Macquarie Bank’s Viktor Shvets warns us to expect disinflation in two years
The bank’s New York-based head of global and Asia-Pacific strategy also predicts China will not be in a position to open up fully until the middle of next year.
Born in Ukraine and educated in both the Soviet system and the Australian system, Shvets was a highly credentialed home-grown pick for MacBank’s annual conference on Wednesday.
He delivered a sobering assessment of the war in Ukraine, which he says will continue for a long time.
Shvets dismisses the prevailing view that NATO expansion and the aggressive privatisation of Russian industry in the 1990s triggered the war.
In the 1990s, he argues, Russia had the choice to become either a democracy or reconstitute the Russian empire: a democracy would allow former soviet states like Ukraine, Belarus and Kazakhstan to develop independently, but an empire would put these states in a very dangerous neighbourhood.
“It has become clear that Russia is not becoming a democracy, it’s not integrating. It is becoming an empire. As soon as you make that decision, not just (Vladimir) Putin, the country as a whole, it is almost inevitable that Ukraine and Belarus somehow have to be integrated or kept within the Russian sphere of influence,” he says.
Shvets says the house view, consistent since the invasion, has been that there is no basis for compromise. This is less about NATO. Russia is not after Ukraine neutrality, but disarmed neutrality and also control – not over everything, but all important strategic decisions have to be under Russian control.
“Countries like Russia or China regard themselves as large continental powers. They don’t view that every country has the same sovereignty. Large countries deserve to have sovereignty. Small countries only have the sovereignty they are allowed to have. The closer you are to China, Russia, the more you lose sovereignty,” he says.
Shvets says behind the imperative to rebuild the Soviet sphere lies historical grievances, from the Napoleonic Wars, the northern wars, the Mongols, the Germans.
“The West tends to look in terms of opportunity and profit maximisers, look at everything as marginal returns. Because of the history of Russia they tend to believe they are surrounded by enemies, they tend to be loss minimisers, to be pain minimisers. They tend to look in average rather than marginal terms and the average doesn’t change that quickly. So the country very much feels they are besieged.”
The Ukrainian-born Shvets says true conflict resolution will only come when one side or the other is exhausted. An independent Ukraine is now armed to the teeth.
Investors are not good at pricing geopolitical risk. Shvets says the reason is that corporate finance and investment theory is built on normal distribution. Investors try to stay in the middle but geopolitical and pandemic crises are the fat tails. To date, investors have let geopolitics look after itself and focused on stock industry trends, company valuations and interest rates.
“Ninety-five per cent of times that’s exactly the right answer in the last five decades,” says the veteran banker. “Increasingly that is the wrong answer if we have those fat tails coming all the time, instead of once a year or five years or 10. How do you invest when one of the biggest variables you are looking at you can neither estimate nor predict?”
Shvets proposes a base case for investors as an environment where financialisation continues and technology will progress but also an assumption that geopolitical and social tensions continue to escalate.
One of Shvet’s biggest winners is the part of his portfolio the team call bullets and prisons. “That is anybody who manufactures weaponry drones, security services, surveillance is clearly one of the beneficiaries. You can join the game or try to find stocks and sectors relatively immune to it. But there is no way of saying how much your equity risk premium should increase and how much should be reflected of geopolitical pressure you are facing,” he says.
The Shvets view on inflation and interest rates is equally confronting. Over the next 10-15 years he believes there will be rapid oscillation between very high inflation and very high disinflation. And that this inflation-disinflation pendulum is already swinging fast.
He says in place of the long period of inflation in the 1970s and 80s and the long period of disinflation that followed, going forward, the world will have both.
“And who is going to determine which one wins?” he asks. “Two parties: one is the government and the other is your fat tails or black swans. The more government puts its finger on the scales the greater inflationary spike you are going to get. The more governments retreat and decide we needed to pay it back or normalise our fiscal situation, the more inflation will start retreating.”
Shorter term – as short as the next six to 12 months – Shvets expects a more disinflationary trend. “People could be surprised how quickly some of those prices could retreat rather than be inflationary. But if you go further down the track to late 2023 and 2024 you could have another significant inflationary spike,” he says.
Macquarie Bank is forecasting four consecutive 50-basis-point rises from the Federal Reserve, which Shvets points out was unheard of 12 months ago. He sees the Fed raising rates aggressively and then backing up in 12 months.
“My view for some time as we go through 2023 and 2024 is there is a much higher probability of loosening fiscal and monetary policies than tightening.”
Shvets says the key criteria is the neutral rate, reached when both quantitative tightening and interest rates neither expand nor contract economies. And he argues only the US among major economies has some room to move rates up.
“On my numbers they are about 200 basis points below what I would regard as the neutral rate. As the Fed starts tightening both from QT and rates getting closer and closer to neutral rates, the volatility of asset prices will increase substantially. When that happens the financial conditions index will go through the roof, inflation and growth will start to disappear and the Fed will have no choice but to back pedal,” he says.
Shvets warns that central banks are tightening in a climate where is no cyclical recovery and where, with the exception of China fiscal policies are retracting on a global basis. “We are taking out $US3 trillion to $US4 trillion of fiscal deficits over the next 18 months,” he says.
Despite China’s zero Covid policy, the Middle Kingdom announced it would achieve 5.5 per cent growth for 2022.
Shvets does not think China has grown at all in the first quarter and that without an effective home grown vaccine the country will not open up until mid-2023.
But he says China will not opt for another massive stimulus. “China rescued capitalism three times, they are not going to do it again. This idea that they will stimulate massively again, that’s been nonsense for two years now. They are going to try and thread the needle, get just enough somewhere near the numbers they need to achieve,” he says.
More Coverage
How to survive the thud as gravity drags Wall Street
The extraordinary price action among investments as diverse as bitcoin or Telsa had to come to an end, and here’s why.
Search for economic security in trade war a loud wake-up call
Australia’s economic policy architecture remains ill-prepared for a more fractured, contested and shock-prone world. Whether we like it or not, we need to construct our own variant of whatothers have called the economic security state.
Macquarie Bank’s Viktor Shvets expects runaway global inflation to swing back to disinflation very quickly, and for the US Federal Reserve to back off from its aggressive rate-rising strategy in as little as 12 months.