Political Shellshocks Loom For Markets

By Michael Every of Rabobank

Shellshock

Yesterday, the RBNZ held hawkishly and talked about a rate hike, with no cuts seen until end-2025. The UK’s inflation numbers were awful both headline and core, with services CPI at around 6%: yet the BOE evidently wants to cut rates as soon as it can. Then the Fed minutes from its May meeting made clear several FOMC members are still prepared to vote for a hike, or to keep rates on hold longer than markets expect. (See here for more from our Fed Watcher Philip Marey.)

Luckily for markets, however, the AI boom rolls on and on: because where would we be without our US asset bubble du jour?

However, there are still more potential shellshock for markets ahead from politics: Bloomberg’s Shuli Ren asks, ‘Has Xi changed His Mind on Housing and Consumption?’ The NOT neoliberal, but Marx-Lenin-Mao-Xi ideology of China’s political-economy was underlined by its release of an AI based entirely on Xi Jinping Thought, which some dub ‘Chat Xi PT’. However, were Beijing to reflate with serious fiscal stimulus, it would hamper Western central banks’ room for rate cuts: look at what commodity prices are doing without any Chinese version of the West’s Covid stimulus.

A smaller shellshock is the UK holding a rare summer election where polls say it’s “Gone on the 4th of July” for the Conservatives. Indeed, the logic of doing this now rather than waiting for November in the hope opposition support dips has political experts saying either PM Sunak has the inverse Midas touch, or there is a looming scandal so bad it’s prompted the worst-snap election since New Zealand’s drunk Prime Minister called a “Schnapps election” in 1984.

The larger UK shell shock is Shapps: the defence minister states, “Lethal aid is now, or will be, flowing from China to Russia into Ukraine.” Yes, China is helping the Russian economy by supplanting Western-centric industrial supply chains, and some of that has dual use, but actual lethal aid is supposedly a ‘red line’ that triggers US and EU secondary sanctions. Yet in January 2022 I warned these would either prove ineffective or bifurcate the world economy into complying/not complying blocs. Our post-invasion research underlined the same binary, and that it’s impossible to model how much economic damage would be done if secondary sanctions had real teeth. More recently, the IMF made the same point.

Markets may think even if this is correct that, like Shapps, ‘this too will pass’, and we can Keep Calm and Carry On Rate Cuts (and/or AI). Yet that’s the same pre-war naïve thinking I decried in 2022. After all, that would mean there are no red lines, so lethal aid can flow to Russia; its military position vis-à-vis Ukraine would be strengthened further; and it would leave Europe unwilling and unable to respond, and the US unwilling to because it has bigger Chinese fish to fry in Asia. Indeed, things already continue to escalate rapidly:

• Poland’s Prime Minister Tusk implies Russia may have started a Warsaw department store fire.

• Poland may shoot down Russian missiles near its border.

• Russia shifted its maritime boundaries with the EU in the Baltic Sea before deleting the text.

• Russia is rehearsing tactical nuclear drills near the Ukraine border.

• The US is reassessing if Ukraine can use US weapons to attack pre-2014 Russian territory.

Meanwhile, Taiwan’s new president Lai Ching-te gave an inaugural address that sailed dangerously close to the China’s red lines. The Global Times rails: “Lai shamelessly stated in his speech that “the Republic of China Taiwan is a sovereign, independent nation” and “the Republic of China and the People’s Republic of China are not subordinate to each other,” spewing various “Taiwan independence” fallacies and hostile provocations against the Chinese mainland… They are well aware that what they are doing now is pushing Taiwan into a dangerous pit of war and danger.” China is already responding with the largest joint military drills around Taiwan for a year, “Joint Sword-2024A“, which encircle it, and include actions around its outlying islands of Kinmen, Matsu, Wuxi, and Dongyin. This is as reports say ASML added kill switches to TSMC technology to be triggered if China invades Taiwan.

Moreover, as flagged in Tuesday’s ‘Wrath of Khan’ Daily, the international liberal order is fracturing further following the International Criminal Court’s (ICC) request for arrest warrants for the Israeli prime minister and defence minister, and three leaders of Hamas. The EU is split: Belgium, Spain, and Ireland back the ICC; France did too, then prevaricated; Italy and Austria are opposed, and the Netherlands’ Geert Wilders strongly backs Israel; and Germany said it didn’t agree with the Court… but would only obey its orders. Yet there is bipartisan support in the US, which President Biden won’t block, to sanction the ICC for its recent action. Naturally, Russia and China are making as much hay as they Khan, splitting the Global South further from the West in the process.

But, hey, “AI!”, right?