Scorched Earth
Doug Nolan
The week experienced the problematic scenario for highly levered global markets: sharply lower stock prices, widening spreads/risk premiums, rising Treasury/sovereign yields, and currency volatility.
Seemingly no place to hide, with virtually all strategies faltering.
De-risking/deleveraging has rapidly intensified.
This is precisely how crises erupt, and the metastasizing Iran War poses clear and present catalyst risk.
All bets are off if hostilities continue to expand.
And while the Islamic Revolutionary Guard Corps (IRGC) military power is rapidly neutralized, it still holds alarming power over global markets.
The S&P500 dropped 2% this week.
This moderate decline was not reflective of the stress throughout global markets.
Myriad speculative Bubbles faltered.
At Tuesday’s lows, the South Korean KOSPI Index was down 20% from the previous Friday’s high.
Wednesday's sharp rally cut the week’s losses to 10.6%.
Japan’s Nikkei 225 index fell 5.5%, with Japan’s TOPIX Bank Index hit 7.6%.
Major indices were down 5.1% in Taiwan, 7.9% in Indonesia, 8.0% in Thailand, 4.6% in the Philippines, and 6.0% in Vietnam.
Stocks were down 6.8% in Pakistan and 6.7% in Turkey.
European equities were under heavy selling pressure.
Losses included France’s CAC40 at 6.8%, Spain’s IBEX 7.0%, Italy’s MIB 6.5% and Germany’s DAX at 6.7%.
Ominously, Europe’s STOXX 600 Bank Index was clobbered 8.2%, the largest weekly loss since “liberation day.”
Italian banks sank 9.6%.
UK’s FTSE 100 equities index dropped 5.7%.
Global equities were hammered.
But I would be more concerned by the week’s bond market drubbings.
Unprecedented leverage, having accumulated throughout global markets, ensures latent fragility.
And when the tide starts to go out, markets have a pretty clear understanding of who has been swimming in their birthday suits.
UK yields spiked 39 bps this week to a five-month high of 4.63%, this biggest jump since gilt deleveraging crisis week, September 23, 2022.
Italian yields surged 35 bps to a six-month high of 3.62%, and Greek yields jumped 33 bps to an almost one-year high of 3.60%.
Local bond yields spiked 72 bps in Peru (6.60%), 58 bps in Brazil (14.15%), 50 bps in Poland (5.53%), 46 bps in Hungary (6.94%), 45 bps in Czech Republic (4.84%), 40 bps in Turkey (28.86%), 38 bps in Romania (6.67%), 37 bps in South Africa (8.62%) and 24 bps in Mexico (9.03%).
Emerging Market CDS jumped 10 this week to a five-month high of 145 bps, with the largest two-week gain (17bps) since April.
War will stoke inflationary pressures – and is certain to increase already monster fiscal deficits.
Not the 50 bps “liberation day” yield spike, but Treasuries were liquidated aggressively.
In a portentous repeat of April dynamics, safe haven buying was MIA.
Five-year Treasury yields surged 23 bps to 3.73%, while 10-year yields jumped 20 bps to 4.14%.
As they tend to do in unstable markets, MBS took it on the chin.
Benchmark MBS yields spiked 26 bps to 5.07% - the largest weekly rise since “liberation day.”
“Muni Bonds See Biggest Decline Since Tariff Fueled-Selloff.”
Treasuries are prominent throughout levered strategies.
They are also integral to scores of hedging strategies.
Importantly, systemic deleveraging risks quickly escalate when Treasury yields surge in the face of “risk off” market dynamics.
Bloomberg:
“Credit Traders Are Unwinding Their Gigantic Bullish Position.”
In a problematic development for highly levered trades (i.e., “basis” and “carry trades”), “swap” market volatility this week went into overdrive.
The 30-year Treasury (vs. overnight swaps) swap rate dropped 5.6 this week to negative 79 bps, essentially matching the decline from “liberation day” week April 11th (down 5.7bps) – which was the largest drop since December 2022.
The five-year inflation expectations “breakeven rate” surged 17 bps to an almost one-year high of 2.62%.
High-yield CDS jumped another 18 this week to a near nine-month high of 349 bps, with a notable two-week surge of 42 bps.
The seven bps jump in investment-grade CDS (to 10-month high 58 bps) was the largest two-week gain since April.
European subordinated Bank CDS jumped 10 to 111 bps (high since May) – with the largest two-week gain (20bps) since the week of April 11th.
It’s worth noting that a couple UK banks led the global bank CDS leaderboard, with NatWest CDS jumping six to 60 bps and Barclays five to 69 bps.
European high-yield (“crossover”) CDS surged 28.5 to 289 bps, the largest weekly move since “liberation day” week (64bps).
Friday’s 15 bps jump was the largest daily move since September.
“Fuel Prices Double in Asia as Supplies from Middle East Collapse.”
“Aluminum Records Biggest Weekly Gain Since 2023 on Iran Crisis.”
