Zoltan Pozsar took a break this week from assessing every conceivable angle of Fed balance sheet rundown to consider the ramifications of what he euphemistically called “geopolitical events” for funding markets.
By “geopolitical events” he of course meant Russia’s invasion of Ukraine. “Perhaps the most important fact to consider when thinking about the funding market implications of sanctions is that Russia is a surplus agent — and surplus agents typically lend a lot of funds in the Eurodollar market,” Pozsar said, a day after the US and the UK moved to cut the country and its banks off from dollars and pounds, even as Germany, Hungary and Italy stood in the way of a SWIFT ban.
Pozsar tallied a total of around $1 trillion in liquid wealth between Russia’s non-gold reserves and private sector liquid investments. $300 billion of that is in short-term money market instruments and another $200 billion is lent US dollars in the FX swap market, something Pozsar noted is “not immediately obvious” from the Bank of Russia’s reports, which only show $100 billion of US dollar exposure.
Recalling Russia’s decision to shed Treasurys in the spring of 2018, Pozsar said there are “tell-tale signs in the data that the proceeds from these sales went into the FX swap market.” What does that mean, exactly? It means the money is still effectively in dollars. Just not onshore. Rather, offshore, in the Eurodollar market.
The upshot is that although the most recent Foreign Exchange and Gold Asset Management report from Moscow showed US dollar assets comprised just 20% of Russia’s non-gold FX reserves as of Q2 2021 (“way down,” as Pozsar put it, from 50% in March 2018), the country’s dollar exposure is likely unchanged — around 50% (figure below).
50%, Pozsar noted, is “more reasonable than the reported 20% for a country that is a big exporter of commodities priced in US dollars.”
In addition to the $200 billion in swaps, the Bank of Russia and the Russian private sector hold claims on foreign banks totaling some $300 billion. Is that a lot? Well, it depends on the context. The answer here is “yes,” and Pozsar emphasized as much. To wit:
$300 billion deployed in the money markets is a lot. $300 billion is enough to push spreads around in funding markets. $300 billion — in the extreme — can either be potentially trapped by sanctions, or moved somehow from West to East to avoid being trapped by sanctions. Each would be a market event.
Most obviously, frozen funds transform surplus agents into deficit agents. In that regard, Pozsar recalled a pseudo-famous note he published with a colleague during the pandemic. When surplus agents turn into deficit agents, the result is “missed payments,” he said, “much like the onset of COVID-19 led to missed payments.”
On the flipside, surplus agents (which here just means Russians), can attempt to shift their funds back East. Then it becomes a classic “If I owe you a dollar, that’s my problem, but if I owe you $1,000, that’s your problem” scenario.
“[It] would mean the partial tear-up of matched FX swap books and outflows of operating deposits as public and private surpluses are moved, respectively, from Western banks,” Pozsar wrote. That, he remarked, would be the banks’ funding problem. “As deficit agents, these institutions may then have to tap the dollar swap lines,” he said.
Pozsar conceded he’s “no expert” on geopolitics. But he is an expert on funding markets. By many (fawning, obsequious) accounts, he’s the expert. And according to the “oracle” (as Bloomberg once called Zoltan), further escalation in Ukraine would likely have “a direct impact on FX swaps and US dollar Libor fixings given Russia’s vast financial surpluses and where those surpluses are deployed.”
His cautionary takeaway: “Whoever moves first, there is a funding impact either way…”
So is Putin trying to take control of the National Bank of Ukraine or some of the larger private Ukrainian banks? Can Putin “launder” money thru those banks?
If or when that happens, those institutions would be sanctioned. The same happened when Saddam invaded Kuwait.
Thank you Dr. H.
This article should make us question how ignorant Fed governors are about the global payments system they influence and regulate. Do the Fed officials who felt compelled to talk up further tightening last night have any clue about how the real world works?
That sure looks doubtful.
This ignorance is setting the stage for Fed independence to be challenged after the next populist wave sweeps through DC.
The timing of attacking Ukraine now is pretty devious. The disruption of any oil or gas deliveries from Russia to the EU causes inflationary impacts globally at a time when central banks are hoping to slowly increase rates. However, as Russia literally tosses jet fuel into the inflationary fires, central banks will be placed in awkward positions to play with rates, and stunt growth in fragile economies. That’s further complicated and compounded by institutions like the Fed that structurally are hindered by selling instruments at losses. The Fed and other banks are somewhat frozen in their options to play hardball. I assume Putin saw this as he was playing chess with his computer models.
That’s the backdrop, but, oh, it gets even more entertaining when you see how that model connects to having China lined up to buy the oil the EU needs. Kinda crafty stuff ..
This month, Russia agreed to sell an additional 10 billion cubic metres of gas to China annually later this decade, equal to 5% of Moscow’s current exports to Europe, and on par with the volumes Gazprom shipped to Beijing last yea
We’re going to have a teachable moment soon…
Every comment I’ve read is valid and article was fully of weighty-ponderables. Times like these I’m glad I’m comfortable deep underground, being a worm and all. Putin may have crossed the Rubicon when he started rattling the nukes just four days into the conflict. He’s stripped away any remaining facade that he can ever be a trusted counter-party going forward. Putin is no longer seen as inscrutable and shrewd in the eyes of Western leadership. Except in the minds of dummkopfs of tRumpian portions and miscellaneous collaborators. Putin has hoisted himself by his own petard into the deranged loose nuke existential threat category. This cluster-duck started even before the Boris and Bill blunders got started and their bromance ended in blood and Putin. That was immediately followed up by George “I don’t do nuance” Bush’s inability to comprehend and/or summon the patience necessary for the PfP (Partnership for Peace) approach to be applied to peripheral former Soviet States. Bush support a gradualist/merit based rules process for full NATO admittance? Yeah, right. His binary-brain really only had the freckless ([f/r]eckless) commitment to the lowercase “l” liberal hegemony wet dream of rapid assimilation choice left. That choice was ultimately made possible by the brief period of a truly unipolar geopolitical world. Probably seemed pretty reasonable by those that would write the history at the time. Considering the long string of idiotic wars and occupations the lowercase “l” liberalism combined with hegemony (not to mention the current fiasco) has got US into over the past thirty years I’d have to wonder if a brief(?) return to taking nationalism (at least that of non/weak-democracies) seriously again might do US some reality-check goodness. A brief refresher in geopolitic power-politics, i.e., “realism”, might do US some good too. Especially, before we attempt yet again to turn our gaze toward China away from our centuries old geopolitical preoccupation with Europe. It would be great if it has sunk into our noggins that Putin’s take home lesson is that we no longer reign supreme in a unipolar geopolitical/economic landscape. Don’t get me started on the perversities of Russia’s self-defeating version of Manifest Destiny! … This is all so insanely complicated it reminds me of a wise worm that once suggested there are times when it is best to keep your head below ground and wait for the vibrations to subdue, but, while you are down there study the roots of the problem. Apparently all those that had the foresight to propose PfP are down here with us Worms, cuz, it sort of boggles the mind the West didn’t see this coming when it was spelled out over thirty years ago. Another variation on the Minsky Moment of sorts. Success (of the lowercase “l” liberalism hegemony) breeds it’s own failure. As is frequently admonished in the comments, “fasten your seatbelts”, because a non-unipolar geo-whatever world stage will be more volatile. That’s why they call it Bi-polar disorder I suppose.