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People and MarketsCommentGC View

EM investors risk repeating Russia mistake

The invasion of Ukraine showed almost nothing is off the cards in Putin's Russia

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An aborted coup in Russia over the weekend has had a negligible effect on the emerging market bond mart, according to fund managers and syndicate bankers.

But the possibility of major internal instability in a nuclear power should be a worry to all, and paying little attention to it means investors risk making the mistake of February 2022 all over again, when the market refused to believe Russia would invade Ukraine.

The march on Moscow by Yevgeny Prigozhin’s Wagner group of mercenaries on Saturday barely lasted a day. The threat of civil war seems to have been averted, for now.

But few really know what is happening in Russia, even those inside the country, which in itself should worry investors. What happens next is anyone’s guess.

One certainty is that Putin has been weakened. That a man, Prigozhin, who led armed rebellion, including killing Russian soldiers, has been allowed to safely leave for exile while his soldiers face no punishment shows this. On Sunday, US secretary of state Antony Blinken said that Putin's hold on power had been weakened and doubt cast on the future of the war in Ukraine.

And there has been some practical affect — oil prices rose slightly on Monday, although they did fall again on Tuesday. Any meaningful rise would heap pressure on energy importing EM economies, as it did last year.

Stock markets in Europe and the US trended downwards on Monday, but they too recovered ground on Tuesday — an indication that investors are at least a little worried about the situation, following the day of heightened tension and speculation.

But US Treasuries, a safe haven fixed income asset, have barely moved. Yields dropped a few basis points on Monday and rose again on Tuesday, but the fluctuations have been minimal — and far from volatile.

Treasury volatility was one reason the EM primary market was so difficult for issuers and investors last year. And while the threat of Russian civil war has barely moved the needle, there is a sense that the market is desensitised.

Were a full scale civil war to break out in the country, volatility of a scale not seen for many months, or even years, would surely return. Cboe's Volatility Index, the VIX, is currently sat at 13.66 after a slight jump on Monday that led to a high of 14.25 on Tuesday morning, still comfortably under the 20 threshold that corresponds to stable, stress-free periods for the market despite the event.

So while equity and fixed income investors were a tad cautious on Monday, that trepidation seems to have already gone. But, markets shouldn't get too cocky.

Political instability in Russia is good for nobody. Despite heavy sanctions, it remains a large economy that many EM countries rely on for commodities. Any supply disruption would cause long lasting pain.

And what might Russian soldiers in Ukraine think, given the chaos at home? The revolt has given impetus to Ukraine’s counter-offensive. While the West would dearly love a total Ukrainian victory, the Russian react to such a humiliation, particularly if Ukrainian soldiers entered Crimea, would not be pleasant.

Few believe Russia would really use its nuclear weapons, but it could, and investors do not like uncertainty. Civil war in a nuclear power has never happened, but risks unthinkable consequences.

Indeed the Russian government has threatened that all means will be considered to protect its territory, including Crimea. The use of nuclear weapons, as investors have told GlobalCapital previously, would render worries over EM bond portfolios irrelevant. The market impact would be catastrophic.

While the de-escalation suggests full blown conflict inside Russia is far off, for now, other militias exist in Russia, and Putin’s grip on power has clearly weakened.

Even peaceful instability would be a worry for the world, and armed conflict a disaster. EM bond investors may not be concerned, but they should be — the lesson of Ukraine should be to always expect the unexpected in Russia.

There was a point when very few thought Putin would actually invade Ukraine, but then he did, and it hurt. Few, if any, Western investors hold Russian debt anymore, but it was not just that group who felt the pain.