The markets opened to the smell of cordite this morning, and not from the usual City fireworks. A drone strike in occupied Ukraine has killed eight civilians on a bus, a grim reminder that the war is far from over, even as the Kremlin's fiscal grip shows worrying signs of strain. For those of us watching the bond markets, this is not a humanitarian story alone. It is a story about capital flight, about the cost of war, and about the slow decay of Russian sovereign creditworthiness.
The attack, reported in the early hours, targeted a bus travelling through territory under Russian control. Eight dead, the Ukrainians claim; Moscow's puppets call it a 'terrorist act'. The specifics are murky, but the financial implications are not. Every such incident reinforces the risk premium attached to any asset even remotely connected to the conflict. Gilt yields in London barely flinched, but the rouble? That is a different story.
We have seen this playbook before. War is inflationary. It destroys physical capital and human capital, and it forces governments to borrow at increasingly punitive rates. Russia's central bank has been fighting a losing battle against inflation, hiking rates to 16% in a desperate attempt to stem the tide. But fiscal dominance is the enemy of monetary policy. When the treasury calls, the central bank must answer. The Kremlin's war machine is consuming an ever larger share of GDP, and the printing presses are running hot.
The drone strike is a microcosm of a larger problem. As the conflict drags on, the reliability of Russian state finances comes into question. Western sanctions have frozen hundreds of billions in reserves, but the real damage is to investor confidence. Capital flight has been a constant theme: $50 billion in the first quarter of 2024 alone, according to some estimates. The wealthy Russians who can get their money out are doing so, parking it in Dubai, in Istanbul, in London's premium property market. The rouble is a leaky bucket.
Now, add to that the cost of occupation. Holding territory is expensive. It requires troops, infrastructure, and the constant suppression of dissent. Each bus that gets blown up is a reminder that the occupation is contested, and that the promised 'stabilisation' is a fiction. The Kremlin's grip is weakening, not just on the ground, but on the levers of economic control. The fiscal multiplier of war spending is negative when it crowds out productive investment.
For the UK investor, the lesson is clear: avoid Russian exposure at all costs. The ETFs that track Russian assets are dead money. The bonds are junk. The currency is a speculator's game. There is no 'bottom' in sight because the fundamentals are deteriorating faster than the news cycle can report.
As for the broader market, the drone strike is a minor aggravation. Oil prices might get a temporary bid, but the real action is in the long end of the yield curve. Inflation expectations are anchored, but barely. The Bank of England is walking a tightrope between taming prices and avoiding a recession. The conflict in Ukraine is a persistent headwind, a source of uncertainty that keeps term premiums elevated.
I have been covering markets for twenty years, and I have learned one thing: when the killing starts, capital follows the path of least resistance. Right now, that path leads out of Russia and into safe havens. The dollar, gold, and short-dated US Treasury bills are the beneficiaries. UK gilts are middling. The real story today is not the eight dead in a bus. It is the slow bleed of an empire that has overstretched its credit line.
The bottom line: war is bad for business, except for the business of war. And that business is a loss leader for the state. The drone strike is a data point in a larger equation of insolvency. Mathematics, unlike geopolitics, is unforgiving.
