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‘The April Selloff Could Repeat’: Russian Ruble Dives As Market Wakes Up To ‘Drastic’ U.S. Sanctions Bill

The "nuclear route" discussion is live again.

On Tuesday, the Kremlin expressed its displeasure at the reimposition of sanctions on ally Iran. Since pulling the U.S. out of the nuclear deal, the Trump administration is seeking to apply maximum financial pressure on Tehran in order to, among other things, curtail the regional activities of the Quds Force, whose influence in Iraq, Syria and Yemen is causing consternation (to put it mildly) among America’s regional allies.

“[We are] deeply disappointed by U.S. steps to reimpose its national sanctions against Iran,” the Russian foreign ministry said on its website, adding the Moscow intends to do “everything necessary in the interests of preserving and fully implementing the [the nuclear deal].”

Well, if Lindsey Graham, Democratic Senator Bob Menendez and a host of other U.S. lawmakers who are supporting a bill proposed last Thursday have their way, Russia will soon have its own harsh sanctions to worry about.

Last week, Graham and 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.” In the cross-hairs: the OFZ market. If that bill gets any traction on Capitol Hill, it will likely weigh heavily on the ruble. For their part, Citi thinks USDRUB would likely hit 70 in the event the Treasury goes the so-called “nuclear route”.

In the linked post above, we took an in-depth look at the context for the new bill. That post was essentially a followup to “‘Black Swans From Helsinki’ Beckon As Senators Ponder ‘Nuclear Option’ For New Russia Sanctions”,  a lengthy piece from last month recapping the brutal selloff that hit Russian assets earlier this year, amid sanctions on oligarchs and coalition strikes on Moscow’s ally in Damascus.

The new bill proposed by Lindsey Graham and Bob Menendez could have far-reaching consequences. As noted above, the legislation includes a line item calling for “a prohibition on and sanctions with respect to transactions relating to new sovereign debt of the Russian Federation.” Foreign ownership of the OFZ market is not trivial and indeed, that exposure is one reason why the U.S. avoided sanctioning sovereign debt earlier this year. Steve Mnuchin explicitly shot it down on April 11, for instance.

Non-resident ownership of the market has fallen since the Rusal sanctions scare this year.

OFZ

(Barclays)

On Wednesday, the Kommersant daily published the full text of the bill (embedded below) and it’s causing some problems for Russian assets. The ruble, for instance, is down sharply, falling more than 1.5% in thin summer trading.

USDRUB

For context, it’s on its way to the weakest levels since November of 2016.

USDRUB2

“The April sell- off could repeat,” Danske Bank’s Vladimir Miklashevsky wrote Wednesday, referencing the brutal collapse of Russian assets documented in the “black swans” post linked above. “If the bill becomes law and Russia replies, the RUB would be hit even more through deteriorating sentiment and selloff of RUS assets”, Miklashevsky continues.

Shares of Sberbank are down sharply on the day, likely in response to the publication of the bill’s text which lists the bank, along with VTB and several other financial institutions.

SBER

In a note dated August 3, Barclays called the proposed sanctions on Russian sovereign debt “drastic”, before discussing the implications of a line in the bill that specifies “a prohibition on and sanctions with respect to transactions relating to new sovereign debt of more than 14 days of the Russian Federation (Federal Treasury, Central Bank and National Wealth Fund) plus associated restrictions on FX swap agreements.” Here’s the bank’s take on that:

The current wording means that the Central Bank’s (CBR’s) bonds, known as OBRs, which are used as an instrument for regulating bank liquidity will be in scope too. Currently the amount outstanding of OBRs is around RUB1,450bn, or $23bn. This means the instrument helps to absorb nearly half of all excess liquidity in the banking sector. Sanctioning OBRs would have important implications for monetary policy, and it is unclear whether this is indeed the intention of the Senators who had introduced the bill.

What’s more, the bill’s definition of sovereign debt also includes “foreign exchange swap agreements with the Central Bank, the National Welfare Fund, or the Federal Treasury of the Russian Federation with a duration of more than 14 days”. We are unsure as to the motivation for this proposal; however, it may be intended to close any potential loopholes for Russia to get access to USD liquidity.

It’s not entirely clear why the market is just now reacting to this, but whatever the case, yields on 10-year ruble bonds hit their highest levels in more than a year and CDS spreads widened out by 5bps as well.

Again, it remains to be seen how much traction this gets on Capitol Hill, but even a watered down version of the legislation that targets sovereign debt would likely take a hefty toll on ruble and other Russian assets.

According to Moody’s, Moscow’s move to unload U.S. Treasurys ahead of a potential new round of sanctions may leave the country less exposed.

“When sanctions were imposed in April, it became clear that transactions in dollars could be problematic to entities and individuals in Russia, so they are planning accordingly,” analyst Kristin Lindow told Bloomberg in a phone interview this month. “I think that is something any responsible policy maker would do.”

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