-so-veiled threats, and brinkmanship, to a number of situations: NAFTA, trade and tech disputes with China, the Iran nuclear deal, etc. This approach has made US leadership less predictable, leaving traditional allies confused. As a result of his trade wars and widespread uncertainty, the world economy has entered a slowdown, which affecting the US economy and risks jeopardising Trump’s chances of being re-elected in 2020.
In Japan, meanwhile, PM Abe seems willing to spend all of his political capital on a referendum to change Article 9 of the country’s pacifist constitution, even as public opinion remains opposed to such a change. Here too, we see a political leader making a bet that could backfire massively on himself. In this case, the bet is taking place in a country that has been fighting deflation for the last 30 years.
These are only a few examples, from four prominent G7 countries, of the recent increase in political recklessness. Other examples could be given as well, both in advanced economies and in developing countries. Brazilian President Bolsonaro’s approach to the fires in the Amazon, for instance. Maduro and his mis-management of Venezuela. Argentina taking on the largest loan on IMF’s history, only to default on it after one year. North Korea’s development of a nuclear program. The list goes on. In our view, having political leaders who play with fire, as if there were no consequences to their mistakes, is very dangerous. When too many of them act in this same way, global risks increase and risk materialises in unexpected ways, with the result being that potentially catastrophic consequences can be realized following incidents that would otherwise have only minor negative effects.
By Brunello Rosa
2 September 2019
This week will be a crucial one for determining the fate of governments in Italy and the UK. In Italy, Giuseppe Conte will come back to President Mattarella to announce whether or not he has been able to form a coalition between the Five Star Movement, the Democratic Party, and other smaller parties. As we discussed in our scenario analysis, there are a number of unresolved issues between Five Star and the Democratic Party, including as to what their government’s program and composition would be. Di Maio’s tough speech last Friday(“either the PD accepts these 20 points, or better to vote. And I may add: the sooner, the better”), was widely regarded as an obstacle to eventual solving of the crisis (hence the fall in equity markets and the spike in the BTP/Bund spread). Additionally, there is a Damocles’ sword hanging over the coalition deal; that is, the vote on Five Star’s online platform Rousseau to ratify such a decision.
Nonetheless, in our baseline scenario, we expect Conte to be able to positively resolve the “reservation” with which he accepted the charge of forming the government. The government would initially be very fragile, as Conte will have a strong political and social opposition to face, as well as a difficult economic condition (GDP contracted in Q2, among other concerns). At the same time, such a government could also count on some powerful allies. The US President openly hoped for Conte to be confirmed as PM. The outgoing European Commission, even with one of its most hawkish representatives (Guenther Oettinger) said it welcomes the possible formation of a pro-European parliament in Italy.
The new Commission led by Ursula Von Der Leyen made Conte understand that Brussels will close an eye regarding the budget, so long as Italy remains fiscally prudent and moves in the right direction (even if not at the ideal speed). Even the Vatican showed sign of sympathy for the new government, with a short meeting between the Pope and Conte on Friday. So, while the navigation could be bumpy, the government’s ship does not necessarily need to sink if the coalition partners do not fight too much amongst themselves.
Market concerns are now actually higher for the government in the UK than for Italy, for a change. During the past week PM Boris Johnson obtained from the Queen the possibility to suspend parliamentfor five weeks between September 9th -12th and October 14th, ahead of a new Queen’s speech. As discussed in our analysis, Johnson claims that this is a normal procedure to allow the new government to focus on its new legislative agenda. But the reality is that the decision was made to prevent opponents of Brexit (or at least, opponents of a no-deal Brexit), who are a majority in parliament, to undertake the legislative actions that would prevent a no-deal Brexit from occurring. When parliament reconvenes on September 3rd, after the summer recess, it will now only have 6 days, and even fewer working days, to try and react to this move.
Though legal challenges have been made against Johnson’s decision, including from the former leader of the Tory party Sir John Major, the possibility that the Labour party will table a no-confidence vote to oust Johnson during this week are much higher now. It is yet to be seen whether this will be a feasible initiative and, if so, whether it will be a successful one. For the time being, markets are skeptical and the pound sterling is reaching all-time lows.
By Brunello Rosa
27 August 2019
In spite of the hot weather and the summer holiday season, policy events are in full swing. In the US, the traditional summer meeting of central bankers in Jackson Hole was closely watched, observers attempting to detect signs that would indicate whether the Fed’s insurance cuts could become the beginning of a more prolonged and deeper easing cycle. The words of the Fed’s Chair Jerome Powell were scrutinised, the prevailing impression of them being that Powell remained cautious about providing precise indications as to what the Fed would do in September and beyond. President Trump, considering these words not dovish enough, even asked on Twitter, “who is our bigger enemy, Jay Powell or Chairman Xi?”.
