‘Nuclear’ Winter? What The Proposed Russia Sanctions Bill Means For Markets

‘Nuclear’ Winter? What The Proposed Russia Sanctions Bill Means For Markets

On Thursday, Republican Senator Lindsey Graham and Democratic Senator Bob Menendez introduced legislation that seeks to turn the screws on the Kremlin for what a bipartisan group of lawmakers describe as “Russia’s continued interference in elections, malign influence in Syria, aggression in Crimea, and other activities.”

The renewed sanctions push comes just 100 days ahead of the midterms and amid heightened scrutiny of the White House’s relationship with Vladimir Putin following Donald Trump’s obsequious press conference with the Russian president in Helsinki last month.

In the three weeks since the summit in Finland, Trump has been at pains to explain comments he made while standing next to Putin that seemed to suggest the man who occupies the Oval Office is inexplicably still inclined to trust Moscow’s assessment of election interference over that of the U.S. intelligence community, which has been unequivocal in their contention that the Kremlin interfered with the democratic process in 2016 and continues to target the U.S. electorate to this day.

Following the Helsinki summit, lawmakers zeroed in on the following statement Trump made in Finland:

My people came to me, Dan Coats came to me, some others, they said they think it’s Russia. I have President Putin. He just said it’s not Russia. I will say this, I don’t see any reason why it would be.

The next day, Trump claimed he meant to say “wouldn’t” rather than “would.” “It should have been obvious [what I meant]”, he told reporters, an absurd contention for “obvious” reasons.

Less than 24 hours later, asked specifically whether Russia is targeting the midterm elections, Trump said “no”. Pressed for answers, Sarah Huckabee Sanders contended the President was not in fact responding to a question about Russian meddling, another absurd contention and another example of the administration’s propensity to tell the public that Americans aren’t seeing and hearing what they think they’re seeing and hearing.

In a subsequent interview with a visibly skeptical Jeff Glor, Trump offered the following not-so-convincing answer when asked whether he accepted the U.S. intelligence community’s assertions about Russian election meddling:

 

For his part, Director of National Intelligence Dan Coats directly rebuked Trump for his comments in Helsinki and for his trouble, Coats found himself in the crosshairs of the White House. Coats was more than a little surprised when, right in the middle of an interview at the Aspen Security Forum in Colorado, he was informed that the Trump administration was planning to invite Vladimir Putin to the White House. Coats laughed before expressing his incredulity at the sheer brazenness of the administration of which he is a part. He would later apologize and Trump would go on to “postpone” Putin’s visit, citing the overhang from the Mueller probe.

That’s the political backdrop for the new comprehensive legislation introduced on Thursday. The name of the bill: Defending American Security from Kremlin Aggression Act of 2018.

This is of course not the first time Russian sanctions have been a hot topic in 2018. A week ago, in “‘Black Swans From Helsinki’ Beckon As Senators Ponder ‘Nuclear Option’ For New Russia Sanctions“, we took readers on a trip down memory lane, recalling the series of events (and tweets) that led to a collapse in the Russian equity market earlier this year amid coalition strikes on chemical weapons facilities in Syria.

For markets, the most important question is whether any new sanctions will target Russian government debt, the so-called “nuclear option” that Steve Mnuchin shot down on April 11. In the “key elements” section of the legislation proposed on Thursday, you find the following line item:

A prohibition on and sanctions with respect to transactions relating to new sovereign debt of the Russian Federation.

Notably, it also calls for Mike Pompeo’s State Department to consider labeling Russia a state sponsor of terrorism:

A requirement for the Secretary of State to submit a determination of whether the Russian Federation meets the criteria for designation as a state sponsor of terrorism.

Geopolitical implications (of which there are obviously many) aside, sanctions on Russian sovereign debt have the potential to ripple through financial markets.

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%. That number (now at ~28%) is still high enough to cause problems.

“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 in late June, documenting the extent to which the U.S. Treasury’s actions have changed the calculus for Russia.

When news of the new legislation hit on Thursday, the ruble slid to day lows:

USDRUB

“We estimate that in the worst case scenario sanctions on sovereign debt could lift OFZ yields by 4% and depreciate the RUB by 15%”, Citi analysts wrote in a note dated Wednesday, adding that “if sanctions are imposed only on the issuance of new OFZ debt, bond yields may rise by 2% and the RUB may weaken by 5%.”

