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Russian roulette

We maintain an upbeat view despite scarier geopolitics.

An escalation of geopolitical tension has dominated the investment backdrop in the past week, with the US announcing further financial sanctions on Russian entities and preparing a military response following reported gas attacks in Syria. With relations between Russia and the west deteriorating at a pace, Russian asset prices have fallen sharply, with the US Administration effectively making it a legal offence to transact any business in US$ with entities majority owned by those on the sanctioned list. In particular, this has impacted aluminium producer Rusal, owned by Oleg Deripaska, which has US$7.6 billion in debt outstanding (including trade vendor financing), and whose dollar based securities have even had their pricing history expunged on data services such as Bloomberg. These US moves have surprised financial market participants and has led to selling of other Russian assets, on pre-emptive fears that any further escalation of tensions could see other entities impacted similarly, with no Russian names seemingly safe from such reprisals. Returning to Rusal, with aluminium prices jumping by 10% and US producers such as Alcoa reaping the benefits, we sense the US Administration will be happy with this outcome thus far, especially with risk assets globally retaining their poise with prices little changed over recent days.

Geopolitical concerns have pushed G3 government bond yields towards the lows of their recent ranges, though US front end (of the Treasury curve) pricing continues to fully discount two further rate hikes in 2018. US core CPI rose to 2.1% this week, as negative base effects from a year ago dropped out of the data series. Notwithstanding this, there seems little acceleration in inflationary trends for the moment, even if commodity prices are starting to generate some interest with oil breaching US$70 and metals prices also firming. In Europe, comments from Ewald Nowotny hinting at a 20bp rise in the deposit rate in H2 2019 were quickly disavowed by the ECB, though this thinking seems to be very close to market thinking anyway.

There is an air of unpredictability surrounding Trump and with Russia hawks dominating the White House these days.

Mark Dowding, Head of Developed Markets


Credit markets, in general, were more resistant to risk-off moves during the past week and it may appear that sentiment is stabilising following a period of hefty supply. Most activity was focused on Russian names with sovereign spreads 40bp wider, issuers such as Gazprom 60bp wider and other issuers suffering even more dramatic declines in prices. Ultimately, we believe that a continued escalation of conflict is in no parties’ interest and we would hope for reconciliation with Putin’s main goal this summer being the upcoming football World Cup. However, there is an air of unpredictability surrounding Trump and with Russia hawks dominating the White House these days, it may be foolish to be too dismissive of the current situation.

In FX, the rouble has been the dominant story as well, initially losing 10% of its value during the past week as short sellers sought to push the currency weaker, without the Russian central bank seeming to worry too much about stopping this for the time being. As the most liquid Russian asset, we feel that the rouble may have been used as something of a Russia proxy and consequently moves may have gone too far – in particular, if Russian domestics conclude that their wealth is not safe offshore and so decide to repatriate it back to the motherland. Elsewhere, the Turkish lira has also been under heavy selling pressure with a central bank not prepared to raise rates to defend the currency. Away from Turkey and Russia many emerging markets have traded relatively well, with investors seeming to discriminate between different sovereigns with very different underlying fundamentals, at a time when robust global growth, firm commodity prices and benign macro policy remain broadly supportive of flows into emerging market asset classes.

Looking ahead, we continue to believe that the stabilisation in core yields creates the condition for risk assets to rally if markets become a little calmer. We retain an upbeat view on global growth and although the geopolitical backdrop may feel a little scary, we would note that when one looks domestically, these recent spats have actually served to boost the popularity ratings of Putin in Russia, Trump in the US, May in the UK and Xi in China. In the US, Trump is declaring trade war success already, with China looking at opening its markets and cutting some tariffs in areas like autos – even as higher tariffs are being mulled in products like soya beans and aircraft. China clearly doesn’t want to give the impression of folding to US pressure, though if one wants to take a more optimistic point of view, it is yet possible that for all of the talk of protectionism, a fairer outcome for global trade could yet be on the cards.

Nevertheless, although we believe that it is correct to retain a structurally bullish view of the world, when conflicts involve military escalation we know that the backdrop can become even more unpredictable. Ultimately, we hope that the US response to the gassing in East Ghouta will be measured and proportionate, but there are no guarantees that this won’t lead to further malevolent behaviour on the part of the Russian state. Maybe the West should think carefully about ‘poking the bear’, especially when they have already put it in an ever tighter (sanctions) cage to begin with.