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October
31
2022

"It's Halloween And There's A Lot For Markets To Be Scared About"
Michael Every

It’s Halloween and, clichéd as it is, there is a lot for markets to be scared about.

Let’s start off with the optimists, who, like Linus and his never-appearing Great Pumpkin, are waiting for a Fed pivot to bring them gifts. Yes, the RBA, BOE, BOC, and (on the surface) the ECB all backed off hawkishness to some degree, and the BOJ stuck to their guns on yield curve control on Friday.

However, the Japanese government is increasing stimulus by another $200bn to fight inflation(!) while insisting JPY cannot fall - something is going to break there; we don’t think the ECB were as dovish as the market interpreted them; the RBA are seen going 50bp this week by at least one big name; the BOE are still likely to go 75bp; and not only is another 75bp from the Fed baked into the pumpkin pie too, but others just upgraded where it stops to 5%, which we said months ago.

Indeed, Eurozone inflation data on Friday will have made the ECB jump, as core inflation did too. The same scare was seen in US personal income and spending, while Bloomberg reports ‘Wages are soaring in US cities with the highest inflation’. Even though we are in a blackout period ahead of the FOMC, the Fed Whisperer at the Wall Street Journal put out another article saying last week’s data offered, “more questions to the Fed than answers about the true trajectory of the economy… But the compensation report... could keep the Fed raising interest rates slightly higher in 2023 than officials had anticipated at their meeting last month."

The depth of analysis on how we get out of this is also terrifying. Central banks are in the dark, with an inflation monster. "Inflation is going up due to Wall Street decisions", says Alexandria Ocasio-Cortez (whom Gad Saad dubs Occasional-Cortex). Stumbling Big Tech aside, Wall Street is going up due to official decisions, whisper some. Stocks have surged off lows and bond yields have tumbled, which the Fed has no desire to see given it loosens financial conditions - so they are more likely to raise rates further.

Worse, fears are soaring on the global supply-side inflation. Even as some FinTwit voices calling for looming deflation now underline that they think inflation will soar again afterwards, a see-saw assumption long floated as a risk here too, Russia cancelled the Ukraine Grain Deal.

As our Michael Magdovitz puts it, removing Ukraine’s food supply from global markets will drive up food prices everywhere. The exception, perhaps, is Ukraine where there will be a glut, which will ultimately cause long-term scarring of the agri economy, because Ukrainians will refuse to produce things they cannot sell. Major improvements in westbound road, rail, and river transport can now handle 50%-60% of Ukraine’s normal exports, which is not enough to stop food prices surging. Meanwhile, it is being reported Ukraine, Turkey, and the UN have notified Russia they are organizing a convoy of 14 grain ships with grain to sail despite the renewed Black Sea blockade. The tensions are palpable.

Showing this is not a one-off shock, but a fearful trend, India will extend its curbs on sugar exports until October 2023, according to the Directorate General of Foreign Trade.

I believe both wheat and sugar goes into pumpkin pie? So does energy - and there again we see more developments that intersect the market and the geopolitical space.

Yes, Europe is basking in a warm autumn, which is taking some of the immediate pressure off. However, the EU just agreed to ban the sale of internal combustion engine cars from 2035. Given that time horizon, why/how will the private sector now invest in desperately-needed fossil fuels, e.g., as diesel inventories, without which nothing industrial or agricultural moves, drift to new worrying lows? Moreover, how will electric vehicles be produced in Europe, or anywhere, without a massive environmental cost? Bloomberg yesterday carried a story --‘It’s Better to Mine Rainforests Than Farm Them’-- underlining that:

“As if the world’s rainforests didn’t have enough problems to contend with, even the transition to zero-carbon power is threatening to level them. Industrial mining ate up 3,265 square kilometres (1,260 square miles) of tropical forest between 2002 and 2019, according to a recent study in the Proceedings of the National Academy of Sciences. Some 80% of that total happened in just four countries: Indonesia, Brazil, Ghana, and Suriname. With the COP27 climate conference in the Egyptian resort of Sharm El Sheikh… expected to increase the focus on the climate needs of developing countries, that’s raised concerns that there isn’t enough land to manage a shift away from fossil fuels.”

But don’t worry: inflation is transitory.

By contrast, Poland has just signed a deal with the US to build six nuclear power stations. Yes, it will take many years, but that is a clear statement of energy, political, and geopolitical intent. In fact some suspect in the long run Poland will aim for its own nuclear deterrent too. That is called a shift in EU power, literally and metaphorically.

