Tuesday, December 16, 2014

1998 All Over Again?

Olga Tanas and Anna Andrianova of Bloomberg report, Russia Defends Ruble With Biggest Rate Rise Since 1998:
Russia took its biggest step yet to shore up the ruble and defuse the currency crisis threatening its stricken economy.

In a surprise announcement just before 1 a.m. in Moscow, the Russian central bank said it would raise its key interest rate to 17 percent from 10.5 percent, effective today. The move was the largest single increase since 1998, when Russian rates soared past 100 percent and the government defaulted on debt.

The ruble lost 2.5 percent to 66.0985 against the dollar as of 12:53 p.m., reversing an early gain prompted by the news.

The announcement, as well as its timing, underscored the financial straits in which Russia now finds itself. If sustained, the new higher rates would squeeze an economy that is already being hurt by sanctions led by the U.S. and European Union, and by a collapse in oil prices. Some analysts said they doubted the economy could withstand such high rates for long.

“This move symbolizes the surrender of economic growth for the sake of preserving the financial system,” said Ian Hague, founding partner at New York-based Firebird Management LLC, which oversees about $1.1 billion, including Russian stocks. “It’s the right move to make, and it wasn’t easy to make it.”

‘Ruble Zone’

The ruble, which has depreciated 50 percent this year against the dollar, is the worst performer among more than 170 currencies tracked by Bloomberg. It gained almost 11 percent today, before weakening to a record.

“In order to limit the negative effects of such depreciation of the national currency on the Russian economy, we decided to increase the key rate,” Russian central bank Governor Elvira Nabiullina said on state TV channel Rossiya 24. “We really must learn to live in the ruble zone, rely to a large extent on our own sources of financing.”

So far this year, Russia has spent $80 billion of its foreign-exchange reserves in an unsuccessful attempt to prop up the ruble, which tumbled past 66 against the dollar for the first time. The currency’s collapse has evoked the turmoil of the 1998 Russian crisis, an event that reverberated through financial markets around the world.
Emergency Gathering

The Russian central bank announced the increase -- the sixth this year -- after policy makers gathered for an unscheduled meeting.

“This decision is aimed at limiting substantially increased ruble depreciation risks and inflation risks,” the central bank said in the statement. President Vladimir Putin, whose annexation of Ukraine’s Crimean peninsula in March prompted the U.S. and its allies to strike back with sanctions, this month called for “harsh” measures to deter currency speculators.

“While such drastic tightening measures will inflict more pain on the economy, we have been arguing for a while that it is not about preventing recession, but full-scale financial turmoil caused by the precipitous ruble fall,” said Piotr Matys, a currency strategist at Rabobank International in London.

Brent, the grade of oil traders look at for pricing Russia’s main export blend, lost as much as 3.3 percent to $59.02 on the London-based ICE Futures Europe exchange, trading below $60 a barrel for the first time since July 2009.
Losing Steam

Russia derives about 50 percent of its budget revenue from oil and natural gas taxes. As much as a quarter of gross domestic product is linked to the energy industry, Moody’s Investors Service estimated in a Dec. 9 report.

The economy may shrink 4.5 percent to 4.7 percent next year, the most since 2009, if oil averages $60 a barrel under a “stress scenario,” the central bank said yesterday. Net capital outflow may reach $134 billion this year, more than double last year’s total.

Others were more optimistic, saying the action was big enough to arrest the ruble’s record decline. “The central bank is trying to stop the avalanche, and such a massive hike may be sufficient,” said Slava Breusov, an analyst at Alliance Bernstein in New York. “No one seems to be thinking what it will do to the economy, as the priority is to stop the ruble plunge.”
If the massive rate hike by Russia's central bank was "to stop the avalanche" then it backfired in a spectacular fashion. The ruble faced intense selling pressure Tuesday falling at one stage by a whopping 20 percent to historic lows despite a massive pre-dawn interest rate hike from the country's central bank.

Welcome to 1998 all over again with important key differences:
Developing countries have allowed their exchange rates to fluctuate, moving away from the fixed exchange-rate regimes prevailing during the crisis in the late 1990s. While weaker currencies fuel inflation, they can also stimulate economic growth by making exports cheaper.

