Ukraine Has 10 Days to Dodge Default

Welcome back to SovereignBeat!

In this publication:

• Fed Expected to Slash Rates Three Times in 2024

• ECB Slows Down on Rate Cuts

• NASDAQ and Chip Stocks Plunge After Biden's Export Curbs Threat

• China's Sluggish Growth Drags Oil Prices Down

• Ukraine's $20 Billion Debt Moratorium Ends—Will They Pay Up?

Let’s dissect

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Markets Snapshot

Developed Markets

• Global: The IMF has upheld its global economic growth projection for 2024 at 3.2% and has marginally increased the forecast for 2025 to 3.3%. This updated outlook notes a reduction in the US growth forecast to 2.6% from the previous 2.7%, attributed to a slower-than-anticipated beginning of the year. In contrast, the Euro Area's growth estimate has been slightly raised to 0.9%, while Germany's forecast remains unchanged at 0.2%.

• US: Fed Chair Jerome Powell's dovish remarks during his interview to the Economic Club of Washington DC on Monday have solidified market expectations for an interest rate cut in September, with the potential return of Donald Trump to the White House keeping trades associated with it in play and on investor minds. In what might be his final public comments before the Federal Reserve's blackout period ahead of the July 30-31 policy meeting, Powell was still cautious but indicated that recent inflation data have been favorable for achieving the Fed's 2% target.

• Powell's comments prompted markets to adjust rate expectations, with traders now anticipating three 25bps rate cuts this year. The implied probability of a first rate cut in September already stands at 98%. The U.S. dollar has been fluctuating, weakening after Powell's comments but gaining some strength during Asian trading hours as investors consider the implications of a potential Trump presidency on inflation and interest rates.

• With Biden dropping out of the presidential race just hours ago, markets are bracing for increased uncertainty and potential volatility. It's also unclear if Kamala Harris, Biden's endorsed candidate, will receive full support from the Democratic Party at this point.

• EU: The European Central Bank (ECB) has kept its main interest rate at 3.75 percent. ECB President Christine Lagarde stated that the decision on a potential rate cut in September remains ‘wide open’ and that the governing council, which had reduced rates from a record high of 4 percent in June, chose not to provide guidance on future rate decisions. The ECB needs more evidence that inflation is on a trajectory to reach the 2 percent target by the end of next year.

• Eurozone inflation has decreased significantly from its peak of 10.6 percent in 2022 to 2.5 percent last month. The ECB maintained their forecast for inflation to average 2.4 percent this year and 2 percent next year, though they slightly lowered their 2026 forecast to 1.9 percent. The Eurozone economy likely grew at a slower pace in the second quarter compared to the 0.3 percent expansion in the first quarter of this year.

• In the swaps market, the probability of a September rate cut dropped to 65 percent from 73 percent just before the announcement. Rate-setters are particularly concerned about political instability, especially after France's recent inconclusive election raised doubts about the inflationary impact of a potentially high-spending government in the Eurozone's second-largest economy.

Equity Markets

• The NASDAQ dropped by 4.1%, breaking a six-week winning streak as several mega-cap technology stocks declined for the second consecutive week. The S&P 500 experienced a smaller weekly decline of about 2.4%, while the Dow was an outlier, posting a gain of 0.4%.

• Growth stocks underperformed, largely due to a sharp decline in chip stocks on Wednesday. This drop followed reports that the Biden administration warned allies about imposing strict export curbs if companies like Tokyo Electron and ASML Holding continued providing advanced semiconductor technology to China. Consequently, major chipmakers such as Taiwan Semiconductor Manufacturing, Broadcom, and NVIDIA, the third-largest company by market capitalization, experienced sharp declines.

• The Russell 2000 Index’s 7.7% surge over two weeks clearly signals a shift toward small-cap stocks, which are anticipated to benefit the most from potential interest-rate cuts.

Commodity Markets

• Oil: Crude oil prices fell to a three-week low this week, closing at $82.5 on Friday, amid ongoing concerns about reduced demand due to China's economic slowdown, which continue to weigh on the market. These concerns persist despite Federal Reserve Chair Powell's hints at potential rate cuts, suggesting that recent inflation data might help the central bank meet its targets, which could, in turn, stimulate economic activity and increase oil demand.

In Motion

Global Finance

Ukraine Restarts Negotiations to Restructure before August 1st

• Ukraine and its international bondholders have initiated new talks to restructure over $20 billion in debt as Kyiv faces a looming deadline to avoid potential default.

• According to a few confidential sources, a group of bondholders has signed non-disclosure agreements, and the second round of negotiations began this week. The initial round last month ended without an agreement, as Ukraine sought greater debt relief. The two sides are bridging gaps on haircuts and coupon payments, with bondholders pushing for more than the ‘symbolic payments’ the IMF expects Ukraine to manage. The current two-year debt freeze is set to expire with a coupon payment due on August 1. Failure to pay within a 10-day grace period could result in a technical default for Ukraine.

• On Thursday, lawmakers also submitted a law for approval to permit a temporary ban on foreign debt payments until October. This legislation, proposed by the cabinet and incorporating elements from a bill by President Volodymyr Zelenskiy’s party, allows for the suspension of payments on international sovereign debt and state-guaranteed obligations. It is seen as a procedural step to facilitate this restructuring. Following the announcement, Ukraine's bonds fell, but some investors bought bonds on the secondary market, viewing the development as progress toward resolving the debt issue. Ukraine’s 2015 restructuring involved a 20% nominal haircut for bondholders and was supported by a similar law to implement the debt workout.

• Earlier this month, Ukraine informed bondholders that its debt restructuring plan would include GDP-linked warrants, issued in 2015 as part of a previous restructuring, alongside its sovereign bonds.

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Our Further Reading Recommendations

• Is this the end of 25-year regime in Venezuela? (FT)

• The Big Exit: Emerging market sovereigns carve a way out of default (Janus Henderson)