MAGGIE LAKE: Hello, and welcome to the Real Vision Daily Briefing. It's Friday, February 25th, 2022. I'm Maggie Lake. There are two stories dominating the markets this week, the Russian invasion of Ukraine and the upcoming Federal Reserve meeting. To help us understand both, I'm joined by D. Smith, founder and CEO of the Strategic Insight Group, and Joseph Wang, former senior trader at the Federal Reserve. Welcome to both of you.

And Dee, I'd like to start with you first. We saw a big bounce in European and US equities today, US stocks just closing, rallying into the close at their highs of the day, the Dow up 834 points around as we settle 2.5%, we have the S&P up more than 2%, the NASDAQ 1.5%, oil backing down to $92 on WTI, $98 on Brent. Gold, also slightly lower. Part of the catalyst, headlines that Russians say they are willing to hold negotiations with Ukraine, is this just a tactical maneuver, or do you think that Putin is looking for a diplomatic solution?

DEE SMITH: It's a complex situation. And what has happened is that the advance of the Russian troops, and it's a multi-pronged attack on Eastern Ukraine, they're not attempting to attack the west at this point. But they're being slowed down by Ukrainian resistance much more than they thought they would be. They're having trouble taking Kyiv, they didn't think they would. They're still really mostly stuck in the northern suburbs, and other suburbs, but they're not effectively in the city center.

There's a lot of resistance around the country and I think that they are feeling a pinch of that. And that's having two effects. One is that it is actually causing them to speed up their timeline in an attempt to do this more quickly. But it is also giving them some pause. And the received wisdom on this situation is that it's relatively easy and easy in quotes there, but relatively easy to take a country, take down a country as the military says, it's much more difficult to control it.

If they're already having problems taking it, I think it is giving them pause. And I think that there is some evidence that there's some dissension in the leadership and concern about what Putin is doing. There certainly have been demonstrations, which is a very dangerous thing for people in Russia to do now. I think there is just some pause in thinking. That doesn't mean there's any pause in action, but they're not being able to proceed as quickly and as effectively as they thought they would. Now having said that, there's no way that the Ukrainians can stop a full throttle Russian invasion, but they can make it very difficult.

MAGGIE LAKE: Yeah. And they appear to be doing that, as you say, perhaps something that Putin didn't calculate. There are so many moving parts to this, aren't there? They're breaking in just the last 15 minutes. Reports that the US will impose sanctions on Putin himself, maybe symbolic, but that is coming, following in the footsteps of the EU. Russia is threatening Finland over NATO.

We have China not coming out and condemning Russia, but reports that some of the state banks have restricted dollar financing in Russian commodities, a lot of uncertainty what's happening with the Black Sea and flow of goods there after some ships were damaged. There is a lot going on. What should we be focused on as we head into the weekend? What are you going to be watching for as critical?

DEE SMITH: There are several things, I think that we need to look at the constraining factors on Putin, there are several of those. The resistance is one, the morale is another one that I think is related to the resistance and related to what I spoke about. There's essentially a, how would you put it, a dissolution of parts of the circle around Putin perhaps, so he may be fighting some battles of his own.

I think one of the things that is really concerning is that he has, apparently-- I've talked to people who've talked to him in the past and recently, he is not the same person. He's been in isolation. He is not thinking perhaps very clearly. Apparently, every time anyone sit down with him, it's just a long diatribe of what's wrong with Ukraine and Russia and so forth.

And he has also created some effect that he did not intend what he wanted to do, and this, I'll have to attribute it back into that attribution remark, the call I was on with a US General yesterday, but he wanted to make Russia great again. And what he's ended up doing is making NATO great again. This is not working out the way he wanted it to, and so there are these limiting factors.

And I'm going to be watching how those play out, I'm going to be watching how quickly he can consolidate territory, which is not as fast as he thought it would be. I think the markets are being irrational to an extent every bit of bad news and they collapse, and every bit of good news and they rally. And the situation, unless it begins to really work itself out very quickly which would mean that he stops where he is and does begin peace talks. You're dealing with a situation where you're going to have huge market effects of this.

Russian oil and gas out of the picture. The projections now that Europe's primary energy bill is going to be about 1.2 trillion this year. That's about 200 billion more than it was forecasted last month. You've got some mitigating issues there, Saudi production increases, maybe a deal with Iran might put a couple million barrels a day back in the market. But you've got food issues. together, Ukraine and Russia account for about 23%, 24% of global wheat production.

Wheat's up more than 5% this week on top of an 80% increase from April to December. Sunflower oil, all these critical minerals, uranium, clay exports, titanium. You take those things out of the market because of a conflict-based situation, and you're going to have massive, in an already inflationary environment I might add, in an environment that's already plagued with supply chain problems, you're going to have massive effects on the commodities market.

MAGGIE LAKE: Yeah, absolutely. You make such an interesting point about him coming out of isolation, maybe out of touch with what's been going on. That is not something we've heard. I'm sure that it's important not to underestimate him, though, at this point. What do you what is your sense on what his grip of power is within Russia?

