Responding to Russia’s continuing attacks on Ukraine, the West has imposed some of the toughest sanctions in modern history. Kim Parlee speaks with Priya Misra, Global Head of Rates Strategy, TD Securities, about the economic impact on Russia and the rest of the world.
- The world has been witnessing the brutal reality of Russia's invasion of Ukraine. Western countries have responded by imposing some of the toughest sanctions in modern history, including targeting specific Russian banks, sanctions on individuals in Vladimir Putin's inner circle, as well as Vladimir Putin himself. And kicking financial institutions, Russian financial institutions, out of something called Swift, which is a financial messaging system.
With more on the impact that she is seeing in trading and what it could mean for the central banks, we're joined by Priya Misra, she's Global Head of rates strategy at TD Securities. Priya, I just want to start with how are the markets working this morning? What are you seeing? What are you hearing?
- So it's an extremely volatile situation. I mean, we saw the news over the weekend. I think we still don't have a lot of the details. For example, you talked about the Swift bank ban, but are they on specific banks? Is energy carved out? Are overall commodities carved out of those transactions?
So I think it's still evolving. And so you asked about the market. I would say the market always prices in the risk of different outcomes. And we've got a really wide spectrum of outcomes here, from the conflict itself intensifying, more sanctions, what's the economic fallout of this? So I think it's extremely volatile.
We're seeing classic, I would say, flight to quality moves. So the dollar is bad. Treasury rates are declining, or I would say general government bond yields are declining. Risk assets are struggling. I think people are looking for liquidity, but I would disentangle all of these impacts into either a liquidity event, or a credit event.
And I think right now, more concerns are on the credit side. What are the losses on Russian assets that investors will need to face? Liquidity, I think, is actually not as bad as one could imagine if you compare it to other episodes, the Lehman crisis, or 2020, the COVID crisis. So I think so far liquidity seems to be OK, but the market's bracing itself, I think, for high volatility, big moves on either side. But it remains pretty evolving.
- Mm-hmm, it really does. I mean, both in the physical context, in terms of what we're seeing, and also in the financial markets. I want to talk about just maybe broader impacts as we look ahead.
When you think about where we're going to see more of these credit events versus liquidity events, let's say the credit events, I'm hearing obviously Europe is going to feel this more probably than North America, but commodities, inflation, we're seeing, inflation in hard and soft commodities this morning. And I want to talk about the Fed and the Bank of Canada in just a few minutes, but where do you see this playing out in the shorter to medium term?
- Sure, so I think the most obvious one is on Russia. In fact, the sanctions are specifically targeted at Russia, sort of freezing liquidity there. So you're seeing this, what we're calling the liquidity bubble, around Russian assets. So I think that's number one.
Then the spillover from Russia into other emerging markets. I mean, there's a wide range within emerging markets. But if investors are moving to developed markets because of higher risk premiums, it does hurt the rest of EM. I would say Asia EM seems to be less impacted than, say, Eastern European EM for obvious reasons, but that would be the next place.
Then you look at exposures between Russia and the rest of the world. And I would say Europe stands out here. European banks have much more exposure to Russia than the US, which is why I would say Europe might have more of the credit risks as well as the liquidity risk, because a lot of these payments, there are more payments between Europe and Russia.
And then you brought up commodities. And that's how this thing can spill over into the rest of the world, and into macro fundamentals is what we're witnessing. Every war is a stagflationary shock. And this is, I think, compounded-- COVID itself was a stagflation shock. And now we're dealing with a war, with already high prices, heading higher. It's not just energy, it's energy, rest of commodities, it's food. And so I think that's why central banks are going to have this really tough time of trying to fight inflation and yet supporting growth, and preventing that, the negative impact on growth that comes from high inflation.
- All right, well then let's talk about the central banks, because they have now a conundrum, I'm sure, as they figure out what to do. I mean, most-- if you look at the markets, markets are pricing in rate increases from both the Bank of Canada and the Fed. A few of them, quite a few of them, actually, over the next little while. Does any of this change what you expect the Fed and the Bank of Canada to do next? And you start with whichever one you want, but that's the thing, is it going to change the next meeting, the next outcome?
- So let me start with the Bank of Canada, because that's this week. We are looking for a hike of 25 basis points. And then two weeks from now, we have the Fed meeting, we are looking for a 25 basis points there too. So it doesn't change what we were looking for, what it changes is the front loading of the hikes, or how aggressive the central banks can be.
Because apart from the inflation risk, there's severe tightening in financial conditions. And part of what hikes do, or quantitative tightening do, is to tighten financial conditions. Well, if the war is tightening financial conditions, then it would argue that in totality, the central banks have to do less.
So I think some of the hawkish talk can be dialed back, and you can hear more of a responsive tone from the central bank. They can still start hikes, but they can absolutely state that, "Look, if the economy starts to slow down, we can slow down our pace of tightening as well." I think push back against the narrative of a policy mistake.
And that's been building up in the US, in Canada, and the UK, that the central banks might overdo the tightening. I think this is where central bank rhetoric is important because they can say, "No, we don't have to, we're not going to overdo it. We're going to watch the economy and watch financial conditions and re-calibrate policy." So I see it more as a medium term impact on central bank policy rather than, as of right now, I don't think it impacts the very near-term move. I think they have to start, given that the fundamentals are still strong and inflation is really high.
- Does it change-- I mean, rates, obviously, are one tool. They also have quantitative easing and tightening. Could anything change on that front in terms of-- could we hear the message that they're reconsidering that?
- I think they still want to exit using both tools, so both quantitative tightening and hikes. But I think the urgency to do QT because it's a relatively less understood-- well, the Bank of Canada has never undertaken QT. The Fed has only undertaken it once. So I think there's less familiarity with that tool.
And so I think their aggression in terms of how quickly to start, how quickly to ramp up QT, I think that can pause a little bit, or it can slow down in terms of how quickly they would do QT. But I think the intent is absolutely to start QT, because I think they need to tighten using both the rate tool as well as the balance sheet tool to make those longer end rates rise. It's one of the reasons why we think long end rates have been so well anchored has been that the central banks own a lot of government bonds. So I think they do want to start QT, but they can be a little measured and gradual in how they implement it.
- Priya, last question for you, to say this is a fluid situation that-- a lot of people are suffering, obviously, in the Ukraine, and we're all watching-- what are you watching in terms of just what's going to be happening next?
- Sure, so apart from what's happening on the ground, which is very hard to get a good read on, but just what's the extent of the conflict. But also what's the West response? And I think details on the sanctions. So we did get some details on the central bank sanctions. And I think that's why the ruble did what it did, because I think the ability for the Russian central bank to intervene has been severely curtailed.
But what are the Swift sanctions on the banking system? Because if they are cutting down all payments back and forth between the Russian banking system and the rest of the world, I think then this has very significant implications. If it's more targeted, then I think it could be less. So I'd be watching for more details on sanctions. What's the Putin playbook after this?
So I think it's really the back and forth of the West versus Russia. And then we have a lot of economic data this week in the US, we have payrolls, as well as ISM and Chair Powell testify. So if it wasn't a busy enough week, we also have the Fed Chair testifying in front of the House and the Senate, so we'll be watching for any comments there too. So plenty to keep us busy this week, for sure.
- Priya, thank you, it's always a pleasure.
- Thank you.