Risk Perspective April/2025: Nash’s Program & the tariff, sanction hegemony
Nash’s program aims at trying to reduce cooperative games to non-cooperative games by means of suitable non-cooperative models of the bargaining process among the players. In short, Leverage! The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1994 – NobelPrize.org One of Nash’s papers ([38], p. 295) contains the following interesting passage: “The writer has developed a “dynamical” approach to the study of cooperative games based on reduction to non-cooperative form. One proceeds by constructing a model of the pre-play negotiation so that the steps of [this] negotiation become moves in a larger non-cooperative game…describing the total situation. This larger game is then treated in terms of the theory of this paper…and if values are obtained [then] they are taken as the values of the cooperative game. Thus, the problem of analyzing a cooperative game becomes the problem of obtaining a suitable, and convincing, non-cooperative model for the negotiation.” History of Game Theory Below is a quote from the Brooking’s Institute on the “Status of Frozen Assets assets” “Falling interest rates would prolong the ERA loan repayment timeline which poses a risk because European leaders may not be able to keep the assets frozen indefinitely, in part because the unanimity of EU member states to maintain sanctions is uncertain. Belgium is considering domestic options if EU sanctions lapse. Political sentiment can shift, and Russia will continue to meddle in European politics, including by exerting pressure on friendly states like Hungary and Slovakia to vote down sanctions. For example, Slovakia is now “last in line” for Russian gas after gas shipments through Ukraine ended and may not be willing to continue voting against Russian interests. This problem is not new, but the more influence Russia has in the EU, the more likely Russia can dislodge the sanctions regime over time.” On April 14th – S&P ratings has revised Hungary’s sovereign credit outlook from stable to negative, warning that increasing fiscal slippage and persistent inflation could threaten macroeconomic stability ahead of the country’s 2026 parliamentary elections. The rating agency affirmed the country’s long- and short-term foreign and local currency ratings at ‘BBB-/A-3’. https://disclosure.spglobal.com/ratings/en/regulatory/article/-/view/type/HTML/id/3352216 Dislodged politics in the region as Hungary’s opposition blocked main roads in central Budapest in April to protest Prime Minister Viktor Orban’s moves against civil society may aid to a necessary shift.. Protesters in Hungary block roads, bridges in opposition to new law banning LGBTQ+ Pride events | AP News Last of poking at Hungary’s political stress – Don’t believe this can cause some discord? https://www.vg.hu/vilaggazdasag-magyar-gazdasag/2025/03/nagybevasarlas-arrestop-varatlan-bejelentest-tett Europe’s Moment of Truth on Defending Ukraine—and the Continent | Council on Foreign Relations Does Europe have an incentive to weaken its growth/growth outlook to engage with public markets over its negotiation powers with the ERA? “In conclusion, an extraordinarily high level of uncertainty around economic and trade policy has been acting as a drag on markets and the economy alike. Financial intermediaries need to adapt their risk management tools in the face of new vulnerabilities and scenarios at a time when it is no longer possible to measure likely outcomes and probabilities. This environment calls for heightened vigilance, which is why we are exploring unconventional sources of risk and vulnerability and using a broader range of tools, such as sensitivity and scenario analyses, to assess the resilience, and dependencies of the financial system. Source: European Central Bank “First, the policies of the new US Administration. There’s a lot of talk about tariffs, but it’s not just about that. The new Administration has also been quite clear about deregulating banks, non-banks and crypto-assets. And beyond that, they have announced that they want to modify corporate tax, which could affect capital flows across the Atlantic. In general, what we’re seeing is that the new US Administration isn’t very open to continuing with multilateralism, which is about cooperation across jurisdictions and finding common solutions for common problems. This is a very important change, and a big source of uncertainty.” – Interview with Luis de Guindos, Vice-President of the ECB, conducted by Jon Ihle on Marcb 16 2025 Figure 1: EUR 30yr Govt Bond Yield (white) vs EUR 30yr Swap Rate (papaya) and the Spread (lower panel) at 99.62 Percentile. 