Ukraine, Not Fed, Caused Wild Stock Swings, One Bank Suggests

This week has the potential to be another minefield for traders and investors. Just like last week. And the week before that. And so on, back to the beginning of 2022.

Unfortunately, “minefield” may need to be taken literally as well as figuratively given the elevated risk of military conflict. On Sunday, I suggested a Russian invasion of Ukraine, if it were to play out as western intelligence officials claim it might, would be a watershed moment — the first “pure” war of conquest by a major world power since World War II.

Equities were perturbed late last week when the White House advised Americans in Ukraine to leave immediately. Jake Sullivan again cautioned that a Russian incursion could commence at any moment, while reiterating that contrary to media reports, the US didn’t think Vladimir Putin had made a final decision. A discussion between Putin and Joe Biden over the weekend yielded little.

There’s never a “good” time for open hostilities, but for markets, the timing is especially vexing. Near triple-digit crude is exacerbating inflation and energy prices are likely to surge in the event Putin pulls the trigger. More generally, markets are on tenterhooks ahead of next month’s Fed meeting — suffice to say shooting wars aren’t conducive to calming frayed nerves.

It’s with that in mind that SocGen’s Jitesh Kumar and Vincent Cassot suggested that the prospect of war in Ukraine, not Fed jitters tied to the January FOMC meeting, was responsible for last month’s equity volatility.

“The intraday vol outperformance over close-to-close vol in January was the highest over the past 30 years,” they wrote (see the figure below).

As the annotation shows, the only comparable episode transpired around the LTCM crisis.

Kumar and Cassot went on to observe that the stock-bond correlation flipped during the period of peak Ukraine news flow. “Right from the beginning of January, both bonds and equities had been selling off simultaneously [but] bonds started to rally as equities were selling off during this period [in] classic risk-off price action,” they remarked.

The figures speak for themselves. The peak shown in the Ukraine story count chart coincided with a large intraday reversal in US equities.

Although European stocks didn’t exhibit the same anomalous spike in intraday versus close-to-close vol as their US counterparts, SocGen noted that the ruble (against the euro) tended to lead US equities in January.

They also mentioned dealer hedging flows as a likely accelerant. “The negative dealer option gamma during this period likely exacerbated these moves intraday — leading to huge swings in both directions,” Kumar and Cassot said. Remember, dealer gamma is the “core truth” of modern market structure, as Nomura’s Charlie McElligott put it earlier this month, in the course of recapping recent events and explaining why intraday swings have seemed so violent.

Writing on February 10, SocGen’s Kumar and Cassot noted that “longer-term volatility as observed in variance swap prices has come down… sitting below pre-Ukraine escalation levels, suggest[ing] the market has, at least in the interim, moved on from this geopolitical risk.”

Around 24 hours later, the situation flared anew. It’s safe to say Ukraine stories will multiply in the days ahead. Based on the January experience, that wouldn’t be the best news for risk assets.