A potential Russian default is beginning to feel like déjà vu
Morgan Stanley recently announced in a client note that they feel Russia is likely to default on their debt as early as April 15, while investors are unsure if Russia will pay its coupon payments by the end of the 30-day grace period starting March 15. Russia has already placed a ban on paying its coupon payments to foreign holders and if this is still the case by April 15, Russia will enter technical default. 2023 Russian bonds are already valued at 29 cents on the dollar with several banks disallowing their use as collateral in client accounts. What is interesting about the situation this time is the striking resemblance it shares to the last time Russia defaulted on its debt. After years of waging war in Chechnya, the ruble was removed from its U.S. dollar peg in 1998 and lost two-thirds of its value essentially overnight. Russia also defaulted on its domestic debt and declared a moratorium on the repayment of foreign debt, all in the name of stabilizing the economy and paying the mounting costs of war in Chechnya. This eventually caused Russian sovereign debt to be cut to junk, and it took the country until 2004 to regain its investment-grade rating.
Fast forward to 2022, Russia has initiated a war in Ukraine, the ruble has lost 37.5% of its value since February 15, and Russia has placed a moratorium on foreign debt repayments. Russian companies can make payments under the sanctions, but the entire world is wondering whether Russia will be able to or want to make the payments on its foreign debt considering the sanctions placed on it by the rest of the world. While a Russian default will certainly make headline news and there are striking parallels to the last default, it had minimal impacts on the U.S. economy in 1998 and will likely have minimal impacts on the economy in 2022. While the Russian default infamously caused the bankruptcy of the U.S. hedge fund Long-Term Capital Management, we now believe that investors are much less blind to the risk of sovereign default than they were at that time and that global banks and the global financial system are now far more diversified and well-capitalized to the point where a Russian default will not cause contagion in the system.
Tensions rise in Ukraine along with the price of commodities
After speculation that additional sanctions could be imposed on Russia, the price of commodities rose yet again. The recent developments of possible sanctions on Moscow’s energy supply skyrocketed the price of oil to over $130 a barrel today, the highest price since July 2008. Similarly, the price of wheat is approaching its all-time high as Ukraine, one of the top global crop suppliers, finds it difficult to maintain production levels given the intensifying conflict. This rapid increase of prices across the board coupled with weakening growth is garnering possibilities of stagflation or even another recession. As the U.S and European allies mull over the decision to ban imports of Russian oil, gasoline prices saw a robust and sudden increase in the U.S. Crude oil prices doubled in 1973-74, 1978, and 2007-08, and all foreshadowed the looming recession ahead. Adjusting out for inflation, crude oil would need to surpass $170 per barrel to be comparable to the 2008 spike. If crude oil sustains a ~$20 elevated shock, Wall Street analysts are projecting a 0.6% and a 0.3% drop in the Euro area GDP and the U.S. GDP, respectively. With little to no indicators of a mellowing in Ukrainian tensions or easing of the recent supply chain fiasco, we will continue to face elevated commodity prices for the foreseeable future.