Russia/Ukraine – War In Europe.
Russia launched a full-scale attack on Ukraine last Thursday. Western sanctions against Russia were initially mild, but turned harsher over the weekend with talk of removing SWIFT-access for some Russian banks. Additionally, EU and US sanctioned transaction with the Central Bank of Russia. This is particularly harmful, as $300-400bn of the $650bn CBR international reserves are estimated to sit in Western jurisdictions. A reduction in Russia’s financial war chest is triggering strong local selling of Ruble and a rush to withdraw cash. As a result, the CBR hiked interest rates to 20% from 9.5% on Friday and imposed restrictions on corporate FX holdings. The measure is likely to impose severe pain on the Russian economy and to leave the Ruble permanently weaker than the level suggested by oil.
Further, western governments increased support for Ukraine by supplying arms. Russia and Ukraine have agreed to negotiate at the Belarus border, though we are not hopeful that these negotiations will yield positive results as Russian / Ukrainian demands are far apart. Russian assets prices today are down significantly as investors await the details of the sanctions, with Russian external debt pricing in a high probability of a technical default. We think pressure on Russia from the West will continue, and hence expect Russian asset prices to remain low. However, given Ukraine’s strong fundamentals prior to the conflict and high support from the West, we see value in Ukrainian assets at current levels.
Global Central Banks – Can the tightening path be derailed?
Central banks are at a cross-roads amid the Russia/Ukraine conflict: Inflation expectations are rallying along commodity prices as oil prices crossed $100 this week, but the war makes central banks wonder if now is the right time to tighten monetary policy aggressively. The fundamental picture for the US with above-target inflation and tight labour markets remains strong and unchanged, also with strong PCE, durable goods and spending data on Friday. We believe a tightening cycle from March onwards is still warranted – even if perhaps at a less front-loaded pace over geopolitical uncertainty.
In Europe however, the war will impact the economy much more directly, calling the path for ECB policy tightening into question. On Friday, Lane estimated the war to decrease Eurozone GDP by 0.3-0.4% in 2022. Most notably, one of the most hawkish voices within the ECB, who at the start of last week wanted 2 hikes in 2022, reversed course following the invasion and called for a delayed exit of stimulus instead. Italian 10Y yields fell 11bps on Thursday as a result, but rose afterwards again to close the week roughly flat. Friday’s press conference by Lagarde added little incremental information on the policy path ahead, as she emphasized all decisions will be made at the March meeting and will be data-dependent. While markets were previously pricing the ECB to hike 50bps by December 2022, this estimate has now fallen to 35bps as of Friday. We remain positioned for wider rates in both the US and Europe, as high inflation keeps pressure high and eventually will lead all central banks to act.
Algebris Investments’ Global Credit Team
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