“Things Could Get Worse In Hours, Days, Or Weeks”

By Michael Every of Rabobank

Fed minutes. And years more of this

Yesterday’s Fed minutes had a few key takeaways. Obviously, the majority of the FOMC voted for a 25bps hike – but some wanted to go 50bps; and that was at a time when US data was looking weaker than it is now. Second, the FOMC care that financial conditions have been easing, and they don’t want them to; which means higher yields, please, and lower stocks, thanks. We got the latter but not the former yesterday. Third, the FOMC don’t see CPI back to 2% until 2025. “Transitory” sure lasts a long time – and perhaps for even more years if you look round you.

The White House is considering releasing the intelligence it has garnered showing China is considering supplying lethal aid to Russia – perhaps within hours(?) To say this escalates geopolitical and geoeconomic risks is an understatement.

Tomorrow sees the China peace plan for Ukraine. On that note, look at this quote from the Global Times: “Since Kiev is deeply influenced by Washington, which is not interested in an immediate cease-fire but prefers a prolonged conflict to keep undermining Moscow and change the status quo by force, it is really hard to see a feasible formula for peace that both sides can accept. Peace may arrive only after more casualties and damage in the battlefields make at least one side change their mind.” Is that an implied threat to help Russia or resignation? Foreign Minister Wang Yi just underlined China-Russia ties are “rock solid”, and “no matter how the international situation changes, China is willing to maintain the sound development momentum on the new model of major-country relationship with Russia”. The Russians said the two countries favour building “a more just world order, and welcome the rise of the number of states which choose the path of free, sovereign development based on their identity and traditions.”

On which, Iraq will now use CNY to settle trade with China – except Anas Alhaji claims this does not include oil. Even if it did, ‘netting out’ was covered in 2022’s ‘Why Bretton Woods 3 won’t work’ and 2023’s ‘War and pieces of gold can’t derail the dollar’, which underline it would not be a game-changer. Nonetheless, one can see how Beijing-Moscow-Tehran would like the game to change; and that will require a US response, including higher Fed funds.

Elsewhere, alongside leaked plans for a Russia-Belarus merger, Dr. Pippa Malmgren warns Abkhazia, Artsakh, South Ossetia, Serbia, Nagorno-Karabakh, Transnistria, Moldova, Norway, Denmark, Poland, and Romania are flashpoints for Russian actions; and these may include sabotaging Norway’s oil and gas supplies to the EU. (Unless the CIA and Norway are going to do it to themselves, which Sy Hersh may soon allege.)

The Israeli press quotes Prime Minister Netanyahu saying any attack on Iran gets harder the longer one waits, and reports he has held five cloistered meetings with his defence staff on that topic, and warned the US and France that he will act alone if necessary.

Yes, these are all hard-to-price binary, fat-tail risks – but there are ever more of them; we had one such shock a year ago, showing they do happen; and the fact we are where we are now was predictable – just not by markets. Yet some still aren’t taking this into their inflation projections. And I include the FOMC in that: 2025 is likely to be optimistic against the above background.

Even if one only wants to only look at the economy, we live in a bifurcating world of K-shaped data where aggregates we are used to mentally mapping don’t work the way they once did.

Yes, goods deflation is evident in some places as demand cools post-Covid, helping unreformed supply chains look more efficient than they actually are – until eggs, vegetables, or baby formula disappear from shelves, exposing structural vulnerabilities again. And let’s not forget to mention the surge in US used car prices.

Yet services inflation is soaring as that sector overheats as much as goods did during Covid. This is not supply-driven, but a global phenomenon of ‘revenge’ services spending – although the lack of supply of staff is making things worse.

If you want a low-end services worker in the US, or anywhere, good luck trying to find one without a huge pay bump; but if you want a high-end US tech worker servicing DEI, you can take your pick as they get bumped. Which one do we have more of in the economy, and which matter for overall inflation and demand? If you can’t work that out then, like DEI workers, wait for the tap on the shoulder as you sip your latte.

What if the K-shaped oligopolistic nature of corporate power means price hikes can be passed on because there is literally nowhere else to buy? As Ben Picton notes this morning following a 2.2% rise in Australia’s Q4 private capex, stronger than the expected 1.1%, businesses are feeling happy despite rising rates and rising CPI, whereas consumers are the gloomiest they have been since the 1991 “recession we had to have”.

Perhaps because the question is also ‘what if nowhere else to go?’ In Australia, higher mortgage rates are being passed on directly into higher rents by leveraged property investors: after all, why should that tax-privileged class face any pain? So, with housing supply stalling, and net immigration about to surge again, rates and inflation are rising in tandem. Unless and until demand collapses for everything but housing – which is about a K-shaped as it gets.

Of course, that’s also a neo-feudal model of the economy, not capitalism. Then again, the geopolitical backdrop is one of war and imperialism, so the shoe fits.

The simple point is this: we arguably have years of hawkish inflation ‘surprises’ in the likes of the Fed minutes because of structural factors still being deliberately overlooked 12 months after the Ukraine war started. And things could get worse in hours, days, or weeks.