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The views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.
Macro strategist Gillian Edgeworth joins host Thomas Mucha to continue our discussion on the macro and market implications of the war in Ukraine, including the conflict's impacts on energy, food, and geopolitics.
2:10 - Update on the war in Ukraine
5:20 - Oil price cap and the future of the Russian economy
8:30 - Russia's economic relationship with China
12:00 - India's and Turkey's relationship with Russia and the West
16:20 - Positive developments in Ukrainian food exports
18:10 - Investment implications of the war in Ukraine
23:20 - Insights from 14 years analyzing the Russian market
25:30 - Collaborative research approach
EDGEWORTH: When I think of President Putin’s success in Russia over the course of the last 20 plus years, his ability to deliver economic stability I think has been central to that. And these sort of policies will erode economic stability over time. So I do come out with a view that while this may be viable over a six- to 12-month horizon, over time it’s going to put political and social stability in Russia at significant risk I think.
MUCHA: Today we’re going to continue our ongoing conversation about the war in Ukraine. Specifically, the macro and market implications of what is a geopolitical crisis of the highest order. It’s also an economic event of huge significance, ranging from the extensive use of economic sanctions against Russia to the ongoing inflation implications across energy and other commodities markets, including food. Well, I think we’ve got the perfect person to help us sort through all the noise and to bear in on what matters from this perspective. I’m joined today by Gillian Edgeworth, Macro Strategist on Wellington’s Global Macro Strategy Group and the Emerging Markets Debt Team. Gillian specializes in Central and Eastern Europe. She’s also one of the people at Wellington that I listen to most closely when it comes to Russia and Ukraine. So Gillian, welcome to WellSaid.
EDGEWORTH: Thanks, Thomas, glad to be here.
MUCHA: So, after seven months of back-and-forth, Russia appears to be on the back foot militarily in Ukraine. Now besides the obvious effect of the supply of additional Western weapons and military intelligence to Ukraine, what do you think the economics are behind this shift in momentum? I mean is this finally sanctions at work?
EDGEWORTH: I think what we’re seeing right now is sanctions having a pretty limited impact on military developments on the ground in Ukraine. My sense is what we’re seeing is a poorly prepared and supplied Russian military effort and much stronger pushback from Ukraine than Russia was prepared for. And in part, I think, as you said, that’s capturing military support from the West. So, I do think sanctions have an impact. I think they’ll have an increasing impact over time. But I wouldn’t ascribe what we’re seeing militarily in Ukraine right now to sanctions or economic sanctions specifically.
MUCHA: So how significant do you think these latest Ukrainian military successes will be in determining the conflict’s outcome or do you think it’s too soon to know?
EDGEWORTH: I try to be humble in forecasting this conflict. I think Ukraine’s recent success is important, I guess, on a few fronts. I think it’s done a huge amount to bolster the confidence within the Ukraine. I think it will help in generating continued support from the West, both in terms of economic and military aid, and that economic aid will be discussed at the IMF annual meetings, in terms of financing Ukraine at least through the first half of next year. This success does not guarantee that Ukraine recaptures everything that has been taken since the 24th of February, and certainly doesn’t guarantee that Ukraine goes beyond those lines and takes back everything that was in place prior to 2014. I think the way that Russia has reacted recently tells you that the president of Russia is willing to double down also. To me it actually reduces the likelihood of a frozen conflict over the course of the coming three months. And instead makes it more likely that this is a conflict that lasts into next year and potentially at least through the first half of next year.
MUCHA: That matches my reading of the situation as well. I do think this goes on for an extended period. This is also what I’m hearing from a lot of my military intelligence contacts in Washington and Brussels and London and elsewhere. So, everyone seems to be gearing up for a long fight. And this leads, obviously, to the question about cost, particularly on the Russian side. Now, some Russian experts, including the prominent Russia analyst Fiona Hill, are out there arguing that Putin isn’t worried too much about the economic repercussions of the war. That his concern stops with the value of the ruble. Now Gillian, in this reading, Putin’s overarching goal is vast territorial domination. In other words, he’s aiming for Russian primacy grounded in a revisionist history and coldly calculated geopolitical imperative. So, cost is not an object here when the stakes remain so high from Putin’s perspective. At least this is the line that I’m hearing. Now, but Western leaders not to mention markets and investors are certainly concerned about the economic and market impacts, today and into the future. So, how are you seeing the biggest near-term economic perils? And do you think Putin can starve Europe of oil and gas indefinitely?
