Gold has slipped back below the $1300, on better than expected U.S. consumer confidence. However, the tone remains broadly consolidative ahead of the two-day FOMC meeting beginning today and more significant economic data out later in the week.
Geopolitical tensions in Ukraine and the middle east are likely to continue limiting the downside in gold. Economic risks are growing out of the Ukrainian situation as well, which warrant some attention.
As Argentina hurdles toward its third default in less than as many decades, it is also worth acknowledging the much more significant global risk of a Russian default. The FT reported on Friday that Russian banks and companies have $161 bln in foreign debt coming due in the next 12-months.
The Russian economy was already on the ropes early in the year, even before the first round of sanctions hit. Russian GDP was just +0.9% in Q1 as they moved to annex Crimea and Russia-backed separatists began making trouble in other parts of Ukraine.
Initial western sanctions were pretty tepid, primarily targeting individuals. Since the downing of Malaysian Airlines flight MH17 though, the west has gotten more serious. The U.S. announced tough additional sanctions last week. The EU is now poised to target Russia’s finance, energy and defense sectors as well.
Depending on how ‘tough’ the new EU sanctions are, they may well push Russia into recession. With the European economy also teetering on the brink of recession, the EU has been understandably reluctant to take a hard-line on Russia. They risk condemning themselves to another economic contraction as well. However, the shooting-down of a civilian airliner, leaves the EU with little room to maneuver.
If Russia loses access to both U.S. and European capital markets, the risk of default increases. Russian CDS spreads have been trending wider; evidence of the growing concern within the market.
When Russia last defaulted in 1998, the crisis culminated with devaluation of the ruble, a default on the domestic debt, a moratorium on payment to foreign creditors, and the shuttering of a number of banks. Russian yields soared to 47% and inflation was running at a stunning 84%.
Concerns about Russia weighed heavily on the U.S. stock market. In August of 1998 the DJIA plunged almost 1,000 points (back when a thousand points meant something) in just three-days. It was nearly a 20% correction.
Markets are even more interconnected today and it’s difficult to assess the counter-party risks that might come into play if the Russian economy starts to unravel. Certainly the European banks have significant exposure. U.S. banks have exposure to Russia as well, but even greater exposure to the European banks that have exposure to Russia. If Russian default risks continue to grow, look for the term ‘contagion’ to be resurrected.
The sharp 2.9% contraction in first-quarter GDP suggests there is some vulnerability in the U.S. as well. We’ll get out first peak at Q2 GDP tomorrow and while most analysts expect a rebound, expectations as to the magnitude of that rebound have ratcheted lower in recent weeks. The median forecast remains around +2.9%, but a number of analyst now have sub-2% expectations.
Russia has been aggressively accumulating gold in recent years, which will provide them with a bit of a buffer in the face of harsher sanctions. Individual investors should be sure they have an adequate buffer against any so-called ‘black swans’ that might take flight from a potential Russian financial crisis.