The Central Bank of Russia’s (CBR) attempts to defend the currency were costing it billions, steadily eating away at its FX reserves. In November it pulled the plug on the policy of maintaining the rouble band of nine roubles to a basket of dollars and euros.
The decision turned a steady decline into a rout, which lasted through much of late November and December. And while the decline of the dollar has slowed in recent weeks, few are interpreting this as the end of Russia's problems.
“It feels less like a period of calm than a brief respite,” says Ilya Spivak, currency strategist at FXCM.
The CBR's decision to float the rouble has been widely praised.
Having tightly managed the rouble for so many years, holding the currency up at an artificially high price, there was bound to be some drama when it let go of the reins and the rouble sank to a level more in line with real-market fundamentals.
Most believe it was still the right decision and Russia will ultimately prove more stable with a floating rouble.
In the short term, however, the CBR’s execution of the float has arguably added to the sense of anxiety among traders. Although its systematic interventions have ended, it has indicated it will still make interventions, leaving traders at risk of being steamrollered.
Its last intervention was on December 15, weeks after it announced the rouble would float.
Spivak says: “The CBR wanted investors to think it could still intervene but at unknown times and sizes. It was a message to investors to be careful shorting the rouble and that has only increased pressure to avoid the currency.”
As the rouble has fallen, so too has liquidity dried up, with volumes going into precipitous decline since around October.
“The market remains fragmented and driven by customer orders, as well as high-frequency traders,” says Sergey Romanchuk, president of the Financial Markets Association (ACI) in Russia. “Market risk is very high and there are only a few liquidity providers out there.”
Speculators were deemed to be partly responsible for the excessive movement in the currency, says Romanchuk, and some Russian banks have since ceased trading the rouble for their own accounts.
“The largest Russian banks have been directly instructed by their managers and heads of desks not to speculate – in fact, some senior executives have publicly announced that they have visited dealing rooms and given instructions to traders not to trade on their own bank book,” he says.
While it is impossible to gauge spot volumes accurately because of market decentralization, CME rouble futures serve as a good proxy for market sentiment, and have seen substantial declines. This market has been impacted by some clearing brokers closing their business with Russian customers, says Romanchuk.
This has had implications on execution and transaction costs for rouble traders. Romanchuk says clients have seen spreads inflate by between two and 10 times their previous levels as a result of this illiquidity.
A number of brokers – including FXCM – have ceased offering rouble pairs. According to the Commodity Futures Trading Commission’s Commitments of Traders report, the rouble saw record-setting net speculative short-positioning in November. The market has now moved to net longs, but the fact net shorts have fallen as open interest drops implies a loss of interest in RUB, rather than a positive shift in investors’ outlook, is driving the unwinding of shorts, say analysts.
As a direct consequence of the sanctions placed on Russia, the forwards market has split between Russian onshore and international offshore counterparties, says Romanchuk. Even spot FX has changed dramatically.
“There are no prime brokerage services offered directly to Russian names in roubles,” he says.
OTC and exchange-traded markets have shrunk in volume twice in the past month, adds Romanchuk, with the OTC market now virtually non-existent.
The cheaper rouble has also left Russia importing more inflation, which was most recently recorded as 15%, and is likely to remain in double digits for some time, while growth is non-existent. The absence of any impetus at the government level to push through the reforms necessary to reverse these trends feeds fears they will remain entrenched.
FXCM’s Spivak says: “Russia is approaching a 1998 kind of scenario,” referencing the collapse of Long-Term Capital Management, which required a bailout to prevent a systemic event, and considerable EM contagion.
“Today the market is still in recovery mode following the 2008 crisis,” says Spivak. “Governments don’t have much room for fiscal stimulus and central banks are very close to the zero bound.
“When the Fed announced its QE 10-year treasuries were yielding around 3%, when the ECB announced its own more recently 10-year Bunds yielded around 30 basis points. If there is a systemic event now, where is the ammunition going to come from?”
Investors will now be concerned the CBR could implement capital controls to prevent roubles leaving Russia – fear that is in part responsible for the rapid selling of the currency already witnessed. It could be that the slowing rate of decline in the rouble and liquidity is evidence that most of the foreign holdings of roubles have already been shaken out.
But it also probably suggests the existing bad news is priced in, meaning it has found a level, at least temporarily, until the next instalment of bad news.
|Federica Mogherini, head of |
the External Action Service
However, while past dollar repo auctions have not been as effective as many had hoped, Chris Turner, head of FX strategy at ING, believes future auctions will fare better.
“In the past, the market has asked the CBR to help facilitate the provision of FX for Russian domestic accounts via repo auctions, but we have seen low demand, possibly because there were problems with the collateral requirements,” says Turner.
“But the authorities will be aware of the upcoming redemptions and should have learned from its previous experiences, so I would expect dollars to be available via official channels.”
ACI’s Romanchuk also downplays this concern. Dollars are offered by CBR via repo against suitable collateral, he says, concluding “there are no problems with settlement inside Russia”.
More generally, money market liquidity has improved since the end of 2014, with large budget payments having fed into banks’ accounts, says Romanchuk, ensuring there are enough roubles circulating within the banking community.
Meanwhile, there remains a chance the sanctions that are so hurting Russia could soon start to ease. The US is unlikely to change its position, but the EU is finding it harder to maintain a united front against Russia.
Federica Mogherini, head of the EU External Action Service, called for dialogue and improved relations, while Greece has shown little appetite for maintaining the status quo.
Although an EU easing of sanctions would be unlikely to lead the US to follow suit, it might at least make it harder to justify increasing sanctions further, and could therefore mark a reversal of sentiment in Russia and allow the rouble to stabilize.