At the start of the week, President Putin finally made his move. Russia will recognize the independence of the Donetsk and Luhansk Republics (DNR and LNR). This could entail the movement of troops into eastern Ukraine under the guise of peacekeeping to support the regions new-found independence. The US reacted with sanctioning two Russian banks and three Russian elites. Germany, meanwhile, halted its certification of Nord Stream 2. Markets have so far reacted to view these as de-escalation moves. More importantly, if we take the precedent of the 2014 Russia/Ukraine conflict, we find that sanctions alone may not be enough to destabilise Russian markets.
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At the start of the week, President Vladimir Putin finally made his move. Russia will recognize the independence of the Donetsk and Luhansk Republics (DNR and LNR). This could entail the movement of troops into eastern Ukraine under the guise of peacekeeping to support the region’s newfound independence. The US reacted by sanctioning two Russian banks and three Russian elites. Germany, meanwhile, halted its certification of Nord Stream 2. Markets have so far reacted to view these as de-escalation moves. More importantly, if we take the precedent of the 2014 Russia/Ukraine conflict, we find that sanctions alone may not be enough to destabilize Russian markets.
Parallels to 2014
The Russia-Ukraine conflict of 2014 is instructive. Back then, Russia annexed Crimea from Ukraine and supported separatists in the Donbas region (where DNR and LNR are located) of Eastern Ukraine. This saw the US and EU lead three waves of sanctions on Russia.
- The first wave in March 2014 saw travel bans on Russian officials involved the Crimea annexation.
- The second wave in April 2014 saw restrictions on business transactions of certain officials.
- The third wave in July 2014 came after Russia’s escalation of military activity in Donbas. It saw more stringent sanctions on Russian banks, energy companies, and restrictions on exports to Russia and access to international capital markets.
Assessing the market implications of the sanctions is complicated by large oil price declines and dollar strength in the second half of 2014 when the third wave of sanctions was introduced. To adjust for the dollar effect, we look at EUR/RUB. Notably, major RUB weakness only occurred in 2014Q4 – this was several months after the third wave of sanctions. If anything, it appears the decline in oil prices was the larger factor behind RUB weakness (Chart 1).
We can cross-check this by looking at the behaviour of USD/JPY and Russia CDS around each wave of sanctions. Here we find that USD/JPY barely moved around the first two waves of sanctions and actually rose after the third wave. As for Russia CDS, we see spikes in CDS around each wave but a dramatic surge at the end of 2014, which was several months after the third wave.
The bottom line from this is that sanctions had a short-lived impact on Russian risk markets. But it was the plunge in oil prices that derailed both Russian risk markets and the country’s currency.
Today the picture is different. Oil prices are close to breaking $100, and the supply-demand picture suggests the risks are to the upside. Meanwhile, EU and US actions have been muted. The most aggressive action would have been to replicate the third-wave sanctions of 2014. This would entail sanctions on the major Russian banks and energy companies. But in the end, lower oil prices may be needed to cripple the Russian economy.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)
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