2013-March 2025 Source: Bloomberg, Bevon Thomas We could almost make a supposition that there is somehow an emerging limited balance sheet capacity to hold physical cash bonds in Europe. Our stubborn-minded explanation would come back to our Game Theory analogy and conjecture back to Comrade Draghi’s famed report of “The future of European competitiveness” https://commission.europa.eu/document/download/97e481fd-2dc3-412d-be4c-f152a8232961_en?filename=The%20future%20of%20European%20competitiveness%20_%20A%20competitiveness%20strategy%20for%20Europe.pdf Our friends at Blackrock came out with this well-presented comment under the worthwhile auspices of what can be done to overcome the shortcomings of bond holdings in the traditional 60/40 bond portfolio. Unfortunately, we would observe that most have played any number of Sharpe World games to then advocate for solutions that do not result in improved risk-adjusted compounded returns. https://www.bloomberg.com/news/videos/2025-04-16/rick-rieder-be-tactical-in-jumpy-uncertain-markets-video In terms of monetary policy, this uncertainty means we need to be extremely prudent when determining the appropriate stance. While most indicators point to inflation moving in the right direction, the environment of exceptional uncertainty requires us to stick even more closely to our data-dependent and meeting-by-meeting approach. Financial stability in uncertain times The European Union is at a crossroads. Defense policy requires a significant overhaul, as outlined as a line of significance in Mario Draghi’s report, challenges relating to trade and economic competitiveness need to be addressed. “In addition to ramping up defense spending, we’ll need to deepen and strengthen our Economic and Monetary Union with a true single market for goods and services that shores up our structural economic growth prospects, supported by a complete banking union and capital markets union” We maintain our belief that risk is endogenous; it is the very manipulations by a Sharpe-drive Federal reserve that create the boom-bust cycle central planners often fail to foresee. Our straightforward view of risk is that it’s not shaped by unpredictable, exogenous shocks—rather, it results from the gradual build-up of fragility. Our frequently cited chart of EUR 25-delta FX butterfly costs, highlighting unforeseen
Risk Perspective March/2025: What if the Coalition Collapses?
Here is a short and crisp video from Ole on the subject of Ergodicity, “Random multiplicative dynamics”, from 2021. Random multiplicative dynamics — Ole Peters “Every trajectory decays, if we wait long enough, and the average of all trajectories always wins, if we average over enough trajectories. Imagine an economy where income behaves in this way. GDP would grow but practically everyone’s income would decline.” A great video and illustration of mathematical fact initially seeming pointless, that eventually connect and become useful later on. Things have continuity, such as a compounding of factors that arise from policy, momentum and leverage in any system. The system orchestrated by the South African GNU (Government National Unity) is currently hanging by a thread, and if the coalition collapses, we might see USDZAR flirting with the 20 mark. This shock would worsen the inflation outlook, but the SARB would probably just sit back and watch the chaos unfold without tightening. SARB MPC Press Conference, 30 January 2025 “Given the challenging global environment, the MPC spent some time during this meeting reviewing a trade war scenario. This featured a universal increase of 10 percentage points in US Tariffs, with retaliatory measures by other countries. The scenario showed higher inflation and interest rates globally, as well as greater risk aversion in financial markets. In response…our model projected the Rand depreciating to nearly 21 Rand to the USD, with domestic inflation reaching 5%, and the policy rate, 1/2 percentage points higher at its peak relative to baseline forecasts” – Governor Lesetja Kganyago delivers the MPC statement on 30 January 2025. The situation is particularly dire as the ANC (African National Congress) and DA (Democratic Alliance) haven’t reached a fiscal agreement – this relationship between the ANC and DA is often marked by tension and rivalry. The ANC’s move to seek support from non-GNU parties to bypass the DA further erodes the partnership, following a series of decisions that left the DA out in the cold. In this note, we aim to answer two questions: (1) what happens to the exchange rate and inflation outlook if the coalition collapses? and (2) how would the SARB react? Our short-term FX models suggest that USDZAR is trading at a relatively modest premium, +2.2% above the average of such models, which is less than one standard deviation (4.3%). If the coalition collapses, we believe that (1) variables linked to South African risk would deteriorate, causing the models to drift higher, and (2) the USDZAR premium relative to such models is likely to widen to extreme levels (2 standard deviations). These observations suggest that USDZAR could approach 20.0 if the coalition were to collapse. Figure 1: USDZAR: Spot versus Model Source: Bevon Thomas, Bloomberg Figure 2: USDZAR: Spot Deviation from Model Av. (%) Source: Bevon Thomas, Bloomberg SARB MPC Press Conference, 20 March 2025 “For now, inflation appears contained…” – Governor Lesetja Kganyago delivers the MPC statement on 20 March 2025 This sort of an FX-move towards 20 is likely to be accompanied by a rise in inflation expectations. Contrary to the containment comment made by Governer