- Rising risk of a full-blown financial crisis in Russia – further intervention/rate hikes on the cards
- Germany’s ZEW sentiment jumps higher, while eurozone PMI rises
- Today’s FOMC: policymakers will begin preparing for an interest rate hike in mid-2015
Russian economy to fall into a deep recession…
After the Russian Central Bank ‘s 6.5% rate hike failed to stop the ruble’s free fall, the prospects for Russia’s economy have worsened significantly. At the very least, the sharp rate hike alone will push Russia into a deep recession. But the risks of a much more serious crisis have clearly risen. The banking sector has foreign currency loans to the Russian private sector worth around 10% of GDP in its books and these will be much harder to service. Meanwhile, external bank debt is also around 10% of GDP, and as a weaker ruble will push up its value, this will also eat into banks’ capital. But the biggest risk is that depositors will withdraw their ruble deposits, causing a bank run, and triggering a deep financial crisis.
…reserves to buy time…
While some analysts argue that Russia’s reserves are large enough to prevent a financial crisis, we are sceptical. Russia’s reserves are not as large as generally thought. Although the headline figure still totals $416bn, due to gold holdings and the fact that part of Russia’s reserves belong to its Reserve Fund and its National Wealth Fund, the liquid part of Russia’s reserves probably is as low as $250bn, on our estimates. In addition, these are likely to have declined significantly over the past few days. What is more, given the panic on financial markets, Russia’s reserves can fall at a much sharper pace than the $60bn drop that we saw in the past half year. Indeed, during the financial crisis, it took just six months of significant financial headwinds for Russia’s reserves to fall by a staggeringly large $210bn, implying that in a full-blown crisis, Russia could run through its liquid reserves in months.
…but oil price recovery is key
We think the authorities will take more aggressive action to try to stabilise the rouble in the form of interventions/aggressive rate hikes. However, the only thing that will really help Russia’s economy now is a serious rebound in oil prices. This would lead to a more significant inflow of dollars, boosting the country’s FX reserves, increasing its fiscal revenues, and underpinning the ruble. If this rebound does not materialise, there is a high risk of a full blown banking and financial crisis.
More surveys pointing to moderate eurozone pick up
Given the upheaval in Russia, markets ignored positive data out of the eurozone. Germany’s ZEW economic sentiment index jumped by 23.4 points to 34.9 in December, staging its sharpest monthly rise since the start of 2013. The rise is in line with our view that German GDP growth increased in Q4 following a disappointing Q2 and Q3. Meanwhile, the eurozone composite PMI rose from 51.1 in November to 51.7 in December. At its current level it is consistent with GDP growth picking up slightly in Q4 from the 0.2% qoq that was recorded in Q3. We expect the economy to benefit from the weaker euro, the drop in oil prices, a strengthening global economy and slowly improving domestic fundamentals.
On the agenda: Fed to drop ‘considerable time’
Since October’s FOMC meeting the US economy has shown solid growth. But concerns about the global economy are still lingering. In the past meeting the GDP growth forecast was already revised down based on the stronger dollar and the deterioration in global growth prospects. Given that on balance the US economy is doing better, we expect the US GDP growth forecast to be revised a little higher, but inflation forecasts are likely to come down a bit due to the decline in oil prices. We expect the Fed to drop the ‘considerable time’ phrase, which suggests that rate hikes are still far off and to replace it with language that suggests that the rate hike is data dependent, in preparation for a rate increase in mid-2015.