Is this a weakened Putin that we're dealing with? Or is it just that he may have misread the situation but still has plenty of cards to play? We know what happens when people protest, he's had an ironclad lock on that country for so long. Do you think it's changing?

DEE SMITH: Not at the moment. I don't know if you watched that conference that he had with his advisors, with them all sitting in a semi-circle, and he was over at the other side of the room. It was Orwellian. It was surreal. He was criticizing them. I don't think he's lost his grip on power, he may have lost some of his grip on reality.

And I think that's very concerning, because-- and I used this phrase in the way but a mad king with nuclear weapons is not a good thing. And the other issue is that he really only understands power. And if the West wants to stop him, and we're starting to do this, but you're going to have to ratchet up these sanctions, and they buy over weeks and months. And the Ukrainians just have days.

MAGGIE LAKE: What about SWIFT? Does that put SWIFT back on the table, especially if there's sense that--

DEE SMITH: I think SWIFT is already on the table. The German in particular, and some other European countries don't want to see that happen because they're still dependent on various things, including energy from Russia and what SWIFT is, I don't know if everybody knows it's--

MAGGIE LAKE: It's worth explaining. It's a critical system that sends secure payments between banks and it's the lifeblood of all the trade flow.

DEE SMITH: Yeah, it doesn't send payments, it send messages about payments in a secure and in a trusted way. There would be ways to work around it, but it's a highly symbolic move almost a talismanic move. And the Germans in particular have not wanted to deploy it. If we're going to really stop him, it's going to require some things that are going to be painful for the West.

And here's the dilemma, is that the danger to financial markets if we do those things becomes greater. If we don't do that, if we go a road of appeasement, then there's very little danger to financial markets in the short run, I'm leaving out the possibility that this becomes a cyber war with untold amount of damage. But leaving that to the side, it's not happening in any obvious way right now. And that's a doomsday scenario, because both sides can do it and it's much easier to be offensive and defensive.

The extent to which we, we don't let him get away with this, it's going to hurt the markets, it's my analysis. To the extent that we appease, that we just slap his hand, the markets will have very little effect. You've got this odd dichotomy there.

MAGGIE LAKE: Yeah. One headline that caught my attention, Meta, Facebook was partially banned in Russia for fact checking content from state-owned media. Is there a risk that Putin can't control the narrative, and there's also risk for countries like Germany, and those who are maybe holding back, there is a real possibility that we may all sit and witness mass Ukrainian casualties or refugee, humanitarian crisis playing out, and that is going to get out whether authorities like it or not, whether Russia bans Facebook from Russia or not.

With social media, we already are seeing these images of civilians walking with suitcases, it's eerie, it's like going back in time. There's risk for both sides on this. But how important is controlling that narrative? And who's more vulnerable? What would it mean for Putin, especially if, as you say, he doesn't completely have cohesion around this decision?

DEE SMITH: It's very important to him to be able to do that. And it's another limiting factor that there are ways around that he does not have the control over the internet that China does, for example. And of course, he has very little control over Ukraine other than to shut power off, which you would have to use a cyber-attack to do. Just as a sidebar, one of the fascinating things about this is these TikTok and others of things going on, and you can tell from the metadata, actually, that they are where they say they are.

Now, having said that, there's a lot of fake videos of old videos and things that have been put in. There's a lot of work going on to try to filter through those, but he is going to have trouble controlling the narrative, particularly when Russian soldiers come home in body bags. And that is going to have the impact on even the Soviet Union in the days of Afghanistan, and before anybody ever heard of the internet. He couldn't control that narrative and he ended up having to have essentially the same experience we had in Afghanistan.

I think a short-term thing will work for him. But as it drags on and gets more onerous, he's going to be more motivated to call some a halt to it or the other danger is, he may before that, be more motivated to become more brutal, and it can get really nasty and the kinds of things that were done in Chechnya, and so forth. And I hope that doesn't happen, but it is certainly within the realm of possibility. And that's really concerning. And you will see pictures of that.

MAGGIE LAKE: It is so concerning, extraordinary times that we are in right now. Dee, we so appreciate you coming on and sharing your insight. Please come back again soon

DEE SMITH: Look forward to it. Thank you very much.

MAGGIE LAKE: Thank you so much. Now, the other big story, of course, is the Federal Reserve. And they're intertwined right now because markets are trying to grapple with both of these forces. Before this week, the Fed was the main story. And we did have data out today partially overshadowed by developments in Ukraine, which showed the PCE, one of the Feds favorite inflation gauges, was the highest since the early 1980s. Consumer spending and durable goods orders were also stronger than expected.

Let's bring in Joseph into the conversation who's been patiently listening. And Joseph, there's so much for investors, for market participants to grapple with. Given everything we've seen on the geopolitical and data front, what are you expecting from the Fed next week?

