Rabo: Sausage War, Trade War, And Cold War

By Michael Every of Rabobank

Today should be a day of contemplation for the markets ahead of key Fed dot-plottery tomorrow. However, it has major focal points in US retail sales, PPI, existing home sales, and industrial production – if economic data actually impact on this iteration of the Fed’s thinking. The evidence to date suggests this Fed is clear about what it wants to do in the way only those with a political mission are, rather than those looking at noisy data and uncertain events. Indeed, as we flagged in our inflation piece last week, the range of short and then long-term inflation outcomes is *very* wide, and depends on political decisions, not econometric models. The Fed isn’t acting that way: it seems to have esoteric knowledge, a revealed truth – or an amazing model. Unless, that is, tomorrow’s dot plot shows a confused and divided institution. In the meantime, the market may yet trade as if the Fed is still data dependent, so watch those numbers today.

On which note, the New York Fed’s year-ahead inflation survey rose from 3.4% to 4% in May: for food it was around 8%, and rent nearly 10%. Yes, this can still be “transitory” – but it will destroy a vast amount of demand in the process. Yet keeping extraordinary monetary stimulus in place to help with that demand destruction risks it not being transitory, one way or another.

Meanwhile, things remain so finely balanced in global supply chains that one small incident almost anywhere could push us further into logistical chaos. As just one example, the French joint-operators of a nuclear power plant in China’s Guangdong province were concerned enough at conditions there to reach out to the US Department of Energy directly (though what they think the US can do is unclear!) The official message is that all is “normal” at the plant, despite gasses being released from one of the reactors as part of a safety procedure. However, even in a benign scenario, imagine electricity generation had to be reduced for a while in China’s ‘workshop of the world’, at a time when there are already strains on the power supply due to a heat wave and lower than normal hydropower from Yunnan (a meteorological trend also being seen in the US West and Taiwan – which the Fed have factored into their model,….right?). Imagine a drop in Chinese production added to the massive backlog at the key Yantian port.

The NATO summit also saw more of the G7 trend. The NORTH ATLANTIC grouping, as France pointed out it is called, for the first time admitted China is a “systemic challenge” it must focus on in places like Africa –where ‘green’ industry inputs are to be found, as flagged yesterday– while (finally) noticing Beijing and Moscow are co-operating militarily. NATO also agreed a cyberattack could potentially fall under the collective defence obligation of Article 5 – as with the Colonial pipeline or JBS meat plants, for example. However, while the language shifted in the direction the US wanted, actual actions were absent. Germany is still in no hurry to ever be able to defend itself, for example – which is at odds with its apparent cynical belief that the US is no longer a reliable long-term partner. So what will protect it, if so? Auto exports?! France? General human kindness?

Similarly, Ukraine’s President Zelenskiy publicly announced his country was joining NATO – before the idea was shot down. Even so, the US pledged to provide Kiev with the means to defend itself, and suggested if it could deal with corruption, the door would remain ajar. That’s the highly explosive backdrop to the Biden-Putin meeting in Geneva tomorrow, where the US president had this to say of his Russian counterpart: he is a “bright, tough, worthy adversary.” Perhaps he should have gone with “Kind, Intellectual, Lovable, Long-lasting, Extrovert, Roguish”?

But before that, we have an EU-US summit today. Obviously, much of the key work has already been done here via the G7 (“Let’s confront China head on.” – “Non/Nein.”) and NATO (“Let’s confront China head on.” – “Non/Nein.”). I am not sure what today’s meeting will bring that’s new. Indeed, the messaging from the French and Germans has been clear – we won’t allow China to push us around, but we won’t follow the US lead in actively confronting China either. (“Because markets.”) This seems to point to an ambiguous, expensive, and geostrategically wobbly EU Third Way – and it’s unclear how much US-EU relations can really deepen/progress past a phew-you-aren’t-Trump bonhomie on the basis of that fundamental divergence.

Yes, we may see a pause on trans-Atlantic trade tensions, for example the 17-year long saga on Airbus-Boeing subsidies – but aren’t these are about to be dwarfed by those over green subsidies as both the EU and US aim to “Build Back Better”, create new jobs at home, and export such green tech to the rest of the world? Problems will also escalate if the US closes itself off to Chinese goods or investment, and the EU remains open to them, and the US is still open to the EU – an issue we saw with steel recently, of course. Indeed, while hoping for the best, the strong suspicion is that in the end, the outcome here will be a paraphrasing of Churchill: “You were given the choice between Cold War and dishonour. You chose dishonour, and you will have Cold War.”

On the other hand, the UK is today expected to announce a new free-trade agreement with Australia, to almost no economic significance, but a feather-in-the-cap for Global Britain: Marmite and Vegemite can perhaps now flow freely between the two, while everyone else except New Zealand holds their nose and says “Eww!!” The real prize, of course, is a US-UK trade agreement – and the UK stance on agriculture in the Aussie deal suggests that is not going to be the political obstacle some thought. But before that, the UK-EU spat over Northern Ireland has to be resolved. As the EU are saying to the UK: “You were given the choice between Sausage War and dishonour. You chose dishonour, and you will have Sausage War.” But might part of the realpolitik of the resolution involve who can show the US more trade (and G7 and NATO) upside?