US & Americas Political Macro Commentary – January 18, 2022

Nicholas Glinsman | January 18th, 2022

COMMENTARIES

·         The last time inflation was at 7%…

·         Ed Yardeni is fixated on margin debt again

·         Food prices are back to where they were in the 2011 crop crisis

·         Latin America’s currencies signal economic damage despite commodities boom

·         Biden’s presidency is lurching from crisis to catastrophe – hence the idea of Hilary Clinton running again

·         Can any leader survive the curse of Covid?

·         Germany does not stand up to Russia, and the EU does not stand up to Germany

·         There are rumours of progress on the Iran nuclear JCPOA talks

The last time inflation was at 7%…

The US had a double-dip recession. In fact, prior to the pandemic, 5plus inflation presaged all seven recessions over the past 60 years. Is the die cast?

Given the above, I want to re-visit Bill Dudley’s Bloomberg op-ed from January 10th, entitled The Federal Reserve needs to get a lot more hawkish. He is predicting that the Fed will turn “a lot more hawkish, both in the near term and over the next few years” than it presently indicates because its inflation forecast is “surreal”. Dudley concludes that the Fed may start hiking immediately after QE ends in March for a total of 4-5 hikes this year. He sees fed fund rates and bonds yields moving well above what’s priced in.

As we have begun to see, having been driven by higher commodity prices and supply bottlenecks, US inflation has now been supplemented by a strong dose of demand-driven price pressure. In other words, standard “cost-push inflation” is being accompanied by “demand pull” inflation in the US, driven partly by fiscal stimulus, partly by consumers reducing their excess savings. As a result, and critically important for the appropriate monetary policy reaction, the US labour market is turning red hot. The unemployment rate has dropped to 3.9% and the number of voluntary job-quitters reached a 40-year high in November. Not surprisingly, wage growth increased to a whopping 6.0% in Q3, measured by the Employment Cost Index for wages and salaries

Given the recent adjustment in Fed language to prepare markets for an increasingly speedy removal of monetary policy accommodation. Dudley’s column was remarkable in two ways:

·         His very harsh criticism of the Fed forecast, and

·         His conclusion that they’ll adjust the policy, relative to the present message, with a rate hike already shortly after the end of QE and that they’ll go much further than presently priced in by markets. He followed it up with an interview on Bloomberg Surveillance the next day (here: Fed May Need to Hike Rates Four or Five Times This Year)

In the interview, Dudley lists four key mistakes by the Fed, which he predicts they’ll recognize shortly:

First, the definition of the Fed’s inflation target has too many vaguely defined variables and too high bars for lift-off, which has led them to delay the lift-off too long. In particular, he refers to their focus on details of the labour market. I think Dudley is right on this: The reference to average inflation over unidentified periods and multiple segments of labour markets made the Fed’s reaction function overdetermined (or undetermined, if you will) to a degree that it provided no real guidance. And – eager to help the economy back on its feet – the Fed’s judgement almost certainly led them to sit on their hands for too long.

Second, Dudley says that the Fed has turned out to be wrong on the labour market, particularly the changes in the participation rate. I think that’s pretty clear now, but I’ll give them this – It wasn’t apparent several months ago, especially when it comes to underestimating the impact on labour markets of the fiscal support during the pandemic and, specifically, the potency of cash hand-outs which (it seemed at the time) were likely to remain as excess savings for longer than now seems to be the case. As a result, US labour markets have taken off like a rocket in recent month.

Third, the Fed was wrong on inflation. The “transitory” story hasn’t played out, as Dudley says. Both commodity price rises and supply-chain issues have proven to be more resilient and less transitory than the Fed expected. Furthermore, they have now been supplemented by a “permanent” story, driven by demand – and that can be explained by the underestimation of the labour market response, as noted above. There could be an additional inflationary element building up, for while the high wage growth could well the story of future high inflation, it will depend on productivity (which has been very strong, thereby limiting the rise in unit labour costs) and whether the participation rate picks up.

