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‘All Bets Are Off’ As Washington Plays Russian Sanctions Roulette

"[The] government and the central bank are monitoring the situation."

It is clear that major sanctions actions are looming against Russia now either by the Administration, by Congress or both. All bets are off.

That’s from Bluebay’s Tim Ash, who I guess spoke to Bloomberg on Thursday for a new piece on the Russia sanctions, but if you want real-time commentary from him, he has a pretty active Twitter feed which is definitely worth a follow.

The “all bets are off” characterization is probably accurate to the extent market participants are going to have an exceptionally difficult time predicting what comes next in terms of further escalations in the rolling diplomatic row between Moscow and Washington, where “Washington” means lawmakers, intelligence officials and the State Department, but not necessarily Donald Trump.

And look, don’t lose me here – you don’t have to be a “Russiagate” conspiracy theorist to think the Kremlin is getting some kind of advance notice from the White House on these escalations. For instance, Wednesday’s trading in the ruble was a bit odd. Russian media published the entire text of the Graham/ Menendez bill (which threatens sweeping sanctions against Moscow predicated on a laundry list of grievances) on Wednesday morning, but it’s not clear why the ruble would have responded as negatively as it did given that the legislation was introduced last week and given that at least one sellside desk (Barclays) had already done a fairly decent job of parsing it.

Hours later, however, the State Department announced the imposition of sanctions tied to the Skripal case. It’s possible market participants were actually anticipating that based on public information because, as noted in the linked post there, House Foreign Affairs Committee Chairman Ed Royce wrote Trump a letter on July 26 essentially asking what was taking so long when it came to determining whether automatic sanctions applicable under the Chemical and Biological Weapons and Warfare Elimination Act of 1991 were appropriate for the Skripal situation. Royce basically demanded the White House respond “no later than 12:00 p.m. on Thursday, August 9”.

Still, it seems odd that the ruble was heavily offered early Wednesday, more than 24 hours ahead of the deadline and it’s not clear why the publication by Russian media of the Graham/ Menendez bill should have been the catalyst given that the information was already in the market.

Anyway, the point is, you’d have to be obtuse to think the White House isn’t in contact with the Kremlin on all of this – that would likely be the case under any administration, and this one is no exception for obvious reasons.

Also, Dmitry Peskov (the Kremlin’s spokesman) isn’t doing a great job of feigning incredulity.  “Such measures are absolutely unfriendly and can hardly be associated with the constructive — difficult but constructive — atmosphere at the last meeting of the two presidents,” he said on a conference call Thursday.

He’s either just putting on a brave face (as Moscow is wont to do) on the way to deliberately understating the case, or else he seems oddly sanguine considering the U.S. just definitively accused Russia of using a nerve agent to assassinate someone and also considering the fact that the Graham/ Menendez bill includes a provision that compels the State Department to make a determination on whether Russia is a state sponsor of terror. I’m not sure “absolutely unfriendly” quite captures it.

Today, Russian lawmaker Sergei Ryabukhin warned that Russia may hit back at the U.S. by restricting exports of RD-180 rocket engines. That according to RIA. Apparently those are a component in Atlas V rockets made by United Launch Alliance LLC, which is a joint venture between Boeing and Lockheed.

So I don’t know, there’s undoubtedly a lot going on behind the scenes here. Congress clearly knows that and isn’t amused, which is why the above-mentioned Ed Royce pushed the envelope on the Skripal case and also why Graham and co. have taken it upon themselves to move ahead aggressively on new sanctions following the Trump-Putin summit in Helsinki during which the U.S. President appeared to inexplicably pander to his counterpart, much to the chagrin of the GOP establishment. There’s a sense in which that summit is becoming a liability for Moscow, although again, depending on what was agreed to when nobody (including and especially Dan Coats) was around, I suppose it’s possible that Putin secured some kind of promise from Trump that any sanctions emanating from the administration (i.e., not from Congress) would be telegraphed.

Whatever the case, this is all coming to a head and there was no relief for the Russian ruble following Wednesday’s rocky ride. At the lows on Thursday, the two-day slide totaled some 5%. Trading volumes in the currency rose to three times the previous day’s level on Wednesday and to the highest since the April sanctions.

USDRUB

(Russian ruble takes dramatic two-day plunge amid fresh sanctions push)

The fallout isn’t limited to the currency, although it’s bearing the brunt. Shares of Aeroflot (the country’s largest air carrier) were hammered on Thursday on the prospect that the second round of Skripal-related sanctions could result in a ban of the carrier’s flights to the U.S. That’s obviously not great for the company, whose shares at one point careened more than 10% lower, but have since recovered a bit.

Aero

(Aeroflot shares are crushed on Thursday)

But the broader Russian equity market is holding up well. In fact, as Bloomberg’s  Heather Burke noted on Thursday morning, this week’s sanctions banter hasn’t even been sufficient to push the MOEX below its 200-DMA, let alone drive it anywhere near its “Black Monday” levels from April (full account of that debacle here).

MOEX

(MOEX still holding up as two-day decline looks like blip compared to April)

That said, Russia CDS has widened out to 156 basis points, the highest in at least a year.

RussiaCDS

(Bloomberg)

Remember, lurking in the background here is the threat of sanctions on Russian sovereign debt. That’s the black swan that could potentially send ripples across financial markets given relatively high (if declining) non-resident ownership.

The prospect of potentially destabilizing market dynamics in conjunction with sanctions on the OFZ market are one argument against going that route. Depending on who you ask, the situation would be manageable or not if the U.S. were to go down that road.

Yields on 10-year Russian government debt rose above 8.2% this week.

BondRussia10

(Bloomberg)

For his part, Finance Minister Anton Siluanov is pretty sure Russia has everything under control. “[The] government and the central bank are monitoring the situation [and] have all necessary instruments to maintain financial stability and, if needed, will use them,” Siluanov said in Moscow on Thursday, adding that the economy has become “more resilient to external shocks.”

Maybe so, but the bottom line here is that investors are concerned about how far this is going to go and while more than a few people are arguing on Thursday that the sanctions help the Trump administration in terms of giving them political cover for the “no collusion!” narrative, I would argue that the Kremlin cloud hanging over the White House makes this situation even harder to manage for asset allocators as there’s no way to get a “clean” read on things, one way or another.

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