Rabo: Even QE-Addled Markets May See This As A Tail-Risk Off

By Michael Every of Rabobank

Narratives in the raw

Yesterday’s big speech from Russian President Vladimir Putin was mostly focused on domestic issues. Apparently his economy is clearly not in a good state – which makes one wonder who has been running the place for nearly 20 years. Yet there was a very blunt comment about Russia’s “dire” demographic outlook – and an equally blunt warning that while Russia did not want to burn bridges with other countries, it would set its own red lines, and those that crossed them would hugely regret it. A few years ago that kind of bellicose rhetoric would have been front-page news. In the present environment it hardly makes the news at all – even if the underlying risk of Russia-Ukraine conflict, and its potential market impact, are tail risks that won’t go away until the huge Russian army on the Ukrainian border does.

Higher up the news-flow today is a massive explosion in central Israel; suggestions this was a missile attack; and against Israel’s nuclear reactor at Dimona. Unconfirmed video suggests this was either intercepted by missile defenses, or hit another target. With Israeli jets striking Syria, this suggests it was an Iranian proxy to mirror the recent Israeli sabotage effort against Natanz. Israeli defense policy is based on the principle of massive deterrence – so the scale of reprisals remains to be seen, and if they in turn lead to escalation. Also recall Prime Minister Netanyahu may have only days left in office: the only way for him to rally the opposition around him as PM would be a true national emergency.

As such, while this could be just another in a long line of tit-for-tat in this region, even QE-addled markets may see this as a tail-risk off. It potentially underlines again how the Suez Canal, even if not directly involved, could again be closed in some geopolitical scenarios, straining supply-chains further; and it may be a knee-jerk positive for energy prices.

The ‘irony’ is that this comes as representatives in Vienna re-heating the 2015 Iran nuclear deal claim “real progress”: which critics claim means the decision has been made to overlook Iran enriching uranium to a 60% level; evidence Tehran secretly broke the terms of the deal before the US walked away; the sunset clauses that mean this is a can-kicking exercise; and Iran’s ballistic missile programme and sponsorship of terrorism.

Yet Reuters now reports a senior US State Department official as saying “Important disagreements between the US and Iran persist…with the negotiations still far from conclusion and the outcome uncertain,” and that “The main differences between Washington and Tehran are over what sanctions the US would need to remove and what steps Iran would need to take to resume its obligations to curb its nuclear program.”

Which seems to say that nothing much substantive has been agreed at all – unless this is all for show. Logically, if the Iran deal collapses there is no end-point but Iranian submission, which won’t happen; or the use of force, which nobody wants. Yet if the deal is re-struck, sanctions are lifted, and Iranian oil can flow, Iran will have lots more to spend on Russian arms. Perhaps this lead to regional peace: and perhaps it does the complete opposite. Life is complicated in a simple narratives aren’t.

If you think geopolitical tensions end there, you are wrong. An explosion at a Pakistani hotel that hosts the Chinese ambassador has also killed four. It’s unclear who was responsible. Note the China-India-Pakistan triangle, which saw recent violent clashes, where borders are still unresolved, and where China is now reportedly planning a mega-dam that would control the flow of water into India, is arguably only out of the headlines for tactical, not strategic reasons.

And speaking of tactics and strategy, in Canada, Huawei executive Meng Wanzhou has won a three-month delay to her US extradition hearing; and the Australian federal government has used new powers to tear up four agreements signed by Victoria, including one with Iran, one with Syria, and two related to China’s Belt and Road Initiative. “This is another unreasonable and provocative move taken by the Australian side against China,” was the official response. Will Aussie exporters see further Chinese measures in response?  

Meanwhile, as we have daggers drawn in the Middle East, bombs in Pakistan, sabres being rattled between Russia and Ukraine, and continued global recognition of growing tensions over Taiwan, today will see 40 world leaders attend President Biden’s on-line climate summit, where all will no doubt make pledges to fight the climate crisis – rather than each-other.

As Politico, not known for its anti-White House views, notes: Why Biden’s Climate Summit Is Overhyped: And who’s going to hold China accountable for its climate pledges, and how precisely? I will quote just one paragraph from the article:

“[US President] Biden is expected to announce a commitment to cut US emissions in half from 2005 levels by 2030. This will be greeted by huzzahs from elite opinion-makers, but this commitment, and this entire effort, is misbegotten. A key theory driving it is that if the US cuts its emissions, everyone else around the world will as well, preserving the Earth as we know it. But even well-intentioned countries are liable to miss, or to manipulate, their climate targets, whatever they say. And not all countries are well-intentioned.”

Yet we also see Italy’s PM Draghi is talking about a EUR220bn reworking of the Italian economy in a plan which is apparently 200 pages long with 500 charts – so more than two charts per page, which means not much text (luckily, many buzzwords are short). 40% of the funds will go to the poorer south: where, Bloomberg notes, “growth challenges have confounded every government since the country was unified in the mid-19th century.” There will be six overall “missions” with 16 categories of expenditure, including greening Italy’s historic buildings, high-speed rail, and lots of other things now classified as “infrastructure”. Let’s see if that is enough for Super Mario to finally jump-start Italy.

In short, we have the optimism of Build Back Better alongside what may be the pessimism of the rawest of realpolitik – but whoever said that there can only ever be one narrative at a time? Wouldn’t that make trading as easy as central banks have been trying –and still failing–to? Or, more cynically, aren’t both actually part of the same meta-narrative – of systemic failure, and the various possible responses to it?