Hello there,

A terrific Tuesday to you as stocks continue to crater on concerns over an impending Russian invasion of Ukraine.

In brief (TL:DR)

• U.S. stocks were lower Monday with the Dow Jones Industrial Average (-0.49%), S&P 500 (-0.38%) and the Nasdaq Composite (-0.00%) all down as concerns mount that Russia will invade Ukraine.

• Asian equities were steady Tuesday as traders parsed geopolitical risks, worries about U.S. Federal Reserve policy tightening and steps by China’s central bank to support growth.

• Benchmark U.S. 10-year Treasury yields fell two basis points to 1.97% (yields fall when bond prices rise).

• The dollar dipped.

• Oil edged lower with March 2022 contracts for WTI Crude Oil (Nymex) (-0.48%) at US$95.00 as the prospect of a political solution with Russia opened up to end the Ukraine crisis.

• Gold held on its recent gains with April 2022 contracts for Gold (Comex) (+0.51%) at US$1,879.00.

• Bitcoin (+4.39%) rose to US$43,568 as the correlation between the cryptocurrency broke with U.S. tech stocks.

In today's issue...

1. When Holding U.S. Treasuries Can Cause a Stomachache

2. It’s Not Russia That’s Itching for a War, It’s the U.S.

3. Think Bitcoin is volatile? Try Tech Stocks

Market Overview

Diplomatic efforts are continuing to defuse the Ukraine situation. While U.S. officials have warned a Russian invasion of Ukraine may be imminent, Moscow has repeatedly denied that one is planned.

Before the crisis flared, markets were already nervous over high inflation and the withdrawal of Fed stimulus.

Meanwhile, Fed officials came out with another round of views on the policy outlook.

Fed Bank of St. Louis President James Bullard said the monetary authority needs to move forward its plans to raise rates to underline its inflation-fighting credibility.

Asian markets were lower on Tuesday with Sydney’s ASX 200 (-0.11%), Tokyo's Nikkei 225 (-0.27%), Seoul's Kospi Index (-0.24%) and Hong Kong's Hang Seng Index (-0.44%) all down in the morning trading session.

1. When Holding U.S. Treasuries Can Cause a Stomachache

• Last week’s whiplash for bond investors underscored the volatility that’s been rippling through the U.S. bond market, which for years had been a relatively boring asset to balance out a portfolio.

• Whatever the case may be, the institutional investors who make up the bulk of U.S. Treasury investors will be in for substantially greater volatility than they are used to.

Bond holders are typically a staid bunch, straight-laced and steely-eyed in their resolve to find certainty of income in an otherwise uncertain world.

But the highest levels of U.S. inflation in four decades has sent more shocks through what has for years been assumed to be a relatively straightforward business.

Last week, bond investors were hammered when U.S. Labor Department Consumer Price Index data saw prices rising faster than expected, leaving more traders betting that the U.S. Federal Reserve will need to get more aggressive with its interest rate hikes starting next month and sending yields soaring (yields rise when bond prices fall).

But in an abrupt turn of events, the prospect of Russian boots on Ukrainian soil has seen investors heading for cover in U.S. Treasuries sending their prices soaring.

Last week’s whiplash for bond investors underscored the volatility that’s been rippling through the U.S. bond market, which for years had been a relatively boring asset to balance out a portfolio.

Short-term rates are being driven up, flattening the yield curve (the difference in yields between long-term and short-term debt).

Making markets messier has been the prospect of so-called Fed runoff, the process of offloading U.S. Treasuries from the U.S. Federal Reserve balance sheet, which is currently holding some US$8.9 trillion worth of Treasuries and mortgage-backed securities.

A flat or inverted yield curve (where short-term debt yields more than long-term debt) could signal to policymakers that investors are starting to pull back in anticipation of a recession.

Long-term debt should typically yield more, because a bond holder’s money is “locked away” for longer, but a lower yield suggests that investors are not confident that there would be other places to put their money and that growth and opportunities could slow.

If the market starts pricing in more short-term rate hikes, an inverted yield curve could result and heighten the Fed’s use of balance sheet policy to tighten monetary policy, instead of the more blunt tool of rate hikes.

Balance sheet policy would mean the Fed reduces holdings of Treasuries by not reinvesting the proceeds of maturing securities, or it could also sell its existing holdings of Treasuries, which would drive up long-dated yields.

Whatever the case may be, the institutional investors who make up the bulk of U.S. Treasury investors will be in for substantially greater volatility than they are used to.