EDGEWORTH: So, let me address the last part of your question first. I think the quick answer to that is no. But I would broaden that question a little to say, can Russia afford to take large amounts of its gas and oil supply off the global market indefinitely? My view of the Russian economy is that the business model is very much reliant on energy production and export. And that production is enabled by the import of machinery and technology from the rest of the world. So, if you look at Russia’s imports prior to the invasion about 50 percent were machinery. Oil is worth about three times as much as gas in terms of budget and export revenue. So, if we start with gas, can Russia afford to take all its gas off the European market for a year? That costs Russia about US$60 billion. That’s manageable. The Russian economy isn’t going to collapse if that happens. That cost over a five-year period is much higher at US$300 billion, and that’s really only taking account of the direct impact; the export revenue loss. And to put that US$300 billion into perspective that’s equivalent to the amount of foreign reserves approximately that were frozen in late February. So, that is certainly something over time that would erode Russia’s ability to grow, Russia’s ability to pay its bills. If we’re to layer on top of that what’s coming up in terms of the G7 oil price cap, it could end up being wider than the G7. Then the economic costs of this grow. So from the 5th of December this year, it’s very likely, that the US in conjunction with Europe and potentially some other countries globally would cap the price at which Russia is allowed to sell its oil globally. If that cap is at, relative to today’s market price, if that cap is at US$50 a barrel, it’s going to cost Russia about US$500 billion over the course of five years. So once we put the cap for oil and a halt to gas together, if gas was to stop in full, that’s not the case today, but we soon come to a total cost of seven to eight hundred billion dollars over five years. Forty percent of 2021 GDP. And that’s only the very direct cost. There’s many, many indirect costs that will materialize from those sort of policies. When I think of President Putin’s success in Russia over the course of the last 20 plus years, his ability to deliver economic stability I think has been central to that. And these sort of policies will erode economic stability over time. So I do come out with a view that while this may be viable over a six- to 12-month horizon, over time it’s going to put political and social stability in Russia at significant risk I think.
MUCHA: As you say those numbers are adding up. And one of the responses that Russia has tried to engineer is a closer economic partnership with China of course. So how are you thinking about China’s role here and how do you see China factoring into this economic conversation going forward?
EDGEWORTH: Yeah, I think what I’ve seen and it’s very helpful to hear other folks at Wellington both within China and outside China and their perspective on this. What I’ve seen is a China that is able and willing to purchase Russian commodities at a discount. So, if we think about the price of Urals currently, it’s trading depending on the day at 15 to 25 bucks a barrel below Brent. That gap is likely to grow going forward because of the upcoming oil price cap. So, China is an important source of commodity exports for Russia. Primarily oil right now but I think that’s going to grow going forward in terms of gas. That’s going to take time, it’s going to take a number of years, but it will grow. And also potentially in terms of food exports from Russia. I think in return, China will be a source of consumption imports for Russia, but I’m still not convinced that what we’re going to see is a China that will provide Russia with some or many of the goods that are sanctioned. And that Russia needs both for its defense sector and potentially also for its energy production.
MUCHA: So, it’ll take the gas and oil from Russia but without supplying the stuff that it needs for the military engagement in Ukraine.
EDGEWORTH: I think that’s what seems to be playing out right now and the decision to divert from that does entail some pretty significant sanctions risk, I think.
MUCHA: So, what do you glean from China’s position in this war? Does that tell you anything significant about the broader geopolitical competition that’s now happening around the world? Or is this simply economic self-interest? Or do you see something bigger at play in this Russia-China bilateral relationship?
