Geopolitical Developments: The Fed’s Recent Hawkishness Has Devastating Implications For The Middle East

The one question for the market that supercedes even COVID is whether the Fed is simply normalizing policy or is turning hawkish on inflation. Fears of the latter translate into fears of falling global growth, which led to the selloff yesterday. Those fears are receding, and the volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action brought several positive factors for US stocks. Copper's chart is signifying global growth. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there was also one negative factor across global asset classes. Oil is pointing to declining global GDP expectations. Expect the S&P 500 to be range-bound over the next few days.

I see the market continuing to consolidate and presenting a buying opportunity in the new year as long as no major geopolitical events occur by year-end. Besides the potential for politicians to commit atrocities across the four corners of Asia, the primary source of geopolitical strife is the restraining actions of the Federal Reserve and how they are interpreted. Technically the tapering and expected rise in the Fed Funds rates are simply normalizations of the extraordinary policies during the pandemic, but many investors view them as a hawkish response to fear of permanent inflation. This hawkishness feeds fears of declining liquidity and ever-rising interest rates, and that would have devastating effects on the trajectory of overleveraged nations like Turkey.

Turkey is an influential nation with no clear identity, given its varied history as a settlement of non-muslim Eastern turkic peoples, then as a sprawling empire and caliphate to a muslim world populated largely with Arabic speakers, then as a republic bent on westernizing but with limited democracy, and presently as the conservative Muslim Brotherhood’s most successful outpost. What Turkey needs is a leader who demonstrates piety but rules based on secular liberalism, and thus promotes the values of earthy cosmopolitanism, commerce and stability through strong European relations. Erdogan has veered in the opposite direction and is now comically tying piety to low interest rates, devaluing the currency and national wealth in the process. Should global investors fear inflation and consequently a drop in central bank liquidity, the Turkish lira was crash until Erdogan raises interest rates and forces Turkey into a deep recession. This might have the salutary effect of catalyzing a united opposition and early elections, but more likely it would lead Erdogan to impose some form of autocratic martial law using the popular trope of foreign manipulation and domination of the nation. Since the 2016 failed coup was a disaster for liberal Turks, Erdogan has space to play his nationalistic card.

The optimal scenario is the Fed resumes its views of the transitoriness of inflation (i.e., inflation will be back to normal in the 2-3% range after the current supply chain issues are ironed out) and this allows global rates to settle. Erdogan would then continue his nonsensical policies of reducing Turkish interest rates, leading to unrest and declining confidence in his acumen and leadership. A democratic removal of Erdogan would not only relieve Turkey of a malevolent leader but potentially change Turkish water policy from a nationalistic bent towards a regional bent, alleviating the strains that caused the recent tragic flooding in Kurdistan. Water is the central long-term issue for the Middle East, and Turkey is critical since it originates the Tigris and Euphrates rivers.

My current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), American Express (AXP), Johnson & Johnson (JNJ), 3M (MMM), Titan Machinery (TITN) and a small net long position in the S&P 500 (the levered inverse ETF SPXU and levered ETF UPRO).