“Markets Are Confusing A Collapse In Demand With An Improvement In Supply”

By Michael Every of Rabobank

2022 was a year dominated by inflation, capped off with a week of 50bp rate hikes from the Fed, the BOE, and the ECB, and even the suggestion of less ridiculously-easy BOJ monetary policy.

Stefan Koopman (see ‘Division!’) underlines the BOE’s 2-6-1 split decision to hike 50bp to 3.50%, with two votes for no change and one for 75bp. He thinks the downshift to 50bp combined with the net dovish dissent signals the MPC is looking for a landing zone in H1 2023, but that it will take some time to get there, particularly due to the tight labour market. He forecasts a terminal BOE rate of 4.75%. The math issue is if the BOE is doing long division.

The ECB also went 50bp, taking the deposit rate to 2%, and reportedly this was only not 75bp due to Lagarde emphasizing several more 50bp hikes to come: one in February, and another one or two after that, which is a clear upside risks to our forecast of another 50bp in February followed by two 25bp hikes (see ‘More to Follow’). Note that even that would not put the deposit rate above the projected level of core CPI by end-2023 (4.2%). Indeed, the updated ECB projections show it missing its inflation target through to end-2025. It therefore intends to maintain restrictive rates, and QT is starting soon too, thought with no active sales of securities.

There were few takers in December 2021 for the view that 2022 would end with rates here, with the promise of them moving higher. However, the risks were visible: the logistics industry was tearing its hair out over how Deep the Ship was that we were in, and military experts were doing the same over Russia’s troop build-up. Have lessons been learned as we head into 2023?

On rates, the market is only very reluctantly being disavowed that imminent pivots loom. The room for further volatility in terms of the level of yields, if not the flattening of curves, as well as in key FX crosses, as the reality of what is actually happening sinks in remains.

On geopolitics, there is still little market focus on potential flashpoints outside Ukraine –although CEOs are aware– and the market is pricing that the Ukraine War is dialling down despite Ukrainians and Russians both saying they are in this for the long haul, and the former just saying that the latter will try for Kyiv again at some point eventually.

In logistics, markets are confusing a collapse in demand with an improvement in supply. First, the absence of ships off the port of LA/Long Beach is due to the slump in retail sales reported this week, but also due to firms moving to other, now more strained, US ports: don’t believe charts showing LA/LB backlogs as a metric of supply chains ‘healing’. Second, if the scale of Covid disruption about to hit China had coincided with demand remaining where it was, we would again be seeing stories of goods shortages and even more rampant supply-side inflation. Third, while ocean carrying rates on most (not all) routes are back to more normal levels, that is in the face of a looming recession: and blank sailings and scrapping older tonnage aims to bring supply down to lower demand to keep freight rates up.  

Indeed, the industry is not learning much from 2022. Shipping Australia warns of ‘Five problems that could slow supplies of food, computers, cars and other goods this winter*’ (inflation, labour unrest, energy shortages, geopolitics, and extreme weather), and notes “global external shocks require a total rethink, repurpose and reform of the process of globalisation.” Yet it “cautions against government support for protectionist maritime policies”, is against Aussie trucking too; urges the Productivity Commission’s inquiry into maritime logistics to drop all key proposals; and opposes “the Federal government handing control of supply chain to unions”.

So, there are huge problems – but doing more of the same is the proposed solution. Shipping Australia specifically argues Oz is failed by its version of the US’ Jones Act, which only allows domestically owned and registered vessels with domestic crews to engage in cabotage, or trade between domestic ports, and should scrap it. They also argue the Jones Act is an economic failure for the US, citing pro-union Democrat AOC on how unfair it is on Puerto Rico(!) while arguing for lower maritime wages and increased foreign penetration of an industry with massive national security implications. They even conclude with the Karl Marx quote that history repeats itself, first as tragedy, then as farce – and again as 2022, I might add.   

