Caveat Emptor

There’s a pattern to this: Washington makes a statement, Moscow braces for impact.

Just today, the Russian ruble is down about 3% vs the US dollar, while stock indices dropped between 0.8% and 2.9%, depending on the index (and that’s in ruble terms). The conventional wisdom is that both cascades were driven by sanctions worries coming out of the Trump Administration.

Russian_Markets_20180808

The conventional wisdom doesn’t get us very far, though, for two reasons. First, we’ve been playing the sanctions game for a long time now. Both sides should be used to it. So, why aren’t these kinds of things priced into the market? Second, there were actually two pieces of news on sanctions, one from the State Department, and the other from the Senate. Which one was the culprit?

Let’s run through some hypotheses.

Up first: Secretary of State Pompeo certified a finding that Russia was behind the Novichok nerve agent attack against Sergei Skripal in Salisbury, promising to implement new – albeit unspecified – sanctions as a result in the near future. That, certainly, was the most immediate piece of threatening news. But we knew it was coming. On these sorts of things the State Department works to a schedule (loosely) and telegraphs its intentions. There was no chance of any other outcome. And as a result, there is very little chance that serious investors didn’t already have this priced in. It simply wasn’t a shock. (Or at least it shouldn’t have been. If it was, we have a much more serious problem of analysis in the Russia-focused investment community.)

Hypothesis Number Two: Sen. Lindsay Graham and a handful of his colleagues tabled something they call the “Defending American Security from Kremlin Aggression Act”. Apart from having an appalling acronym – DASKAA (bringing to mind what Rudyard Kipling’s giant snake would have been called in German) – the bill has some potentially serious implications. According to a draft of the bill published today in a Russian newspaper, it would ban trading in new Russian sovereign debt and penalize collaboration in Russian overseas energy projects (see Nord Stream 2), as well as bolster existing personal, financial-sector and energy-sector sanctions.

But if DASKAA is driving today’s sell-off, that, too, represents an error in judgment. For one thing, Pompeo’s actions – vague as they may be – would seem calculated to undercut the need for new legislation on Capitol Hill. Moreover, I’d be surprised if Graham’s bill has legs, particularly ahead of an election in which the GOP seems determined not to run away from Trump. And I’d be equally surprised if the Kremlin doesn’t know that.

Maybe, then, we should consider a third hypothesis: Moscow still hasn’t learned how to deal with the Trump Administration. After the Helsinki summit, many in the Russian political and economic establishment (and the border between the two is even vaguer than Pompeo’s promises) may have actually believed that the two leaders had genuinely reached an understanding, and that said understanding would naturally extend to the policies and behaviors of the Trump Administration as a whole.

Ever since the Salisbury attack, however, the professional Russia hands in the State Department, Department of Defense and the National Security Council have shown a remarkable knack for manipulating both sanctions policy and – perhaps more importantly – sanctions messaging, in order to inflict financial damage and increase Moscow’s sense of insecurity.

While the Russian economy can live with sanctions, the real problem is volatility. As a result, if Putin came to Helsinki with an ‘ask’ from Trump regarding sanctions, it would probably have been just to keep things on an even keel. Trump, I imagine, is likely to have agreed.

Thus, what may not have been priced into Russian markets was the Kremlin’s continued inability to do a deal with a US president singularly uninterested in policy and overwhelmingly driven by image.

Buyer beware.

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