Once the inflation bandwagon gets rolling, it’s very hard to stop

Outlook: We can attribute the dollar’s gains to the usual suspect—divergence in monetary policy that widens the current and expected yield differential. The Fed delivered yet another policy member, NY Fed Pres Williams, affirming the May hike will be 50 bp. At the same time, the ECB delivered no fresh words, policies or guidance. This was expected, but apparently disappointed anyway.

Elsewhere, China cut reserve requirements by 25 bp, a smallish move compared to lowering lending rates. This comes ahead of Q1 GDP and the other monthly data dump from China on Monday. Bloomberg warns “the data will likely show a pickup in growth that masks a major setback toward the end of March, when lockdowns in Shanghai, Shenzhen and elsewhere clobbered the economy.”

This leaves the world with two major economies either cutting rates or holding to an accommodative stance (curve control in Japan that caps the 10-year at 0.25%) compared to Europe with “no change” and the US, UK and Canada/Australia/New Zealand on the higher rates trajectory. While the correlation of yield diffs with currencies is not rock-solid, it’s certainly an important factor. Differentials may even become the “Main Event” again.

Oxford Economics finds that 50% of those it surveys expect a recession in Europe in the next 12 months. If that sufficient reason to put off fighting inflation?

This reminds us to reconsider our forecasting timeframes. Yes, we trade on the near-term data, but those longer-term forecasts for growth and inflation never seems to include an option in which (1) the Russian war is over and (2) China gets some form of zero-Covid it can live with.

Or both. Let’s say those two Events occur by the fall, say Oct 1. We must expect the usual post-war and post-pandemic consumer spending spree everywhere in the world. Inventory hoarders will release supplies. Ports will clear out. There will be dancing in the streets. The West will shower Ukraine with reconstruction money, some of it to be spent in other countries. Not least is the price of oil tanking, on the drop in uncertainty even in the face of higher demand. How about oil back to (say) $60? This is the point at which the Fed and other central banks are going to look brilliant.

This is not a forecast! But it is a warning that talk of recession really does need to be moderated by alternative outcomes. We are not seeing that kind of talk anywhere, yet. Note that once the inflation bandwagon gets rolling, it’s very hard to stop. The Fed’s tools are not up to the job, either. Nobody is talking about price controls or new rules against price gouging, but the data we have already indicates inflation is hardly likely to subside back to the 3-4% level next year as just about everybody is forecasting. See the charts from The Daily Shot.

Our criticism of the economics profession can be summed up by the one and only economist joke—if you forget your phone number, an economist will be glad to estimate it for you. These days we have Nobel winner Krugman saying recession ain’t necessarily so, while fat-ego ex-TreasSec Summers says a soft-landing is improbable and recession is for sure.

Bloomberg notes that in a recent survey, only 27.5% of economists foresee recession. We say this doesn’t pass the “So What?” test. They didn’t foresee the subprime mortgage-backed securities business bringing down the financial system in 2008, either. (Actually, one Fed board member [Fred Miskin] did, and presented a paper at Jackson Hole on that subject, but disgraced himself shortly afterwards and had to depart, so became the boy crying wolf rather than the boy with a finger in the dike.

The point: uncertainty is high and when uncertainty is high, Kahneman warns we tend to fall back on old heuristics, meaning rules-of-thumb that might not have worked in the past but seem sensible. They’re not, and are not a substitute for judging risk, either.

We say the old ideas about inflation and recession may well turn out to be invalid because of the pandemic and the war. In the last 50 years in which no yield curve inversion was not followed by a recession, we didn’t have a war. And the one inversion that didn’t bring recession was during the height of the pandemic.

And that’s on top of our inflation/recession assumptions based on a history that didn’t have quantitative easing to contend with.

Maybe it’s true that historically, recessions follow inflation with an average lag of 13-33 months, but none of them followed conditions of QE, war and pandemic. If that lag really something we can count on?

And where does the real rate enter the picture? Again, QE has screwed that up and will take more than a year to fix.

Since it’s a holiday, let’s get a little wild and consider the other scenario—Russia does something so awful that it qualifies as a trigger to Nato’s Article 5. The US NSA advisor mentioned this yesterday—if Russia interferes with Nato member deliveries of weapons to Ukraine outside of Russia, it would trigger Article 5. This is a far more direct warning than the dancing both sides have been doing with moving military capability, including nuclear, closer to the Russian border. Russia fumes it’s a threat, but the US has now become specific about what brings Nato into the war. You have to wonder if the West has some intelligence on this subject.

We have taken the position that for all practical purposes, this is World War Three and the US and Europe are already participants via their sale and donation of armaments in vast quantities. It’s like the West hired Ukraine to be our proxy army in the long-standing war of Russia against Europe. This is how the Ukrainian foreign minister couched it and he is not wrong. What if there is an actual formal declaration of war and full participation by Nato?

Among other outcomes, all our economic forecasts go out the window. So: inflation, recession, Russia, oil—rinse and repeat. 

Foreign Affairs: The UK has seized £10 billion in property belonging to two Abramovich associates (he’s the soccer guy), the biggest seizure ever. The UK list now runs to 106 names. In the Ukraine, the government has seized not only the property but the person of an oligarch with strong ties to Russia. In the US, National Security Advisor Sullivan said two somewhat shocking things—the US has no intention of giving back any of the seized Russian assets. (Remember the US did give back seized Iranian bank accounts decades later.) Secondly, focus is now enforcing sanctions, i.e., hunting down those who violate the sanctions, including those inside Russia.

The Economist says the sinking of the Russian Black Sea Fleet flagship Moskva is the biggest naval loss since WW II. The Ukrainians did it with domestically produced Neptune missiles. It has only a few left but is getting re-stocked with missiles from the UK.

All the military commentators are pointing out that the Ukrainian military is superior to the Russian. The sinking of the Moskva by a Ukrainian missile is disputed by the Russians, who say it was a fire. If it was a fire, is that not incompetence? And this ship was a command center.

The visual news from the Ukraine war is racking up increasing evidence of Ukrainian military superiority and Russian incompetence, which the Russians are perhaps trying to disguise by re-directing attention to photos of horrific Russian conduct—bodies in the streets from civilian massacres, civilian building bombed to rubble. Experts say this is the Russian playbook—to appear ruthless and cruel, to terrify the invaded into submission.

But we have an equal amount of photos showing Russian military incompetence, starting with that 40-mile truck convey bogged down outside Kiev. In other places, trucks and tanks are wrecked and abandoned, some of them not road-worthy in the first place and some originally civilian, so not physically capable of carrying heavy military stuff. And Russia is sending in more, just as spring mud mires anything one foot off road.

Did Russia buy substandard stuff, suggesting corruption in the quartermaster section, or is it just that the largely conscripted soldiers are careless and can’t be bothered to maintain transportation equipment? Western military logistics experts say the failure of the Russian military down at the truck and re-supply level may well be fatal to the invasion, fancy bomber planes and high-end missile notwithstanding. You don’t win if you have to walk.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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