EDGEWORTH: Yeah, I think it’s still very early days, but I guess one aspect that we could draw down into is the decision to freeze reserves, and the message that has sent to many emerging markets globally who save in dollars. I think the implications or ramifications of this conflict and the reaction to this conflict will play out over many years. But I think we should expect countries at least at the margin to diversify their savings. I think it’s very difficult to diversify in full, but I think at least at the margin we will see that. In terms of other countries, I think we need to monitor how the oil price cap is going to work. The US is working hard to bring a number of countries on board right now. I think certainly imposition of sanctions on other countries because they don’t adhere to the cap is something the US would prefer to avoid. And the cap at least in theory is set up in a way that should allow the US to avoid that, but this is a pretty unique policy, and I’m sure there’s things that we’re not seeing. And there is clicks in the system that we don’t fully understand at this point that may not work. So I think the economic ramifications of this in terms of economic alliances are only beginning to play out. We’ll know a lot more in six months. We’ll know even more in 12 months’ time. But there will be change I think because of it.
MUCHA: One of the economic relationships that’s creating frustration, in Washington at least, is India’s position, and their willingness again similar to China to acquire as much oil as possible. How do you think about that? Or do you think this is a short-term economic self-interest development? Or do you think, again, there’s something, you know, more structural happening in these markets?
EDGEWORTH: I think we need to remember that you have a large group of economies out there outside of the G7 that have just emerged from COVID and that have had a very tough time getting through COVID, both economically and socially. And now we’ve layered a war on the global economy which is distorting both energy and food or grain prices globally. And arguably, to some extent, their availability. India’s relationship is interesting. I think whether or not India signs up to this oil price cap is one element of things. But even if India doesn’t sign up, my expectation is that there will be adherence. As I listen to Tushar Poddar, our macro strategist for India, that I think will help in cementing or repairing to the extent that repair is needed that US-India relationship going forward.
MUCHA: Yeah, it’s been a longstanding view of mine that India is obviously a huge part of the great power competition. It’s part of the Quad security alliance, it’s definitely drifting, at least on the military side, toward the West. And so, this current situation with Russia is an irritant to US policymakers but they seem more confident about the long-term direction of India in this geopolitical competition. Now, I can’t say the same for Turkey. I know you follow Turkey very closely. So how do you think about this Turkey-Russia relationship and how it may change as a result of the Ukraine conflict?
EDGEWORTH: I think what President Erdogan is trying to do in Turkey is maximize the benefit from varying relationships. Russia, Ukraine, NATO, the EU, US. Keeping in mind that he’s moving towards an election by June next year at the latest. His economy is under significant pressure both in terms of inflation, but also in terms of FX reserves. So we’re seeing from some perspectives Turkey play a constructive role. I think we can say that about the grain deal. Turkey was central to negotiating that between Ukraine and Russia. We can see that with the recent prisoner exchange, which certainly within Ukraine was viewed as a large boost to morale. Simultaneously, Turkey has been a very big beneficiary of Russian financial flows. You can think about that in the form of tourism flows from Russia. You can think about it in terms of real estate purchases from Russia since the war. Exports from Turkey into Russia are going strongly. And I think the other thing you’re seeing is increasing negotiations around gas and the price at which Turkey buys gas from Russia. Turkey has also been a purchaser of Russian oil at that Urals-Brent discount or somewhere around there. So to date I think President Erdogan has been quite successful in, not perfectly, but balancing relationships while easing some economic pressures that his own economy has faced. There has been pushback. I think we’ve all seen the press reports with the US strongly encouraging Turkey not to evade sanctions, and Turkey has had problems and challenges with that in the past with Iran. There may be a challenge in terms of if President Putin is to push ahead and close Russian borders to working-age males; will you still see the same numbers traveling to Turkey for tourism or real estate or business more broadly going forward? But to date I think at least at the margin Turkey has been able to balance many relationships in a way that it has benefited somewhat economically. It’s not an easy balancing act that President Erdogan is part of right now. So let’s see. Definitely something to monitor. Something that we’re very focused on.
