Are Russian Bonds Toxic Waste or Golden Eggs?

One man’s toxic waste is another man’s golden goose.  A new round of economic sanctions imposed on Russia last month by the U.S. is creating havoc in investment circles.  A recent article by Ben Aris at Russia Insider describes Russian debt assets as ‘toxic waste again.’

That doesn’t mean these Russian debt assets actually are bad investments, just that those who currently hold them have to get rid of them because the rules have changed.

And they are no longer legally allowed to own them.

Because of that what were one minute the darling of the investment world instantly turned into garbage, selling if anyone can find a buyer at discounts even Crazy Eddie would blanche at.

All the previous sanctions imposed on Russian companies had only affected new securities – listings of new shares or bonds. Existing securities were unaffected.

Not now. The Specially Designated Nationals And Blocked Persons List (SDN List) released on April 6 not only sanctions those listed, it bans any investor with US exposure (European banks with US branches count) from doing any business with the sanctioned names. Investors were supposed sell all their stocks, bonds and debt within 30 days – i.e. before May 7.

This has sent the market for Russian securities into the floor.

Criminal Idiocracy

Politicians are a stupid and cowardly lot. Batman had it right, because they are, in fact, criminals.

For their own purposes they pass laws which force losses onto those who did nothing wrong, in this case those who purchased Russian corporate and sovereign debt in European markets over the past few years.

It’s theft, pure and simple.  Those having to sell these securities to get into compliance will face horrific losses, 70 to 80 cents on the dollar, in some cases.

Overnight, a healthy and prosperous market became a desert of the real all because John McCain’s nose was out of joint over being outmaneuvered in Crimea a few years ago?

And Donald Trump is too cowardly to say no to this insanity?

If I was a truly cynical man I would venture that ex-Goldmanite Steve Mnuchin engineered this so his buddies could play Johnny Bench at their bond desks in Hong Kong picking these things up for pennies. That would be crude wouldn’t it?

Crude but certainly plausible.

Russia is harmed by this.  Coupon payments have to be made in the currency of the debt.  The push here thanks to these sanctions is to limit Russian companies’ access to euros, in the same way that crashing the ruble and oil markets in 2014 was designed to starve Russia of dollars, forcing the bonds to be settled as they mature versus being rolled over because the companies had lost access to U.S. dollar funding.

Since that time the Russians have switched to euros, Chinese yuan and rubles.  But, with the bank of Russia keeping interest rates too high, there is little appetite for issuing ruble-denominated debt, when the euro markets offer far better rates.

This is the same thinking that trapped Russian corporates in 2014.  Blame can be laid at the feet of both parties, the companies looking for the lowest cost of capital and the central bank slow-playing the recovery of the Russian economy through overly-high interest rates.

It is a situation like this that fuels the notions that the Bank of Russia still works for the West rather than Russia herself.  Personally, I’ve been screaming at BoR President Elvira Nabullina to lower borrowing rates faster for more than a year now.

While both consumer and business lending are growing finally, the BoR is still encouraging Russian companies to seek out loans denominated in anything other than Rubles at a time when the avowed policy of the Russian government is to de-dollarize as much as possible.

In other words, the high interest rate policy is encouraging the very behavior the BoR says it is trying to fight, by inviting foreign capital into Russia only to see it fly out in the event of a new attack by the U.S. on its banking system.

Foreign ownership of Russian bonds is now 30% versus just 5% at the start of the year, thanks to high interest rate arbitrage.

Such that now there is more than $176 billion dollars in euro-denominated debt which has to be serviced.

These bonds have to be sold to new investors, harming them, which Mnuchin, Trump and the rest of the bozos in Washington could care less about.

Next Stop: City of London

Then the next step will be to cut Russian companies out of the European banking system.  The Gypsum Lady, U.K. Prime Minister Theresa May, has all but made that threat in the wake of Skripal-Gate, but it has not been revisited.

It’s likely because she knows she can’t do that until the markets for Russian securities are clear and London bond traders have figured things out.  Even Mnuchin, as Mr. Aris, pointed out, had to back off to allow the market time to get in compliance.

In March, the ECB seized Latvian Bank ABLV to remove an avenue in which Russian businesses can bank within the EU.  Again, so much of this is about getting Russia and Gazprom to stop building the Nordstream 2 pipeline as well as repudiate its relationship with Iran.

But, it simply won’t work.

Russian President Vladimir Putin and his chief economic advisor Sergei Glazyev have been pounding their shoes on the table to get the ‘oligarchs’ to repatriate their funds and bring their core business practices back to Russia.

The West cannot be trusted.  Glazyev, in particular, has been adamant about this to stop the capital flight out of Russia through the banking system.

So, in effect, the U.S. is doing exactly what Putin wants done, bring the capital home.  He’ll give them tax breaks, similar to what Trump did for U.S. corporates in his tax bill.

Between making ownership of the bonds illegal it also puts upward pressure on the ruble in forex markets as companies now have to scramble to raise euros to service the debt.

It’s a mess. But, it’s a mess that can be handled because Russia isn’t alone in the world anymore.  Today, unlike late 2014, it has a much better and deeper relationship with China to get the right currency into the right hands at the right time.

It was the opening up of ruble/yuan swap lines in December 2014 that stabilized the Russian equity markets and ensured that the worst of the ruble crisis was over.  Today, with a similar market dislocation attempt by the U.S. the ruble has pushed up a few points, but nothing potentially catastrophic.

The Rush to Nowhere

The urgency with which all of these false flags, hybrid and physical war actions, etc. that the U.S., the U.K., Israel and Saudi Arabia are occurring tells me that time is running out to stick this landing and get the desired result – regime change in Iran and Russian submission to U.S. hegemony.

