Earlier this year, Russian assets took a beating amid a renewed sanctions push that at one point looked like it might escalate to include Russian government debt.
On April 9, Russian equities fell the most since 2014 in response to new sanctions against dozens of oligarchs and companies (Treasury blacklisted Rusal and En+ setting in motion the Oleg Deripaska drama that upended the global metals market).
For some companies, it was an outright bloodbath (chart below shows the hardest hit names that day).
The ruble fell the most since 2016, sovereign CDS blew out and generally speaking, it was an absolute train wreck.
That episode was set against the backdrop of a coordinated strike by the U.S., the U.K. and France against regime targets in Syria in retaliation for (another) chemical attack on civilians in rebel-held Douma, perpetrated by Bashar al-Assad.
On April 8, following that attack, Trump lambasted Russia and Iran for their support of Assad. Sensing a U.S. strike might be imminent, Moscow suggested they might intercept any missiles fired at regime targets. That didn’t go over particularly well with Trump, who, in an absurdly hyperbolic April 11 tweet, delivered the following warning to the Kremlin:
Get ready Russia, because [missiles] will be coming, nice and new and “smart!” You shouldn’t be partners with a Gas Killing Animal who kills his people and enjoys it!
Trump would go on to accuse Russia of playing “devaluation games” with the ruble, a bizarre thing to say considering that the proximate cause of ruble weakness at the time was U.S. sanctions and the threat of Trump firing a “nice and new” missile at a certain Russia-allied “Gas Killing Animal”.
Around the same time, Nikki Haley suggested that a decision on more Russia sanctions would be made “in the near future”, a contention that was promptly refuted by the White House which, on April 16, put the brakes on things. According to the Russian Foreign Ministry, the Trump administration called them after Haley’s comments to assure them that additional sanctions weren’t actually in the works.
Through it all, the worry was that the U.S. might end up sanctioning Russian government debt. Record foreign ownership (34% of Russia’s ruble debt at the time) helped keep it insulated, but the “nuclear option” of targeting OFZs hung over Moscow’s head. For his part, Steve Mnuchin attempted to play down those fears on April 11.
Well, 14 weeks and one boondoggle in Helsinki later and everyone is back to talking about Russia sanctions. Specifically, Lindsey Graham and Bob Menendez are all set to introduce bipartisan legislation aimed at sending a message to the Kremlin. Here’s the joint statement:
We are fully committed to ensuring Congress maintains an active role in both confronting Russian aggression and ensuring that the Executive Branch takes the necessary steps to protect the U.S. and our allies. That is why we will be introducing comprehensive legislation in the coming days to ensure the imposition of mandatory sanctions under CAATSA, while levying additional sanctions to ensure the maximum impact on the Kremlin’s campaign against our democracy and the rules-based international order.
Just as Vladimir Putin has made clear his intention to challenge American power, influence, and security interests at home and abroad, the United States must make it abundantly clear that we will defend our nation and not waver in our rejection of his effort to erode western democracy as a strategic imperative for Russia’s future.
We hope to build momentum in the coming days and be joined by more colleagues on both sides of the aisle in support of this important effort.
The Senators’ legislation will include:
- Increased sanctions on the Russian energy and financial sectors
- Increased sanctions on Russian oligarchs and parastatal entities
- Sanctions on Russian sovereign debt
- Sectoral sanctions on cyber actors in Russia
- Establishment of a National Center to Respond to Russian Threats
- Senate approval requirement for U.S. withdrawal from NATO
- Bolster effort to counter Russian disinformation and hybrid threats
- Establishment of a sanctions coordinator office at the State Department
- Reporting requirements to tighten sanctions implementation under the Countering America’s Adversaries Through Sanctions Act (CAATSA)
- Authorizing assistance to bolster democratic institutions across Europe to defend against Russian interference
Note the bolded bullet point. According to one GOP source who spoke to Bloomberg, they’re going to tread lightly there. To wit, from a piece published on Tuesday:
In the House, GOP leaders plan to move cautiously on any Russia sanctions that cast a wide net and could have unintended consequences, especially when it comes to sovereign debt markets, according to a GOP aide. House Republicans tweaked a separate Russia sanctions bill last year to resolve concerns from energy companies working on projects with foreign partners.
As Bloomberg noted in late May, the sanctions jitters that dominated headlines in early April prompted an exodus from the OFZ market, with foreign ownership dropping by $3 billion to 31%.
“Russia managed to borrow less than a half of what it aimed to in the second quarter as U.S. sanctions against Moscow disrupted debt issuance plans, finance ministry data show”, Reuters wrote late last month, documenting the extent to which the U.S. Treasury’s actions have changed the calculus for Russia.
The new sanctions push on Capitol Hill is in part a response to the Trump-Putin summit. Lawmakers from both sides of the aisle were aghast at the President’s performance and now, there’s renewed bipartisan support to take action.
In a July 18 note called “Watch out for ‘black swans’ from Helsinki”, BofAML warned about the possibility that sovereign debt would be targeted. Here are some useful excerpts from the bank’s note:
Sovereign debt as a potential new target
Existing draft bills on potential new anti-Russia measures primarily target equity and debt of Russian entities, but tend to exclude exports. Thus, the latest initiative to impose sanctions against Russia was the “Defending Elections from Threats by Establishing Redlines” (DETER) act (S. 2313) from January 2018. It was specifically designed to respond to any potential future elections meddling. The draft envisages automatic sanctions if the Director of National Intelligence determines that a foreign country (with a specific focus on Russia) or its agent has interfered in elections. The bill suggests the extension of sanctions to new debt issued by the state or state-owned entities, blocking of assets of state entities, main state banks, major oil and gas companies as well as personal targeted sanctions against a wider list of Russian businessmen and politicians. However, Section 201(a.1) of the bill specifically excludes trade from future restrictions, which reduces risks to Russian energy exports.
Given Dan Coats’s response to the Helsinki summit and the subsequent “awkward” moment that found the Director of National Intelligence laughing when he was informed about Putin’s planned visit to the White House later this year, it will be interesting to see what role he plays in any future election-related sanctions effort.
As far as what would happen to the market should Treasury go the so-called “nuclear route”, BofAML (in the same note cited above), writes the following:
Plentiful FX assets in the CBR will likely be deployed to protect Russian capital markets from any excessive volatility under the negative scenarios of sanction extension. Overall, non-resident exposure to Russian sovereign debt remains manageable. Non-residents’ holdings account for RUB2123bn or 30.5% of the OFZ market as of June 1, 2018 and stood at US$16.7bn or 42.7% of the Eurobond market as of April 1, 2018. We think that this amount of debt could be easily taken over by the local banking system with the help from the CBR, as was the case in 2015. This should limit risks to overall macroeconomic stability, although it might not prevent market volatility near term.
In any event, investors will want to monitor the evolution of the renewed sanctions push going forward – especially in light of the President’s waffling when it comes to recognizing election meddling.