This question was motivated by the intensification of the trade war between the US and China, with China first announcing tariffs on USD 75bn of imports from the US (itself a retaliation to Trump’s decision to impose additional tariffs starting from September 1st), to which the US responded with a further retaliation. President Trump tweeted that tariffs on the USD 250 billion of imports already in place would be raised to 30% from 25% on October 1, and that the remaining USD 300 billion of imports set to become effective on September 1stwould be taxed at 15%, rather than 10% as had initially been announced.
Another front of the many US confrontations now taking place is Iran. On this front, there might be marginally positive news coming from the recently concluded G7 meeting in Biarritz. Iran’s Foreign Minister Javad Zarif was invited to the side-lines of that meeting. Though President Trump did not meet with Zarif, we can consider it positive news that a channel of communication was opened between the two sides (thanks to French President Macron, who organised the meeting).
Other items on the agenda of the G7 meeting besides trade wars and tension with Iran included the digital tax that Macron wants to impose on US tech giants in France, and emergency measures to combat the fires in the Amazon forest. The Amazon represents another very sensitive front in international relations, of course. Brazil’s President Jair Bolsonaro is insisting that Brazil’s portion of the rainforest belongs unequivocally to Brazil – but the rest of the world is claiming that the forest is the “global lungs”.
Around the table in Biarritz there were key players in two other critical political developments that were cited by Powell as global risks; namely, “the collapse of the Italian government and Brexit”. Italy’s PM Conte – who resigned last week – is waiting to see whether he will be reconfirmed as prime minister in a new coalition government between Five Star and the Democratic Party. Italy’s President Mattarella will hold a second round of consultations on Tuesday and Wednesday this week. If at the end of this round the possibility of forming a new government is not clear, the President will dissolve parliament to hold early elections, which will most likely take place on November 3rd or November 10th.
UK PM Boris Johnson made his debut at the G7 in Biarritz meanwhile, and there had the chance to meet again with French President Macron and German Chancellor Merkel, together with EU President Donald Tusk. Johnson re-affirmed his tough stance on Brexit, threatening not to pay the GBP 39bn Theresa May had pledged to pay as part of the Withdrawal Agreement. He is facing a tough return to Britain. When parliament re-opens, he will have to face a no-confidence vote, which could bring down his newly formed government and allow for the formation of a caretaker government that would postpone Brexit and prevent a no-deal scenario from materialising. In response to this threat, Johnson has asked legal advice on whether he can shut down parliament (or, technically speaking obtain a “prorogation”) for five weeks, so as to make sure that no-deal Brexit cannot be blocked by parliament. The EU partners have given the UK the onus to come back to the negotiating table within 30 days with examples of “alternative arrangements” to the Irish backstop, for a deal to be signed. We are clearly going to have to wait until the last moment to find out whether or not a deal is reached.
By Brunello Rosa
19 August 2019
We have written several times about the rise of populism at global level, and its repercussion on the political, economic, and financial developments of the countries in which the populist phenomenon is strongest. We have also discussed the potential repercussions for the liberal order and its institutions, such as the European Union, that were created after Word War II as a response to the damage caused by the nationalistic and populist movements of the first half of the 20th century.
Plenty of studies have been published that discuss the origin of this new wave of populism. A useful taxonomy is one in which contemporary populists have been classified into three categories: those who reached power for cultural or “identity-related” reasons (e.g. Brexit); those who claim to be anti-establishment (e.g. Donald Trump), and finally, those who came to power as a result of a widespread socio-economic malaise (e.g. Five Star and Lega in Italy). In this column we want to focus on the underlying causes of the last of these three categories: socio-economic populism. At the core of any economic malaise there is under-development and lack of opportunity, especially in emerging markets. In developed economies, however, where per capita income is much higher, it is the uneven or unfair distribution of income and wealth that seems to be the driving force behind the rise of populist forces in recent years.
As discussed in our recent in-depth analysis, income and wealth inequality (or lack of “inclusion”, to use the expression of the IMF/World Bank) is one of the main causes of subdued growth and historically low real interest rates. As the IMF said in its 2018 Annual Report, “reducing inequality can open doors to growth and stability.” Yet by causing subdued and uneven growth, inequality is also a primary origin of protest movements that want to rectify this situation, which sometimes are or have been classified as “populist.”
