Rabobank: We Soar In 2021 Then We Crash Back Again In 2022

By Michael Every of Rabobank

I Just Don’t Have the Energy

It takes a lot of energy to keep repeating how out of line with reality our current market exuberance is. (“Riskiest borrowers make up biggest share of junk bond deals since 2007” says the FT today. After all, there are no global risks,….right?)

The good news: we are doing well in some places with the virus vaccines. Israel shows two shots help reduce infection rates in the over 60s by 94%; however, there has also been a marked drop-off in vaccination rates in other demographics there, and its hospitals are being told to prepare for a surge in the admittance of sick children who cannot get vaccinated. Moreover, the UK has reported *another* virus strain that is particularly worrying. In some African economies estimates are that it could take 3-5 *years* to get people vaccinated against the original strain at the current pace. In short, this is still a race against time – and yet markets have decided we can all stop running and drink the victory champagne here. That is no way to win a race.

Energy is the latest example. While 2020 brought us negative oil prices, 2021 brings wall-to-wall talk of a floor-to-ceiling green revolution AND a surge in oil and gas prices, helped by a bitterly cold winter. As a result, Texan energy prices from the electricity grid surged 10,000% yesterday and millions are still without power, prompting the Soviet-style joke on Twitter: “Texas is proof that if you assemble enough Californians in any one place, a rolling blackout occurs”. Moreover, consider the spike in oil prices is happening despite nobody flying anywhere: imagine where oil would be today if they were. The geopolitical backdrop certainly isn’t helping keep energy prices low, however, with Houthis off the US terrorist list and then immediately striking the Saudis; Russia rattling sabres at the EU;, Iran saying it won’t allow some nuclear inspections past next week; a US contractor being killed by a rocket attack in Iraq; and Turkish President Erdogan claiming that the US is supporting PKK terrorists in Iraqi Kurdistan who recently killed 13 Turkish hostages.

Yes, higher oil pushes up US breakevens and hence a lot of the ‘reflation trade’ momentum. But does anybody believe that pushing up energy bills 10,000% is what people mean when they conceive of ‘reflation’? I bet an hour of good ‘ol Texas electricity that Joe Public is thinking of higher wages – not oil, gas, electricity, rent, or food prices as a sign of ‘recovery’.

Yes, we have major US fiscal stimulus, and significantly north of $1 trillion is likely to flow into the economy soon, it seems. Yet none of this is going into productive investment like the power grid, or any green new deals, just into consumers’ and states’ pockets; and none of it changes the structural balance of power between labor and capital.

On one hand this money *is* badly needed by struggling millions (and states); yet it will be a sugar-rush high that temporarily pushes up demand (and covers for tax shortfalls) against limited supply, and so sees inflation spike even higher. If it is spent: a Bloomberg/Morning Consult survey, whose numbers sum to 161% not 100% due to multiple answers being possible, showed that while 62% of those asked said they would allocate their stimulus money to food, housing, and health, a further 34% said they would save it, and 20% said it would be used to pay down credit card or student debt. But hey, I am sure some champagne will get drunk too.

Then we crash back again in 2022 as stimulus wears off AND inflation base effects flip the other way, and we face the same structural economic problems while the political capital for stimulus may have been expended.

At which point, we are already in the run-up to the November 2022 Congressional elections, where we already have former Trump strategist Steve Bannon floating the idea that former-President Trump could run for Congress and become Speaker of the House in order to impeach President Biden(!) (The unofficial Trumpforspeaker.com is already up and running before he is.) Meanwhile, Speaker of the House Pelosi is pushing for a 9-11 style commission to investigate what happened on 6 January – so little sign of politics returning to unity or even to normal.

Anybody thinking this is the time to be cracking open the political champagne because fiscal and monetary policy are about to work in unison must already be drunk.  Unless, of course, one thinks both a future Trumpist Republican party and a Biden Democratic party would find common ground on fiscal-monetary fusion ahead. That could prove possible given the demands of the population.

Yet if so, consider what would follow. If it’s Trumpism, we know it is tariffs and MAGA; and looking to the EU as a lead for the Green Biden White House, wouldn’t it logically mean similar things in different guise?

A key European steelmaker just argued that in order to decarbonize they are going to have to invest EUR15-40bn, which will push up the price of ‘green’ steel. Positively, that would mean both inflation, which we have now, and lots of capital investment, which we don’t. However, if it doesn’t mean higher wages too, it means poorer consumers. They would likely then opt for imported ‘dirty’ steel from China…which is why we see suggestions there may be EU ‘green’ tariffs. That is decarbonisation and deglobalisation unless all economies act in green lockstep – and it still hinges on higher pay, which still requires more barriers for goods, services, and capital in developed economies. Imagine that with a big government fiscal push behind it too.

So, yes, there is a path to real reflation ahead, if we have the energy. But it isn’t what we are seeing now in Texan energy markets, which is partly weather, partly supply and demand, and a lot of asset-price juicing by central banks (e.g., the RBA’s minutes today made clear that rates are on hold for years and years, and QE is not going to end soon) alongside traditional sugar-high fiscal spending.

The ultimate path to real reflation likely runs through something far more like the heavily-regulated world of Bretton Woods than the heavily deregulated world of Bloomberg Woods. Few in said markets seem to have the mental energy to understand that uncomfortable fact, however.