Iran and Israel Tensions Rising in A Dangerous 'Game of Bluff'

Political

Palestinian-Israeli conflict

Summary:

Regional tensions likely to be influenced by evolution of Gaza war and occupied West Bank attacks…

Iran and Israel are engaging in a dangerous "game of bluff" as the world braces for Israel's promised response to an Iranian missile and drone attack over the weekend which itself came after an Israeli strike against its Damascus embassy, analysts have told The National.

"We are in game of bluff in which it is in the interest of the two main players, Israel and Iran, to do the opposite of what they say and to say the opposite of what they do," said Bertrand Badie, a leading French analyst on the Middle East.

Both sides have recently attained previously unreached thresholds in their decade-long proxy war.

Israel's April 1 bombing of Iran's embassy in Syria, which killed seven people, was unprecedented because it occurred on embassy soil, viewed in diplomatic terms as the equivalent of sovereign territory.

Iran's retaliation on Saturday night is widely viewed as a face-saving exercise which was both escalatory and gave Tehran the opportunity to say it would not go further.

It was the first-ever attack on Israeli soil but Tehran also gave ample time to Israel and its allies to shoot down the hundreds of drones. The little that fell in Israel caused little physical damage and injured one child.

Israel's military has warned that it "will be met with a response" while its top diplomat Israel Katz has seized on signals of Western support to push ahead with a diplomatic offensive against Iran, calling for further sanctions.

"Iran seeks to demonstrate strength in a spectacular fashion while making sure they cause little damage likely to trigger a strong Israeli response," said Mr Badie, professor emeritus at Sciences Po University in Paris.

"Israel consistently decries Iran's attacks as life-threatening while also projecting invincibility. Meanwhile, the US says that Iran is serious but it would be even worse if the escalation continues."

It's a dangerous game of contradictions that creates uncertainty and allows both parties to interpret the situation in a reassuring manner, said Prof Badie.

"The situation in the West Bank and Gaza will largely dictate how the situation evolves," he said. Sources have also told The National that Iran is gearing up to counter an Israeli retaliation, possibly within its border.

More than to 34,800 people have died in the enclave in Israel's war of retaliation since the Hamas-led October 7 attacks that killed about 1,200 people.

Israel withdrew earlier this month from south Gaza for tactical reasons but has said that it is preparing a ground offensive on the southern city of Rafah, where 1.3 million people have found refuge from the fighting.

In parallel, the situation has steadily worsened in the occupied West Bank, where Israeli settlers protected by the army killed a teenager and injured dozens of Palestinians in a rampage on Sunday after the disappearance of an Israeli boy and the discovery of his body the following day. Israel has also increased targeted killings of Hezbollah and Hamas operatives in neighbouring Lebanon.

Israeli decision-makers may have decided that the response to the October 7 attacks represented a good pretext to dismantle Iran and its regional allies including Hezbollah and Hamas, but that is likely to cause never-ending escalation, warned Prof Badie.

"It is in Israel's interest to play the Iran card, for which there is minimal consensus, as long as it doesn't go too far in its strikes. On Gaza, Israel is officially alone, and we have seen rhetoric condemnation of the war from its US ally," he said.

Prof Badie said "careful interpretation" was needed of continuing geopolitical tensions between Iran and Israel.

US, UK, French and Jordanian assistance, in addition to reports of support from other Arab countries, in destroying Iranian drones on Saturday does not imply, as media reports have claimed, a strategic realignment in the region or a new air-defence alliance, he added.

"It is a defensive reaction," said Prof Badie. "The so-called Global South follows fluid diplomatic options that adapt to circumstances."

Source: The National News

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Thomas

Economic

Political

When the Bank of England governor, Andrew Bailey, told an event in Washington on Tuesday that the UK economy was "disinflating", it raised the hopes of mortgage payers and indebted businesses that a cut in the cost of borrowing could be on the way soon.

But less than 24 hours later, the latest UK inflation data and worsening interest rate forecasts have curtailed those aspirations.

The figures from the Office for National Statistics released on Wednesday showed a fall in the consumer prices index to 3.2% in March, worse than the expected 3.1%.

Meanwhile, City investors, who previously had run ahead of Bailey's signalling to bet on four or even five interest rate cuts this year, now consider the governor's talk of the disinflation process "working its way through" to be overoptimistic.