Their core argument inverts the actual problems 2022 raised, including for central banks. They rightly point out the Jones Act hasn’t seen either the US or Australia build more merchant ships; but they fail to point out that this is the failure of neoliberal capitalism in the face of competition from state capitalism and mercantilism, not the Jones Act. Without beating any nationalist drum, Shipping Australia has NO AUSTRALIAN SHIPS, with membership comprised of Hong Kong, Dutch, Japanese, Taiwanese, Danish, Italian, Djibouti, and Norwegian/Swedish firms. Their argument against “government support for protectionist maritime policies” is against proposals to build a national Aussie carrier to ensure services in an emergency, and to reduce prices in what the White House alleges is a cartelised global industry. The Chair of the Aussie parliament’s Joint Standing Committee on Treaties meanwhile stresses, “Without a sovereign shipping capacity, our economy and security is at risk…. Maintaining an effective maritime capability requires naval capacity, an Australian merchant marine, a shipbuilding and sustainment industry and, of course, a skilled workforce and training framework.” He adds there is no Australian-flagged ship capable of transporting petroleum.

Where this links to central banks is that capital flows where it can make most money – and that isn’t into a rival to a global ocean carrier cartel, however needed. Or into infrastructure; or into productive investment that increases supply. Economies practising mercantilism do all that – and so they dominate said supply. As such, it doesn’t matter how low you set Western rates, because there are financial bubbles to chase instead of vital investments. Yet then you end up with highly vulnerable logistical systems and economies, and rate hikes, as 2022 demonstrated.

Logically, the way to get cheaper long-term ocean carrying without a recession, and the spare capacity to build up one’s navy at short notice, is to have the Jones Act; and a larger ship-building industry and a larger merchant marine. That history is clear for the US: W.L. Marvin (1903) underlines if you don’t control the oceans, you don’t control much – and if you control the oceans militarily, but not economically, you won’t control them for long, because you are literally paying to open the doors to your own rivals. That is why legislation is before Congress to strengthen the Jones Act.

Likewise, it seems the only way to get more supply of reliable key goods is for a protectionist shield for the private sector to operate behind; and state spending to jump start it; and central-bank rate hikes to choke off bubble alternatives. Relatedly, the US Inflation Reduction Act, alongside Europe’s energy crisis, is threatening to suck European industry and jobs to the US. Again, a policy of tax incentives and local content provision alongside state spending –and the failure of Europe’s neoliberal reliance on Russia– is a gamechanger. So much so that Germany’ Scholz says Europe must be included under the same US policy umbrella, like Canada; and France’s Macron warns if Europe doesn’t, then there won’t be much of Europe left, so the EU will then have to respond in kind.

Meanwhile, Indonesia is going a route I spent 2022 arguing would end up being embraced after others have been tried and failed: to get the central bank to cover the fiscal deficits required to jump-start state supply-side spending, even as rates are raised. Its parliament just passed legislation mandating Bank Indonesia to directly finance the budget in times of defined crisis, as it has been doing, while also recognising a digital rupiah as legal tender. I suspect 2023 will be a year in which these kind of thoughts will resurface in ‘developed’ markets too.

In short, whether it be rate hikes, the shift towards mercantilism, or defence spending, we are all keeping up with the Joneses… and getting rid of ‘the Jones Acts’ only makes sense if you think that more neoliberalism is still the cure for all our problems. Which is like saying we need more housing bubbles and exotic derivatives after 2008; more Brexit after Brexit; more QE after QE; more crypto after FTX; more globalisation and integration after Ukraine; and more rate cuts after decades of them ending up with double-digit inflation – but of course these are still popular views in some circles. Yet if you think the Joneses trend won’t have enormous economic, market, and geopolitical consequences then you are making the same error to end-2022 as you would have made at end-2021 when ignoring panicked logistics industry or military experts.

This is my last Daily for 2022, though the Global Daily goes on under other authorship until just before Xmas – so please keep reading! Best wishes from me to all readers.

Happy Friday – and an early Happy New Year.