In our analysis we discuss how income inequality has been increasing since the 1970s, when the primary distribution of income began to become skewed more towards profits, interests and rents and less to labour.
At the same time, the neo-liberist revolution of Ronald Reagan and Margaret Thatcher also made the redistribution of income via taxation and subsidies less effective, on the back of what was labelled as trickle-down economics. Many years of increased globalisation, with its inherently deflationary forces (including on wages), reduced labour share of income in the most advanced economies (and parallel increase in the profit and interest share of income), diminished power of trade unions, mass privatisation of public goods, and inability of taxation and subsidies to redistribute income in a fairer way, have led to the current situation. Workers in many countries feel deprived, and are therefore willing to give a chance to political leaders who claim to be on their side, however inconsistent with this claim those leaders’ biographies might be.
The policy solution to this problem seems quite straightforward: a more active role of fiscal policy, to promote income redistribution, increased public expenditure in infrastructure and education, the provision of job opportunities to younger generations by the public and private sectors. Some of these solutions are becoming popular even among the US electorate, with the rise of political leaders such as Bernie Sanders and Alexandria Ocasio-Cortez, who are not afraid of being labelled “socialists,” a description which just a few years ago would have killed any political career. Nevertheless these solutions are easier said than done. Once in power, even their proponents realise how difficult implementing such policies tends to be, given binding budget constraints.
Wealth inequality is even harder to assess than is income inequality, as it is often a legacy issue (as wealth is accumulated over generations), and as it is the result of the cumulative effect of income inequality over a long period of time. A group of economists has suggested the adoption of a “wealth tax” as a solution to this issue. This might well be a solution, but the political economy of adopting such a tax would be complicated, and so might ultimately prove to be counter-productive.
All this is to say that income and wealth inequality are here to stay for the time being, and will continue to feed populist movements around the globe. Policy solutions are available, but their implementation is complicated and sometimes politically toxic. This means that probably things will have to get worse before they can get better.
By Brunello Rosa
12 August 2019
Last week, we observed that political risk has been rising again, especially in Europe. In Italy, following months of indecision, Lega’s leader Matteo Salvini decided to pull the plug on Conte’s government by tabling a no-confidence motion in the Senate. As we discussed in our flash update last week, that officially marked the beginning of a government crisis which is expected to lead to a snap election being held in late October. If that election takes place, Salvini – who has asked the Italian voters to given him “full powers” – could become Italy’s Prime Minister by the end of the year. Salvini’s budget plans are certainly not in line with Italy’s budget discipline of the last few years, and therefore Italy is likely to soon be on a collision course with the EU Commission (again!). Markets are already reflecting these developments, with the 10y BTP-bund spread back to 240bps, and equity prices having fallen by 2.5% last Friday. Also on Friday, Fitch kept Italy’s rating at BBB, with a negative outlook, clarifying that a government collapse in H2 2019 was already part of their baseline. As we discussed in our medium-term scenario analysis in October 2018, Italy is now choosing what we labelled an Austro-Hungarian path. This could eventually lead the country to become an “illiberal democracy,” as theorised by Salvini’s maestro, Hungary’s Prime Minister Victor Orban.
Italy is not the only country to be experiencing a political drama. In the UK, PM Johnson has confirmed that the country is ready to leave the EU with “no ifs and no buts” by October 31st, with or without a deal. He might have been lured into doing so by US assurances that the Trump administration will be at the UK’s doorsteps “pen in hand” to sign a free-trade agreement with the country.
In fact, such a deal might be difficult to achieve: a number of US politicians with Irish roots would reportedly be very reluctant to ratify any trade deal that risks endangering the provisions of the Good Friday Agreement for Ireland, and in particular the existence of an open border between the two sides of the island.
Also, former US Secretary to the Treasury Larry Summers said that any trade deal signed with the US after a “no-deal” Brexit would be particularly advantageous for the US (for example, health insurance companies could try to replace the NHS), but very dis-advantageous for the UK, given that the UK may be in a desperate position after crashing out of the EU. (Brexit uncertainty has already caused UK’s GDP to fall in Q2 2019). As a result of all of this, a new standoff between the UK and the EU Commission is likely to begin soon, which might lead to new elections. Press reports suggest these might take place immediately after Brexit, possibly even on November 1st. The effects of the no-deal would then not yet be immediately visible or able to influence voters’ opinion.
