Unless you’re Priti Patel or Kevin Foster at the UK Home Office, each morning most people wake with thoughts of a human tragedy worsening by the hour. Sadly, fears are now growing that the destruction of Ukraine could turn into a long-term attritional conflict. My hope is it won’t but we might need the global financial system to send some distress signals. Already, I am seeing financial market developments which take the breath away. So, let’s take a look at these emerging financial shock waves and consider their potential positive impact on peace prospects. Here are the events which I am watching most closely……

Commodity Markets: Russia and Ukraine are giants of the commodity markets and early market analyst attention focused on energy(gas prices) and food(wheat prices). However, it is the metals markets where all the headline action is happening. Arguably, the market is “broken” given the London Metal Exchange (LME) took the extraordinary decision to cancel all trades in nickel today after the price doubled to $100,000 per tonne in just 24 hours. The interesting bit is not the price move but the early indications of the counterparties in trouble. Reports suggest the China Construction Bank struggled to meet margin calls of hundreds of millions of dollars and that a Chinese metals tycoon nicknamed “Big Shot” is on the hook for multi-billion dollar losses. Apparently, even “Big Dog” of Downing Street would struggle to argue he was not a party to this trade.

Bank Stocks: According to the Financial Times as recently as 2 months ago Russia’s largest retail bank, Sberbank, was Europe’s second most valuable bank by market capitalisation behind HSBC. Sberbank and its 102 million customers have just seen its share price collapse by more than 99% as sanctions cut the bank off from access to the US dollar. The worry from here is that a big Russian bank like Sberbank or VTB gets into trouble. Recall the lessons of the 2008 financial crisis(GFC) and know that assets(long term) and liabilities(short term) all look good and ‘matched’ until they’re not. Now consider the Russian ruble which has lost 50% of its purchasing power in less than a fortnight. These are dangerous times for the global banking system. Nobody wants to get caught with the credit hand grenade and banking memories are still fresh from the Lehman Brothers implosion.

Financial Plumbing: The nickel market might appear a little niche for you and, if so, you can skip this section except to say and know that there’s lots of weird stuff happening in hidden corners of the financial system, in the plumbing so to speak. My check list of weird starts with 10 year US bond yields at levels almost the same as those of 2 years maturity in a year when the Fed is expected to hike interest rates 5-7 times. Meanwhile, euro 10 year real swap rates are hitting record lows of MINUS 195 bps. Let’s just say the cost of money is seeing some strange gyrations which leads us to the more critical issue, access to short term funding. Remember the GFC liquidity freeze in 2008? Well, one metric which measures funding stress is starting to move – FRA/OIS spreads are widening which can be an indication of banks NOT TRUSTING each other.

The intention of highlighting the above is not to scare but to indicate shock waves moving through the financial system and there might actually be good news to come of it. As written in previous articles, my belief is that Russia is in a race against time before the Kremlin regime goes broke. There are many amongst the commentariat that believe China will support Moscow by giving access to new payment systems, credit card ecosystems, buyers, markets etc. I disagree.

On March 12th seven Russian banks will be disconnected from the SWIFT messaging/banking system which is seen as an important date. It isn’t. March 16th is much more important being my mother’s birthday and the day $100 million of interest payments are due on Russia’s foreign bonds(debt) denominated in euros and dollars. If the Russians default on those payments it could kick off a rush by creditors to seize Russian assets overseas. And this is where chaos might ensue and force Chinese hands. We have already seen Chinese firms in trouble in the commodity markets. However, two markets of even more Chinese relevance could be massively disrupted by a Russian default:

  1. Chinese companies have clocked up a staggering $27 trillion of debt. It won’t take long for market traders to work out that if one “rogue” nation can default then an increasingly belligerent Beijing regime (think Hong Kong and Taiwan) could be next. Disruption of Chinese debt markets would not be welcomed by the Politburo for one other very big reason…
  2. The Chinese real estate market is estimated by Goldman Sachs to be worth over $52 trillion. The travails of the Evergrande group and its $300 billion debt pile are well known so the Beijing authorities are already acutely sensitive to real estate market weakness. They will know debt market problems will quickly become property market distress.

It won’t just be me watching the trading screens in Dublin on March 16th . The epicentre of the global aviation leasing industry is in Ireland and already there are press reports of Russian lack of co-operation with requests to release aircraft sitting on Russian territory. But guess who has been increasing its exposure to aviation leasing/finance in recent years? Yep, China. And that might not be a bad thing…

Perhaps it’s a coincidence but on a day when a Chinese bank and a Chinese nickel producer both get into serious financial difficulty it is interesting to see President Xi has made some calls. Specifically, he spoke to European leaders, Scholz and Macron, urging “maximum restraint”. Yes, China will try to back Russia in its political machinations, but if Xi is beginning to worry about financial shock waves hitting Chinese commercial interests then Vladimir Putin will have made another dreadful strategic miscalculation.