Broken Markets, Big Headlines, Chickens And Eggs

Tuesday was about “broken markets” and “big headlines.”

That’s how Nomura’s Charlie McElligott described another day of incredible fireworks and epochal shifts, including a meltdown on the LME, a joint US-UK ban on Russian crude and what he described as a “potentially paradigm-shifting” plan in Beijing to aggressively raise stakes in Russian commodities companies, a move that could suggest Zoltan Pozsar’s latest prediction is already in the process of realizing.

Speaking of Pozsar’s predictions, it’s not just “Big Shot’s” nickel short that’s getting squeezed. Peabody found itself tapping Goldman for a $150 million multiple draw unsecured credit line after posting $534 million to satisfy a margin requirement on its hedges.

One key point — and McElligott underscored this — is that the read-through in rates from the commodities tumult is a reflection of the Fed’s dilemma. The figure (below) has a chicken-egg feel to it.

“With the exponential commodities moves, the move in breakevens to new highs has been accordingly violent,” McElligott wrote, noting that this is “becoming a two-way risk for the Fed.”

For months, policymakers stuck assiduously to talking points about well-anchored longer-term inflation expectations. That became a life raft of sorts once “transitory” had to be jettisoned. Now, though, the surge in raw materials prices risks being the final straw for weary consumers.

“These ‘sticky higher’ levels in forward breakevens risk resetting longer-term inflation expectations higher,” Charlie went on to say, before noting that at the same time, “the move in inflation is keeping real yields far too negative for the Fed’s liking.”

Lower reals are conducive to looser financial conditions, which is at odds with the Fed’s plans to tighten — they’re also an ostensible referendum on the outlook for the economy. BMO’s Ian Lyngen and Ben Jeffery on Tuesday called the recent decline in real yields a “palpable vote of no-confidence for the growth outlook.”

“It follows intuitively that 10-year breakevens are at record highs,” they went on to say, noting that “300bps is within striking distance and if Biden delivers on more sanctions related to Russian oil imports, another leg higher in breaks will be the path of least resistance.”

Well, Biden did indeed deliver. The US announced an embargo on Russian crude Tuesday. “We will not subsidize Putin’s war,” Biden said, addressing Americans, adding that “defending freedom comes at a cost.”