How to read the end of the risk associated with the Brexit of March 29th? Look at the 10-year Bund rate. It dropped into negative territory with the risk of an immediate and brutal shock related to Brexit. With the UK’s exit from the EU postponed, this immediate risk disappears and the rate comes back into positive territory again
Source Bloomberg
Concerns and uncertainties on world economic activity having been gathering pace since the fall. The swift decline in world trade reflects this change in pace, moving into the red with a contraction of 0.4% in January vs. yoy growth of 4% in September 2018. This turnaround has triggered concern from the OECD and the ECB, prompting them to slice back growth projections for the euro area in particular.
The very heart of this economic question is whether this shock is permanent and persistent, and in this respect, there are two interrelated questions worth noting, as well as another third aspect.
The first point is the political explanation for this downturn. Trade tariffs applied by the White House have shifted the balance of trade between the US and China, leading to a swift slowdown in trade in Asia since the start of the fall and acting as the main contributing factor behind the decline in world trade as a whole. By targeting China directly, Donald Trump is actually damaging the entire region.
The other aspect is the uncertainty triggered by the White House’s political choices, as doubts on trade following border tariffs are further heightened by the threat of fresh trade moves. A case in point is the German automotive sector, which could be hampered by a border tax of 25%, as the US threatens to impose tariffs on $11bn in European exports to the US in retaliation for European subsidies to Airbus. The WTO will have the final say, but there is also a further threat as Boeing is now struggling with recent problems on its 737 Max.
I follow this graphic step by step. The change in trend on the Jolts’ survey reflects that found in the Conference Board survey. The job market may be changing in the United States. You must have that in mind.
Theresa May is in Berlin and Paris to request a new deadline. It’s a safe bet that she will get some time. The date discussed is December 31, 2019. It is a little less than what Donald Tusk was talking about, who was ready to go up to a year.
As no one knows the possible consequences of a lack of agreement, no leader will take the risk of being the one who could trigger the possible apocalypse.
Business leaders are making arrangements to manage the possibility of a Brexit but none wants a disruption that would have a negative impact on their business.
This procrastination has a cost. This is true for the English who, if they had not stored heavily, would have been in a recession for the last two quarters. This is the case of the European Union too. Any meeting with employees, clients, bankers or industrialists gives pride of place to the concerns about Brexit. Let’s not doubt that this uncertainty affects behavior and also penalizes the growth of the EU. We are thus in a war of attrition, looking for who will exit first. This may be the worst solution because costs will accumulate on both sides of the Channel.
Because, let us be clear, an additional period does not mean an agreement on the British side on the scheduled date. British are in the EU for an extended period.
The change of the US monetary policy trend has been radical since the end of January.
At its January 29/30 meeting, the Fed said it was no longer committing to one or more rate hikes, which was confirmed in March when the “dots” chart was published, and it was going to stop the downsizing of its balance sheet, which it confirmed at its March meeting, indicating a balance sheet target of 17% of GDP in the autumn.
The key elements explaining this radical change lie in the international environment. The Fed sends the signal that because of the uncertain global environment, it wants to remain agile by no longer committing on future movements.It even gives the feeling of wanting to limit its “forward guidance” in order to have more leeway in its monetary policy management.
This role of the international environment may be a source of surprise as the economy is self-centered. Its opening rate is 14% in 2018 against 19% in the Euro zone.
A research by Laurent Ferrara and Charles-Emmanuel Teuf at the Banque de France, quoted by Fed’s Richard Clarida in a recent BdF colloquium, suggests that the international environment is a key factor in the reasoning behind FOMC’s decisions
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The authors create an index containing terms related to the global economy, and integrate it into a Taylor formula. The addition of this indicator in the Taylor Formula , that links interest rate to economic activity and inflation, is significant. Greater attention to these external factors is driving the Fed to more accommodating behavior.
We can therefore better understand the change in tone of the US central bank since the beginning of the year. The international environment has deteriorated rapidly (see graph below) and the Fed is taking into account even if its economy remains robust.
See the initial post of Laurent Ferrara and Charles-Emmanuel Teuf on the Banque de France blog
The graph below traces the pace of their index from 1993 to 2017
The following graph shows a Global Economic Policy Uncertainty Index. It suggests and validates the wait-and-see attitude of the Fed in 2016, but emphasizes the opportunity given to it in 2018 to tighten the tone with lower tensions as measured by the index. The year 2019 actually suggests more wait-and-see.