Last week, investors were putting their money on the Bank's first interest rate cut taking effect in August, with many also predicting an earlier date. Now the expectation is increasingly skewed towards a first cut in September or even November.

A half-point cut by the end of the year is priced into financial markets, when only a few months ago the expectation was that there would be a 1.25 percentage point cut. Sunak Hopes of Pre-Election Interest Rate Cuts Frustrated by Inflation Slow Puncture_1

Sunak Hopes of Pre-Election Interest Rate Cuts Frustrated by Inflation Slow Puncture_1

Currency dealers agree that a later date is more likely. Across the Atlantic there has been speculation that the Federal Reserve will delay its first cuts in the cost of borrowing after a rebound in US inflation to 3.5% last week.

This would make the UK the first of the two central banks to cut, an expectation that pushed down the pound from $1.27 to 1.24 against the dollar. In the wake of Wednesday's UK inflation figures the pound has begun to recover.

The prospect of a first cut as late as November plays badly for Rishi Sunak, who is widely expected to delay a general election to the autumn in order to benefit from an improving economy. An essential element of any improvement would be the prospect of reduced interest rates.

The Conservatives calculate that lower borrowing costs will bring back into the Tory fold many of the mortgage-paying millennials who have deserted them in recent years. To maintain any chance of this happening before the election, Sunak could pick a December or even January date. Yet even such a delay may not be enough.

Bailey hedged his bets in his speech to the International Monetary Fund event in Washington by saying the global situation remained volatile and the prospect of renewed disruption to shipping could increase prices again.

The governor has come under fire more than once for describing the last two years of inflation as transitory, given the UK is considered to be the most open economy in the developed world and therefore the most likely to catch an economic cold when the world sneezes.

The coronavirus pandemic and the Russian invasion of Ukraine spelled disaster for a country dependent on imported energy and food.

In essence, Bailey was, and remains, correct. Fuel and energy prices were bound to settle, and when they did, the inflation cycle would be over.

He might say he was only wrong about the length of the transition, blaming it on the war in Ukraine, which he failed to foresee, like many others.

However, March's inflation figures show that core inflation, which strips out energy, food, alcohol and tobacco, declined only to 4.2% in March from 4.5% the previous month. Analysts had expected a decline to 4.1%.

Services inflation, which is closely monitored by the Bank as an indicator of domestic price pressure, fell even less and remains high at 6%, down on 6.1% in February.

It is these figures that are influencing the financial markets. They fear the UK has failed to tackle the essential building blocks of inflation. If that is true, interest rates will remain high well into 2025.

Source: The Guardian

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Devin

Economic

Central Bank

A drop in the European Union's carbon price this year could mean that a fund intended to be among the world's biggest schemes for new green technologies will be smaller than budgeted for and potentially jeopardise some low-carbon projects in the EU.

After soaring above 100 euros per ton of CO2 last year, the cost of EU carbon permits had nearly halved by February, as emissions covered by the market plunged as a result of lower power demand and higher renewable power generation.

The fall has wiped out 4.1 billion euros ($4.36 billion) in potential revenues for Europe's budget for low-carbon investments so far this year, analysis of market data shared with Reuters by consultancy Veyt showed. Carbon Price Fall Deprives Europe's Green Funds of Billions_1

Carbon Price Fall Deprives Europe's Green Funds of Billions_1

While the dip in emissions shows the carbon market is helping the bloc meet its climate goals, it also means the scheme is raising less than expected for EU green transition funds and to pay for the climate efforts of member states.

The EU Innovation Fund is the bloc's main fund for nascent technologies like hydrogen and carbon capture, which the 27-nation bloc is banking on to meet climate change goals.

By the EU's own estimates, the fund should raise 40 billion euros this decade, if CO2 prices averaged 75eur/t in that period. The benchmark EU carbon price has remained below this level for more than three months. It was trading at around 70eur/t on Wednesday.

As a result, EU carbon revenues so far in 2024 are 30% less than if carbon auctions had achieved the average 2023 price, which was 83.6 eur/t, the data from Veyt shows. Carbon Price Fall Deprives Europe's Green Funds of Billions_2

Carbon Price Fall Deprives Europe's Green Funds of Billions_2

"If there is less money it will affect the number of projects the funds can support," LSEG carbon analyst Yan Qin said.

The carbon market also feeds a Modernisation Fund to help the poorest EU countries shift away from fossil fuels.

Less cash for the energy transition would be a blow to European industries that are struggling to go green while staying competitive internationally. Some are already shifting investments to the U.S., to benefit from clean tech subsidies.

