Steven Guinness

With less than six weeks before the UK is due to leave the European Union, the geopolitical environment is growing increasingly unstable. Whilst this is not necessarily an indication that Brexit will happen on October 31st, there have recently been some interesting developments globally that merit closer examination. Let’s start with Brexit itself.

Brexit

As it stands, a Halloween exit from the EU remains the default position. Prime Minister Boris Johnson has pledged that if he cannot agree a withdrawal deal with the EU at an upcoming summit on October 17th and 18th, he will not ask for a further extension to Article 50. This is in spite of a bill that passed through parliament in September that legally compels Johnson to go to the summit and request a minimum three month extension if a deal is not forthcoming.

If there is no agreement on a Brexit deal, and assuming Johnson keeps his word and leaves the summit without an extension, I would take this as an indication that the 31st exit date will hold. Parliament would not go quietly, however. One possibility is that right before the departure date MP’s try to force a vote on revoking Article 50 to stop a no deal exit.

This is potentially shaping up towards an eventual no deal mired in legal wrangling. But in the end the manner of such a departure will not matter. As the Article 50 text states, once the treaties binding the UK’s membership to the EU cease to apply, the UK is out. Any rulings made thereafter would not alter this fact.

Many consider Article 50 to be a mechanism designed to thwart Brexit from ever happening. But you could also reason that Article 50 works well from a globalist perspective. If elites want no deal to occur, then Article 50 is the ideal construct as through it they can control the timing of the point of exit and pull the UK out at their convenience.

Watching how Brexit is unfolding, it feels to me like the process is now reaching a crescendo. Perhaps this is why several key positions within the EU are about to change. EU Commission President Jean Claude Juncker is stepping down, as is European Central Bank President Mario Draghi. The date of their departure? October 31st. Christine Lagarde – a leading proponent of digital currencies – will take the reigns at the ECB from November 1st, the day when a new round of quantitative easing will begin to the tune of €20 billion a month. Is this all a mere coincidence?

Meanwhile, the Bank of England still has no forecast for a no deal / no transition exit from the EU, even as the possibility of such a scenario remains open this late in the process. They gave two reasons for this, the first being that no deal is not the policy of the government, and second that it is not the most likely outcome. At a Treasury Select Committee this month, BOE governor Mark Carney said the central bank will instead ‘take stock in November of where the UK stands as a country and adjust accordingly‘.

The BOE’s next policy meeting coincides with their latest inflation report on November 7th. As I have detailed over the months, the economic ramifications of a no deal event would over the ensuing months almost certainly prove inflationary.

On the other hand, there is the possibility that Article 50 is extended again for at least another three months to January 31st. Incidentally, this is the date that Mark Carney is due to depart the Bank of England. In this three month window a snap general election would likely be called, out of which I would expect the Brexit Party to gain enough support to be the deciding factor in the make up of the next government. A Boris Johnson / Nigel Farage coalition would fully encapsulate the narrative of a resurgence in political nationalism, and set the UK on a course for a ‘hard‘ Brexit come January.

An October 31st exit is not certain, but it feels more likely this time around than the original leave date of March 29th. Especially with Boris Johnson in Downing Street.

Federal Reserve

Last week the Fed began a series of sudden overnight repurchase operations in response to a sharp drop in liquidity in financial markets. The liquidity the Fed made available was initially not enough to satisfy demand, resulting in the Fed’s target range of 1.75 – 2% interest rates being breached. So far the Fed have injected hundreds of billions of dollars into the system. They plan to continue these operations until October 10th, and have left open the option of extending past this date.

Dubbed the ‘Fed Repo‘, these actions are not as many analysts claim quantitative easing ‘in all but name‘. They are short term loans, whereas QE is a permanent form of liquidity injection in which the beneficiaries are not obliged to repay. In short, the Fed have been lending ‘primary dealers‘ money, but the dealers in question have put up some form of collateral in order to acquire the funds, such as Treasury securities.

Therefore, the Fed’s balance sheet, which over the past two years they have trimmed by over $600 billion, is not going to grow through these specific actions.

There are questions now about whether bank reserves in the U.S. are sufficient to maintain market stability. In other words, are there enough dollars in the system to keep it from malfunctioning? When announcing a cut in interest rates last week, Jerome Powell mentioned in regards to reserves that ‘we’re going to learn a lot more in the next six weeks‘.

The Fed’s next decision on monetary policy takes place on October 30th – 24 hours before the UK is supposed to leave the EU. If a no deal happens, then it is not difficult to imagine this having an impact on market liquidity, especially if traders were to re-position funds into alternative currencies or be forced to liquidate holdings for cash.

Many expect the next FOMC meeting to be where Powell announces ‘QE4‘. But even if he does (which I am sceptical about), the announcement would come too late to prevent the immediate fallout of an October 31st exit. It would be an example of the Fed acting after the event and not before, which fits with how they reacted to the 2008 financial crisis.

