Sanity will likely return once the markets have had time to process the move, but the wild market volatility displayed this week shows just how unbalanced these markets have become and just how delicate the situation is.
Of the 170 currencies tracked by Bloomberg, the Russian ruble has been the worst performer of them all this year, losing 50 percent of its value in 2014 after the double whammy of western sanctions and slumping oil prices. For a country that relies on oil and gas for half of its budget revenue and a quarter of its GDP, there should be no surprise that the recent plunge in oil price is having a huge impact on the Russian economy.
So far this year the Kremlin has $80 billion of its fast-dwindling foreign exchange reserves trying to prop up the ruble, but to no avail: earlier this week the currency fell to a fresh low against the dollar with no sign of a floor yet. Things are so dour that people on the streets of Moscow have taken to joking that 2015 will be the year of 63s: $63 oil, 63 rubles to the dollar, and Putin will be 63 years old. The joke may be on them; both oil and the ruble may be a lot worse than 63 next year if this week is any indication.
So it should be no surprise that the Russian central bank raised its key interest rate this week. What is surprising is the severity of the shift. In the middle of the night on Monday, the bank announced the prime rate was going up to 17% from its current 10.5% effective immediately.
As it turns out, the move is not only not surprising to the likes of CitiFX and JP Morgan, it's not nearly enough. As one senior ruble trader for CitiFX notes, “Hiking the key rate to 17.0% is not enough to get a hold of a currency that can drop 10% in one day.” Of the major Wall Street FX traders, only Goldman seemed to approve of the 6.5% hike: “The decision clearly removes the uncertainty over the CBR's strategy that in our view was a major driver of the recent Ruble volatility and hence is positive.”
Meanwhile, the markets are already coming to their own assessment of the hike. The result, as hoped, was a spike in the value of the ruble: it was up 11% on the news. But that move was short-lived, with the gains wearing off later the same day and the ruble immediately fell off the cliff. As of press time, the ruble was in freefall, hitting 76 to the dollar, triggering a panic sell-off on the Russian stock market, which plunged 15% on the day.
Sanity will likely return once the markets have had time to process the move, but the wild market volatility displayed this week shows just how unbalanced these markets have become and just how delicate the situation is, not only economically but politically. As much as the hawks of the “New Cold War” propaganda would love to see the downfall of the Russian economy and Putin's government in turn, no one wants to see a still militarily powerful nation like Russia plunged into chaos.
For now, the situation remains in the realm of finance, but the economic effects will kick in in earnest in the New Year as the Russian economic contraction accelerates. In the end, Russians may end up praying for a year of 63s instead of a reality that threatens to be even worse.