Several Russian banks have now been cut off from SWIFT. SWIFT, which stands for the Society for Worldwide Interbank Financial Telecommunication, is a communications system that facilitates cross border money transfers for financial institutions. The action is a major step that is anticipated to have a severe impact on the ability of these banks to conduct international transactions. The ban will require banks to conduct their everyday interbank transactions via an alternative mechanism or routed through fledgling rival systems, adding to costs and creating delays in the clearing of funds. As of now, energy- and agriculture-related transactions continue to be excluded from the SWIFT ban. Following the announcement of the ban, there have been rising concerns over the liquidity position of Russian banks, with widespread reports of Russians queuing up to withdraw cash at ATMs. In a worst-case scenario, Russia could be vulnerable to a major banking crisis. We anticipate that major central banks will stand ready to help contain any financial contagion risks should liquidity issues spill over into Western institutions.
For global fixed income markets, a risk-off regime has taken hold. This has resulted in some spread widening, as evidenced by European investment-grade corporate and high-yield spreads widening by 15 and 40 basis points,1 respectively, over the past week. Meanwhile, US Treasury yields have decreased from their recent highs as a result of a flight to safety. In addition, the US curve continues to flatten, pointing to rising concerns over slowdown risks. Separately, the USD has been well supported, being a defensive asset, while higher-risk currencies, including emerging market currencies, have come under significant pressure.
The Central Bank of Russia (CBR) has been targeted with a freeze on official currency reserves. Russia’s total official reserves are currently reported at $630 billion, much of which is held outside of Russia. Part of these reserves will be made inaccessible, which will greatly restrict Russia’s access to foreign currencies. In a worst-case scenario, the CBR may retain control over foreign exchange reserves held in China and its gold reserves, totalling an estimated $230 billion. The reserve freeze will limit the CBR’s ability to support the Russian ruble through intervention in the currency market, as well as its ability to provide foreign exchange liquidity to the domestic banking system. Against this backdrop, the ruble weakened by approximately 20% on February 28, which forced the CBR to implement a massive interest rate hike from 9.5% to 20%. In addition, the CBR has imposed capital control measures, including a local broker ban on selling Russian securities held by foreign investors. In addition, the Russian authorities have banned all Russian residents from transferring foreign currency abroad, including for foreign debt, part of a package of retaliatory measures for U.S. and European sanctions.
Looking ahead, the Russian economy potentially faces substantial challenges, including a major recession, rampant inflation, debt defaults and goods supply shortages, as well as the risk of a domestic financial crisis. On Friday, Russia’s sovereign rating was cut to BB+ by S&P, placing the sovereign debt in the high-yield category. Meanwhile, the London-listed depositary receipts of several Russian companies have crashed, losing well over 50% of their value during Monday’s trading session. Separately, Deutsche Börse, Germany’s largest stock exchange operator, suspended trading in 16 Russian securities including Aeroflot, Rosneft, Sberbank, VTB and Gazprom because of sanctions imposed by the EU.
The new round of sanctions includes smaller measures. In a symbolic move, the United States has announced that it has directly targeted Vladimir Putin, along with Foreign Minister Sergei Lavrov, with an asset freeze. Several other key individuals have been hit with an asset freeze, along with a travel ban. In addition, most Western countries have barred Russian aircraft from operating in their airspace.
The invasion has far-reaching consequences for the global economy. With the conflict intensifying and both economic and military tensions increasing, the probability of adverse economic scenarios, including a global recession, has increased. What happens in the next days and weeks will largely determine what the magnitude of the global economic fallout will be.
Endnotes
1 Spread is the difference in yield between a fixed income asset and a government bond with a similar maturity. The spread on European investment-grade corporate and high-yield spreads was based on the option adjusted spread for the Bloomberg European Aggregate Corporate Bond and Bloomberg Pan-European High Yield Bond Indices as of February 28, 2022.
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