From Pantomime to Farce

This time last year we wrote an article entitled ‘Pantomime Monetary Policy’ where we mocked the denial and inaction of central bankers in the face of rising inflation, especially high asset price inflation. For much of 2022 central bankers bleated that inflation was ‘transitory’, but with consumer price inflation now tagging 8-10% across the Atlantic, they  are now of the view that ‘there are few signs that inflation pressures are easing’ to quote the latest Federal Reserve meeting minutes. Now they may get it badly wrong again.

As the central banking chorus grows, an array of macroeconomic indicators are dropping sharply like fizzing meteorites to earth – components of the Conference Board lead indicators, Philly Fed Survey and Empire State Manufacturing indicator – have all fallen to levels only seen during the 2008 recession. Financial liquidity is contracting rapidly (this has proven a good indicator of where inflation goes, with a lag). Note that if inflation doesn’t fall, then liquidity must contract even more.  

Economic sleuths will have noticed the recent drop in the price of oil, welcome from an inflation watching point of view, but a move that also tells the story of weaker growth ahead. Together with the drop in some of the above-mentioned releases, this suggests that a recession is not far away, if not upon us (curiously the Fed economic forecasts and those of the White House exclude such a scenario). More compelling evidence comes from the bond market where there is an epidemic of steeping if different calibrations of yield curve.

Yield curve steepening occurs, in very simple terms when longer maturity bond yields (10 year for example) fall well below shorter term ones (2 year), essentially forecasting weaker growth in the future. Unlike equity markets, which have predicted nine of the past five recessions, the yield curve has a better record, predicting six of the past five recessions. Another important indicator is the health of housing markets. In the rate sensitive and generally over valued and over leveraged markets (Canada, Sweden, Australia and New Zealand for instance) aggregate prices are dropping

Many economists are now sounding the alarm, and readers should brace for a media debate on whether we get a W, V or U-shaped recession. As it stands, unlike government bond markets, corporate bond and equity markets are not pricing in a recession and may well be vulnerable.

But, the outlook is however more complex than that.

Notably, different elements of the business cycle are behaving in odd ways. While lead indicators and more speculative indicators of inflation (lumber, used car prices for example) are dropping, labour markets are very strong and in general business activity seems to be healthy. Many of these elements may disimprove with time, or a lag as economists say, but these strands of strength make for several dilemmas for central bankers.

Do they for example bludgeon the cash rich consumer and healthy labour market in order to force inflation down or permit a higher level of inflation to stay in place with many unforeseen consequences for companies and asset prices. As it stands, there is a risk that interest rates run high for too long – thus discovering hitherto hidden pockets of risk and leverage. This will be a key story for 2023 and we will come back to it. An additional strand of this story will be the acute social and wealth inequality related aspects of this.

There are two more things worth saying about the business cycle.

The first is that it has been distorted and vandalized by a range of factors – lengthened and prolonged by both globalization and low interest rates (the three business cycle expansion phases during the period of globalization were the longest on record) and then the effects of COVID on labour markets, consumer preferences and fiscal policy. The commercial rupture between the US and China will also skew it and most likely the large outstanding debt load across many countries and companies will produce shorter, staccato’d business cycles.

Second, and finally there are not enough policy makers with a vision for the structural improvement of their economies. Liz Truss managed to identify a low trend rate of growth as a problem, but her response to it was hopeless. Since the global financial crisis, policy making across different countries, notably Europe, has been about crisis management. As such there are few large economies that are targeting gains in productivity and build infrastructure in new economic areas. When that happens we will be free of unconventional business cycles.

 Until then, we are in the hands of the central bankers.

The Kennedy Tapes

In a June note ‘Summer Surprises’ we spoke of tail risks to the war in Ukraine, noting the risk of a missile strike on Poland. In that respect we were not surprised by Wednesday’s missile hit on Poland, though relieved that it was not graver, and perhaps, more deliberate.

Oddly, the incident in Poland made me think of the evening of June 30, 1998 when Argentina beat England on penalties in the World Cup. I had rushed back from London to watch the match, having been to a more interesting event – the European launch of a book called ‘The Kennedy Tapes’. Memorably the book was launched by Caspar Weinberg, one of the longest serving secretaries of defense (his efforts to become secretary of state were stymied by the likes of Jimmy Baker and George H Bush). His introduction to the book that evening was passionate and telling, even for a Republican.

To give you more detail, ‘The Kennedy Tapes – Inside the White house during the Cuban Missile Crisis’ edited by Ernest May and Philip Zelikow, is a compilation of the conversations that John Kennedy, his brother Bobby and advisers held during the Cuban Missile Crisis – JFK had had recording devices fitted in the Oval Office to record his meetings and deliberations. Apparently, JFK was incensed that some advisers had backed the Bay of Pigs invasion privately but later publicly gave opposing views (there is more detail at the JFK Library).