Holcim said the Innovation Fund had been a trigger for low-carbon investments in Europe. The world's largest cement maker has already won fund backing for carbon capture projects in Belgium, Croatia, France, Germany and Poland.

"We've never invested so much in Europe in decades, and that's partly thanks to the Innovation Fund," Holcim Vice President of Public Affairs Cedric de Meeus said, adding it may bid for the fund again in future.

Rebound?

Analysts say the EU carbon price dip is likely temporary and prices are set to rise this decade since the market is designed to gradually cut the supply of permits each year, while a special "reserve" will also soak up some excess supply.

Still, some have lowered their forecasts. A Reuters survey of analysts in 2022 gave an average price forecast for the benchmark contract of 94 eur/t in 2024. That had dropped to 74 eur/t in a poll in January.

"The market has turned more bearish than anyone expected," said LSEG's Yan Qin.

Veyt carbon analyst Ingvild Sorhus said prices are being dampened by short-term factors including a recent EU move to sell millions of extra carbon permits to raise money to help countries quit Russian gas.

A European Commission spokesperson said it has not changed the 75 eur/t carbon price it uses to estimated the size of the Innovation Fund. It does not comment on the carbon market price.

Uncertainty

The Innovation Fund supports low-carbon technologies which developers said lack funding as they are deemed too risky for investors, and national government budgets are stretched.

"Without that (the EU fund), the projects are not really bankable," said David Strittmatter, CEO of German start-up ICODOS, which launched a pilot plant last year for low-carbon methanol fuel.

"It's really one of the very few instruments that can help us to get to that scale," he said, adding that a squeeze on Germany's national budget has prompted other local climate projects to target the EU fund instead.

The Innovation Fund is heavily oversubscribed. Its latest funding call for large-scale projects last year awarded 3.6 billion euros to 41 projects, after 239 applied. A call for smaller projects also received bids for nearly three times its 100 million euro budget.

German start-up Heatrix is considering bidding for support for its first commercial plant, to convert renewable electricity into high-temperature industrial heat.

Co-founder Wei Wu said the dip in carbon prices should not prompt companies to abandon decarbonisation plans, but could delay investments in emissions-saving projects that a higher EU carbon price would help make economical.

"I hope it's just a temporary state ... And it's going to rise again," she said.

($1 = 0.9397 euros)

Source: Reuters

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ING

Energy

Palestinian-Israeli conflict

The risk of disruption to Middle Eastern supply grows

While price action in the oil market has been somewhat surprising following Iran's attack on Israel, the risk of tensions in the Middle East impacting oil supply is certainly growing.

The lack of price strength following Iran's recent attack is largely due to a large risk premium already having been priced into the market. ICE Brent rallied from a little more than US$86/bbl at the start of April to over US$90/bbl in anticipation that Iran would respond to Israel's suspected airstrike on its embassy in Syria. Secondly, the market is also in limbo, waiting to see how Israel responds to the recent attack. The longer the market waits for Israel's response the more likely the risk premium starts to fade.

Risks to oil supply because of the ongoing tension in the Middle East are at their highest since October last year. Any further escalation would only bring the oil market closer to actual supply losses We believe there are three key supply risks facing the oil market as a result of current tensions. These include stricter enforcement of oil sanctions against Iran, Israel retaliating by targeting Iranian energy infrastructure and the worst-case scenario - that significant escalation eventually sees Iran attempting to block or disrupt oil flows through the Strait of Hormuz.

Stricter sanctions enforcement

Israel's allies are pushing for a diplomatic response to Iran's attack, although it would appear that Israel is looking at a potentially more aggressive approach.

The US and Europe are looking at potentially imposing stricter sanctions against Iran following the attack. The US already has oil sanctions in place against Iran.

The issue is that the US has not strongly enforced these sanctions since Russia's invasion of Ukraine, given concerns over oil supply and higher prices. As a result, Iranian oil supply has grown from an average of a little over 2.5m b/d in 2022 to close to 3.2m b/d in March 2024. If the US was to properly enforce sanctions, it would leave around 700k b/d of supply at risk.

There is potential for further supply losses due to sanctions. Legislators in the US are considering a bill called the Iran-China Energy Sanctions Act, which would attempt to crack down on Iranian oil flows to China. There is also scope for the EU and other allies to agree on multilateral sanctions, which would only make it more difficult to move Iranian oil.

