Last August, on the heels of Donald Trump’s embarrassingly obsequious press conference with Putin in Helsinki, sanctions risk came calling again for Russian assets.
On August 2, Lindsey Graham and Democratic Senator Bob Menendez introduced sweeping legislation aimed at punishing Moscow for its malign activities on the world stage. The name of the bill: the Defending American Security from Kremlin Aggression Act of 2018, or, DASKA for short. Graham famously called it “the sanctions bill from hell”.
Six days later, on August 8, the State Department announced the imposition of sanctions tied to the Skripal case (after a lengthy delay that found Trump ignoring a Congressional request for a determination on Russia’s culpability, much as the White House is doing now with Saudi Arabia and the Khashoggi case).
From a market perspective, the most important question last August was whether any new sanctions would target Russian government debt, the so-called “nuclear option” that Steve Mnuchin shot down on April 11. Simply put, the renewed sanctions push served as an uncomfortable reminder of the series of events (and tweets) that led to a collapse in the Russian equity market last April amid coalition strikes on chemical weapons facilities in Syria.
The “key elements” section of the legislation proposed by Graham and Menendez last year contained 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 called for Mike Pompeo’s State Department to consider labeling Russia a state sponsor of terrorism.
Geopolitical implications (of which there were obviously many) aside, sanctions on Russian sovereign debt had the potential to ripple through financial markets, which is why it’s big news that a similar bill is now back on the table.
As you’ve probably heard, DASKA was resurrected on Wednesday by Graham and Menendez, as well as other members of the Senate Foreign Relations Committee. The language is largely the same. It seeks to hold Russia accountable for the Kremlin’s “interference in democratic processes abroad, malign influence in Syria, and aggression against Ukraine.” Menendez said this:
President Trump’s willful paralysis in the face of Kremlin aggression has reached a boiling point in Congress. Putin’s actions cannot be tolerated, and the consequences of inaction are quickly compounding — further humanitarian disaster in Syria, regional instability, kidnapping of Ukrainian sailors and seizure of ships, and the steady erosion of international norms. One thing is increasingly clear: Moscow will continue to push until it meets genuine resistance. That is why we are introducing a proposal to actually address the realities of the Kremlin threat in a holistic way, all while sending a crystal clear message to our adversaries that the U.S Congress will protect our institutions, allies and values even if the President chooses not to do so.
And here is Graham’s statement:
Our goal is to change the status quo and impose meaningful sanctions and measures against Putin’s Russia. He should cease and desist meddling in the U.S. electoral process, halt cyberattacks on American infrastructure, remove Russia from Ukraine, and stop 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. The sanctions and measures we propose are designed to respond in the strongest possible fashion.
The bill includes a number of elements that have the potential to destabilize markets, not the least of which are calls for sanctions on Russian banks, sanctions on energy investments and, again, sanctions on Russian sovereign debt.
You’ll be forgiven if you’re having a hard time keeping up with what exactly it is that’s going on when it comes to US sanctions on Russia and the country’s affiliates. This is a perpetual tug of war between the administration and Congress and trying to make sense of it is complicated by the fact that some of Trump’s domestic policy allies (e.g., Lindsey Graham) are pushing hard for the White House to take a tougher stance on Russia, despite the president’s insistence that “nobody has been harder on Russia” than he has.
Treasury’s decision to lift sanctions on businesses tied to Oleg Deripaska last month complicates things further still.
As difficult as it is to keep track of, you want to keep this on your radar screen. The threat of sanctions against Russian stated owned energy projects outside of Russia is a big deal, as is the renewed threat against Russian sovereign debt. Also note that the legislation blocks Trump from pulling the US out of NATO without a Senate vote.
So, what does this mean for markets? Well, as alluded to above, anytime this comes up it conjures memories of April 9, when Russian equities fell the most since 2014 in response to the original sanctions against dozens of oligarchs and companies (i.e., when Treasury blacklisted Rusal and En+ setting in motion the Oleg Deripaska drama that upended the global metals market).
If you ask BofAML, it’s not the bill itself that’s surprising for markets (after all, it’s basically the same bill as DASKA 2018), but rather the timing.
