Economy

LONDON (Reuters) -A British subsidiary of mining and trading group Glencore (OTC:GLNCY) was ordered to pay a total penalty of 276.4 million pounds ($310.6 million) in a London court on Thursday for seven bribery offences in relation to its oil operations in Africa.Glencore Energy UK Limited was ordered to pay a 182.9 million pound fine by Judge Peter Fraser at Southwark Crown Court, who also approved a 93.5 million pound confiscation order.The judge said that the offences to which Glencore had pleaded guilty represented “corporate corruption on a widespread scale, deploying very substantial sums of money in bribes”. He added: “The corruption is of extended duration, and took place across five separate countries in West Africa, but had its origins in the West Africa oil trading desk of the defendant in London. It was endemic amongst traders on that particular desk.” On Wednesday, Britain’s Serious Fraud Office (SFO) told the court that Glencore Energy UK Limited paid – or failed to prevent the payment of – millions of dollars in bribes to officials in the five African countries.Employees and agents of the firm used private jets to transfer cash to pay the bribes, prosecutors said. The UK subsidiary pleaded guilty in June to the seven bribery offences. Glencore, a Swiss-based multinational, said in May it expected to pay up to $1.5 billion in relation to allegations of bribery and market manipulation in the United States, Brazil and Britain.Clare Montgomery, representing Glencore, said: “The company unreservedly regrets the harm caused by these offences and recognises the harm caused, both at national and public levels in the African states concerned, as well as the damage caused to others.”Judge Fraser said in his sentencing remarks: “Glencore has engaged in corporate reform and today appears to be a very different corporation than it was at the time of these offences.” More

The Bank of England has raised interest rates by 0.75 percentage points to 3 per cent in its most forceful act to tame inflation for 30 years.Forecasting a “very challenging outlook” with a long recession ahead, the central bank, however, issued unusually strong guidance that interest rates would not need to rise much further to bring inflation back to its 2 per cent target. The BoE’s Monetary Policy Committee said market expectations that interest rates would peak at 5.25 per cent were too high. The majority of the committee, it said, believed that “further increases” might be required “for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets”.The BoE’s decision matched the US Federal Reserve’s 0.75 percentage point rise on Wednesday and an identical move by the European Central Bank last week. Raising rates to 3 per cent took the UK official interest rate to its highest level since late 2008. It is the largest increase since 1989, apart from a swiftly reversed rise on September 16 1992, known as Black Wednesday.Seven of the nine MPC members voted for the three-quarter point increase, saying in the minutes that “a larger increase” at the meeting “would help to bring inflation back to the 2 per cent target sustainably in the medium term, and to reduce the risks of a more extended and costly tightening later”. More to follow . . .  More

For the occasional visitor to Washington DC, the turnround in US attitudes towards China is stunning. Earlier this century, US businesses piled into China, following the country’s accession to the World Trade Organization, and ranked among Beijing’s loudest lobbyists in Washington. But China’s astonishing economic rise, its much-trumpeted ambitions to attain global technological supremacy and President Xi Jinping’s lurch towards a more assertive nationalism have wrecked that Washington consensus. Today, the US security state has reasserted primacy over market forces. For the moment, Washington is at pains to resist the idea that it has plunged into a cold war with China. But the talk around town last week was not far short of one. The US administration’s move on October 7 to impose expansive export controls on advanced semiconductors to China certainly turns the dial towards confrontation. It highlights how serious the US has become in further slowing China’s emergence as a technological superpower. But it also raises big and unpredictable questions over the US technology sector itself, which investors are scrambling to process.Washington’s hawks have been energised by their success in stunting China’s ambitions to dominate the world’s 5G telecoms infrastructure by blacklisting its national champion, Huawei. “We are not going to be 5G’d again,” vows one former US government official. The latest clampdown on China shows similar intent in the fields of supercomputing and artificial intelligence. “This is strangling with an intent to kill” China’s AI ambitions, says Greg Allen, a senior fellow at the Center for Strategic and International Studies and a former Pentagon official.China may be particularly vulnerable to a squeeze on leading edge semiconductors but some US strategists think the administration will go even further. “I am expecting further action like the October 7 move in other areas like quantum information services, biotech and even more on AI,” says Martijn Rasser, senior fellow at the Center for a New American Security think-tank.While Washington’s hard-knuckled approach must surely be rattling Beijing, it is also unsettling some of the US’s own companies that have bet big on China. Several US tech