Central Banks Will Soon Deflate The Global Economy But One Nation Is Using NATO To Offset The Pain — How Money Impacted GeoPolitics This Week

Lost in the euphoria of the market melt-up is recognition of the Fed’s negative liquidity stance and its historical impact on equities. The Fed is committed to QT and yesterday its weekly release showed that the balance sheet was unchanged from last week but excess reserves declined by a modest 17bn, as the Treasury built up its account balance by $70bn but the Fed sterilized most of this with a decline in reverse repurchase agreements of $44bn. Excess reserves are bound to continue decreasing unless another financial crisis emerges, and that combined with ECB tightening and eventual BOJ tightening will deflate asset prices. For now the bulls couldn’t care less as they believe inflation will hit 2% by next year, giving the Fed reason to cut rates and offset the liquidity decline. Consequently the volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought several positive factors for US stocks. Copper and oil charts are signifying global growth. The action in major currencies indicates the $US is weak. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to rocket over the next few days toward 4600 before correcting hard.

Liquidity tightening will soon hit American consumers and firms that need to refinance debt but it’s already hurting export-oriented countries who need a robust global economy to forestall recession. Among these nations is Sweden, whose vast left-wing electorate turned sides and pushed to join NATO this past year, recognizing not just the enhanced security benefits but the lift that NATO would give to their declining economy and real estate sector.

Sweden’s membership in NATO will make the alliance more efficient and effective but it’s also important for the Swedish economy. The tipping point to joining NATO is generally credited as last year’s full-scale invasion of Ukraine but the reality is economics played a key role since Swedes were divided about NATO even after the first invasion in 2014. Neutrality served Sweden very well, and given their extensive cooperation with NATO since the 1990s most Swedes felt they were both rational and highly moral in opposing full membership. Sweden not only got the security benefits of cooperating with NATO (which was profound since Sweden was a better NATO partner than many members who have limited military capabilities and budgets) but acted to prevent Russia from being even more belligerent. The 2022 invasion alerted Swedes to latent belligerence in the Russian elite’s perspective and this dovetails with the needed economic benefits of joining NATO asap.

Sweden is facing a property crisis with awful echoes of the steep decline it faced in the 90s when its last property bubble burst. The Swedish electorate is restive due to years of immigration controversies and now with inflation so high the economy is arguably the worst in Europe. So the NATO deal helps immeasurably in lifting confidence and in providing the venerable Swedish arms export industry a shot in the arm for increased exports.

The Swedish property sector will still decline profoundly but the NATO deal forestalls a deep dive in confidence. The liquidity draining of the ECB and the Fed has hurt Swedish purchasing power and so the NATO deal kills two birds with one stone, all to the detriment of the world’s most violent and important aggressor, Russia. This prescient move is a rarefied example of geopolitics offsetting financial policy, and the confluence of liberal politics and liberal economics will help set the stage for an eventual bull market in equities once valuations return to earth.

My current positions include 3M (MMM), Pfizer (PFE), and a large position in SPXU, which nets out to an extremely short position in equities.