Fourth, Dudley suggests that the Fed was “too concerned about taper tantrum”, and as a result, “markets don’t take them serious” anymore. This is obviously a massive criticism, but it is one that didn’t surprise me. Remember, central banks have to do their job of delivering on the mandate. And while they’ll always want to look at markets to read the key input for financial conditions and to watch for signs of instability – not volatility. Volatility is never an objective, of course, but central banks must not allow themselves to become hostage to markets.

This is a key point, and Dudley says that the Fed has now fallen into this trap – which I’m sure will sting his former colleagues. As this gets corrected with 4-5 rate hikes this year – maybe one per meeting, which would take the Fed funds rate upper bound to 1.25%-1.50%  – Fed fund rates could proceed to 2%-3%, driving bond yields to 2.5%-3.0%, according to Dudley. He also suggests that if inflation settles at 2.5%-3.0% (which he expects once the bottlenecks ease, due to the demand story), then Fed fund rates at 3%-4% “seems reasonable”. That would put pressure on equities and the crypto world, but it will “not cripple” markets, he says. I think Dudley is right here…

Dudley is definitely right when he says that “the Fed should not be a nice guy, but do its job”. Whether his expectations turn out to be accurate remains to be seen. It’s more aggressive than the consensus forecast, although I have to say that I do find Bill Ackman’s suggestion attractive in a Bagehotian sort of way:

Ed Yardeni is fixated on margin debt again

And you can see why:

Food prices are back to where they were in the 2011 crop crisis

Food is getting more expensive around the world due to increases in demand and scarcity because of transportation and supply chain issues. And the timing couldn’t be worse, coming just as government stimulus fades and consumer savings start to run dry. Have a look at the UN Food and Agriculture World Food Price Index below, as it shows how grocery prices have jumped back to where they were in 2011. Those increases were attributed to dry weather affecting large grain producers, including a drought in the US and a fire in Russia that destroyed its grain crop. The impact was magnified in Middle Eastern countries where bread is a staple, more than likely leading to the Arab Spring.

Now, the post-pandemic rebound is doing the same thing to prices that natural disasters and civil wars did a decade ago, which demonstrates the magnitude of the problem. 

And if that weren’t enough, orange juice prices keep climbing after the fovernment agricultural forecasters said they expect the smallest Florida orange crop since World War II. The US Agriculture Department said last week that it expects Florida to produce 44.5 million 90-pound boxes of oranges this year, trimming its already low expectations and predicting that the crop will wind up smaller than the one that was ruined by 2017’s Hurricane Irma. If the forecast is accurate, it will be the smallest harvest since 1945. The big culprit this time around, the Florida Department of Citrus said, is citrus greening, an incurable disease that thins the crowns of trees and saps their vitality. Spread by invasive tree lice, greening has plagued Florida’s groves since it was first detected there in 2005. In a report on Wednesday, the Agriculture Department said a lot more oranges than usual are on the ground, and the fruit that is being harvested is unusually small.

Needless to say, futures prices have kept climbing:

Latin America’s currencies signal economic damage despite commodities boom

Remember this common rule of thumb?

What was good for copper was good for Chile’s peso.

Last year the pattern broke. World copper prices rose 25 per cent in 2021, but the Chilean peso’s value crashed by nearly 17 per cent against the US dollar — one of the worst performances by any major emerging market currency.

Chile’s experience was not unusual. Despite a strong global rise in commodity prices last year, the currencies of all major Latin American economies weakened, some dramatically. The Colombian peso lost 16 per cent of its value against the dollar, while the Peruvian sol weakened by more than 9 per cent. Brazil’s real suffered its fifth consecutive year of devaluation, losing nearly 7 per cent.

I would posit that the striking divergence, unprecedented in recent years, points to a deep sickness in Latin America’s economies. Such performance shows the region is coming out of the pandemic with deeper structural damage than many perceive.

The pandemic’s combined impact on Latin America’s people and economies was greater than in any other region in 2020. After a struggle to procure vaccines early last year, most Latin American governments managed to buy sufficient stocks during 2021 and the region ended the year as the world’s most vaccinated. However, while the most serious health effects of the pandemic are fading, the economic damage looks much longer-lasting. Latin America was already the emerging world’s slowest-growing region before the pandemic, managing just 0.9 per cent year-on-year increases in GDP on average from 2014 to 2019, according to Goldman Sachs data.

