7 exciting things happening in geopolitics and the financial markets 27th September 2022:
1) DXY
The DXY rose above $114 yesterday as currency pairs around the world continue to suffer from the dollar’s rise. The dollar is the best of a bad bunch, with some predicting a US recession wouldn’t be deep if it was to occur. This was before the bond activity that led to a 0.5% difference between 2s and 10s. Other countries that hold debt in dollars are struggling, especially as interest rates rise. This could lead to de-dollarisation around the world.
2) Nord Stream Pipes
Both Nord Stream 1 and Nord Stream 2 pipelines have been damaged and are leaking gas into the Baltic Sea. There are two leaks on Nord Stream 1 and one on Nord Stream 2. Three leaks occurring on the same day are unprecedented, without some interference. The pressure in both pipes dropped, indicating seawater entering the pipe. Russia had shut off Nord Stream 2 completely after maintenance a few weeks ago. These damages will ensure the flows won’t be turned on and Europe is on its own. MacroVoices podcast host Erik Townsend predicted October is when Russia would cut off gas flows to Europe. This would be to try exerting the most damage for the winter months. He wasn’t far off.
3) Wheat Prices – Exports out of The Russian Wheat Belt
Escalation in Ukraine last week led to sharp rises in exports that come out of the area, including wheat and grain prices. This has since reversed. The reason cited was a stronger Russian harvest of 100 million tonnes and reduced demand. How can demand ease when we have food insecurity across Africa and the Middle East, and the fact that none of this grain could get to Europe? This gives Russia complete control over where it sends its exports and if it does at all. Could Russia use food insecurity to further squeeze Europe? Putin has criticized the current deal to get exports out of the Black Sea, saying Russia has been “cheated”. A sudden change in the current deal would not be surprising.
4) Bond Yields
There are still a few folks in the markets who don’t know what’s going on. If sentiment is going to reverse, we need to get all the quick profit hunters from the bull market out of the market. This only comes from panic, and we’re not there yet. One way we could get there is through some aspect of the financial markets breaking.
Bonds are looking a little bit broken. As interest rates rise, bond prices fall, which means yields rise. If inflation isn’t transitory, interest rate hikes will continue. This will further reduce bond prices and increase yields. Strong dollars being held as a safe haven is reducing liquidity in the bond market. Any bailouts and quantitative easing to prop up the bond market would increase liquidity, but also inflation. A bit of a vicious circle. Times will be tough for a while.
The $MOVE index tracks treasury bond volatility. It broke about 150 yesterday. The last two times this occurred were in 2009, and COVID in 2020. If one thing breaks, everything follows.
5) Interest Rates
Lots of interest rate hikes last week. All occurred as expected. One reason market analysts don’t think markets will crash is up to this point, the selloff has been structured. One contributing reason to this could be that most news is anticipated before it is announced. Yet, the FED hiked 75bp last week, as expected, but the market fell. It appears that a bear market is unfolding with large bear traps forcing prices up, even though there is no change in market fundamentals. This can only occur when inflation starts to come down in a trend, not a one-off reading.
6) Pound on Tax Cuts Close to Parity – UK Borrowing
The new chancellor in the UK, Kwasi Kwarteng published a mini-budget to parliament last week. He cut taxes by scrapping the top 45% rate of income tax and cutting stamp duty when purchasing homes. Yay! But then the pound dropped to a level not seen since 1985 against the dollar.
Economic growth is the government’s priority, with 2.5% annual growth as the target. How this can occur when inflation is close to double figures and those worse off are having to tighten their belts is beyond me. It’s like the government is trying to make things easier for the 1%, hoping they will spend to increase growth.
More pain for the less well-off as bankers’ bonuses won’t be capped. This aims to grow the UK (or London) as a financial centre. Corporation tax won’t be hiked to 25%, it will remain at 19%. The 1.25% national insurance rise will not occur in one of the only moves that affect most of the country.
All this is to encourage increased spending to boost growth. This comes after the energy package of £150bn. This led to panic in the pound and a rumoured emergency Bank of England meeting to raise rates. The bank governor Andrew Bailey announced this wouldn’t happen, but he would “change interest rates by as much as needed” to curb inflation. It seems the BOE, and government have different priorities.
7) Partial Russian Mobilization
Russia announced partial mobilization last week. This led to a rush out of the country, and Russian airlines weren't selling tickets to men aged between 18 and 65.
Another key aspect of the Russia and Ukraine war is the referendums being held in Kherson, Zaporizhzhia, Luhansk and Donetsk. These referendums aren’t seen as valid as Russia doesn’t have full control over any of these regions, and they are illegal under international law. The fear is that if these referendums are in support of Russian annexation, then any future attack by Ukraine on these territories will be treated as an attack on Russian territory even though these referendums are illegal.
Even nations that are closer to Russia, such as Turkey and China, want a solution to the current conflict. Erdogan said last week that Crimea should be returned to its rightful owners. There’s so much propaganda about the war that it is difficult to know what to believe. It's certain that the majority of us want a peaceful solution.
I’ve rambled a lot about these first topics, so I’ll have to stop here for today. Here are some other important topics I’ve noted down over the last week.
1) Hungary and EU Issues – Further Sanctions Against Russia Would Hurt EU Countries
2) New Italian Prime Minister
3) Chinese Radar Reflection Barge