By the end of play on Friday, the markets appeared to have returned to their “glass half full” mentality.
Analysts were rushing to say that the sanctions would be light; that there might be peace talks going on. And the markets have rebounded somewhat.
Let’s say that’s not what happened. In fact, over the weekend things escalated dramatically.
It is no exaggeration to say that we are now in a real economic war.
It is therefore not surprising that the markets had a difficult start to the day.
Russia disconnects from the financial system
This morning, as I write this, the price of oil is back above $100 a barrel, stock markets around the world have fallen – but not dramatically – and the Russian ruble has fallen. For perspective, a fortnight ago one pound would have bought you just under 104 rubles. Starting this morning, it’ll net you 140. Not that you’d want to buy any, as chances are you’ll have a hard time spending them on anything.
This is because the US, UK, EU etc. did a lot over the weekend to disconnect Russia from the global financial system. They imposed sanctions on the Russian central bank and also exclude some (but not all) Russian banks from the Swift international payment system.
What does it mean? Rather than getting into the weeds on technicalities, the important point is that it will be difficult for the central bank to defend its currency, and it will also be very difficult for Russia to do business with any entity dominant.
The only area where there is still some room for maneuver is the energy sector. But as others have pointed out, how many banks will want to allow Russian companies now that they’re a pariah (because they won’t want to risk breaching current or future sanctions)?
There have also been other big moves. Germany drastically changed its foreign policy over the weekend. The country now plans to meet the NATO target of spending 2% of GDP on defense from around 1.5% currently, something the US has long been asking Europe to do.
(US spending exceeds 3.5% while the UK has consistently exceeded the 2% target). Estonia, Latvia, Poland, Lithuania and Romania.)
European airspace is also closed to Russian planes – this is still bad news for airlines, although in the context of Covid it is probably relatively minor.
What does all this mean?
The risks for the financial plumbing
The ruble, obviously, has collapsed. The Russian central bank raised interest rates from 9.5% to 20%. Meanwhile, Russian companies would be forced to sell 80% of their revenue in foreign currency – in other words, exchange any dollars, pounds or euros they get for rubles, to help prop up the currency.
So far, these moves don’t seem to be helping the ruble much. Indeed, it has become much more difficult to put a price on Russian assets. Blonde Money’s Helen Thomas draws a comparison to the collapse of Lehman Brothers in September 2008, in that suddenly no one knew what a large swath of assets scattered throughout the financial system was worth.
The difference here is that exposure to Russia in general has declined while its misbehavior has increased over the past decade, so this is unlikely to be a moment of 2008 for the financial system in general.
But to paraphrase Credit Suisse’s Zoltan Posner, an analyst who has become the go-to man for insight into the plumbing that underpins the financial system (even if someone speaking honestly only understands about half of it he writes) – you can’t pull a country out of the global payment network without some payments being missed and things getting messy.
This is the kind of thing you would think central banks are likely to be prepared for. They are used to hiding cracks, so I would expect the worst of this morning’s volatility to fade away fairly quickly.
But for Russia? Most likely, the 2008 comparison may not cover it. Severe inflation is almost certain at these levels and hyperinflation is a real risk.
What about the broader market reaction, beyond the initial rush for “safety” by investors desperately trying to raise cash and lose leverage?
When it comes to the flight of Russian assets, probably the most notable reaction from a UK-based company with exposure to Russia was that of BP, which decided to shed its nearly 20% stake in Rosneft, the Russian state company. fuel company. Bloomberg’s Javier Blas estimates it could cost BP up to $25 billion to exit.
No wonder BP’s stock price took a big hit today, despite soaring oil prices.
Sometimes the best decision is to do nothing
This all goes back to the point I made on Thursday, that the big risk with Russian assets now was that they would become unsaleable due to sanctions or capital controls. This is where we are now.
In the longer term, does this accelerate an eventual abandonment of the US dollar as the world’s reserve currency? Some say “yes”, but I’m not quite sure that’s the logical conclusion.
It’s not that I don’t agree that it’s the general goal of some nations; China and Russia have specifically wanted to create an alternative system to US dollar hegemony for a long time. But it’s hard to put together a viable alternative to the current global financial exploitation system if everyone who subscribes to it is pariah states. It’s not great marketing.
I’m not saying for a minute that the US dollar will always be the world’s reserve currency. I’m just saying that in my view the jury is out on whether this might actually slow rather than hasten any move away from the dollar (and not just in the short term – the dollar index inevitably jumped this morning as it has always done done when there is market jitters).
What can you do? My first point, as always, is to keep a cool head. Don’t panic when selling or buying. My second point is a reiteration of the one I made on Thursday – this escalation is inflationary (and probably stagflationary). None of this makes it easier to transport the items we need from A to B, which increases the cost of those items. So the points I made about making sure your portfolio is inflation proof still stand.
But above all, I would come back to my first point: making investment decisions in times like these is particularly difficult. If you’re going to do this anyway, stick to your process and make sure you write everything down first. But be careful. There’s a lot of room for bad surprises right now, even more than usual.