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May
17
2022

Everything We Know About the End of the “Everything Bubble”
Michael Every

Everything Everywhere All At Once

Today’s title, referencing a soon-to-be-released movie that looks a superior version of a multiverse of madness than the one starring Dr Strange, nicely sums up our current global situation. Everything is happening everywhere all at once – yet key markets are failing to capture it or aren’t explaining the second or third order implications where they are.

US stocks failed to carry over the Friday dead-cat bounce on Monday, with the S&P -0.4% and the NASDAQ -1.2%. Treasury yields correspondingly went down, with the 10-year at 2.88% (-6bps) and the 2-year at 2.54% (-3bps). So did the USD, slightly. However, the real move was in oil, which rose more than 3% regardless on news Shanghai is to reopen slightly. As Bloomberg put it, ‘Bonds Signal Inflation Peaking Even as Commodities Spike,’ adding “Inflation expectations in the US bond market are subsiding despite the recent resurgence in the commodity complex. That aligns well with the perception that the risk of recession is increasing. At some point supply-shock-driven inflation is likely to bring about its own demise via demand destruction, and bond investors look to be signalling we are getting close to a tipping point for broad price gains even if wheat and crude stay elevated.”

I always listen to the bond market over the equity and FX markets; or at least I used to when we had a real bond market rather than one where yields are pegged by the BOJ, leaving otherwise silly FX as the only market with common sense. Today, one must add commodities as ones to watch. Oil and wheat are only a small part of CPI. However, you mess with them, and you mess with everything everywhere all at once, directly or via second or third order effects. 

The same Wall Street which wrongly shouted “transitory!” all the way to 8.5% y-o-y US headline CPI and now-entrenched services-sector inflation, and who have never been to a port or a warehouse, or driven a truck, or a forklift, are now confidently telling us that inflation has peaked. They are correct the US is, as Lloyd Blankfein just put it, at “very, very, very high risk” of a recession. Indeed, US Michigan consumer confidence just collapsed to a near multi-decade low, the complete opposite of what we saw the last time the Fed was hiking like it is now back in 2000 - and about to burst a different tech bubble.

However, oil is at $113 and rising despite the slowdown. US retail gasoline just hit a new record high in nominal terms, and even in real terms is not far off the peaks seen around the Arab Spring- or the Iranian Revolution. Those in the know underline that even if more oil were pumped, it would not help because the problem is the structural lack of capacity at refineries, which will take a long, long time to reverse. That feeds into the price of almost *everything*.

With a lag, into food – which also leads into the price of everything else given demand is to a large degree inelastic. Unsurprisingly, we hear more warnings of food shortages. This apparently means little to a Wall Street which worries most about which low-carb lunch option to have delivered by the Western equivalent of India’s dabbawalas, as it dresses up the Dickensian DM-meet-EM-in-the-middle I was predicting back in the early 2000s as techno-progress. Until they need to find infant formula, that is.

Likewise, as covered in our ‘In Deep Ship’ report, US supply chains remain structurally hampered. Truckers, who face soaring diesel prices, are seeing freight demand slump along with the slowing economy: if this carries on, many will go to the wall, removing a vital cog from the logistics machine when it needs to ramp up again. Rail is overloaded and underfunded. And, as we mentioned in 2021 after listening to people in the relevant industry rather than Wall Street, the International Longshoremen’s Association President, representing the port union on the US East and Gulf coasts, just said that he will “fight tooth and nail” against further marine terminal automation," adding, “Automation does two things: it makes the companies rich and the longshore workers unemployed.” In short, expect strikes to shut down US ports again, meaning nobody gets any of the goods they need regardless of price.

One can look at all of this and say that it just ‘means recession’, and so lower bond yields. Yet that is not seeing everything that is happening everywhere all at once.

Sri Lanka is officially down to its last day of petrol. It was already going hungry – now it will be immobile. Angry people were already burning down politicians’ houses. Now they seem to be attacking anyone looking wealthy. ‘Oh, that’s just Sri Lanka,’ some say. True. But Iran is seeing food protests; so is Tajikistan. Significantly lower bond yields, when oil and food prices are rising and demand is largely inelastic, and “demand destruction” means hunger, is not something that ‘just happens’ like it could when commodity prices were low. Especially not when it also implies a collapse in the stock market and in housing and soaring unemployment to boot. Yes, such a global risk-off phase may be bullish for core bond yields like the US and Germany – but in many places it is a potential disaster. If Wall Street continues to say commodities don’t matter and inflation has peaked, the likelihood is that we will see dozens more African, Middle Eastern, and Asian countries experiencing exactly the same socio-political destabilisation.

Consider that if Wall Street is saying inflation has now peaked, and is pushing bond yields lower, it is taking the Fed’s foot off the gas in terms of financial conditions – naturally, in a self-serving manner that helps prop up asset prices. One arguably needs to look at a matrix of bond yields and commodity prices:

• If bond yields are rising and so are commodities, the Fed are behind the curve - chaos follows everywhere all at once.
  
  
• If bond yields are falling and so are commodities, the Fed has achieved its goal – alongside a global recession and far lower asset prices.
  
  
• If bond yields are rising and commodities are falling, the Fed is on its way to its goal – but assets fall too.
  
  
• If bond yields are falling and commodities are rising, the Fed is on its way to falling behind the curve – chaos follows everywhere all at once.