All these domestic political risks are resurfacing at a time when geopolitical risks are also on the rise, and as the global economy is particularly fragile. As we will discuss in greater detail in John Hulsman’s Geopolitical Corner later this week, a few days ago India’s PM Modi reduced Kashmir’s autonomy, and by doing so inflamed a region that is geopolitically one of the hottest in the world (especially given that both India and Pakistan have nuclear military capabilities). Meanwhile the US has decided to rebrand China as a currency manipulator after many years, following the depreciation of the RMB to above 7 US dollars for the first time since 2008. (The RMB depreciation was caused by the threat of new US tariffs on Chinese imports, which we discussed last week). With this move by the US, the risk of a currency war has been added to the ongoing trade and tech wars between China and the US. It should not come as a surprise that all these political and geopolitical risks are taking a tolls on the global economy.
By Brunello Rosa
5 August 2019
At the end of last week, US President Donald Trump threatened to impose a 10% tariff on the remaining USD 300bn of imports from China beginning on September 1st, if by that date an agreement is not reached between the Chinese and US governments. After the small level of hope generated from the “positive” meeting between Trump and Chinese President Xi Jinping at the G20 meeting in Osaka, this turn of events makes the possibility of a comprehensive trade deal between the US and China being reached soon even slimmer than it had previously been. In the days preceding this latest of Trump’s threats, he had warned markets and the general public that China’s tactics might have been to wait until November 2020 before signing any agreement, in the hope that by January 2021 they could deal with a more conciliatory, Democratic president.
Unfortunately, events are unfolding in line with our view that a controlled escalation between the two countries is more likely than a full-fledged deal being reached, and that at best the US and China can only agree on temporary truces during what may prove to be a long-term technological and geo-strategicnew cold war— or Cold War 2, as we labelled it in early May. A comprehensive and long-lasting agreement is hard to envision, even if Trump were to win re-election in 2020. At most, a more prolonged truce between China and the US could be agreed upon, but such a truce would remain fragile and subject to interpretation and controversy.
Needless to say, the market did not respond well to the latest turn of events. Equity market sold off massively throughout the world, reinforcing a move that was already taking place as a result of the disappointment that followed the Fed rate cut on Wednesday 31 July. Long-term sovereign bond yields in US, UK, Europe and Japan collapsed. In those jurisdictions where the market could expect more rate cuts from central banks, sovereign yield curves steepened. Elsewhere, they continued to flatten. Even in the US, where the Fed has 225bps of easing space available, the 2y US Treasury yield closed the week down by 16bps, while the 10y yield fell by 24bps on the weekly basis. The net result has been a re-flattening of the yield curve, after the marginal steepening that had occurred in anticipation of the Fed’s rate cut.
In the past, a flattening of the yield curve has been associated with upcoming recessions. In our analysis, we have argued that with the long end of the US yield curve being anchored by low yields in Germany and Japan, this correlation between the curve and recession probabilities has diminished. Nevertheless the latest developments do not bode well for the US or the global economy.
To begin with, it would be delusional to think that lower policy rates by the Fed could compensate higher tariffs, which risk having a disproportionate and non-linear effect on the economy.
Second, in addition to the ongoing trade and tech war there are also unabated tensions with Iran, which have recently escalated with the seizure by Tehran of a UK super-tanker. This stand-off is likely to be prolonged; the Iranian government might wait for the end of Trump’s presidency before re-opening the diplomatic channels of communication, in the hope of dealing with a less confrontational US president.
Finally, as the global manufacturing recession continues, the global economy might be on the cusp of a downturn which looser monetary policy alone might be insufficient to avert.
By Brunello Rosa
29 July 2019
Last week, Boris Johnson was elected leader of the Conservative Party and, as a result, Prime Minister of the United Kingdom. Johnson’s program has the acronym DUDE: Deliver Brexit, Unite the UK, Defeat (Labour’s leader) Jeremy Corbyn, and Energise Britain. His first speech, made in front of 10 Downing Street, was a profusion of optimism; it was an attempt to rally the country’s sense of pride over its glorious past and purported luminous future outside the EU. Johnson promised to take the UK out of the EU by October 31st, “no ifs and no buts.” Polls show that this new, energetic and defiant approach has resulted in a 10% bounce in the Tory support, to 30%, ahead of Labour (25%), LibDems (18%) and the Brexit party (14%).
