Hive Intelligence Report: US, Russia and Ukraine, and Crypto Yields

Every week, we bring together our community of macro experts to discuss the latest market developments. In this piece, we distil the insights from our conversations up to 17 January. These are views from our network rather than the views of the Macro Hive research team. ‘[Day]’ indicates the day the comment was made.

US

A conversation on the US backdrop

• Unemployment rates are dropping very fast everywhere. Central banks will want to moderate the pace to elongate the cycle. Especially with higher wage growth than post-GFC. They need to bring growth below potential to moderate medium-term inflation. The bigger problem is the very high starting inflation level. Therefore, they will likely need to bring growth much below potential.
• They don’t have to bring growth below potential. They have to bring output below potential.
• In the US, GDP in levels is above the pre-COVID trend. That would need some slowdown till the trend catches up
• Or you assume that some demand was a one-off and that supply constraints may also ease.
• This is the Goldilocks. The market is trading this narrative much earlier than I thought, I would have expected it to manifest sometime in Q2 when there would be some signs of inflation slowing again. But let’s be clear, to achieve Goldilocks we are really threading the needle. The fact demand and supply will be so perfectly in-sync and well behaved to allow the Fed to tighten just enough to keep risk markets happy is possible, but unlikely.
• It is reasonable to have a base case that some of this inflation pressure wanes by Q2. Therefore, the crucial thing is that inflation rates start to ease by then.
• The magnitude of Fed’s QT also matters a lot and how they reduce the balance sheet – passive, depending on redemptions, or/and active (selling off securities). If Bostic’s statement is to be taken at face value ($100bn per month) then they must aggressively start selling securities as UST redemptions are below $60bn per month for the majority of the months up to end-2023. Even when you add FRNA and TIPs redemptions you reach the same conclusion. Obviously, that $100bn includes MBS and agencies which they must sell as maturities are much longer dated.

Rates and quantitative tightening

• Last time we had quantitative tightened the curve kept flattening. And back then even the ECB was quantitative tightening, and the EUR curves also kept on flattening. Also, there was sensitivity on quantitative tightening.
• Assuming a faster pace of QT than in 2018, the US Treasury has lots of room to raise issuance in the front end/T-Bills and help the start of the Fed’s QT this year. But towards year-end it may have to substantially increase coupons issuance. TIPs net issuance may increase regardless which does not bode well for risky assets ceteris paribus.
• Real yields are distorted – the Fed went from 8% of the market to 22% in a few months, buying more than the annual issuance. So, QT could hit breakevens more than nominals – optically real yields move higher.

Do risk assets react automatically or do they think that the breakevens market is not necessarily inflation expectations anymore?

• That depends on whether you believe risk rallied last year because real yields collapsed.
• It must have been a factor, but not the only one.

Will the Fed adhere to Jamie Dimon and his 6 or 7 hike outlook?

• If data is generally weaker it’s hard to see 6/7 hikes.
• Activity data is temporarily weak. No doubt this is a hit from Omicron. But we all know Omicron will ‘end; in one to two months. And at that point the consumer will once again start spending (savings are still high). Meanwhile, inflation isn’t going away at all, and may even accelerate under Omicron as supply chains are jammed up and people stay out of the workforce for longer. The market may delay pricing six hikes, but it doesn’t reduce the likelihood by much.
• It’s hard to say that US households will continue to spend at this fast of a pace. Latest consumer debt data showed a large increase which puts doubts on how large excess savings are for the majority of the population. Some are now claiming they are below pre-COVID levels. That is an extreme, but excess savings are declining now. Looking at total cash deposits for 90% of households over their total liabilities, that peaked in Q2 last year. Still above Q1 2020 though. The ratio bottomed pre-2008 crisis, so overall households balance sheets are much healthier now. But that will change as the Fed starts hiking.

Can we compare the reaction function of yields to those of the 1970s?