“Iran Conflict Sparks Global Rush For Critical Fertilizers.”
“Fertiliser supplies threatened by closure of Hormuz, prices soar.”
“Wheat, Corn Futures Rise as Iran War Disrupts Fertilizer Supply.”
“Wheat Climbs the Most Since 2024 as Grains Follow Surging Crude.”
“Iran War Threatens Vital Supplies to Farmers.”
The Bloomberg Commodities Index jumped 8.0% (to a near four-year high), the largest weekly advance since Russia’s invasion of Ukraine.
Crude’s (WTI) 36% advance was the “largest weekly gain in history.”
I can’t help but believe the President bet that the incredible strength of U.S. and Israeli military forces ensured a quick and decisive victory.
And while war justifications have gone through a series of modifications, I’ll assume Trump and Netanyahu simply couldn’t resist a weakened and vulnerable Iran.
Secretary Hegseth likes to use sports analogies.
For President Trump, there are elements of a “heat check.”
All indications suggest American and Israeli militaries have performed exceptionally.
Trump and Hegseth exude confidence – clearly emboldened and resolute.
And we can pray this gets wrapped up in a few weeks.
It’s reasonable to presume that the U.S., Israel and the world will be safer following the downfall of Iran’s extremist regime.
The problem I have, as someone who has been alarmed by mounting risks of “World War III”, is that this war is exactly how one might script the start of a major global confrontation.
March 6 – Washington Post (Noah Robertson, Ellen Nakashima and Warren P. Strobel):
“Russia is providing Iran with targeting information to attack American forces in the Middle East, the first indication that another major U.S. adversary is participating — even indirectly — in the war, according to three officials familiar...
The assistance…, signals that the rapidly expanding conflict now features one of America’s chief nuclear-armed competitors with exquisite intelligence capabilities.
Since the war began Saturday, Russia has passed Iran the locations of U.S. military assets, including warships and aircraft, said the three officials, who spoke on the condition of anonymity...
‘It does seem like it’s a pretty comprehensive effort,’ one of the people said…
When asked this week about his message to Russia and China, which are among Iran’s most powerful backers, Defense Secretary Pete Hegseth said that he didn’t have one and that ‘they’re not really a factor here’.”
It’s difficult to believe that Russia and China will not be factors as this war unfolds.
Iran is a close ally.
And I have little confidence that the Trump administration carefully thought through ramifications – some potentially monumental.
Certainly, this move has stunned the world.
Countries, previously known as allies, are flabbergasted.
Friendly Middle East nations must be absolutely enraged.
And while this Pete Hegseth “warrior ethos” show might play well with MAGA, it certainly does not instill confidence for much of the country or the world.
Odds are not remote that this goes terribly wrong.
In an acutely unstable and hostile world, our nation has become only more isolated.
It was ill-advised timing to embark on a major war with myriad risks so elevated.
Our military’s supply of key munitions has become worryingly depleted.
Throughout the Gulf, interceptor inventories are said to be dangerously low.
A catastrophic scenario of unrelenting attacks on regional energy infrastructure cannot be dismissed.
The Strait of Hormuz turning into a disaster zone is also within the realm of possibility.
The Iran War also has the potential to be disastrous for a vulnerable Ukraine.
Their shortage of Patriot missiles and interceptors will become a pressing issue, certainly to be exploited by Putin.
And a more aggressive Russian military assault will force Europe into a more forceful Ukrainian defense, increasing the likelihood of overt confrontation.
“We’re going to have to choose that person along with Iran.
We’re going to have to choose that person.”
Politico: “Asked how much influence he expects to have over Iran’s future leadership,
Trump replied:
‘I’m going to have a big impact, or they’re not going to have any settlement, because we’re not going to have to go do this again’.”
“People are loving what’s happening… Cuba’s going to fall, too.”
“I have to be involved in the appointment, like with Delcy in Venezuela.”
“What we did in Venezuela, I think, is… the perfect scenario.”
“It’s going to work very easily.
It’s going to work like in Venezuela.”
I’ll borrow a line from the New Republic’s Alex Shephard.
“Trump burbles on as if long-term implications are woke.”
Clearly, circumstances in Iran have nothing in common with Venezuela.
March 1 – The New Arab:
“The killing of Iran’s Supreme Leader Ayatollah Ali Khamenei has triggered an immediate and emotionally charged response from Shia outside Iran, from senior clerics and militant leaders across the Muslim world, to protesters on the streets of South Asian and Middle Eastern cities.
While Tehran has entered a formal transition period, reactions beyond its borders reflect the extent to which Khamenei was seen not only as Iran’s leader, but as a central political and symbolic figure for parts of the wider Shia world.
Khamenei’s influence extended well beyond Iran’s state structure.
