The reaction of governments worldwide to the epidemic has been predictable – countries announced emergency lifelines, with regulators cutting rates and/or providing liquidity injections. Transport flows and even entire countries have been locked down. On Friday March 13, US president Donald Trump declared a national emergency in the US.
Nevertheless, these moves had little impact on the markets: money cannot cure the virus. It takes time to assess the real impact on the economy, though it is already obvious that the spread of the virus is mounting significant pressure on the financial sector, consumer names, tourism and transportation. Closed production facilities and forced unpaid leave also weigh on personal income.
Last Thursday, the NY Fed announced a new program designed to provide a record-high liquidity injection of $1.5tn (in three $500mn tranches).
The news stopped the market correction: on Friday, stock indices spiked after the largest fall in 33 years. Still, while one of the main reasons behind last week’s sharp plunge in the markets was a liquidity deficit, the determining factor of the correction is different – the looming threat of global recession. In addition, we must acknowledge that this factor has not disappeared – as the epidemiological situation in North America and Europe worsens, the correction could resume.
The key concern is the pandemic’s ripple effects – the economic fallout is palpable even when the infection rate starts to fall. In China for instance, many enterprises face logistical problems and bottlenecks when trying to attain spare parts and ship ready-made products. This means that even if the peak of the epidemic in the EU and US is passed in April or May, these regions will still face major difficulties through the end of 3Q20.
Russia government to support the ruble
The global COVID-19 epidemic has already dealt a blow to the Russian economy. The collapse of the OPEC+ agreement and consequential plunge in oil prices and ruble weakening have exacerbated the already high macroeconomic risks.
A little more than a month ago, on 31 January, we released our macroeconomic forecast for 2020. Today, our expectations (GDP growth of 2% with an average ruble rate at RUB64/$) look obsolete and we have placed them under review. We plan to update our base case forecast before the end of the month.
The global economy appears to be on the brink of a recession, and the COVID-19 epidemic continues to spread rapidly, hitting demand for commodities. Moreover, the situation is aggravated by disputes among major players in the crude markets, which have transformed into a full-fledged economic war. Obviously, low oil prices and a weak ruble will affect the future performance of economic indicators, but much will depend on how long the oil crisis lasts and what steps are taken by the governments to deal with it.
Now we believe that the coronavirus epidemic in key economies will last at least until mid-2020 and trigger major negative consequences for global production volumes: we expect global economic growth to slow to 1% y/y in 2020, whereas just six weeks ago we forecast growth of 2.9%. Fears about the coronavirus, uncertainty about the growth outlook and low oil prices should trigger major capital outflow from the Russian market, which should put even more pressure on the Russian currency.
Pressure on crude prices will be accompanied by a price war in the oil market: we have modelled a crisis scenario with 2020 average Brent price at $35/bbl vs $60-70/bbl (our previous estimate from January).
The new situation poses clear risks for the Russian economy, but not all is bleak. If the aforementioned scenario plays out (average Brent price at $35/bbl and the global economy slowing to 1%), we estimate Russia will post mildly negative GDP growth in 2020 at -0.5% y/y; inflation will accelerate to 4.3% y/y by YE20, but will be unlikely to go higher, as suppressed domestic demand will cap CPI growth. Consequently, fiscal priorities will change from pro-growth to anti-crisis and, hence, Russia’s monetary response will lead to possible rate hikes and FX interventions. On balance, the worsening macro is bad news for banks and the consumer sector, whereas exporters, including O&G, should be relatively less hit, while gold and utilities offer a ‘safe haven’.
Russia government rides to the ruble’s rescue
As far as monetary policy goes, last week, the government, the CBR and state-owned companies took coordinated measures aimed at supporting the ruble. The CBR increased limits on FX swap operations with $(up to $5bn) and, starting from 10 March – for the first time in more than 4 years – it began to intervene via $sales, though the volume of such interventions ($50mn per day) indicates the goal is to have a psychological rather than economic effect. State companies (Gazprom) also promised to increase FX sales.
