Top of the Pops
First off, today will be the last newsletter until June as I’m taking the next two weeks to spend time with my fiancée and our respective families as we’re getting married on the 27th. ‘Service’ will resume as usual on Tuesday June 1. As usual, if you’ve got any leads for research projects in motion germane to anything covered here and think I’d be a good fit, please do let me know. I’ve always depended on the kindness of strangers. Today’s roundup is missing a long column as I’ve got an appointment in the early afternoon, after which I’m off to handle more family logistics, my apologies.
For those that didn’t look through the IEA report linked yesterday, I though I’d pull the following to illustrate the problem for Russia assuming a net zero scenario emerges. I remain highly skeptical that we will see the cessation of investment into oil & gas fields because of their political value, let alone the room for privately-held explorers and operators unconcerned about investor sentiment who can fill the gaps where national companies don’t. Accelerations in competing fuel sources, though, will just accelerate the relative destruction of equity value and intensify political conflicts domestically when they eat away at demand at the levels the IEA scenario calls for. See the geography of output amid persistent decline:
North America — the combined oil & gas sectors of the US, Canada, and Mexico — far overpower what Russia can do to the market during decline. Saudi Arabia benefits because of its low costs, relationships with foreign firms, and excess capacity. Russia doesn’t at all, and even if US shale takes a permanent hit from COVID, it’s still a massive source of supply. Natural gas is a slightly different story but the same overall problem. One has to factor in that the US in particular has far more fiscal capacity to ramp up green energy, battery deployments, and expand its research efforts than Russia, which then allows it to export more of its production rather than consume it domestically (though the politics at the state level are fraught). Putinism was initially built on the promise of perpetually increasing hydrocarbon demand, a dynamic that has allowed its oil & gas sector to keep holding the economy together despite stagnation as it and other resource extraction industries absorb a higher relative share of national investment despite attempts to diversify. Those tradeoffs fall apart once external demand for Russia’s main exports begins to fall. It’s not a novel insight or a new one for this newsletter, but something that has to be constantly reiterated and complicated since the US isn’t pricing carbon domestically for now. The IEA’s stance on net zero will entail a massive increase in resource extraction, yes, but not one that can sustain the same political arrangements in Russia.
What’s going on?
Russia’s sovereign holdings of US Treasuries has reached an historic low. The Central Bank’s data shows Russia holds a measly $3.976 billion in T-bills, most of which have short-term maturities. For context, Russia held $170 billion of them from 2010-2013 and they remain far and away the safest financial asset in the world. The sanctions regime starting in 2014 never stopped them from holding them, so this has been a choice on their part to diversify away. But Europe, despite providing safe financial assets, still struggles with long-run stability because of the constant political tensions within the Eurozone over fiscal policy, fiscal integration, financial market integration, and the serious defects of the currency union exacerbated by Germany’s ‘debt brake’ politics. It’s ironic that the prudence Russia’s so obsessed with domestically makes it politically far more difficult to make EU debts as reliable as US Treasuries (though they’re still very, very safe for the most part). Vedomosti sources justify the sell down now on the basis of inflationary fears, basically implying that US stimulus makes them a less attractive draw while sidestepping the problem that the effects of inflation on sovereign debts are differential — inflation levels in Russia, for instance, are far higher than in the US where the economy is surging more strongly in terms of its capacity utilization and supply chain bottlenecks. This is strictly true, but sidesteps the reality of MinFin, the Central Bank, and the Kremlin’s approach to de-dollarization and macromanagement — they’ve just taken on higher levels of risk, frequently realized losses due to exchange rate fluctuations with non-dollar currencies, and hurt themselves. There’s never been any evidence Washington has ever seriously considered banning them from holding US Treasuries for the obvious reason that doing so would be an insane political risk for markets and the role of US Treasuries as a premier safe asset, even if congressional hawks say stupid things as they’re wont to do. Moscow is betting on the successful emergence of a unified EU bloc to provide an adequate long-term substitute to US sovereign debt — China has a long way to go on this front as it struggles with the liberalization of its capital account — at the same time it loves to sow discord in Europe. Yet again, there is no coherent strategy here. You can’t have it all geopolitically and economically.