• We can’t. Now we have a debt-to-GDP ratio that is four times higher than back then.
• But isn’t debt more resilient now because we have so much of it?
• You shouldn’t argue it this way. It’s an equilibrium argument. Lower rates have allowed for more debt. And because of more debt, higher rates have a larger impact which reduces the upside to rates. Contrary to the popular misconception, more debt is not a bad thing, it’s the mirror image of savings. The level of debt is not a reflection of supply of debt only, it is the quantity at which demand and supply hit equilibrium.
• But at 130% US debt/GDP higher rates will also create debt sustainability questions, and bond investors want to be paid for that, right?
• Debt sustainability is not a function only of debt levels. You can borrow more against your income if you were to lock a low rate. The notion that there is too much debt relies on the common view that rate levels are artificially held at an unsustainably low level, and it is a bubble. Which is an argument of ‘markets are dumb’. There is, of course, bad debt. But that is more a function of funding bad investments as opposed to a function of some artificial level of rates. Is there no place where rates are artificially low? Yes, there are. But that is not the case for the US Government or others like France.
• But there is a thin line where too much government debt crowds out private borrowing, which reduces growth. Thus, raising government deficits.
• That is a different point, which is a lot deeper nuanced and politically charged. There are occasions where this is very true, such as Greece, and it has to do with the structure of the economy itself as opposed to the debt level. There are other cases, however, that, without public investment, private investment fails to pick up the slack due to co-ordination issues. Energy investment is one such sector. Having said this, still failed to witness how too little debt, in places like Germany, have crowded in tons of private investment.
• The whole notion of crowding out private debt rests on the now discredited loanable fund theory. That is, there is a limited set of savings/cash available that needs to find a home. This is not the case, and most economists work on the idea that banks do not actually lend reserves, but rather the process is exactly the opposite. And yes, that is a different issue to why government bond yields are low in a monetary sovereign country with a lot of ‘debt’.

Market skew

• SPX skew has taken a tumble as lower strike puts were rolled higher, and the typical skew reset lower.

UK

• The UK has a big energy crisis. They are debating, in the House of Commons, on whether to remove VAT on energy bills. A lot of the ‘cheaper’ alternative energy providers have gone bankrupt. Some are looking at 3/3x energy bills which is hitting lower income families.

Employment

• Employment has been a good story for a long time in the UK. There are lots of job vacancies still.
• But UK, post-Brexit, immigration policies have also contributed. Anecdotal stories are seeing Eastern Europeans leaving to return to their home countries. Sectors they typically work in, home decorating and construction, have seen prices increase strongly. Combined with a shortage of lorry drivers, another sector they significantly contribute to.
• This is not a temporary supply problem; this is a permanent labour supply shortage.

France

• The Macron utility attack on EDF didn’t come as a huge shock given the French state’s willingness to interfere with markets to achieve short-term political aims. But this simply applies to a further haircut to the entire French equity market – each time the state meddles – in doing so they rob the brilliance of their people to compete with the world.
• The consequences to future access to capital is impinged and as competitors become absorbed via global M&A flows French firms run the risk of becoming economic orphans – with domestic flows unable to compete with global economies of scale.

Emerging Markets

EM sovereign credit

• Trading poorly to start the year. There are no clear country-specific triggers. But a general malaise around slowing growth in EM, worsening current accounts, political unrest is common, inflation is high, and people are still long.
• Some are getting friendly on the premise than Omicron is not bad. But having to exclude China.

Trading China

• CNY is expensive against the basket. If you’re going to be short EM FX, this would be a good choice. They will stick with zero-COVID all year. A lot more cities and regions will lock down. There’s the risk of supply chain cracks when export-focused cities are hit by COVID.

Czech Republic

• Even though the Czech central bank is typically hawkish the scale of recent rate hikes has been surprising. CNB said that CPI could be as high as 9%. They tend to think in MCI terms, so currency strength should take out some of the need for more hikes.