While new sanctions might be introduced, the key question is whether these sanctions will be more strictly enforced. There will be concerns over the potential impact supply losses could have on oil prices, and the Biden administration would not want to see higher oil prices and pump prices in the lead-up to US elections later in the year.

If we were to see stricter enforcement of sanctions, this is not something that will become immediately apparent to the oil market. It will take time for it to become noticeable in tanker tracking data.

Losing in the region of 700k b/d of Iranian oil supply would be enough to push the oil market into small deficit over the second half of the year, which would imply ICE Brent averaging US$92/bbl in 4Q24 versus our current forecast of US$85/bbl for the final quarter of the year. This is under the assumption that OPEC+ decides against rolling over supply cuts into the second half of the year.

Iranian supply disruptions

With it still unknown how Israel will respond to Iran's attack, we cannot fully rule out the potential for Israel to target Iranian energy infrastructure. Iran is an important oil producer, with it being the fourth largest OPEC member, pumping close to 3.2m b/d. Any targeting of Iranian energy would likely provide a boost to oil prices.

We believe the likelihood of Israel targeting energy infrastructure is rather small. This would not go down well with allies, given the impact it would have on oil prices.

If we assume that the bulk of Iranian oil exports are halted, we could see Brent average a little under US$100/bbl in 4Q24.

Iranian escalation and the Strait of Hormuz

The worst-case scenario for the oil market would be if we saw escalation to an extent where Iran attempts to impose a blockade through the Strait of Hormuz. The Strait of Hormuz is the most important chokepoint globally for oil trade. A little over 20m b/d of oil flows through the Strait, with exports from key producers Saudi Arabia, Iraq, Iran, the UAE, Kuwait and Qatar.

We believe the likelihood of a blockade is low, given firstly, it would be difficult to impose, secondly, it would not be in Iran's own interest, and finally, it would likely see a strong global response. However, it is still worth exploring the impact.

The potential impact would dwarf the disruptions we have seen in the Red Sea in recent months, given the volume of oil that flows through the Strait and also due to the fact that there is no alternative route for the bulk of these oil exports. As we mentioned in a note earlier in the year, Saudi Arabia does have 5m b/d of pipeline capacity, which would allow crude to be carried to the Red Sea and exported from there, while the UAE has a pipeline with capacity of 1.5m/b/d which would allow for the export of oil from the Gulf of Oman, so avoiding the Strait. This still leaves approximately 14m b/d of oil supply at risk in the event of a blockade.

This would lead to a significant price shock where we could see Brent break above US$200/bbl by the end of the year, given the significant drawdown we would see in global stocks. Prices would need to remain elevated to ensure significant and rapid demand destruction, and any supply response from other producers would take time.

How could supply losses be dealt with?

The ability of the market to respond to any potential supply disruption would depend on the severity of any supply cuts. Given that OPEC is sitting on more than 5m b/d of spare production capacity this means that the market should be well placed to respond to most supply hits. This will largely depend on the willingness of OPEC to increase supply. The group will likely become increasingly concerned about potential demand destruction if prices move too high, sustainably above $100/bbl.

OPEC spare capacity would be able to help the global market in the case of stricter sanctions against Iran or any significant supply disruption from Iran. Where this spare production capacity does not help, is if there was a blockade of the Strait of Hormuz - the bulk of spare capacity sits within the Persian Gulf. Saudi Arabia, the UAE, Iraq and Kuwait hold 95% of total OPEC spare capacity.

Any significant supply shocks would also likely lead to a coordinated global release of stocks from emergency reserves. While the US has drawn down significantly on its strategic petroleum reserve (SPR) since Russia's invasion of Ukraine, the SPR still stands at more than 360m barrels, leaving it with the option to tap into this.

Significantly higher prices would also ensure there is a clear incentive for producers elsewhere to increase drilling activity. While US producers would be the quickest to respond, it would still take several months for increased drilling activity to feed through to higher oil supply.

The key takeaway is that the oil market from a supply perspective should be able to cope relatively well with any disruptions/losses to Iranian supply. Where it becomes increasingly more difficult for the market is if Persian Gulf supplies are lost due to a blockade of the Strait of Hormuz. Middle East Escalation Boosts Oil Supply Risks_2

Middle East Escalation Boosts Oil Supply Risks_2

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Thomas

Economic

Central Bank

When consumer price inflation first reared its ugly head in the aftermath of the Covid-19 crisis, the initial reaction of central bankers and politicians was to dismiss it, along with anyone expressing concern over it. As Federal Reserve Chair Jerome Powell put it, consumer price increases were merely "transitory" and nothing to be too worried about.

