Red-Hot Inflation And Ice-Cold Realpolitik

By Michael Every of Rabobank

The US CPI print for January was red hot at 0.5% m-o-m headline and 0.4% core, with the former rising to 3.0% y-o-y and the latter to 3.3%. Even if due to things like eggs it leaves egg on the face of the “Rate cuts!” crowd forced to crowd the next Fed into end- 2025. Worse, as yields jumped and Fed Chair Powell huffed and puffed in Congress, President Trump demanded lower US rates and said they would sit alongside higher US tariffs, making clear economic statecraft is in and economic policy is out.

However, that was far less important than the ice-cold realpolitik served up next. US Defence Secretary Hegseth announced the US, while backing NATO, was pivoting to Asia and Europe must defend itself better by spending 5% of GDP on it, not 2%. That’s been rumored for a while and most of Europe has treated it as a joke, not a reality. Nobody is laughing now.

Not when Hegseth added Ukraine won’t enter NATO or recover its lost territory, and no US troops will be in the no-man’s land guarding it from Russia, only Europeans, who will not be covered by NATO’s Article 5 mutual defence pact. Moreover, Europe will pay most to rearm and rebuild Ukraine, while the US gets access to its rare earth and mineral rights for any aid provided to Kyiv. Some still might have seen this all as a joke.

Until President Trump started ceasefire talks with President Putin, with no European representation, suggesting a possible rapprochement: @vtchakarova asks what if Trump agrees to join China’s Xi and attend May’s 80th anniversary of its WW2 victory in Red Square?

Europe’s response via the “the positive long-run productivity benefits of higher military R&D spending, which Europe could do with. Markets are not yet grasping the scale of these shocks, which is perhaps understandable. But when they do, they will move.

Similarly, in Canada, Liberal Party leadership candidate Carney has pledged to use the government’s emergency powers to “accelerate the projects that we need.” Like spending 5% of GDP on defence?

Meanwhile, in the Middle East, far closer to the EU than the US, Israel is reportedly considering strikes on Iran’s nuclear sites later in the year, news that comes days ahead of a deadline that may see it restart its war with Hamas.

And Asia has to start thinking about the consequences of the US pivoting in that direction. What does that mean for US ally defence spending? Does Japan have to think about a 5% of GDP figure in short order too? What about Australia and New Zealand? Has Hegseth learned the names of any ASEAN members yet? The fiscal, rates, FX, and real economy implications are again enormous – and that’s before we get to the geopolitical tensions inherent in this strategy, which should be clear. The Trump – Modi meeting we are about to see is also of great importance in this and other regards.

Do recall that we had months ago dubbed 2025 as ‘The Year of Living Dangerously’!

On which note, today we may also get US reciprocal tariffs announced. On that, Yannis Varoufakis talks of ‘Tyler Durden Thu, 02/13/2025 – 12:10

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