Rabobank: Don’t RUB Me The Wrong Way

By Michael Every of Rabobank

Now even the luvvies at the Oscars are suddenly violent, and the British phrase “Don’t rub me up the wrong way”, meaning don’t irritate me, is particularly appropriate.

The Financial Times, again, has an optimistic story about Russia’s demands of Ukraine, and this time it could be an Oscars’-host joke: “Putin claims what he actually said to Ukraine was ‘Don’t be nasty’.” The FT says Russia claims it no longer wants Ukraine to be “denazified” and is even happy with it joining the EU – provided it hands over Crimea and the Donbas. For those who feel like slapping someone in response, Ukraine has already underlined it is prepared to remain neutral, but it won’t give up any territory, demands security guarantees nobody is willing to give with territorial issues outstanding, and that any agreement must go to a referendum, closing off any backroom deals some in the US/EU/markets might like to do to make this all go away.  

So, a plank towards an off-ramp? Perhaps. Or it could be Russian “Maskirovka” given the entire war effort has been predicated on the anti-Nazi line so far. Not a very good mask, if so, given newly promoted Chechen warlord/Russian Army lieutenant general Kadyrov reportedly just stated: “Very soon we will complete the assigned tasks in Mariupol and report to the President of the Russian Federation on our readiness to take Kyiv.” One thing we can be sure of is that any negotiators with Russia will do their own catering given the last set who tried to talk peace, including oligarch Roman Abramovich, reportedly then suffered symptoms of chemical poisoning.

Yet “Peace in our time” will continue to see wild market swings – on top of the wild market swings we were already seeing. In particular, oil plummeted once again due to Shanghai going into lockdown. Presumably this latest Chinese Covid closure is economically serious enough to justify Brent closing down nearly 7% on the day, despite the fact that it has leaped back up again after all the others. Nobody ramping oil markets again, honest.

Meanwhile, Russia is pressing ahead with plans to insist on a switch EU payment for its gas to RUB by Thursday. It has underlined it won’t export it for free, while the EU says it won’t pay in RUB. That is as binary a trade as you can get, and the potential outcomes should be obvious. The FX market seems to think so anyway, with EUR/RUB strengthening from 165 at its low to 105 at time of writing. But are we really going to see Russia “win” like that given the huge geopolitical and geoeconomic implications?

The much-vaunted Russia-India RUB-INR trade flaunted as the previous catalyst for “the end of the dollar!” is, according to the Indian press, looking far more mundane. The Business Standard reports India and Russia may keep RUB out of the proposed INR-RUB trade, given its high post-sanctions volatility: payments for the rising level of commodity trade that is indeed happening are likely to be settled in INR *pegged to the dollar*, and deposited in an Indian bank account. Under the proposed trade mechanism, when India imports goods from Russia, INR equivalent to the dollar value will be deposited in an Indian bank account. When India exports goods to Russia, Indian exporters can be paid from the same account in INR. You know who used a similar arrangement to work around sanctions? Nazi Germany. I’m sorry, I mean “Nasty Germany”.

The key points are that:

commodities will continue to be PRICED in DOLLARS, as we saw with the purported Saudi CNY oil sale;

Russia, for now, is still accumulating new USD and EUR reserves via its energy trade surpluses; and

nobody wants to touch RUB. Not even India, an emerging ‘neutral’ heavyweight in what article after article now say is a bifurcating world economy.

The Atlantic just added to that pile with ‘The World is Splitting in Two’, arguing: “Changes in governments and leaders could prevent what seems an inexorable slide into a new world. Barring that, though, what could emerge are two semi-distinct spheres, with tighter economic ties within than between them. Each will use different technology and operate on different political, social, and economic norms. Each will likely point their nuclear missiles at the other and compete in a zero-sum game for power and influence. This is not the world anyone wanted. But it may be the world we’ll get anyway.” And the US Senate just passed its version of the anti-China/US industrial policy bill to boost semiconductor production at home 68-28, sending it off to be reconciled with the already-passed House version.  

