There’s trouble in paradise, and by “paradise”, I mean Russia.
The ruble came under all manner of pressure on Thursday following comments from Prime Minister Dmitry Medvedev, who decided it was a good idea to say the following at a conference in Moscow:
It’s necessary to move from neutral to stimulating oversight of the credit sphere to create conditions for more confident economic growth. Interest rates remain quite high despite the successes in holding back inflation.
He went on to advise the central bank to be “active” when it comes to addressing high interest rates.
Suffice to say that implicit encroachment on central bank independence is not exactly what the market wants to hear at a time when EM is under all manner of pressure. The ruble fell sharply when Medvedev’s comments hit the tape.
That’s the weakest the ruble has been against the greenback since March of 2016. The currency was the fourth worst performer in EM last month.
“It seems that the market has interpreted comments from PM Medvedev as political interference in the monetary policy”, Rabobank’s Piotr Matys said Thursday, adding that “such remarks may undermine the credibility of the central bank and Governor Nabiullina, who is well respected by investors for acting decisively during the ruble crisis only a few years ago”.
On Tuesday, Nabiullina suggested a rate hike is indeed on the table, saying the following in Sochi:
There’re a significant number of factors for holding the rate and some factors have appeared that allow to put the option of a possible rate increase on the table. We’ll assess all the risks.
This comes as the U.S., the U.K., France, Germany and Canada released a joint statement faulting the Kremlin for the Skripal poisoning. This week, the U.K. charged two would-be assassins in the incident. The two men have been identified as Russian military foreign intelligence service operatives. Of course Maria Zakharova (Sergei Lavrov’s swaggering spokeswoman), doesn’t know anything about the two suspects. “The names, as well as the photos, published in the media mean nothing to us,” she said on Wednesday.
In August, the U.S. leveled sanctions against Moscow in a long-delayed response to the incident. That came within a week of a sweeping new sanctions bill introduced by Republican Senator Lindsey Graham and Democratic Senator Bob Menendez, whose proposal includes the possibility of sanctioning Russian sovereign debt, the so-called “nuclear option” that Steve Mnuchin shot down earlier this year after sanctions on Russian oligarchs catalyzed steep losses for Russian assets.
The threat of sanctions on sovereign debt casts a pall over Russian assets and in the event that becomes a reality, the ruble would likely feel a significant amount of pain. That said, hitting the OFZ market with sanctions would be a truly dramatic step to take and ultimately, you’ve got to think the White House would push back.
The problem (and this is something we tried to drive home In July following the Helsinki summit and also last month as the sanctions push gathered steam), is that Russian assets are vulnerable from multiple angles, whether it’s souring relations with the west, rising inflation or just a generalized deterioration in EM sentiment. Here’s a bit of color on all of that from Goldman, out on Thursday:
Russian headline inflation rose to 3.1% yoy in August from 2.5% yoy in July (Cons.: 3.1%, GSE 3.0%) due to a normalisation in food inflation which contributed 0.5ppt to the 0.60ppt increase in headline inflation. Going forward we expect inflation to rise to close to 5% by April next year due to the VAT increase in January, normalising food prices and the weaker Ruble.
Though CBR governor Elvira Nabiullina said that the Board will discuss the option of a rate hike next week, we think the Bank will keep rates on hold. We think that the threshold for rate hikes is still high despite inflation likely to breach the 4% target in Q1-19. A rate hike can do little to address the temporary factors in our view, fueling inflation in the short run. Even the exchange rate appears to be mostly reacting to political Russia-related news rather than global rates or volatility in other EMs.
On Thursday, Morgan Stanley said another hike is possible this year should inflation expectations become unanchored and/or if the U.S. does push ahead with sanctions on sovereign debt.
So that’s the context for Medvedev’s Thursday comments cited above and you can see why they would unnerve markets. Also on Thursday, Finance Minister Anton Siluanov said Moscow could eschew foreign borrowing in the event volatility in EM doesn’t calm down. He also characterized the yields investors are now demanding as “unacceptable”. 10Y yields have risen to their highest levels since early 2016:
As far as Medvedev’s Thursday comments (which, again, amount to a call for rate cuts at a time when a rate hike is in the cards), Commerzbank had this to say:
[This] came at the worst possible time.