How the international stand-off over Ukraine evolves will determine the direction of Russian equities and bonds as well as the ruble.

Julien Holtz, Luc Luyet & Lauréline Renaud-Chatelain, Pictet Wealth Management.

Russo-Ukrainian tensions can be seen through the lens of other conflicts involving Russia, including the Russo-Georgian war (2008), the annexation of Crimea (2014) and separatist fighting in the Donbas region of eastern Ukraine. We do not expect the current round of tensions to be resolved quickly as Russian and Western positions are, at this stage, irreconcilable.

US policymakers seem to be considering sanctions on key Russian sectors (banks, energy) and firms, blocking access to the SWIFT global payments service, prohibiting all transactions on sovereign debt, holding up the inauguration of the NordStream 2 gas pipeline and targeting Russian president Vladimir Putin directly. The Russian economy is well armed to resist external shocks, thanks to low external debt, dual fiscal and current account surpluses, and large FX reserves. Its main vulnerabilities are weak growth and a high dependency on exports to Europe.

Foreign exchange. The ruble has many attractive features, such as its low valuation (both relative to its long-term equilibrium value and to the oil price), its high carry and the support provided by Russia’s large current account surplus. But the ruble may depreciate more than it already has if tensions continue (perhaps -6% against the US dollar in the next couple of months). Conversely, de-escalation would likely lead to a significant appreciation of the ruble (+12%).

Fixed income. Russia sovereign and corporate bonds have sold off year to date. Sovereign bonds in US dollars have been the worst performer given the risk of US sanctions hanging over primary and secondary trading of Russian sovereign debt. We could see Russian 10-year government bond yields reach 11% (up from 9.8% on 25 January), and spreads over US Treasuries could widen further than the current spread of around 280 bps as the risk premium continues to build.

Equities. Russian equities have also been suffering year-to-date. The drop is fully attributable to valuations, whereas high energy prices have kept earnings expectations steady. With 12-month forward price-earnings ratios close to their 2014 lows of 4x, valuations are beginning to look attractive. A scenario à la 2014 would imply limited, single-digit (8%) downside from here. We could see significant upside potential for the MSCI Russia over a couple of months should a de-escalation scenario materialise (around ~35% in USD terms, in our view).