What should not be forgotten here is that a growing liquidity crisis in the U.S. comes in the wake of the Fed having actively engaged in reducing the size of its balance sheet for almost two years. Only since then has market volatility become widespread. Their actions in the Repo markets are not a cure all, nor are they QE. I would suggest that they are a temporary measure to control the speed of an impending financial downturn, perhaps with Brexit serving as a near term trigger event.

U.S / China Trade War

Two days removed from September’s FOMC meeting, news broke that a Chinese trade delegation team in the U.S. had unexpectedly cancelled their planned visit to U.S. farms in Montana and Nebraska. No official reason was given for the cancellation, but what it illustrated was how closely developments in the trade war continue to be in correlation with the policy announcements of the Fed.

Here are some examples:

  1. A day after the Fed raised interest rates on March 21st 2018, Donald Trump asked the U.S. Trade Representative Robert Lighthizer to look into applying tariffs on $50 – 60 billion of Chinese goods.
  2. Two days following another hike from the Fed on June 13th 2018, 25% tariffs on $50 billion of Chinese products were announced.
  3. On September 17th 2018 the U.S. announced 10% tariffs on $200 billion of Chinese imports to begin on the 24th. The Fed raised interest rates on the 26th.
  4. When the Fed cut interest rates on July 31st this year, a day later the Trump administration imposed new 10% tariffs on $300 billion of Chinese goods. These came into effect on September 1st.

As much as Donald Trump criticises the Fed, he has a curious habit of announcing escalations in the U.S. / China trade war that serve as well timed distractions from the central bank’s actions and communications.

The trend since 2018 has been for every round of talks to peter out into no agreement. The stop start nature of negotiations has allowed for the gradual imposition of tariffs that over time have weighed on financial markets and kept geopolitical tensions between the two nations elevated.

Most recently White House advisor Michael Pillsbury signalled that if China does not reach a deal with the U.S. soon, Donald Trump would likely escalate the trade war further by ratcheting up tariffs. Pillsbury described the current tariffs as ‘low level‘ which could subsequently be raised to ‘50 per cent or 100 per cent‘.

What are the chances of an upcoming round of talks in early October yielding little progress, leading to Trump doubling down on tariffs in and around the Fed’s next meeting? Based on past evidence it is a distinct possibility.

Iran

Just over a week ago two oil processing sites in Saudi Arabia were attacked by what the U.S. and the Saudi’s claim were a mixture of missile and drone strikes. Both nations were quick to pin the blame on Iran, despite the apparent lack of hard evidence.

Since then the U.S. have responded by announcing that an unknown amount of troops and additional missile and air defence systems will be deployed to Saudi Arabia, and that new economic sanctions have been levied against Iran’s National Bank. According to Treasury Secretary Steve Mnuchin, the U.S. has now ‘cut off all source of funds to Iran‘.

So far Donald Trump has not been inclined to respond to the attacks militarily. Iran have warned Trump that any retaliatory strikes would lead to ‘all out war‘, whilst Saudi Arabia have said they will respond with ‘necessary measures‘.

A few weeks before the oil refinery attacks, the British flagged tanker ‘Stena Impero‘ was seized in the Strait of Hormuz following the capture of an Iranian tanker off Gibraltar.  This stretch of sea connects the gulf with the Arabian sea, and is where a fifth of the world’s oil passed through in 2018 (estimated at 21 million barrels a day). For this reason it is one of the most important shipping routes. Earlier this year Iran threatened to close the Strait of Hormuz if they were ever prevented from using it.

Tension with Iran has been gradually percolating since Trump entered the White House, and was solidified back in May 2018 when he abandoned the Iran nuclear deal that was signed between the U.S. and Iran in 2015.

If the attacks in Saudi Arabia lead to further outbreaks, the shutting down of one of the world’s most prolific waterways for oil is a strong possibility. This would have an immediate impact on the price of oil globally, and if prolonged on global inflation.

With the U.S. economy consumed by tens of trillions in debt and fundamental economic data showing increasing signs of a downturn, a conflict with Iran in the short to medium term could be a catalyst for the U.S. falling into recession.

Since central banks began to tighten monetary policy – in particular the Federal Reserve with its balance sheet reduction scheme – we have witnessed a perpetual rise in political conflict. The false recovery narrative that grew out of the 2008 crisis, coupled with the re-affirming of inflation targets that were abandoned pre Brexit and Trump, presented central banks with a window to tighten financial conditions. If the past is any guide, then they will once again allow multiple crisis scenarios to reach a tipping point before contemplating some form of renewed stimulus.

Inducing crises is how globalists have historically gained greater power over the financial system. The question is how they will respond to what I believe will prove to be an inflationary recession / depression. The mandate for 2% inflation remains prominent in their communications. If that persists then do not count on central banks to support markets indefinitely.