Rabobank: A “V For Vendetta” Recovery?

Submitted by Michael Every of Rabobank

Recent market pricing has been based on expectations of V-shape patterns in key indicators; as such we can expect volatility as we get the wrong kind of Vs. Not a boarded-up Winston Churchill in London, but rather an upsurge in virus cases.

New infections are up in many parts of the US – mostly in states where reopening continues anyway. They are up in ‘ahead-of-the-virus-curve’ Israel – where a senior health official says a second wave is already underway…and yet weddings of up to 250 are now allowed. They are up in Iran and in Tokyo. Moreover, in China parts of Beijing are once again locked down after an outbreak at a major food market – blamed on foreign fish so far. In short, Covid-19 appears stubbornly persistent despite political claims of total or partial victory over it: and this is summer: imagine what winter might look like.

Regardless, efforts keep being made to get the economy moving again. In the UK, for example, the government appears ready to make the “2-metre distance” rule the 1-metre rule – just as the WHO report arguing the reduction in distance is safe is rubbished by other experts. As we keep repeating, voluntary lockdowns are not something one can control for, and the British public are shown to NOT be keen for 2 to become 1.

As an example of that China’s latest data releases have mostly disappointed. New home prices were up 0.5% m/m, as that epic bubble shows yet another mini-leg higher. However, in the actual economy we saw industrial production up only 4.4% y/y (vs. 5.0% expected, and despite steel and cement output climbing to a new record high); retail sales -2.8% y/y (vs. -2.3%); property investment -0.3% y/y (vs. -0.8%, the only ‘good news’ aside from unemployment dropping from 6% to 5.9%, which is not a series the market takes seriously); and fixed asset investment -6.3% y/y (vs. -6.0%). In short, even with a ‘build it and they will come’ attitude, and even with the virus “having been beaten”, it still looks like China’s Q2 GDP will be negative y/y.

Don’t expect an economic V to follow either. Bloomberg is running a story titled “One-Third of US Job Losses Are at Risk of Becoming Permanent”. The Fed’s Powell already alluded to this, which helped prompt a market sell-off on Thursday that was immediately reversed by misplaced optimism on Friday. Yet imagine what high structural unemployment on top of our current unfair asset-rich, income-poor global paradigm is going to look like. Think we face a shrinking centre, declining middle-class, political polarisation, and populism now? Add millions of people whose jobs just disappeared with no cash cushion to see them through to retraining for work in a new, worse-paid sector about to be flooded with applicants. Do that and you have to imagine another ‘wrong kind of V’: the movie “V for Vendetta”. Unless you really think everyone is going to be sat at home day-trading; or that governments are going to keep up a WW2 level of spending for at least another 18 months. Either way it’s lower for longer forever on rates until we eventually reach the tipping point where inflation is V-shaped. Yet that’s a political story, and David vs Goliath for the moment.

That’s not to say slingshots are not being prepared. One needs to see the link between these kind of domestic problems and the international arena: as Klein and Pettis argue in their new book “Trade Wars are Class Wars”. In short, inequality at home and trade surpluses/deficits run internationally, and subsequent trade tensions, are always two sides of the same coin.

Is it pure coincidence then that the South China Morning Post reports “Beijing can expect more concerted efforts against it from the US, Australia, Britain, Canada and New Zealand”, as the Five Eyes group coalesces into a new coalition, which other recent actions show also involves India, Japan, Vietnam, and perhaps Indonesia. (A potential ‘Mahan’ grouping I have been flagging for some time.) Perhaps. But it’s ‘useful’ coincidence.

So is proposed US legislation targeting China on everything from trade to technology to capital. Moreover, Friday saw US Treasury Secretary Mnuchin reportedly float the possibility that looming US sanctions on Hong Kong could include USD usage too. Watch that space very closely. Meanwhile Graham Allison, the author of the recent retelling of the ‘Thucydides Trap’ where the US and China are Athens and Sparta, is now arguing in The National Interest that Huawei could potentially also prove a US-China casus belli.

EU foreign policy chief Josep Borrell this weekend reiterated that Europe will not pick a side and will work with both on areas of mutual interest. Really? Let’s see who replaces Germany’s Angela Merkel, who is pro-China in her (in)actions. Further, let Borrell digest the speech US President Trump gave at West Point over the weekend, where he stated: “It is not the duty of US troops to solve ancient conflicts in faraway lands that many people have never even heard of.” US politicians make increasingly-Churchillian statements about China, but that’s a line lifted from Chamberlain: the EU had better hope “many people” in the US still know where Europe is on a map! (On which note, Poland just invaded the Czech Republic in a “misunderstanding”.) Yes, the EU super-tanker turns slowly, but it may need to do so rapidly. As with the UK’s banning then unbanning of “The Germans” episode of ‘Fawlty Towers’, will it be a case of ‘Don’t mention the don’t mention the “Don’t mention the war”’?

None of this virus, economic data, or geopolitical backdrop is bullish EM, except perhaps for Mexico (which is bolted on to the US via the USCMA). Neither is it bullish risk. Instead, it still says long USD strategically, if not tactically, and long bonds, and long duration. Yet we cannot forget that central banks are determined to see ‘the right kind of V’ and will do whatever it takes to get one…even when it isn’t actually possible.