When I read the book, I recall being struck by how thoughtful and strategic JFK and Bobby were (by the way there is a very good book about his murder ‘Who Killed Bobby?’ by Shane O’Sullivan, not to mention the film ‘RFK Must Die’). The book does not dwell on what produced the Cuban crisis but gives a superb and dramatic insight into the reaction of the Kennedy administration to it. JFK and his brother are generally calmer and more considered than their public reputations allow, and it is largely owing to this ‘calm’, and the advice of capable advisers, that an escalation did not occur.

Historians, politicians and public policy practitioners should read the ‘Kennedy Tapes’, even today, where the dilemma that the Kennedys faced is now ever present. Consider that the US/Japan/South Korea ponder the ever more powerful missile tests of North Korea, the now near public shadow war between Iran and Israel over the former’s nuclear program, the potential threat to China’s southern flank of a Japanese nuclear missile program or even the acquisition by Taiwan of long range missile technologies, the many risks from Russia’s arsenal to Ukraine and Europe, and to depress readers even more, the risks that terror groups acquire high level missile technology and deploy it into Latin America or Europe.

With respect to the immediate risk of a Russian strike into Poland and the threat of an attack on a NATO or western country, leaders will do well to follow the deliberate strategy evident in the Kennedy Tapes.

Whilst I have read a few books on war, I am not a military strategist, though I have enough experience with econometrics to know that tail risks are rising. This can encapsulate the possibility of some form of truce or settlement (perhaps Turkey or India or even China will be the initial matchmaker) but also of more sinister action by Russia given Ukraine’s progress in the south-east of the country. I suspect that the more Ukraine forces the Russian army back and the closer they approach Crimea, the heavier that attacks on Ukrainian infrastructure will grow, and as some hold, the prospect of an aggressive attack on the Ukrainian president will also rise. The recent meeting in Ankara of Bill Burns (CIA Director) with his Russian counterpart is a demonstration of the very serious undertones to the tail risks present.

There is a common thread in the ‘Kennedy Tapes’ and Bill Burns own recent book ‘The Back Channel’, that of the value of diplomacy. Worryingly in the cases of Iran and North Korea, the limits of diplomacy appear to be exhausted – by North Korea’s increasingly belligerent and attention seeking missile tests, and by Iran’s decision to supply weapons to Russia. In 2023 we may well see ‘Cuban crisis’ style deliberations around these two countries, both of which present dilemmas for Western policymakers.

In the case of Iran, any outside aggression or perceived interference could derail what is a surprisingly robust (though bloody) protest movement. In North Korea, the calculation is one of geography (namely the proximity of Seoul to North Korea) and of the viability of Kim Jong Il’s regime. And that’s before we have even considered Taiwan.

Have a great week ahead


Odd Couples

Spats between Europe and the US tend to be tempestuous, short-lived affairs – thankfully. In the Suez Crisis, Britain and France stormed towards Egypt only to be reined in by a raise of the American eyebrow. Dominique de Villepin’s speech against the invasion of Iraq was a glorious affair (please read the bande dessinée ‘Quai D’Orsay’ or watch the film of the same name with Thierry Lhermitte and Julie Gayet), but the tanks still rolled in. Then there was ‘The Donald’, lecturing the Germans on their energy and security policies, to guffaws of laughter and much derision, though he was quite right in the end.

Now, there is another, largely avoidable, though consequential tangle coming between the US and Europe. America’s increasingly concerted efforts to nobble the Chinese economy, and Europe’s slow awakening that it finds itself in strategic competition with China and to an extent the US and must boost its ‘strategic autonomy’, are two geopolitical threads that risk crossing each other in a disorderly way.

The complications of this intersection of interests were on display last week as Olaf Scholz visited China- a man standing nervously on cracking geopolitical ice flottes – he managed to disappoint everybody. His coalition partners were vexed, France’s proposal for a joint EU visit was spurned and America wondered whose side Scholz is on (that of German industry is the answer).

This tender diplomatic environment is just one outcome of a world where globalization as we know it has crumbled and we are now in the interregnum phase before the contours of a new world order are established. The problem being that two or maybe three parties want to establish the rules, standards and institutions of that world order.

There are several problems. America wants to have its diplomatic cake and eat it – it expects Europe and other nations to disengage from China – recall the diplomatic error over the creation of AUKUS. Further its domestic fiscal policy is reinforcing the negative side-effects of its foreign policy. For instance, European car manufacturers will suffer the consequences of the Inflation Reduction Act (David Skilling elaborates on these points in his recent ‘Peak West’ note).

Europe by comparison wants to bake its own cake but doesn’t quite know how. The idea of strategic autonomy has yet to fully take flight – and to be cruel this has yet to evolve beyond ‘strategic yogurt policy’ (in 2005 the French government shielded Danone from a takeover bid by Pepsi).

In a world where the three large regions are fast developing distinct expressions of their values, Europe and America have a common cultural and historical thread and share an interest in promoting democracy. On both sides of the Atlantic, democracy is under threat – from within by populists, and from without by anti-democratic countries like Russia and China.

In that respect, we ask what can be done to ensure that Europe and the US do not trip over each other as they keep an eye on the bigger picture.

The first is that American companies and policy makers need to take into account that the narrative in Brussels and major European capitals has changed towards ‘strategic autonomy’ across a range of fields (defence, telecoms etc) and anyone wanting to do business across Europe needs to fit their pitch into this framing.

