Grinding To A Halt?

By Bas van Geffen, CFA, senior macro strategist at Rabobank

Grinding to a halt

A cargo ship has grounded in the Suez Canal early this morning. Though the Xin Hai Tong 23 was re-floated relatively quickly, it certainly brings back the memory of the 2021 stranding of the Ever Given and the knock-on effects this had on global supply chains. This reminder of supply chain fragility is not just relevant for routes through the Suez Canal. The Strait of Malacca remains a key weakness to potential geopolitical tensions, and the reliability of the Panama Canal is being affected by climate change. Last month, the Panama Canal was already forced to lower the maximum depth of ships passing through, as drought hits the water levels. In other words, fewer goods can be transported at a time.

Aside from the reminder that we should no longer rely on hyper-efficient, yet easily disrupted, supply chains, the grounding of the Xin Hai Tong 23 also provides a great metaphor for the overnight news flow.

First of all, updated estimates for German Q1 GDP show that the economy did not just grind to a halt in the first quarter of the year; the statistics office now estimates that GDP shrunk by -0.3% q/q. This means that Germany did, after all, experience a winter recession as the industrial motor suffered from the gas crisis. The 0.3pp downward adjustment means that, barring upside revisions to other countries’ GDP estimates, Eurozone growth has probably stalled in Q1.

Unsurprisingly, inflation has hit consumers’ willingness and ability to spend, at least in volume terms: household consumption expenditure was down 1.2% in Q1. And while the economy will probably re-float, the monetary tightening cycle should prevent it from picking up much steam. The one bright spot, perhaps, was the strong investment spending. Gross fixed capital formation in machinery and equipment rose by 3.2% q/q. While that may be a drop in the ocean when one looks at the sheer amount of investments needed to ramp up Europe’s domestic production capacity in order to reduce the continent’s international dependencies, the number could’ve been far worse in the face of ECB policy tightening. So, for now, the ECB may actually be quite pleased to see this division in the German GDP breakdown: lower consumer demand should hopefully lead to lower inflation, while the continued fixed investments should alleviate supply constraints in the longer term. That said, much of this consumer slowdown is attributable to the sharp decline in households’ disposable incomes, whereas much of the effects of higher rates are probably yet to be seen. The past two Bank Lending Surveys have pointed at a marked slowdown in demand for loans – usually heralding a drop in investments.

Turning to the US, the debt limit talks continue the pattern of stranding and being re-floated. Ironically, President Biden now sees himself very much stuck in the debt ceiling talks he vowed to avoid. For Fitch the current brinkmanship was sufficient to put the United States’ AAA rating on negative watch. Although the rating agency “still expects a resolution to the debt limit before the x-date,” they see increased risks of missed payments, and the debt limit illustrates the failure to “meaningfully tackle medium-term fiscal challenges.”

This adds to the Fed’s challenges. The minutes already revealed a considerable divergence of opinions regarding possibly pausing the hiking cycle. For now, a hold in June remains a pausebility, but whether this would also be the de facto end of the hiking cycle depends on the amount of credit tightening that is still expected to materialize.

Moreover, the Fed now has to worry about potential fallout to markets and the US economy, should the debt ceiling lead to broader market turmoil – particularly in the Treasury market that underpins the global financial system. Should this happen, a number of policymakers suggested that the central bank should be ready to re-float the financial market. This would most likely be done through the central bank’s liquidity tools, the minutes suggested.  It’s unclear what these measures would entail exactly. However, during the debt limit standoffs in 2011 and 2013, the FOMC discussed various options, including repurchases to inject liquidity, or even buying or swapping Treasury securities that had technically defaulted – although Powell expressed strong disapproval of such extreme measures.

At the same time, central banks certainly cannot breathe easily. The shock-increase in gauges of underlying inflation in the UK made that point all too clear. Yesterday we already stressed the upside risk that this poses for the Bank of England’s policy trajectory, and sterling markets are certainly pricing for this. Yet, despite the unexpectedly high core and services inflation rates, Governor Bailey gave a much more measured first reaction to the data release. He refused to speculate where the April inflation data leave the Bank relative to its latest forecasts.

And returning to the topic of grinding halts, Ron DeSantis (R-Fla) put his name in the hat for the 2024 elections. He is considered to be the most serious challenger to Donald Trump for the Republican nomination to date. Unfortunately for Mr. DeSantis, the launch of his presidential campaign started with a number of technical hiccups. The live feed on Twitter crashed repeatedly before the event started, and the stream froze several times during the programme. While that might be an indication that his bid drew a large online audience, Twitter hasn’t exactly been a stable platform since Musk took over.