Italy’s moves to sign a deal with China and get involved in its Belt and Road Initiative (BRI) are highly significant as Italy is the first of the European Union’s founding countries to join this program. By way of reminder, the Belt and Road Initiative aims to develop stronger trade between China and various other regions of the world. Italy is the 12th European Union country to get involved in this program. Meanwhile Greece, Hungary and Poland are not opposed to it, and rail transport between Chengdu and Lodz has increased considerably over the past five years due to trade between the two countries. However, Sweden is fairly opposed to the Chinese program, while France and Germany are reacting cautiously – probably as they see potential business and trade opportunities, but also the restrictions involved in the program as it is primarily dictated by China.
The value of the Italy-China agreement is not yet huge and does not reflect a firm commitment between the two countries, but it has already caused some strife in the Italian government between Di Maio who went all out to promote the agreement, and Salvini who wanted none of it.
China sets great store by this international drive and the country’s role in the global balance, and when Xi Jinping set up the BRI in 2012 just after he took over as President, he put this world view center-stage again. His aim then as now is to root China’s fresh phase of growth within a broader context and link it back to the country’s development more than 2,000 years ago when the growth of the Silk Road network shaped Asia, sprawling out as far as Europe. During his recent visit to Europe, Xi Jinping was keen to remind listeners of the very long-standing relationship between Rome and the Han dynasty, which ruled from 206 BC to 220 AD, and he also referred back to the rich 13th century Venetian merchant Marco Polo’s trip to China. He took great pains to mark the country’s historical ties with Italy, but also China’s long-standing influence and role across the globe.
China’s incursion into Europe via the BRI obviously raises questions on the relationship between the two regions: targeting one of the EU founder countries marks a new milestone, especially as Italy has already been on the receiving end of quite a bit of China’s investment in the region. The UK has traditionally been China’s favorite focus for investment since 2000, with a total of €59.9bn up to 2018 according to Merics, but Italy ranks third with €15.3bn, just behind Germany’s €22.1bn, while France is fourth with €14.3bn.
However, Italy’s political choice raises a number of questions.
Is this decision a way to divide Europe amidst a global backdrop where doubt already prevails over European harmony? Several countries no longer want to comply with EU rules as strictly as they did before: Italy is a case in point, but we could also mention Poland, Romania and a few others. Considering European wariness of China, could this be a way for it to drive a wedge between the countries of Europe? This is a valid question as by promoting an easing of European-led restrictions, perhaps China could gain some more leeway to implement its worldwide growth strategy while also shoring up its international position…
Well may we wonder then whether Italy’s move is also a way for Southern Europe to put pressure on Northern Europe and the European Commission, as the region could use the relationship with China to gain leverage – particularly Italy, as tension with Brussels has soared since the coalition government took over.
China has already invested in the port of Athens (Piraeus), the port of Sines in Portugal, the port of Valencia in Spain, and has taken a foothold in the industrial port of Venice (Mestre-Marghera). The country – alone or sometimes via Hong Kong – now owns or manages 10% of European ports, while there are also bids to manage even more. This is a hefty figure and these moves could fuel imbalances and pressure between European states in a less harmonious Europe.
So all this begs the question whether China’s behavior as it seeks to extend its influence is a reflection that Europe is relegated to second place. The old continent harbors strong purchasing power, but it is divided despite the European institutions and does not seem to have a role to play in the tech battle between China and the US. So is this a way for China to disrupt Europe’s supposed unity with the US and move forward in the technological war, which will ultimately lead to China’s technological domination in Europe as it asserts its worldwide position? We recently saw threats from the White House – particularly to Germany – as it sought to stop the use of Huawei equipment when renewing mobile phone infrastructure.
Lastly, the key point in the Italy-China agreement is the port of Trieste, an industrial free zone that is set to be China’s bridge into Italy. Trieste boasts major advantages that Piraeus does not have, and these explain much of why Chinese investments in the port of Athens ended in failure. Firstly, the port of Trieste is already part of a broader industrial framework: secondly, there is a much more extensive rail network than in Greece, which makes Munich closer via this route than if getting there from Hamburg, in terms of both time and distance. In other words, Trieste is close to southern Germany, northern Italy and south-east France, and the route from Shanghai to Trieste is almost 10 days shorter than the route to ports in the north of Europe. This is very important and could put Trieste in a position to rival with Rotterdam or Hamburg, and this factor could play a crucial role in shaping the new European landscape.
This post is available in pdf format My Weekly Column – 1 April
