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West braces for global ‘rewiring’

Red sea interest rates
Red sea interest rates

Lord Cameron, The Tories’ original Davos Man, touches down in Switzerland on Wednesday with a new mission: rather than wooing business leaders, he will be meeting Gulf states for diplomacy as conflict in the region deepens.

The war in Gaza and strikes in the Red Sea have cast a long shadow over the gathering.

Shell on Tuesday became the latest company to announce that it was suspending shipments through the Red Sea indefinitely following sustained attacks against ships in the region.

It comes just days after the UK and US launched strikes against Houthi rebel targets in Yemen as tensions in the Middle East mount.

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White House national security adviser Jake Sullivan insisted on Tuesday that the US was “not looking for a regional conflict”.

“Through a combination of steady deterrence and steadfast diplomacy, we seek to stop the spread of conflict and create the conditions for de-escalation,” Sullivan said in a speech in Davos.

Despite Sullivan’s warm words, money managers are preparing for another long war.

Thomas Donilon, chairman of the BlackRock Investment Institute (BII), says he believes fighting in Gaza will “continue for a long time”.

“I think there’s months more fighting ahead and… the longer that the most intense phase of the military action goes on, the higher the risk of escalation.”

Conflict in the region threatens to prolong the inflation crisis that has gripped the world for the last two years.

By adding weeks to the time it takes to ship goods to Europe and thousands to the cost, strikes in the Red Sea may keep prices high. Hopes of rapid falls in interest rates look to be dashed in the process.

It is simply the latest crisis in a procession that have buffeted the world in recent years, claiming countless lives and livelihoods in the process.

“There are too many wars in the world, affecting not only the life and wellbeing of people, but also business,” says Matthias Rebellius, an executive board member of German industrial giant Siemens.

Yet to some observers, the crisis in the Middle East is symptomatic of the way of the world. Disruption and instability are the new normal and, as a result, a return to the interest rates seen over the last decade may simply be wishful thinking.

Donilon believes a “rewiring of globalisation” has long been underway that is not only turning friends into enemies but making relationships between countries more transactional.

This rewiring is one reason why interest rates and inflation are unlikely to return to the lows of a few years ago, he says.

Gita Gopinath, the deputy managing director of the International Monetary Fund (IMF), is just one of a growing chorus of economists and business leaders who believe the job of taming inflation is not yet done.

At Davos, Gopinath called market bets on aggressive rate cuts this year “exuberant” and argued that borrowing costs will remain higher than they averaged over the last decade and a half for the foreseeable future.

“At the very least, central banks will be much more wary of inflation going forward,” Gopinath said on Tuesday. “We are moving to a regime where central bankers are going to be a little more cautious about running the economy hot and also preemptively not waiting until they see inflation go up.”

This will be a shock. Many working people today have never known a sustained period of higher interest rates.

“If you’re 40 years old or younger, you thought that you thought 0pc was just how it worked,” says Chuck Robbins, the chairman and chief executive of Cisco. “And that’s not the case. So I do worry a little bit.”

The Bank of England slashed rates to 0.5pc in 2009 in the wake of the financial crisis and took borrowing costs as low as 0.1pc before policymakers began raising them in 2021.

“We had this free money mentality for this very long time so money was being thrown at everything,” Robbins says. “Some people call this the new normal. This is the normal. We just got away from it for a very long time.”

Bob Moritz, global chairman of PwC, believes higher rates will test the mettle of a generation of executives who have become used to rock-bottom borrowing costs.

“What we have seen, and what I have experienced, is the quality of the leadership team is really going to be the differentiation looking ahead,” he said on the sidelines of the World Economic Forum in Davos.

“We’ve grown up with leaders that, in the last probably 15 years now, knew nothing but low interest rates coming out of the 2008 crisis. In fact, in some countries, we had negative interest rates.

“Many of these individuals don’t know how to manage through a high rate, or a higher rate, interest rate environment. Likewise, with volatility of energy pricing.

“We’re going to have leadership teams challenged.”

Those who do struggle are unlikely to get the same helping hand from the state that businesses have relied on in the past. Covid handouts and decades of money printing by central banks have left scars on the minds of policymakers.

“We’ve gone through three years where governments [have been] viewed as the insurer of last resort, where [policymakers] come in and quite liberally, send money to households and firms,” Gopinath said.

“That has created an expectation setting and you can see that it’s much harder to actually roll off the subsidies that were provided during the pandemic.”

Covid spending sprees have created a “huge temptation to finance everything with debt issuance” instead of raising taxes or cutting spending, the IMF chief warned. That can only end badly.

“If you look at the political economy around the world, and with this election period that we’re in right now, it’s hard to think that anybody is sitting down and thinking about this question hard enough.”

Patrick Gelsinger, the chief executive of Intel, warns 2024 will be a “turbulent year” in which close to half the world’s population will cast their vote at the ballot box. The outcomes are yet another unknown that could fuel inflation, derail growth – or do the opposite. It is all up in the air.

For now, Gelsinger and his peers are focused on dealing with the situation in the Middle East. Like many others, Intel’s products have been forced to reroute around the Cape of Good Hope.

But even if the Red Sea crisis resolves itself, Davos Man fears the world is not returning to the way it was before. A tougher new normal has set in.