Powell's commitment to 2% and the Ambiguity of Georgia

Hi all,

Your host has spent the past week preparing for a business trip to one of the countries in Sub-Saharan Africa. This entailed applying for a visa, getting jabbed with the vaccine, arranging meetings and plenty of other things. We'll provide you with updates on the trip in the next publication. Nevertheless, the world doesn't stand still, and there are many market dynamics and news we're eager to share.

Now, let’s get straight to the business, shall we?!)

Markets Snapshot

Oil Prices

• Crude oil prices fell by more than 4% to around USD 85/barrel, nearing two-week lows, driven by economic outlook, monetary policies, and war in the Middle East. Interestingly, The World Bank predicts Q4 2023 oil prices at USD 90/barrel, falling to USD 81/barrel next year, assuming Middle East stability. In a worst-case scenario, prices could spike to USD 157/barrel, according to the bank.

Stock Prices

• Stocks rallied throughout the week amid growing optimism that the Federal Reserve has concluded its aggressive interest rate hikes aimed at curbing inflation. Friday's jobs report also provided reassuring signs, as average hourly earnings in October rose less than expected compared to September.( Wage growth could potentially fuel inflation). It appears that the recent Israel-Gaza invasion last Sunday and the potential involvement of other countries in the conflict did not dampen stock market optimism.

Global Finance

Federal Reserve

Last Wednesday, the U.S. central bank kept the federal funds rate at its 22-year high, ranging from 5.25% to 5.5%, for the second time in November.

Implications:

• This decision underscores a well-balanced approach toward reaching the 2% inflation target without excessive tightening.

• Financial conditions, encompassing the costs of corporate borrowing, have become more restrictive since the Fed's previous meeting in September. This change is notably evident in the surge of long-term Treasury yields to 5% last month, as we previously reported in our SovereignBeat publication. It has disrupted global markets, coinciding with a period of escalating geopolitical tensions (or rather ‘Israel - Hamas war’).

• It is still too early to conclude whether the uptick in yields will be sustained, despite the Fed's recognition in its statement that increased financial and credit constraints could begin to take negative effect on the economy.

• Markets responded positively as the Fed chair spoke, with the S&P rising 1.1% and the Nasdaq Composite gaining 1.6% on the same day. The two-year Treasury yield fell to 4.94%, its lowest in three weeks, while the 10-year yield hit 4.76%, the lowest in two weeks. Traders reduced expectations of a December rate hike even further.

Geopolitics

Israel-Hamas Conflict Spillover Looming?

• The death toll in Gaza has risen due to an Israeli ground offensive in Gaza City against Hamas militants. The conflict has led to over 9,000 fatalities, and President Biden is calling for a ceasefire to secure the release of hostages

• On Wednesday, Jordan announced the recall of its ambassador from Israel accusing Israel of creating an “unprecedented humanitarian catastrophe”. Ministry of Foreign Affairs said its envoy would only return if Israel ceased its war on the besieged territory. It also told Israel to recall its ambassador to the kingdom amid the crisis. (Aljazeera)

• On Friday, Hezbollah leader Hassan Nasrallah warned of the potential for a broader regional escalation if Israel persists in its Gaza conflict, marking his first speech since the war began. Nasrallah said that “all scenarios are open on our Lebanese southern front” and that “what happens on the Lebanese front will depend on what happens in Gaza”. The Lebanese armed group claims to have lost 57 fighters, while Israel reports that six of its soldiers have been killed in their exchange of fire and missiles.

• While the euro area exports a modest 0.4% of its GDP to Israel and its neighbors, the Israel-Hamas war can erode consumer confidence and tighten financial conditions.

Georgia's Paradox: Profiting from the Russian-Ukraine War, Yet Losing with a Pro-Russian Government

Before you start throwing stones at me , consider this: real GDP growth exceeded 10% last year and is expected to surpass 6% this year. In comparison, the average real GDP growth for emerging market economies is 4.1%, and the largest economy in the world, the US, only grew by 1.9% in 2022.

Let me elaborate further. This robust growth is primarily a result of positive spillovers from the russian war in Ukraine, particularly in the transportation and information and communications technology sectors, alongside strong foreign direct investment, concessional financing, and a rebound in tourism. Since the russian war in Ukraine began, approximately 200,000 russian citizens have entered Georgia. Among them, 60,000 have chosen to stay, while others have crossed into Turkey and Armenia. For a nation as small as Georgia, with just 3.7 million people, the significant influx of newcomers, many of whom either have the means to stay in the country, spend money, or possess skills to seek employment and pay taxes, is poised to have a substantial impact on economic growth.

Georgia's strategic position, historical and economic connections with russia, and its open immigration policy make it a natural destination for russian migrants. Furthermore, like Armenia and Turkey, Georgia refrains from implementing Western sanctions on russia, enabling russians and their capital to move unrestricted across its borders.

And here is where the ambiguity starts, and all paths are closing for Georgia. Despite this substantial economic uplift brought by russians, the majority of Georgians endorse their country's path toward the EU and perceive russia as a threat. Yet the ruling political party, 'Georgian Dream,' is seen as having russian ties and frequently accuses Ukraine and the West of trying to involve Georgia in an armed conflict with russia. Consequently, seeking closer relations with Moscow may not win Georgian Dream any extra votes. In fact, the party could jeopardize its chances in the 2024 parliamentary elections if the EU withholds Georgia's candidate status due to the 'Georgian Dream' party's extensive involvement with Moscow. Despite the liberal policies towards russia that have contributed to immense economic growth, the country grapples with long-term institutional challenges that could prove more costly in the long run.

I just remind you that all members of the European Union maintain investment-grade (IG) credit ratings, including Greece, which was in default a few years ago but recently received an upgrade to BBB- by S&P! To be frank, if we were to place Georgia in Central Europe and make it a member of the EU, they would likely not need to take any additional actions to achieve an IG rating. Just imagine the substantial increase in foreign direct investment that would come with an investment-grade rating and EU membership. EU membership serves as a strong indicator of a nation's institutional excellence—a critical cornerstone in achieving success, recognized by credit rating agencies.

Is it worth more than trying to maintain the relations with russia instead? The question is, of course, rhetorical.