There is also another angle. To pencil in very low bond yields is to ignore politicians who are not going to ignore the risks of what is going on in Sri Lanka happening to them. There is now no mystery as to how one can raise long-absent final demand: you use fiscal policy. It was always that simple, it’s just that we had had decades of enforced ignorance rammed down our throats by ordoliberals. Yes, you also have to control supply chains to control inflation at the same time – but that won’t stop politicians reaching for stimulus as soon as things turn down.

Do you really think that if unemployment, energy, and food all soar, and stocks and housing fall, that politicians will refuse stimulus measures? Yes, the UK government is telling people to cook meals for 30p(!), ride busses all day to keep warm, or to ‘get a job with higher wages’, but this is electoral ricin, and it is rumoured to be considering tax cuts by the summer. Elsewhere in Europe we see energy subsidies, which given supply-side constraints effectively push the burden onto the world’s poorest, creating more Sri Lankas. In short, don’t rely on fiscal policy to be restrained into a downturn.

Meanwhile, nominal pay is rising rapidly, and the worse things get, the more people will demand more of it. Yes, real pay is falling for many - but that is an impetus for more pay rises, and will not stop just because Wall Street says ‘inflation has peaked’: not when the alternative is homelessness, hunger, and ‘Sri Lanka’. Yesterday, Microsoft announced it was nearly doubling its wage budget to retain staff. Of course, smaller firms that make up the backbone of the US economy are least-well placed to compete with this trend – which further polarizes between hot and not, winners and losers, and those who eat and those who get eaten. If real wages keep falling, political temperatures will keep rising regardless even if bond yields fall.

Also, deglobalisation is happening. As I have repeated regularly, it was never going to be driven by leftist sentiment about the working class vs. the upper class; but as soon as you make it a rightist shift over national security, it can and will.

Yesterday, the Wall Street Journal carried an article about the trend for ”friend-shoring”, flagging that Central America is emerging as a new hotspot for textiles. Why not Latin America next, to help escape the gravity of China’s commodity appetite? Today, US logistics magazine Freight Waves carries an op-ed titled ‘Free trade is dead, welcome to ‘Freedom Trade’’, which sounds like the recent UK suggestion of an economic “network of liberty” with the G7 as its “economic NATO”. Indeed, the US Defence Production Act was recently tweaked to also include Canada, UK, and Australia as “domestic” production in regard to EV batteries/rare earths. Japan is seeing its manufacturers come home, and is subsidising them to do so; so is the UK, post-Brexit - without subsidies. Yes, this means higher costs and higher prices. And yet it is happening.

True, there are still laggards. The CSIS think-tank argues in ‘US Business Leaders Not Ready for the Next US-China Crisis’, that “The bad news is that very few corporations engaged in China have contingency plans or long-term strategies to hedge against the downside risks of growing geopolitical competition,“ and that “corporations need to think about their operating environment the way geostrategists now are.”

Indeed, besides a focus on commodities, it is all geostrategy now. You can’t look at your usual market and not at what is going on everywhere else all at once. For example, Turkey is blocking Sweden and Finland’s entry into NATO. Is this a usual attempt to force concessions over the Nordic stance towards Ankara’s bête noire, the PKK, or a genuine geopolitical shift to follow its purchase of Russia’s S-400 anti-aircraft system? Given the pressures all EM are under, and Turkey being a major energy and food importer, as well as reliant on exports to the EU, it is hardly likely to be positive for the struggling TRY, close to its record low of 15.66. Indeed, will soon-to-be-more-weaponized Fed swaplines to help flailing EM be made available to a country going down that geopolitical path? 

Everything. Everywhere. All at once. Not your usual market metric going up or down a bit.

Even in Australia, where the latest RBA minutes noted, “…upstream price pressures were increasingly being passed on to final consumer prices of many goods, as supply chain pressures persisted and demand remained strong. Members noted it was possible that firms' price-setting behaviours were undergoing a change from the pre-pandemic period, with businesses becoming more confident that raising prices would not significantly reduce demand or erode their competitive position.”

Then again, the Bank also added:

“Housing prices in Australia could also be more sensitive to rising interest rates than assumed, which would be likely to result in lower household wealth and consumption. At the same time, there was also potential for consumer spending in Australia to be stronger than forecast, given that households in aggregate had not begun to draw down on the savings accumulated during the pandemic and the high household saving rate could normalise more quickly than assumed. Another source of domestic uncertainty related to the behaviour of prices and labour costs at unusually low levels of unemployment, given the limited recent historical experience to draw on.”

In short, they really don’t know what’s going on. Which ironically puts them in a stronger position than those who think they do - by not looking at everything everywhere all at once.

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Michael Every is the Head of Financial Markets Research Asia-Pacific. Based in Hong Kong, he analyses the major developments in the Asia-Pacific region and contributes to the bank’s various economic research publications for internal and external customers and to the media.

Michael has nearly two decades of experience working as an Economist and Strategist. Before Rabobank, he was a Director at Silk Road Associates, a strategy consultancy based in Bangkok. Prior to this, he was Senior Economist and Fixed Income Strategist at the Royal Bank of Canada based in both London and Sydney. Michael was formerly also an Economist for Dun & Bradstreet in London, covering ASEAN. 

Michael holds a Masters degree in Economics (with distinction) from University College London and speaks Thai.

economics.rabobank.com