by Rob Waldner, Invesco Canada
The uncertainty created by Russia’s invasion of Ukraine should make central banks cautious, says Rob Waldner. He anticipates the U.S. Federal Reserve is unlikely to raise rates by more than 0.25% in March.
The Russian invasion of Ukraine has realized a worst-case outcome in the stand-off that has persisted for the last few months. In our view at Invesco Fixed Income, it is hard to see a near-term resolution to this issue, and markets are likely to have to deal with elevated levels of geopolitical and economic uncertainty for an extended period of time. Even if the military part of the invasion concludes quickly, the country will likely remain unstable with an uncertain political future. Russia’s presence in Ukraine will likely be resisted, and any political solution that would allow Russian President Vladimir Putin to consolidate control is unlikely to be successful over the long term, in our view. Instead, it would likely usher in an extended period of political volatility.
Impact to fixed income markets
Markets will have to deal with this uncertainty and will likely price in an ongoing discount on Ukrainian and Russian assets. In the case of regime change in Ukraine, impairment of existing Ukraine debt is likely. Russia’s debt will probably not experience a similar deterioration in credit quality, but uncertainty should keep yield spreads elevated in the near term. Unless draconian sanctions are imposed by Western governments that limit the ability of Russian entities to pay coupons and maturities, we do not believe the risk of near-term default across Russian debt has increased. Indeed, before this action, Russian sovereign debt and many large Russian corporate issuers were rated investment grade by Moody’s, Standard & Poor’s, and Fitch, and we do not expect the fundamental credit quality of most Russian issuers to be impacted dramatically in the near term.1
Russian fixed income assets received some positive news yesterday when the sanctions announced by the U.S. and other Western governments did not directly impact the trading in existing debt instruments or the ability of Russian issuers to service their debt. Sanctions were placed on a number of important Russian banks, but secondary trading in capital markets should not be dramatically impacted. The sanctions prohibit the issuance of new debt in U.S. dollars, but do not directly impact the existing debt owned by global investors.
Uncertainty has led to sharp moves in most Russian assets and relatively low levels of available liquidity. As long as there are not additional sanctions on existing Russian debt, we would expect the market for Russian credits to stabilize somewhat in the coming weeks and we would expect liquidity to return. Prices and liquidity will likely remain depressed from pre-invasion levels, however, as there does not appear to be a clear near-term resolution or exit path from the conflict.
What about inflation?
It would appear that Western governments have also tried to minimize the damage of this crisis on their own economies. Few sanctions on Russian energy producers and no restrictions on Russian energy exports should help to contain the inflationary impact of this crisis in the West. A sharp spike in energy prices would likely boost inflation and impair growth — a very bad outcome from a policy perspective — and it appears Western policy makers will try to avoid such an outcome. This uncertainty should give central banks a reason to be cautious, and we believe the U.S. Federal Reserve is unlikely to raise rates by more than 0.25% at the March Federal Open Market Committee meeting, whereas before this crisis, a 0.50% increase was becoming increasingly likely.
1 Source: Bloomberg, L.P., as of Feb. 24, 2022
This post was first published at the official blog of Invesco Canada.
