`Market Fundamentalism' Tested as New Storm Hits Russia

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(Bloomberg) -- Russia is gambling that a policy mix born amid its confrontation with the West four years ago is good enough to carry it through an even worse standoff this time around.

The authorities held little back when staring down a market rout in 2014 after the conflict in Ukraine prompted sanctions, ultimately allowing its ruble to trade freely after spending a fifth of its international reserves trying to prop it up.

Now that flexible currency provides support for the Russian economy as President Vladimir Putin faces the fallout of the most punitive U.S. penalties yet and President Donald Trump’s threat of military strikes in Syria. Central bank Governor Elvira Nabiullina on Tuesday said the swings in the ruble were no reason for action even as it dropped almost 4 percent that day.

The central bank’s response is “in the spirit of ‘market fundamentalism,’" said Sergey Romanchuk, the head of foreign-currency trading at Metallinvestbank in Moscow. But “the moments of fear in the market, when uncertainty is great” require “intervention by the regulator.”

The outlook for oil may prove the difference this time. With crude prices soaring to levels last seen in 2014, the ruble recouped losses on Wednesday and appreciated against the dollar for the first time in four days, gaining further on Thursday. In local-currency terms, a barrel of crude has never brought in so many rubles for the Russian budget.

For the moment, the central bank is hopeful that those fundamentals will offset the gyrations from geopolitics. Late Wednesday, the ruble suddenly reversed course after U.S. Treasury Secretary Steven Mnuchin soothed traders by saying that his agency advised against Russian sovereign debt sanctions.

The furthest the central bank has gone was a comment Thursday from a senior official who didn’t rule out a rate hike when asked about the options for the next meeting on April 27.

Investors anticipate the ruble will remain among the world’s most unstable currency, with a gauge of three-month implied volatility trading at over 16, according to data compiled by Bloomberg. The cost of insuring Russian sovereign debt against default for five years using credit-default swaps jumped as high as 162, the highest since Aug. 1, although it remains well short of its highs in 2015.

“The lesson is that high volatility has been and will be the ruble’s significant feature,” said Vladimir Miklashevsky, a senior economist at Danske Bank A/S in Helsinki. “Markets have to get used to live with that fact. The Russian central bank will not ‘save’ the ruble.”

What our economists say...

The Bank of Russia has the tools to act if the panic deepens. The ruble move isn’t extreme enough to trigger intervention, and it bolsters the credibility of the float to let the currency absorb the shock. The policy framework is all-weather, and it’s not yet time to invoke the exceptions in the fine print.  

--Scott Johnson, Bloomberg Economics

Under Nabiullina’s stewardship, policy makers have focused on inflation with dogged perseverance. Despite bringing consumer-price growth to the lowest level in modern Russian history, the central bank has moved cautiously to ease monetary policy. Meanwhile, its war chest has grown, with reserves up 30 percent since a 2015 low.

Russia’s real interest rates remain among the highest globally, and prospects for a cut in borrowing costs later this month are receding because of the market turmoil.

The question, however, is whether Russia’s policy framework is still a good fit for a world seemingly on the brink as conflicts threaten to spiral out of control.

“The central bank can’t stabilize the market under the conditions of growing geopolitical risks,” said Natalia Orlova, chief economist at Alfa-Bank. Its stance and communication assumes that “they are working in a full-fledged market economy, governed by economic laws. But in fact, they are working in a completely different economic landscape.”

©2018 Bloomberg L.P.

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