It Wasn’t Priced In

Losses continued to pile up for US equities on Wednesday amid a deluge of dour Ukraine headlines and what certainly looked (and felt) like more of the same in terms of accelerant flows and exaggerated price action.

Ukrainian government websites suffered a second apparent cyberattack in the space of a week, and the US said the Russian military is in an “advanced” state of readiness on the border. Vladimir Putin now has an estimated 150,000 troops on Ukraine’s doorstep(s). Russian forces are “as ready as they can be” for an invasion, the US warned. Ukraine told any of its citizens currently in Russia to get out immediately.

Separately, sources said the White House is considering tapping the SPR for the second time in six months in an effort to bring down crude prices. The news alarmed equities, which extended losses on the headlines. JPMorgan said crude could average $110 in Q2 on Ukraine risk. The S&P touched its lowest levels of 2022. The whipsaw continues (figure below).

“Institutional ‘day-trading’ of short-dated options is enhanced and incentivized by the pervasive ‘Short Gamma’ options Dealer profile [we’ve] been embedded in for the past two months on account of demand for hedges,” Nomura’s Charlie McElligott said, adding that this setup “naturally presses the day trend into the close,” which helps explain “remarkably wide intraday trading ranges and why we’re so often closing ‘on lows’ or ‘on highs’ nowadays.”

Also on Wednesday, Joe Biden sanctioned Nord Stream 2 and its corporate officers. The move came around 24 hours after Olaf Scholz effectively killed the link. “These steps are another piece of our initial tranche of sanctions in response to Russia’s actions in Ukraine,” Biden said, in a statement, promising “further steps if Russia continues to escalate.”

“Through his actions, President Putin has provided the world with an overwhelming incentive to move away from Russian gas and to other forms of energy,” Biden went on to say. Russia might counter that these are the types of measures which “provide the world with an overwhelming incentive to move away” from US dollars.

The problem, though, is that there’s no real alternative, especially not when you’re cut off from pounds and euros too. By contrast, there are other places to get oil and gas. As it turns out, the US produces quite a bit itself. Imagine that. And, in a bind, the White House can always draw up some new defense deal with the Saudis in order to compel the Kingdom to open the taps. Riyadh always wants more weapons and more security guarantees.

Unfortunately for multi-asset investors, bonds were no help at all during Wednesday’s rout. Treasurys were cheaper by up to five basis points, which was notable considering both the risk-off mood and a solid five-year sale. Simultaneous selloffs in equities and bonds (simple figure below) shouldn’t surprise anyone given the backdrop. But they’re vexing nevertheless.

“With the S&P 500 already down >10% year-to-date, to suggest there is growing apprehension in domestic equities would be an understatement,” BMO’s Ian Lyngen and Ben Jeffery remarked. “That said, with >160bps of hikes priced in for the year, if 10% is the depth of the correction in stocks owing to the Fed’s rate normalization efforts and Putin’s actions in the Ukraine, we’d characterize that as a vote of confidence for risk assets.”

That’s for sure. However, it’s becoming clear that Ukraine wasn’t priced in. Or, perhaps it’s more accurate to say traders priced in what they thought was the worst-case scenario, only to discover that shrill warnings from Western intelligence agencies weren’t merely “hysteria” after all. (Who knew you couldn’t trust the Kremlin, right?)

Suffice to say this isn’t over. None of it. To the extent Russia does plan a full-on invasion, it hasn’t started in earnest yet. And to the extent the Fed does plan a full-on tightening cycle, that hasn’t started yet either. It’s very difficult to imagine equities have seen the lows.

Writing Wednesday, Rabobank’s Michael Every called the first tranche of Western sanctions “milquetoast.” “They will see Russian oligarchs move yachts around, and cash, but they will not stop a Russian war machine rolling,” he wrote, adding that some market participants “posited that perhaps Putin could claim reinvading what he had already invaded once was a win and just sit there, grumpily; the West could sit on its weak sanctions, smugly; and then markets could ramp up again, rampily.”

It’s a nice thought. But, as he went on to say, Putin’s assertion that Minsk is dead, Biden’s contention that Russia has already invaded and the fact that Kyiv couldn’t acquiesce to the Kremlin’s demands even if it wanted to, means there may be no off ramp now.

In the same afternoon note cited above, BMO’s Lyngen and Jeffery wrote that “we suspect there is still more drama on the geopolitical stage to unfold before the market is comfortable completely moving on to trade what’s next.”