Russia/Ukraine War – Russia’s weakening position
Russian forces retreated from Kherson just over a week ago, depriving Putin of the only regional capital seized during the nine-month invasion. The withdrawal to the eastern side of the Dnieper River marked a reversal of Russia’s biggest military achievement since the start of the war. Russia appears to be struggling to gain terrain elsewhere in Ukraine too. Fighting continues in Donetsk as Russian forces attempt to advance towards Bakhmut and Siversk, but Ukraine appears to have successfully held off the latest assaults. The current Russian push towards Bakhmut followed a major defeat in the east in September when Russian units were forced back in the Kharkiv region.
Overall, with the latest loss of the strategic Kherson region, Russia is clearly in a weaker position. The general perception is that if any negotiations were to occur in the near term, they would be done from a position of strength for Kyiv.
Further, Russia’s weakened position and international isolation was reinforced after the G20 Summit last week, with the issue of a joint 17-page declaration condemning Russia’s war in Ukraine. Last week also saw discussions between CIA Director William Burns and his counterpart Sergei Naryshkin in Turkey. This is the highest-level public meeting between officials since Russia’s invasion of Ukraine. Whilst it was made clear these were not negotiations to try and end the war, but rather to discuss the consequences of the use of nuclear weapons by Russia, we view this as a positive development in communications between Russia and the US. This was further proven by headlines from Deputy Foreign Minister Sergei Ryabkov last week saying Moscow is open to further talks with the United States on “strategic stability” – a term used to mean reducing the risk of nuclear war.
US – Encouraging data
U.S. supplier price increases slowed in October for the second straight month, adding to signs that inflation pressures could be abating. The producer-price index came at 8% yoy, down from 8.4% yoy in September. Core PPI came at 6.7% yoy, down from 7.1% yoy in September.
The October report reflected a broad-based slowdown in gains for goods prices, with declines for passenger cars and household furniture. The big drop came from the trade services component, which measures gross margins for wholesalers and retailers, and accounts for nearly a quarter of the core. Trade services fell 0.5%, the second straight decline and the biggest drop since December 2020. The yoy rate fell to 11.1% from 12.3% in September, signalling a sharp drop in supplier margins.
Given Vice Chair Brainard’s two recent speeches in which she has highlighted the potential scope for margin compression to reduce inflation, this is an important report.
Further data from last week included Retail sales, which came in stronger than expected. October retail sales rose 1.3%, from 0% in September. Sales ex-autos rose increased 1.3%, from 0.1% in September. The headline was boosted by a 1.5% jump in auto sales and a 4.1% rise in gas stations’ sales. The latter is largely due to rising prices in October and is unlikely to boost headline retail sales again in November. Overall, real consumption is on course for a decent fourth quarter. As long as people remain willing to run down excess savings in the face of higher borrowing costs and uncertainty over the economic outlook, consumption will stay reasonably strong into next year.
Whilst data from the US last week was encouraging, comments from St Louis Fed President Bullard arguing for a terminal rate of at least 5-5.25% (from 4.75-5% previously) tempered hopes of a slowdown of the tightening cycle in the US. Following these headlines, US 2 year yields rose from ~4.35% to ~4.49% on Friday. Whilst this is a pullback, we maintain our overall positive view on markets in 2023 as we think we are approaching peak central bank hawkishness, consistent with our previous weekly Bullets. Hence, we think the Fed won’t deviate much from the path they have guided, and we view Bullard’s comments as a way of ‘calming’ markets following a strong week. The US Terminal rate priced by markets remains at ~5% and is expected to be reached in May 2023.
Algebris Investments’ Global Credit Team
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