(The contrast could not be clearer with a German Chancellor struggling with an energy crisis and deindustrialisation; about to head to Beijing to offer a share of Hamburg port over the heads of other stakeholders rejecting the deal; and despite the Marxist policy/paradigm shift at the 20th CCP Congress; and as the President of EU Chamber of Commerce in China states, “People say China is a big market - no, China is a huge economy with a small accessible market,” as EU exports to it are only slightly larger than those to Switzerland; and implied criticism from his president.)

Then we can turn to supply chains, and US-China, where the Financial Times reports ‘Workers flee China’s Covid restrictions at Foxconn’s huge iPhone factory’ – which speaks for itself, as does the manufacturing PMI at 49.2, down from 50.1, with the services PMI at 48.7, down from 50.6. And on related logistics, the industry press (Freight Waves) notes:

“The uncertainty and chaos of this changing trans-Pacific paradigm --from decades of decreasing friction and lower costs to a new trend of increasing friction and higher costs-- will drive unpredictable and disruptive shipper behaviour similar to that seen in 2018, 2020, and 2021. Stockouts will be followed by inventory gluts and vice versa, as importers pay too much to move their goods that are stored too long and arrive too late, compressing gross margins… 

If the US and China decide to pursue a policy of mutual divestment, we should expect a more diverse, less China-centric trans-Pacific trade… Eastbound freight flows may have more widely distributed origins as China’s share diminishes… The change in network structure could threaten the stability of the container-ship alliances that control capacity in the trans-Pacific and make the 20,000-plus TEU mega-ships built to serve the largest ports harder to fill and less competitive. Capacity could structurally loosen on what are now the densest lanes, like Shanghai to LA, while slots could be harder to find on more obscure but growing lanes. The upshot here is that even a prudent trade strategy seeking to de-risk China by sourcing goods in other Asian countries will be exposed to knock-on effects from the challenges the US-China trade is fated to face.

Importers and their transportation providers will need to build links between operations teams and strategic planners so that emerging trends in markets can be identified. Tariffs, embargoes and many other forms of economic warfare are potentially on the table. For 20 years, the trans-Pacific was relatively easy, boring, and cheap. Now it’s becoming exciting, difficult, and expensive - and will probably stay that way for some time to come.”

Linking several of the above themes are op-eds arguing along the lines that ‘The West Needs an Energy and Resource Alliance’ – which it clearly does. But doing so involves stakeholders understanding the underlying conjoined problems, rather than focusing on just one of them at a time – like soaring Gilt yields triggered by the BOE’s actions as much as the PM’s – and presuming tax hikes ‘solve it’; or the level of inflation, without knowing what is driving it; or the bullet points agreed at COP26 without thinking of the logistics and geopolitics; or the fact that US-China ocean freight rates are tumbling, and LA-Long Beach port is finally seeing few ships waiting offshore – because a recession looms, and ships have diverted elsewhere to avoid backlogs! (Ignore anything anyone who shows the China-US freight rate chart as proof of deflation ahead says if they do not also mention these simple industry facts.)

All this, and we have huge country-wide protests in Iran continuing even as the government claims enough is enough now, and it may crack down even more, potentially triggering a real public uprising; an Israeli election tomorrow that could shake the region up further; and a Lula presidential election win in Brazil, with unclear consequences for any number of economic policies and geopolitical angles. In China, Xi Jinping’s first outing with his new Politburo Standing Committee, all in attire half-way between business suits and Mao suits, was to Yan’an, the end point of the CCP’s Long March; and Hong Kong, trying to relaunch itself to global CEOs with a big shindig, is seeing an incoming cyclone potentially hitting C-suite attendances.

To conclude, economic historian Adam Tooze, always a must-read, is talking about a “polycrisis” in the FT this weekend. I was calling it a “metacrisis” in January when most weren’t even calling it a monetary policy tightening cycle, but I agree.

But don’t worry, this is all transitory. And I am the Great Pumpkin, Charlie Brown.

Michael Every is the Head of Financial Markets Research Asia-Pacific. Based in Hong Kong, he analyses the major developments in the Asia-Pacific region and contributes to the bank’s various economic research publications for internal and external customers and to the media.

Michael has nearly two decades of experience working as an Economist and Strategist. Before Rabobank, he was a Director at Silk Road Associates, a strategy consultancy based in Bangkok. Prior to this, he was Senior Economist and Fixed Income Strategist at the Royal Bank of Canada based in both London and Sydney. Michael was formerly also an Economist for Dun & Bradstreet in London, covering ASEAN. 

Michael holds a Masters degree in Economics (with distinction) from University College London and speaks Thai.

economics.rabobank.com