Invest-ability Bulletin 14/02/22: War Drums

Markets slide on Ukraine conflict fears and what may come next from the Fed.

European stock markets have opened sharply lower and oil prices spiked to fresh multi-year highs amid mounting tensions between Russia and Ukraine. German chancellor Scholz flies to Kiev and Moscow to try to avert war, which the US says could start in the coming days.

The FTSE 100 declined 2%, whilst shares in Frankfurt and Paris were down more than 3%. Travel & Leisure, Banks and Autos led the decliners on the Stoxx 600 with losses of around 3-4%. Brent crude futures rose above $96 to the highest in almost eight years. Banks are being hit as they are not only exposed to Russia through outstanding loans (SocGen, UniCredit, Raiffeisen being among the most exposed) but also fears that Russia could be cut off from the Swift payments network. BP shares were down 3% despite the spike in oil prices due to its stake in Rosneft. Russian steel exporter Evraz whacked 35%… 

Travel stocks are bearing the brunt though, with IAG and TUI down 7% or so, Wizz Air off 9% – I guess a war in Europe would put people off going on holiday a bit, but also disruption to air space. Havens are getting some bid, EURCHF weaker with the Swissy bid. Gold is a tad weaker after spiking sharply on Friday, still above $1,850. Bitcoin doing nothing at $42k…Russia has third highest mining hash rate. Soft commodities so far not seeing any big reaction (US contracts). US stock futures are lower with E-minis below their 200-day moving average. NQ futs broken out of the bear flag and looking to extend lower. 

Clearly concerns are mounting about Russia’s intentions over Ukraine. War seems ever closer – does the West have enough backbone to stand up to Putin? Biden’s disastrous Afghan debacle has emboldened Russia to move…but will it? Remember a war would be inflationary – higher energy prices, higher food prices…particularly for Europe, where PPI is already totally off the leash – last up 26.2%!

The other story driving that’s been driving the price action is the Fed. Data on Thursday showed inflation hit 7.5%, its highest level in 40 years, helping to fuel a sharp selloff in rates, although this cooled somewhat by Friday as rising tensions saw bonds catch some bid.  

Stocks on Wall Street ended the week sharply lower amid the backdrop of rising bond yields and rising geopolitical risks. The Nasdaq Composite fell 2.78%, the S&P 500 was 1.9% lower at 4,419. The Dow Jones fell over 500 points, or 1.43%. For the week the Nasdaq and S&P 500 declined about 2%, whilst the Dow slipped by 1%. 

Is it really the situation in Russia driving the risk-off mood? I’d say it’s got something to do with it – the market took a leg lower as the White House warned of a full-scale invasion. But that’s on the margins and headline driven; it’s more about the Fed and the total uncertainty over what policy moves it might make in the coming weeks and months. Traders were probably selling the Russian headlines as an excuse as they didn’t want to hold risk over the weekend after a rough week for bonds. US equities were lower last week, whilst stocks in Europe firmed up – better concentration of value/cyclicals over tech/growth/momentum. Europe is catching up today though to erase last week’s modest advance. 

Where is the Fed? 

Fed positioning has turned 180 since December – all the talk now is of an inter-meeting rate hike, last performed in 1994. But the thing is we simply don’t know where the Fed really stands – is it 4 or8 hikes this year? Does it keep hiking as the data slows, inflation gets worse, and Russia invades Ukraine? To those that think it would use war as an excuse not to tighten, you’ve not been following the massive pivot they have made. 

Why is the Fed suddenly positioning in this way? Wages might be one. Even as the transitory narrative was put to rest, officials have stuck to the line that they see no evidence of a wage price spiral. The data from the Atlanta Fed is not encouraging on this front.

So those comments from James Bullard … more like James Bear-ard…on Thursday the St Louis Fed president called for 100bps of hikes by July, a 50bps increase to kick things off and said the Fed should be open to considering an inter-meeting increase. The Fed is still buying bonds and we have this kind of chatter. There is mounting concern/expectation that it’s going to go full 1994 and hike rates between meetings…cue the big selloff on Thursday. Bonds eased back Friday but stocks continued the run lower.

So, what does an emergency hike or 50bps starter for ten actually signal? First, panic. Second, cements the believe of many in the market that the Fed has become dangerously decoupled from reality. An early hike would also require an early end to QE, which could further upset markets. 

Bullard is expected to be on CNBC at 8:30AM (13:30 GMT) on Monday. We should note that several FOMC members have been pushing back against the Bullard narrative. And note on Friday an absolute tonne of Fedspeakers popped up on the calendar for this week. Monday’s schedule also features a Closed Board Meeting at 16:30 GMT …these are not uncommon but given the remarks from Bullard traders are on watch for any announcement.

In fact, there has been a standard response among market participants to ignore whatever Bullard says. Steve Liesman over at CNBC says a number of Fed officials he spoke to do not favour a 50bps hike in March.  

Over the weekend San Francisco Fed president Mary Daly seemed to row back Bullard a bit, saying: “The most important thing is to be measured in our pace…abrupt and aggressive action can actually have a destabilizing effect on the very growth and price stability we’re trying to achieve”. 

Nevertheless, the market is buying the hawkishness and then some. It’s also baking in a rate cut as early as 2024 – the result of an aggressive front-loaded hiking cycle that the market thinks will need to be unwound as it leads to a slowdown. 

BofA: “Despite the Fed’s hawkish pivot, they are falling further behind the curve. The data for January have been stunning. .. At this point we haven’t changed our Fed call [for 7 hikes in 2022], but we see a good case for one or two 50bp hikes out of the gate.” 

Any other data? 

Consumer sentiment data from the US last week was very soft – the UoM headline coming in at 61.7 vs 67.2 before and below an estimate of 67.5. The consumer expectations reading declined to 57.4, levels last associated with 08-09. Inflation expectations also ticked higher…no let up.

This week will see some more colour from the Fed in the shape of the FOMC minutes from its last meeting, as well as a raft of Fedspeakers. Little on the slate this morning in terms of data…eyes on Ukraine for now.  

Christine Lagarde will be speaking later, perhaps giving some more steer on those hawkish remarks from the last press conference. Chief economist Lane is talking on Thursday. He recently wrote a blog in which he warned that the “supply/demand mismatches seen during the pandemic have been extremely rare in history”, and “Since bottlenecks will eventually be resolved, price pressures should abate and inflation return to its trend without a need for a significant adjustment in monetary policy”. Still holding the transitory candle despite the storms that are blowing. 

To which we turn to oil, which this morning rose to its highest since August 2014, with Brent futures trading north of $96 a barrel. This is all about the geopolitical risk premium…binary outcome ahead depends on Putin. Technicals still look hugely overbought but the geopolitical premium continues to be a tailwind. 

Meanwhile the IEA says Saudi Arabia and UAE could ease volatility in oil markets by pumping more. Only trouble is that OPEC members are generally finding it hard to meet the current quotas. Inventories are still at historic lows, market super tight but IEA says global supply-demand balance to more into a surplus as early as Q2. Right now it’s the Ukraine and Russia headlines driving the price action – de-escalation this week would see a heck of a squeeze on all those speculative longs…CFTC data shows these have been coming down for about 4 weeks as traders trim their positions the closer it gets to $100.

Neil Wilson is chief markets analyst at Markets.com

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