The largely reshuffled cabinet reflects this new, assertive approach to Brexit. Leading Brexiteers have been given key ministerial roles. Dominic Raab is replacing Jeremy Hunt as foreign secretary, Andrea Leadsom is replacing Greg Clark as Business secretary, Jacob Rees-Mogg (the Chairman of the ultra-Brexiteer European Research Group) is replacing Mel Stride as Leader of the Commons (which organises the government’s activity in the House of Commons), Michael Gove is replacing David Lidington (Theresa May’s de-facto deputy PM) as Chancellor of the Duchy of Lancaster and key adviser to the PM, in charge of coordinating Cabinet activity. Additionally, former pro-Remain Sajid Javid is replacing Philip Hammond as Chancellor of the Exchequer, and is preparing an extraordinary budget to speed up preparations for a no-deal Brexit. Finally, political strategist Dominic Cummings, the former campaign director of “Vote Leave”, is now special advisor to the PM.
In a series of updates, we have discussed what consequences the election of Boris Johnson could bring about. Regarding Brexit, Johnson’s attempt to renegotiate the deal with the EU will at first likely result in a firm “no way” from the EU. That could in turn trigger a confidence vote that, if lost by Johnson, could result in a Labour-led minority government being formed, a new general election being held or even a second referendum. In case of new elections, a tactical Tory alliance with Nigel Farage’s Brexit party would become likely.
Such an outcome would change the nature of British politics: by making an alliance with Farage, the Conservatives, one of the cornerstone parties of the UK political system, would be institutionalising the populist movement (which morphed into a party at the latest EU elections) that has led to Brexit. In other European countries we have seen how fringe national-populist parties have come to power by making alliances with the traditional, mainstream parties (for example in Austria, under the government of Sebastian Kurz). Once contracted, the virus of populism is very difficult to get rid of: it tends to become part of the political discourse, and never fully leaves. A seemingly endless list of countries all around the world, from Latin America to Europe and Asia, know this all too well. What is astonishing to watch is the US and UK, countries that were leaders of the liberal-democratic order that was born after World War II, entering such a difficult phase of their history as well.
We believe a period of political turmoil is likely to begin for the UK. The Brexit plane is not going for a soft landing. In the best case, it is going to be a very bumpy landing – but no one can rule out a crash either. The key point to understand here is that what seems a failure to most of the international observers, including us, might not be perceived as such by the new Tory and British leadership. In the next article for his Geopolitical Corner published this week, John Hulsman will discuss in detail how Johnson perceives the Anglosphere to be his geo-strategic horizon, and this does not require any participation in the European integration process, which is perceived rather as a chain to be freed from.
By Brunello Rosa
22 July 2019
This week, the long-awaited period in which G10 central banks start becoming more accommodative will begin, starting with the ECB’s Governing Council meeting on Thursday. As we wrote in our preview, the ECB will mostly just be laying the groundwork for more significant easing measures to be adopted in September, when a new set of staff forecasts will also be provided. It may, however, also give something of an appetizer in July, in terms of beginning the process of accommodation immediately to a certain extent. Currently markets remain buoyant about the arrival of Christine Lagarde at the helm of the ECB, as she is expected to provide continuity with Mario Draghi’s era. Additionally, press reports revealed that the ECB is looking at the appropriateness of its official goal (to keep inflation “below, but close to 2%”) to achieve its price-stability mandate. These reports suggest that a more “symmetrical” approach would provide less of a disinflationary bias and more headroom for an easier policy stance.
Similar thinking seems to be underway in the US, where the Fed (whose FOMC meets next week) appears to be on the verge of moving de facto to some form of average inflation-targeting regime, suggesting that after a prolonged period of target under-shooting, monetary policy could be kept more accommodative than is justified by the stage of the business cycle alone, in order to make up at least part of the miss in the price level. As a result of these considerations, the recent testimony by Chair Jay Powell before the US Congress, and a speech by the President of the New York Fed John Williams (which required an unusual clarification), market expectations about the size of the rate cut in July have swung wildly in the last few weeks, between 25bps and 50bps. After this period of volatility in expectations (amounting to “confusion,” according to some press reports), they seem to have stabilised at 25bps. We will discuss all of this in greater detail in our upcoming preview for the FOMC meeting.
The same week as the Fed meeting, the BOJ and the BOE will also hold policy meetings. As discussed in our recent overview of the policy stances of the G10 central banks, the BOJ could start making the first changes in its language as early as July, whereas the BOE will remain mostly reactive, with the change in the British government and Brexit developments dominating the macroeconomic environment. Other G10 central banks, such as the RBA, RBNZ, and BOC, have already acted or adjusted their rhetoric in response to these developments. But some other central banks, such as the Riksbank, have expressed more caution, in consideration of the more limited easing space available to them. On the other side of the spectrum, Norges Banks has, so far, remained fiercely hawkish.