firms, including AMD, Nvidia and Intel, will lose valuable, if relatively small, export markets in China. And Washington’s restrictions may have further knock-on effects: foreign manufacturers may strip US components from their products to skirt Washington’s ban and keep selling to China. The recent flood of government subsidies in the semiconductor sector as the US and EU seek to reshore chip production may also exacerbate the cyclical swings in the industry, eroding profitability. And US aggression is bound to accelerate China’s ambitions to develop its own semiconductor industry by all means possible, helping to create a formidable future competitor in basic chips. It may even goad China into retaliation. Beijing has a stranglehold over rare earth supplies, vital for every electrical device. And for the foreseeable future the US will remain critically dependent on Taiwan for its supply of advanced chips, making the island vulnerable to intimidation or blockade from Beijing, even short of invasion.But what remains striking about the relationship between the US and China is the extent of their economic interdependence. In 2021, the US still imported more goods from China than any other country and exported more goods to China than any other country, bar Canada and Mexico. If the nuclear calculus of cold war 1.0 between the US and the Soviet Union was one of mutually assured destruction, the economic backdrop to any cold war 2.0 between the US and China remains one of mutually assured co-operation. The company that most exemplifies the delicate tightrope walk between the two countries is Apple, says Richard Kramer, senior analyst at Arete Research. “Washington is not in a position to tell the most valuable company on the US stock market, with 18 per cent of its sales and a majority of its supply chain dependencies in China, to shut down its China operations,” Kramer says. “Nor is Beijing going to see Apple’s $74bn of China sales just stop, and tell the Chinese people their iPhones will be the last ones they ever buy.”Historically, nationalist impulses have had a nasty habit of scrambling economic rationale. But for the moment, at least, the US and China are condemned by their consumers to collaborate as much as compete. If that were to change dramatically, Apple would be among the first to [email protected] More

BT’s chief executive has called on the new UK government to extend the “super-deduction” tax break in order to boost growth, as Britain’s biggest mobile and broadband operator is forced to raise its cost-cutting target because of soaring inflation.Philip Jansen said the scheme was “a major success, not just for our industry” and it had enabled the creation of 4,000 jobs across BT Group since it was introduced in March.Prime Minister Rishi Sunak, who was chancellor at the time, was the architect of the “super-deduction” allowance, which gave significant tax breaks to businesses that invested in new infrastructure, plant and machinery assets. The allowance is due to expire at the end of March 2023. Former prime minister Liz Truss made no commitment to continue the scheme and was intent on replacing it with so-called low-tax investment zones.“Digital infrastructure is an absolutely certain, unequivocal, no regrets move” for the new Conservative government, Jansen said in an interview with the Financial Times, adding that continuing the tax relief would support “their business case, not ours”.Jansen’s comments came as BT said it would increase its cost-savings target by a fifth and push ahead with inflation-linked price rises in 2023 for the majority of its consumer and wholesale customers, as it seeks to mitigate higher energy and inflation costs than previously forecast.BT revised its cost-savings target from £2.5bn to £3bn by the end of 2025 as the company said its energy bill had increased by £200mn this year compared with last year.“Inflation is pushing us hard,” said Jansen. “Everyone is going to have to share the pain on cost savings. Everyone needs to treat the money as though it’s their own money.”This could lead to job losses, he added, but he did not elaborate on numbers.“Inevitably that means some jobs won’t exist in the future . . . We’re doing this in a sensible, controlled way, using natural attrition as much as possible to reduce overall headcount,” he said.BT is embroiled in a pay dispute with staff, led by the Communication Workers Union, about a pay package offered in April. Over the past few months, about 40,000 employees have downed tools across eight days, calling on Jansen to return to the negotiating table to discuss pay.The group on Thursday posted second-quarter revenues and profits broadly in line with analysts’ estimates, bolstered by its consumer and Openreach divisions, which both implemented inflation-linked price increases in April.BT shares have floundered this year, shedding more than a quarter of their value. They fell nearly 7 per cent on Thursday morning.The former UK monopoly reported flat revenue during the period compared with the previous year at £5.24bn, which was in line with consensus forecasts, and a 5 per cent increase in adjusted earnings before interest, taxes, depreciation and amortisation to £1.97bn, which was slightly above estimates.Earnings in the consumer division increased by a fifth to £670mn, offsetting an 18 per cent drop in adjusted ebitda in the enterprise division.Most telecoms groups have passed on some inflation rises to customers this year. BT opted to increase its mobile and broadband prices in line with the consumer price index, plus a further 3.9 per cent.BT has said it will use the same formula next year, when inflation is set to top 10 per cent, despite pressure from the UK regulator and the Labour party to rethink the model during the cost of living crisis. More

