Dips And Rips

We are Institutional Foreign Exchange Tradingstill in a trading mode, not forextrustindex mode, quite yet. 

There was a complete turnaround in risk assets yesterday due to what was perceived as a lack of significant US/EU sanctions against Russia (status quo for SWIFT payments and energy exports) and no NATO troops being deployed to Ukraine (which was always a low probability event anyways), resulting in E-Mini recovering from -2.5% to close up 1.5% at 4288 while NASDAQ was up 3.4%, with gold and crude giving up their gains as well.

These appeared to be little in the way of large-stop out or panic activity given the volatility of the moves, 

Fed speakers Bostic and Mester reiterated that hikes remain data-dependent, with another strong US auction of 7-year and dealer takedown at multi-year lows rounding off an intense week for supply.

It feels like while markets believe the worst-case scenario has been sidestepped for now in terms of sanctions on Russia, investors are likely to wait to see how events play out over the weekend before sizing up positions.

PCE data due later will provide further insight into the current domestic inflation dynamic in the US.

Over recent days, financial markets had started to prepare for a worst-case scenario in the Russia-Ukraine conflict. As a result, the latest escalation has led to fierce price action but no panic selling. 

Investors might start to try and fade the geopolitical crisis, notably as SWIFT and energy were carved out from the sanctions packages.

The critical near-term risk is what happens to energy prices; beyond that, the main question is how monetary and fiscal policy will respond to a stagflationary shock and w whether the Fed and ECB will stick to their normalization plans.

However, since the US economy is likely to be one of the least affected by the goings-on in Europe, the US dollar could remain bid and US stocks supported as war drums beat in the background.

Gold

I think gold will continue to take cues from the energy market and the USD/RUB. Still, The US stands out as the economy with the least direct negative growth impact of the crisis versus Europe, so beyond the near-term uncertainty, the ultimate Fed conclusion may well lean hawkish.

So far, Fed members, even the usually dovish Bostic, didn't seem to be too bothered by the situation in Ukraine, at least from an economic or policy point of view.

And with risk starting to stabilize, there is less need for gold as a hedge.

Still, I think prudence suggests holding some gold in your back pocket as we are not out of the fog of war just yet, even despite some thought that post-sanctions might mark peak uncertainty from a market viewpoint.

Oil

Speculation by traders does not necessarily make for rational pricing of risk. The oil prices grabbed the headlines, although this is a reflection of risk pricing (neither supply nor demand has changed)

While sanctions have been levied, energy has been carved out as ultimately, Europe needs Russian gas more than Russia needs to sell gas to Europe, and it seems clear that this latest escalation sets the stage for protracted negotiations and an extended period of oil and natural gas reflecting a much higher geopolitical risk premium.

Against this backdrop, the hope of a new Iran deal is lost in the fog of war. I still think a new deal could trigger a significant correction in oil, but risks are skewed to the upside even with the return of Iranian volumes. At the same time, the Russia/Ukraine situation remains unresolved.

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