It is US versus China. It is inflation against deflation. It is buoyant retail sales here, sluggish reading there. The US is expected to weather the period of inflation, possibly without falling into recession, China is struggling to revive its economic fortunes. The focus is now firmly on Chinese woes and scepticism is growing whether the beating heart of global and oil demand growth will stage a convincing recovery any time soon. As the expansion in Chinese industrial output and retail sales slowed Barclays downgraded the country’s 2023 GDP growth estimate to 4.5%, below the official target of 5%, which looked conservative just a few months ago. Overnight we learnt that new home prices fell for the first time this year adding to the economic malaise.

Risk was off yesterday. Equities fell and the two major crude oil benchmarks dived more than $1/bbl. Backwardation narrowed. Products were hit even harder. Both Heating Oil and RBOB settled around $2.5/bbl equivalent in the red. Again, the pragmatic approach is understandable and the temptation to shed length is stronger in a rising market, something that we witnessed in recent weeks. It is, however, worth remembering that whilst dismal Chinese data has been causing headaches of late and has provided the perfect and justified excuse for investors to go on the defensive yesterday the global oil balance shows no signs of loosening up, something that was on display after yesterday’s settlement. The API reported a sizable drop of 6.2 million bbls in crude oil stocks whilst gasoline inventories thinned by 760,000 bbls. Distillate stockpiles were up by 660,000 bbls.
 

Obliterated Rouble

The gut reaction of the market in the immediate aftermath of Russia’s invasion of Ukraine was to get rid of everything that was Russian. It included the country’s currency, the rouble. It had been steadily moving between 55 and 83 against the dollar in pre-war years but when the annexation of eastern Ukraine began at the end of February 2022 the rouble started to weaken considerably and at one point it changed hands at 150 against the dollar. A relative calm and strength ensued, and a comparatively resilient Russian economy, capital controls and swelling export revenues helped the currency recover well above the pre-conflict level and at one point it flirted with the 50 mark. Of course, the emergency rate hike to 20% in February 2022 also played part in stabilizing the Russian currency.

Dark clouds, however, have been gathering above the country’s economy and the rouble has been weakening gradually but relentlessly for the past 13 month. The selling has intensified lately and on Monday 1 US dollar was, once again worth more than 100 roubles. Anxiety in monetary circles and in the Kremlin has visibly grown and the Russian central bank was forced to hold an extraordinary meeting yesterday amidst finger pointing. The outcome, unsurprisingly, was a hike of borrowing costs from 8.5% to 12%. According to the acolytes of Russian monetary policy, ”the decision is aimed at limiting price stability risk”. The market was less than impressed and albeit the rouble settled above Monday’s close it was assessed at 98 against the greenback. Talks of re-introducing capital controls are providing renewed support this morning, nonetheless, at 97.20 the Russian currency is far from being out of trouble.

The weakening of the rouble is an inevitable consequence of the war the country wages against Ukraine. Military activity costs money and acts as a break on economic expansion. The country’s economy is shrinking, the GDP faltered by 2.1% last year and further struggles are pencilled in for this year. Assorted sanctions against the country have a conspicuous impact on trade leading to deterioration in both exports and imports. The country’s revenues from fossil fuel sales, whilst increased in 2022 due to high prices, started to plummet in 2023 as a result of cheaper global oil and western boycotts targeting oil imports. Defence spending is on the ascent and the budget deficit has ballooned to around $28 billion. Russia’s current account surplus fell to $25 billion in the first seven months of the year, 85% below the record high in 2022.

A weak currency can lead to elevated inflation (hence yesterday’s central bank decision to hike rates), which, in turn increases the cost of imported goods and services. On the other hand, it supports the value of exports in domestic currency but makes servicing foreign debt more expensive. So, what to expect in case the rouble remains under pressure?

Russia is in trouble, but the pain is self-inflicted, war-time economies tend to experience relentless rises in inflation. The 4% target level will unlikely be achieved, the central bank estimated a price rise of around 5%-6.5% this year escalating to 11% in 2024. Cutting spending might help to mitigate the inflationary pressure but such move is implausible – military spending must be maintained and Putin’s pledge to increase state pension adhered to. Imports from ‘friendly’ nations will remain high whilst exports will continue to suffer as the consequence of western sanctions. Neither monetary nor fiscal policies will be tightened considerably. 

As for oil, the old mantra could well be at work at a compounded rate. A strong dollar, or better say a weak domestic currency, encourages exports. Crude oil and refined products make up the lion’s share of Russia’s export. With international crude oil prices on the rise again the weaker Russian currency would guarantee a windfall in petro-roubles. There is an almost irresistible temptation to step on the output accelerator. Whilst it seems a perfectly reasonable effect of the weaking rouble Russia might find it difficult to accomplish such mission. Firstly, it is not entirely clear how much spare capacity Russia has, secondly with Russian crude oil printing well above the $60/bbl price cap the number of willing buyers is diminished, and thirdly a unilateral output increase could jeopardize Russia’s relationship with Saudi Arabia who voluntarily reduces its production in order to support prices. Nonetheless, the end justifies the means, and Russia could become a reluctantly disobedient member of the OPEC+ alliance and do whatever it takes to maximize export revenues.