“January inflows into Russian assets likely indicate market participants did not believe Russian sanctions would be an immediate focus from the new Congress, especially given the discussions around China and the government shutdown”, the bank writes, adding that “renewed focus may thus trigger some re-pricing.”
They go on to explain that “a reaction similar to the one experienced in April is unlikely absent sanctions implementation.” I’m not sure that’s saying a whole lot – obviously, the reaction across Russian assets would be more violent if sanctions were in fact implemented.
If that were to happen (and you can bet this will meet resistance from the White House assuming it ever makes it off the Hill), BofAML muses that USDRUB “could test 70 before authorities react, and OFZs could move some 50bp, crossing 9%.” Russian stocks, the bank says, “could sell off another 10%, erasing the January gain and reaching valuations similar to the ones reached in 2014.”
The ruble hit its weakest levels against the dollar in a month this week on the news and yields rose the most since September.
When it comes to the currency, remember that CBR has been preemptive, a policy stance which is likely to make bears think twice. Nabiullina hiked in September, a move that came just days after Dmitry Medvedev threw caution to wind by suggesting rates were too high. She (Nabiullina) hiked again in December against consensus.
“In the last policy statement the CBR mentioned geopolitical tensions as a driver for a potential market volatility as well as deterioration of inflationary and FX expectations”, BofAML goes on to say, in the same note cited above, adding that “the risk of a new protective 25-50bp rate hike in March could increase if RUB again approaches or exceeds [the] 70/$ level.” Between that and rising oil prices, one would be inclined to think that the ruble is likely to remain resilient, especially if US monetary policy continues to lean dovish.
As far as the LNG threat in the new legislation is concerned, it’s basically meaningless right now, but could have implications down the road. Here’s Barclays:
To date, Russia has engaged in very little activity outside the country in LNG, with the exception of a couple MoUs, and its domestic LNG sector developed relatively late to global peers, due to the historical dominance of the pipeline export routes. As such, the direct effect of this measure would be limited, and to us there is likely to be some relief for the LNG sector in Russia in that it has not been targeted more explicitly at this juncture. Nevertheless, a step towards targeting Russia’s LNG gas sector in some form, alongside crude oil projects, is a new development that could have implications for Russia’s gas industry in the longer term via constraining the country’s exposure to global LNG trends and know-how, and if restrictions were to apply to assets outside of Russia such as transshipment facilities.
In other words, lawmakers on Capitol Hill are targeting things that don’t exist yet, and while that is by definition immaterial at the current juncture, it’s foreboding in that it suggests Russia’s LNG ambitions could be targeted by the US Treasury.
Ultimately, the fact that this is back on the radar is just another geopolitical stumbling block that most investors will invariably ignore right up until it matters. If you ask me, it’s notable that this is now conspiring with louder and louder calls from Capitol Hill for the administration to hold Crown Prince Mohammed responsible for the death of Jamal Khashoggi, not to mention the Kingdom’s role in perpetuating the humanitarian crisis in Yemen.
Mueller probe or no Mueller probe, collusion or no collusion, obstruction or no obstruction, there is quite a bit of bipartisan support for forcing Trump to change course on a number of foreign policy fronts, including his half-hearted sanctions efforts vis-a-vis Russia and the Saudis. That, in and of itself, is “not nothin'” – so to speak.
If the White House continues to resist these kinds of bipartisan calls for action, it may raise doubts in the minds of Republicans about why exactly it is that Trump is so reluctant to crack down on Moscow and Riyadh in the face of irrefutable evidence of malign activities. If nothing else, those doubts could lend credence to Democratic calls for investigations into Trump’s business dealings. After all, you don’t have to buy the collusion/obstruction story to believe that Trump’s foreign policy is being influenced by foreign money.
As far as markets go, Morgan Stanley summed things up nicely a week prior to the reintroduction of DASKA:
[Dovish Fed policy] bring[s] some relief and reduces the risks of emerging market capital outflows… but uncertainty over sanctions and risks of markets volatility affecting the ruble and inflation expectations remain.