Political independence is supposed to insulate central bankers from the volatility of public opinion. But they themselves can give the impression of changing views with the zeal of born-again believers. From holding on to treating rising inflation as temporary longer than most last year (in my view correctly, as Free Lunch readers know), they are now the greatest champions of severe monetary tightening, come what may. But they may only have swung from one uncomfortable place to another, as warnings mount that they are tightening too much. As an example, read my colleague Colby Smith’s Big Read on the Fed’s dilemma, or the piece by Jeanna Smialek of the New York Times on the brittle popularity of Federal Reserve chair Jay Powell. It has been a big week for central banking. The European Central Bank raised rates by 0.75 percentage points last week, the Fed did the same yesterday and the Bank of England is today announcing its latest rate decision (expected to be a large rise as well) and will publish a new policy report on its analysis. That should be interesting reading, as the previous one said the BoE expected inflation to fall well below its target, and the economy to fall far below its potential, in a few years.If this is, perhaps, the moment of maximum uncertainty, then we should expect the debate on what central banks should do to reach fever pitch soon. In the interest of that debate being as good as possible, I would like to probe some claims a lot of people seem to treat as not just true but obviously true. Below are three contentions often treated as self-evidently true which are nothing of the sort. Our economic situation is a lot more complicated than simplistic claims would have it.Contention 1: Central banks could have prevented this inflationary rise had they acted soonerThose who accuse interest rate-setters of being “behind the curve” must be presupposing that central banks could and should have acted sooner to stop inflation in the first place. Set aside the difficulty of forecasting energy prices, especially when Russian president Vladimir Putin is weaponising them. What if central banks had known with certainty how energy prices would behave?Then they would have known that between May 2020 and June 2022, energy prices would rise by 85 per cent in the US. They would have known that they would rise more than 80 per cent in the eurozone in the two years to last month. With energy purchases making up close to 10 per cent of consumer prices, that alone would mechanically add 4 points to measured annual inflation, before any repercussions on other prices. So what, precisely, do their detractors (or they themselves) think central banks ought to have done? To have prevented the relative rise in consumer prices from lifting the general price level, all other prices would have had to fall by about 8 per cent on average in those two years. That is completely unrealistic, especially since many of those other goods and services use energy as inputs. So non-energy inputs, above all wages, would have had to collapse. But there is nothing central banks could have done to engineer a double-digit per cent fall in everyone’s salaries over a year or two. The big relative price shocks meant temporarily high inflation was unavoidable.So we cannot argue from what central banks should have done to what they should do now. Any sensible argument must take this “sunk cost” of unavoidably realised inflation as a starting point and discuss what can be done from here on. And that depends on a proper understanding of what the current inflationary pressures are. Contention 2: At least some current price pressures come from excessive demand, which central banks must eliminateThe conventional view is that inflation is to some extent driven up by aggregate demand in the economy that is out of hand because of pandemic-era stimulus. At least in the US, many accept that demand is a big part of the story. But the inconvenient fact is that the total volume of goods and services purchased is still shy of the pre-pandemic trend in the US (it was getting close before the Fed started tightening), and falls quite a way short of it in Europe. To think this is more than these economies can produce is to be very pessimistic about the permanent damage wrought by the pandemic, despite the strong and fast recovery from it.True, nominal gross domestic product — that is, the value rather than the volume of all purchases — this year has broken through the pre-pandemic trend in the US, by 4 to 5 per cent. (But not in the eurozone, which some take to vindicate the view that inflation is demand-driven in America but not in Europe.) But to attribute this to excess aggregate demand begs the question. If specific prices go up but total demand stays the same, the nominal value of that stable real demand will go up, as in the example above. (The specific prices in question are, of course, those for energy, and in 2021 prices for durable goods when US consumers massively shifted their spending away from services towards goods.) In other words, nominal spending will go up if some prices rise even if volumes that people want to buy remain unchanged — perhaps