The recent sanctions imposed by the Biden administration represent a significant escalation in pressure on the Russian government in the wake of a variety of actions that President Biden and his advisors felt had not been fully addressed. This includes the Solar Winds hack, election interference, and the poisoning of dissidents on foreign soil, among others. My read on the sanctions are as follows:
1. The Biden administration is attempting to draw a line under certain outstanding issues, as described above, but is also seeking to provide clarity on how it will respond to further provocative actions. The message to Moscow should be very clear: Further interference is unacceptable.
2. It’s notable that the order was released essentially simultaneously with an offer to meet with Russian officials and, if not to “reset” relations, to at least look for ways to stabilize relations.
3. From an investment perspective, most of the initial impact has been contained to the ruble and the Russian bond market and has been surprisingly muted for such strong sanctions. Investors rightly perceive that while the political impact is significant, the actual market impact is limited at this point.
4. The question is, what would escalation look like? The immediate concern is that the U.S. might ban secondary trading on Russian government bonds sometime in the future (the existing executive order only affects primary local currency debt offerings). Other potential avenues of escalation could be sanctions on large, state-owned entities or even more targeted measures against Russian President Putin’s allies or Putin himself. The worst-case scenario would be removing Russia from the Society for Worldwide Interbank Financial Telecommunication system (a network that enables financial institutions worldwide to send secure financial information), which has not been seriously discussed.
5. As far as a trigger for more stringent sanctions, the executive order (E.O.) made this clear in our view. Per the U.S. Department of the Treasury:
“In particular, this new E.O. authorizes sanctions to counter Russia’s harmful foreign activities that threaten the national security and foreign policy of the United States, including: undermining the conduct of free and fair elections and democratic institutions in the United States and its allies and partners; engaging in and facilitating malicious cyber activities against the United States and its allies and partners that threaten the free flow of information; fostering and using transnational corruption to influence foreign governments; pursuing extraterritorial activities targeting dissidents or journalists; undermining security in countries and regions important to the United States’ national security; and violating well-established principles of international law, including respect for the territorial integrity of states.”
6. The biggest concern we see is the possibility of further incursions into Ukraine by Russian troops. This would almost certainly lead to an escalation of sanctions. Unfortunately, while the Russians have refrained from any rash movements, they continue to probe Ukraine defenses and test the resolve of the U.S. and its allies. Room for error is slim.
7. The E.O. has been carefully thought through and designed to send a very clear message to Moscow, while minimizing damage to U.S. investors. I was struck by the excellent coordination between the White House, the Treasury, and other players with regard to the rollout of sanctions. I think this is critical considering the room for misunderstanding between the U.S., its allies, and Russia.
8. Finally, the reactions to the E.O. from officials we’ve talked with and read statements from underscore the deep distrust that exists between the U.S. and Russian governments. While outright hostilities are unlikely, the room for mistakes is clear. Paradoxically, I think this order may help that situation by making the “red lines” of the U.S. administration more clear.
The Berkeley Street Emerging Markets team will continue to monitor the situation closely.
Derrick Irwin is a portfolio manager for the Berkeley Street Emerging Markets team at Wells Fargo Asset Management (WFAM). He joined WFAM from Evergreen Investments, where he served as a senior research analyst. Earlier, he served as an analyst with Advest Inc. and as a portfolio manager with Goldman Sachs & Co. He began his investment industry career as an analyst with Merrill Lynch & Co. Derrick earned a bachelor’s degree in economics from Colgate University and a master’s degree in business administration with an emphasis in finance from the University of Pennsylvania. He has earned the right to use the Chartered Financial Analyst® (CFA®) designation and is a member of CFA Society Boston.
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