We had predicted the same as recently as 2020: but added USD was not going to ‘split’. Yes, there will be a move away from it in pockets, as we see in RUB-INR trade and already saw in Russian gas in EUR. More so given the back-to-back freezes/seizures of Russia’s and Afghanistan’s USD (and EUR and JPY) reserves.

Yet, like the ghost of Banquo, the US dollar is always sitting there at the feast, if not as a safe store of value (as US inflation soars) then as a method of accounting (try to calculate global GDP with five different currencies simultaneously, why not?) and, due to the Eurodollar built on that back, as a method of exchange to pay US dollar debts. If you don’t believe that is true then by implication you must believe that almost all Eurodollar debt is eventually going to default.

If countries want to hold fewer USD reserves because of geopolitics and economies halting exports of the vital commodities USD are supposed to allow others to freely purchase, then that is not negative for the US dollar. Quite the opposite! It is negative for global trade. That may be in USD, and so there is less physical demand for them, but Eurodollar debts still have to be paid back, with rising interest, IN DOLLARS – and when there are less USD reserves, and flows, to do so with. That backdrop is arguably positive for the US dollar for now – unless, and I repeat, you are trading an avalanche of Eurodollar defaults.

Where we are seeing global FX reserve diversification, it is 75% driven by shifts into the likes of Canadian, Aussie, or Singapore dollars for example, all of which are still under the emerging Western/Anglosphere geopolitical umbrella. (Canada finally just opted for the F-35 as its fighter jet of choice, underlining that fact.) Such a development opens up some opportunities: Australia might be able to shift to invoicing more regional trade in AUD in ASEAN over time, for example.

However, we are not yet seeing the much-touted global switch to holding reserves in “commodity-backed” currencies of the future like CNY or RUB. That will require a game-changing economic policy shift or geopolitical event first. The first is seen as theoretically possible if politically unlikely, and the latter as perhaps strategically inevitable, but not necessarily to the dollar’s detriment: being nasty again, one could have made the same trade in the 1930s – and see how that worked out.

Some might ask how we can move towards a ‘world split’ when the US dollar still has no true rival. The answers are, variously, “carefully”, “badly”, and, looking at history, “riskily”.

The current backdrop implies huge physical disruptions; huge market volatility; huge financial pressures forcing equally huge geopolitical decisions; and huge geopolitical decisions forcing equally huge financial outcomes. What it does not imply is any real use for traditional ‘rule of thumb’ metrics or ‘spot-plus/minus’ forecasting across markets. After all:

Bloomberg noted yesterday that what the Treasury market is now seeing “does not happen 99% of the time”. Neither does a collapse of most of the global order. But that’s cold comfort to ‘the 1%’;

JPY is trading like an EM currency, now down 7.7% YTD. That, as the BOJ steps in to offer to buy “unlimited quantities” of JGBs at 0.25%, showing Yield Curve Control (YCC) is finally being used again. Unlike when YCC when yields are too low, this has a seriously destabilising impact on the currency, especially if the US is leaning in the other direction. (Again, this is an eventual structural outcome we flagged years ago, if not for Japan per se.) Chatter is now that there may not be BOJ FX intervention until we hit a round number like 130 – in which case we could soon get there. More so given the government is extending fuel subsidies and talking about fiscal stimulus. Which FX cross will follow that lead?;

Commodity-exporting Australia, where the RBA keeps sitting on its hands so that a slice of the population can keep sitting on their property portfolios, just saw retail sales leap 1.8% m/m. What’s a central bank who already dropped YCC to do?;

Bloomberg agrees with the take yesterday that in the battle of bonds vs. stocks, “Equities’ New Haven Role May Spring Leaks is History’s Tale”;

It also adds that “Global Supply Lines Brace for ‘Menacing’ Economic Storm to Widen’ as we remain ‘In Deep Ship’ on the logistics front; and, to conclude

Please don’t RUB me up the wrong way – or you might get a slap in the face.