because pandemic government support could have made them less credit-constrained without driving them to buy more than before. Whether this kind of phenomenon or “excessive” aggregate demand is the cause, is precisely what is in contention. Contention 3: But supply is down so even ‘normal’ demand is inflationaryA related argument is that negative supply shocks — in particular energy prices, but also pandemic-related shortages and bottlenecks — mean that even quite normal levels of aggregate demand have become inflationary. And everyone agrees we have had negative supply-side shocks. But dwell for a moment on how ambiguous this term is. It normally refers to economic disturbances that reduce the volumes of goods and services an economy can produce, and therefore raises prices. But consider this: the global volume of oil production is as high as before the pandemic. US production of crude oil this year is shaping up to be the strongest on record. What about chips, which everyone was worried about last year? No sign of a supply shortage there either: US imports of semiconductors are nearly 50 per cent higher than they were before the pandemic (in value terms — but neither import prices nor domestic producer prices have risen anywhere near that much). The US’s own chip production is at record highs.In the EU, of course, there is no doubt that the supply of natural gas from Russia has been significantly reduced, as a result of Putin’s weaponisation. But the latest EU gas market report states that total imports of natural gas actually increased slightly in the second quarter compared with a year earlier (its tiny domestic production was little changed). Europe’s rush for gas was successful, as buyers seem to have found substitutes for all the missing Russian supplies. Since these are the goods at the core of the supply shock story, what is going on? Prices have very clearly risen a lot, but quantities have not fallen. It’s a funny kind of negative supply shocks that don’t lead to a negative change in supply. They are, more precisely, relative price shocks that inevitably affect inflation. For net importers of energy, they must also inevitably affect income — more has to be handed over to foreign producers for the same quantity of energy as before, so the country as a whole is poorer (see the recent speech by the BoE’s Ben Broadbent on how this complicates monetary policy). But that is not the same as saying the country must inevitably produce less than before. If it can get the same amount of energy (or semiconductors) as before, even if at a higher price, the supply capacity of the economy in a basic physical sense should remain unchanged, even if more of what is produced has to be handed over in payment. And that raises the question both why demand needs to be brought down to align with supposedly lower supply, and whether it can possibly help inflation to reduce production from what it could otherwise be. It also explains why it is important to ask, as Paul Donovan does in the FT, whether one can encourage lower spending by consumers without reducing employment and wage growth.In his press conference yesterday, Powell said the Fed aimed to “moderate demand so that it comes into better alignment with supply”. If only things were that simple.Other readablesCOP27, the global climate conference, is on next week, and leaders meet against the backdrop of reports pointing out how badly off course we are to reach net zero. The most frustrating thing about it is that if we got serious about our policies, we should expect getting to net zero to be less painful than many think, as I argued in a “Free Lunch on Film” released earlier this year.David Pilling reports on what it takes to wean South Africa off coal.I was in Dublin last week, where my resident colleague Jude Webber and I interviewed the Taoiseach (prime minister), Micheál Martin. He told us the electoral system for Northern Ireland helped to polarise an already fragmented party landscape and was ripe for reform.What is Luiz Inácio Lula da Silva’s economic vision for Brazil?George Soros explains why UK prime minister Rishi Sunak should issue perpetual bonds.Bruegel has the latest stock-taking on how sanctions have affected the Russian economy and budget.Numbers newsThe eurozone posted awful inflation numbers for October. But it is impossible to avoid high inflation when energy prices have gone up by more than 40 per cent in a year. Meanwhile, there are strange things going on behind the overall number: services prices grew by only 0.1 per cent in October, and have hardly moved in three months.Megan Greene points to the US inflation gauge that suggests inflation has already peaked. More

