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Russia’s Currency Problems
Russia is scrambling to keep the Ruble from collapsing.
Recently, we talked about the risk/reward of investing in Russia. While that opportunity still exists, the rewards are decreasing.
Anticipating international blowback, Russia shored up its reserves of foreign currency. The problem is most of that is abroad. And now much of it is frozen.
With the Ruble tumbling, the central bank hiked interest rates 20% in an emergency order, telling firms to sell their holdings of foreign currencies.
By selling all their foreign currency revenues, export firms have to buy the Ruble as an alternative.
But that’s only the start of problems.
Unsurprisingly, Putin banned all Russian residents from transferring hard currency abroad, including to service foreign loan contracts.
This move could potentially put $478 billion in external debt at risk of default.
All these moves make it harder and less likely for foreign companies to invest in Russia should the conflict resolve itself.
Not that these moves aren’t a good idea by Russia’s central bank and government, but they make it so foreign investors require additional compensation for them to take on ‘political’ risk.
While Russia has moved further away from foreign investment in the past decade, that’s also come at a heavy cost. The Russian economy has grown at abysmally low rates for several years before the 2020 recession.
In a nutshell, Russia has left itself with slower economic growth coming out of the conflict. And the longer it stays in, the worse its future gets.
Russia Complicates Planned Rate Hikes
Typically, central banks are reluctant to raise interest rates in the face of global conflict.
This time they face an unprecedented conundrum.
Oil vs. Economy
Russia is one of the largest energy exporters in the world.
Globally, they supply 12% of the world’s oil and 17% of the world’s natural gas. About 50% of that oil goes to Europe as does around 70% of its natural gas.
That’s a big reason why Europe cannot simply shut itself off from Russia. Doing so would immediately collapse their economies.
As oil works its way over $100 a barrel, drivers are beginning to feel the pain at the pump.
The average price of gas per gallon in the U.S. rose to $3.61 from $3.356 a month ago and $2.717 a year ago.
Americans faced similar issues in the late ‘70s under oil embargos.
At the time, the U.S. central bank, led by Paul Volker, raised interest rates past 15%, driving the U.S. economy into a recession, albeit briefly.
Fed members know that higher gasoline prices act as a tax on consumers. That means if they raise rates, the average American is paying more for gas and their loans.
Such an impact could quickly dampen demand across the board, which may not be a bad thing.
Fed officials have to contend with the fact they could raise rates and drive the U.S. economy into a recession.
Given how heavy demand is, that may technically be needed.
You see, a recession is a decline in real GDP for two consecutive quarters (the National Bureau of Economic Research also takes into account several other factors).
With how much GDP has expanded in the last year, a corrective contraction could be what we need to reset the economy and may not cause widespread problems.
Unemployment is extremely low with incredibly tight labor markets. So, it’s fair to say that it could absorb higher rates without a major impact.
The Bottom Line: While Fed officials may soften their rate hike schedule, it’s unlikely they will delay it.
We should expect them to hike interest rates at their next meeting.
That bodes well for banks including JP Morgan (JPM) and Citigroup (C).
With higher rates, come higher borrowing costs. That means you should expect to pay more for home loans, credit card interest, and the like as well.
The good news is that if the Fed is successful, you’ll see prices on everything from food to cars stop climbing.
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