‘The Stagflation Tail Just Picked Up Massive Delta’

The assets most at risk from Vladimir Putin’s decision to invade Ukraine are Russian assets. That was on full display Thursday. Local equities suffered an unfathomable drop, for example.

But outside of assets with direct (i.e., literal) exposure to Putin, and, of course, commodities (more on that below), rates and sovereign bonds are perhaps the most vulnerable to a near-term reversal, as the knee-jerk flight to safety presents a “problem for consensus ‘short’ positioning,” Nomura’s Charlie McElligott said Thursday.

CTA triggers are max short across G10 bonds (figure below) as central banks’ hawkish pivot (which accelerated this week when RBNZ delivered another hike), emboldened bearish wagers. The same goes for front-end rates. “CTA model net bond exposure is 4.3%ile since 2010,” McElligott noted.

Of course, any initial bid for duration (i.e., haven buying amid the Ukraine panic) would need to be considered against the inflationary read-through of the conflict in eastern Europe.

“Be mindful of the potential implications of the inflation catalyst here,” McElligott went on to say, pointing to the figure (below) which shows various trajectories for the energy component in Euroarea CPI under different assumptions for oil prices.

Brent rose beyond $100 on Thursday following Putin’s military strikes. As Nomura’s FX team noted, Russia was projected to account for some 13.5% of all global fuel exports this year. In 2019, they were responsible for around 40% of the EU’s natural gas imports and a third of crude oil imports. And then there’s metals, wheat, coal and so on.

Agricultural commodities are in the spotlight too, for obvious reasons. The risk of production disruptions in Ukraine is now very real, and Russia is the world’s largest exporter of fertilizer. Its share is even larger if you include Belarus, Nomura observed.

The bottom line, to quote Charlie, is that “the ‘stagflation’ tail just picked up massive Delta,” as yet another inflation shock looms at a time when central banks are constrained in their capacity to bolster their respective economies by the necessity of combatting inflation.

Summing up, McElligott wrote that “this means global central banks are either going to have to push back and hike regardless in an attempt to tame the inflation beast, pulling-forward eventual ‘Stagflation’ or even ‘Recession’ odds rapidly in the process or, conversely, that we are going to have to digest even higher and more persistent inflation, while [policymakers] try to prevent yet another growth shock through an attempted calming of financial conditions and market vol.”