Buongiorno and welcome to Europe Express.Today is Giorgia Meloni’s first trip to Brussels since becoming Italy’s first far -right leader since Benito Mussolini. We’ll examine the stakes of her encounters with top EU officials and why she has made a point recently about tempering her anti-EU rhetoric.We’ll also hear from the Netherlands, where a court ruling has thrown a spanner in the works of carbon capture technology.In Greece, the government has reached out to supermarkets in a bid to keep staple foods at affordable prices, given the spiralling inflation. And in Belgian asylum news, the European Court of Human Rights yesterday said it had issued an order for the Belgian government to provide housing to a plaintiff who has been living on the streets for months. (We wrote here about the plight of thousands of asylum seekers in a similar situation.)Tamed firebrandAs a rabble-rousing opposition leader, Italy’s Giorgia Meloni was known for her punchy invective against the EU, writes Amy Kazmin in Rome. Just three years ago, Meloni was slamming its “anti-democratic drift,” demanding “the restoration of national sovereignty and the reduced role of the EU”, and calling European bureaucrats agents of “nihilistic globalist elites driven by international finance.”But as the new prime minister of a country facing recession and rampant inflation, currently receiving an influx of nearly €200bn in common borrowing, Meloni is out to mend fences with the powers that be in Brussels.While in the EU capital today, Meloni is scheduled to meet Roberta Metsola, president of the European parliament; Ursula von der Leyen, head of the European Commission, and Charles Michel, president of the European Council. They will all use this first encounter to parse out whether the new Italian leader is likely to prove a constructive player or a disrupter set to give them severe headaches in the future. Even before the election, Meloni had been noticeably toning down her aggressive Eurosceptic rhetoric, as she sought to remake her image as willing to work closely and cooperatively with the EU.A staunch supporter of the Ukrainian cause, she expressed interest in stronger European defence co-operation; pledged to implement the massive EU-funded reform and investment programme laid out by her predecessor, Mario Draghi, and insisted she would be prudent in the management of public finances.While many of these same messages were reiterated in a long address to parliament last week, Meloni has also made it clear that her new government will not be submissive and will push for the reforms of EU policies that she believes are in Italy’s best interest. She also won’t be shy of openly expressing her views on EU matters. For example, Meloni pledged in parliament that Italy would respect the deficit and debt limits imposed by the Stability and Growth Pact, while also making clear that she would advocate reforms allowing Italy to spend more on productive investment.“The government will respect the current rules,” she said. “At the same time, we will offer its contribution to those that have not worked.”She has also expressed dismay at the ECB’s moves to raise interest rates as it seeks to curb inflation, a policy that will hit Italy particularly hard, given its high debt burden of around 150 per cent of gross domestic product.Overall, Meloni could well have numerous differences with the EU in the months ahead. Brussels is now waiting anxiously to see whether she’s as combative in the negotiating room as she is on the soapbox.Chart du jour: End of globalisation?In his latest column, Martin Wolf explores the history of globalisation and draws a rather glum conclusion about how it may end this time around, given the nuclear arsenal and the lack of global co-operation in fighting climate change.Legal setbackNo one said that saving the world was going to be easy but EU climate regulations have made it more difficult for at least one project in the Netherlands, writes Alice Hancock in Brussels.A top Dutch court yesterday dealt a blow to Europe’s largest carbon capture installation, developed by the energy majors Shell and ExxonMobil and the gas companies Air Liquide and Air Products in Rotterdam port.In a preliminary ruling, the Dutch Council of State, which rules on draft legislation, said that nitrogen emissions should be counted in construction projects, in line with EU law. This means that even if the project being built is ultimately an installation designed to reduce the country’s greenhouse gas emissions, no exemptions from the nitrogen emission rules should be granted. Environmental campaigners have been lobbying against the construction of the carbon capture facility, called Porthos, precisely because of the nitrogen emissions that would go up, rather than meet EU reduction goals.Porthos said the ruling would “lead to some delay” of at least “several months”. Once up and running, its carbon capture storage should take in 2.5 megatonnes of CO₂ per year, Porthos added, which would contribute to the country’s emissions reduction targets.In a broadcast interview after the decision, Christianne van der Wal, the Dutch minister for nature and nitrogen policy, said the council’s advice was “clear and simple: You really have to emit less nitrogen and really restore nature. Only then do you have the space to fully grant permits.”The NGO that has championed the issue, Mobilisation for the Environment, now has six weeks to examine Porthos’s study of potential nitrogen emissions during the construction before reporting back to the Council, which will issue a final ruling. The Council of State did not rule out that the project may go ahead in the end, after all: “Porthos is delayed, but not off the track,” it said. Greek discountsIn its attempts to fight soaring inflation, the Greek government has asked big supermarket chains to offer dozens of essential goods at discount prices, writes Eleni Varvitsioti in Athens.From now on and as long as it’s needed, Greek consumers can go on a mini treasure hunt in the aisles of their supermarket and look for a specific label that confirms that the product in question is sold at a reduced price. (No subsidies are involved.)Each supermarket chain is free to choose which products will be in this low-cost category, but they have to include all staples such as bread, rice, pasta, feta cheese, and olive oil, among others. Greece’s inflation for October was below the eurozone average but still very high at 9.5 per cent.