Via Rabobank,
“And he shall judge among the nations and shall rebuke many people; and they shall beat their ploughshares into swords, and their pruning hooks into spears; nation shall lift up sword against nation, neither shall they forget war anymore.”
(With apologies to Isiah 2:4)
The US has increased its pressure on Ukraine to pause the war by turning off military intelligence to it, removing Kyiv’s ability to fire missiles into Russia. This action has further outraged and –given their reliance on US systems in NATO– terrified Europe. Note President Eisenhower did the same vis-à-vis then-and-current ally South Korea in 1953, which didn’t want to stop fighting; the US didn’t want a direct war with China, or more inflation, and made it clear military aid would stop until an armistice was achieved. That frozen conflict seems where Ukraine-Russia is heading, especially as President Zelenskyy just said what rejected what the Russian terms for any formal peace deal (demilitarisation, formal renouncement of lost territories) would be.
Europe has added its own pressure on Zelenskyy as Germany’s ministry of defence admits it can’t supply more materiel to Ukraine either as it’s out of stock.
That underlines the need for the German announcement on infrastructure investment and rearmament yesterday, which saw 10-year Bund yields rise 31bp on the day, their worst performance since 1997. EUR jumped.
Ahead of today’s EU ReArm summit President Macron addressed his nation, stating:
“Our prosperity and security have become more uncertain, and it must be said, we are entering a new era… if a country can invade its neighbour in Europe with impunity, then no one can be sure of anything anymore, and it is the law of the strongest that applies, and peace can no longer be guaranteed on our continent itself.”
He added that the future of Europe will not be set by the Kremlin or Washington, DC, and spoke of extending the French nuclear umbrella to Europe.
This is going to come at a vast cost. If you think a 31bp rise in Bunds captures the scale of shocks involved in a soft-power Europe trying to set its own future in a hard-power world then you spend too much time in soft-power circles. For starters, the FT op-eds today that ‘Europe must trim its welfare state to build a warfare state’: like it or not, that is starting to sound a bit MEGA (Europe, not America) and DOGE. One wonders what the ECB will say about it today.
Europe is outraged by US actions vs Ukraine and what some call the White House’s “reverse Nixon” strategy (so, ‘Noxin’?) of trying to split Russia from China, as with China vs the USSR in the 1970s: there is talk of Trump–Putin kinship or kompromat even in the financial press. However, facing a united China and Russia, when until this week Europe refused to rearm, is something all geostrategists, some belatedly, see as a deeply flawed US strategy. Moreover, the eurocentric fail to spot that Trump is not only pivoting from Europe to focus on Asia –which the EU largely thinks of in terms of trade not security– but is trying to use the quid pro quo gained there for Putin’s help with nuclear negotiations with Iran.
After all, Tehran is close to a nuclear weapon and Israel, who just rehearsed a joint strike on it with the US, to having to remove what it sees as an existential threat the hard way. Were that to occur, it would have a vast negative impact on the US and European economies. That key issue isn’t even part of current EU conversations; but as Europe rearms and tries to find its own place in the world, it will find it has to join more such dots in more locations at an ever-higher price.
It also goes without saying that the odds of ‘Noxin’ and an Iran deal success are very low; but the alternative scenarios are not ones markets want to think about.
Again, they do not imply just a 31bp move higher in 10-year Bunds. Especially not when the Chinese embassy in the US tweets: “If war is what the US wants, be it a tariff war, a trade war or any other type of war, we’re ready to fight till the end.”
On the first of those fronts, President Trump granted a one-month pause on 25% tariffs on autos from Canada and Mexico, and is reportedly considering exempting some agri products, as well as potash. Markets obviously loved that, presumably because it affirmed their view that ‘there aren’t going to be any tariffs really’ – which is certainly easier to model.
What they won’t love at all is the Wall Street Journal’s Fed whisperer Nick Timiraos saying, ‘The Two-Headed Monster Stalking the Economy Has a Name: Stagflation’.
Because nobody is allowed to use the S word. Trump is using the term, “A little disturbance” instead.
Markets think the White House won’t do anything that allows them to go down, as if the 100+ radical executive orders so far, and constant talk of tariffs and resetting Bretton Woods, is just talk and the actual US focus is the old economic policy play of tax cuts and deregulation. An economic commentator I heard on TV yesterday was noting Trump was “using the art of the deal” with Canada and Mexico. What deal is this art working towards, exactly? Fiddling with efficient free trade just for the sake of it?! Saying “because markets” without thinking “because what?” is not a real response, or a predictor; sometimes headlines saying ‘European rearmament’ can mean an explosive surge in Bund yields.
Yet Trump hasn’t mentioned stocks so far, and the word from D.C. is their focus is on Main Street, not Wall Street, with willingness to tolerate “disturbance” for at least the next six to eight months, while blaming it on Biden, in order to get a framework in place that allows for growth based on what Trump thinks GDP is *for*, e.g., the new office of ship building in the White House.
That doesn’t mean there aren’t some market- and inflation-friendly measures being floated: as one example, Trump economic advisor Navarro wants to see oil in the $50s.
That would certainly offset some tariff inflation. However, that is also the point at which the US oil industry makes its money, so some serious economic statecraft is going to be required there, not economic policy.
On which note, as all is in flux, former Australian PM Abbot is publicly lobbying for a free-movement and free-trade deal for Australia, New Zealand, Canada, and the UK, so a slimline Anglosphere version of the EU. That could easily appeal to all four countries worried about the US direction under President Trump. However, don’t think for a moment that the US wouldn’t then want to bolt that mechanism on to itself provided there was a joint external tariff vs China. In fact, you could bank on it.
In the US, and purely on the bank/economic front, the latest Fed Beige Book noted
“Overall economic activity rose slightly since mid-January. Six Districts reported no change, four reported modest or moderate growth, and two noted slight contractions. Consumer spending was lower on balance, with reports of solid demand for essential goods mixed with increased price sensitivity for discretionary items, particularly among lower-income shoppers… Manufacturing activity exhibited slight to modest increases across a majority of Districts. Contacts in manufacturing, ranging from petrochemical products to office equipment, expressed concerns over the potential impact of looming trade policy changes.”
You know what that doesn’t sound like? An Atlanta Fed GDPNow at -1.5% q-o-q annualised, apparently a recession warning, but largely due to a surge in imports into the US to try to front-run tariffs.
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