Once it became clear that it would not be such a short-lived problem after all, and that inflation was here to stay, much of the mainstream financial press echoed the narrative of political leaders who blamed it all on "supply chain issues." According to that theory, prices were climbing due to the lingering effects of the lockdowns, business shutdowns and logistical disruptions to global trade during the pandemic. While not entirely implausible, this rationale failed to account for across-the-board price hikes. It was not just specific industries or particular categories of goods that were affected; everything was getting more expensive, and fast.

Another explanation blamed the Russian invasion of Ukraine – arguing that the war and subsequent sanctions against Moscow had wreaked havoc on energy markets, and as oil and gas got more expensive, everything else did too. This line of reasoning appears sound on the surface. The problem is that the consumer price increases preceded Russia's invasion by months, so even though the war might have aggravated pressures in the energy market, it did not cause the larger global inflationary wave we experienced.

'Greedflation'

As months passed with consumer price indexes (CPI) breaking records in many advanced economies, and as households were pushed into dire financial straits, public discontent made it imperative for politicians to find a scapegoat. "Capitalist greed" was a natural choice.

As Fortune reported, "Albert Edwards, a global strategist at the 159-year-old bank Societe Generale, released a blistering note on the phenomenon that has come to be called 'greedflation.' Corporations, particularly in developed economies like the U.S. and the UK, have used rising raw material costs amid the pandemic and the war in Ukraine as an 'excuse' to raise prices and expand profit margins to new heights."

There is no doubt that individual companies took advantage of the inflation narrative to raise prices, and to levels much higher than what their actual cost increases could justify. However, they could only do so because of preexisting and widely recognized price increases – this "passing on the cost" excuse would never have worked in an environment that was not already perceived as inflationary. No group of bad actors, greedy CEOs or rogue corporate executives could possibly have managed to raise consumer prices across the board and throughout the entire world economy.

Even if some companies did try to squeeze out some extra profits by feigning or exaggerating increased costs and unjustifiably hiking their prices, the "greedflation" explanation still fails to account for the concomitant price increases across so many other commodities, companies, sectors, regions and nations. As with the Ukraine war theory, instances of corporate avarice might have exacerbated the problem, but they did not cause it.

The idea that corporate profiteering is the main inflation driver not only puts the cart before the horse, but it contradicts the prior explanations. If there were pandemic-related supply chain bottlenecks and energy market distortions caused by the Ukraine war, then it means the cost of raw materials did increase for producers, justifying higher prices.

Political appeal

As misleading as this theory is, it is undoubtedly politically attractive. United States President Joe Biden embraced it during a February meeting with union workers in Las Vegas ahead of Nevada's Democratic primary, where he blamed corporate greed for high inflation. This narrative appears to have gained considerable traction. A poll by Navigator Research found that "since January of 2022, there has been a 15-point increase in the share who say 'corporations being greedy' is a 'major cause' of inflation (from 44 percent to 59 percent), with 17-point increases among independents (from 45 percent to 62 percent) and Democrats alike (from 55 percent to 72 percent)."

One can see how appealing such a populist concept can be, especially to those who have seen the real value of their paychecks shrink even as corporate profits and CEO bonuses explode. And it is not just politically expedient: it also helped sell the idea of the Global Minimum Tax on corporations to curb "excess" profits, which was further advanced this January after years of talks at the Organisation for Economic Co-operation and Development. How the Real Cause of Inflation Has Become a Moving Target_1

How the Real Cause of Inflation Has Become a Moving Target_1

While blaming big corporations might have helped channel public anger toward supposedly evil capitalists and the rich, it did not do anything to solve the actual problem of inflation. In fact, the situation for most ordinary people became even more difficult. Even as official CPI readings have climbed down from their record highs in recent months, the higher interest rate policies used to achieve that result have amplified the financial pressures on the average household.

In the U.S., credit card balances increased by $50 billion, to a total of $1.13 trillion, during the last quarter of 2023, according to the Federal Reserve Bank of New York, while interest rates on credit cards rose from an average of 14.6 percent to 21.5 percent since the Fed began its series of rate hikes. Overall household debt reached an unprecedented high of $17.3 trillion at the outset of 2024.

