By Michael Every of Rabobank

Resetting expectations

Yesterday saw the Nikkei -2.2%, the Dax -1.7%, the S&P -2.7%, and the Nasdaq –3.8%, while the US Treasury 10-year yield the White House is now focused on was -5bp to 4.16%. As the headlines put it, markets were “swooning”, first on China drifting back to deflation, then on President Trump’s comments that refused to rule out a US recession. Frankly, that commentary managed to be both very shallow and deeply myopic at the same time.

China is “struggling” with deflation due to mercantilism. An economy that ‘must’ grow at 5%, and via more supply, not demand, necessarily makes too much, exports it, and… dominates global supply chains. Many Western economies could do with that right now – as Trump implied.

He made clear he wants to reset the US, and by extension, global economy: "I hate to predict things like [a recession]. There is a period of transition, because what we’re doing is very big. We’re bringing wealth back to America. That’s a big thing. And there are always periods of - it takes a little time... But I think it should be great for us... What I have to do is build a strong country... You can’t really watch the stock market. If you look at China, they have a 100-year perspective. We go by quarters. And you can’t go by that. You have to do what’s right." Vice-President Vance put the same thing another way: “President Trump's economic policies are simple: if you invest in and create jobs in America, you'll be rewarded. We'll lower regulations and reduce taxes. But if you build outside of the US, you're on your own.”

Markets, which presumed Trump 2 would retain Trump 1’s monomania for stocks, just want what’s right for them. However, anyone who thought shifting the US to production-based mercantilism from asset-based financialisation via economic statecraft over economic policy could be done without assets falling didn’t understand either ‘ism’, or statecraft. Hence the sell-off.

Of course, this attempted US reset could go horribly wrong; or right. Either way, markets will be dragged along behind it.

We are also seeing a matching US global foreign policy reset via political statecraft:

The US and Ukraine are to meet in Saudi Arabia today to discuss ending that war, as Senator Graham threatens to sanction Russia aggressively if they don’t come to the table; the US wants a deal, not war between Israel and Hamas, and it, not Israel, is now seen in charge of hostage negotiations and the end game; the US is also getting tougher on Iranian oil, as the Houthis reportedly get ready to attack things again; Trump seems set for a June ‘two birthdays’ summit with China’s Xi despite the escalating trade war; and the FT’s Gideon Rachman claims Trump is “Making Europe Great Again” after decrying all the actions that led to that outcome.

Again, this attempted US reset could go horribly wrong; or right. Either way, markets will be dragged along behind it. So, do try to keep up.

Moscow is now blaming the UK for instigating global wars - a Russian obsession and a good way not to blame the US, helping build détente, perhaps. However, that flatters the UK as much as recent comparisons between PM Starmer and Churchill. The looming UK Strategic Defence Review (SDR) reportedly states the military is so weak after 25 years of hollowing out that it will take ten years to become “match fit”, and require “much more” investment, and “industrial policy” to onshore production, tech, and jobs, as well as a recommendation this is done without the US.

Oddly for military thinkers, the SDR seems to assume an economics-style static backdrop when it will be dynamic and antagonistic. What if Russia, China, or even the US make the UK’s “industrial policy” or military decoupling more difficult and expensive via grey-zone sabotage, supply chain ‘shocks’, or economic statecraft countermeasures? At the very least, anyone thinking “much more” investment was covered by the recent policy shift away from foreign aid to defence spending, or that this is going to take only ten years, or that the government has a shovel-ready plan for military protectionism to allow it to happen is likely mistaken.

The same applies to Europe: will the new “four-year” loosening of the EU’s Stability and Growth Pact, or the 1.5 percentage points of GDP, be all we get as it rearms? Half a Euro tank or a Euro combat aircraft to replace US systems like the F-35 for fear of built-in ‘kill switches’ --so requiring even more complex new supply chains to be built from scratch, and economies of scale, i.e., larger orders, to make it affordable-- is no use to Europe at all.   

Meanwhile, geopolitics is ‘even’ seen in central banks’ hallowed halls – as anyone who’s read their history knows is actually line 1, page 1, chapter 1.

In the US, the Fed is now in blackout mode ahead of its meeting next week – but what will it say if markets keep falling even if as recently as Friday the US economy was seen as “fine” by Fed Chair Powell?  

In Europe, Politico notes ECB Governing Council’s Kazaks has become the first member to say that seizing €200bn of Russia’s FX reserves to help Ukraine is a “viable option,” with other Baltic central bank officials reportedly privately endorsing the same, and pressure maybe building to act. ECB President Lagarde is still opposed for now, but recognzses it will ultimately come down to politicians, who face a huge rearmament bill, not central bankers: and that’s a dynamic central bankers need to get used to going forwards.

Were this to occur it would be the most radical European economic statecraft step in that area since WW2. It would shatter EU assertions of their defence of the ‘rules-based order’, or unilaterally rewrite them, reduce the attractiveness of the Euro as a global reserve currency just as the same is being said of the US dollar in some quarters, and could even have an impact on the holding of Eurozone government bonds by key Global South asset holders. And what if the US opposed the move, bringing US-EU financial tensions onto the table alongside trade, geopolitical, and military?

In short, seizing Russia’s FX reserves would prompt urgent discussions about a reset of the global financial system, and its bifurcation.

That’s where a lot of what has been discussed in this Daily logically ends up, if you look through the “markets swoon” headlines. Time to reset your own expectations accordingly?