By Michael Every of Rabobank
Put and Call of Cthulhu options
“Nor is it to be thought...that man is either the oldest or the last of earth’s masters, or that the common bulk of life and substances walks alone. The Old Ones were, the Old Ones are, and the Old Ones shall be. Not in the spaces we know, but between them….Their hand is at your throats, yet ye see Them not; and Their habitation is even one with your guarded threshold….Man rules now where They ruled once; They shall soon rule where man rules now. After summer is winter, and after winter summer. They wait patient and potent, for here shall They reign again.” - H.P. Lovecraft, The Dulwich Horror
Yesterday was a terrifying day. Even market mania could not compete with the evil spirits that gripped them. US stocks started up but closed down, the S&P sitting at a key moving average; so did key bond yields, with a pronounced curve flattening, US 2s down 6bp peak to trough and US 10s down 10bp to 1.40%; so did energy; and so did basically everything. The Russell up 2%+ intraday but finished the day down over 2%, only the 9th time in history it has done that.
The ostensible reason for the terror was the new Covid variant, Omicron, being found in the US. Despite the fact this was inevitable given the recent pick up in global travel and cases elsewhere, the NecronOmicron was taken as being as evil a portent as the horror book ‘The Necronomicon’ created by H.P. Lovecraft a century ago.
Which is odd, because while there are genuine reasons to be deeply fearful of a virus variant that could underline what some sceptics have been warning about since day one --that, in a worst case, mutations might outrun vaccines, keeping us trapped in our present insanity forever-- there is also a possibility Omicron is highly transmissible AND mild, which is exactly what one would *want* to see in order to defeat this biological foe. The scientific jury is still out on that one, but for once there is at least some logical reason to travel in hope.
Yet there was reason to fear other Old Ones: inflation and central-bank policy errors. Indeed, as The Hill states, ‘Powell, Yellen say they underestimated inflation and supply snarls’ in testimony to Congress. Of course, the message from Yellen was still that fiscal stimulus must proceed anyway, and was only a small driver of inflationary pressures, and all the proposed fiscal spending was inflation neutral(!) because it was revenue neutral(!)…because there are no differences in marginal propensities to consumer between rich and poor(?!); but Powell did not walk back the hawkishness he showed earlier this week when given the opportunity to do so. The horror!
Yes, Omicron could complicate re-opening the US economy, and is already disrupting supply chains in Asia again. It will of course be used as an argument for more stimulus ahead if so – on top of the same fractured supply chains that helped drive inflation so high in the first place. So, while markets might like the idea of said stimulus, they won’t like the inflation that will come with it. After all, even the Beige Book just noted: “Prices rose at a moderate to robust pace, with price hikes widespread across sectors of the economy,” without saying “But lumber! But used cars!”
Trust me, neither Powell nor Yellen truly understand this issue yet even after their limited mea culpas yesterday (as long-term shipping rates move higher, and The Federal Trade Commission ordered nine major retailers, including Amazon, Kroger, and Walmart, to release company information on ongoing supply chain issues to help better understand them). If they did, then just like hapless characters in Lovecraft novels, they would have been driven mad by the knowledge of their true powerlessness in the face of far greater forces.
Yet in that ignorance, if Omicron is just a shadow and not a monster, the Fed has little excuse not to press ahead with what the market is screaming will be a huge policy error. On which note, horror fans know the Necronomicon gained a second lease of ‘life’ in ‘The Evil Dead’ movie of 1981. You want to scare markets? Look where Fed Funds and 10-year Treasuries were then, if you dare: “Groovy”, as Ash from the Evil Dead likes to say? I think not. Yet that is what happens when you push up demand in response to supply-side shocks that shift the economic paradigm in ways arrogant mortals don’t understand – and, after the inevitable blood and tears, an adult with a shotgun and chainsaw hand has to sort things out. (As well as going all neoliberal, moving supply chains offshore, and so setting us up for the inevitable horror sequel we are now deep into.)
True, the collapse in energy prices we have just seen is deflationary – and indeed, the real fear for many is a surge in supply-side inflation, and then a Fed policy error, and then a deflationary monster on the other side. Which would (un)naturally release all kinds of ancient evils of its own on the policy front, no doubt. Volatility is something we can expect: things will go bump in the night – and intra-day too. What put and Call of Cthulhu options does that suggest?
And there are other Old Ones markets are opting to remain deliberately ignorant of. Escalation between Russia and Ukraine continues: Moscow claims Kyiv is stoking tensions along the border, alleging 125,000 Ukrainian troops, half its total, have been moved to the hotspot Donbass region; Belarus’s Lukashenko gave a TV interview in which he stressed “Ukraine is ours,” and he would support Russia if required (as if there was any doubt); US Secretary of State Blinken stated Russia is "laying the groundwork for an invasion"; and NATO argues Russia has no right to declare Ukraine can never join, which has always been a red line for Moscow.
To some, this is all taking place ‘At the Mountains of Madness’. Yet things are starting to edge towards the territory where either someone blinks --meaning either the US or Russia gives enormous geopolitical ground on Ukraine and relative global power-- or the growing tail risk is both sides create an inexorable dynamic towards another kind of terrible policy error. It would also flow through to supply chains globally in ways we cannot grasp – and comes on top of former Japanese PM Abe stating that if China were to move on Taiwan, it would be “economic suicide,” prompting diplomatic complaints from Beijing.
Frankly, all we can be sure of now is volatility, and that if the Necronomicon is opened, the results will always be terrible. Worry about that more than Omicron?