MUCHA: You mentioned Turkey’s role in the grain deal. And that’s a topic I did want to pick your brain on. The charge from the West is that Putin has weaponized food supplies, you know, repeatedly threatening to halt grain and fertilizer exports, in particular, from Ukraine. On the other hand, Putin cites duplicity from the West. He blames the West for famine in developing countries. How do you think this piece of the conflict plays out, this agricultural piece of it? And, you know, what do you think a prolonged ban on exports do to food prices? I’m looking for any sort of positive developments here; any sort of green shoots.
EDGEWORTH: Yeah. It is nice to have something positive to talk about. Since Ukraine has regained control of Snake Island, food exports from the port of Odessa and others in that part of Ukraine have gathered steam. And if you combine Ukraine’s increasing ability to get tankers through that part of the world, along with the EU’s willingness to set up solidarity corridors and reduce customs bureaucracy at the border into EU countries, we’re seeing quite a significant improvement in grain exports from Ukraine right now. And it’s up considerably from where we were in the lows in March and April. Some of our local contacts tell us that by September or October we could see grain from ports in Odessa and close by running about two-thirds of prewar levels. That’s certainly a lot better than I thought we would be even two three months ago. And the rest being exported by solidarity corridors that look set to remain. Now, obviously Ukraine’s harvest this year is going to be negatively impacted by the war. And this deal on access or safe access to the ports expires or will have to be renewed in November, so that is a risk. But I think the trajectory over the course of the last few months has been much more positive than anything we expected heading into the summer.
MUCHA: Yeah, that is a positive development, particularly when you look at the global implications of this and how food is so tightly aligned with political stability around the world, so hopefully that’ll maintain. Now Gillian, now that we’ve sort of set the table here, I have a fuller picture of your thoughts, I mean what are you looking at over the near and medium term on the market impact side? I mean what are you focusing on right now when you look at this war?
EDGEWORTH: Yeah, so when we think about investment implications from everything that’s going on right now, and I look at the region close to Russia and Ukraine, I think the investment implications are many. There’s some things we know and there’s some things that are still definitely going to change. So I think at this stage we know for the most part Nord Stream 1 is shut down for this winter. That seems like a high likelihood outcome. We have a good sense that the oil price cap is going to come through beginning on the 5th of December and then rolling through to other products January and February next year. Couple of things I’m looking at are Russia’s willingness and ability to remove barrels of oil from the market. And potentially force global inflation pressures into year-end and early next year by doing so. I think the second thing I’m looking at to gauge how this conflict is going to impact markets is Russia’s ability to retain or retake land as conscripts get onto the ground. We hear and would love to hear from you on this one, but that’s already happening. Albeit with limited training. The other thing we’re keeping a close eye on is the threat of nuclear, which we think and hope is a low probability event. But definitely not something we can take our eye off and is something that I think is weighing on markets right now. So, they’re all the moving pieces within Russia that broadly we think are important to watch. Structurally, I think it’s fair to say that Russian markets will be closed to institutional investors until there’s a commitment to halt this war and cover and compensate Ukraine for the damage done. Other implications: Europe’s energy mix will change. I think this is something you discussed in your last episode with Tim Casaletto. That’s top of mind for most policymakers in Europe at this point. In the near term, what’s happening is very large stagflation shock for Europe. It’s fueling inflation and lowering real consumption and investment. But ultimately, it’s speeded up commitment to a much more environmentally friendly energy mix. Watching the increase in defense expenditure across Europe play out, we’re seeing budgets for next year now beginning to be presented and that increase in spending very clear in Poland, Romania, Czech Republic. And one other aspect I’m keeping an eye on is the impact of this on countries within the former CIS region. The conflict between Armenia and Azerbaijan. Kazakhstan’s enthusiasm to separate itself from Russia versus its ability to separate itself from Russia, given that much of its oil flows through a pipeline through Russia. So there’s many, many moving parts. It’s history in the making. I’m sure I’ve missed out on lots there. There are the pieces we have some transparency on right now. But no doubt they’re going to change over the coming months.
