There Doesn’t Appear To Be A Good Option

By Michael Every of Rabobank

It was another wild day yesterday in markets. Very strong US housing data allayed fears of immediate recession, but then raised them that the Fed might keep hiking even as credit conditions turn. So, as our current global financial crisis, which is still not a Global Financial Crisis, rumbles on, all focus is now on the FOMC, in its biggest meeting for many years.

Imagine they don’t hike. On one hand – phew! On the other, markets could be spooked that a Fed set to do 50bps weeks ago is suddenly not willing to focus on its inflation mandate.

Imagine they hike 50bps. Panic. Chaos. Tears before bedtime.

Imagine they hike 25bps and are hawkish, with a shift higher in the dot plot in some form. A slightly milder version of the above would ensure.

Imagine they hike 25bps and are dovish, or say they are done. Commodities and risk assets will likely soar. But inflation will still be there unless there really is a credit crunch looming after this liquidity pinch.

In short, there doesn’t appear to be a good option (ZH; or as we said two days ago, ‘”Whatever The Fed Does On Wednesday Will Be A Mistake“) Moreover, as often repeated here, the Fed trade-off is not just about inflation vs. financial stability. Whether the players involved today see it or not, it’s also about the global role of the US dollar, which Treasury Secretary Yellen yesterday pledged was something that needed to be zealously guarded. (Although she meant it more in terms of a financialized US economy seeing constant capital inflows from countries running structural excess savings, to little benefit to the US ex. Wall Street.)

The FOMC meeting coincides with the wrap-up of Xi and Putin doing the same and agreeing:

• A peace plan Russia accepted, because it cements current gains, and the West rejected;

• An invite for ICC-indicted Putin to visit Beijing;

• A declaration that both sides will “provide strong mutual support in defending each other’s fundamental interests, above all sovereignty, territorial integrity, security, and development”, which sounds like an alliance; and

• Putin floating Russian trade with EM and China now be cleared in CNY.

This is not a workable ‘Bretton Woods 3’, a concept that will now drift on longer than the bank that sold the idea to markets. I already rebutted that Russia can clear its oil and food —which Putin suggested he might give away free to Africa(!)– in CNY if it wants. Pricing of commodities will remain in US dollars, and the trade cleared will just be netted out in CNY, which nobody opts to hold for structural reasons of China’s choosing. All the big trade deficits in the West are the ultimate balance that has to clear, and can’t be in CNY – though Russia’s economy will. Sorry, Lebanon, Egypt, Kenya, etc., with your US dollar shortages, with no Fed swaplines so far. No easy dollar alternatives for you as well as no easy dollars. Yet, if the Fed were to pivot, it would throw fuel on the ‘BW3’ fire, boosting calls for a shift from fiat dollars to commodity currencies that ‘hold their value’.

Then again, it isn’t all about which money you can digitally print in a crisis. Russia is helping Egypt build nuclear power stations, swinging another strategic economy (Suez Canal, anyone?) potentially back into its orbit. Lots of that kind of thing is happening all over.  

For a strident view on the Putin-Xi meeting and its broader implications, @samagreene, professor at the Russia Institute at King’s College London, notes:

“…China’s domination of Russia is complete. Xi praised Putin, touted strong relations with Russia, unity in the UNSC, and promised coordination on IT and natural resources trade. And that’s it. Putin, by contrast, was almost obscenely generous – and not just with his praise…. He pledged completion of the Strength of Siberia 2 pipeline… [which] replaces structural dependence on Europe with structural dependence on China, at a time when Russia is a price taker for hydrocarbons. That’s a strategic win for China.

Further, Putin announced a reorientation of agricultural trade towards China and a strategic role for China in  developing Russia’s far east and high north – a move Putin’s own security apparatus has long resisted (for obvious reasons). Again, strategic wins for China… And Russia offered Chinese companies first dibs on the assets of departing Western companies – again strengthening China’s presence in Russia, with no reciprocal strengthening of Russia’s presence in China…

While there were undoubtedly agreements we are not meant to know about, there is no indication here of a significant increase in military support for Russia – nor even of a willingness on Xi’s part to ramp up diplomatic support. A swing and a miss for Putin…

Putin greeted Xi with a rhetorical bear hug. Xi gave Putin a pat on the head and told him to run along now and play… Putin tells his people he’s fighting for Russia’s sovereignty. In truth, he’s mortgaged the Kremlin to Beijing. The question now is one for Xi: What will he do with his newest acquisition?”

That leaves the EU facing a two-for-one in Russia and China, and as Politico notes, ‘Europe’s China policy will shape transatlantic relations’. The implication is large German firms lean on the large German government, “putting Europe’s priorities on a likely collision course with US strategic goals, which will focus on confronting China in economic, military and, increasingly, ideological domains.”

On which, US historian Kotkin says,

“So I’m in love with the Cold War. I’m in favour of the Cold War. The Cold War is not only a good thing – it’s a necessary thing, because we have to uphold…the terms of the way we share the planet…. You know, I hear a lot of people saying, “Oh my God, no Cold War with China. God forbid we should have a Cold War with China.” And I think to myself, “What world do these people live in?” First, we’re already in a Cold War with China, because China started that long before we understood that that’s what they were doing. And secondly, would you prefer a hot war? The alternative to Cold War is capitulation– which you can imagine I’m not in favour of– or hot war.”

Yet maybe the EU is feeling Cold too. As @Schuldensuehner points out, China is losing importance as a German export destination: February exports to it were -12.4% while those to the US were +19%, making it by far the most important market, as well as supplying key LNG imports (and Fed swaplines); France is number two, far ahead of China. Moreover, Germany is considering China export restrictions similar to those of the US, according to its economy minister, who adds, “We have to prevent losing our technology leadership because we don’t look closely.”  Notably, China just threated the Netherlands over its tech export controls (“This will not be without consequences. I’m not going to speculate on countermeasures, but China won’t just swallow this.“): how long until the same message is heard in Berlin?

A bifurcating world like this only complicates real economy investment decisions, supply chain issues, and monetary policy decisions.