Now, despite higher commodity prices, it risks settling back into mediocre growth, this time with fresh problems: extra debt taken on during the pandemic, rapidly rising inflation and much greater political risk as voters punish incumbents and swing towards populist outsiders. In other words, the market is treating Latin America as if it had suffered a structural shock and not a cyclical shock. Just consider the region’s lurch towards political extremes in 2021. Peru and Chile elected hard left governments and socialist candidates are leading the polls for presidential elections this year in Brazil and Colombia. In a period of rallying commodity prices, the correlation between commodity prices and currency strength has broken because of political risk, to a large extent. In Colombia, Chile, Peru and Brazil, the political and policy risks are high.

Chile epitomised the trend. It elected last May a special assembly dominated by the left to rewrite the constitution, which is widely regarded as one of the region’s most investor-friendly. Seven months later, voters chose Gabriel Boric, a hard-left millennial former student activist, as president. Boric has vowed to abolish the country’s private pension system, raise taxes by 5 per cent of gross domestic product to fund a big increase in public spending and impose restrictions on the mining industry. Markets have reacted to the region’s drift towards political extremes. About $50bn has been pulled out of the country since political unrest erupted in October 2019, according to the central bank. Peru suffered the biggest capital flight last year since records began in 1970, with some $15bn leaving the country.

The exception to the weak currency rule in Latin America has been Mexico, whose leftwing populist president has pursued nationalist and interventionist policies but also free trade with the US and fiscal discipline. Reflecting this, the Mexican peso fell only 4.5 per cent against the dollar last year, by far the best performance of any major Latin American currency. Mexico is the best home in a bad bunch, given President Andrés Manuel López Obrador’s austerity, the country’s relatively low levels of government debt and the likelihood that it would keep its investment grade rating. The problems in Mexico are not short-term macro ones, but long-term ones of very low growth as a consequence of López Obrador’s economic policies. Nevertheless, the country’s advantages have kept investors interested in Mexico, at least in the short term.

In Brazil, the region’s largest economy, President Jair Bolsonaro has largely abandoned efforts to push through any more major structural reforms or big privatisations and is boosting spending to try to improve dire poll ratings and prepare the way for a reelection campaign. However, weighing on sentiment is uncertainty about what sort of economic policies leftist icon Luiz Inácio “Lula” da Silva, the current poll leader for October’s presidential election, would pursue if elected again. Lula’s former finance minister Guido Mantega argued in a recent article written at the behest of his former boss that a new Lula government should launch an “ambitious” investment programme, champion state-led industrial policies and aim to create a “social welfare state”. Of course, none of that went down well with markets, and rightly so.

Yes, there is a lot of bad news already priced into the currencies of Brazil, Colombia and Chile. However, the weakness of the region’s currencies in the face of a commodity boom points to much bigger challenges than political risk alone. You only get rewarded with a stronger currency in a commodities boom, if the boom serves to make you richer as a nation. The markets are foreseeing that this commodities boom didn’t bring prosperity, so the currencies didn’t deserve to go up. It was a boom for a dozen commodities companies, but it didn’t translate into wider economic prosperity. Herein lies the problem.

Biden’s presidency is lurching from crisis to catastrophe – hence the idea of Hilary Clinton running again

British politics may seem particularly degenerate this week, yet Boris Johnson’s troubles are as nothing to the pile of disasters engulfing America’s Commander-in-Chief. Joe Biden’s leadership is a catastrophe – and it’s only getting worse. Let us count the crises. The number of Covid hospitalisations in America has just hit an all-time high. Inflation is worse than it has been in almost four decades. Biden’s preposterously expensive ‘Build Back Better’ plan is stuck in Congress. And his approval rating has, according to one poll, sunk to 33 per cent, five points lower than Donald Trump in the same poll at the same stage of his presidency.

Rather than tackle the manifold problems he faces, Biden has taken to banging his head against legislative walls. On Thursday, his vaccine mandate – intended to force the Covid vaccine on the employees of large companies – was rejected by the Supreme Court. Biden responded by expressing bolshy disappointment at the Court for blocking “commonsense life-saving requirements”. How low can Joe go?