As eyes turn to China as markets still struggle to absorb the new pro-full employment logic of the US Federal Reserve and its willingness to run things hot, evidence now suggests that China’s low base effect growth against last year is now over. Economic activity is registering at pre-pandemic levels according to the Capital Economics data cited by Kommersant. The following is % growth year-on-year by quarter:
Blue = industrial production Orange = capital investment Grey = retail
Retail is clearly out front still even with the growth slowdown returning things to ‘normal’ but price inflation in China accelerated in April to 6.8% vs. 4.4% in March in annualized terms. The supply chain bottlenecks that are hurting consumers everywhere, and slamming Russia, are hurting China as well given that manufacturers have to deal with growing delivery delays and respond to competition from importers for volumes of output that might be consumed domestically as well. China’s trade surplus surged to $43.3 billion in April as well after settling at a much lower $13.8 billion in March when the low base effects were peaking. China can keep ‘carrying’ commodities markets and its fair share of growth, but these factors underscore the extent to which it’s now the US and US policy factors driving the global recovery most of all, at least till Europe realizes debt isn’t an existential risk, and the extent to which Russia’s long-run gamble on Chinese and Asian commodity demand now faces a potentially very different distribution of global growth in the years ahead the longer China and Asia’s largest exporters struggle to increase domestic consumption levels along with their European counterparts.
Turns out that ruble exchange rate isn’t benefiting from a weaker dollar thanks to importers who’re adapting to the “reopening surge” in demand — imports for Jan.-April were up 50% and reached $78.3 billion. Despite the fact that the USD has weakened from the flood of liquidity pushed out into the global financial system and Brent crude has settled close to $70 a barrel, the ruble actually weakened because importers rushed to grab dollars to cover invoices. When the exchange rate dips below 74 rubles to 1 USD, market participants rush in for more USD. It’s an interesting dynamic to follow and suggests that the ruble may have a harder time recovering lost ground from last year during its strongest ‘recovery’ phase, which would then lock in higher import costs during said recovery and erode some firm and consumer spending power. Geopolitical risks persist, yes, but the decoupling of the ruble from oil prices has left Russia in this position as well. Banks are also bringing inflows of Euros and USD at the highest levels seen in the last year for the most recent available data — €816 million and $697.1 million in March, with other currencies accounting for roughly an additional $200 million in value. My sense is that banks are bringing in currency where they can to meet demand from households panicking about inflation and importers trying to pay down invoices for goods that face global supply bottlenecks. Hard to see the ruble regaining ground even if oil prices climb much higher since those additional revenues and earnings floating through the economy will end up financing more import activity and hoarding behavior.
Retail chain Lenta is now acquiring European competitor Billa’s 161 supermarket locations in Russia per a deal settled in Euros — €215 million all told. On its own, it’s not a huge announcement (though the valuation seems quite high to me) but it comes just after a blockbuster acquisition I wasn’t able to cover yesterday. Russia’s second largest retailer, Magnit, acquired its third largest retailer by turnover — Dixie — at 93 billion rubles. That’s €1.03 billion for comparison despite Dixie owning a whopping 2,600 locations. The kicker? Magnit is majority owned by VTB, a state bank. The deal sets it up to compete with the market leaders at the X5 Retail Group but also hands the state a more direct means of pushing the country’s biggest retailers to the table for price control negotiations. Lenta’s just doing what it can to stay in the game. The poorer Russian consumers become, the more pressure for retailers working in industries with thin margins to consolidate to try and cut costs. The more they consolidate, the easier the administrative side of Moscow’s challenge to rein them in becomes since it centralizes business decision-making power — corporations are, after all, bureaucracies. The retail market is still very competitive and no firm yet has a market position so large as to achieve a particularly hard edge on pricing power at the national level, and most local the regional level as well though I’d have to dig more into what the data looks like. E-commerce is the other side of this since first-movers on that side can consolidate market positions and move into break & mortar food retail over time a la Amazon, for instance. Here’s one forecast excluding car sales for the size of the e-commerce market in the years ahead:
Blue = market size, trlns rubles Green = E-commerce % share of retail Red = growth of E-commerce market
Competition is alive and well in the retail space, and the state’s not trying to kill that (yet). However, the expanded use of pressure and agreements with private retailers is going to start shifting business incentives for acquisitions and investment strategies in ways we’ll only start seeing next year or even the year after.
COVID Status Report
New cases fell to 7,920 and reported deaths came in at 390. All the decline was registered in Moscow, it looks like. Despite the statistical noise, there does seem to be some evidence that a more broadly observed increase in the number of critical cases of COVID have risen — the link concerns Ulan-Ude. My own bias is that if it’s happening there, it’s probably happening across the regions based on the hospitalization trends from Moscow and Piter. Hospitals are scrambling to bring back bed capacity exclusively for COVID patients. Authorities in Crimea are reporting an increase in cases of COVID and pneumonia and they’ve seen no fall in critical cases. Week-on-week hospitalizations in Piter are up 27% with the total case load up a much more modest 3.5%. Smol’ny’s now calling it a 3rd wave officially. But different regions and cities have different reactions. Until we have more data on excess mortality for April that goes beyond the assurances from Golikova that things had settled down to 2019 norms, it’s hard to suss out any gap in the data. One thing’s clear — there’s still no ‘national’ public health effort aside from the shift at MinZdrav and from the Kremlin as well trying to nudge Russians to get vaccinated as fast as possible.
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