By Jamie McGeever

ORLANDO (Reuters) – Russian sovereign defaults evoke nervy Times on Wall Street.

The August 1998 Russian government’s default on its last rouble of debt in August 1998 caused tremors that led to one of the largest financial earthquakes, resulting in the near collapse of the mega-U.S. hedge funds Long-Term Capital Management and their rescue.

What if the default occurred in 2022?

Russia is due to make coupon payments in March on two U.S. Dollar bonds. The coupons aren’t subject to any clauses that would allow Russia the ability pay in roubles, or other currencies. However, President Vladimir Putin issued a directive last week prohibiting foreign debt payments in any other currency than the roubles.

Russia may technically default on the two interest payments of $117 million in regular dollars on its dollar-denominated bonds. This is after a grace period expires.

Fitch Ratings Agency says that default is likely and Carmen Reinhart (World Bank chief economist) says Russia is “squarely default territory”.

Russia will default against the background of global market volatility following the invasion of Ukraine, Feb. 24, and the near unprecedented financial, trade, and economic sanctions placed upon Moscow.

After the 2008-2009 Great Financial Crisis, global banks were greatly strengthened. We know that policymakers are willing to do whatever it takes in a crisis. It is essential that systemic risks are low.

However, the interconnectivity of global markets and financial systems has never been greater. High levels of volatility, stress and dislocation are possible, as evidenced by the recent global nickel market.

It is difficult to predict where and when with certainty. Investors will be influenced by fear of contagion for many months.

We can all recall August 1998 as Russia’s shock-and-aweful devaluation and default of some of its rouble debt.

The spread of contagion was rapid after the Asian financial crisis. LTCM was a large and heavily-leveraged investment fund that bet on convergence of a variety of spreads including Danish mortgage bonds. It got severely burned just weeks later.

Graphic: US High Yield Credit Spreads – 1990s: https://fingfx.thomsonreuters.com/gfx/mkt/lgvdwabxdpo/1990Spreads.jpg

Graphic: US Financial Conditions Index – 1990s: https://fingfx.thomsonreuters.com/gfx/mkt/klpykbrbepg/USFCI.png

It is part of market legend to recall the failure of LTCM in 1998 and the subsequent $3.6billion bailout by the Federal Reserve.

Willem Buiter served as an outside member of the Bank of England’s Monetary Policy Committee during that period. While he acknowledges the important and clear differences that exist between now and then, he warns of potential casualties.

We always experience the butterfly effect. “The bad news is that we don’t have much information about the net of indirect and direct exposures of financial entities and other non-financial entities, asset and commodity market markets that are so in turmoil right now,” he stated.

POOR VISIBILITY

The internet runs far and wide.

Russia is the third largest oil producer in the world and the joint top exporter. It is also the second largest gas producer, producing 40% of Europe’s gas. Nornickel is Nornickel’s world-largest palladium producer as well as the largest producer of refined nickel. Russia and Ukraine together account for 29% of the global wheat exports.

These commodities’ prices have soared by record numbers or at all levels. It’s good news to be on the right side, but it can prove disastrous if your position is on the wrong.

Uncertain entities have reported losses of billions after they were misled by nickel prices that rose to over $100,000/tonne, causing the London Metal Exchange not to trade in the metal.

Charlie Robertson was the global chief economist of Renaissance Capital when he first started working in the stock market back in 1998. The ripple effects of volatility and the recent magnitudes of price changes could cause havoc where it is least expected.

The implications are too complex for the markets to price. Which bank is being owed money when 500 aircraft are stranded in Russia by airline leasing firms? What bank will be exposed Which bank will be exposed? He wonders which country is likely to see its prime minister ousted because of rising food prices.

This alone is cause to worry. A Russian default will likely increase downward pressures on the global economy. Goldman Sachs (NYSE 🙂 says global financial conditions have been the most tight since 2009.

Robertson believes that “it’s plausible” we could see a global recession in just six months.

Graphic: Global Financial Conditions Index – Goldman Sachs: https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkolojpx/KNQdg-global-financial-conditions-at-tightest-since-2009.png

(The views expressed in this article are the opinions of the author. He is a columnist with Reuters.

(By Jamie McGeever; Editing by Paul Simao)