Blaming consumers

The pain caused by the tightening measures might have been worth it for many people if it had actually made a noticeable difference in lowering their grocery bills or other basic expenses. But despite the picture painted by official CPI readings, that did not happen (this is because these readings are unrepresentative of the real economy).

As public anger began to swell once again, a new theory was needed for why so many average citizens were struggling to afford both credit card payments and daily necessities. Having run out of villains to blame, the latest narrative sought to blame consumers themselves.

"Doom spending" is the newest concept deployed in the inflation debate and it effectively seeks to explain higher prices as a product of higher demand. Proponents say that higher demand stems from overwhelmed consumers (particularly Gen Z and millennials) who are crippled by anxiety and fears over economic uncertainty and the general state of the world. These people, the argument goes, seek relief through mindless spending, especially on luxury goods, big-ticket items and expensive traveling.

The evidence for this hypothesis is either anecdotal or based on poor-quality surveys. It also does not explain why this kind of consumer behavior has not been observed during previous eras of strife or challenges. Why did consumers not splurge on designer handbags to manage their stress after 9/11, during the eurozone crisis, or even at the height of the pandemic?

As Occam decreed, the simplest explanation is the right one. Put plainly, the core problem has never been about goods and services increasing in price; it is about money itself decreasing in value. The cause is also quite straightforward: chronic monetary and fiscal profligacy, also known as the "print and spend" doctrine embraced in most advanced economies.

Source: GIS

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Kevin Du

Energy

China's wind farms produced over 100 terawatt hours (TWh) of electricity in March, the highest monthly total ever by a single country and as much as all of Europe and North America combined, data from energy think tank Ember shows.

The production total was 25% more than during the same month in 2023, and helps extend China's dominant position as by far the world's largest renewable energy producer.

China's output total in March was more than twice the generation in the United States, the second largest wind producer, and nearly nine times more than produced in Germany, the number three producer.

China Widens Wind Power Lead with New Generation Record_1

However, the March tally may also be the highest for the year, as seasonal wind speed changes mean that China's annual peak for wind output typically occurs around March or April, before declining through the summer as wind speeds slow.

Nonetheless, the output record marks a new milestone for clean energy trackers, and ensures that China remains the leading driver of global clean energy output.

Widespread Progress

China's wind power generation stems from several large wind installations across the country.

Some areas, especially Inner Mongolia in the north and Xinjiang in the west, host some of the world's largest wind farms, and account for the largest share of China's wind power output.

But the build-out of wind generation capacity is taking place in all regions, resulting in a growing volume of clean energy in all major power-consuming regions. China Widens Wind Power Lead with New Generation Record_2

China Widens Wind Power Lead with New Generation Record_2

And output in all provinces, including Guangdong in the south, Yunnan in the southwest, Anhui in the east, and Heilongjiang in the northeast, have recorded close to record high production totals so far in 2024.

That widespread rise in wind output has helped push wind power's share of China's total electricity generation steadily higher, to an average of 11.4% during the first quarter of 2024 from 9.6% during all of 2023, according to Ember.

That share compares to around 62% for coal and around 12% for hydro, and so cements wind power as China's third largest source of electricity. China Widens Wind Power Lead with New Generation Record_3

China Widens Wind Power Lead with New Generation Record_3

Solar power grabbed a roughly 6% share of China's total electricity generation in 2023, and will likely expand that share in 2024 thanks to continued increases in solar generation capacity in the country.

Solar power will also play a critical role in boosting electricity generation during the summer months, when overall power demand in China is at its highest due to rapidly rising use of air conditioners.

But wind farms will likely remain the most important source of renewable power in China for the foreseeable future, due in large part to their ability to produce electricity even when the sun doesn't shine, and from locations spread throughout the country and often close to major demand centres.

Further growth in domestic wind power generation capacity is also expected throughout 2024 and beyond as part of Beijing's ambitious plan to reach carbon neutrality by 2060.

That means even higher wind power generation totals can be expected going forward, ensuring that China will retain its position as the global wind sector leader.

Source: Reuters

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Alex

Economic

Central Bank

The United States economy has had a good run. Gross domestic product (GDP) growth is encouraging (2.5 percent in 2023 and more than 3 percent during the last 2023 quarter), and the February 2024 price inflation rate was down to 3.2 percent – higher than expected but still a commendable result.

