Putin’s Ukraine Gambit Turns Debt Sanctions Into a Real Threat

A massive troop buildup on the border with Ukraine has turned the once unthinkable idea of U.S. sanctions on Russian sovereign debt into a real possibility for investors.

Yields on ruble bonds, known as OFZs, jumped to the highest level in more than a year last week and were edging higher again on Tuesday as the market watched deepening tensions between Moscow and Washington take another turn for the worse.

“This makes OFZ sanctions significantly more likely,” said Paul McNamara, an emerging-markets investor at GAM Investments in London. He doesn’t expect a full-scale Russian offensive, but said “there are a lot of outcomes that are worse than the current situation.”

Putin’s Ukraine Gambit Turns Debt Sanctions Into a Real Threat

The administration of U.S. President Joe Biden was already preparing more penalties on Russia over alleged election interference and hacking before the latest flareup in Ukraine. NATO joined the Group of Seven nations and the European Union on Tuesday in calling for Russia to de-escalate.

The threat of OFZ sanctions, often dubbed the “nuclear option,” has been hanging over bondholders for years, but after several false alarms, most investors weren’t considering it a base case. That may now be changing.

Analysts at JP Morgan Chase & Co. downgraded the ruble and Russian bonds last week, citing the escalating tensions and the risk that U.S. investors might close long positions on OFZs. The Finance Ministry has had to rely on state-run banks to meet demand at its latest debt auctions after a sale was canceled due to reduced appetite from foreign buyers.

The Treasury Department warned in 2018 of global financial market turmoil if Russia’s sovereign debt market were sanctioned because of how deeply tied the Russian market is to global indexes.

Since then the California Public Employees’ Retirement System, or Calpers, has cut all of its bond holdings in Russia. Foreigners have curbed their share of the total market to just 20% from about 35% last year as the Finance Ministry sold more debt to locals.

Russian officials say the move wouldn’t cause much damage to Russia’s financial markets because local banks and non-U.S. investors would step in to replace those forced to sell. A move to ban U.S. banks from buying new issues of Russian Eurobonds in 2019 did little to dent the Kremlin’s access to foreign funding.

An even harsher measure that has been mooted in Washington in the past would be to bar Russian banks from the international financial messaging system used for most international money transfers, a measure that has been used against Iran. Foreign Minister Sergei Lavrov warned last month that Russia needs to find alternatives to the system, known as SWIFT, to make itself less vulnerable.

“If it goes to an outright military conflict, I wouldn’t exclude SWIFT sanctions, which would be really disruptive,” said Viktor Szabo, a money manager at Aberdeen Asset Management in London.

©2021 Bloomberg L.P.

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