The problem with tactics like this is simply that if they don’t work, if the target doesn’t collapse then you’ve got nothing left to him them with. And, like Ali versus George Foreman, the counter-attack will be a knockout.

The bottom line is that because Russia is in such a good financial position — low Debt to GDP, growing albeit slowly economy, buoyant oil and natural gas prices, more than ample foreign exchange reserves — investors are lined up deep to get access to their markets and their assets.

In markets, it’s a verity that a big actor can manipulate price in the short term, think stock buybacks for example, but they cannot overwhelm the primary trend.  A decade of QE can’t raise the price of worthless mortgage-backed securities.

If you believe that’s possible then you don’t believe in the power of markets, the power of people acting in the aggregate over the actions of the very few acting in concert.

The demand for Russian assets was there in 2017.  Despite the best laid plans of Washington and Downing St. that demand is still there and it will ensure that Russia will not be locked out of capital markets in the future.

Dollar and euro markets are gone.  They will figure something out with China.  People are clever.  Russians especially so.  They will always find a way to get around the diktats of a would-be Emperor.

N.B. – Thanks to Trauma2000 at the Russia Insider forums for spurring me to answer Mr.Aris’ article.

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16 thoughts on “Are Russian Bonds Toxic Waste or Golden Eggs?

  1. Maybe Putin´s new prime minister rumored to be appointed next week will work out a way for his underlings in the finance ministry and perhaps with the help of a new central bank governor to purchase the bonds going begging.


    On Tue, May 1, 2018 at 1:21 PM, Gold Goats ‘n Guns wrote:

    > Tom Luongo posted: “One man’s toxic waste is another man’s golden goose. > A new round of economic sanctions imposed on Russia last month by the U.S. > is creating havoc in investment circles. A recent article by Ben Aris at > Russia Insider describes Russian debt assets as ‘tox” >

    • We’ll see, but I doubt Nabullina is going anywhere. She’s lost the fight to keep interest rates high, having pulled them down to 7.25% after declaring that 8% was sufficient in December.

      So, expect rates to come down to around 6.50% this year. The interbank markets are screaming for this, still a full 25 basis points below the benchmark rate, indicating that there’s no stress in the market, and she should cut rates again, this time by 50 basis points.

      Nabullina has been consistently behind the curve, I feel on purpose, for the entirety of this part of the rate cycle. And she is stifling growth.

      Now, that’s the bad news in the short term. The longer-term perspective is that Russia’s growth that is occurring today is only the most profitable and needed by the Russian economy, thanks to a high cost of capital, but it is also starving long-term projects of capital which is why companies keep looking overseas for money.

      She should maneuver markets to around a U.S. + 2% benchmark rate with a 10 year yield near U.S. + 4% and then back off.

  2. Hi Tom

    As a keen observer of the relentlessly escalating Anglo-US-NATO hostility towards Russia, I trust and hope you are right about the likely results of this latest escalation. However, John Helmer – a long-term, Moscow-based Russia-watcher for whom I have considerable respect and who endears himself to neither the Russian nor Western establishments – has just posted this alarming article. Is Putin really about to capitulate – because however sugar coated and caveated about with soothing words of ‘de-escalating tensions’ etc etc, that is surely what the appointment of Kudrin would mean?

    I’d be interested in your take on it.

    • John Helmer is interesting but he’s also generally over the top in his assessment of what’s happening.

      My big question for you and him is, “If this is true why did Putin fire Kudrin as his chief economic advisor in 2016 and promote the Stolypin Group and Sergei Glazyev?”

      Moreover, why have things economically been moving in Glasyev’s direction since that happened? Nabullina finally lowering interest rates, a threatened nationalization of Rusal if Deripaska didn’t capitulate, experiments in blockchain, etc. if Kudrin was still truly in the picture?”

      I think Helmer is crying wolf here because he knows that Kudrin is the wrong guy and is worried about him getting a seat back at the table, and with good reason.

      A lot of Russian analysts and sympathizers are freaking out at Putin’s passivity but it is still the right play.

      • Thanks Tom

        You’re probably right – and I sincerely hope so.

        I still rate JH though – OTT a bit sometimes maybe but his in-depth analyses of geo-political-impacting events and various personalities & Russian companies nearly always include good stuff that is not available (or difficult to find) elsewhere. The fact that his site is regularly under DDOS attack indicates that he must be getting under the skin of some powerful players too – which also argues for keeping tabs on his stuff. It will be very interesting to see what happens on the ‘New PM’ or Kudrin VP front then eh?

      • Also, in fairness to JH, he did include the FT article predicting the Kudrin promotion and pointed out that its kite-flying articles had proven spectacularly wrong before

      • I read John Helmer, I like him, I also take him with salt. The same way I take many of the Russian and Asian commentators.

        I think Kudrin is trying to get back into Putin’s good graces. I think John is over-stating the case at this point as to the success of his campaign to do so.

        We’ve seen this before by Atlanticists (as The Saker calls them) try to create a narrative for themselves in the press.

        And usually very little comes of it.

  3. “The fact that his site is regularly under DDOS attack indicates that he must be getting under the skin of some powerful players too – which also argues for keeping tabs on his stuff. It will be very interesting to see what happens on the ‘New PM’ or Kudrin VP front then eh?”

    I agree. Helmer is a great resource, even if I disagree with his conclusions. I feel the same way about The Saker, Dmitri Orlov and others. I read them and then integrate what they are saying with what I am seeing (and stripping out their inherent leftist bias) and go from there.

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