Russian bond markets mount partial recovery from sanctions blow

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LONDON — Russia’s government bonds recouped some losses on Thursday as investors considered news the United States had imposed sanctions on Russia to punish it for alleged meddling in U.S. elections, cyber-hacking, bullying Ukraine and other “malign” acts.

Although the broad array of sanctions dented hopes that a proposed summit between U.S. President Joe Biden and Russian President Vladimir Putin might ease tensions, some investors said the actions could have been more severe.

“It is not the worst. It is not forcing anyone to exit Russia positions,” said Viktor Szabo, portfolio manager at Aberdeen Standard Investments.

“Clearly, it increases the uncertainty – it is just the next step in a long trajectory, and the trajectory is the same – so I think that in a few months time we might see further sanctions.

“But until then we are fine, unless we have a military escalation in the Donbass,” he added, referring to the eastern region of Ukraine where Ukrainian troops have battled Russian-backed forces in a conflict that began in 2014.

Among the actions, Biden barred U.S. financial institutions from taking part in the primary market for rouble-denominated Russian sovereign bonds from June 14. U.S. banks have been barred from taking part in the primary market for non-rouble sovereign bonds since 2019.

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Moscow’s dollar-denominated bonds, which had rallied amid the summit talk, sold off as much as 3 cents, taking some issues to one-year lows. But as more details of the sanctions emerged, the bonds recovered most of those losses.

Later in the day, JPMorgan said U.S.-sanctioned Russian bonds could be excluded from key indexes including the emerging market local-currency GBI-EM and the EMBI Global Diversified, though no immediate action would be taken.

Liquidity and accessibility are key for the bonds to remain in the indexes, and investors didn’t expect issues with those as U.S. entities will be able to access the secondary markets.

Yields on locally traded, rouble-denominated OFZ bonds jumped almost 20 basis points to around 7.37%, just short of 12-month highs hit last week, before recovering to around 7.16%. The rush to insure against exposure to Russia risk pushed five-year credit default swaps (CDS) up 15 basis points (bps) in earlier trading to above 118 bps, before easing back to 105 bps.

Russian assets have been under pressure in recent months from the sanctions worries and the largest build up of Russian troops on the Ukrainian border since Moscow’s annexation of Crimea in 2014.

“With this now transpiring, this layer of certainty could paradoxically improve prospects for Russian risk assets once the dust settles, given the likely reduction in the geopolitical risk premium,” said Ehsan Khoman, director and head of EMEA emerging markets research, MUFG.

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OFZs

U.S. investors have been banned from buying new dollar-denominated Russian debt since 2014, so the latest measures on the rouble bonds known by their Russian abbreviation, OFZ, would be an additional stress.

Russia uses OFZs to finance its budget deficit. Total OFZ issuance is 13.86 trillion roubles ($182.22 billion), central bank data show. Foreign pension funds and other international asset managers hold just over 3 trillion roubles worth, roughly 23%.

Nearly 7% of OFZs are held by U.S. investors. Extrapolated to the new sales the Russian finance ministry has planned, that would take away almost $3.4 billion in demand.

If the United Kingdom joined the ban, that would be another 7% of demand gone. The European Union would account for another 5%, although there is little suggestion so far that it will participate.

Although direct purchases of OFZs by the central bank were unlikely, the central bank and finance ministry would “kindly ask” the largest Russian banks to absorb additional OFZ offerings by providing long-term instruments, said Sofya Donets, Russia and CIS economist, Renaissance Capital.

Sanctions-linked damage to Russian markets has been heavy in the past but short-lived.

The rouble slumped 17% in 2018 after the United States briefly put harsh sanctions on Russian aluminum giant Rusal and then added more curbs on some officials after the poisoning of an ex-Russian spy, Sergei Skripal, and his daughter in Britain.

On Thursday, it lost as much as 2% at one point before clawing back to be around 0.6% down.

“There has been a bit of whiplash,” Saxo Bank’s head of FX strategy John Hardy said. “Earlier in the week, it looked like the U.S. was making overtures about a (Biden-Putin) summit and now it looks like they are going to slap on sanctions.”

(Additional reporting by Sujata Rao in London and Rodrigo Campos in New York; Editing by Larry King, Catherine Evans & Shri Navaratnam)