We confirm our positive stance on Russian OFZ market and believe that long and medium-term bond issues will retain price upside for the rest of the year. Despite the ongoing presidential race in the U.S., we assume that the risks of further sanctions against the Russian sovereign debt are low and would target specific government officials and not influence sovereign debt market and local currency. Therefore, Russia’s Central Bank’s dovish tone and a moderate growth in the Finance ministry’s appetite will support demand for the OFZs. If the key rate drops to 3.75% by the end of the year in line with our projections, the longest OFZs’ yield could reach about 5%, which implies price upside on the long end of the curve by 10%.
Geopolitical risks outweighed again, though not for long
In late June, The New York Times reported that Russia is linked to killing the U.S. forces in Afghanistan. The U.S. policy-makers called for U.S. President Donald Trump to consider imposing new economic sanctions on Russia, triggering volatility spikes in both the money and debt markets. However, an NDAA Amendment submitted to the Senate following the news does not target the Russian debt. The proposal would impose a visa ban and an asset freeze on the Russian officials and military. Donald Trump is not planning an immediate response to intelligence reports on the Russian involvement because he does not believe the reports are true or “actionable.”
The rouble sovereign bond market
Despite the seemingly challenging environment in the OFZ market at the beginning which came under pressure on June 30, a turbulence spike eventually turned out to be temporary. Against higher trading volumes, yields on the middle and long sections of the curve rose by 14–20 bps, making Russia a top-loser in the emerging bond markets that day. The Finance Ministry's not quite successful ₱28 bln primary OFZ sales (the lowest volume raised since last April) have worsened the sentiment. Therefore, the market returned to the mid-May levels, when the Central Bank made a bold key rate cut. However, by the end of the trading session the market was ready for an upward correction. Sovereign bond market recovery continued after a Wednesday day-off. Now the government bonds have erased about half of the earlier declines.
The Ministry of Finance has tried to safeguard the market against excessive pressure driven by excessive supply
The Finance Ministry’s plans for the third quarter were among the key market news on Tuesday. The ministry decided to increase the borrowings to ₱1 trln, targeting middle maturity bonds (70%). Although the figure looks quite impressive at first sight, we believe it is unlikely to have a negative impact on the market. Initially, the Ministry of Finance intended to raise ₱600 bln in the first and second quarters of this year (a total of ₱1.2 trln). The plan was effectively beaten by almost a third, as total placements reached ₱1.6 trln. In particular, a record of ₱1.1 trln bonds was placed in the second quarter (which means a ₱870 bln net inflow including redemptions).
OFZ placements in 2019-2020, bln RUR
Source: MinFin Russia, ITI Capital
Against this backdrop the third quarter supply will pick up by as little as 15%. Since there will be more auction days (13 vs 11 in 2Q20), the weekly average supply will be reduced to ₱77 bln from ₱100 bln in 1Q20. If the external environment is favourable, we do not see any issues in meeting the placement targets. The demand will continue to benefit from expected easing of the Central Bank's monetary policy and limited inflation risks.
Rouble rate forecast
Demand for the rouble is driven by three factors. The first is demand from non-residents, which continues to grow sustainably on the back of dovish Central Bank’s rhetoric. The net inflow from non-residents to the OFZ market ytd amounted to ₱188 bln, or about $3 bln. The demand is largely driven by the demand for global risk and credit quality of Russian sovereign bonds. The second factor is annual FX-sales by the Finance Ministry worth ₱200 bln ($3 bln), or ₱10 bln a day, roughly 4% of the average daily trading. Daily FX-sales fell by half from the peak levels and will fall further to 5.7bln roubles a day from July 08 till August 06 according to today’s MinFin press release.
The third factor is domestic flows, in particular, FX-sales by exporters during the tax period and July dividend payments. July taxes are on the highest during the year due to Q2 payments for VAT and income tax, while the bulk or 60% of total dividends is paid in July. For example, FX-sales for tax and dividend payments in July may amount to $8 bln ($3 bln of which are dividends). The bulk of tax payments (VAT+MET and excise duties) are paid on July 24.
The main risks for the rouble are sanctions, which is likely to be imposed if Joe Biden, a Democratic nominee, wins, and the risks of a second wave of the pandemic closer to the fourth quarter.
Source: ITI Capital, Bloomberg
USDRUB vs Urals correlation analysis
Source: ITI Capital, Bloomberg
Iskander Lutsko, Olga Nikolaeva
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