By Michael Every of Rabobank
On 25 January in ‘The Ukraine Metacrisis’ we argued “Despite the lack of market concern until very recently,…there is a serious risk of a serious war over Ukraine…. we underline this is part of a larger metacrisis that will prompt shifts in the global architecture, creating far greater economic, financial, and geopolitical volatility longer term.” On 7 March, markets finally started to get that message.
- Commodities went through the roof again: oil surged, and is surely heading to new record highs over $147 per barrel; natural gas surged, with Europe’s front-month TTF contract at one point hitting the equivalent of $600 per barrel oil(!) – and Russia is now suggesting it may shut down NordStream 1 (not 2); metals surged, and nickel went up 82% on the day, along with Twitter rumours of a huge hit taken from being short; certainly liquidity is evaporating in commodities markets as mark-to-market margin calls are being made; soft commodities surged – and wheat was limit up once again; and as industry expert @JLinvilleFert tweeted, “If this fertilizer market feels different, that is because it is. Our market is used to dealing with long to only slightly short physical world positions. It has never had a truly ‘short’ physical inventory situation. Needless to say, fear is driving the bus right now.”
- Equities went in the opposite direction: the Dow is now in a correction (-10% from the peak) and the Nasdaq in a bear market (-20%); the German Dax is on the cusp of a bear market year-to-date (-19.2%); the Nikkei is in a correction (-12.4%). Passive tracking funds who had bought Russian equities now have to carry them marked to zero.
- Bond yields bear flattened on the supply-side inflation shock: US 10s were up 10bp and 2s up 13bps, taking 2s-10s to just 22bp at time of writing; at this rate, we could even see the US curve invert before the first Fed hike.
- FX saw EUR/CHF briefly crash through parity and the broad DXY hit 99.3, while the Ruble hit 155 at one point Monday before recovering to 128.
- Crypto crumbled as the White House will sign an executive order this week aimed at these assets to ensure Russia cannot evade sanctions. No more xxxcoin and/or pictures of marsupials in sunglasses to help maintain their war effort?
So, can we now say what I have heard voices from the buy-side mumble continuously throughout this unfolding disaster – that *finally* the war “is priced in”? No. Even allowing for day-to-day volatility and certain short squeezes, we still can’t.
The White House, in Jimmy Carter fashion, says the US “needs to be prepared for a long, difficult road ahead.” That won’t sell well in November this year, or on Wall Street. Indeed, the usual market-optimism to ”buy the dip” does not hold true when there is no central bank running the show. Yes, the Fed could hold back from tightening into a supply-side shock of epic proportions, which might bring some brief near-term relief. Yet the real pivot needs to come from the war, and wars do not care about markets.
Yesterday saw brief optimism when the Kremlin spokesman said all Russia wanted was Ukraine to say it won’t join NATO and give it Crimea and the two Russian breakaway territories it already held, and the war would stop: an off-ramp! Except there are huge trust issues. And, in typically disinterested, un-Trotskyite fashion, markets did not check that this offer was made AFTER the Russians had already told the Ukrainians the other part of the deal was making President Zelenskiy a figurehead leader with a pro-Russian prime minister running things – which was immediately shot down.
Even without digging, markets could have used game theory techniques favored by those who don’t just buy stuff based on MSCI or JP Morgan dictates while knowing they only have to ‘match benchmark’, whether that be -50% or up 50%, and they have had an ‘acceptable’ year. If Putin was blinking under pressure, what incentive would Zelenskiy have to give up the territory and sovereignty that was already unacceptable to Ukraine before the war started? None. Unless one thought Zelenskiy was thinking “because markets”, which too many in markets apparently think everyone else always is. He wasn’t. And Putin isn’t.
Except where Russia is creating new markets. With Visa and Mastercard walking away, Russian banks are already pivoting to China’s UnionPay as the driver for a new ‘Mir’ system. Which is an ironic name given it means both ‘peace’ and ‘the world’ in Russian; and given this war is about rebuilding a “Russkiy mir” – a Russian sphere of influence. And that war is going to get worse before it gets better. Putin is now more, not less popular in Russia, and is prepared to keep escalating - the country will cut itself off from the global internet on 11 March and go behind a national firewall, like China.
On which, another market fallback line of optimism is that China will sort this out. ‘Now is the time for Beijing to build bridges’ --which it does too much of in the real world-- and ‘To show it is a good global citizen’. Again, markets are not paying attention to the actual dynamic. Yesterday, Beijing criticized the *US* for starting this war, and for trying to move NATO into the Pacific, echoing Russia’s talking points. The Foreign Minister stated the friendship between the two nations is "ironclad" and stressed their plans to maintain those ties ahead, adding "No matter how perilous the international landscape, we will maintain our strategic focus and promote the development of a comprehensive China-Russia partnership in the new era.”
On the other hand, The Peterson Institute for International Economics argues:
“…despite Beijing's insistence that it will not implement sanctions, Chinese firms may well find it in their interest to comply, even while protesting. That is because Washington has made it clear that firms flouting the controls would be put on the Commerce Department's entity list. The other countries working with the US could shut off violators' access to their technology too.
Beijing would also pay a heavy reputational cost by undermining such a powerful alliance and in effect standing up publicly for a country that has violated China's long-stated principle that countries should not invade other countries. Of course, restrictions on sales to China and its massive market would be harder to swallow than those on Russia, but the flip side of this interdependence is that China is still heavily reliant on foreign technology. The more Beijing is seen as enabling Russia's adventurism, the more it will be seen as a serious security threat by countries other than the US, even if it does not invade Taiwan.”
These issues are not going away. Just as Russia crossed the border into Ukraine, the international community has crossed a border into making internationally supported export controls more legitimate as a tool to punish outliers.”
As Russia shows, sometimes international actors do not act as markets think they will. We already saw that with China’s ‘Common Prosperity’ last year, from which no lessons appear to have been learned by those guided by MSCI and JP Morgan; or those who think CNY is a long-run sage haven when it is so clearly a political currency at a time of soaring geopolitical tensions, and as yesterday’s Chinese FX reserve data fell $8bn when they should have risen $70-80bn, suggesting capital outflows. Moreover, don’t think that the weekend’s ‘Two Sessions’ declaration by China that it wants even more technology and supply-chain self-reliance is not related.
All of this brings us to another key point. As von Clausewitz makes clear, “War is a continuation of politics by other means.” In this regard:
- Putin has already lost. He cannot hope to rebuild his Russkiy Mir of hearts and minds, or as an economically viable territory given Western sanctions, even if we now hear rumors of Western preparations for establishing a Ukrainian government in exile; yet
- The West also has no achievable political goals: it wants Russia to change, which it will not do under Putin. As such, its economic war risks continued escalation (as argued yesterday) ending with even more market damage, and then, logically, a Hitler-in-the-bunker scenario for a country with thousands of nuclear weapons. Yet if the West now offers Russia an off-ramp, it rewards global irridentism and revanchism at a time when China is already standing firmly behind it.
Is this underlying geopolitical instability being fully priced in by markets that aren’t doing the game theory on that either? I still think not – but we are perhaps starting to get there.
The next shoe to drop is to realise that there is no logic for the usual rapid bounce, or slump, from current low, or high, levels. Unless, that is, the Russians are serious about their ‘offer’ yesterday, and are truly prepared to walk away with their reputation, national security regarding NATO, and economy all in tatters in order to hold what they de facto already had.