Stagflation rewrites the hedge book as oil breaks old safe havens

Stagflation is writing the hedge book now. With oil threatening to keep inflation elevated amid softening growth, investors are looking toward alternatives like specific equities, option overlays, CDS, commodities, and the USD for protection while moving away from typical safe havens like bonds.

But first, what exactly is stagflation? Stagflation is what happens when the economy sees a toxic mix of inflation and stagnation of growth — usually accompanied by higher unemployment and tighter monetary conditions. Prices rise, but consumers’ purchasing power dwindles, and low economic growth hits business confidence. This often happens at times of significant supply chain disruptions. We went through what that looks like in practical terms in our explainer a couple of years ago, when similar concerns had been rampant in light of the Covid-19 pandemic and the Russia-Ukraine war.

Bond yields have soared as traders expect slower economic growth and a surge in consumer prices. Two-year US yields climbed about 9 bps on Thursday to their highest since August, while German two-year yields climbed 8 bps to 2.39%, and UK bonds rose as much as 30 bps to 4.17%, though later pared the gains, Bloomberg reports.

Stocks are also victims of the selloff: Global equities have shed USD 6 tn since the war started. In Japan, the Nikkei 225 dropped more than 5% in a single day, the business information service reported elsewhere. The drop was relatively contained in the US, with the S&P 500 falling 0.6% on Friday — but the outlook isn’t looking good. JPMorgan has turned “tactically bearish” on US stocks, while veteran strategist Ed Yardeni assigned the S&P 500 a market meltdown probability of 35%, up from 20% earlier.

So what hedges are proving safe? Goldman Sachs Asset Management has added non-linear downside protection — think protective puts and options — and credit hedges, while Invesco is steering investors toward commodities routed through the Strait of Hormuz — aluminum and grains included — as shipping risk becomes an investable theme.

Currencies are snapping back to instinct: Bloomberg’s USD index is near a two-month high, despite investors entering the conflict positioned for USD weakness — what Barclays strategist Mitul Kotecha described as a market that had been “hedging America” before running back to the USD when the headlines worsened.

Not every refuge looks old-school, though: Chinese equities are holding up on diversified energy supply, Australia’s currency is drawing support from stronger commodity prices, and some Asian managers are rotating into nuclear-energy and digital-economy names instead of classic defensives.

MARKETS THIS MORNING-

Asia-Pacific markets started the week mixed, with Japan’s Nikkei and the Shanghai Composite down and the Hang Seng and South Korea’s Kospi in the green, as investors digest the latest developments in the regional war and fluctuating oil prices. Over on Wall Street, stocks are set to open in the red, with futures down this morning.

The values in the table above are listed according to the market position as of 3:30pm IST / 2pm GST.