Home Business Insights & Advice The economic impact of the ‘new Cold War’

The economic impact of the ‘new Cold War’

26th Apr 18 11:24 am

The impact on the markets

Tensions between the West and Russia have been been rising in recent weeks and months, with anger at alleged Kremlin involvement in the poisoning of ex spy Sergei Skripal on the streets of Salisbury and arguments over the ongoing conflict in Syria.

The UN has warned that this could lead to the development of a new Cold War, while others say we’re already there, with a series of Russian diplomats expelled from Western nations in reaction to Salisbury and new sanctions being considered.

Events such as these are bound to have an impact on the markets too. Christopher Vecchio, senior currency strategist for Daily FX, offers us his take on what we can expect the economic fallout to be from the hostility between Russia and the West…

The current situation for the Ruble is reminiscent of how it performed when sanctions were levied by the West after Russia invaded Crimea in 2014. Then, just like now, a sharp depreciation of the Ruble was experienced (the Ruble fell from $0.1720 to $0.1549 between April 9 and 11).

But, one major difference to note is that the weakness in oil prices, which developed through 2014 and 2015, is a backdrop not currently present.

Another fresh wave of sanctions could upend a fragile Russian economy, which has only recently started to grow again following the Crimea-related sanctions.

For evidence of the impact of current events, investors should look no further than what’s been happening in Russian bond markets. Yields on dollar-denominated Russian 10-year government debt are now above 5%, which is more than 125-bps higher than where they were at the end of 2017.

Likewise, 5-year credit default swaps have increased to just below 150-bps, up nearly 50% from where they were at their low in March.

But, for context, 5-year Russian credit default swaps traded above 600-bps following the imposition of Crimea-related sanctions at the start of 2015.

We’re still very much in the early innings of any market turmoil – but concrete action rather than a war of words on Twitter will need to take place for further pain to manifest.

So, what should investors expect to see moving forward? It seems that volatility will persist in both the Ruble as well as the US Dollar in the near-term.

While the former is dealing with heightened geopolitical tensions due to issues in Syria, the latter is also grappling with trade tensions with China.

Increased volatility in both equity markets and FX markets, coupled with downward pressure on sovereign yields, is a ripe opportunity for Gold to rally. A break through the January 2018 closing high of $1358.27/oz in Gold (USD terms) would suggest a move towards $1440/oz is in the cards by the end of June.

What about the fallout for other countries? Well, it’s possible that a response by the United States and her Western allies could result in retaliatory measures by Russia towards the European Union, ensnaring the Euro in the recent fray.

But Russia’s main leverage over Europe is the gas it exports to the region, which is a far more potent counterpunch heading into the winter months rather than at a time of year when we are exiting them.

We should also be watching to see if Russia steps up military exercises in the Baltic region, as Estonia, Latvia, and Lithuania all use the Euro. On top of this, prolonged uncertainty and saber-rattling could impact the airline industry in Europe, which would have a real negative impact on growth – thereby keeping the ECB on its easing path for longer than intended.

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