Korea

• The Bank of Korea were a bit hawkish on Friday and talked about more hikes leaving policy still accommodative. It is still difficult to see them going again in February given that would be three consecutive hikes. February is also the last meeting of the current governor. There’s no visibility on who will come next, given the presidential election.

Russia and Ukraine

• Very fast-moving developments around Russia Ukraine, the situation is very tense, fluid, and difficult to assess with a very high degree of conviction.
• Last week hopes of some progress from the talks have given way to some sharp rhetoric from the Russians, and both NATO and the Americans warning of a conflict. Some of the people on the ground suggest a full-blown invasion is not in Russia’s interest, nor the likely outcome. Instead, what could happen are Russian surgical strikes, particularly on the Bayraktar drone’s facilities that Ukraine has obtained from the Turks. You could also see other military depos housing the US provided anti-tank Javelin missiles being hit, and the production facilities of the local version. Precedence for such strikes have been set both by US and Israel.

If this is the likely outcome, how will the US/West and Ukraine respond?

• On the US’s part, the nuclear option is passing one of those two bills introduced last week in the house and the senate that call for very punitive sanctions including cutting Russia from Swift, prohibition on holding/trading Russian debt, banks, oil exports, and Putin himself. The senate bill has the White House’s support. If it’s a matter of surgical strikes, Moscow’s view is that the US won’t take the nuclear option – if they do, all leverage on the Russians is gone. Russia might as well go the whole hog then. You may see sanctions like you’ve seen before – some entities and personnel, another bank or two, some businesses associated with the Russian military, some people close to Putin, but they will stop short of swift and commodity exports. The Russians have and can live with such an outcome.
• What’s more difficult to assess is the Ukrainian response. Zelensky is a novice, relatively new in his role, and being hammered in the polls. He could try something dangerous in Donbas. The hope is that with NATO having made clear it will not put troops on the ground in the event of an invasion, Zelensky understands that such a provocation will bring a heavy and swift Russian response that they will not win. That’s perhaps why you had statements from the Ukrainians welcoming talks between Russia and the West, while Zelensky has suggested a trilateral summit between him, Putin, and the US president. There is no word yet on whether this will happen.

Where are we now?

• The situation is fluid. As the cyber-attacks on Friday and discussion above show, Russia does not need to invade to inflict damage on Ukraine or make its point. An invasion will not help Putin, will not be popular domestically and will come with severe consequences for the economy. This will not be some faraway war in Syria, it will be next door with a country next door which shares history, culture, and close people-to-people links. That’s why there appears to be little domestic support for such a war.
• In any event, you do not give a two and a half month notice to the Ukrainian army, far right nationalists, and the West, and then invade – that only means a bloodier nose for Russia in the event an invasion happens. Putin must have learnt from the US’s experience in Afghanistan, Iraq, and elsewhere – it’s very difficult to hold urban and far-flung rural areas, particularly if the locals are hostile. It will be a costly engagement for Putin, financially and for domestic politics. Russia will lose the macroeconomic and geopolitical gains it has made — and lose them for very little in return.

Market implications [Friday]

• It’s only been one working day since the failure of talks so the impact on Russian and Ukraine credit will continue. Even before current tensions, Ukraine had a high beta – the Eurobond float is amongst the largest in the HY sovereign space; the Ukrainian corporate space is the largest of any single B credit. And like Egypt, Nigeria, it has heavy engagement of tourist money. So, weakness will continue. Although the timelines are unclear, if the above scenario pans out (surgical strikes, contained response from the US and Zelensky), it could mark a bottom for Ukraine/Russia credit (till the next phase, at least).

Ways to trade an invasion

• Long bunds and maybe switch into some Oman, Bahrain, Angola 25-years. All of which should benefit from higher oil.

COVID

• The virus is running out of people to infect. What we saw in South Africa and the UK will now happen in the US.

• The UK is disjointed on COVID policy. Welsh and Scottish parliaments decided to do harsher lockdowns than England. Interestingly, Scotland still had a higher infection rate than England.

