Russia wants to destroy the west, China wants to exploit it

Outlook: US data is skimpy this week--new home sales, durable goods and the preliminary PMI. Next week we get payrolls and the important component will be average hourly earnings.

We can’t forget all data these days, but must admit some background factors are really what’s running the markets. Not in any order, they include China’s policy of shutting things down when Covid appears and potentially worsening the supply chain situation.

Another is finding alternative to Russian energy wherever it can be found. The IEA says it can’t be done. Italy was first out of the gate, travelling to N. Africa. Next up is Spain, considering completing a pipeline from Algeria to near Barcelona and potentially, to France. Germany made a deal with Qatar. Saudi Aramco, reporting tremendous profits, said it will increase capacity (and everyone else should, too) because it’s unrealistic to think the need for oil can be replaced. The Saudis wouldn’t take Biden’s phone call and Boris Johnson came back from the Middle East with empty hands. Not a soul has said the one surefire way to reduce demand for energy is to reduce the number of people on the planet demanding it, aka population control. You can pick a fight with just about everyone on that subject. As for Iran and Venezuela, back-burnered again.

The bottom line of finding alternatives to Russian oil and gas is that it would ruin Russia for even longer than sanctions-induced pariah-hood. Once these contracts get made, they tend to stick. This returns us to the joke, attributed to John McCain, that Russia is just a gas station with nukes. It doesn’t have much of ant economy. It doesn’t have world-leading products except maybe caviar. It doesn’t have a deep and wide management pool. Instead, the Russian economy is a bunch of thugs controlling assets by brute force and hiring foreigners to manage the businesses (e.g., oil companies). And clearly it’s a failure. Apple, Microsoft, Google and Amazon all have market caps greater than Russia’s GDP.

And bringing up China again, the only reason China would want to support Russia has nothing to do with having the same or similar ideologies, but rather to get its hands on those assets. And it’s not sure it the price is right (yet). Russia lacks transportation capability to get oil and gas to China. China would have to build it. Considering the lack of return on the Belt and Road Initiative, China must be hesitant. Infrastructure is expensive.

Russia wants to destroy the west. China wants to exploit it. If China has any ideological ventures in mind, it’s grabbing Taiwan. Mr. Xi must have a team carefully examining whether the Taiwanese would or could fight back as well as the Ukrainians, as well as the response of the west. Putin misjudged both the Nato and the Ukrainian response to his invasion. China watches. It won’t make the same mistake.

Finally, the background factor that is actually influencing sentiment more than data is evaluating the degree of commitment at the Fed to raising rates to kill inflation. This is a very big debate among Fed watchers, who believe that if the Fed were serious, it would have done 50 bp last week, as St. Louis Fed Bullard wanted. And still wants. According to the WSJ, seven of the policy committee members see Fed funds over 2% this calendar year, which means one of those hikes must include a 50-pointer. Also, for 2023, the Fed’s official stance is 2.4%, but most members foresee 2.8%. We didn’t get the 50 bp this time because of uncertainty over the war, which logically is silly. There are no circumstances under which war reduces inflation. Growth, maybe. Inflation, no.

“Federal Reserve governor Christopher Waller said Friday that overseas events and the risks they pose drove him to favor a smaller rate rise by the central bank earlier this week than would have been suggested by U.S. economic data alone. ‘The data is basically screaming at us to go 50 [basis points] but the geopolitical events were telling you to go forward with caution.’”

Mr. Bullard politely points out that the policy is unwittingly easing because of inflation and the Fed will have “to move quickly to address this situation or risk losing credibility on its inflation target.” Richmond Fed Barkin is conciliatory, saying the current path only takes away stimulus–it doesn’t put up obstacles–and is not going to generate an economic downturn. He, like Waller, is open to 50 bp.

We continue to reject the idea that the Fed engaged in a dovish hike. We might get some more information as early as today when both Powell and Atlanta Fed Bostic speak at a conference (National Association for Business Economics).

Let’s add something just now starting to get attention–food. Ukraine is a big producer of food for Russia and Europe. How will be it be replaced? Trying to get recent data on food stockpiles is quite hard, presumably because it’s considered a national security issue. NikkeiAsia claims that China has stockpiled more than half the world’s grains. India also has a large stockpile of grains. In the US, we do not stockpile food at the Strategic National Stockpile, but FEMA has food. Sometimes it has too much and its ends up spoiled. The Council on Foreign Relations says the US stockpiles oil, helium, lithium and some other stuff, but on the whole, stockpiles of food, like that famous 1.4 billion tons of cheese, are privately owned and good luck finding out how much of what. We also have butter and, weirdly, raisins.

We could well be facing a global food shortage, not only from the loss of Ukrainian and Russian supplies but also hoarding, and not just hoarding of commodities themselves, but also dollars. Last week JP Morgan predicted the Egyptian pound will need to be devalued, and sure enough, today the central bank devalued by 10.76% and raised rates by 100 bp. Note that Egypt devalues fairly often, and expectations of devaluation causes dollar holders to hoard. Reuters reports grain shipments have been held up at Egyptian ports, “after importers could not obtain necessary foreign currency for letters of credit to get their goods cleared, bankers said.”

Expectations for developments this week are low and poor. We can’t expect much from Nato and the EU on Ukraine, although you never know. Commodity prices are gyrating madly and a wise trader who is not expert in any one will stay away. We continue to see the Fed as hawkish and the ECB as failing to respond strongly to inflation. Big picture, this has to be dollar favorable; it’s just taking rather a long while to get there.

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