MUCHA: They are certainly going to change over the coming months. This picture remains incredibly fluid. I was recently in Washington talking to senior-level US policymakers, party leadership, and intelligence and defense types. I’d say a couple things. One there’s a sense in Washington that, again, this is going to be a long conflict. I was struck by the unity among both Democrats and Republicans towards the war. And I keep hearing over and over Putin cannot win. I hear that from policymakers in Brussels as well. And so, you know, I’m gaining a sense A, that there’s quite a bit of unity on this and that’s only deepening what you said earlier about Ukraine’s military successes, I agree. I think that’s reinforcing that unity. The second thing I would say is that there is a growing sense at least among Western policymakers that Russia is indeed on the back foot. Ukraine is currently winning this conflict, in their view. And there’s not a lot of confidence in Russia’s ability to operationalize this partial mobilization. We’ll see. As you say a lot of potential outcomes here, but that’s the sense of the policymakers that I’m speaking with. The last thing you mentioned and I’ll second this, is the nuclear risk. That is being taken extremely seriously at the Pentagon, at the CIA, at the White House, on the National Security Council. You’ve seen a big uptick in warnings from US policymakers, national security adviser, US secretary of state. You know, warning Russia not to do this. There is concern about this and it’s part of the conversation in Washington, in London, in Brussels, in Tokyo, and elsewhere. And so, you know, I think all of this underscores your point about potential outcomes. And how as investors, we have to be ready for all sorts of things happening.
MUCHA: So Gillian, how long have you been analyzing Russia? Let’s dig into your history here and your research process. You know, what was your path to this particular focus and role here at Wellington?
EDGEWORTH: Sure, so I’ve been covering Russia now for 12 to 14 years, and it was really a role that began on the sell side and began with a small number of countries and expanded to include more countries, and over time that began to include Ukraine and Russia.
MUCHA: What has surprised you most over those 12 years or so when you think back at Russia as a market?
EDGEWORTH: Let me take the politics and the economics separately. The economics piece up until the 24th of February; I think the surprise was Russia’s ability to learn from mistakes. And build on those mistakes. And I think that’s one of the reasons that sanctions to date have potentially been less effective than what many expected when they were announced at the end of February and into early March. So that shift to a very conventional monetary policy, that shift to a very tight rules-based fiscal policy, a large cleaning up of the banking system, a variety of tax changes designed to encourage improved efficiency within the energy sector. So, a very large swathe of economic, to some extent governance reforms when it came to the economy. Within the politics I think probably what’s most striking at this point is that within a 35-year time period, we’ve moved from a massive opening up, that I think at the time few struggled to forecast, to what has now been a very significant exclusion all over again unfortunately from much of the rest of the global economy. And one that is going to take even in a positive scenario many years to repair.
MUCHA: That’s an insight that certainly resonates with me as well. I’m detecting a much stronger focus on national security among policymakers and putting national security above globalization in a lot of different industries. And I think the Ukraine conflict has accelerated this focus on national security and I think we’re in for a very long-term trend here when it comes to geopolitics and the markets and what this does for globalization and how we think about that. But I’m curious, Gillian, what’s your approach to researching such an incredibly fraught, complex issue, given the tragic humanitarian scale of this war? How does that human, that physical, that emotional, that economic toll factor in to your analysis, your forecasts?
