Financial markets were roiled this week by the Russian invasion of Ukraine. Rather than a limited incursion in the eastern region of the country a broad-based invasion was launched into all of Ukraine, triggering volatile selloffs in risk assets and forcing money into safe havens like US Treasuries and gold. Energy and commodity markets soared, with oil prices briefly surpassing $100 a barrel Thursday. As we approach the weekend Russian troops were threatening the capital, Kyiv.
Treasury prices jumped sharply on the flight to quality, bringing the 10yr T-Note’s intraday yield down to 1.84%, 22bps below the recent high of 2.06% established last week. It has subsequently traded back up toward 2%. Volatility is the word of the week, and there are now legitimate questions about whether and to what degree the Ukrainian mess might change the Fed’s calculus regarding rate hikes and policy stance. Some policymakers like Christopher Waller believe the Fed should remain focused on the data stream rather than geopolitics. He has no problem with a 50bps hike in March if the inflation readings continue to come in hot. Cleveland Fed President Mester acknowledged that the unfolding situation in Ukraine will be a consideration in determining the pace at which to remove accommodation, saying “time will tell whether Ukraine changes the outlook for policy”. But Atlanta bank President Bostic suggested that “we continue with our liftoff plan” if numbers come in close to what’s expected. The inflation situation is compounded by the war-related jump in energy costs which could push headline inflation even higher than its already-elevated levels. Expect the Fed to stay the course and start normalizing policy in March as planned… but a 50bps move is probably less likely now.
The yield curve has flattened even further in the wake of Ukraine. The yield spread between 2s and 10s is now inside of 38bps, the lowest level since April 2020 when the COVID pandemic was just getting started. Persistent curve flattening will be on the Fed’s radar as an indicator of slower growth coming down the pipe and raising the specter of stagflation if price increases don’t settle down.
Lost in the shuffle of war news was the drumbeat of positive economic data. The Case Shiller home price index rose 18.5% YoY, the purchasing manager’s index for both manufacturing and services beat expectations along with consumer confidence, personal spending, durable goods, and capital expenditures. The Fed’s preferred measure of inflation came in at 5.2% as expected. That level is the highest it’s been since Ronald Reagan was President and Vladimir Putin was a young KGB agent in training.
US 10yr vs 2yr T-Note Yield Spread
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