Russia defaults on its foreign sovereign debt for the first time in over a century

Markets

The short squeeze on bond markets stopped on Friday. US Treasuries underperformed German Bunds during the WS risk rally (+3%). US yields rose by 4 bps (5-yr) to 5.9 bps (30-yr). German yields ended narrowly higher on the day. EUR/USD gained slightly ground, from 1.0523 to 1.0553, but first resistance at 1.0627/42 was never in danger. EUR/GBP sticks with the 0.86 big figure. UK FM Truss in an opinion piece in the FT adds weight to the UK’s decision to push through with a bill to change the Northern Ireland protocol. The UK wants to fix problems in four areas: customs and agri-food checks, regulation, subsidy control and VAT and governance. The EU started legislative action against the UK for this infringement against the withdrawal agreement. New brexit struggles add to our bearish views on sterling medium to long term.

Last week’s move brought a little more balance in a unidirectional (bond) market focused on central bank’s inflation fight. Some future downside growth risks and their potential impact on the normalization cycle are now discounted. It doesn’t change the near term trajectory of expected policy rate paths though. We stick to our view that July and September meetings are priced in, leaving scope for consolidation over Summer. September forecasts by the ECB and Fed will be decisive on the continuation of the core bond sell-off medium term, which remains our favored scenario as we don’t see scope to halt tightening cycles any time soon.

The first days of the trading week could see a continuation of last week’s trends (improved risk sentiment, correction/status quo on bond markets, dollar slightly in the defensive). The ECB forum on central banking in Sintra will grab a lot of attention, but we expect Lagarde and co to stick to the views spelled out at the June 9 policy meeting and at the June 15 extraordinary meeting. It’s probably too early to get additional details on the proposed ECB tool to avoid unwarranted market fragmentation. Today’s eco calendar only contains May US durable goods orders. Later this week, we’ll get US consumer confidence, Richmond Fed manufacturing, EC confidence numbers, US PCE deflators (lagging on CPI), US manufacturing ISM and especially June EMU inflation numbers on Friday. The monthly dynamic is expected to stay high, resulting in a new record high Y/Y outcome. EMU core CPI might even push through the 4% Y/Y barrier. Such readings could tilt the growth vs inflation scale again a little bit more if favour of the latter.

News headlines

Russia has defaulted on its foreign sovereign debt for the first time in over a century. The 30-day grace period that kicked in on May 27, when Western sanctions made it unable to pay about $100 million interest payments, ended on Sunday. Seeking to avoid it, Russia announced last week it would switch to servicing its $40bn of outstanding sovereign debt in rubles, citing a “force-majeure” situation created by the West. The last time Russia defaulted on foreign debt was in 1918. During the financial crisis and ruble collapse in 1998, then president Yeltsin’s government failed to pay on $40bn of its local debt. Bondholders are now expected to keep a wait-and-see approach. Their claims only become void three years from the payment data.

The Bank of International Settlements in its annual report said the leading economies are closing in on the tipping point into a world where rapid price increases are (perceived) normal, more synchronized, dominate daily life and are difficult to quell. It recommended its central bank members to be decisive and not to be shy of inflicting short-term pain and even recessions to prevent moving into such a scenario. “The overriding priority is to avoid falling behind the curve, which would ultimately entail a more abrupt and vigorous adjustment. This would amplify the economic and social costs of bringing inflation under control.”, it concluded.

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