EDGEWORTH: Yes, it’s difficult sometimes to separate the humanitarian tragedy that’s happening within Ukraine from investment implications. This is a sad chapter in history that we’re watching unfold currently. For me, I’m trying to keep front of mind that there’s a lot of difficulty in forecasting this conflict from quarter to quarter. When I think back to the 24th of February and the consensus that Ukraine may fall within days, such a large landmass, to where we are today, part of the Russian army falling in a way that seemed to have surprised many military commentators. There’s many twists and turns in this conflict ahead, which at this point we don’t have full transparency on. In terms of investment implications, keeping that in mind is key and then accompanying it with scenario analysis is key. Understanding the impact of this conflict continuing for quite some time. The impact that has on asset prices is important. But also understanding the extremes. What do we do if we wake up tomorrow and there’s leadership change in Russia? What do we do if we wake up tomorrow and there’s an even larger-scale mobilization underway in Russia? And we’re looking at an attempt to take all of Ukraine all over again? So understanding the investment implications of that and being able to react in a timely fashion I think is very important. I think the other anchor, and we’ve already talked about it a little bit but it may be worth reiterating, is just keeping in mind how much it’s going to take to get back to pre-Feb 24th relationships. And again, we do think it’s going to take quite some time and a lot of effort, and that’s an environment where some asset prices will need to carry a large premium for some time to come.
MUCHA: Yeah, I think the length of the conflict and where we end up is so dependent on what happens on the battlefield that the probable outcomes here are so wide. So, I agree. I think scenario analysis is probably the best you can do. Putting probabilities on those types of scenarios and having a plan for each one of those scenarios. It’s clearly been humbling to a lot of people to watch this. But I agree. I think the humanitarian aspect of it, the tragic aspect of it, adds another layer to this and it makes geopolitical risk a lot more real. And, you know, I’ve detected a change not only in policymaker views but, you know, across the firm, across the industry. People are taking the risk of conflict now more seriously. And that includes potentially Taiwan, South China Sea, North Korea. So, you know, I do maintain that this conflict has been quite significant just on the psychological side of things. The other question I wanted to ask you, Gillian, related to this question, is about collaboration at Wellington. I mean, how are you using the resources at Wellington to better see the future?
EDGEWORTH: We’re very lucky to have as many resources as we do at Wellington. And there’s so many different aspects to this conflict that feed on themselves. Whether that’s commodity prices and pressure in Russia to do something like the Ukraine deal, whether that’s the more global macro toll and pressure from countries like India, for example, to find a solution to this war. Whether that’s the energy aspect in Europe. So, reading and speaking to as many folks possibly with as many different angles as there are within the firm I think is really very, very helpful. Our morning meetings I think have also been important just in raising those questions even if people don’t have answers all the time. And sparking that whole thought process.
MUCHA: Yeah, I’ve found that everyone has a view because this war touches upon so many different aspects of the global markets, the global economy, global politics, domestic politics, geopolitical shifts. So I agree, I’ve had a lot more conversations with a lot more people around the firm since February 24th. That’s for sure. Let me end here. You know, one of the things that we like to do on this podcast, Gillian, is we’re always looking for good suggestions about books or podcasts or things that are helping you see the world more clearly. So, do you have any recommendations for us in that area?
EDGEWORTH: So I don’t have one specific recommendation. Again, I think it’s just so important to diversify your information sources on this issue. I certainly spent a lot more time on Twitter. And that requires some filtering. But some of my information comes from there. I’m lucky enough to have colleagues that have grown up in the region and their perspectives are very helpful, in terms of filtering through this conflict. There are some great books on Russia out there, Catherine Belton, Dmitri Trenin, prior to the war, have both written books that I’ve found quite influential in my thinking about Russia. And there’s so many good podcasts. It’s just making sure that you’re diversifying and not listening to the same one or two folks all the time, but the amount of media and information and discussion that’s jumped up since this has been very helpful and it is good to get different perspectives on it.
MUCHA: Yeah, I follow Dmitri Trenin as well, and I do think it’s incredibly important to get the informed views from as many different perspectives as possible. The diversity of thought on such a complex issue, it’s absolutely required to be an analyst right now. So Gillian, thank you so much. Thank you for everything you do for the firm. Thank you for helping us try to see through this tragedy to the economic and market implications. It was great to have you here.
EDGEWORTH: Thanks, Thomas, great to be here, thank you for the invite.
Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk. Podcast produced September 2022.
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