AUKUS-ward If You “Don’t Do Geopolitics”

By Michael Every of Rabobank

US CPI, even weaker-than-expected 0.1% m-o-m headline and core and 2.4% and 2.8% y-o-y, wasn’t the main event. Neither was President Trump again calling for the Fed to cut 100bps at its next meeting to lower US debt-servicing costs (when our Fed-watcher Philip says it will cut 25bps in September, then stop.) Instead – again – it was geoeconomics and geopolitics.

The ECB’s Lagarde used a platform at the PBOC to state that “coercive trade policies are not a sustainable solution to today’s trade tensions” — in the same way violence is never a solution to violence?– and are “far more likely to provoke retaliation and lead to outcomes that are mutually damaging” – which is exactly where the threat of violence can come in. Was that aimed at the US or China though? She also added, “That means both surplus and deficit countries must take responsibility and play their part.” Was that aimed at China and Germany as well as the US?

Trump tweeted an unwritten “framework” based on the unwritten Geneva “consensus” would see Chinese students back at US universities and rare earths provided to US firms “up front”, with China facing a 55% US tariff and the US a 10% China tariff. However, the Wall Street Journal says the rare earths are only for six months. It seems this on-off process will continue until one side builds a Harvard or the other gets now-weaponised rare earth processing in place (as Bloomberg puts it: ‘China Hit World’s Pain Point on Trade – and Will Do So Again’). Guess which is easier?

Trump also said he’ll set unilateral tariff rates within two weeks for countries not negotiating in good faith, while Treasury Secretary Bessent added the 90-day tariff pause could be extended for those who are – and that China can’t export its way to prosperity and must prove it’s a reliable trade partner.

Russia offered to help Iran remove the weaponized parts of its nuclear programme and build its civilian reactors. That looks a quid pro quo for the US stepping back on support for Ukraine, toppling other dominoes in the Great Game at the expensive of Kyiv and Brussels.

However, that was eclipsed by the US announcing the removal of non-essential staff from its Iraqi and regional embassies and military bases, the former having been placed on high alert with emergency action committees activated after Iran’s defence minister said they would strike those targets if attacked. Moreover, US Senator Cotton stated: “Today @SecDef confirmed that Iran’s terrorist regime is actively working towards a nuclear weapon. For the sake of our national security, the security of our allies, and millions of civilians in the region this cannot be allowed to happen.” Western intel sources also reportedly state Iran has exploited negotiations to actively diminish the potential impact of military strikes on its nuclear sites.

As such, there are press reports the US will announce the end of Iran nuclear talks within hours. That only appears to leave one option – albeit with the Russian offer in the background, perhaps. None of this is a cheap bluff, if that’s what it is; it’s a card you play knowing it’s costly and only works once… unless it’s an essential move because of expected developments.

To say oil, up around 4% at the time of writing, is not where it would be if an attack on Iran were to transpire is an understatement – if it’s not just US military bases and embassies that Iran hits in response. Welcome to one of the key, stacked, geopolitical, binary scenarios I’d flagged for 2025 as The Year of Living Dangerously.

As if that were not enough, the Pentagon also announced it’s reviewing the AUKUS defence treaty as it can’t build enough nuclear subs (or ships) to provide Australia with them ahead. That’s awkward for those who think stuff just appears and don’t get that, as with rare earths, it doesn’t – with disastrous supply-chain consequences. We now see the same dynamic in the world’s military hegemon – it can’t make enough of what it needs. That’s why –alongside structural reforms– it needs to bring back industrial production. Yet the same people who lambaste the US for doing that, “because markets”, also lambaste it for not protecting them everywhere for free. Just as awkwardly, this US move comes just after Australia’s PM Albanese said he wouldn’t be bossed around on defence spending by the US and, alongside the UK and New Zealand, sanctioned two Israeli ministers in a way the US didn’t like. 

The message is clear: the US can step back from defending Australia (and New Zealand) just as it has from Europe if the latter won’t step up at a far higher cost than Australia or New Zealand are currently budgeting for.

At the very least, the US seems to be insisting that Canberra pledges to use any US subs vs China in a potential war over Taiwan. Do that and maybe Australia can keep AUKUS – yet they will likely pay a high price elsewhere, including on trade; and if they don’t, they will have to pay an even higher price for defence, at the very least – the US could squeeze Australia (and New Zealand) in many ways, just as it can Europe. In short, it looks like the D for Decision Day I have long warned of may finally loom Down Under after years of have-your-cake-and-eat-it-ism.

Yet showing somebody is still on a sugar high, Australia reportedly thinks a new security pact with Europe, ahead of a possible FTA, is an answer. Sleep well, Aussies (and Kiwis): Spain and Germany are ready to protect you at the drop of a hat, just as you are ready to fight Russia. Even France, which had wanted to play that role, is going to be overstretched with a huge budget deficit and a lot of Europe to patrol now the Baltic states are being mentioned by Russia.

Similarly, geopolitical events have again eclipsed a careful UK government spending review assuming they wouldn’t even when everyone could see they could. In particular, yesterday’s 4-year plan only sees defence meeting at a 2.6% of GDP level from 2027 onwards, then stopping, even as NATO will require 3.5% to 5%, and a failure of AUKUS would send a further shock through Whitehall. That’s not just ‘what is GDP for?’ but ‘who is paying for that GDP?’

Indeed, Bloomberg notes ‘Britain Counts the Mounting Cost of Taxing Wealthy ‘Non-Doms’’, where “Over 4,400 business leaders have disclosed an overseas move in the last year”; and as the Telegraph bewails ‘Britain ‘surrendering Gibraltar’ after agreeing to EU passport controls’ where Brits “will have to deal with Spanish guards when they land on the Rock after deal agreed.” Yes, The Rock which once underlined British global naval dominance is now to be in the Schengen zone.

You might want to think none of this really matters compared to a 0.1%. In which case, I would suggest that is about as much of the big picture impacting on inflation that you see.