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Fed May be Making a Second Big Mistake, as Geopolitical Tensions with Russia Escalate

The Russian natural gas is now bubbling somewhere in the Baltic Sea, being wasted in front of the horrified eyes of hundreds of millions of Europeans suffering from a historical energy crisis.

Why? Well, we don’t know exactly why, but two explosions were detected in the area, and damaged the Nord Stream pipeline system.

Does it look like an accident? Regarding the geopolitical context: not really. And Germany and the US suspect that it’s a sabotage from Russians rather than a technical issue.

Good thing is, there was no gas flowing through the pipeline anyway, as Russia cut the European gas weeks ago.

Bad things is, damaging the infrastructures clearly pushes the tensions between the West and Russia to a no-turning point, and dashes hopes of seeing an improvement anytime soon – both on the geopolitical and on the energy front.

The European natural gas prices, which have been coming down since the end of August peak, jumped 17% yesterday, while crude oil gained 2.30% on news that Russia now wants OPEC+ to cut output as deadlines to implement Russian fuel bans approach.

Interestingly, even if the barrel of crude flirted with the $80 offers following the tasty mix of Russian news, gains in crude remained limited.

This is a sign that the pricing in oil markets is mostly driven by the demand sign concerns as the rapid policy tightening from the Federal Reserve (Fed) – which leads to an unbearable rally in the US dollar, and applies an unsustainable pressure on other currencies and their central bank policies – is now destroying the global oil demand prospects, and even the news of lower OPEC output can’t bring the oil bulls back to the market.

But it’s all good, says Bloomberg, Europe has enough liquified natural gas to get through winter without Russia. And then?

Here, have some more tensions

Plus, if the escalation on the energy front is not enough, governments of the four Moscow-occupied areas of Ukraine have all declared victories in the referendums with, of course, an unprecedented majority of residents saying YES to joining Russia.

After the chaos in Britain and the far-right victory in Italy, we now have mounting tensions with Ukraine – and we are only Wednesday!

FX markets continue boiling

The mounting tensions with Ukraine and the spike in nat gas prices fuel the European inflation expectations, but in vain. The EURUSD is pushing lower against the US dollar as recession worries mount.

Bloomberg Economics say that we will see at least a 1% drop in the European GDP starting from the Q4, and we could see the economic contraction fall as much as 5% ‘if the coming months turn especially icy’ and the European nations ‘fail to share fuel supplies’.

These numbers are as bad as the 2009 recession. But what was better in 2009 is: central banks had room to act to save the day, by slashing rates to zero, and pumping trillions in the system by buying huge quantities of sovereign bonds and saying ‘WHATEVER IT TAKES’. Now it’s different. The European Central Bank (ECB) is expected to hike the interest rates by 75bp in the next two meetings, the German 10-year yield spikes above 2.20% from below 0% at the start of the year. And even then, the euro is set to test the 0.95 against the US dollar and slip below this level.

Similarly, the pound remains under a decent selling pressure as the Bank of England (BoE) officials are pushing the can down a very steep road, saying that it’s more appropriate to wait 5 WEEKS before taking action.

Meanwhile, the IMF now warns the UK that they DO NOT RECOMMEND splashing untargeted fiscal money while inflation remains elevated in the world, and in the UK. They emphasize that it is important that fiscal policy doesn’t work at cross purposes to monetary policy.

The IMF basically says: you, guys, are going to get severely burnt if you continue doing what you are doing.

But in vain. Liz Truss probably won’t stop until she gets burnt. Good news is, she will get burnt very, VERY quickly. But until then, we will see the UK dive a bit further. The speed at which the UK’s yield curve shifts higher is almost as scary as the little girls in the Japanese horror movies.

And beyond the troubled euro, pound, and horror movies

Even the safe haven assets are out of action right now. I no longer talk about yen as a safe haven currency, as the Bank of Japan’s (BoJ) uncomfortably dovish stance will certainly continue pushing the dollar-yen higher, with temporary pauses if the BoJ intervenes directly in the FX markets – which could create interesting dipbuying opportunities for those who have the guts to swim against the BoJ.

The dollar-swissy, on the other hand, is about to test parity. The Swiss franc is still cool, but not as COOL as the US dollar.

Elsewhere, gold trades in tandem with other risk assets, under the unbearable pressure of a relentlessly stronger US dollar. If gold prices follow an ABCD pattern since 2011, we could even see the price of an ounce fall to $1260 an ounce.

I am not saying that will happen, but technically it is possible. What could save gold, which failed to be a good hedge against both a market rout, a war and skyrocketing global inflation this year? An eventual slowdown in rising yields… maybe?

Fed is probably making a second big mistake

But even then, the Fed officials are pushing hard to make sure no one breaths.

James Bullard said that he sees interest rates going to the 4.5% range, which is a full percentage point higher than this projection back in April.

Neel Kashkari, who was normally a dovish Fed member, also falls for the dark side saying that the Fed moves are ‘appropriately’ aggressive.

While Charles Evans sees interest rates peaking at 4.50-4.75%, but at least he says he is getting ‘a little nervous about going too far, and too fast with the rate hikes’.

And it’s possible. Squeezing the world economy like a lemon may not be the greatest idea, and going this fast given the world context – the war, the energy crisis – will not make up to the fact that the Fed waited too long before acting against inflation last year.

So, it is well possible that after having wrongly insisting that inflation was ‘transitory’, the Fed could now make a second Big Mistake of tightening beyond-appropriate.

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