Russia/Ukraine – No relief yet.
The Russian invasion of Ukraine has entered its third week. Despite direct talks between Ukrainian and Russian foreign ministers in Istanbul, there has been no tangible progress on a ceasefire. The Kremlin is allegedly alarmed by the Russian military’s inability to capture Kyiv. Based on intelligence reports, Russia has about 4 weeks of ammunition left, though they are potentially saving their most lethal defence systems for last. We therefore expect the conflict to continue, rather than to deescalate. Russian asset prices have continued to fall as sanctions grow and more companies pull operations out of the country. Investors are debating whether the Russian government will pay its USD coupons due on March 16th. The Russian Finance Minister has indicated that as long as the sanctions are in place, the government will honour debt obligations but pay in RUB instead of a foreign currency. This would be an event of default, which is our base case. We do not see value in Russian assets despite them trading at very low levels, as we expect considerable economic deterioration and sanctions to remain in place for many years. On the other hand, we think Ukrainian asset prices are cheap. In addition to strong fundamentals prior to the invasion, there is increasing monetary support from the west. Last week the US congress agreed a $13.6bn aid package for Ukraine and the IMF have also approved $1.4bn in emergency funding. 

Fed Preview – Rates Lift-off ahead.
This Wednesday the Fed will likely hike rates and thereby herald the end of their historically easy monetary policy following Covid. A hike of 25bps seems given for the March meeting and is fully priced, following several speakers comments in favour of lifting-off this month, and Powell’s testimony backing 25bps as the base-case. Odds for 50bps are slim, currently only priced at 4%. In addition, details on QT will show if the Fed starts to run-off its balance sheet in June or earlier, and if they will start with mortgage holdings only amid liquidity concerns in US treasuries.

Last Thursday’s inflation prints showed no signs of abating, as month-on-month core inflation rose by 0.5% for the fifth month in a row. Paired with almost record tight labour markets at 3.8% unemployment, the picture for hikes is clear – if there wasn’t the Ukraine war. The negative supply shock in commodities affects both consumers and producers in the US, so far resulting in 2022-consensus revisions of growth by -0.2% and of inflation by +0.9%, since the war outbreak. Yield curves in the US are already flat and risk inverting, as Goldman Sachs estimates that the current 2y-10y yield spread implies a 20-35% probability for a recession in the next 12 months.

Markets currently price 160bps of hikes in 2022, implying a 91% chance they’ll hike 25bps at every of the seven meetings this year. We think that the risks to this pricing are to the upside, as persistent commodity inflation can cause second-round effects in the US, un-anchoring longer-run inflation expectations and forcing the Fed to frontload their hikes further.

Algebris Investments’ Global Credit Team