The collapse of the Russian Ruble, what does it mean?

There are many factors that determine the strength of one currency versus another.  The interest rate differentials between countries, the level of a country’s fiscal discipline compared to another, and the stability of one’s government are just a few of the variables that influence the flow of global capital and, subsequently, the strength or weakness of a currency.

While it can also be debated whether a stronger or weaker currency is suitable for a country at any point in time, it goes without saying that a collapsing currency is not good for any country.

Russia's currency, the Ruble, has tumbled over the past week after Western nations came to an agreement to put crippling sanctions and other strong measures on Russia’s financial sector in retaliation for its recent invasion of Ukraine. 

As you can see in this chart that dates back to 2000, the Russian currency has crashed to the point where it is now trading at an historically low level.

In fact, at one point during the trading day on February 28th, the ruble had fallen 30% against the U.S. dollar after the U.S., European Union and United Kingdom announced bold moves to block some Russian banks from the SWIFT international payment system.  Restrictions were also placed on Russia's access of its more than $600 billion of foreign currency reserves.

In a flight to quality maneuver, global capital swiftly moved out of Russian assets and into developed country investments, primarily U.S. securities (i.e. U.S. Treasury bonds). This flow of capital into U.S. assets has not only perpetuated the purchase of U.S. dollars and the selling of the ruble, but the dollar has also strengthened against most global currencies over the past week as well.

And even though a flight into dollar denominated assets is a vote of confidence for the United States as a country and its economy on the global stage, it also can have negative ramifications for U.S. investors in the near-term.

As we discussed in previous thought leadership content, a strengthening dollar against foreign currencies tends to make non-U.S, equity and bond investments less attractive for U.S. investors when those foreign company profits and interest payments are converted back into more expensive U.S. dollars.  A stronger dollar also has the tendency, all else being equal, of providing an obstacle for other types of investments that are priced globally in U.S. dollars for the U.S. investor, such as commodities (gold, copper, etc.). 

Increased demand for U.S. Treasury securities, such as the 10-year bond, could cause the price of those bonds to go up (and the yields to decrease). This month, with the Federal Reserve expected to begin the process of increasing the Federal Funds rate (short-term interest rate), concerns over a flattening or inverted yield curve is something that investors are keeping a very close eye on.  Historically, an inverted yield curve has been a strong leading indicator of an economic recession.

So how does a collapsing currency, in this case the ruble, affect Russia? 

For the average Russian, the sharp devaluation of the ruble means an immediate drop in one’s standard of living.  In Russia today, as the purchasing power of their ruble has dropped sharply, consumers who hold rubles have found out that they can buy far less with their money.

Russians are large consumers of imported goods and the prices for those items have skyrocketed overnight as they are forced to spend more rubles to buy those goods. Foreign travel has also become much more expensive as the weak ruble buys less currency abroad.

The fall of the ruble is also likely to worsen the inflation situation in Russia as well, and this has heightened fears of bank runs in the country.

The deeper turmoil on the Russian economy is likely still to come if price shocks and supply-chain issues cause Russian factories to shut down due to lower demand. A rapidly depreciating ruble could also make it extremely difficult for Russian companies that need to issue debt in order to raise capital. 

Perhaps realizing that they have fewer tools available to them in preventing a further collapse of their currency in the short-term, the Russian central bank raised its key interest rate to 20 percent from 9.5 percent.  Only time will tell whether such a drastic measure will be able to eventually stabilize the value of the ruble.

From an investment standpoint, investors around the globe have understandably been liquidating positions in Russian stocks and bonds.  Russian bonds have seen prices drop to levels that suggest a risk of default is a strong possibility.

With the uncertainty of whether Russia will be able to get access to their large stockpile of foreign exchange reserves and help prop up the value of the ruble, it brings up the question of whether foreign investors of dollar-denominated Russian bonds will ever get paid back in the future.

From an economic point of view, the collapse of the Russian ruble has enormous ramifications, not only for the Russian domestic economy, but also for global financial markets.  The thoughts raised here scratch the surface on ways in which a country, its economy, and investors can be affected when confidence erodes overnight.

Our feeling at Clearwater Capital Partners is that the U.S. dollar will trend lower against international currencies, in aggregate, at some point in the future.  Despite that, the characteristic of the dollar continuing to be a “safe haven” currency during times of international stress is something that we watch very closely, particularly when it comes to tactical allocation changes within our investment strategies.