The labor market is in great shape. Last February, the unemployment rate was 3.9 percent, and in January the job openings rate was 5.3 percent: although this figure is dropping, it remains significantly higher than it averaged in the past (3.5 percent). In other words, unemployment is not a problem, and the demand for labor is vibrant.

This is, of course, good news for the U.S. Federal Reserve Chair Jerome Powell, and President Joe Biden now has plenty of encouraging economic results to support his reelection bid. There are a few clouds on the horizon, however.

Interest rates and 'corporate debt cliff'

Many assumed that the Fed would soon make credit less costly and more readily available – but they have been disappointed. The Fed's 2 percent inflation target may not be achieved by the end of this year, and there are fears that tight monetary conditions might weaken GDP growth. Such worries are partially justified.

Many American companies took advantage of the long period of abnormally lax credit conditions. They borrowed heavily, especially during the worst of the Covid-19 pandemic, and a large share of those debts are to mature in the next couple of years. Many companies will not be able to pay them back and will try to refinance their past borrowing through new loans.

The cost of debt servicing on those new loans is undoubtedly going to be higher than anticipated. If interest rates do not drop significantly during the next quarters, many balance sheets will take a heavy hit, and some borrowers could go broke.

This is the so-called "corporate debt cliff" created by years of irresponsible monetary policy. Depressed interest rates ended up rescuing inefficient businesses that should have suffered losses or gone bankrupt a long time ago. Instead, they kept draining scarce resources from the healthy part of the economy. The cliff will, at long last, eliminate the poor performers, but it will not be painless.

Doing the right thing

There is also some good news. Broadly speaking, the monetary picture is improving. Regrettably, no one knows what the interest rates should be because the authorities keep manipulating money and credit markets, but the Fed is aware that there is much liquidity around. The nominal money supply (M2) is currently just below its 2022 peak and twice as high as its 2014 level. Indeed, keeping interest rates relatively high is the only way of eliminating the monetary overhang.

In other words, the Fed is doing the right thing and, hopefully, will stay the course even after the presidential election. Its policy of steadying the monetary picture will draw some flak and take time. However, it produces a welcome result: The probability of reducing inflation without causing a recession (a "soft landing") is considerably higher today than it was just a year ago.

The government keeps adding to the debt

Another, and potentially more severe, threat is public finance. At the end of 2023, the U.S. government debt was about 124 percent of GDP. This figure is below the 2020 peak of 127 percent, but it is still high.

On the one hand, there is bad news for the Department of the Treasury: the budget deficit continues to add to the accumulated debt; the Fed seems unwilling to buy U.S. securities (Treasuries) to the extent it did in the recent past; and relatively high interest rates make debt servicing expensive. On the other hand, there is good news: productivity has increased faster than expected and generated enough growth to stabilize the debt-to-GDP ratio and keep markets happy. Public Debt Spells Trouble for the U.S. Economy _1

Public Debt Spells Trouble for the U.S. Economy _1

Moreover, the rise in productivity has not been matched by an increase in salaries. Thus, profits have been rising, and more investment resources are available. The debt burden is heavy, but the economy is in good shape, and there is no shortage of buyers of U.S. securities.

However, some caution is in order. The 2024 budget deficit is expected to be 5.6 percent of GDP. Of that, 2.5 percent is the so-called "primary deficit" (the fiscal deficit for the current year minus interest payments on previous borrowings), while 3.1 percent is debt servicing. Now, since about one-third of the U.S. public debt must be refinanced by the end of 2024 at interest rates higher than those obtained in the past, the cost of debt servicing could rise by about 0.4 percentage points, to some 3.5 percent of GDP. Hence, the key to stabilizing the burden of debt is the primary deficit, which must not exceed the current level – or drop if growth slows down.

The real yield on the 10-year Treasury is currently about 1 percent, which is not high by historical standards, especially if the economy grows faster than 2 percent. It is reasonable to expect that real interest rates will rise further, especially if corporate America remains in good health. Regardless of Mr. Powell's hints to the contrary, the margin for a nominal interest rate cut is limited.

If private companies offer better investment options, it might be difficult for the government to sell its bonds unless it provides a high coupon (the annual interest rate) to attract investors. Put differently, markets do trust the U.S. dollar as a safe currency and the U.S. government as a solvent debtor. However, suppose companies believe that this high level of productivity growth is going to last. In that case, corporate bonds will flood the market, and debts – private and public – will be financed or refinanced at relatively high rates.