Column markets fear ‘butterfly effect’ if Russia defaults: McGeever

Image shows a US dollar placed over a Russian ruble banknote seen through broken glass
FILE PHOTO: In this March 1, 2022 illustration, a U.S. dollar is seen above a Russian ruble banknote seen through broken glass. REUTERS/Dado Ruvic/Illustration

March 11, 2022

By Jamie McGeever

ORLANDO, Fla. (Reuters) – Russian sovereign bankruptcies provoke jittery times on Wall Street.

Shocks from the Russian government’s last ruble default in August 1998 contributed to one of the biggest financial shocks to date – with a near-collapse and bailout of US mega-hedge fund Long-Term Capital Management.

Would a default in 2022 – even a technical FX default as early as next week – have similarly deep and far-reaching consequences?

Russia has coupon payments due March 16 on two US dollar-denominated government bonds that have no clauses allowing Russia to pay in rubles or other currencies. But a decree by President Vladimir Putin last week bans paying foreign debt in anything other than rubles.

The result is that Russia could technically default on two periodic interest payments on dollar-denominated bonds totaling $117 million once a 30-day grace period has expired.

Rating agency Fitch says a default is imminent and World Bank chief economist Carmen Reinhart says Russia is in “square default territory”.

If Russia defaults, it will do so amid widespread global market volatility since the February 24 invasion of Ukraine and near-unprecedented financial, trade and economic sanctions imposed on Moscow as a result.

The global banking system was significantly strengthened after the Great Financial Crisis of 2008-2009, and we know that policymakers will do “whatever it takes” when confronted with a severe financial crisis. The systemic risk must certainly be low.

But the global financial system, markets and investment flows have never been so closely linked. The risk of severe volatility, stress or dislocation in certain areas – as seen in the global nickel market this week – must certainly be high.

The only problem is that there’s almost no way to know for sure where in advance. Fears of contagion are likely to permeate investor thinking in the coming months.

The mind is thrown back to August 1998, when Russia stunned the financial world by devaluing its currency and defaulting on part of its ruble-denominated debt.

So shortly after the Asian financial crisis, the contagion spread like wildfire. LTCM, then a huge and highly leveraged fund betting on the convergence of a range of spreads, including Danish mortgage bonds, was badly burned just weeks later.

Chart: US High Yield Credit Spreads – 1990s:

Chart: US Financial Conditions Index – 1990s:

The failure of LTCM in 1998, and a subsequent $3.6 billion Federal Reserve-coordinated bailout are part of market folklore.

At the time, Willem Buiter was an external member of the Bank of England’s Monetary Policy Committee. He notes the clear and important differences between then and now, but warns that there will be sacrifices.

“We always have the butterfly effect. The bad news is that we don’t know much about the web of direct and indirect exposures of financial and non-financial companies to asset and commodity markets that are in such great turmoil right now,” he said.


The web runs deep and wide.

Russia is the world’s third largest oil producer and joint top exporter; it is the second largest gas producer and accounts for 40% of European gas; Nornickel is the world’s largest producer of palladium and the largest producer of refined nickel; Russia and Ukraine together account for 29% of global wheat exports.

The prices of all these commodities have skyrocketed, in many cases by record amounts or to record highs. Good news if you’re on the right side of the movement, disastrous news if you’re on the wrong side.

Some companies are said to have suffered billions of dollars in losses after being caught on the wrong foot by nickel prices soaring past $100,000 a tonne, prompting the London Metal Exchange to halt trading in the metal.

Charlie Robertson, global chief economist at Renaissance Capital, had a hard time on the market in 1998. He warns that the magnitude of recent price action and volatility mean the ripple effects are being felt where least expected.

“Markets cannot price in the full impact of this. Who do the airline leasing companies owe money that stranded 500 planes on Russian soil? Which bank is exposed? What about all these companies that are up to their necks in commodities trading? In what country does rising food prices oust a prime minister?” he muses.

If that’s not cause for concern, a Russian default would likely add to the downward pressure already building on the global economy. According to Goldman Sachs, global financial conditions are the tightest since 2009.

“It’s a plausible scenario that within six months we have a global recession,” notes Robertson.

Chart: Global Financial Conditions Index – Goldman Sachs:

(The opinions expressed here are those of the author, a columnist for Reuters.)

(By Jamie McGeever; Editing by Paul Simao) Column markets fear ‘butterfly effect’ if Russia defaults: McGeever


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