“I’m happy that thousands of citizens who chose today to use our ‘household basket measure’ have a significant benefit in their weekly consumption, and this was our goal”, development minister Adonis Georgiadis told Antenna news.The ministry has also created a dedicated website where consumers can browse through the discounts at each supermarket — which are allowed to change their list every week. Proving the public’s interest (or maybe just the teething problems of this initiative), the website crashed yesterday under the heavy traffic.What to watch today Italy prime minister Giorgia Meloni meets top EU officials in BrusselsGerman chancellor Olaf Scholz hosts summit with Western Balkan leaders in BerlinGerman foreign minister Annalena Baerbock hosts her G7 counterparts in MünsterNotable, Quotable

Grain deal: Russia yesterday agreed to resume grain shipments from Ukraine via the Black Sea, ending a four-day standoff that threatened to reignite a global food crisis. Show me the money: Azerbaijan has warned the EU that it will only be able to meet its commitment to double gas exports to the bloc if provided with fresh investment in its pipelines and long-term purchase contracts. More

Good morning. The big hedge fund Elliott Management thinks we are on the road to hyperinflation, much deeper market declines, and possibly global strife. The Federal Reserve seems a bit less worried. Let us know which you think is right: [email protected] and [email protected] FedThe stock and bond markets, which do not always behave particularly coherently in response to Fed press conferences, were cogent in response to yesterday’s. Here is a chart of the S&P 500 against the two-year Treasury yield:

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At 2pm, the press release landed. As everyone expected, the rate increase was three-quarters of a percentage point, the same as last time. The wording, too, was almost identical to the release from six weeks before, except for this key sentence:In determining the pace of future increases in the target range, the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.This is more or less a jumble of things Fed officials have said before, but the fact that it was inserted into the statement at this particular moment gives it meaning. The crucial words: “lags” and “cumulative”. Both suggest that what the Fed has done already is strong medicine for the treatment of inflation, implying that future doses might not need to be as large. As you can see above, markets signalled their immediate, if measured, approval. Stocks rose and yields fell.Then came chair Jay Powell’s press conference. Powell did give the market what it has hoped for and speculated about for weeks — a signal that the pace of rate increases would soon slow:I have said at the last two press conferences that at some point it will become appropriate to slow the pace of increases. So that time is coming, and it may come as soon as the next meeting or the one after that. No decision has been made. It is likely that we will have a discussion about this at the next meeting.Now, if the context were benign, those words might have been equivalent to Powell, with a flourish, releasing a flock of white doves from behind the podium. But the context was not benign. The words were prefaced by the Fed chair saying that, as the tightening cycle ages, the pace of increases is less important than the ultimate level of rates, and how long that level is maintained. He said his estimate of the peak rate had risen since the last meeting; noted that the Fed was much more worried about under- than over-tightening, because the latter mistake is easier to repair; and said it was premature to even discuss a pause in rate increases. See the chart above past 2:20pm for the market response to that. It may appear odd for Powell to say that while he is increasing his estimate of where rates need to go, he wants to get there more slowly. But there is a logic here. As rates move higher, the possibility of a financial accident increases. A crisis in the financial system (Treasury market breakdown? Big fund blow-up?) could force the Fed to loosen policy even while inflation is still running hot. A more measured pace of increases, even on the way to a higher peak rate, gives everyone some time to adjust, decreasing the chance that something breaks. The day’s drama was relatively small in scale, though. Both stocks’ and Treasury yields’ end-of-day levels are within recent ranges. A treat was briefly dangled before the markets, then snatched away. Taking a step back, how much has really changed? We wrote Tuesday that there is a real risk markets are underestimating how long peak rates will be sustained. Markets expect the fed funds rate to touch 5 per cent in the first half of 2023 and then begin falling immediately. We think that is too optimistic, and yesterday’s emphasis on “cumulative” effects and the asymmetric risk of not doing enough made us feel more confident in this view. Whatever the terminal rate ends up being, Powell will hold there until he is sure inflation will stay down. The rates peak may end up looking more like a rates mesa.On the other hand, a more gradual ascent for rates might also mean lower market volatility. Inflation that is still high, but grinding lower, and rates that are