Under the (relatively) benign scenario wherein only new OFZ issuance is hit, the bank assumes non-resident participation in the market falls to 21% by the end of next year, at which point OFZ yields would rise to 9.69% from 7.7% currently. In the even non-resident participation falls to zero, well then by the end of next year, Citi sees yields rising to 11.90%.

The bank’s assessment calls for USDRUB at “about” 70, which would entail another 12% lower from here.

USDRUBProjection

In a July 18 note, BofAML called non-resident exposure to Russian sovereign debt “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”, the bank wrote, adding that in their view, “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.”

That assumption may be tested depending on how much traction the newly proposed legislation gets on Capitol Hill.

“The Senator’s initial intention (most sensitive for the Russian financial markets) was to impose tighter sanctions against sovereign debt and the banking sector, if Russia is confirmed meddling into the US elections process”, Credit Suisse remarked on Thursday, adding that investors will be intently focused on “the contents of the draft and potential support it may get from other Senators.”

Perhaps as interesting as anything else will be how the White House responds to this, especially ahead of the midterms. Last week, Trump made the comically ridiculous claim that the Kremlin is aiming to engineer a Democratic sweep in November.

“I’m very concerned that Russia will be fighting very hard to have an impact on the upcoming Election”, the President tweeted, before saying this:

Based on the fact that no President has been tougher on Russia than me, they will be pushing very hard for the Democrats. They definitely don’t want Trump!

Right. They “definitely don’t want Trump.” And they “definitely don’t want” Congress to push for the nuclear option when it comes to sanctioning sovereign debt either.

Pressed to reconcile Trump’s seemingly mixed messages, John Bolton and Dan Coats had the following to offer at a press conference convened on Thursday afternoon:

 

If the President is truly intent on showing Moscow just how “tough” he is, well then he’ll slap sanctions on the OFZ market – irrespective of the potential market fallout.

Full press release on the Defending American Security from Kremlin Aggression Act of 2018

WASHINGTON — U.S. Senators Lindsey Graham (R-S.C.), Bob Menendez (D-N.J.), Cory Gardner (R-CO), Ben Cardin (D-MD), John McCain (R-AZ) and Jeanne Shaheen (D-N.H.) introduced the Defending American Security from Kremlin Aggression Act of 2018,comprehensive legislation that will increase economic, political, and diplomatic pressure on the Russian Federation in response to Russia’s continued interference in our elections, malign influence in Syria, aggression in Crimea, and other activities.

“The current sanctions regime has failed to deter Russia from meddling in the upcoming 2018 midterm elections,” said Senator Graham. “Our goal is to change the status quo and impose crushing sanctions and other measures against Putin’s Russia until he ceases and desists meddling in the US electoral process, halts cyber-attacks on US infrastructure, removes Russia from Ukraine, and ceases efforts to create chaos in Syria. The sanctions and other measures contained in this bill are the most hard-hitting ever imposed — and a direct result of Putin’s continued desire to undermine American democracy. I strongly believe that DNI Coats’ assessment — that the warning lights are blinking red when it comes to Russian meddling in the 2018 election — is accurate. These sanctions and other measures are designed to respond in the strongest possible fashion.”

“Vladimir Putin continues to pose a growing threat to our country and allies. While Congress overwhelmingly passed a strong set of countermeasures last year, unfortunately, the Administration has not fully complied with that legislation. This bill is the next step in tightening the screws on the Kremlin and will bring to bear the full condemnation of the United States Congress so that Putin finally understands that the U.S. will not tolerate his behavior any longer,” said Senator Menendez. “The Kremlin continues to attack our democracy, support a war criminal in Syria and violate Ukraine’s sovereignty. With the passage of this legislation, Congress will once again act to establish a clear U.S. policy to hold Russia accountable with one clear message:  Kremlin aggression will be met with consequences that will shake Putin’s regime to its foundation.”

“The United States must continue to take strong actions against Vladimir Putin’s Russia for their global violations of international law and repeated attempts to undermine U.S. democratic institutions,” said Senator Gardner. “I fully support this bipartisan measure that will impose further economic sanctions against the Kremlin and also includes my language requiring the State Department to determine whether Russia merits the designation of a State Sponsor of Terror, along with Kremlin allies Iran and Syria that are already designated.  Unless Russia fundamentally changes its behavior, we must not repeat the mistakes of past Administrations of trying to normalize relations with a nation that continues to pose a serious threat to the United States and our allies.”

