Sure, the fundamentals may be decidedly more favorable for countries other than Turkey, but as we saw with Russia in April (full recap of that episode here) and as we’re about to see with Russia again thanks to a renewed sanctions push, decent fundamentals will not carry the day if access to dollars is curtailed either by sanctions or simply because the Fed is contributing to a global dollar funding crunch.
That’s from one of several expansive pieces on Turkey we published Friday, and the overarching point in that passage is that some market participants seem to be underestimating the chances of a spillover from the lira situation into emerging markets as a group.
The collapse of the lira grabbed the spotlight late in the week, but it’s important to remember that the ruble is now staring down the prospect of sanctions on sovereign debt thanks to bipartisan legislation introduced by Lindsey Graham and Democratic Senator Bob Menendez earlier this month. Russian media published the full text of that bill on Wednesday and hours later, the State Department announced separate sanctions on Russia in connection with the Skripal case.
Depending on how much traction the Graham/ Menendez bill gets on the Hill and depending on whether additional sanctions are in the cards from the Skripal poisoning, the ruble could well be in for tough times.
Earlier this mont, Citi suggested USDRUB could go to “about 70” if the worst case scenario plays out and non-resident participation in the OFZ market falls to zero. Well, this week was the worst week for the currency since the 2015 oil crash and we’re now not too far from that target.
Asked this week by Bloomberg about that 70 target in light of how quickly we’re already getting there, Citi’s analysts said traders are already pricing that in. “Uncertainty will linger on at least until Congress is back from summer recess”, they noted.
Fidelity’s Paul Greer had a great series of soundbites this week on the extent to which “idiosyncratic” risk in EM doesn’t seem so “idiosyncratic” anymore.
“We remain anxious about the potential for further sanctions escalation between the U.S. and Russia, which will likely lead to further dislocation in Russian markets”, he told Bloomberg, in an interview, adding that while contagion from Turkey, Argentina and the April turmoil in Russian assets was previously contained, “this time, the move is broader.”
In that context, do note that Friday was the worst day for the MSCI EM FX gauge since May of 2017.
“US sanctions targeting Russia are already at a much more advanced stage but last week’s bipartisan bill introduced in Congress highlights considerable risks in case new measures affecting new sovereign debt and transactions of major state-owned banks are implemented”, Barclays wrote on Thursday, in their weekly emerging markets letter. Goldman, meanwhile, had this to offer on Friday:
If enacted, this [Senate] bill would have a much more severe impact on Russia’s macro economy and financial markets than the sanctions announced under the Chemical and Biological Weapons Control and Warfare Elimination Act of 1991, although the scope and details are still to be clarified. For now the senate bill could be seen as a warning ahead of the mid-term elections. From a macro standpoint as well, risks increase in the new year as the scheduled hike in indirect taxes could cut short any recovery in growth as a result of increased oil production. We will wait to see the precise details of the sanctions before altering our RUB forecasts, but it is clear that the currency is likely to trade weaker than the 61-63 range it has held since April as headline risk is to remain high at least until the mid-term election.
You can draw your own conclusions here, but I guess what I would encourage folks to consider is that in addition to the fact that the outlook for Turkey is now exceptionally dire and on top of the fact that sanctions on the OFZ market would be enormously destabilizing for Russian assets, this is all playing out against a backdrop where the administration in the U.S. is increasingly prone to leaning on unilateral sanctions and tariffs to “solve” problems.
When you combine that with a recalcitrant Fed and what hawkish U.S. monetary policy entails for EM sentiment, you’ve got yourself a rather toxic brew.