09 August 2018
Foreign policy is a hot spot
The Kremlin will probably continue clashing with the US over its increasingly assertive foreign policy. This includes broader Western disagreements with Russian military missions in the Ukraine and the Middle East, as well as suspected Russian interference in both US and European elections.
Russia appears to be implementing a more aggressive foreign policy stance to promote the idea of a ‘strong Russia’ to its own citizens. Russian living standards are arguably in decline for a variety of insurmountable structural factors, including the entrenched corruption among the ruling elite. With that in mind the Kremlin seems to consider a forceful foreign policy as a way to strengthen national pride and confidence, helping cement domestic stability. However, this approach leaves it on a collision course with Western security interests and democratic values.
Unaligned strategic interests
Given unaligned strategic interests, the US may continue to tighten sanctions against Russia. Since the eruption of the Ukraine crisis in 2013, the US has implemented several rounds of sanctions against Russia, including travel bans and asset freezes against individuals close to Putin. However, these sanctions have been largely ineffective at moderating Russia’s aggressive foreign policy, and therefore US legislators are increasingly contemplating more drastic action such as sanctioning state connected enterprises and potentially even Russian sovereign debt.
Revelations from the ongoing Mueller investigation on the Trump campaign’s possible connections with the Kremlin could further motivate US lawmakers to intensify pressure against Russia. Similarly, both Democrats and Republicans seem to be dissatisfied with the President’s recent outreach to Putin at the Helsinki summit. By scaling up sanctions, legislators could force Trump to row back his Russia-friendly stance.
Russian asset valuations are vulnerable
For foreigners investing in Russian assets, fiercer US sanctions could have negative implications. First and foremost, several Russian asset classes have appreciated in value in recent years and may be vulnerable to political event risk. For example, the chart below shows how much Russian bond prices have risen, as indicated by the near multi-year low in local currency yields, and the meaningful appreciation of the rouble since early 2016.
Source: Bloomberg, August 2018
While asset prices did react to post-2013 US sanctions, the direct impact has been relatively mild and temporary - in fact, the slump in oil prices in 2014 probably had a bigger effect on Russian valuations. However, the new US sanction proposals contain much harsher measures, including potentially extensive bans on trading Russian corporate and sovereign securities. The market may react more severely to such measures, especially if foreign investors are forced to sell their existing holdings.
Overall, it remains challenging to forecast the scale of any future US sanctions against Russia with precision, but the trajectory towards further escalation appears in place and investors will have to navigate these events carefully.
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