Tuesday, December 16, 2014

Russia Goes Paul Volcker on Interest Rates - Massive Hike to 17%

It is clear that Russia is struggling to cope with a combination of western financial sanctions and the huge drop in oil prices. The ruble has taken a nose dive downwards which we noted in this earlier blog post. Yesterday, it looks like the Russian Central Bank decided to take a page from the old Paul Volcker playbook to try and support the ruble and fight inflation. They hiked interest rates to 17% with sudden massive rate hike. Below are two news articles on this. One from a western source (CNBC) and one from a Russian media source (Sputnik news). Below each link are a few quotes from each story.


"The Russian central bank's dramatic rate hike further threatens financial stability in the troubled economy and is thus unlikely to put a floor under the country's currency or stocks, say analysts."
"The Central Bank of Russia (CBR) unexpectedly hiked rates by 650 basis points to 17 percent overnight after the beleaguered ruble plunged to a fresh record low. The currency rebounded to 60.00 to theU.S. dollar following the move but has since crumbled during Tuesday's session and hit a fresh all-time low of 73.1708 by midday London time."
"This is essentially a panic situation, the central bank took the most drastic action they could think of," Uwe Parpart, managing director and head of research at Reorient Financial Markets told CNBC."
"Oil price stability will be the main determinant of stability in Russian assets, Parpart said. The price of oil - Russia's main export and revenue source - has fallen 46 percent in the past six months due to abundant supply—partly from U.S. shale oil—and low demand growth."
"If oil prices continue to drift lower, the central bank's measures will be overcome by more panic in a matter days."
"With such uncertainty, it's much too early for investors to gain exposure to Russia, he said."
"The Russian Central Bank's decision to raise key rates to 17 percent will indirectly affect the currency market but its influence will not be immediate, Central Bank head Elvira Nabiullina said Tuesday."
"We have ditched regular intervention by introducing a floating currency exchange. I believe that this was a completely correct decision and this decision has lowered the attractiveness of speculators to operate on the currency market against the Central Bank," Nabiullina said on Rossiya-24 television."
"I would like to emphasize once again that the hike in our key rates are oriented first of all on lowering inflation and inflationary expectations. This will indirectly influence the currency market, but this may not be immediate," she added."
"According to Nabiullina, the ruble iscurrently undervalued, and that over time it will return to a more normal valuation. She did not specify how much time is required, however."
My added comments: 
I guess we may be about to find out how much impact a crisis in Russia will impact the rest of the world. This move by the Russian Central Bank clearly indicates that they are operating in crisis conditions. The CNBC article says if oil prices keep falling that panic may set in. 
This radical move also shows that people will do unexpected things under pressure. All this uncertainty and volatility is not going to help out the global economy. We know that for sure. When we see oil falling 40% or more this quickly, a massive unexpected 6% overnight hike in interest rates in Russia, stock markets falling sharply, and gold rising and falling very quickly (down over $20 yesterday and now up over $20 as I write this today), we know that things are not stable. 
All these things are signs that there is potential trouble in the system because all kinds of investments and derivatives are tied to these volatile price movements. Investors expect a reasonably stable environment when these investments are made. So, the risk of an unexpected default by some large entity goes up when volatility flares up like this. As always we have to stay alert.

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