War Anniversary Sanctions: Weakest Move on Russia Yet?

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In this publication:

• USD gains against Euro

• S&P smashes through 5000

• Middle East tensions fuel oil prices

• IMF rides to Egypt's rescue

• Weakest ever sanction response on Russia

Let’s dissect

Markets Snapshot

Debt Securities

• US Treasury yields took a dip from recent highs, influenced by strong demand at a three-year note auction, putting downward pressure on the USD. Despite this, on an annual basis, the 10-year Treasury yield surged by 0.29 percentage points this year, accompanied by a 0.2 percentage point increase in the two-year yield.

• Jerome Powell's recent more cautious stance on rate cuts in the last FED meeting suggests that Treasury yields may stay higher for an extended period, despite robust economic data. The market has swiftly revised its expectations, with the anticipation of a March Fed rate cut plummeting to below 20% after the meeting, marking a significant departure from earlier predictions.

• As a result, the EUR depreciated to USD 1.075, reaching its lowest level since November 13. Despite both the ECB and the Fed showing reluctance to decrease rates earlier, investors seemed influenced by weak EU economic indicators, including deepening producer price deflation and a decline in German exports. Consequently, investors chose to favor the dollar over the euro.

Equity Markets

• The S&P 500 soared to a historic high, hitting the 5,000 milestone for the first time on Thursday. The equities benchmark closed at 5,027 to notch five straight weeks of gains.

• Nvidia and Meta led a robust market surge, both climbing over 30% since the new year, partially offsetting worries about the Fed's rate reduction pace. Despite gains from the largest companies in the S&P index, only half of its stocks have risen this year, with less than a third outperforming the index. The Russell 2000, reflecting smaller US firms, is 20% below its 2021 peak, highlighting smaller companies' sensitivity to changes in borrowing costs and their impact on profit margins.

Oil Prices

• Crude oil prices surged past USD 80 per barrel, increasing by almost 5% last week. This surge was driven by escalating tensions in the Middle East and, again, concerns about potential disruptions in the oil supply chain. This time, the refusal of Israeli Prime Minister Netanyahu to accept a Hamas ceasefire proposal, highlighted by US Secretary of State Blinken, has raised concerns among investors regarding the possibility of further unrest. This unease is compounded by significant drops in US gasoline inventories and an unexpected increase in US crude stockpiles.

Global Finance

$10bn Rescue Package for Egypt

• Russia's full-scale invasion of Ukraine in 2022 prompted foreign investors in Egyptian debt to withdraw $20 billion, worsening the heavily indebted country's acute foreign currency shortage. As a major grain importer globally, Egypt was hit hard by surging wheat prices, coupled with elevated global energy prices, resulting in inflation soaring to over 30%.

• The country is set to boost its $3 billion IMF program, part of a larger financial package, with a new arrangement potentially exceeding $10 billion and involving contributions from the World Bank. Egypt is already the IMF’s second-biggest borrower after serial defaulter Argentina. As the IMF's second-largest borrower after Argentina, Egypt faces delayed reviews of its existing program secured over a year ago. IMF Managing Director Kristalina Georgieva made it clear that the main reason for proceeding with an expanded program, despite suspending disbursements on an earlier $3 billion loan, was the war in Gaza.

• Finalisation of the Egypt-IMF negotiations focus on vital reforms, including tightening monetary and fiscal policies and transitioning to a flexible exchange rate. This progress is crucial as Egypt faces challenges with high USD-bond yields, averaging around 13.5%, and widened spreads over US treasuries. Egypt's central bank raised its benchmark interest rate by 200 basis points to 21.25% last week. The unexpected decision, while surprising analysts, is considered to be a positive move by the IMF and could expedite securing a larger loan. This is likely to result in another currency devaluation, given that it is one of the requirements set by the IMF to unlock financing.

• After three devaluations since early 2022, Egypt's pound has lost half its value against the dollar, with the official rate around 31 per dollar. Despite the black-market rate surging to 65-70 last week, indicating a severe foreign exchange shortage, the currency experienced a noticeable appreciation below 60 per USD this week. This shift followed a crackdown on the parallel market and rumors of substantial Gulf investments and a new IMF program. The central bank aims to control the parallel rate before unifying the exchange rate by implementing tighter policies, increasing external borrowing, and eventually facilitating a devaluation for a more stable currency.

• In addition to that, Egypt faces another blow with a sharp drop in Suez Canal revenues, down nearly 50% in January. Attacks by Yemeni militants on Red Sea vessels have led many ships to avoid the canal, impacting a crucial source of foreign currency for the government.

Our thoughts

• An IMF breakthrough is vital to rescue Egypt from its worst economic crisis in decades. The urgency is heightened by the Israel-Hamas war next door and the crisis at the Egypt – Gaza strip border. The emerging deal aims to cover Egypt's external funding gap in the fiscal years 2024 and 2025, as the government grapples with scarce hard currency and near exclusion from international bond markets.

Geopolitics

New EU Sanctions on 2-Year War Anniversary

• EU prepares 13th sanctions package for the second anniversary of Russia's invasion of Ukraine, proposing penalties for 55 companies and 60 individuals in response to the ongoing war. The package targets those linked to weapon production, supply of critical technologies, and electronics for Russian defense firms. Also includes shipping companies aiding ammunition transport from North Korea to Russia. Unanimous approval from all EU member states is required. If passed, this would be the EU's 13th sanctions package.

• According to Bloomberg, new economic restrictions are also in progress but may not be finalized by the Feb. 24 deadline that marks the two-year anniversary of Russia's full invasion of Ukraine. Coordination with G7 allies is underway, with each expected to unveil their own sanctions package before the anniversary.

• The EU also aims to conclude and approve a plan to offer Kyiv new economic assistance following the agreement of the bloc's leaders on a multi-annual €50 billion support package two weeks ago. This decision came after all members convinced the sole holdout, Hungarian Prime Minister Viktor Orbán, to withdraw his veto. We have previously wrote about Orbán's visible strategy of inducing panic and strengthening his negotiating stance with the EU to unlock additional funding for Hungary here.

Our thoughts

• Two years of war represent a symbolic day, necessitating a united Europe to demonstrate support for Ukraine that transcends debates within the EU council. If confirmed, the latest sanction package on Russia would be the EU's weakest and most unambitious to date. It is crucial for the EU to act cohesively and fast on the Russia issue, as the initial goal of neutralizing the geopolitical threat appears to be slipping away. In this context, the timely €50 billion assistance to Ukraine becomes increasingly critical, especially as tens of billions of dollars in US aid remain blocked in Congress. For now, the outlook remains bleak.

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