His genial elder statesman persona is breaking under the strain. It’s hard to recall a worse speech by a US president than the one he delivered on Tuesday in Georgia. “Seems like yesterday just yesterday the first time I got arrested,” he began, a nod to his notoriously dubious account of being arrested for trying to see Nelson Mandela. He angrily proposed removing the Senate filibuster, an important part of the US legislative process, to embolden his plans to nationalise the election process and override state-by-state changes to favour the Democrats. Biden’s rage was theatrical and hammy: the voice of a desperate leader who fears being judged at the ballot. The mid-terms are coming up in November, and the Democrats are already anticipating heavy losses, with both the House (a certainty) and the Senate (closer but probable ) going to the Republicans.

The only source of optimism for Team Biden is the hope that things can’t get worse. Americans love a comeback narrative, and the largely anti-Republican corporate media will desperately try to build one in the run up to November. Expectations here are now so low that anything less than a historic trouncing could be interpreted as a surprising boon for the White House.

In the meantime, his party is turning against him. The number of Democrat voters who disapprove of his job performance has doubled since his inauguration. Democratic operatives in Washington whisper darkly about a ‘plan B’ to force Biden out ahead of 2024. The original ‘plan B’ was the vice president, Kamala Harris, but her political ineptitude is so mind-blowing that it makes Biden seem competent. This week, she told reporters that the administration would send out 500 million free Covid tests next week, only to be corrected by the White House, saying they would be dispatched next month.

So now political operators are talking up emergency replacements. Last week Douglas Schoen, formerly a Democratic party adviser, took to the pages of the Wall Street Journal to moot the possibility of Hillary Clinton running again for the White House. A wild idea, no doubt, given her enduring unpopularity. But the fact that it’s been taken seriously shows the desperation in Democratic circles.

Oh what fun that would be!

However…

Can any leader survive the curse of Covid?

If Boris Johnson wanted to console himself, he might say he’s far from the only politician having deep post-Covid political problems. No one, not even Keir Starmer, is immune from scrutiny of their behaviour in lockdown – and almost no leader, anywhere in the world, can claim their pandemic strategy was a success. Everyone gambled – and to a greater or lesser extent, everyone lost. Now, the political reckoning begins. From Australia to Israel, most of those who were in power at the start of the pandemic have either lost power – or look as if they soon will. Lockdowns brought agony but not the benefits that their advocates promised. Imperial’s Neil Ferguson predicted the lockdown he recommended could reduce deaths to about 20,000 – up to two-thirds of whom, he said, might have died within a year anyway. The death toll now stands at seven times this figure and after Britain has suffered some of the strictest, longest lockdowns in the world.

In Sweden, at the other extreme, the Prime Minister who fended off lockdowns lost power after a coalition power struggle. Stefan Löfven’s restraint meant Sweden ended up with no diktats and the least economic damage in Europe in 2020. But there was no political dividend for him. The deaths that did happen – half of which were in woefully-unprotected care homes – were not forgiven. Löfven’s prize for keeping Covid out of the headlines was to be scuppered by mundane issues like rent control.

The world over, it’s hard to find any leader who can genuinely claim their Covid policy was a success. It’s all too easy to find leaders who have panicked and abandoned their previously-vaunted principles. “We’re not a country that makes vaccination mandatory,” said Justin Trudeau. But his government is now exploring it, a logical segue for a Canada which imposed draconian no-jab, no-job policies for public transport staff. Québec is even proposing a tax for the unjabbed. The approval rate for how Trudeau handled the pandemic was 59 per cent this time last year; it’s now 41 per cent.

Australia is now abandoning its ‘zero Covid’ policy but Scott Morrison, its Prime Minister, is struggling to take his country with him. His decision to close off from the rest of the world came at huge social cost and some of the longest lockdowns in the world. Australia’s death toll was the lowest in the G20 and it’s now reopening, to a far-milder omicron variant. Going from ‘zero Covid’ to what he used to disparage as ‘let it rip’ seems to be a change that’s too dizzying for many Australians to cope with. His coalition government is now eight points behind in the opinion polls, with an election due in May at the latest.