JOSEPH WANG: Hi, Maggie. First of all, thanks for inviting me here. I really love Real Vision. And thanks, Dee, for a great discussion. That was super interesting. Before this whole Ukraine thing happening, what the market was thinking about was what would the Fed do? And I think to understand what the Fed will do in the next meeting is to look at the world from the Fed's perspective.

What does the Fed care about in full employment and price stability? Now, where are we on those? Full employment has been met. We see employment compensation at multiyear highs, we've had Fed governors come out and tell you that we've met full employment. What about inflation? Well, inflation is far, far above the 2% where the Fed would like it, like you mentioned.

From this lens, you can interpret what Ukraine and this Russia scenario will impact the Fed. As Dee mentioned, there's a potential here for significant surges in commodity prices. The Ukraine incident, that is a potential upside risk for inflation, something reminiscent of what we saw in the negative supply shock in oil back in the 1970s. In my view, this thing keeps the Fed on track. There's no way the Fed is going to say, look at this and become more easy.

They're going on track, they're going to hike probably once every meeting. The more recent take we have from this is from a speech by Governor Waller a couple of days ago, and he was still open to 50 basis points. Now, that's probably not the basis points in March. Now, that's probably not the most likely outcome. But if we get a big CPI print in, say, March 10, when the next one comes out, that's on the table. Right now, what's happening in Ukraine hasn't changed the Fed's calculus, in my view.

MAGGIE LAKE: Yeah. If anything, perhaps put more pressure on them as they try to grapple with inflation. Do you think-- we always talk about the Fed having blunt instruments to try to deal with this, do you think that they are going to be successful in trying to fight inflation?

How much of this is an expectation game, and how much do we have to wait? Because there is a lag between what they do and any effect on the economy. How are you thinking about all of that? And will that determine the pace of tightening? Do they need to be more aggressive to show they're getting in front of it?

JOSEPH WANG: Yeah, that's a really interesting question. The Fed raises overnight rates and tightens and how does that actually feed into the real economy? I don't really think there's a consensus on this. I think most economists have the view that you've just enunciated monetary policy as to the longer variable lags, so if we hike now, maybe sometime in the future, things will slow down.

But when Chair Powell was asked about this, he's like, yeah, I don't think that's how it works. In fact, when I hike rates, that's immediately priced into the markets. And he's right. The Fed by communicating that the Fed is going to hike maybe multiple times this year, you can already see that priced in the short-term interest rate markets, priced in the 2 Year Treasury, and priced into the belly. I think in the impact is immediate. But here's the thing, though, it seems like in my view, the impact of the Fed is much stronger on the financial markets than the real economy.

I'm not sure if an extra say one 200 basis points is going to effect on consumer spending or business investment, it doesn't seem likely would make a difference, especially when, let's say, in an inflation environment where businesses are having record profits, and employees are having record wage gains. I think the primary impact would be on the market, and it can be a substantial impact. The way that I look about this is that the primary mechanism from how the Fed impacts markets is its impact on the debt market.

The Fed's raising rates, very direct impact on let's say, short-term to medium-dated Treasurys, and then they're promising to do very aggressive QE to make sure the long end goes up as well. And when you're doing that, though, mechanically, what happens is you're haircutting everyone's bond portfolios.

And if you do that, just through rebalancing mechanisms, let's say you're a targeted fund, maybe you're just the classical investor with a 60/40 portfolio, maybe, let's say you're a risk parity strategy, hedge fund, you're going to have to sell equities to rebalance. I think that impact is probably the most direct impact, and you see that play out a little bit heading into this year. And I think we're not done yet.

MAGGIE LAKE: This is so important. You're talking about what we refer to as quantitative tightening, correct? The reducing your balance sheet. And we mentioned at the beginning of the program that you are a former Fed trader, you are on the open markets desk during, if I'm not mistaken, during their last attempt at quantitative tightening. You really understand the mechanics of this in a way that most of us don't.

If I'm hearing you correctly, you're saying that just by the mechanics of how this works, everyone takes a haircut, you have to rebalance. And therefore, you're going to have to sell equities. From where we are now, what does that look like? What kind of downside risk does that present?

JOSEPH WANG: really hard to measure. Basically, what's going to happen in the coming months is the Fed is going to try to, what they would say as increase the term premium on longer-dated Treasurys and what we would say is they're trying to make the Treasury rate go higher. And there are good reasons for this. If you look at the housing market, we're going up 20%, 30% a year, that's not socially desirable. That makes housing unaffordable, and there's a risk of financial instability there.

The Fed isn't on aggressive quantitative tightening. And you can see the mortgage markets respond. In just in the past couple months, primary mortgage rates have gone up 1%, so 3% to 4% now. What the Fed is trying to do is increase the supply of duration into the market. Longer-dated Treasury rates are largely determined by supply and demand. Fed holds $5.5 trillion in Treasurys, it holds $2.5 trillion in mortgage agency MBS. By trying to get that off its balance sheet, by letting it roll off, potentially selling the agency