Economic pessimism persists. Inflation looking increasingly entrenched. Policy makers’ conundrum: how to respond to the cost of living crisis? Lack of liquidity could spell market instability. Putin’s hybrid warfare means nothing is off-limits. Recent US decisions vis-à-vis China look like tech warfare. Advances in green energy tech are exceeding expectations. Rising interest rates reduce investors’ appetite for distant pay-offs.

  • ECONOMIC PESSIMISM – The mood is pessimistic. Put bluntly by the IMF: “Risks to the (economic) outlook remain unusually large and to the downside”. These risks span monetary policy miscalculations, dealing with over-indebtedness (global debt, public and private, now exceeds 350% of global GDP), policy divergence in the largest economies, further $ appreciation and cross-border tensions. In the words of Larry Summers: “We’ve got the most complex, disparate and cross-cutting set of challenges that I can remember in the 40 years I’ve been following this stuff”.
  • ENDURING INFLATION – Like so many others, we got inflation wrong, when in Summer 2021 we assumed it would be transitory. Our apologies. Its recent rise continues to defy expectations. September figures (Y-o-Y) were higher than most analysts had anticipated: 9.9% in the euro area, 10.1% in the UK, 8.1% in the US, and even 14% in Chile – a country that hiked rates earlier and more aggressively than most. Why then is inflation proving so stubborn? Negative shocks are part of the explanation: Russia’s aggression in Ukraine, and geopolitical turmoil more generally, have had a considerable impact on food and energy prices. But so have expectations. A fundamental reason for elevated core inflation may be related to behavioural changes that entrench it still further. As firms and households become ‘obsessed’ with inflation and fear it will keep rising or remain elevated, it becomes harder to stop.
  • COST OF LIVING CRISIS – Real term wage increases are occurring in only just over a third of countries globally – mainly in Asia. The rest, mostly in the ‘West’, are suffering. As enduring inflation erodes real incomes, it worsens the cost-of-living crisis, squeezing hardest those on the lowest incomes (an example: the price of a tomato pasta meal in the UK has just gone up by 58% Y-o-Y). Such increases, whether impacting basic food staples or fuel, dramatically affect consumer sentiments, placing policymakers in a cleft stick: the expansionary fiscal policies which are politically and socially necessary at a time of rising industrial action and social unrest, have become hard to implement as they tend to lead to higher yields on government bonds. The recent, narrowly avoided financial meltdown in the UK proves that combining an anti-inflationary monetary policy stance with an over-expansionary fiscal policy is the surest path to a vicious loop.
  • RISING CONCERNS ABOUT LACK OF LIQUIDITY IN THE MARKETS – Higher interest rates combined with lower growth could endanger the stability of the global financial system. There are indeed mounting concerns among central bankers and market participants that an economic recession might entail a broad-based sell-off across all kinds of assets (stocks, bonds, housing, commodities) that would in turn be accompanied by serious financial instability. What just happened in the UK is proof of that. In a similar vein, Yellen expressed concerns about illiquidity issues in US Treasuries – the most liquid market in the world.
  • PUTIN’S ASYMMETRIC WARFARE – Ukraine’s military gains are exposing (1) Russia’s inability to counter them through conventional warfare and (2) the state of dereliction of the Russian army. As a result, Putin is now engaged in hybrid warfare which he will progressively ramp up. Pipelines, German trains, US airports: such acts of sabotage and intimidation destined to sow confusion will increase. Vladimir Putin is a master in “strategic ambiguity”. His tactics will ensure that while nothing we see can be construed as true, we then fear that anything and everything is possible. The West is no longer at peace, not yet really at war, but acutely aware that the Kremlin can take the conflict any which way and everywhere. The consequence: Ukraine and NATO countries should expect more nasty surprises, and businesses and investors be ready for heightened econ. uncertainty.
  • ECONOMIC AND TECH WARFARE – The decision made by the US administration to drastically reduce the ability of US companies and ‘persons’ (as well as non-US companies using US technology) to operate within the Chinese semi-conductor industry amounts to a declaration of economic and tech war on China. It’s as if a “superpower had declared war on a great power” (says Ed Luce. This is a dramatic geopolitical move considering that 90% of the production of those high-tech chips originate in Taiwan. It will constrain China’s expansion in AI and supercomputing in the next 3-5 years but will turbocharge China’s willingness to develop its own chip industry. It also increases the odds of a conflict (military or otherwise) over Taiwan, as indicated by the concomitant warnings from senior US officials that China could invade Taiwan within the next two years and by President Xi’s assertions that Taiwan independence is his reddest of all red lines not to be crossed. Businesses and investors: prepare for a two-blocs deglobalization process. You’ll be asked to take sides, and there’ll be great opportunities for those who can take advantage of this ‘rewiring’.
  • ONGOING GOOD NEWS ON THE ENERGY FRONT – Russia’s war has had the unintended positive effect of changing the global energy outlook for good. First, it has forced Europe to come to terms with the idea that it made no sense to rely on Russian energy. While we should not cry victory too soon, the energy situation in the EU is much better than anticipated. Price signals have worked and forced adaptation: demand for energy is lower, diversification greater and gas prices are faltering. Second, it has made the necessity and possibility of moving to green energy ever more real. As we’ve repeatedly said, achieving a net zero carbon global energy system is not merely in sight, it’s just around the corner. The exponential growth in renewables triggered by the convergence of SWB technologies (solar, wind and battery energy storage) will slash the marginal cost of electricity. But beware, in the process, it will leave carbon-emitting energy resources stranded (notably coal and gas).
  • MONEY’S TIME VALUE – With interest rates rising, the time value of money is back on investors’ minds. Investment themes that look great sometime in an ill-defined future have lost their lustre and this is why there is now so much reticence about ideas like the Metaverse or autonomous vehicles. Prudence!
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