The original promise of Antipodean zero Covid strategies was to sit tight, wait for vaccines to arrive and then reopen to the world. Once, this looked crazy. Then, it seemed vindicated when Pfizer, AstraZeneca and Moderna managed to come up with jabs that tested between 76 and 95 per cent effective. They’d get jabbing, then reopen: Jacinda Ardern, Prime Minister of New Zealand, said last year would be “the year of the vaccine”. She was as good as her word: in both New Zealand and Australia, 92 cent of those eligible have now been double-jabbed. But we now know that vaccine protection wanes quite quickly, hence the need for boosters. Omicron now dodges AstraZeneca’s jab, and two jabs of Pfizer are not much better: UK tests show they are just 20 per cent effective against infection from omicron after 15 weeks. So the Australians and New Zealanders who made such progress with the double jab find themselves vulnerable to a variant that needs boosters (taken by 18 per cent of Australians and 14 per cent of New Zealanders). Even booster protection wanes: to about 40-50 per cent after 10 weeks, according to British studies. This is why endemic Covid, not zero-Covid, is looking like the only sensible option. But the journey to this conclusion is a political Via Dolorosa for those leaders who spent two years espousing zero Covid strategies. Ardern was lucky to have had her re-election during the pandemic, in a New Zealand where 80 per cent of voters backed her strategy. That fell to 60 per cent last October and stands at 46 per cent now. She is still two years away from a general election – so has time to recover.

Joe Biden is unlikely to stand again. He was elected president on a promise to “shut down the virus” which always was a stretch. He failed, and ended up with threatening no-jab, no-job policies – which have been divisive and ineffective. Americans are losing their fear of the virus: now, for the first time, the number of those disapproving of Biden’s Covid policy exceeded those who back it. His approval ratings have now fallen faster than any leader in modern American history. He is in trouble for all kinds of reasons: the Afghan debacle, inflation and more – but Covid is proving the crowning issue. His Covid policy is now backed by only a minority of Americans. Micah Roberts, a Republican pollster, summed it up: “As goes Covid, so goes the Biden presidency, and that’s really proving to be quite true.” Biden’s staggering borrow-and-spend package was billed as a response to the pandemic but there was always a risk of pouring the fuel of borrowed money on the fire of a rebounding American economy. As we now all know, inflation is now higher in America than at any time in the last 39 years.

In Ireland, Taoiseach Micheál Martin’s lockdowns have not really paid dividends. The curfews, the curbs on weddings are all still in place – in a country where the omicron variant is still spreading fast, but posing nothing like the threat of the original strains. Sinn Féin, the official opposition, is now 10 points ahead in the polls. Martin needn’t fight an election for three years, so he has time to recover. But a Covid effect can quite clearly be seen.

Those who fought elections during the height of the panic benefited from the phenomenon of rallying behind the flag and the leader in time of crisis. Mark Rutte’s record on Covid persuaded Dutch voters to overlook his other shortcomings and re-elect him last year – but that was in March, where the sense of emergency had not abated. Talks to put togther his coalition took 271 days.

The Hong Kong flu of 1968 inflicted a horrific death toll, but it was not compounded by the economic, social and public health damage from lockdowns. The difference now is that we have the technology to track new pathogens in real time. New daily data flow combines with social media to create a contagion of fear. This leads to demands that Government locks down – even if ministers think it won’t do much longterm good (as was the original UK position). It seemed plausible, back in March 2020, that lockdowns might have somehow suffocated Covid – as seemed to happen in China. Now, even China is struggling to make zero Covid work. How long is Beijing prepared to remain cut off from the rest of the world? How long can it keep plunging its megacities into lockdown after just a few cases?

Johnson writhes in his own particular type of Covid agony. Other leaders broke the rules: in Sweden, lockdown advocates were caught going to nightclubs (the 34-year-old Ebba Busch) or indulging in the Christmas sales (Löfven). But there has been nothing on the scale of the No. 10 nightclub: with eight separate parties in the Prime Minister’s home under investigation. When Buckingham Palace was bombed in 1940, the Queen Mother famously said that now she could “look the East End in the face.” The Prime Minister now has precisely the opposite problem. On May 20, when he attended his drinks party in No. 10, a Bletchley Park codebreaker was buried – with hardly anyone at the funeral, as per Johnson’s orders. Could he look that family in the face?

