War Is A Balence Sheet
The fog of war and money
Pricing risk has always been some slippery voodoo, and it’s about to get worse. The French Bond sell-off I wrote about the other day showed just how quickly an energy-price assumption – once spooked – can flip into a financing problem. The blind spot is that the global market system which moved in fairly predictable patterns since World War II has undergone a radical upheaval. The lessons you are drawing from those old patterns are less relevant with every new shock to the system. Say that out loud and are going to make your friendly quant a lot less likable.
Take oil prices. Brent crude is currently prices some 20% over-pre-war sales, even though volumes have largely recovered. It’s more a matter of logistics than supply: since the fighting started the market has seen spasms of whiplash in the available shipping of uneven supply, blockades and impounding of black fleets. Then there is the fear which trades at a premium while being divorced from the fundamentals. It’s no good betting on what the market should do, it can stay wrong longer than you can stay solvent.
The knock-on is those higher oil and shipping costs feeding through the system to make everything more expensive and central banks reluctant to cut interest rates. This squeezes customers and businesses, weakening both demand and tax revenue. When that happens you get a “flight to safety” which is bond-speak for your money is scared and wants to come out of the rain. This explains why this uneven misery has relieved the pressure on the 10-year Treasuries.
If you’re looking for a new pattern du jour - the greenback is rising and falling tightly with the price of oil. The opposite is true of the Euro which is rising on falling oil prices. The logic is straightforward: Euro debt offers higher yields along with some elevated risk. When investors get really spooked, they tack towards safe-havens. Markets are currently vibrating toward a panic with the “hotting up” in the Strait of Hormuz after the mid-terms. This is true of all conflicts, but in Iran the uncertainty is exacerbated by the shifting randomness of strategy and war aims. For investors, there is simply no good way to calculate on off ramp.
A Long Kick Down the Road
So much for the short term calculations. Iran isn’t the only conflict that has Europe worked into a corner. Vladimir Putins has changed the continent’s immediate and long-term security calculations. Increased defense spending will boost EU manufacturing but – like AI – those returns are years off. Even a cease-fire and lifting of Russia sanctions won’t change the underlying fact that the bloc is in the pocket of a super-power for its security and a deranged czar to keep the lights one. If Europe ever plans to be the master of its own fate again, it will require both a security and energy built out that - setting generous future commitments against measly tax receipts – it can’t afford. Meanwhile, European voters have taken to the streets for promises those tax revenues can’t keep.
Liberal democracies, it seems, are very good at kicking the can down the road.
The Feild Guide
An energy shock, defense and energy security build-outs, insane rioters and even weaker growth might each manageable. In concert, heavily indebted governments face high borrowing costs, over-taxed taxed citizens, wilting domestic economies and existential foreign threats is triggering intense anxiety. And with good reason, a nasty attack after the mid-terms may spike prices to $130+. That fear premium is now bleeding from energy markets to the S&P, big tech and critical minerals. With the knock-on that European bond markets are whispering about debt crisis as populist foolishness on both ends of the circus spike while inflation rises for the rest of us.
It’s never a good idea to try to time the market. I’d add that predicting which way an agitated and confused mob will break is also a low-percentage thing to do as well. The best bet is to hold the line because the uncertainty won’t last. Too many pissed off people have talked themselves into a corner. Plan your finances accordingly. And if, by some sympathetic miracle, nothing happens… well there is your answer. But I wouldn’t bet on that.
