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Western sanctions decimate the Russian economy


America and Europe hit Russia with suffocating economic sanctions

Russian central bank raises interest rates but cannot defend currency

Stocks retreat, US dollar and oil advance as traders reduce risk

Capital flees Russia

The invasion of Ukraine has sent markets into a tailspin. Europe and America finally took off the gloves and announced a new round of crippling economic sanctions against Russia. These include the expulsion of several Russian banks from the SWIFT international payments system and freezing most of the FX reserves held by the central bank.

This is essentially a one-two punch from the West. It will deal a heavy blow to Russia’s financial institutions and perhaps spark a recession, while also leaving the central bank powerless to defend its currency by preventing access to its own war chest. The Russian central bank raised interest rates to 20% today in a last-ditch attempt to fight currency depreciation, but the rouble still collapsed to a new record low.

Capital is fleeing the country and Russian assets are on fire sale. Many large players have announced they will divest their Russian holdings, people are queuing up for cash machines, and soft capital controls have already been introduced by ‘prohibiting’ foreigners from selling securities on the Moscow Exchange.

Markets react

Pricing geopolitical risk into financial markets is notoriously difficult. There is no exact formula for how to protect a portfolio against potentially catastrophic events, so oftentimes investors tend to overreact by dramatically slashing their risk exposure and deleveraging.

Crude oil has been the best barometer of market concerns around this conflict. The prospect of sanctions constraining Russian supply has turbocharged energy prices, although Western powers have been careful not to target the sector explicitly, fearful of the collateral damage on the European economy from soaring fuel prices.

This is also why the euro is under pressure. The sanctions could come back to bite Europe by squeezing consumers and restraining the banking sector in countries with high exposure to Russian money, so currency traders are taking cover in the safety of the US dollar.

What now?

Stock markets were hit by a powerful wave of selling as well. European markets are down almost 2% while futures point to a similar loss when Wall Street opens today. ‘Cut risk first, ask questions later’ seems to be the strategy among money managers.

The one piece that doesn’t fit the puzzle is gold. Bullion opened higher for the week but has already surrendered those gains, which is strange considering that Treasury yields are also sinking. It could be that the Russian central bank is dumping gold on the open market to shore up its devastated currency, since most of its FX reserves have been frozen.

Looking ahead, markets will remain hostage to incoming headlines. Russian forces have encircled Ukraine’s capital, Vladimir Putin has put his nuclear arsenal on high alert, and the European Union has pledged to deliver arms to Ukraine, including fighter jets. Hence, the situation is very unpredictable.

One ray of hope comes from the peace talks that will be held between Ukrainian and Russian officials today. While the negotiations might not stop the war, they might be enough to lift risk sentiment. A lot of the negativity has already been priced in and everyone is hedged at this point, so any piece of good news could have a tremendous impact in terms of calming the markets.

Source: https://www.xm.com/research/analysis/marketComment/xm/daily-market-comment-western-sanctions-decimate-russian-economy-155847
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