A few additional comments around the U.S. House of Representative’s decision on July 25 to support the latest Russia sanctions bill, including sanctions, also levied on Iran and North Korea.
First, I know this revised bill (from that earlier passed by the Senate) has to go back to the Senate for approval, but it seems inconceivable that the Senate will not now approve the House bill, given the huge majorities in support of tighter sanctions on Russia already in both houses.
Once approved by the Senate, the bill will go to President Donald J. Trump for final signoff.
And therein also, and despite Trump’s own “special chemistry” with President Vladimir Putin, in the context of the Russia-gate scandal now engulfing the Trump presidency, it seems inconceivable that he would risk battles with Congress by not signing this bill into law, when he likely needs to expend any remaining political capital trying to secure some much needed “wins” on his domestic policy reform agenda, including reform of Obamacare. A presidential veto would in any event likely only delay the adoption of the Russia sanctions bill given that Congress would then only look to override the presidential veto in a follow-up vote.
Second, whichever way you look at this, this is bad news for Russia.
We can argue about the strength of the specific sanctions, on sectors, companies or individuals, but merely by being put in the same basket as Iran and North Korea these sanctions will impart significant and further reputational damage on Russia, as some investors will want to think again before committing longer-term investment in Russia. And critically by codifying these sanctions they likely ensure that these sanctions remain in place for decades to come, unless we see an about turn in terms of Russian policy towards the USA, the West and the near abroad – which under Putin seems unlikely.
So sanctions will remain in place for a long time, and they will likely deter foreign investment into Russia – at a time when Russia is desperately in need of that investment.
After three years or more of competition/conflict with the West, military intervention in Ukraine and Syria (and before that Georgia), and sanctions, plus arguably 18 years of largely failed economic policies (at least at the microeconomic level – macroeconomic policies have been much more prudent/orthodox and successful) under Putin, the Russian economy faces stagnation. Sanctions will just further sap longer term investment into Russia, and with it growth, and will further capital flight and the brain drain out of Russia. They will serve to further the isolation of Russia, from the West, and further the stagnation of the Russian economy which has been the key theme playing out over the past few years.
Third, so far the market reaction to the latest sanctions iteration has been muted.
This might reflect an erroneous assumption in my view that Congress will ultimately not agree to this sanctions bill, or that Trump will ultimately veto it. It might also reflect the fact that the assumption is the short-term impact will be limited – and reflective of the fact that Russia has shown some durability (at least in terms of macroeconomic balances) against sanctions lobbied thus far – albeit there has been a discernible impact on growth. I think also in credit markets there is an assumption that sanctions will not be extended to secondary trading, while restrictions on new debt issuance will continue to provide a technical underpinning to markets, by limiting new supply. In the short term, this underpins credit spreads, and acts to stabilize Russian markets, but does not help the long-term growth story.
It is also fairly remarkable to think that at the start of the year, the consensus in the market was that soon after taking office, Trump would remove sanctions on Russia. And yet, we are actually likely to see a tightening of sanctions on Russia through this latest congressional bill. And yet, despite this, Russian credit spreads are tighter by around 20 basis points year-to-date – partly this might reflect the broader market hunt for carry. But it also implies that markets are still discounting the impacts from additional sanctions on Russia.
This sanguine mood might change depending on the result of the report slated to be produced within 180 days by the U.S. Treasury and national intelligence over the impact of expanding sanctions to include sovereign debt and derivative products. Any extension of sanctions to secondary trading of Russian sovereign debt would likely produce an extreme market reaction – albeit that said, I would still expect Secretary Mnuchin to veto the adoption of any such measures at this point of time given Trump’s own well stated views on Russia – notwithstanding any further escalatory actions from Russia itself. But this still does create a risk of something more extreme.
Perhaps more importantly in terms of market reaction will be how Russia responds to approval of the latest Russian sanctions bill. Therein Moscow is promising tough, albeit not asymmetric measures. I think it might be mindful not to risk a further tit for tat on the sanctions front, which would likely only hurt the Russian economy further. I think it would also be mindful of not wanting to further undermine potential allies remaining in the White House and in the Trump administration. But a fair question now must be whether the Putin administration sees any hope that these allies can deliver anything positive towards Russia, and that rather Moscow must now be seen to show strength in response to this affront to its status by the DC establishment. The risk perhaps now is that Moscow opts to go back on the geopolitical offensive, with the risk of new stresses in relations with the West around flash points in Ukraine, Syria, Libya and even North Korea. Likely all this would just take US/Western-Russia relations to new lows still, and with the risk of yet more sanctions on Russia, causing even more damage to the Russian economy.