Geopolitics beyond Ukraine

Key Points

• Short-term convergence of economic interests between Beijing and Washington, but pressure around the Taiwan issue is mounting.
• It will probably take a significant slowdown in domestic demand to anchor a deceleration in US inflation, but some supply-side action – e.g., on oil – could help. The negotiations with Iran on a nuclear deal are becoming key on this front.

The geopolitical bandwidth may seem to be saturated by the Ukraine war, but the world’s widest fault line remains the rivalry between the US and China. Yet, the economic interest of the two parties may – for a while – converge. Even if no final decision has been made, the Biden administration is looking into terminating the punitive tariff hikes levied on Chinese products under the Trump administration to help in the fight against inflation. Faced with yet another postponement of its much-expected transition to a growth model driven by domestic consumption, being able to count on unimpaired access to the US market would come at the right moment for China, which could foster a more conciliatory attitude towards Washington. Yet, Joe Biden is at the same time exerting more pressure on the Taiwan issue. It’s far too early to talk about a “general détente” between the two superpowers. Still, the discussion on the tariffs acts as a nice reminder of an iron law of economics: protectionism is inflationary. This may degrade a bit the level of popular enthusiasm for “deglobalization”.

Last week’s release of the US inflation print for April seemingly indicated that, although the rise still exceeded market expectations, consumer prices may have started decelerating. Yet, when corrected for the used cars’ item, the data suggests inflationary pressure continues to widen to more sectors. The US administration’s response – e.g., calling on Congress to support the Clean Energy Act or tweaks to the Affordable Care Act – could easily be drowned in bitter politicking, with the looming mid-term elections pushing for even more polarization. It may be more because of what the Biden administration can no longer do – stimulating demand – that inflation will ultimately slow down, albeit at a cost to economic growth which we think will be substantial in the second half of the year.

Yet, the supply-side component of inflation could respond to US policy, especially if it coordinated with strategic partners, e.g., in this initiative to create an “alliance of oil buyers” to negotiate with OPEC.  This however draws attention to the nuclear deal with Iran (Tehran is proposing to double its oil output as a trade-off) which remains politically extremely delicate.