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BofA is out with its weekly flow show and there are some interesting points which tend to back up what we’ve been saying lately.

European equities suffered their biggest outflows on record in the week to March 2nd as investors rushed for the exits on the Ukraine invasion. The week also saw the largest outflows from financials and the largest inflow to energy since Mar ‘21. They note war is stagflationary, warn of an “inflation shock” and argue investors should be “maximum” defensive.

Russia/Ukraine means a bigger “inflation shock”, smaller “rates shock”, bigger “recession shock” – i.e. inflation shoots higher, CBs pull their hawkish necks in a bit, growth stalls, yield curves invert and we head for staglfation period. This is very bear market territory.

BofA says the Federal Reserve and European Central Bank are “hopelessly trapped between deflation on Wall St & inflation on Main St”, noting that euro area producer prices were up staggering 30.6% YoY pre-invasion.

“Oil price spike, military-sanctions escalation cycle, financial market accidents threaten global recession,” they say. BofA analysis shows this is the strongest start to any year for commodities since 1915, with all-time high in prices of coal/aluminium, and oil/wheat at the highest since ’08.

But they say it is too early to position for Fed/ECB pivot & QE5 – this requires minimum SPX <3800-4000. Currently E-minis S&P 500 futures sit around 4,300 and nowhere near the invasion low of Feb 24that 4,100. By pivot they mean a jarring halt to the tightening circus we have been expecting and keeping APP/QE for longer. So, in the absence of any de-escalation, investors should be “maximum defensive”.

SocGen sums up the inflation/recession shocks: “For the monetary authorities, this complicates the question of whether to front-load monetary tightening in light of strong demand, tight labour markets and strained supply chains, or to delay because of headwinds for household consumption, trade and growth”.

I feel the interesting thing about this is the likely divergence between CBs – they were already at different speeds exiting the pandemic and the asymmetry of how the Ukraine conflict affects the US and Europe will only magnify differences. In short, I see the Fed sticking more closely to hikes this year than the ECB, which was only being rather tentative anyway. This could drive further weakness for the euro

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