MACRO ADVISOR: Busy June means Russia risk premium to change

MACRO ADVISOR: Busy June means Russia risk premium to change
Busy June means Russia risk premium to change.
By Chris Weafer of Macro-Advisory May 26, 2016

Late May to end June is shaping up to be a busy and very important period for global markets. Many of the events to take place in these weeks will also have implications for Russia, both geopolitically and for the economy. By the time we get into early July the risk premium applied to investing in Russia is likely to be materially different to that used in mid-May.

First up will be the G7 meeting in Japan on May 26-27. The summit has lost a great deal of its ability to influence global markets in recent years and, given that it will be President Barack Obama’s last appearance, expectations are again very low. We can expect the usual rhetoric about need for unity, veiled criticism of China’s expansion in the seas not too distant from the meeting venue, and lots of the usual political and economic clichés. From a Russian investor perspective, the point of interest will be whether there is even a hint of an olive branch or more tough language and criticism. Markets will translate any such comments into sanctions risk perception.

The June 2 Opec meeting will provide the first public platform for the new Saudi Arabia oil minister and, more importantly, for the expected more aggressive oil policy, which seems to be personally dictated by the country’s very powerful Crown Prince Muhammad bin Salman. He undermined former Oil Minister Naimi at the Doha talks and directed the tough line against any unilateral (as Riyadh saw it) production freeze. It is possible we may hear the Saudis talk about an increase in production for the second half of the year in order to protect market share. All else being equal with other factors, such as the Canadian fire, the meeting is more likely to lead to price weakness through the summer and that would also bring the ruble lower.

The final US election primaries will take place on June 7. It is now clear that the election will be between Donald Trump and Hillary Clinton, but that will only be formalized after June 7. From then onwards, there will be more discussion about their likely policies and included in that will be how each may approach Russia. It is reasonable to conclude that a Clinton presidency will bring more of the same from Washington with people such as Assistant Secretary of State Victoria Nuland expected to retain an influential role. The prospect of a Trump presidency is full of unknowns, but would likely result in some initial efforts to improve relations. But that presidency is hugely unpredictable and nobody has any idea how relations would unfold after that initial rapprochement. As to which the Kremlin might prefer? There are pros and cons to support both choices; a tough but predictable Clinton or a (initially) friendly but wild card Trump?

Back home, the Central Bank of Russia (CBR) will hold its next monetary policy meeting on June 10. The CBR has held its benchmark Key rate steady at 11% since last summer, as it worried about high inflation and the effect of the unpredictable oil price on the ruble exchange rate. The statement issued after the April meeting was noticeably less hawkish and, given where inflation and the ruble are currently, opens up the possibility for a 50 to 100 basis point cut. That would certainly satisfy many other government agencies and probably would be a welcome indicator for the Kremlin just ahead of its most important business and investment forum of the year (SPIEF) in St Petersburg.

While Russia investors will watch the CBR decision, the main global policy event will be the US Federal Reserve’s policy meeting on June 14-15. Expectations are rising (again) that the Fed will raise its benchmark rate at that meeting. That would strengthen the US dollar. A stronger dollar is always bad for the oil price and may again increase the volume of capital flowing back to dollar assets. The former would be a clear negative for Russia, while the latter would not be helpful, albeit only marginally negative at this stage.

Who’s at SPIEF?

The St Petersburg International Economic Forum (SPIEF) will take place on June 16-18. The importance of the event is partly to see which CEOs of the world’s major corporations attend. A good attendance will be viewed as an indicator of reducing risk, and raise sanctions optimism for 2017, while a poorly attended event will be negative. The current indications are that the former is more likely this year. The event also offers President Vladimir Putin and government officials a platform to announce new policy initiatives.

Towards the end of the month the focus will shift to the EU sanctions renewal. The Council of EU leaders will meet on June 28-29. By then it should be known what recommendation the committee of ambassadors has made about sanctions renewal. It is now almost a certainty that the recommendation will be to renew all sanctions because the conditions set out in Minsk II have not been met. Here also, as with the G7 summit, investors will be more interested in the language used and whether comments can be interpreted as either resolutely tough or offering some hope for a more favourable decision in early 2017.

Own goal?

Then we get into the British factor. Early in the month, on June 11, Russia and England take to the football field in Marseille in one of the opening games of Euro 2016 football championship. The bigger event, in terms of global impact, will be the Brexit vote on June 23. Investors in the EU, and elsewhere, are watching closely and, no doubt, there will be a global impact with either outcome. But, will it specifically matter to Russia?

For now the main impact on Russia is the lazy default favoured by challenged politicians all over the EU; blame anything you don’t like on President Putin. The headline in pro-EU newspapers in the UK “A vote to leave would only favour Putin” has been made more than once during the campaign. But would it?

The critics say that the EU without the UK would weaken political unity generally, and against Russia in particular. The obvious question is “what unity?” The EU has looked more like a dysfunctional family for a very long time. London’s position on Russia is largely dictated by Washington, while the key decision makers about sanctions in the EU are Germany and France, again with a heavy US influence. That is not going to materially change whether the UK stays in or leaves. Moscow’s trust in the EU, which it views as no different to Nato, has been just as damaged as the other way round. Sanctions staying or easing is not going to change that. Moscow is now determined on a path of diversification in geopolitics, investment and trade partnerships. It has learned the lesson that over-reliance on one political-economic block is a very bad idea.

The economic impact will be marginal also. Trade with the EU has collapsed since early 2014 due to reciprocal sanctions, so a weak sterling or weak euro, ie. in the event of an exit vote, will have little effect on Russian trade or inflation. The more important factor for the Russian economy is the price of oil and the key drivers of that include US shale and Iranian production plus Chinese and other Asian demand growth. EU oil demand is quite static and would be only marginally impacted by a UK recession or slower growth across the EU.

Gas demand and gas prices have fallen in recent years due to climate changes, competition from cheap US coal and the emergence of liquefied natural gas (LNG). It is unlikely that demand for imported gas will fall much further especially as internal EU production is slipping by 10bn cubic metres (cm) annually. In any event, the competition from LNG and solar energy is a bigger concern for Gazprom than the trend in the UK economy.

No matter what factors you look at, whether the UK stays in or choose to leave the EU will only have a very marginal real impact on Russia. President Putin will continue to be portrayed as the villain, if not for an exit vote then for something else. That won’t change – it is, and will remain, the one constant in the risk calculation.

Chris Weafer is a founding partner of Macro-Advisory, which helps investors cut though the noise & focus on underlying trends, real political risks, & opportunities in Russia/CIS, Eurasia Union, & Mongolia. Follow him on @ChrisWeafer