Notes From Underground: To Russia With Love (Or Blinken Blinked)

Ten days ago, we published a blog post titled, “Sanctions Are Sanctimonious.” And lo and behold, this past week the U.S. moved to remove sanctions on the completion of the NORDSTREAM 2 pipeline, allowing Russian gas to flow freely and readily into Germany without paying the massive transit fees to the Ukraine. This is the culmination of the project promoted by previous German Chancellor Gerhard Schroeder.This story is huge for it shows that the world is — as NOTES portrays it — far more dynamic than the static analysts would have us believe.


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It seems like yesterday that Secretary of State Antony Blinken was asserting the U.S. to place even more sanctions on Russia as his boss was calling Vladimir Putin a thug and a murderer. The Russians took advantage of the “good news” and issued a long delayed bond offering and sold close to $2 billion of five- and 10-year debt. Also, if the removal of sanctions is indicative of more positive things to come, watch the ROUBLE, which has closed above the 200-day moving average for the last few days. I have remained long of RSX, the Russian fund for the past few years as it provides a solid yield but is far too heavy with energy/fossil fuel. Plus, the Russian central bank is helmed by one of the best bankers, Elvira Nabiullina.

The Biden administration is courting Russia for either an attempt to get greater support for a new Iran deal or, as some of NOTES readers have suggested, trying to move Russia a bit further away fro China. These are good conjectures as is also the idea that the U.S. is trying to repair some of the ill will with Germany created by the Trump administration. Given the way the DAX closed against the SPOOS it may be that repairing relations through removing sanctions on Russia will help generate greater economic activity in Germany. The S&P/DAX closed below the 200-day moving average.

However, it remains to be seen whether the newfound strength in the DAX can be sustained. The DAX has performed well with the EURO currency finding strength as the differential between German/U.S. yields has narrowed by 25 basis points. There are positives for Europe as it attempts to rebound from the huge destruction of the Covid virus. Lots of issues to contend with but listen to the markets for guidance.

The SANCTIONS relief for Russia hints at some big deal on the offing. (As an aside: President Zerensky of Ukraine is very upset with the U.S. decision to remove the Nordstream sanctions, which will create a headwind for the Ukrainian economy.) The removal of the SANCTIONS is more critical than last week’s release of the FOMC minutes. And it appears that Vladimir Putin has again outmaneuvered the Biden/Obama foreign policy team just as he did in Syria in 2013. (This is not partisan politics but facts on the ground.) Many things in motion with potential for spurring market volatility.

***On Friday, the New York Fed’s Liberty Street Economics blog published a post titled, “Is the United States Relying on Foreign Investors to Finance Its Bigger Budget Deficit?” The article notes that the Treasury’s Statement of Public Debt climbed to over $21 trillion from $16.7 trillion over the course of 2020. This hasn’t been a problem because U.S. private savings have skyrocketed and the FED is still buying $120 billion of assets every month.

As Stan Druckenmiller recently discussed and the article supports, foreigners have been NET SELLERS of TREASURIES. But if the extra savings generated during the pandemic disappears as private spending ramps up, the U.S. will be more dependent on foreign financial inflows. The post ends on a very cautionary note. The authors said, “The amount of U.S. borrowing has to be equal to the sum of net lending by the rest of the world. Essentially, any increase in the U.S. saving shortfall has to be matched by a bigger saving surplus elsewhere and the mechanism that makes this identity hold has very unclear implications for exchange rates and global asset prices.”

This is a critical factor as the U.S. and the FED have kept real interest rates deeply negative. How high will rates have to go in the U.S. to attract money? This is why NOTES continues to stress that a world’s reserve currency needs to act as a genuine fiduciary. HOW HIGH WILL WE SEE RATES RISE in an effort to attract investment? What will be the damage to equity and bond prices that have operated on far too much leverage? If not now, when?

***Is a FED adjustment to its administered rates really a market-moving event (outside of the funding markets, that is)? This will need to be considered but on first blush it seems laughable. But the market seems to think it might be a bigger deal. Sorry, I just don’t get it as it would be a move to fix the fragility in the short end.

The bigger issue will be if the FED moves to lessen the pressure on the reserve markets and begins buying longer term Treasuries. There are many questions to be answered in the next few weeks as how to resolve the excess reserve and banking regulations that are causing imbalances in the short-term funding markets. Take a look at the commentary from Credit Suisse’s Zoltan Pozsar and Bank of America’s Mark Cabana to educated yourselves.

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