G10 central banks tend to set the pattern for all other central banks in the developed world (e.g. in South Korea, the central bank cut its policy rate for the first time in three years), but also in Emerging Markets. An easier stance in the G10 reduces the pressure on EM central banks to keep rates high to sustain their currencies and contain inflation. A number of EM central banks have already cut rates in recent months as a result of this changed landscape, including in China, India, Russia, the Philippines, and Malaysia.
Now the time seems ripe for even the embattled Central Bank of Turkey to cut rates, after the defenestration of its Governor by President Erdogan. At its meeting on Thursday 25 July, the TCMB is expected to cut rates by a whopping 250bps, from 24% to 21.5%, in a supposed sign of normalisation after the defensive hikes it adopted at the height of the Turkish Lira crisis during the summer of 2018.ns (amounting to “confusion,” according to some press reports), they seem to have stabilised at 25bps. We will discuss all of this in greater detail in our upcoming preview for te FOMC meeting.
by Brunello Rosa
15 July 2019
Last week, when we commented on the selection of the new heads of the top five EU institutions, we highlighted how the end of the musical chairs game that the selection process resembled delivered only a very a fragile political equilibrium. We also took a non-consensus view of the situation, arguing that time is on the side of the national-populist parties in Europe, which, during the five-year tenure of this new parliament, will have the option of making a proposal to the European People’s Party (EPP) to form a coalition together. Already during the past week, events of this kind have been unfolding more rapidly than even we would have expected.
As numerous press reports suggest, the new EU Commission (EC) President Ursula Von Der Leyen is having a hard time securing the votes she will need on July 16thif she wants to win a vote of confidence from the EU Parliament. With the far-left GUE and the Greens having formally announced their vote of no confidence towards President Von Der Leyen, she now needs to rely on a three-party coalition of EPP (179 seats), Socialists & Democrats (153 seats) and Liberals (105 seats). Theoretically speaking, this ruling coalition could count on 437 votes, much more than the 374 necessary to reach a majority in the 750-seat European Parliament.
However, a number of MEPs, especially those from the German Social Democrats, are still upset by the method by which Von Der Layen was chosen (in particular, the trashing by French President Macron and German Chancellor Merkel of the Spitzenkadidat system that was introduced in 2014). Others are unimpressed by the lack of ambition of her political program, which so far seems to be just a sensible continuation of the status quo. Additionally, some members of the EPP, such as Viktor Orban’s Fidesz, want a softer stance taken by the future EC regarding the application of Article 7 (namely, the sanction imposed on misbehaving countries) in exchange for their vote. So, what seemed to be a vote that Von Der Leyen could take for granted could instead become extremely problematic.
Facing this situation, it was suggested to her to postpone the vote to September, so that she could gain more time to convince the rebellious MEPs to give her their support. But she understood that nothing would change in the next two months, and that her position could become even weaker if she were to let this situation fester for a longer period of time.
But here is where the situation becomes intriguing, if perhaps also dangerous. A number of populist-nationalist parties have offered their support to Von Der Leyen, in exchange for a more favourable attitude taken by the EC President on the dossiers close to the various party leaders. PiS, the Polish party of the nationalistic leader Jarosław Kaczyński, has offered its support in exchange for a softer stance on the application of Article 7, like Hungary’s Fidesz. Lega and Five Star have offered their votes in return for a “heavy” portfolio for Italy in the new EC, such as Competition, or Industry.
Von Der Leyen might manage to convince the rebellious MEPs from her own coalition to fall into line and allow the Commission to have a working and cohesive majority from the start of her term. But she might not have enough time for that. In that case, she may be forced to accept parties to allow for the birth of a Commission presided over by herself. Such a Commission would become vulnerable to the requests of the national-populists sooner than even we had anticipated. Von Der Leyen’s manoeuvring space to reform Europe in the direction of the “United States of Europe” (the way she reportedly would like to see the EU become) would be further reduced. As a result, the process of EU dis-integration would likely accelerate further in coming years.
If Von Der Leyen fails to reach a majority this week, this would open up a serious institutional crisis in the EU, forcing EU leaders to find another solution. Such a solution is difficult to identify, as Von Der Leyen was chosen as part of a “package” that is difficult to unbundle, a package which also included the selection of David Sassoli who has been already elected President of the EP, Charles Michel as President of the EU Council, and the arrival (which markets have already greetedpositively) of Christine Lagarde at the helm of the ECB.
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