The madness continues. The decision to order children to wear face masks in school, I understand, was made when an incorrect figure was flying about inside Government, claiming they cut transmission by a third. An official study this month found a difference in Covid absences of just 0.6 percentage points between schools where pupils wore masks and those where they did not. Only last week, Sage modellers admitted that they got omicron models badly wrong. How many other restrictions were ordered on similar mistakes?

This will be remembered long after Covid. It is now (rightly) harder to use intelligence to justify military action; in future, it will be harder to use modelling to justify restrictions on people’s lives. Just as Iraq eclipsed everything else Tony Blair did over his 10 years, the lockdowns – and the Prime Minister’s behaviour during them – may eclipse everything else he did, even the Brexit deal. “It might be a Churchill moment,” says one backbench Tory. “We’d thank him for his effort in Brexit and the pandemic, but it’s time to turn the page and the nation wants a new leader.”

There are lots of reasons that leaders fall, especially after a protected crisis. The crash of 2008 claimed many political scalps, as did Iraq. A failed consensus has many political victims, because those who presided over the mistake enter denial. They cannot recognise what they did was wrong – so, unable to adapt, they need to be removed. The political future may well belong to those who can restore the liberties that lockdown measures tore away. And the new leaders will be those who can talk plainly about the collateral damage, something that those who ordered lockdown struggle to acknowledge.

Germany does not stand up to Russia, and the EU does not stand up to Germany

The tragedy of Europe is that Germany is not standing up to Russia, and that the EU is not standing up to Germany. A Russian invasion will see many losers. I expect the EU, apart from Ukraine itself, to be one of the biggest.

If and when Russian invades, it will inadvertently expose Europe’s internal divisions. I say inadvertently deliberately, because I don’t think this is Vladimir Putin’s primary objective. He is concerned that a colour revolutions in Russia’s periphery, as he calls them, might eventually encroach on Russian politics itself. It is absurd, of course, to argue that Nato might invade Russia. This is a Russian strawman. The threat to Russia is much more subtle, but no less real. There is not much the US can offer to alleviate Putin’s paranoia. He wants a political buffer zone, with Ukraine and Belarus definitely in that zone.

What Russia always does, which the EU almost never does, is act according to its own definition of strategic interests. What defines strategy is the willingness to pay a shot-term cost in service of a longer-term objective. European, and German foreign policy in particular, is nonstrategic in the sense that it is focused on short-term gain. If you prioritise car exports, you leave yourself with fewer degrees of freedom to pursue other interests: human rights, climate change, supply security, technological leadership.

If and when Russia invades, Germany and other European countries might at one point run out of gas. That would depend on how energy enters into this conflict. Germany has left itself in this position because successive governments failed to develop a coherent energy policy. Three nuclear plants went offline at the beginning of this uear, as will the last three at the end. With the Greens in government, there is little chance of a policy reversal. The new coalition has ambitious plans for investment in renewables, but the maths does not add up. The energy transition requires unprecedented investment in modern gas-fired power stations as an interim solution. That means Russian gas for the most part. The Greens might kick up a fuss over Nord Stream 2, but I don’t think they will have the nerve to leave the government over a pipeline, and sacrifice their investment programme for renewable energy sources. The deal is done.

If and when Russia invades, it will be a matter of smoke and mirrors. Russia has no interest in occupying all of Ukraine. It will never invade a Nato country, and try to occupy it. One major concern is that Putin may at one point choose to close the Suwalki gap, the stretch of land along the Polish-Lithuanian border that separates the Russian province of Kalingrad from Belarus. That would give Russia direct land access to the southern Baltic Sea, and drive a wedge through the EU. The Baltic States would at this point be geographically isolated from the EU, surrounded by Russia from all sides. It might also seek to extend its military control of the Black Sea, cutting through the Ukrainian lands that separate it from Transnistria, a Russian-speaking breakaway province in eastern Moldova.

