Russia’s ruble-denominated Moscow Interbank Currency Exchange (MICEX) slumped to the lowest level in a year on June 15 after the US government codified sanctions on Russia into law and tightened the regime of restrictions in the first step of what could turn into much more painful and long-term sanctions regime.
The bill must still be approved by the upper house of represenatives and then signed into law by US president Donald Trump before becoming law.
However, the vote commanded an unusual bipartisan support with a 97-2 vote in the normally divided government, highlighting the anger American politicians feel over alleged Russian meddling in the 2016 presidential elections.
The Russian stock market immediately sold off by 1.7% on the news taking the index to its lowest level this year. As of the end of trading on June 15 the MICEX index was down 1.5% to 1,810, off from an all-time high it set earlier this year. Likewise, the dollar-denominated Russia Trading System (RTS) was down 2.6% to 998, dropping back below the 1,000 mark. All-in-all, after a stellar year in 2016 when the market gained some 50% y/y, the MICEX is down 18% YTD and the RTS 12%.
The codification of the US sanctions is a serious escalation as the previous sanctions were imposed by an executive order signed by president Barack Obama and as such only needed the president’s signature to be removed. Now the sanctions are law they will need a majority vote in the house to be lifted – and given the bipartisan nature of US politics these days the chances of raising a majority of votes to do Russia a favour is unthinkable at this point.
The decision echoes the Jackson Vanik bill that imposed sanctions on countries that were not “market economies” like Russia, where state-owned firms could be deemed to be benefiting from non-market competitive advantages like state-subsidised energy. Those restrictions took 37 years to remove, long after the original reasons for imposing them ceased to be valid.
And the new measures could extensively broaden the reach of the initial sanctions. The existing regime targets a very short list of state enterprise and individuals close to President Vladimir Putin personally. The EU equivalent regime is even more limited in scope – more symbolic than effective.
However, the new proposed amendments would allow for the expansion of sanctions to state-owned entities in the rail, shipping, metals and mining sectors, as well as energy pipelines, according to Alfa Bank analysts.
“If there are tougher sanctions which are also codified then this will be clearly damaging for the Russian investment case. All of that is unclear for now, as specific proposals have not been tabled,” Alfa said in a note.
In a strategy note titled 'Blood on the Street', Russian brokerage BCS Financial said the sell-off has raised the risk/reward profile of Russian stocks to its best since the summer of 2016.
"Our house view is that we are buyers with a fundamental 22% upside on a 6-12-month horizon and expect the market to bottom out over the next few weeks," chief strategist Slava Smolyaninov said in the report. "Even from a technical perspective, the market has not been so oversold since January 2016, so this is a rare case of blood on the street."
Sentiment towards Russia has also not been helped by weaker oil prices, with Brent trading at $47 a barrel on June 15, down from the mid-50s highs set in recent months. API data showed US inventories expanded by 2.75mn barrels last week and as IEA data forecasts new supplied from Opec's rivals will exceed demand growth next year. Oil slumped further overnight on a surprise US gasoline supply gain.
Finally Russian stock prices will also feel some downward pressure after the US Federal Reserve hiked interest rates by 25bp to a target 1-1.25%, the second hike this year. Rising US rates undercut EM stock prices and the 2008 sell-off in emerging markets started in earnest when the Fed rapidly hiked rates in 2008, triggering the selling when the rate hit 5.25% - the point when returns on super safe US treasuries were sufficient for investors to trade out of higher yielding but significantly more risky EM stocks and bonds. That point is still a way off, but the journey towards it has now started.