Rabobank: We Have To Wait… But Not Much Longer

By Michael Every of Rabobank

Yesterday was quiet in terms of data but once again significant in terms of the Russia-Ukraine dynamic. For the optimists, the meeting between Presidents Putin and Macron resulted in the former saying the suggestions of the latter vis-à-vis Russia’s security demands were “useful”, and that some of them “could become part of the basis for our next steps”. We still don’t know what these are, but Macron will try to explain them to Ukrainian President Zelenskiy today.

More pessimistic was Putin: making clear he does not see NATO as a defensive alliance (“Ask the citizens of many countries – Iraq, Libya, Afghanistan.”); if NATO lets Ukraine join and tries to retake Crimea then it means nuclear war; and quoting a foul Russian ditty about necrophilia(!) in regards to Ukraine – “You may like it or you may not, but you’ve got to put up with it, my beauty”. Some also wonder if Putin is trying to divide NATO by flattering Macron’s role and dovish stance relative to Biden’s more hawkish one.

There are also bad omens in that neither Putin nor Foreign Minister Lavrov will attend the Munich Security Conference on February 18-20 this year, which one of them usually does; that the ground north of Kyiv is expected to have frozen his weekend, if that is part of anyone’s equation; and President Biden, who thinks it is, told all Americans to leave Ukraine, as “I wouldn’t want them getting caught in the crossfire should Russia invade”.

That was just before his meeting with German Chancellor Scholz, who pledged Western unity. However, at their joint press conference President Biden stated if Russia invades, the NordStream 2 pipeline is finished: the Chancellor refused to even name the project and declined to commit to ending it. CNN also reports President Zelenskiy has refused to see German Foreign Minister Baerbock due to his anger over Germany’s stance on Russian gas. The EU is still thrashing out the sanctions it is prepared to put in place – but without German backing what they will be?

Indeed, Wolfgang Munchau from Eurointelligence yesterday released a report, ‘The Two Germanys’, in which he argues not only will Berlin not sanction NordStream 2 regardless of Russian action, but that in the scenario that Russia attacks a NATO member, Berlin would also refuse to trigger the Article 5 collective defence clause, and might even block it in the North Atlantic Council, stymieing NATO’s ability to act. These are explosive allegations that undermine the bedrock of the Western alliance if true.

At least climatic conditions alone tell us that all this diplomatic and undiplomatic to-and-froing and awful uncertainty cannot continue much longer before the window for action closes: that binary option for Putin, and many underlying market options, will either be triggered or not.

A welcome step back from the risk of hot war is that of trade war, and global trade news is about both the winding down and ratcheting up of tensions. The US and Japan struck a deal to remove Trump-era steel tariffs, which makes sense now they are both in the Quad together.

However, Bloomberg says “US Patience With China Wears Thin as Trade-Deal Pledges Unmet”, noting while the US does not have December and 2021 trade data yet (it is out today), it is clear China did not meet the terms of the Phase One Trade Deal. (Which we never expected it would.) It is likely to come in around 60% of what it pledged. The key question is what the US does about it.

• To talk about a new deal when the last one wasn’t met exudes weakness.

• To reduce tariffs looks weak too, and won’t even do much about inflation given the concentrated market power of large firms who wouldn’t necessarily pass the savings on.

• To do nothing after complaining bitterly is to look impotent.

• To raise tariffs further would give the market a heart attack –“because Trumpism”– despite the US and Chinese economies adjusting to previously-unthinkable-for-economists existing tariffs.

There is an echo of the Ukraine situation here. The current dynamic is seen as unacceptable, but so is retreating, so is doing nothing, and yet escalation only makes things worse. So what is the resolution? It is always easy to say “deescalate”; but clearly someone has to accept a zero-sum loss. Although economists argue trade is always a positive-sum game, it clearly it isn’t at times, and runs right through geopolitics in a crisis, as we see now.

Meanwhile, the market keeps talking about the escalating number of rate hikes we can expect to see from the Fed, the BOE, the BOC, and even the ECB (and the latter potentially this year, in the eyes of one member of the Governing Council). The timing is hardly propitious, and the US2s-10s curve at just 61bp is already where it stood in mid-2005, three years before the global financial crisis, and late-2017, two years before the Fed realized it had made the latest in a long line of policy errors. We can hope that it is the milder of the two episodes that this curve trend reflects.

One also doubts we have three years, two years, or even one year before the next inflection point/recognition of policy error is made.