Though much has changed, much is still the same


The ideas and thoughts that follow are those of the author.  Funds on the Quay Partners platform may seek to take positions in the securities and countries mentioned. 

My thoughts are with those affected by the tragic events that are occurring in Ukraine.  Regardless of whom we think is it blame for the position we find ourselves in, we are all united in hoping for a rapid de-escalation with a minimal loss of life.

What is very interesting to me is how quickly everyone has become an expert in this topic.  Often it is the same people who were also experts in Covid.  I am envious of such a skillset and only wish I had this ability.  In a race to be first, we have taken for granted the importance of accuracy.  So much has been said this past week that I personally have had great difficulty understanding the difference between reality and perception.  Between fact an opinion.  However, conversations I have had fill me with optimism.  More people are asking difficult questions and importantly demanding answers.  I encourage everyone in the pursuit of truth and dialogue.  It may be one of the only good things that comes from this.

I do not claim to be an expert on Russia or Ukraine.  I think to do so, would require one to have a thorough understanding of history, culture, geography, and geo-politics.  As well as having the ability to understand Russian and Ukrainian.  I cannot claim expertise in any of these.  Therefore, I will not attempt to try to explain how we have arrived at the circumstances we find ourselves in.  I feel an article on LinkedIn would not do this topic justice or provide it with the respect it deserves.  My focus will be on the financial market impacts of what we are currently experiencing and where it may lead us.

On Thursday 24th February, Russia invaded Ukraine.  The initial reaction from financial markets was as expected with equities lower and a general “flight to quality”.  What surprised me was the rapidity of the rebound in risk assets experienced on Thursday and the continuation of it into Friday.  Understanding why this may have happened could allow us to better decide where we may headed.

Some of the reasons that have been cited follows.  They are by no means exhaustive:

  • Russia is an isolated issue that will not have broader ramifications.
  • People were already short risk going into it, so the moves were not as dramatic as expected.
  • Linked to the above, people are very heavily positioned long in commodities.
  • The issue with Russia will mean that central banks will not hike as aggressively out of fear of destabilising the market.
  • The sanctions that have been put on are not that serious, so nothing to be concerned about.

People are certainly long commodities.  Fund manager survey suggest as much.  The sanctions that have been placed on Russia are interesting in what they do not cover.  There has been no attempt thus far to punish Russian energy.  The governments in Europe and the US understand that to do so would push energy prices even higher and certainly cause political pain.  Without the added pressure of sanctions on commodities to drive them higher, it becomes harder to justify holding longs.

The VIX curve has been inverted for some time and equities have been moving lower for a while.  So there certainly would have been accumulation of hedges that need to be taken off.  Perhaps a thought that we have seen the worst and complacency pervades market participants.

The interpretation around central bank response functions is very interesting and warrants further analysis.

Let us do a thought experiment:  Imagine that Russia was not an issue.  Supply chain bottlenecks would still need to be worked through post covid.  Governments are encouraging wage increases where possible.  A lack of capex in energy is testing inventories with very little in the way of supply if there were an adverse shock.  The push towards green energy is doing the same.  Ratios of vacancies to applicants is high.  Overall, we can conclude that there would be an inflation issue.  The question really becomes one of extent.  The central bank response is to increase rates to suppress demand, thus causing a relief on the supply side.  Hopefully this can be done without unemployment going up or causing too much damage to growth.

The situation with Russia and Ukraine may get better, worse or stay the same.  In the first scenario we end up in the backdrop of our thought experiment.  In the other two, we bring the inflation problem forward and potentially exacerbate it.  If sanctions are placed on energy, then we will all have to become accustomed to higher prices across the board.  The status quo may lead to increased spending on cyber security.  Conflicts are not known to be deflationary.

So, for me, I do not think that the backdrop changes much.  Central banks may still need to hike aggressively regardless of the geo-political situation.

I still like the short EUR and short GBP trades.  This week consumer confidence and retail sales in the UK fell.  Both points were ignored given the headlines elsewhere.  Perhaps higher energy prices are finally starting to hit consumers.  In Europe, I think we will struggle to get a coherent and effective response to the situation in Russia.  I do not subscribe to the notion that Russia is an isolated issue.  It is clearly bad for growth and sentiment.  I think Europe and UK will suffer.

Talk has increased around China potentially taking more aggressive steps towards Taiwan.  I have no view on this.  People do like stories and extrapolating but whether there is any truth to this remains to be seen.  What is clear is that China rates have stopped moving lower despite easy policy. This is very interesting.  Fixed income no longer can be viewed as a safe haven.  Maybe Asia now becomes a net importer of inflation from the rest of the world as supposed to an exporter of deflation as they have been historically.

Japan is the clear outlier globally with respect to policy.  It is where we can see the most change.  JPY has been trading poorly with very little strength shown even during the Russia escalation.  20% of imports are fossil fuels.  With prices remaining elevated and a weak currency, it is only a matter of time before they will need to change tack on policy.  I will stay long JPY and also inflation linked stocks in Japan but do note the poor performance of the former.

Real rates have been moving higher in the US, but gold prices have been going up.  This was before the Russia/Ukraine situation deteriorated.  If budgets are about to blow out more then I think owning gold and being short real rates could work quite well.

It seems even though much has changed, much is still the same.

Good luck!




Quay Partners Group is a service-as-a-platform investment management solutions for independent hedge fund managers and family offices.

 Supun Ekanayake is a Partner at Quay Partners Investments (UK) LLP and has over 15 years’ experience trading across all asset classes.          

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 26th February 2022