Rates Whipsaw After Russia Launches Attack on Ukraine

Crazy…wild…dramatic – all adjectives to describe the extreme volatility in today’s trading session. With the overnight news of Russia attacking Ukraine, risk assets were absolutely pummeled to start the session – Nasdaq down more than 3% and S&P 500 more than 2.5% in the red. But by the end of the day, both were in the black (Nasdaq +3.35% and SP500 +1.50%), representing the largest single-day recovery in nearly 15 years. Rates markets experienced similar volatility – UST yields/swap rates initially 13-15bps lower across the curve to start the day before retracing most of the decline to finish only 1-4bps lower. In energy markets, Brent crude crossed $100/barrel for the first time in 14 years, while natural gas futures in Europe surged more than 50%.

Cleveland Fed President Mester believes geopolitical tensions between Ukraine and Russia pose medium-term risks for the US economy. While Mester remains in support of a March rate hike, the conflict “will also be a consideration in determining the appropriate pace at which to remove accommodation.” Barring any unexpected turns in the economy, Mester believes a “series” of rate increases will be necessary after March to combat the risks of runaway inflation. Despite her hawkish stance, she believes a 25-basis point hike would be appropriate in March, as a half percentage point bump is “not compelling” as a starting point.

Inflation is forecasted to have jumped 0.6% in January. At 5.8% year-over-year, US inflation already at its highest level in 40 years, and tomorrow’s inflation report is expected to show it trending even higher. As the Fed’s primary inflation gauge, a continued rise in the PCE price index will drive conversations around the central bank’s plan to tighten their policy and could prompt officials to adopt a more aggressive hiking schedule.