*Foreign Reserves

Developing countries’ foreign reserves dwarf the amount they had in the late 1990s, which will help them weather the volatility in financial markets. As a group, emerging markets hold $8.1 trillion, compared with $659 billion in 1999, according to data compiled by the International Monetary Fund.

*Debt

Instead of borrowing in dollars, the governments now mostly raise financing in local currencies, allowing them to pay back the debt without having to draw down foreign reserves. External debt amounted to 26 percent of developing nations’ gross domestic product last year, down from 40 percent in 1999, the IMF data show.

One caveat is that companies have replaced governments as a source of concern on debt issuance. Corporations in developing countries sold about $375 billion of international debt between 2009 and 2012, more than double the amount in the four years before the 2008 financial crisis, the Bank for International Settlements said in September.

*Interest Rates

While rates are rising in some developing nations, they remain a fraction of the levels seen in 1998. Russia raised its benchmark rate 6.5 percentage points to 17 percent effective Dec. 16 at a late-night meeting. Some short-term rates soared over 100 percent back in 1998. In Brazil, policy makers have raised benchmark rates to 11.75 percent. That’s still less than half the rate levels from 1998.
I just finished writing a comment on how the plunge in oil won't crash markets via the credit markets and then Russia blows up, sending a jolt across global financial markets.

Why are Russian woes unnerving markets? Because investors are worried of another full blown emerging markets crisis. Bank of England Governor Mark Carney said the selloff in emerging markets may harm more core markets:
Bank of England Governor Mark Carney said the selloff in emerging markets may worsen, posing the risk of higher borrowing costs and weaker growth in core markets.

Even as U.K. banks’ exposure to Russia is “very modest,” and ties between the two countries “relatively limited,” Carney said the central bank was “not complacent at all about the dynamics in the global economy.”

“We do see there is some prospect for a sharper adjustment across emerging markets and that could rebound back into core markets, and raise risk premia and challenge financial conditions, with some impact for financial stability and ultimately for growth,” Carney told reporters in London today.
Carney is absolutely right, central banks can't ignore the carnage in Russia and other emerging markets which also experienced a commodity boom/ bust. Have a look at this chart of the iShares MSCI Emerging Markets (EEM) over the last year (click on chart to enlarge):


The rout in emerging markets has nothing to do with Russia's problems. This will exacerbate the pain ahead but it's got more to do with the plunge in oil and commodity prices and the slowdown in China, which just experienced its first contraction in manufacturing activity in seven months.

And if you think things are bad in Russia, look at the charts of Petrobras (PBR) and Vale (VALE) and you'll see an eerily similar picture to the Russian stock market (RSX) which has been plunging lately. When it comes to emerging markets, I agree with those that warn to prepare for more pain ahead.

Skeptics will say "So what? The US economy is humming along fine. Why should the Fed care about Russia and a possible crisis in emerging markets?". I can show you the reason in one chart Sober Look tweeted last night (click on image to enlarge):


This is the chart which keeps Janet Yellen, James Bullard and other Fed officials up at night. This is why the Fed can't ignore the plunge in oil and turmoil in emerging markets unless it wants to see deflation in America, which is coming no matter what the Fed does. At least that's what inflation expectations and the bond market are telling me right now.

We shall see if the Fed bursts the bubble on Wednesday but in my humble opinion, if it doesn't take a more dovish stance pointing to global weakness, it risks making the biggest policy mistake of all time.

Below, Richard Haass, president at Council on Foreign Relations, and Bloomberg’s Henry Meyer and Hans Nichols discuss the fallout from the ruble reversing the biggest gain in 16 years against the U.S. dollar following a rate hike to 17 percent by the Russian Central Bank and whether or not the Russian economy is heading for a repeat of the default of 1998. They speak on “Bloomberg Surveillance.”

And Georgetown University Professor Angela Stent discusses the ruble and Russian economy on “Bloomberg Surveillance,” also stating why it looks like 1998 all over again but there's an "element of unpredictability" that should worry all of us as the U.S. and its allies pushes Russia further into isolation.

Finally, Gary Shilling, founder of A. Gary Shilling, discusses why the U.S. could catch Russia's cold. “The markets are telling us there is something else there,” warns Shilling. I think he's right.


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