Trends We’re Tracking: Falling Fixed Income Returns, Russia’s Foreign Reserves, Authoritarian Brain Drain
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Rising yields in Q1 lead to worst fixed income returns in decades
The first quarter of this year was one of the worst for fixed income in decades. However, as total returns on major indices were falling, yields were increasing (albeit inconsistently), producing an inversion in key parts of the yield curve. These developments have precipitated outflows from fixed income funds and reflected a deep unease among bond investors who had looked to fixed income as a safe haven. Yet, research shows that a cyclical rebound may be in store, offering a potential entry point into an asset class that is suddenly yielding more.
Short shelf life for sell offs after geopolitical events
Markets are initially roiled when a crisis occurs, but it is important to remember that markets are also resilient and tend to bounce back quickly after the initial shock. Looking at historical crises certainly proves that investors must remain patient rather than panic. Vanguard looked at how markets reacted after 22 geopolitical events and found that the total return after six months after an event was five percent, on average, and that return jumped nine percent after one year from the event.1
Russia’s foreign reserves and the impact on the global financial system
In response to Russia’s invasion of Ukraine, the U.S. and its allies took the extreme action of freezing $630 billion of Russia’s foreign reserves. The magnitude of this act is largely unprecedented, and may have long-term ramifications on the global monetary system. The seizure of a sovereign nations assets by another may be a significant blow to the confidence of the current financial system, which is largely based upon the U.S. dollar. Furthermore, this action highlights the fact that the U.S. dollars and U.S. Treasurys held as foreign exchange reserves by central banks are actually liabilities of the Federal Reserve and U.S. Government – liabilities which may be seized or frozen at will.2
We are starting to see the impact of financial sanctions, as Russia is using alternate payment methods for international transaction of oil. In comments made from Russian officials, the government may adopt more flexible payment options, allowing “friendly” nations to purchase Russian oil with their own fiat currency or bitcoin. While “unfriendly” nations will be forced to pay for oil with gold or Russian Rubles.3 Saudi Arabia may follow suit and move away from U.S. dollar denominated oil sales, as the country is in talks with China to price oil contracts in the Chinese yuan.4 These actions may erode the trust of the current U.S. dollar based financial system and cause countries to diversify away from the dollar as the global reserve currency.
Authoritarian regimes and brain drain
The tragedy of Russia’s war in Ukraine continues to unfold and the latest report from the United Nations (UN) migration agency estimates that over 11 million Ukrainians have been displaced and millions have fled the country since the Russian invasion commenced on February 24th.5 But this exodus is not just confined to Ukrainians; a similar trend, although at a lower scale is happening among Russians too. A poll taken before the invasion indicated that approximately 43 percent of the Russians between the age of 18 and 24 want to leave the country for good. Deteriorating economic conditions in Russia, owing to global sanctions and internal crackdowns on anti-war and anti-regime protests, seem to have accelerated this trend. It is estimated that as many as 200,000 Russians have fled their country since the start of Russia’s invasion, which further proves that authoritarian regimes cause significant ‘brain drain’, or also academically known as ‘human capital flight’.6,8,9
Similar trends of human capital flight’ were witnessed in Germany from 1945-47 during the war; and again, seen in Hong Kong as expatriates and locals fled the region after the protest crackdowns in 2019; and Venezuela due to its authoritarian regime and adversely impacted its economy.7,10
On the flipside, developed nations with more favorable policies and opportunities provided by capitalism and democracy have benefited by attracted intellectuals, scientists and others fleeing repression. So modern history and economics gives clear indication that apart from global sanctions, ‘brain drain’ might cripple Russia’s long term economic productivity.
Strategic petroleum release helps stabilize oil prices
On March 31, the Biden Administration announced that it will release an average of one million barrels of crude oil per day from the nation’s Strategic Petroleum Reserve (SPR) for six months, approximately 180 million barrels of crude oil in total. This is the largest SPR release in history.
While the release will not solve the structural oil supply deficit, it will help stabilize oil prices in the short term. Since Russia invaded Ukraine, not only had oil prices risen sharply, but they swung sharply on a daily basis with an occasional daily movement of more than $10. Without the deterrence of the SPR release, oil prices could easily experience super spikes of over $20-30 in a very short period, which would cause severe damages to global economy.11,12 Indeed, the volatility of oil prices has subsided since the SPR release. Additionally, while the SPR release is a temporary, stop-gap solution, it buys precious time for Biden Administration and oil companies to work out plans to contain surging oil prices.
1. Vanguard, “Geopolitical sell-offs are typically short-lived,” March 1, 2022, https://www.vanguard.com.au/personal/education-centre/en/insights-article/geopolitical-sell-offs
2. Jon Sindreu, “If Russian Currency Reserves Aren’t Really Money, the World Is in for a Shock,” The Wall Street Journal, March 3, 2022, https://www.wsj.com/articles/if-currency-reserves-arent-really-money-the-world-is-in-for-a-shock-11646311306
3. MacKenzie Sigalos, “Russia is considering selling its oil and gas for bitcoin as sanctions intensify from the West,” CNBC, March 24, 2022, https://www.cnbc.com/2022/03/24/russia-might-take-bitcoin-as-payment-for-oil-and-gas-as-sanctions-rise.html
4. Summer Said and Stephen Kain, “Saudi Arabia Considers Accepting Yuan Instead of Dollars for Chinese Oil Sales,” The Wall Street Journal, March 15, 2022, https://www.wsj.com/articles/saudi-arabia-considers-accepting-yuan-instead-of-dollars-for-chinese-oil-sales-11647351541
5. IOM UN Migration, “7.1 Million People Displaced by the War in Ukraine: IOM Survey,” April 5, 2022, https://www.iom.int/news/71-million-people-displaced-war-ukraine-iom-survey
6. “How the War in Ukraine is Accelerating Russias Brain Drain,” The Economist, March 25, 2022, https://www.economist.com/the-economist-explains/2022/03/25/how-the-war-in-ukraine-is-accelerating-russias-brain-drain
7. Kok Xinghui, “Hong Kong exodus pushes Singapore’s monthly foreign visitor arrivals from city to 2-year high,” South China Morning Post, March 11, 2022, https://www.scmp.com/week-asia/health-environment/article/3170076/hong-kong-exodus-pushes-singapores-foreign-visitor
8. Rayhan Demytrie, “Russia faces brain drain as thousands flee abroad,” BBC.com, March 13, 2022, https://www.bbc.com/news/world-europe-60697763
9. Stephen Mihm, “Russia’s Brain Drain Will Be Hard for Putin to Stop,” Bloomberg, March 9, 2022, https://www.bloomberg.com/opinion/articles/2022-03-09/ukraine-invasion-russia-s-brain-drain-will-be-hard-for-putin-to-stop?
10. Matthew Brooker, “Hong Kong’s Brain Drain is Causing Real Pain,” Blroomberg, February 17, 2022, https://www.bloomberg.com/opinion/articles/2022-02-17/hong-kong-s-brain-drain-is-causing-real-pain-as-market-watchdog-bleeds-staff?
11. Derek Brower, “Big Oil has nothing to complain about under Joe Biden,” Financial Times, April 1, 2022, https://www.ft.com/content/3fe7d626-7e3e-4cb9-bce5-6798c50c47e8
12. Goldman Sachs Commodities Research, “Oil Record Large SPR Release Does Not Resolve Oil’s Structural Deficit,” March 31, 2022.
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