“It is once again up to Congress to strengthen America’s resolve against Vladimir Putin’s pattern of corroding democratic institutions and values around the world, a direct and growing threat to U.S. national security,” said Senator Cardin, a senior member of the Senate Foreign Relations Committee and one of the co-authors and lead negotiators of the Countering America’s Adversaries Through Sanctions Act (CAATSA). “Importantly, a number of the recommendations from the report on Russian interference I commissioned six months ago are included in this legislation. I’m pleased to partner with my bipartisan colleagues to build on CAATSA and further protect ourselves and our allies from a Kremlin that shows no sign of abiding by or respecting international norms.”

“For nearly two years, our nation’s top intelligence officials have repeatedly warned that the Kremlin is continuing its efforts to target our elections and sow chaos among our citizens,” said Senator McCain. “Until Putin pays a serious price for his actions, these attacks on our democracy will only grow. This bill would build on the strongest sanctions ever imposed on the Putin regime for its assault on democratic institutions, violation of international treaties, and siege on open societies through cyberattacks and misinformation campaigns. Moreover, this legislation would modernize our diplomatic tools and secure our critical infrastructure to better deter and defend against Putin’s aggression. We must confront this challenge – not as Republicans or Democrats, but as Americans. Because ultimately, Putin’s true aim is to undermine all of us – our country, our freedom, and all that America stands for.”

“We must stand arm-in-arm with our allies against the Kremlin’s hybrid attacks on the U.S. and democracies across the world,”said Senator Shaheen. “This bipartisan legislation sends a strong message of unity and deterrence against the Kremlin, while closing security gaps that leave our nation and its citizens vulnerable. I look forward to working with my colleagues in the Senate to advance this bill and harden our defenses against malign foreign influence.”

Key elements of the legislation include:

  • A strong statement of support for NATO and a requirement for two-thirds of the United States Senate to vote to leave NATO
  • Provisions expediting the transfer of excess defense articles to NATO countries to reduce some NATO countries’ dependence on Russian military equipment.
  • The establishment of an Office of Cyberspace and the Digital Economy within the Department of State.  This office will lead diplomatic efforts relating to international cybersecurity, Internet access, Internet freedom, the digital economy, cybercrime, deterrence and responses to cyber threats.
  • Provisions aimed to pressure the Russian government to halt its obstruction of international efforts to investigate chemical weapons attacks as well as punish the Russian government for chemical weapons production and use.
  • Making interfering in our elections a ground of inadmissibility under immigration law
  • The International Cybercrime Prevention Act which would give prosecutors the ability to shut down botnets and other digital infrastructure that can be used for a wide range of illegal activity; create a new criminal violation for individuals who have knowingly targeted critical infrastructure, including dams, power plants, hospitals, and election infrastructure; and prohibit cybercriminals from selling access to botnets to carry out cyber-attacks
  • The Defending the Integrity of Voting Systems Act which would allow the Department of Justice to pursue federal charges for the hacking of any voting system that is used in a federal election
  • New sanctions on political figures, oligarchs, and family members and other persons that facilitate illicit and corrupt activities, directly or indirectly, on behalf of Vladimir Putin
  • Sanction on transactions related to investment in energy projects supported by Russia state-owned or parastatal entities
  • A prohibition on and sanctions with respect to transactions relating to new sovereign debt of the Russian Federation
  • Sectoral sanctions on any person in the Russian Federation that has the capacity or ability to support or facilitate malicious cyber activities
  • A requirement for the Secretary of State to submit a determination of whether the Russian Federation meets the criteria for designation as a state sponsor of terrorism.
  • A prohibition on licenses for United States persons to engage in activities relating to certain projects to produce oil in the Russian Federation
  • A requirement for domestic title insurance companies to report information on the beneficial owners of entities that purchase residential real estate in high-value transactions
  • An extension on the cap of Russian uranium imports
  • Reinforcement for the State Department  Office of Sanctions Coordination
  • A report on the net worth and assets of Vladimir Putin
  • The creation of a National Fusion Center to Respond to Hybrid Threats.  The aim of this center is to better prepare and respond to Russian disinformation and other emerging threats emanating from the Russian Federation.
  • A reauthorization of the Countering Russia Influence Fund

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