The second, related element is that Europe needs to do at least two things – give itself a chance to establish strategic autonomy by putting in place the capital markets, tax frameworks and incentives that will allow innovation to thrive. We are far from this point and there are too few pan-European consumer and fintech platforms – Sumup is one, Doctolib becoming another. The second is to help partners like the US to understand the mapping of ‘strategic autonomy’ and where they can be involved commercially.  

The US and Europe ideally need to work more closely on stemming external interference in their electoral processes in particular, and economies in general. For instance, this time last year Europe announced its democracy package – aimed at safeguarding interference on political funding, media and voting rights – but it is effectively porous given the ability of foreign actors to penetrate individual countries without proper surveillance and sanction.

Then, there is talk that the G7 could become the organising body for the democratic Western world – though in effect this boils down to the US-EU axis. There was a time when the UK acted as a bridge for the US into Europe, but Brexit and the degradation of the UK’s soft and institutional power by Boris Johnson have broken this bridge – it may now be up to smaller states like Ireland to better interpret and marshal an open, diplomatic exchange between the US and Europe.

Such a move might help the US-EU axis but then the bigger question remains as to what the EU and US do together- would they try to destabilise public life in China or adopt permanent sanctions and restrictions on Russia. This might well be a false avenue – the best they can do together is convince the likes of Indonesia, Bangladesh and India to move closer to them and thus tilt the balance away from autocracy.

Have a great week ahead



There is a scene at the end of the film ‘The Firm’ where the character played by Tom Cruise is chased along the Mississippi bank in Memphis. As we might expect, our hero escapes. I was in Memphis recently, and ‘re-created’ the run along the mud bank, and then across the Harahan bridge into Arkansas – which looks very much like Tennessee, and no sign at all of Bill Clinton.

In my visit to Tennessee one private objective was to pick up a sense of the fractured political climate in the US ahead of the midterm elections – though disappointingly all the people I met were pleasant, intelligent and well informed. On then to New York, where at a breakfast meeting, I spotted Bill Barr at the next table no doubt conspiring on the election with a Republican Senate candidate.

Then, a quick, regular homage to the tomb of Alexander Hamilton (see chapter ten of the Levelling) before a meeting in the new World Trade Centre. The last time I was there, I shared a podium (one the very impressive top floor) with JD Vance, author of HillBilly Elegy, and now a Senate candidate in Ohio.

At the time – I had greatly enjoyed his book – my impression was of someone who was authentic, somewhat unpolished and with strong views. I recall him being very critical of Donald Trump. Since then, Vance has been swallowed up in the bitter morass of American politics, and viewed from Europe, been radicalized. This is a pity given his life story and achievements, but emblematic of the intensity and complexity of public life in the US.

It was always a testing environment – an examination of the period Hamilton lived through (and the fact that he died in a duel), highlights the vitriol of the press and political debate back then (Ron Chernow’s book is a good reference point). There is also a school of thought that holds that the quality of politicians has been on a downward tack since the Founding Fathers, Andy Borowitz’ new book is an example (‘Profiles in Ignorance’).

Against the backdrop of the ebb and flow of the fortunes of strongmen leaders (Bibi is back, Bolsonaro is out, Boris is on tour) and the context of a worldwide democratic depression, the mid-terms are interesting for what they tell us about the theatrical aspect of American politics (notably the Pennsylvania race between Dr Oz and John Fetterman), the pulling power of Donald Trump and the health of American democracy.

In that respect, the barometers to watch are the relative success of ‘non-Trump’ Republicans (for example Doug Ducey in Arizona or Joe O’Dea in Arizona), the extent to which candidates at the extremes of both parties do well (worryingly both Kevin McCarthy and a group of left wing Democrats including Alexandra Ocasio-Castro have tried to suggest that America’s support for Ukraine be limited).

Listening to the debate, it seems that the notion of ‘truth’ is very much up for grabs, both in the sense to which candidates and their supporters have flexible views on the rules of the political process, and to the extent to which they feel their own lives need to correspond to their policies – Herschel Walker the former Dallas Cowboys running back and now Republican candidate in Georgia is a case in point in terms of his stance on abortion.

The race will also give a steer as to the runners and riders in the 2024 Presidential election – I suspect that on balance the Republicans will do relatively well in the mid-terms (a barometer of the extent to which Americans care about the economy versus abortion for instance), and Donald Trump could claim credit for this and declare his candidacy for the Presidency (he is, statistically, the most ‘losingist’ President since Herbert Hoover having lost the Presidential election and the Senate and Congress).

It is not clear who the Democratic candidate might be – officially Joe Biden is a contender and problematically for the Democratic race there are few other obvious contenders (maybe Mayor Pete?). My own view is that the really interesting political figures are found at the mayoral and gubernational levels – Mike Duggan in Detroit and Francis Suarez in Miami.

In previous decades, a relatively good mid-term for the Republicans would have fostered talk of bi-partisan cooperation with a Democratic President – something that Joe Biden excelled at during his career. This time is different. The battle for American democracy may just heat up.