still rising, but more slowly, could calm the market palpitations that now follow rates-relevant data releases, notes BlackRock’s Rick Rieder. And as Sonia Meskin of BNY Mellon told Unhedged, tightening delivered in smaller doses should be easier for markets to swallow:Markets tend to respond more to changes in near-term event probabilities (size of next rate hike) than probabilities of events farther out (ultimate level of terminal rate).Lower rate-driven volatility, all else equal, would be good for risk assets. But restrictive monetary policy — however gradually delivered — slows the economy, squeezes margins, and increases bankruptcies and defaults. Avoiding a financial accident is not the same as avoiding recession. (Armstrong & Wu)One good readHow much would you pay for Joan Didion’s sunglasses, which her estate is now auctioning off? The $400 to $800 suggested bid strikes us as low. More

The writer is director of Belgrave Capital Management and Banca del CeresioThe dollar has strengthened by about 20 per cent in the past year and pundits generally attribute this performance to rising interest rates and to “haven” buying at times of turbulence. While the first reason seems more accurate, the main channel through which rising US rates impact the dollar is little understood despite the vast implications it has for the current set up of the international monetary system. The rise in value of the dollar in a crisis is often interpreted as a flight to a perceived haven but in reality much of it is due to the need of non-US investors to buy dollars to cover losses on dollar assets or reduce the hedges on them. After decades of chronic current account deficits, the US has attracted vast amounts of foreign capital to finance them and has accumulated a deficit of external financial assets compared with liabilities of more than $18.5tn. Foreigners currently own more than $14tn in dollar-denominated bonds. About half is held as official reserves, with the rest mostly in the hands of investors in countries with chronic current account surpluses. Foreign institutional investors most likely hedge the currency risk on their dollar-denominated bonds. For any investor with a risk budget or under risk-based regulation, owning a foreign bond without hedges is unappealing, given the volatility of currencies.Also, supported by academic studies, investors have developed more conviction on the direction of interest rates and equity markets than on currencies. So they often prefer to bet on the former but hedge the latter. They usually hedge their exposures by selling the greenback and agreeing to buy their home currency at a future date.Over the past year, investors have suffered substantial losses as the price of bonds fell worldwide as interest rates have risen. And since the value of their dollar bond portfolios fell, foreign investors had to adjust their hedges down, buying back dollars and selling their home currencies. This is an activity usually carried out by back offices which at least on a quarterly basis adjust the size of their currency hedges to the value of the portfolio. Accurate data on how much of the foreign holdings of dollar bonds is actually hedged is not available. But about the half of the $14tn in dollar-denominated bonds held as official reserves is not hedged. We could assume though about half of the $7tn remainder, or £3.5tn, is hedged. Losses on US bond portfolios have been around 20 per cent this year, so the proportion of hedges being unwound would have been around that level.That means foreign investors would have bought back around $700bn, an amount likely to be way larger than the speculative flows chasing the dollar up for whatever other reason.The adjustment of hedges is hence a determining factor explaining the dollar strength over past year. We have seen similar patterns in recent crises. The alternative explanation of haven dollar-buying was never convincing in cases like the financial crisis, when the US was suffering from failing banks in the middle of a real estate crisis.If my hypothesis is correct, there are profound implications for our floating exchange rates system. One of the key ways that international imbalances were expected to remain contained was that a chronic current account deficit country such as the US would at some point suffer a currency depreciation because foreign investors would become saturated with the risk of dollar-denominated assets. This depreciation would then help the US rebalance its current account. But a Dutch pension fund, say, owning Treasuries on a hedged basis is unlikely to be saturated by US risk. That is because on one hand the Treasury will not default on its obligations as it may print dollars to repay them. And, on the other, the risk that excess dollar printing will lead to a devaluation is taken care of by currency hedging. This way surplus countries are ready to accumulate more liabilities of deficit nations.As this happens, the financing of imbalances adds to cross-border financial flows that keep growing. The US debt to foreigners increases, as do their claims on the US. The financial system is required to intermediate these ever-growing balances, straining bank balance sheets. More fundamentally, chronic imbalances increase measures of potential financial instability such as debt to gross domestic product ratios. We need to address these new and little-recognised dynamics before the international financial system accumulates more risk than it may bear. More