Fixed Income Comment: The initial weakness in UST has resulted in the RU30 spread tightening to +171 bps over UST

As expected, Fed Chairman Greenspan’s testimony before the Joint Economic
Committee simply reaffirmed the consensus view that policy accommodation in
the US remains accommodative and will be removed at a measured pace. With
Greenspan’s comments remaining consistent with ongoing Fed rhetoric and
FOMC statement commentary, the pre-speech selling pressures across UST
were soon eroded and the 10-year note yield held at sub-4.0% levels. As a
result of such moves, EM debt weakened slightly over the day and Russia
suffered from its more liquid status and the Russian EMBI+ index lost 0.37% with
the spread widening 2 bps to 171 bps. With few trades actually occurring across
the shorter-duration credits, activity was confined to the benchmark RU30 bond,
which traded from an opening level of 1107/8 to a low of 1101/4 before recovering
in late session to close at 1103/4. With the move itself largely tracking
developments in UST, the RU30 spread over the 10-year notes held in the recent
174-176 bps range. Elsewhere in Russia, the ARIES curve is becoming
relatively inactive and the longer dated ’14 issue steadily losing its high liquidity
appeal. That said, given the lack of momentum by market participants to
undertake spread tightening trades the respective ARIES ’14 spread over RU30
widened further yesterday from -7 bps to -5 bps and in our view is approaching
what appears to be a ‘fair value’ range. In consideration of such factors and the
diminishing impact of the PC settlement we expect the spread to retest the parity
threshold over the near-term. While most Russian corporate and banking sector
eurobonds were marked lower in line with the sovereign curve, demand for the
ALROSA credits was clearly evident. Indeed, lack of supply regarding the
shorter-dated ALROSA ’08 led to market outperformance, and the credit rose
almost 0.5% on a cash price basis.

With Russia opening slightly firmer this morning, benchmark bond trading at
111.0, the initial weakness in UST has resulted in the RU30 spread tightening to
+171 bps over UST. While today’s key data highlights remain US trade balance
and import prices, we anticipate a modest response as the main market focus
remains on next weeks all-important PPI and CPI data. In our view yesterday’s
comments by Greenspan suggest that beyond this month’s FOMC meeting (Fed
Futures market fully pricing in a 25 bps rise) the Fed will increasingly become
data dependent in determining its future policy moves. Looking ahead, this will
essentially increase the event risk associated with key price and employment
data releases for both UST and EM debt.