“A wise guy’s always right,” Al Pacino’s Lefty Ruggiero told Johnny Depp’s Donnie Brasco, during a discussion about Cadillacs and mistresses. “Even when he’s wrong, he’s right.”
The same goes for repo “oracle” Zoltan Pozsar, apparently. Even when he’s wrong, he’s right.
Last weekend, after Western nations moved to sever the Kremlin’s ties to the global financial system, Pozsar suggested central banks might need to intervene to calm funding markets. Although there was consternation aplenty, and notable spread widening (figure below), there was no real panic, per se.
But that doesn’t mean Pozsar was wrong. Like Lefty, he’s always right. “Yes, we got central banks’ need to step in to calm funding market pressures this week wrong (still no need yet), but we got the direction of spreads right,” he wrote, in a new note. “There was no premium last week but there is some funding premium now, and it feels that things can get worse still, so net-net, our call was absolutely right.”
In his latest, dated March 4, Pozsar backed away from last week’s Lehman analogy. Sort of. But not really.
“Again, we are not saying that we are about to have another Lehman moment, only that things can get much worse than you realize,” he said, before summing the situation up in refreshingly straightforward terms.
“When you rip $500 billion of FX reserves from the system, sanction and de-SWIFT banks (which goes live March 12th), and force Western banks and commodity traders to self-police and not trade commodities from the single-largest commodity producer [in] the world (Russia), unforeseen things can happen and do happen,” Pozsar explained.
That captures a lot in a few words. What became clear over the past several days is that although a formal embargo on Russian energy and commodities could be used as a last resort, it’s somewhat superfluous currently. Rather than risk running afoul of the US Treasury, market participants are self-sanctioning — they’ve gone on what some analysts described as a “buyers’ strike.” Nobody wants to get caught up with OFAC sanctions. That’s among the riskiest things you can do.
This is a problem, and not just because it threatens to push up inflation at a time when price pressures are already the most acute in a generation across many Western economies.
“If you believe that the West can craft sanctions that maximize pain for Russia, while minimizing financial stability risks in the West, you could also believe in unicorns,” Pozsar went on to say. The catalyst for funding pressures so far isn’t the straitjacket on CBR or knock-on effects from the SWIFT bans, “but rather the market’s self-imposed unwillingness to buy, move or finance Russian commodities,” Zoltan wrote.
That unwillingness is “driving the current massive bid for cash,” he said, noting that if the rally in raw materials is one for the history books, “so the margin calls must be historic too.”
By Friday afternoon, what was already the largest weekly commodity rally in history was even more impressive. The figure on the left (below) shows Bloomberg’s spot index rose an unthinkable 13% over the week.
The figure on the right (above) gives you a sense of the trajectory.
Pozsar proceeded to speculate on a tsunami of margin calls for market participants long physical commodities and short futures.
“These include every commodity producer in the world including Russia, and every major commodity trading house, respectively,” he said, emphasizing that although he’s not privy to such things, “it’s reasonable to wonder if Russian commodity producers are experiencing margin calls now.”
If they are, how are they supposed to pay? For one thing, Vladimir Putin made the transfer of hard currency illegal. The decree included debt service payments. More broadly, Pozsar wondered if producers might just decide not to pay given that the central bank’s reserves were seized (or most of them, anyway). Commodity trading houses, meanwhile, might need to fund margin calls by drawing down credit lines, among other measures.
You may have read that Urals is offered at a massive discount. Shell just bought a cargo from Trafigura at $28.50 below Dated Brent, for example. Rosneft is in the process of trying to sell 83 million barrels. This matters. Potentially a lot. “Commodities are collateral and every crisis occurs at the intersection of funding and collateral markets,” Pozsar wrote, in the same note, before equating Russia’s discounted flagship grade to subprime CDOs suddenly being downgraded from AAA to junk.
“Will all commodities sourced from Russia trade at a significant discount?”, he wondered. And then: “Is it possible that the Western boycott of Russian commodities is turning AAA commodities to junk?” Finally: “Does going from AAA to junk trigger margin calls?” Zoltan’s answer: “You bet!”
That was hardly the end of it, but it did mark a kind of chapter break, if you will. From there, Pozsar shifted gears, but not before summarizing the main risk posed by everything noted above. I’ll leave you with the following excerpt, which is vintage Zoltan:
We could be looking at the early stages of a classic liquidity crisis that has elements of both collateral and liquidity problems (1998 and 2008), where some players — commodity traders — are not regulated and have no HQLA, and some players — state-linked commodity producers — are not liquid enough because their backstop — the Bank of Russia’s FX reserves — has been seized. I don’t know, but neither do you and that’s worth some funding or risk premium.
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