With rising inflation looking more recalcitrant than expected, central banks will be more hawkish than dovish. With shortening supply chains and rising protectionism, localisation is gaining ground on globalisation. That said, the rest of the world still stands to be impacted by any hit to China’s growth inflicted by the Evergrande debacle. The Eurozone is vaccinating its way back to pre-pandemic economic levels faster than expected, while in geopolitical terms, Biden’s form of US isolationism means Europe must gain more ‘strategic autonomy’ – a tough call. Society and the planet now matter at the electoral urns – except for those on the far right for whom they don’t.
- Mild stagflation is gaining ground. Despite extraordinarily accommodative monetary and fiscal policies, growth is slowing, due to a combination of Delta variant stubbornness and enduring supply bottlenecks. Meanwhile, inflation levels are running well above target and rising, first and foremost in food and energy, but also in core inflation. If negative supply shocks persist, this may prove less temporary than we initially assumed, setting in motion a self-fulfilling cycle of higher inflation expectations (inflation is all about psychology) and higher wage demands.
- In much of the world, fiscal support is being withdrawn while central banks are tightening monetary policy, or about to do so – pushing bond yields higher. In the coming months, the best outcome scenario of a continued output recovery combined with a gentle decline in inflation will be put to the test, unnerving market participants. More persistent pressures on inflation mean that the next moves from central banks are likely to be ‘hawkish’ rather than ‘dovish’.
- The supply chain crisis and the ensuing logistics crunch (most acute in semiconductors and container shipping) are forcing manufacturers and assemblers to opt for greater localisation, hastening de-globalisation for supply-side reasons. Testimonies from business leaders in manufacturing and retail make it clear that supply chain optimisation has come at the cost of much fragility, and that greater resilience equates to shorter supply chains. ‘Just-in-time’ is giving way to ‘just-in-case’. Although ‘nearshoring’ is embryonic, it will ultimately alter trade patterns, leading to greater regionalisation and therefore less globalisation (together with slightly higher inflation).
- Evergrande (China’s most indebted property developer) is a hugely consequential story, possibly reminiscent of the 1980s housing bubble in Japan. A Lehman moment is unlikely, but in today’s China, property and related activities – the key engine of the country’s remarkable growth – represent almost a third of the economy, with housing wealth accounting for around 80% of overall assets. Accordingly, some economists estimate that a 20% fall in economic activity in the property sector could lead to 5-10% fall in GDP growth. This means that an end to the housing boom and its unwinding will sharply decelerate Chinese growth, with cascading effects in the rest of the world.
- The Eurozone, often derided by the media and analysts, is in fact getting it right. Its model for dealing with Covid works and minimises disruption (by constraining activities for non-vaccinated people, it has achieved one of the world’s highest take-up vaccination rates). High frequency data shows an increase in consumer confidence and suggests that the eurozone economy could return to its pre-pandemic level over the next two quarters. While the Eurozone is not out of the woods yet, the combination of pledged investments and structural reforms contained in all national “recovery and resilience plans” financed by EU borrowing is robust and promising. In the years to come, Europe may well surprise on the upside.
- Worldwide, geopolitics, internal politics and related governance issues are throwing a major spanner in the works of the investment world. The inability of Blackstone (one of the ‘best-connected’ and ‘most prudent’ Western buyout groups in China) to buy Soho China for USD3bn begs the question of whether China risks becoming barely investible for foreign investors (who own USD800bn of financial assets in China’s onshore markets while the 230 Chinese companies listed on US exchanges are valued at more than USD2tr). Meanwhile, throughout the world the definition of what is “strategic” is expanding, with a whole range of industries – from wind farms in the US to food in France – becoming ‘off-limits’ to direct foreign investors. As protectionism increases, so too will this trend.
- In the meantime, the tectonic plates of geopolitics are shifting fast, and nothing illustrates the rapid transition to ‘messy multilateralism’ better than the AUKUS deal. The new military alliance between Australia, the UK and the US has left France high and dry. Some of the consequences: (1) It is an insult to a NATO partner that exacerbates the trust deficit with the US (particularly palpable in the Middle East); (2) “There is far more continuity between the foreign policy of Biden and Trump that is recognized” (R. Haas) – US isolationism will endure (it is not “across-the-board” – China is the exception); (3) It forces Europe to seek ‘strategic autonomy’ (even though it’s very hard to achieve, as the example of French forces in Mali proves).
- The fact that all five Nordic countries are now led by a centre-left government and that the SPD won the recent German elections (with a strong showing for the Green Party) prove that the median voter is moving to the left and that electoral outcomes are increasingly determined by environmental and inequality considerations. As Biden’s victory shows, this phenomenon is not confined to Europe and is giving rise to the so-called Cornwall consensus (to which we referred last July) that places solidarity, inclusion, and the environment at the core of “Building Forward Better”. The broad implications for businesses and investors: (1) A more forceful / benevolent state, (2) fiscal profligacy, (3) higher taxes, and (4) more regulation.
- BUT this doesn’t mean that the far-right is not still lurking in the wings. A fact now on full display, with evidence ranging from the recent victory of an anti-vaccine party in Austria’s regional parliament to the inability of the US authorities to vaccinate a substantial portion of its population. The same pattern emerges everywhere: anti-vax attitudes grounded in anti-science and anti-establishment sentiments serve as a lightning rod for all sorts of grievances. They are gaining some traction as the “normalization trap” (when things become more common, they also become more acceptable) gives them legitimacy. This fuels populism, illiberalism, and tribalism. In some extreme cases, like in the US, it is indicative of a possible impending constitutional crisis looming before the 2024 elections.
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