As Supreme Leader under the doctrine of Velayat-e Faqih, he combined religious authority with ultimate political control over the Islamic Republic…
In Iraq, Grand Ayatollah Ali Sistani, the country’s most senior Shia cleric, issued a statement mourning Khamenei and acknowledging his ‘unique role in leading the Islamic Republic of Iran for many years is evident to all’.
Sistani urged the ‘great Iranian people’ to ‘maintain their unity, to stand firm and thwart the aggressors’ sinister goals’.”
“There will be no deal with Iran except UNCONDITIONAL SURRENDER!”
I have not heard of one analyst schooled in history who believes Iran will surrender without one hell of a fight.
If the President is serious, expect bombing 24/7 - for the duration.
I’m not sure the American public and global community will have the stomach for what will be day-after-day of horrific “collateral damage.”
It’s only a matter of how devastating the unfolding tragedy becomes for the desperate Iranian population.
We are fortunate to live thousands of miles from two major wars, with the Iran War potentially evolving into a proxy war parallel with the war in Ukraine.
The President clearly doesn’t recognize the vulnerability of U.S. and global market Bubbles – the unprecedented speculative leverage - the growing fragility of the U.S. Credit system – the potential for de-risking/deleveraging to unleash instability and mayhem.
With both sides gaining further momentum this week, the Credit problems vs. AI arms race collision course accelerated this week.
To be sure, after the past week’s happenings, we’re now much closer to speculative deleveraging, triggering market illiquidity, panic and dislocation.
With atrocious timing, the outbreak of war is quite a booster for festering Credit issues.
Unless TACO makes a miraculous appearance, the Trump “put” is a major war casualty.
And with the war posing significant inflationary risk, confidence in the Fed “put” is not where fragile markets need it to be.
In short, things could really run amok.
Blue Owl slumped another 6.3% this week, boosting y-t-d losses to 33.8%.
Blackstone was down 2.6% (down 28.4 y-t-d), and Ares Management fell 1.8% (down 31.9%).
KKR was squeezed 4.2% higher (28.4%), and Apollo recovered 3.9% (24.9%).
The KBW Bank Index dropped 3.6% this week, and the Broker/Dealers lost 3.7%.
Goldman Sachs fell another 4.4% and Morgan Stanley lost 3.8%.
Providing evidence of hedge fund de-risking, the Goldman Sachs Most Short Index outperformed, gaining 2.3% this week (up 8.8% y-t-d).
March 3 – Bloomberg (Rene Ismail):
“Business development companies are sitting on a massive pile of leveraged loans, which could be sold to meet redemption requests and push spreads wider, according to Deutsche Bank AG analysts.
BDCs — private debt funds that bundle direct loans — own nearly $143 billion of leveraged loans…, more than the $120 billion currently held by leveraged loan funds.
The BDC market is already down about 11% so far this year…
Redemption requests have been picking up across BDCs in recent quarters, fueled in part by anxiety over the potential for AI to disrupt the business models of the software industry, a mainstay of both the private credit and leveraged loan markets.
Further withdrawals could force private debt managers to liquidate those loans.
‘If BDCs start to place greater weight on the outflow risk, more selling will emerge in dollar-denominated leveraged loans, and we would expect a broader spread widening to emerge,’ wrote the analysts…”
March 3 – Bloomberg (Laura Benitez):
“Apollo Global Management Inc. Chief Executive Officer Marc Rowan warned that a shakeout is coming for private credit firms as the industry faces a wave of concerns about rising defaults on loans to software companies.
For weeks, private credit executives have faced questions from investors over whether the $1.8 trillion industry can withstand sustained pressure if the software sector is upended by artificial intelligence in the coming years.
Rowan’s comments came as business development companies have been hit by redemptions in recent weeks amid those broader investor concerns. ‘This will be a shakeout — I don’t think it is going to be short term,’ Rowan said...
‘It was foreseeable.
It was predictable.
And all you can do is have been a good underwriter, a good risk manager, have done a small number of stupid things’.”
March 3 – New York Times (Steven Erlanger):
“The Islamic Republic of Iran’s first priority is to survive.
To do that, its leaders will want to drive up the cost of the war for President Trump — in terms of American casualties, energy costs and inflation — to try to persuade him to declare victory and go home.
Faced with the overwhelming firepower of the United States and Israel, diplomats and analysts say, Iran is working to enlarge the battlefield from its own territory to the broader region.
The goals are to damage oil and gas infrastructure in neighboring countries, shut the Strait of Hormuz to shipping and curtail air traffic — all to disrupt the economies of the Persian Gulf and drive up global energy prices and inflation.
Iran will also be trying to exhaust the number of expensive missile interceptors held by its enemies.
‘The war has become a test of wills and stamina,’ said Vali Nasr of the Johns Hopkins School of Advanced International Studies…
‘Iran is facing qualitatively superior militaries, so the strategy is to test their will by expanding the battlefield, complicating the war and increasing the danger to the world economy’.”
Scorched Earth.
0 comments:
Publicar un comentario