Kganyago, our inflation forecasting model indicates that if USDZAR stays at 18.6, inflation would probably accelerate and stabilize around 4.0% – below the SARB’s midpoint target (4.5%). A weaker FX and higher inflation expectations would push inflation to 4.4% YoY in 4Q25/1Q26, aligning with the SARB’s more hawkish estimate. Figure 3: South Africa: Headline Inflation – %YoY Source: Bevon Thomas, Bloomberg Given the policy rate remains restrictive at this level, we believe the resulting inflation path wouldn’t necessitate interest rate hikes. In the event of such a shock, we expect the SARB to signal that the easing cycle is over, essentially saying, “Good luck, everyone!” Disclaimer: This document does not constitute a communication that is an invitation or inducement to engage in investment activity (or financial promotion). It is intended for viewing by clients of Bevon Thomas that are reasonably believed to be eligible counterparties or professional clients under the Securities Act of 1933, the Securities Act of 1934, the Spanish securities market law or the French monetary and financial code. Persons not falling within the above descriptions must not act upon or rely on the contents of this document. The contents of this document are for informational purposes only and do not constitute investment advice nor an inducement to trade. Read our Disclaimer by clicking here Visit our website: www.bevonthomas.com
Risk Perspective February/2025: An NHB hike this year? Not there yet but not ruled out!
We expect Hungary’s inflation to be much higher than what the NBH and consensus expects for this year. This out-of-consensus forecast is consistent with no cuts this year. If anything, our model suggests that there could be some limited hiking premium. EURHUF may move lower on a more hawkish NBH, although the big HUF discount that existed at the start of the year has completely disappeared. We update our inflation outlook following the significant upward surprise in Hungarian inflation this week. We also consider the stronger FX as well changes in other relevant variables. The inflation outlook remains challenging: we currently do not expect headline nor core inflation to return to the target band until 2Q26. Our models point to headline inflation declining gradually from 5.5% to 4.9% in March. Headline should then reaccelerate from 3Q25 due to base effects and reach a 5.7% YoY average peak in 4Q25. The disinflation process then resumes in 1Q26. Figure 1: Hungary Inflation – %YoY This expected reacceleration in headline is driven by (1) a reacceleration in core and (2) a rebound in non-core inflation which averaged a low 1.5% YoY in 3Q24. The reacceleration in core is due to a deterioration in inflation expectations, an increase in TTF prices and base effects linked to the 4Q24 dip in core that should revert in 4Q25. Figure 2: Hungary Inflation Forecasts – %YoY Following this update, our inflation outlook remains significantly more adverse than that expected by the NBH and consensus. If our outlook materializes over time, the NBH is done cutting and might even need to consider hiking at some point. The interest rate rule used in our model suggests Bubor would need to rise from 6.5% to 7.1% by year-end. It would then gradually move back to its current value by 2Q26 as inflation eases. Such gradual up-then-down dynamics suggest the NBH may opt to keep the policy rate unchanged throughout the next quarters. However, if the outlook deteriorates from here, the difference between an interest rate rule and current Bubor may widen to levels that would require policy action. Figure 3: Hungary Inflation %YoY with Noncore Source: Bevon Thomas, Bloomberg Figure 4: Hungary 3M Bubor – % Market implications: The HUF front-end prices in one -25bps cut for this year. Our higher-than-consensus CPI view suggests that the NBH won’t have space to cut at all this year unless the scenario changes. If anything, our base case is consistent with some limited hiking premium. Therefore, we still see scope for an additional move higher in the front-end despite the adjustment that already took place. Figure 5: EURHUF Spot vs Model As for FX, HUF is now trading with a premium relative to our short-term FX models for the first time since July. While a more hawkish NBH should support the currency, the big discount that existed at the start of the year has now completely disappeared. Disclaimer: This document does not constitute a communication that is an invitation or inducement to engage in investment activity (or financial promotion). It is intended for viewing by clients of Bevon Thomas that are reasonably believed o be eligible counterparties or professional clients under the Securities Act of 1933, the Securities Act of 1934, the Spanish securities market law or the French monetary and financial code. Persons not falling within the above descriptions must not act upon or rely on the contents of this document. The contents of this document are for informational purposes only and do not constitute investment advice nor an inducement to trade. Read our Disclaimer by clicking here Visit our website: www.bevonthomas.com