That said, the most substantial support for the ruble should come from the government, possibly as soon as this week. The completion of the legislative process for the government to purchase the CBR’s Sberbank shares allows the Minfin to make FX sales from the NWF. The result – in 1-1.5 months (the transaction, according to Siluanov, will be completed in one tranche in April), the Minfin will sell cRUB2.3tn worth of foreign currency. This is a large amount for the Russian FX market and such volumes will, undoubtedly, provide significant support for the ruble. Therefore, even if oil prices fall below $30/bbl, we do not expect Russia’s domestic currency to weaken below RUB80/$.
CBR: No rate hike for now
The plunge in oil prices and strong selloff in global markets could not but affect the ruble’s exchange rate. Last week, the Russian currency entered a new corridor of RUB70-75/$. At the close of trading on 13 March, the ruble was worth RUB72.60/$(v RUB68.57/$on 6 March).
We believe that global markets could only be expected to stabilize once more clarity is given regarding the pandemic in key regions of the world — this can happen no sooner than in 2 weeks (see above). In turn, this means, for the time being, pressure on the Russian market is unlikely to disappear, which will, in turn, affect the ruble.
However, we also do not expect a serious weakening in the ruble from current levels. The ruble will be supported by FX sales from the NWF, which may begin as early as this week. Therefore, we expect that the exchange rate could stabilize at RUB70-72/$or even appreciate to just below RUB70/$in case of sizeable currency interventions. This applies if oil prices remain stable at $33-38/bbl; should they slide below $30/bbl, Russia’s domestic currency may weaken to RUB75-80/$.
In our opinion, increased capital outflows from Russia, combined with the weak ruble and higher inflationary risks, leave no room for the CBR to ease its monetary policy. Although the market expects a rate cut of at least 25bp, judging by interbank rates, we still believe the CBR will keep the key rate unchanged at 6% at the next meeting on 20 March. In case of higher risks to financial stability – for example, in the event of a sharp increase in capital outflows from ruble bonds – we could see a rate hike, possibly an ad hoc one, albeit we see a low probability of this so far.
The Fed’s unexpected 50bp rate cut on 3 March was immediately forgotten by investors. Moreover, after several days, market consensus was already expecting a new rate cut soon. Late Sunday, the Fed – a day before its scheduled meeting – announced a new emergency rate cut to 0-0.25%. We believe that the market’s reaction should mirror what we saw before – the very fact of a rate cut cannot change the situation, but will be treated by the market as a sign of panic. In this light, we would not be surprised if next week the sell-off not only continues, but intensifies.
The Fed has utilized almost every lever available, the only tool left to stabilize the markets is the liquidity mechanism – we expect further expansion of the REPO and asset purchasing operations (first and foremost, UST).
Commodities have further to fall
Oil prices may not be at rock bottom yet. Last week’s events showed that, on the one hand, the price war is affecting more OPEC countries, while, on the other hand, there is no readiness to resume negotiations (the meeting of the OPEC+ technical committee was postponed indefinitely due to disagreements). Amid growing expectations of a global recession, the backdrop for oil prices looks far from favorable: in the short term, we may see prices fall below $30/bbl. However, oil quotes could be propped up thanks to restocking by importing countries – last week, China and the US announced their intention to use low oil prices to increase oil purchases and freight rates for tankers grew 10 times. At the close of trading in London on 13 March, Brent was worth $33.85/bbl (v $45.27/bbl on 6 March).
Gold is not a hedge against recession. In a recession, gold is not a defensive investment, albeit large sales are also unlikely. So far, movement in the gold price is determined by demand for liquidity: when this demand surges, as was the case last week, gold prices plummet – traders sell the metal to get liquidity. However, for the medium term, it should be noted that a sharp increase in liquidity injections from central banks and governments will fundamentally support gold quotes, as well as demand for raw materials and risky assets. At the close of the market on 13 March, the price stood at $1,530/oz v $1,674/oz a week earlier.