Russia Sanctions and the Fixed Income Market

Markets have been moving quickly, but there are a few things to highlight about recent price action. First, Russian debt, both hard currency and local currency, is largely shut down for trading. The web of central bank restrictions, bank sanctions, actions taken by investors and/or clearing exchanges, and restrictions by the Russian government mean positions are frozen. 

This situation will likely remain for the foreseeable future, with investors unable to liquidate significant risk. Operational guidance for many sanctions are still to come – and there may be some limited ability to buy and sell hard currency securities - but any liquidity improvement near term will be limited.

Second, prices for Russian government securities are pricing in a default scenario, and we think that is a likely outcome. It’s unclear why Russia would want to use hard currency to repay these securities at the moment, and we expect much of this debt to enter “grace periods” over the coming month. Russian hard currency sovereign securities are indicated at 10 – 30 cents on the dollar and will likely remain there.

Third, as we wrote last week , the markets have dramatically repriced central bank expectations. Any near-term European Central Bank hiking expectations have been taken out of the market, and Federal Reserve expectations have been scaled back to four hikes this year. We believe this is a rational repricing and expect rates to remain rangebound with steeper curves. Hiking cycles will be more elongated, which should help keep rates lower.

Fourth, the key macroeconomic risk emerging from this event is energy prices. While we think the markets can compartmentalize much of the Russia situation, the channels for energy prices are harder to fix. It will be difficult for OPEC, for example, to make up for Russian production if that leaves the market. Demand destruction may be the cure for higher prices, which obviously has negative ramifications for growth.

Finally, spillover to credit markets has remained relatively limited. Spreads have widened, but U.S. high yield spreads, for example, remain below 400 basis points. We expect this to continue where spillover pressure to credit markets remains relatively muted, given the strength of fundaments and an outlook for lower, but still positive, global growth.

Overall, we expect the volatility to continue. But given that Russian securities have been repriced to default levels, we believe those immediate impacts are largely over. Debates about the economic impacts and central bank responses will now become front and center.