Every: The End of the Beginning

“You may not be interested in war, but war may be interested in you.”

The end of the beginning

by Michael Every, Global Strategist Rabobank

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” - Churchill

Last week saw pure market panic. Rates markets are now pricing in 50bps cuts from the Fed at multiple 2024 meetings, or even intra-meeting: it’s not higher for longer, but when we see zero rates and QE again, apparently.

July payrolls were weak (114K vs. 175K expected) with a surprise rise in unemployment to 4.3% triggering the so-called Sahm ‘recession’ rule --suddenly a thing-- after initial jobless claims had also risen more than expected. However, there might have been distortions to data from Hurricane Beryl: if so, August’s data will be better. True, there are also issues over the BLS births/deaths model’s ‘assumed’ jobs, and revisions, and payrolls stripping out demographic change, whether official or unofficial – but they didn’t appear Friday. In short, the labour market is cooling, but not collapsing, which is what the Fed wants.

We also saw a plunge in tech stocks. Few in markets or financial media had much bad to say when that bubble(?) was blowing, but when things flip, they demand rate cuts: heads I win, tails I don’t lose. But taking the froth off stocks is also what the Fed wants.

A few months ago, USD/JPY chatter was 170 or 180, because the BOJ couldn’t hike much without blowing itself and the Japanese economy up, while the Fed couldn’t cut much. Regardless of the 15bp BOJ rate hike and hawkish rhetoric from Governor Ueda last week, driving markets to talk of 140 in USD/JPY, that remains true. We already have a plunge in Japanese stocks which hardly backs demand-side inflation there; and we know services-demand and supply-side inflation pressures still lurk in the US. Short covering alongside unwinding the Yen carry trade that’s lifted US (and other) stocks surely doesn’t have much further to run; then huge rate differentials will kick in again - unless the Fed is going back to Covid-era monetary policy.

Even if so, it’s still just the end of the beginning. With populism surging, can Western society take a deep recession? And we would start with huge fiscal deficits and post-WW2 levels of public debt. More austerity would create chaos, so, we’d surely see massive state spending backed by the central bank instead. That would make bond bulls happy; but it would also make the case to the public --and the parts of the world that makes the things we buy-- that our system is broken. We can push yields down and hold them there, as post-2008: but only with weaker currencies vs. hard assets, key EM FX, and commodities – which means supply-side inflation.

Moreover, beware more populist anger. This is already a problem in the EU, and even the UK just saw violent country-wide riots against mass migration and “Two-Tier” policing. PM Starmer was head of the Crown Prosecution Service during the last riots in 2011, and cracked down hard: yet, as a journalist asked him, will another hardline approach, with no change to other policies, resolve this issue or pour oil on troubled waters? Won’t ‘vanilla’ rate cuts and QE just allow house prices and stocks to rise further, with that inequality leading to more anger?

So, the West still might have to adopt protectionism and/or more closed borders to reflate and recycle capital internally, as already proposed in the US. In which case, it’s the 1930s redux or 1930’s lite: that’s not the bullish ending markets foresee when they shout, “rate cuts!” and “QE!” in a political vacuum.

From seas of red to the Red Sea: geopolitics is risk-off bids for bonds, but also with an inflationary tail risk. As soon as today, say some, or symbolically on August 12-13, the Jewish fast of Tisha B’Av mourning past calamities, Iran and its Axis of Resistance will launch another missile and drone barrage at Israel. US and European forces will again help shoot these down, but many are expected to get through, and Israel is prepared to strike back hard. Its government has set up a secure bunker, and across the political spectrum there is a view that full war with Hezbollah and/or Iran is required to break the strategic encirclement Tehran has spent years creating around it (and which the US and EU haven’t stopped because they don’t want any more regional confrontation.) Meanwhile, other reports have Iran telling all those entreating it to hold back that will attack hard regardless of whether this causes a war or not; and that Hezbollah was told by Tehran to deliberately target civilian populations. It seems war looms.

Israel will be hit hard if so; but Lebanon far harder; and the US has reportedly warned Iran that Israel could bomb its key energy infrastructure, as it did to the Houthis. Indeed, with Israel (deliberately) lacking US bunker-buster bombs needed to hit Iran’s nuclear sites under mountains, perhaps only oil infrastructure is left to aim for. In a larger war, Axis forces may strike Gulf energy to try to force the West to stay Israel’s hand. In short, we could see the start of a violent oil-shock ahead, with no idea of how it then ends.

One can understand Western reticence about doing anything offensive rather than defensive, especially if Russia and China support Iran, forcing the US to either divert from Ukraine and Taiwan or cede an ally’s security and its own regional influence. Kuwaiti newspaper Al-Jarida has claims from a senior Iranian source, which may be disinformation, that the US is desperate to find a way out and back to the 2015 JCPOA deal, and blames Israel for this all, not Iran. However, rapprochement takes two or it’s just retreat, and certainly no deterrent to further violence. On which note, major US non-NATO ally Qatar, which houses Hamas leaders, has reportedly banned any military use of the US Al-Udeid airbase located there vs. Iran.

Meanwhile, other headlines underline how much the market misses on geopolitics in general:

• Astoundingly, the UK Ministry of Defence hired BELARUSSIAN coders to write the software for its nuclear submarines – because ‘they were cheap’? That’s neoliberalism for you, if so.

• The recent Russian-US spy swap incentivises future hostage taking, and revealed deep agent children growing up abroad unaware they were even Russian until exchanged back to Moscow – how many more are out there? You think none?

• Relatedly, @isakaminska asks how many successful market traders may actually be state agents using their insider knowledge to finance intel operations. A few names spring to mind, but perhaps the clue was always there given the world’s most famous spy says, “The name’s Bond.” Putting the Smiley on some faces, it seems, is ‘Tinker, Tailor, Soldier, Trader’.

Having started with Churchill, I end this Daily warning we have only seen the end of the beginning on multiple fronts with the words of the Bolshevik revolutionary Trotsky:

“You may not be interested in war, but war may be interested in you.”