Finally Going Nuclear

At long last, US officials decided to “go there,” where “there” means hitting Russian sovereign debt in retaliation for ongoing Kremlin mischief, including, but not limited to, the SolarWinds hack and ceaseless attempts to meddle with America’s fractious democracy.

“Treasury is leveraging [sweeping new authority] to impose costs on the Russian government for its unacceptable conduct, including by limiting Russia’s ability to finance its activities,” Janet Yellen said Thursday.

OFAC issued a directive that prohibits US financial institutions from participating in the primary market for ruble or non-ruble denominated bonds issued after June 14 by Russia’s central bank, sovereign wealth fund and the Ministry of Finance. It also “further prohibits US financial institutions from lending ruble or non-ruble denominated funds to [those] three entities,” Yellen continued.

Often described (somewhat morbidly, given the parties involved) as the “nuclear option,” targeting Russian sovereign debt is a broadside too big to ignore and risks jeopardizing tenuous plans for a summit between Joe Biden and Vladimir Putin.

“We don’t want our bilateral relationship to operate on the principle of one step forward, two steps back,” Dmitry Peskov said Thursday, adding that the scrapping of (non?)plans for US warships to visit the Black Sea isn’t enough to facilitate a deescalation in Ukraine where “the situation is quite tense.”

He also warned that Russia is prepared to deliver a “reciprocal” response to any sanctions, but that’s obviously impossible. Moscow has no “reciprocal” answer for Yellen’s sovereign debt prohibitions, or at least not if “reciprocal” is supposed to convey proportionality. Although Thursday’s move wasn’t seen as draconian, the White House indicated it has scope to expand the debt sanctions.

A senior Russian government official who spoke to Bloomberg said the details of Treasury’s sanctions suggest the move is “the least painful option” for Moscow. It’s possible, the official noted, that Americans could still participate in the secondary market.

Yellen also took aim at multiple Russian tech companies for their support of the Russian Intelligence Services, which she accused of “execut[ing] some of the most dangerous and disruptive cyber attacks in recent history, including the SolarWinds cyber attack.” Treasury didn’t stop there. The same notice calls out the FSB for being “involved in the August 2020 poisoning of Aleksey Navalny with a chemical weapon… engag[ing] in activities that materially contributed to the possession, transportation, and use of Novichok related to a March 2018 poisoning in the United Kingdom [and] using its cyber capabilities to target Russian journalists and others who openly criticize the regime, as well as US government personnel and millions of private citizens around the world.”

Speculation that Russian sovereign debt was “fair game” (if you will) began to build anew as Russia stoked border tensions with Ukraine. OFZ yields rose Thursday and the ruble fell.

“A level of uncertainty and a permanent threat of retaliation is likely to be a persistent feature of the investment landscape,” JPMorgan’s Anezka Christovova wrote earlier this month. “Additionally, tensions with Ukraine have recently introduced another dimension of risk,” Christovova added, noting that US investors comprise a quarter of foreign OFZ holdings. Harkening back to the Rusal tumult, the bank suggested that this time around, Washington may adopt “a gradual approach,” in order to avert “upsetting markets.”

Some said Thursday that going “nuclear” may not be as destructive as it sounds. GAM’s Paul McNamara, for example, suggested that simply barring US financial institutions from the market “isn’t enough to do much damage.” Another analyst told Bloomberg that OFZ sanctions may catalyze $10 billion in outflows from local bonds and another $5 billion from Russian stocks.

According to The Bank of Russia, non-resident investor holdings of OFZs dropped 170bps last month, to just over 20%. Foreigners’ share of primary auctions shrank to 9.6%.

Whatever the case, the Kremlin could use a dose of accountability. And please, spare me the “Whataboutism.” Sure, the US meddles in other countries all the time. In fact, America just yesterday decided to finally throw in the towel on a two-decade adventure in Afghanistan, which any Russian old enough to remember the 80s could have told Washington was doomed from the moment mission creep kicked in.

The point isn’t to traffic in normative statements. I don’t care much about what “should” happen or what’s “right” and “just.” All I’m saying is that when you’re openly antagonistic and relish your role as global antagonist (as Putin most assuredly does), sometimes you get your hand slapped. He counts himself lucky that Russia is still powerful enough to make chopping one of those hands clean off impractical.