Blain’s Morning Porridge – 24 March 2022: How to Win Wars and Beat Recession
“As the facts change – amend plans accordingly.”
This morning: The West will win the economic war against Russia, but it will take time and impose recessionary costs, while triggering pain across markets (including the housing bubble). But when it’s done… it will time to put your buying boots on!
As a market strategist my role is to unentangle the big themes from the immediate noise. I can’t help myself from delving into micro-matters as I do so. It’s in the snippets of news and data found in the detritus of markets that clues are found suggesting where we might go longer-term..
Dominating all financial flows are the consequences of the Russian invasion of Ukraine. Two themes particularly stand out; i) how does the West win the economic war Russia unwittingly finds itself fighting, and ii) how does the West avoid recession/stagflation in its wake.
Western Sanctions are taking effect – and they are being watched very carefully by China and all non-aligned states. The implications of the USA and the West not hesitating to weaponise the global financial system and the dollar… will not be lost on them. The more they are seen to succeed, the better the chance the global economy emerges intact and functional.
Russia is clearly hurting. I read that sugar prices spiked 40% in a single day in Moscow, and the well regarded Russian Central Banker Elvira Nabiullina tried to resign. Experts say Russian oil and gas infrastructure will quickly degrade without Western spares and expertise. On the other hand, Russia is now demanding payment for oil and gas in Roubles – causing a significant spike in the currency. (Separately I hear the Chinese are delighted to be paying Russia RMB for their energy.)
Russia’s economic warfare strategy – which is being put together on the wing as they never expected such a unified sanctions hit – is to drive a wedge into the European response to invasion. They are hoping some European leaders will blink first. They are looking for weak politicians who talk tough on sanctions but will “enable” deals to keep their struggling economies on track. Without an 100% effort, the Sanctions Blitzkrieg against Russia can only achieve so much – which is why the Russians are trying to unpick it.
The West will ultimately win the economic war with Russia, but in the short-term is enticing for weak governments, like Italy, to consider free-riding and doing side-deals. The result will only be to maintain Putin in power for longer, and cause China to consider…. The challenge to the West is to ensure a transition from Russian oil and gas happens as quickly and with as little friction as possible for Europe, and that China clearly sees its best interest as part of a global economy.
The fly in the ointment is the transition period. How long will it take? New German LRP facilities won’t build themselves overnight. It will take time, and higher energy costs mean recession across Europe is pretty much nailed on. Is Europe willing to take the pain? This will be a big test for the new German chappie…
A critical zone is the Gulf – where the capacity to increase supply exists. Despite the Americans quickly shipping new Patriot missiles to Riyadh, thus far Saudi and the Emirates have proved unwilling to turn on the spigots – pretending neutrality. That may be a mistake. All wars – even economic ones – have winners and losers. It would be foolish to be associated with a clear loser – which will be Russia.
Ensuring Russia’s oil and gas can swiftly be replaced with alternative souces is a critical part of the Western War Strategy.
I expect a message has already been delivered that tacit Gulf support for Putin in order to protect investments, while keeping oil prices elevated, will be punished – perhaps in the form of access to dollar markets becoming difficult, or military favours being withdrawn. Such diplomatic games are played softly, with tact. A deal will be struck. The Gulf rulers will be seen to remain strong and independent. No one would want to see Dubai’s troublesome Grey rating on the Financial Action Taskforce on money laundering elevated to Black status, and access to dollar markets becoming difficult.
Apparently, earlier this week there were a record number of new property transactions closed in a single day in Dubai – over $550mm on one day – begging the question how much Russian money looking for a safe haven was involved. The optics could look better.
The second part of the outlook is the Recession threat.
Yesterday one of my colleagues conducted a very simple poll on Linked-in – asking followers of Shard Capital if they expect a UK recession this year. We got a good number of responses from financial professionals – and it was close. 49% expect a recession this year, 8% don’t know, and 43% said no. Remember, a recession is technically 2 consecutive quarters of GDP decline.
The key metrics to consider are that interest rates are already very low, and employment is very high – both of which suggest any short-sharp inflation spike could be absorbed. However, consumers are being hit with a massive cost of living shock – higher taxes, rising insurance, higher food and energy bills will effectively zero any discretionary spending. I have read estimates of a £2000 per head tax and inflation hit this year – that is 15% of post-tax earnings on average wages, in a country where everyone is crippled by enormous personal debt and very few people are regular savers.
The economic impact on consumers – who quickly burnt through any pandemic savings – will be enormous. While wages are rising in the public sector, private companies can’t afford higher salaries as their costs go through the roof. Yesterday’s UK inflation numbers show wages lag prices.
My own guess is we are likely to get stagflation – the current food and energy shocks combining with the end-Covid China supply chain shock to trigger a slowdown quite swiftly. But, I am not going to panic about it. At least… not yet.
It’s been fascinating to watch what’s occurring in the US, and especially Fed Head Jay Powell’s comments about the unsustainability of the current labour market. Some US investment firms now anticipate a much swifter rise in US rates. The effect will be to take out swathes of Zombie corporates (unprofitable, overindebted, and effectively burst firms), thus freeing workers to join more profitable businesses – but such transitions take time.
In the short-term I am expecting considerable economic pain – inflation, a consumer credit crisis, even a burst in housing bubbles across the west. Tough, but not end of the world stuff. Medium term, rates will remain historically low, and company earnings will recover as the economy shakes off the immediate energy cost spike.
There are plenty of other threats to overlay this simple analysis – what’s happening in Egypt as food prices spark a domestic currency crisis, could be repeated across the globe, triggering all kinds of social pain.
It could even happen in the UK if confidence in sterling collapses in the wake of further government sleaze and incompetence, a housing bubble burst (although historically UK housing always recovers within a few years) and a continued failure to build any meaningful new markets post-Brexit. (And don’t take my word for it: the UK’s Office for Budget Responsibility recently commented: “since 2019 the UK appears to have become a less trade intensive economy with trade as % of GDP falling 12% since 2019 – two and a half times more than any other G7 country”.”
Scary days ahead – but things are never as bad as we fear, and seldom as good as we hope.
And finally… for anyone that read my rant on Renault yesterday: Reason 283 we all hate the French, the bad news early this morning is they are stopping Russian production: Renault suspends Russia Business. A plate of morning porridge is strong stuff.
Five things to panic about this morning..
FT – Robert Armstrong and Adam Tooze: China Under Pressure, a debate
WSJ – Putin Wants Europe to Pay for Gas in Roubles
WSJ – Russia’s Oil and Gas Industry is starting to feel the bite of sanctions
BBerg – Russia’s Top Central Banker wanted out over Ukraine, Putin said No
BBerg – Blackrock’s Larry Fink says War to speed shift to Green Energy and Digital Currencies
Out of time, and back to the day job…
Strategist – Shard Capital
I was not part of your survey about the chances of a 2022 recession. I think I’d probably say “no”. But if you asked, what are the chances of a global recession in 2023…well, it’s almost certain.
Western Europe is in big trouble.
A NSS award wining its way to you Eduardo…
I reckon Stagflation on the cards. Europe did very well post Ukraine, but the cracks are appearing. Higher Energy Prices, Null-Entropy Japanification of the economy… they need to do something dramatic…
So does UK – although I was a soft Brexiteer – its been a zerogain and massive credibility loss for UK.
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