The Jokes Write Themselves

By Benjamin Picton of Rabobank

It’s important to maintain a sense of humor in the markets. Here at Rabobank we occasionally get accused of being perma-bears but I think that’s a little unfair because, like any team, we have a diversity of views and some of us are actually quite upbeat! Nevertheless, we have been fairly negative on the global outlook for a while. I prefer to think of this as cheerful pessimism, which Charlie Munger assures us is the best way to be, and he ought to know.

Indeed, there is much cause for mirth because funny things happen in the markets all the time. A case in point is the news over the weekend that the Bank of England will be leaning on the expertise of Ben “sub-prime is contained” Bernanke to lead a review into the Bank’s forecasting performance. We’re not suggesting that a bit of navel-gazing wouldn’t be justified for the Bank given its recent forecasting performance, but if you’re going to take advice on a subject wouldn’t it make sense to ask somebody with more of a track record of success?

Another famous Bernanke clanger was his assurances to Congress that the United States would not enter recession in 2008. I don’t want to jinx it, but that sounds eerily similar to the prognostications of another former Fed Chair, Janet Yellen, who has also been telling us pretty much the same thing recently. Yellen isn’t alone in her view. Following the decision to increase the Fed Funds rate last week Jerome Powell told us that Fed staff no longer expect a recession in 2023. That probably invalidates my working theory that Yellen’s no recession call might just have been the magic mushrooms talking, but it still might be worth checking what was on the menu at the Bank of England when the Bernanke decision was made.

Regular readers will know that our resident Fed expert, Philip Marey, has been cheerfully pessimistic for quite some time about the prospects for US growth later in the year. That is still the case, but the dataflow recently has been pretty good. Second quarter GDP last week beat the consensus forecast by miles, the core PCE deflator showed moderation, durable goods orders were strong and new jobless claims continue to outperform. Talk of a soft landing, or even “no landing” is creeping back into markets, but risks are legion! Commercial real estate jitters, deep losses on bank ‘hold to maturity’ portfolios, sky-high PE ratios and oodles of debt are all known-knowns (that we are ignoring for the time being), but what about the unknowns?

For this, I turn to my colleague Michael Every:

Saudi Arabia is to hold a peace summit over Ukraine, without Russia(!), and is potentially interested in a peace deal with Israel, with strings attached for the far-right Israeli government and the White House, which would have to offer a mutual defence treaty, against Iran, and backing for a Saudi civilian nuclear program – those who know the Middle East can see the upsides *and* the downsides of that potential dynamic. But ‘Peace now’, then, to match the ‘rate cuts soon’ vibe? Hardly! Consider: Kyiv may (or may not) have been behind new drone attacks on Moscow; Ukraine’s counter-offensive may finally be working; Russia’s Medvedev has stated Ukrainian success would require a Russian nuclear response; and, as the Financial Times (and others) warn, ‘Putin is looking for a bigger war, not an off-ramp, in Ukraine’, the Polish PM and senate suggest the Wagner group may soon stage a provocation at the Suwalki gap between Belarus and the Russian enclave of Kaliningrad to test NATO unity. In short, far fatter tail risks than another 25bp hike from the Fed or ECB remain present. Even assuming we don’t get a bigger war, NATO defence spending needs to surge to keep pace with rising global threats just as some economists are talking about fiscal prudence again. Japan, which just tightened monetary policy, will see its military spending leap from $122.5bn to $310bn over the next five years. Meanwhile, the New York Times warns Chinese hackers placed malware in key US infrastructure, which logically may need to be replaced, alongside ongoing onshoring. In short, markets may like doves but there is no guarantee of either ‘peace now’ or ‘rate cuts soon’.

It’s hard not to see some black humor in staging peace talks that don’t include the main belligerent. Signs of further Russian aggression are particularly concerning given the position of relative weakness that Europe is starting from. The German manufacturing PMI released last week looks absolutely diabolical, as do the preliminary growth figures for the second quarter. The situation is sufficiently serious for Economy Minister Habeck to caution last week that the economy faces five difficult years of green industrial transition.

Greeks and Italians who have been subject to more than a little finger-wagging from Berlin over the years may be enjoying the Schadenfreude for the time being, but a weak Germany in a time of geopolitical tensions is not in the broader interests of the EU. That is no laughing matter.