By Michael Every of Rabobank
Escalate (...to deescalate?)
Last week saw a plausible(?) Powell Pause and Collins say a December cut wasn’t a done deal: only gool ‘ol Goolsbee was left to sell the usual “RATE CUTS!” mantra to fretful markets. Imagine if someone other than him were to start suggesting the risks of a possible US rate hike: talk about hypothetical escalation in Treasury market volatility!
There’s escalation in the search for a US Treasury Secretary too. Kudlow is out, Lutnick’s self-promotion may be backfiring, Bessent is still in, and now Senator Hagerty, Apollo Global CEO Rowan, former FOMC voter Kevin Warsh, and even Robert Lighthizer are being floated. Can you imagine the market reaction if Lighthizer gets the nod? Moreover, while Warsh was pro-trade in the past, which markets like but clashes with Trumponomics, he was withering on TV a few weeks ago about “the Fed wandering into politics on a permanent basis…for all seasons and all reasons” via zero rates and QE, saying they have “a framework that is unanchored.” Is a ‘higher for longer’ voice at Treasury an even less palatable thought for markets (and Trump?) than tariffs?
BOJ Governor Ueda just refused to say if he backs a rate hike in December: and boom! USD/JPY moved from 153.87 to 155.11 before settling down around 154.9 again. You didn’t even have time to spell out ‘escalate’ and ‘deescalate’ before the market leaped.
In geopolitics, the world just saw a meaningless-hugs APEC summit where China’s Xi took centre stage for the photo (due to alphabetical arrangement: but one alpha next time is going to say that things need to run “A, B, C, T”). However, there were two important developments.
First, the US and China agreed that they won’t allow AI to control nuclear weapons, just humans; Skynet was just averted as long as the Russians sign up too.
Second, China warned the US it still has four non-negotiable red lines: Taiwan, democracy, human rights, and China's right to development. If the US arms Taiwan more, expect escalation; if the US tries to push back against the CCP, expect escalation; and if the US tries to limit China’s rise -e.g., via tariffs- expect escalation. Let me make a bold forecast: expect escalation.
China already said from 1 December it will tighten export controls on "dual use" materials such as tungsten, graphite, magnesium, and aluminum alloys commonly used in tech supply chains. (Recall the “strategic goods fallacy” noted in my report on economic statecraft: everything can be ‘strategic’.) As with recent Chinese sanctions on goods supplied to a US drone maker, physical supply chains are weaponised. Now imagine a surge in US goods demand around/ahead of tariffs, and a deliberate reduction in Chinese supply.
In parallel, Russia announced a ban on the export of enriched uranium just as the US, and world, realises it needs to go nuclear again rapidly: it will now only go to “friendly countries” like India, Iran, and China. Russia also just stopped selling piped natural gas to Austria.
Europe is grappling with “conclusive” proof of armed drones for Russia made in China, a stated red line for the EU; or an opportunity for it to show it buckles under pressure. Might it fudge and pretend Beijing knows nothing about these drones rather than taking tough trade and sanctions actions ahead of an imminent “moment of acceleration” where “With a [US] tariff wall ... if you are a friend, you are in. If you are not a friend, you are out. And I am going to judge you on whether you want to be a friend,” as Draghi put it.
Of course, in statecraft, escalation doesn’t have to stay in the field of economics. Reports are that North Korea may now send as many as 100,000 soldiers to fight in Ukraine, which would be an enormous help to Russia, regardless of what they might be watching on their mobile phones when they get there.
In response, President Biden has lifted the ban on US long-range missile systems in Ukraine being used against targets deep inside Russia proper. President Putin has previously stated he would consider this as the US itself being at war with Russia. If this US policy successfully deescalates the war instead, it will show the White House decision not to do so years ago -at the cost of hundreds of thousands of lives- was completely wrong; moreover, the likelihood would rise of much more US escalation in many more places to reassert its primacy. Yet if this policy just escalates the war here, or somewhere else later, everything obviously gets worse: we just don’t know how/how much. As the first long-range Ukrainian missile attack on Russia is now expected within days, we won’t have to wait long: I reiterate Russia’s response can be across fields, not just in the fields of this awful war.
In another conflating and escalating war, reports have it US “major non-NATO ally” Qatar (though some in Team Trump may debate each of those words) has kicked Hamas leadership out… and they have moved to US major NATO ally Turkey: let’s see how that works out for them after previous clashed over S-400s and F-35s, among other things. Let’s also ask what might happen if Israel were to go after Hamas in Turkey, which could be seen as an attack on a NATO country…
Team Trump has said that from day one, it will aim to crush the Iranian economy: presumably no large benefits given to Tehran this time, and sanctions on oil will actually be enforced – which could create further stand-offs with China, and maybe India.
Nearby, the Houthis are displaying weapons the Pentagon describes as “amazing”, which doesn’t suggest the Red Sea/Suez are going to be back on line for global trade any time soon. A new approach will be needed. A key maritime voice is suggesting an “America First” response to the Houthis would be for a large US naval taskforce to escort solely US-flagged commercial vessels safely through the region/Suez. This would show the benefits of having a US flag, and paying US tax, protected by a US Navy that until now has policed the world’s seas for all ocean carriers at a high cost to the US taxpayer and no geoeconomic or geostrategic benefit to the US in a mercantilist world. As I wrote in 2021, assuming such a naïve navy approach would last forever would leave those reliant on global maritime trade -but with no navy- In Deep Ship.
Relatedly, some claim Trump is preparing a root-and-branch shake-up of the Pentagon: strategy, tactics, operations, personnel (including charges against those responsible for the Afghanistan retreat debacle), and murky accounts. As I have noted already, there is little sign of BAU anywhere in this emerging admin.
What a fun backdrop for the G20 meeting to be held today in Brazil: free trade and free hugs anyone?
It’s clear we are going to get lots more escalation on multiple fronts ahead: it isn’t yet clear how we can then deescalate again – but one travels in hope.