If and when Russia invades, Germany will appease. Germany will push for minimal sanctions, and only those that don’t damage German exports. They will veto any proposal to cut Russia off from the Swift payment system, if such a proposal were ever made. Nord Stream 2 is safe because neither the EU nor the Biden administration want to upset the Germans. A Republican majority after the mid-term election this November might change the Americans’ policy, but by then the gas will have  already started to flow.

If and when Russia invades, the Europeans will huff and puff as they always do, and complain that they are not invited to various diplomatic tables. Sitting at tables is a big thing in Europe. Expect to hear a lot of side issue debates, like majority voting in the Council on foreign policy. What they will not debate is an increase in defence spending.

If and when Russia invades, nobody will confront it. And nobody will confront the appeasers. Completely outwitted with nowhere to go, watching from the distance. It is what happens when you leave the strategic thinking to others.

There are rumours of progress on the Iran nuclear JCPOA talks

Last week saw reports of rumours of progress on Iran nuclear JCPOA 2.0 talks.  We remain cautious on taking those reports at face value, as we have repeatedly seen spin emanating from Iran and others that is not matched by results.  In fact, on substance, (that is, if you remove politics from the equation), reverting to the terms of the original JCPOA deal no longer makes huge sense, as many key provisions are so much closer to sunsetting anyway.  Having said that, we are now closer to 50-50 on whether there will be some form of a deal, whereas we were more like 90% “no deal” as recently as a month ago.

Both Russia and, to a lesser extent China, are encouraging an agreement.  Russia is playing a constructive role here – both on the merits and to show the U.S. that it can be helpful (or not) on a broad range of issues Biden cares about.  The sides are on a hiatus for a few days, although working groups continue to meet.   Further, both Europeans and Rob Malley (the lead U.S. negotiator) fundamentally want to get back to a deal, as they accept that it was Trump who pulled out of the deal unilaterally, so the burden is on the U.S. to get back to the previous baseline.  But, politics doesn’t allow that to be the final word.  And the U.S. is still trying to get some changes to among other things, timing of the sunsets and to date Iran has not accepted those proposed changes. 

The Biden Administration is remaining very tight lipped on the status of the talks, which we interpret as a sign that things could be trending positive.  We also note that the Biden team has not seriously thought about the consequences of no JCPOA suggests the possibility of a deal.  That is, there is still no credible “Plan B”.

Chances of a deal have increased for two other reasons: 1) Israeli PM Bennett saying that Israel is not a party to the JCPOA – potentially stepping back from threatening progress, and 2) word that the implementation committee was now engaged around the timing of Iran returning and sanctions relief.  This is a concrete turn that would presumably only occur after there was sufficient progress on the basic terms.  Iran wants all the sanctions removed before they start dismantling.  That won’t happen, as it is politically untenable, so they will have to compromise.  Whether they can get there is still an open question.

While we don’t think the Houthi attack on Abu Dhabi earlier today will have a direct impact on the talks, it will add to U.S. domestic pressures against any deal with Iran, which unto itself is consequential.  In Tehran, the attack doesn’t reflect Iranian positions on the talks.  There, they are seen as two separate issues (nuclear issues from regional policies).  Still, the Abu Dhabi attack is another sign of Iranian/Iranian proxy mischief and is hard to compartmentalize this politically.  The Emirati-Israel axis will work this very hard in Congress (and the media) and Republicans are going to make noise; the attacks are going to make centrist Democrats even more nervous.  A deal with Iran now will add to that narrative about Biden’s alleged weakness.

We are also cautious on expressing too much optimism, given the increase of Iran oil exports in violation of sanctions, especially to China.  At today’s high prices, even exports at a discount to market prices provide a significant benefit to Iran’s economy, and allows Iran to continue to operate without the level of economic pressure expected by Washington from compliance with sanctions.  Given apparent U.S. unwillingness to take on China and its banks over sanctions breaking, the pressure on Iran is lower than that which might compel them to make the compromises necessary to allow President Biden to defend the outcome from domestic U.S. political attacks from re-entering into a JCPOA 2.0, or an even weaker interim deal.