2. It's Not Russia That's Itching for a War, It's the U.S.

• It’s been Washington that revealed blood had been transferred to Russia’s border with Ukraine, sending investors headed for cover, and it’s been Washington which has said that there has been no de-escalation on the Russian side.

• For its part, Moscow has repeatedly said that its troops are on the border for exercises, with ally Belarus, and there remains little appetite among the Ukrainian military’s top brass, which is extremely corrupt, to join NATO.

While it’s undeniable that Moscow has sent some 130,000 troops to essentially encircle Ukraine, much of the rhetoric of an impending attack hasn’t come from the Kremlin, but Washington.

Till date, Moscow has made demands regarding European security and Russian Foreign Minister Sergei Lavrov has said that diplomatic options are still available, but it’s been Washington that has said the Kremlin remains intent on invading Ukraine.

It’s been Washington that revealed blood had been transferred to Russia’s border with Ukraine, sending investors headed for cover, and it’s been Washington which has said that there has been no de-escalation on the Russian side.

Yet that’s not how a game of global poker works – world powers don’t withdraw their troops until they have their demands met, or at least their grievances heard.

Moscow has said repeatedly that it was prepared to keep talking to the west about its security concerns and said that there was still a “way forward” in negotiations.

That view was met with cynicism from the U.S. State Department, with spokesperson Ned Price responding,

“We have taken note of his (Sergei Lavrov) comments. What we have not taken note of is any indication of de-escalation. We have not seen any tangible, any real sign of de-escalation.”

Moscow has been urging NATO to drop its “open door” policy towards membership, with respect to former Soviet bloc countries, but especially with regards to Ukraine.

Over the past few decades, more former-Soviet bloc countries have joined NATO, including Estonia, Latvia and Lithuania, further isolating Moscow and threatening its various borders.

Russian President Vladimir Putin has long held that the biggest mistake former Soviet Union leader Mikhail Gorbachev made was giving Soviet territories their independence.

After the collapse of the Soviet Union, the U.S.S.R. became the Commonwealth of Independent States, or CIS, an attempt to replace the communist bloc with something akin to the Russian empire.

But several former-Soviet territories did not ratify the CIS charter and have moved increasingly further away from Moscow’s sphere of influence, including Georgia, which withdrew after the Russo-Georgian war that was backed by Moscow, and Ukraine.

Washington is in many ways all but egging on Russia to invade Ukraine, without necessarily understanding Moscow’s concerns about how it feels increasingly boxed in by growing NATO membership, especially among former Soviet bloc countries.

For its part, Moscow has repeatedly said that its troops are on the border for exercises, with ally Belarus, and there remains little appetite among the Ukrainian military’s top brass, which is extremely corrupt, to join NATO.

3. Think Bitcoin is Volatile? Try Tech Stocks

• According to data compiled by Bloomberg and based on five years of price movements, Bitcoin has moved more than one standard deviation from its average (in either direction) just five times this year.

• Nevertheless, Bitcoin and the Nasdaq 100 still remain positively correlated, with the tight linkage shared by these two asset classes still near an all-time-high, according to Bloomberg.

While many investors may be turned off by Bitcoin’s volatility, high-flying tech stocks, which it has long been associated with, have been far more volatile of late.

According to data compiled by Bloomberg and based on five years of price movements, Bitcoin has moved more than one standard deviation from its average (in either direction) just five times this year.

Whereas the tech-heavy Nasdaq 100 index, has moved one standard deviation from its average a whopping 12 times, with the only other time that has happened in the last five years in 2020, during the onset of the pandemic that roiled equity markets.

Part of the reason of course is that tech stocks have been attracting eye-watering valuations for some time now, especially high-profile loss makers, whereas cryptocurrencies like Bitcoin, although the subject of speculation, do not hone themselves to existing valuation matrices.

While growing concern that monetary policy tightening by major central banks will dampen demand for risk assets like Bitcoin, the highest level of U.S. inflation in four decades is also feeding into the narrative that the cryptocurrency could provide a hedge against price rises as well and may be contributing to its recent ascent even as tech stocks tumble.

It helps that much of the leverage that fueled the speculative bets which saw Bitcoin rise to an all-time-high of close to US$69,000 last November have also been more or less flushed out of the system, whereas leverage is still abundant in the Nasdaq 100.

So far this year, Bitcoin’s 8% decline compares favorably with the Nasdaq 100’s 13% fall and the tech-heavy index has proved far more volatile than Bitcoin, even though the latter trades far more frequently.

Nevertheless, Bitcoin and the Nasdaq 100 still remain positively correlated, with the tight linkage shared by these two asset classes still near an all-time-high, according to Bloomberg.