Hey There Income Hunter,
The hawks’ talons were out again yesterday as the FOMC minutes from the March meeting were released.
The minutes were definitely more sharp than expected …
- The Fed is weighing quantitative tightening (QT) – which may be as large as $95 billion a month – starting in May
- A number of Fed officials say .50% rate hikes may be needed
- The Fed fears public loss of confidence in its resolve over inflation
Notice the language that they use …. weighing QT … rate hikes may be needed …
Knowing how the Fed works and having followed their every move for most of my career, I would say they are trying very hard to get the stock market crash and to make their job easier …
I don’t know if that will work but there are cracks building in the global financial system and with or without the Fed’s help they will give way …
Today, I’ll lay out one real systemic risk that so far is being ignored and it could be weeks away from becoming a serious liquidity shock.
Commodity Producers and Margin Calls
A very big issue developing right now is that Russian commodity producers are experiencing massive margin calls.
You see, producers sell futures contracts on their commodities to lock in longer-term contracts.
For example, a natural gas producer is sitting on excess supply and can lock in a sale at 10% above the current price. He is now long physical supply and short a futures contract that trades on exchange.
Now, Russia invades Ukraine and the price of natural gas futures are up 20% so the producer is given a margin call to cover the deficit in his margin account.
The problem is the producer has tapped into his credit lines already and can not find a lender because Russia’s foreign reserves were frozen AND his foreign banks are banned from doing business with him.
Banks Will Not Take Oil or Gas for Money
The dynamics in play here are really important to understand because every financial market crisis begins when lenders will not even lend against a borrower’s collateral …
So here is the problem …
In today’s world, commodities are the most valued asset – and sanctions have disrupted the flow of funds while prices are the most volatile they have been in decades.
Commodity traders are not regulated and have no highly-rated financial assets to offer a lender to secure a loan. Some players, like state-linked commodity producers – are not liquid enough because their backstop (the Bank of Russia’s FX reserves) have been seized.
The commodity trading shops went to the Euro central bank (ECB) with hat in hand telling them they needed funding or they may default on payments … then on Friday this headline flashed on Bloomberg:
ECB TURNS DOWN ENERGY TRADERS PLEA FOR FUNDING SUPPORT
Of course the headline was quickly buried, but this is the type of situation that can build into a funding crisis.
So, either central banks will have to expand the collateral they add to their balance sheets or they will have to go back to QE and add liquidity to the system.
This is the first real situation that has erupted since the war started but there will be many more as central banks begin draining liquidity from the system.
Back to the Fed, I am sure they are blind to this situation because they don’t see commodities as a threat to the global financial system and only know how to react to a crisis instead of preventing one.
Bring It Home
So, the Fed is about to initiate quantitative tightening and drain liquidity from a global system that demands it …
Check out the current number of tightens priced into the bond market as of yesterday:
Almost nine rate hikes of .25% are expected in 2022. That’s 2.25% higher interest rates into an economy that is begging for more liquidity because inflation is crushing their margins. Woof.
The commodity squeeze is not going away and I believe it will be the signpost that will give us clues as to when the Fed will have to flip from QT to QE. That will present an incredible trading opportunity …
Until then, keep selling the rips in stocks. And as always …
Live and Trade With Passion My Friend,
Griff