China Policy Errors

• Zero-COVID didn’t make much sense, but even less so with Omicron. It’s hard to see how this plays of for Xi: ending zero-COVID is an implicit admission of policy error; keep it and it will destroy China’s economy. Will they pretend Omicron is not there?
• They will not pretend. They have shut down several cities. However, the population is still very supportive of their zero-COVID strategy. There will be an exit strategy at some point.
• It will not destroy the economy either. They have become quite smart at keeping the export sector going strong during this disturbance. Domestic consumption is impacted negatively, of course.
• However, China may fail in zero-COVID. But they have a fighting chance because of their contact tracing system and a population that is more accepting of these lockdowns.

Weakened immunity

• The European Institute of Medicine warns that boosters weaken the immune system. You can’t have ongoing bi-annual shots.

Commodities

Our latest webinar in the Expert Speaker Series saw Andrew discuss with Amir Adnani, CEO and Founder of Uranium Energy Corp, whether now is the time to buy uranium.

Is it time to sell copper?

• It is hard to sell copper because of China. These days huge copper demand comes from electric vehicles, irrespective of China.

Takeaway from ‘The Energy of Tomorrow: The Promise, Failure, and Possible Rebirth of Nuclear Power‘

Watch ‘The Energy of Tomorrow: The Promise, Failure, and Possible Rebirth of Nuclear Power‘.

• The nuclear industry was supported initially to help governments build nuclear weapons rather than develop alternate sources of power.
• Governments have controlled the development of nuclear power significantly through regulation.
• Technology has now moved to ensure that safety and efficiency are much higher, but to regulation focus ALARA (as low as reasonably achievable risk) there is no absolute threshold of safety which eradicates the scientific improvements (you still have to use your profits to increase safety).
• The initial investment to get a license is huge. And then you must follow regulations such as ALARA which eat any economic efficiencies in nuclear power.
• Nuclear power now is pretty much a massively clean and efficient power source for potentially the next 1,000 years, if we wished to use it as such, and that would drive other significant developments as the amount of power we could produce is huge.
• There is almost zero chance of regulations changing at the moment due to historical and/or political reasons.
• It should be noted that it doesn’t appear there are similar restrictions in China where they are doing huge nuclear builds.

EU carbon credits

• Shipping, buildings, and road transport should be included in ETS programmes a year earlier than originally planned, according to a leaked EU Parliament draft on carbon market reform seen by Carbon Pulse on Wednesday that also seeks sweeping changes to free allocation and the addition of a whole new sector.

Crypto

Which country has the highest percentage of crypto owners?

• Ukraine at 12.73%.

What yield can you get on your fiat in crypto space?

• This exercise excludes DeFi, liquidity pools, yield farmers, and staking. It is simply purchasing stablecoins and depositing to one of the lending platforms. The rates are quoted in APR and the costs of initial purchases of stablecoins are not included. Neither are the network fees for the transfer fee or deposit, withdrawal, insurance, etc fees on the platforms which vary. Those that require large capital deposits into the native token have also been excluded.
• The simple average floating rate across the platform is just under 7% (Chart 2).

Trade Ideas

The dollar downtrend has started and John Tierney says value stocks are no longer laggards!

• Short USD [Friday – post data]. USD has entered a downtrend and this data should be a USD negative.

Interesting Reads and Listens

In our latest podcast I discuss the right asset allocation, avoiding crypto scams, and 2022 trades with Mark Yusko, Founder, CEO and CIO of Morgan Creek Capital Management.

Read

• Putin’s Challenge to Western hegemony – the 2022 edition by Adam Tooze
• Thread on Ukraine
• The Architecture of a Web 3.0 application by Preethi Kasireddy
• Thread of Monday’s China data

Listen

• This Week in Geopolitics: What Kazakhstan means (55 minutes)
• Specialists now agree on endemic ending (25 minutes)

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)