A road by any other name
The Fed minutes provided something of a surprise. The same FOMC so recently telling us it would not raise rates until end-2024 because the economy is unfair -then shifting to end-2023 after a supply-chain snarl it didn’t predict- reports “various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of incoming data.”
So when is that – 2022? Isn’t that…(checks calendar) six months from now?! Of course, there were some doves talking about unemployment data too. However, it is a further warning for markets that US mega-QE may be a star-crossed love not long destined for this world – and parting from it is likely to be far more sorrow than sweet for most asset classes.
US Treasury yields continue to plunge, again making a mockery of those who had been saying this time the break-out was real. 2s closed at 0.21%, down 6bp from their recent peak; 10s spent part of the day below 1.30% and closed at 1.32%, down 13bp from the Wednesday intraday high; and 30s are at 1.94% when they were 2.45% in March. What an economic dawn is projected in that yield move! Yet just as the Fed (and RBNZ) is leaning towards tightening, the ECB and PBOC are leaning the other way. Which is going to get ‘interesting’: imagine a market with the Fed (and RBNZ!) leaning one way and the ECB/PBOC/BOJ/RBA the other.
Bloomberg quotes ECB officials that the Bank’s review will see a shift to a new inflation goal of 2% that “allows overshoots when needed” vs. the current “below 2% and no overshoot”. The Fed already has Flexible Average Inflation Targeting (FAIT) but we don’t have a new ECB inflation policy name yet. Will it be Flexible Inflation Targeting (FIT)? Or Flexible Average Targeting (FAT)? Or Flexible Level of Average Targeting (FLAT)? Or Flexible Level of Average Prices (FLOP)? But what’s in a name? ECB rates are on hold for even longer, if that is possible, and ECB-QE -once thought impossible- will flow for longer. And asset prices will rise higher, making young/poor people angrier, and no deflationary structural problems will be addressed by any of this, says the bond market.
China’s State Council also let it be known it will “use monetary policy tools, including RRR cuts, in a timely way to further step up financial support for the real economy, especially small firms” – so policy easing. Note it wasn’t the PBOC saying this, underlining how monetary policy in China differs from the West (for now). This will be taken as bullish by the same people recently telling us China was experiencing a great V-shape recovery, but RRR cuts won’t help if the problem is a lack of confidence and too much debt: directly lowering the cost of borrowing for SMEs will, but banks are risk-averse, and SME funding is a problem everywhere. RRR cuts will help push CNY lower though: which is deflationary for the world – or it would be without a Bullwhip supply chain effect.
Meanwhile, the State Council is also reportedly proposing monetary policy instruments to support carbon emissions reduction targets in the form of relending quotas with preferential rates issued to qualified financial institutions to encourage funding for green loans. In other words, subsidized green borrowing; which is great for the environment…and for Chinese firms about to be hit by Carbon Border Adjustment Mechanisms (green tariffs) from the US and EU. Unless CBAMs exclude imports using state-aid -which the US and EU are themselves likely to adopt to go green- what will the criteria for excluding such Chinese goods be? The Great Game rolls on – under a new name. And so does a potential physical bifurcation to match that in rates.
On which note, China’s Global Times didn’t get the recent memo about presenting a more lovable face. In response to Japan’s Deputy PM affirming his country would fight alongside the US in support of Taiwan should China invade, which Beijing naturally took as a provocation, the GT responded: “Japan will dig its own grave if it crosses red line of Taiwan question…Japan will become the target of China’s military strike. This will endanger Japan’s survival.” More free trade, anyone?
At the same time, Politico reports: “EU countries are finally getting serious about their response to China’s Belt and Road Initiative…[EU] governments want the Commission to spend the next nine months coming up with a list of “high impact and visible projects” to rival Beijing’s scheme…Among the challenges for the Europeans will be coming up with a name for their plan which is as catchy as Belt and Road. It will also need a logo…[to] deploy the EU’s soft power.”
*Among* the challenges?! Is this EU geopolitical “open strategic autonomy” or a marketing exercise? Are a “catchy name” and logo really the challenge in a realpolitik struggle for resources and value-chain position, and the subsequent economic power to back the EU’s political-economy values system in the 21st century?
What is to be built, and to benefit whom, for example? By the very dint of the EU responding to the BRI, this process can be zero sum.
How about funding? Nobody in the EU wants to pay for a ‘BRI’ despite ECB QE4EVA making it easily done. Politico says “There’s no price tag for the EU’s new scheme, but the Council will call for a mix of public financing and private investment,” with the EIB and EBRD in the mix. Yet note China has (very) broadly sunk as much as $2.5 trillion into BRI, much of it money-losing.
And who, apart from France, will be willing to defend the EU scheme on the ground in an increasingly sharp-elbowed global environment? (“Oh dear, your road got huge potholes in it overnight…shame. Mine is still usable though.”) Moreover, how does this all sit alongside the G7 pledge to build a “B3W” BRI rival, or the Franco-German-Sino-African scheme floated on Monday this week? Questions, questions.
Yet a road by any other name would be as sweet, so here are some suggestions for the EU:
- The Melt and Fold;
- The Frog and Toad; or
- Roady McRoadface (courtesy of Rabo’s Erik-Jan Harn)
By Michael Every of Rabobank