Russian Fixed Income Daily
- Moscow curve still offers large spread over OFZs
- CenTel-4 growth supports positive view for Pyaterochka
- Buy Salavat-2, YTM target 8.6%...

FX and money market

Yesterday, due to end of month effect in the money market we saw a short-lived overnight interest rate spike to 6%, however, now from the beginning of new month, it is staying around 2%, while the Russian bank balance is continuing to rise to RBL316.6bn. We believe that money market conditions will stay in a good shape till mid-September as there are no other tax payments scheduled for this period. In the FX market, the rouble traded around RBL/US$28.56 on average trading volumes. However, towards the evening the euro rebounded showing its strength against the dollar on the back of the revised and downgraded US 2Q05 GDP figures. As a result, currently the euro is trading at US$/EUR1.2338 which immediately pushed the rouble up to RBL/US$28.46. Today we expect the local currency to remain under the pressure of the euro performance and to see the rouble in the range of RBL/US$28.44-28.49. At the same time, scheduled for tomorrow US changes in non-farm payrolls could strongly influence on the euro/dollar trend.

Olga Golub, Moscow (7 095) 755 5176

Rouble bond market

Wednesday demonstrated reduced exchange turnovers compared to a very active Tuesday. Price action was again mixed: OFZs and high-grade corporate bonds remained unchanged, while munis and second-tier corporates were growing reasonably.

Upward movement on the local debt market was capped, as the recent large tax payments and the end-of-month effect were keeping short-term rouble rates at increased levels: 1-day MIBOR is now at 4.74%, significantly higher than its ‘normal’ level, located close to 2%. However, today we should see a significant improvement on the money market, as the balance in correspondent accounts of Russian banks is expected to reach its monthly high usually observed on the first day of every month.

US Treasuries continued supporting the local market yesterday, as on the very weak Chicago PMI index release US10Y bumped into 4%, though having not broken it downwards. We expected this event a bit later, and anticipated that by the time US10Y approaches 4% the upward sloping yield support line limiting the growth of 10-year Treasuries will also be located closer to 4%. But currently the yield support is at 3.9%, which suggests US10Y still has room for further growth. Anyway, right now US10Y is at 4.03% against 4.09% yesterday, and Russia’30 is at 114.375, having surpassed our goal 114 set for it in mid-August. If US10Y reaches 3.9% level in the immediate future and the spread 130bp over it is retained, Russia’30 will reach 115.5.

Government bonds

Not much has been happening here recently, apart from the very slow growth on the long end of the curve. Yesterday OFZ 46018 was located at 7.57% to maturity in 16 years, having descended in yield by more than 1% within 1 month. As we do not see any specific reasons, why OFZ yields should further go down, we currently do not recommend playing speculative games with long government bonds, although understanding that a downward correction in them appears to have a very low probability, at least in the first half of September.

Tomorrow, September 2, MinFin is planning to sell to the market the remaining parts of OFZ tranches that were not fully placed previously. The offered volumes are: RBL0.23bn of OFZ 25057, RBL0.13bn of OFZ 25058, RBL0.65bn of OFZ 46017, RBL0.06bn of OFZ 46018. As can be seen, the sizes are quite small, so they should not significantly affect the pricing of corresponding OFZs.

Municipal bonds

Price changes for most liquidly traded bonds in the secondary market: Moscow-39 +20bp, MosReg-5 +4bp, Novosibirsk-3 +47bp.

Moscow-39 continues its growth: yesterday the bond reduced its yield to 7.66%, which is already quite close to our current target 7.6%. Nevertheless, if we look at spread charts, it becomes clear that the paper is still significantly undervalued relative to the OFZ curve: its spread over OFZ 46014 is 26bp, while in the beginning of August it was almost equal to zero. We maintain a Buy recommendation regarding Moscow-39.

The process of Moscow spread compression should affect not only Moscow-39, but also shorter Moscow bonds. We specifically recommend Moscow-39, as it is the longest issue providing the largest capital gains and at the same time being the most liquid bond in the sector. However, if more exposure to Moscow is necessary, Moscow-36, 41 and 38 also appear very attractive.

Corporate sector

Price changes of corporate benchmarks in secondary trading: Gazprom-4 +10bp, Lukoil +2bp, RZhD-3 -25bp, FSK UES +1bp. Second-tier bonds: Megafon-3 +21bp, Salavat-2 +27bp, CenTel-4 +64bp, ChTPZ +0bp.

Significant growth of CenTel-4, which is currently yielding 8.73% to maturity in 4 years, supports our view that its peer bond Pyaterochka should trade at least at 8.75%, as the latter is better than CenterTelecom from a credit point of view. We maintain a Buy recommendation for Pyaterochka.

Also, Salavat-2 is currently yielding 8.94% to maturity in 4 years, which is significantly worse than CenTel-4 and NKNH-4 (8.5% for 3.5 years). We believe that Salavat-2 can reach level 8.6% in the nearest future, which promises a price upside of 100bp. We are adding Salavat-2 to our Buy list.

In the second-tier segment we also are maintaining a Buy recommendation regarding ChTPZ, which was yesterday trading at 8.66% to put in 3 years, while our target for the bond is currently located at 8.4%.

Short term market view

As we mentioned earlier, the market should see a reduction of the liquidity deficit already today. In addition, strength of Russian Eurobonds supports the local debt market. In such conditions increased portfolio duration should help better capture the capital gains we are expecting in the first half of the month.

Dmitry Dudkin, Moscow (7 095) 755 5480

Mechanism of government guarantees

From 2006, the new mechanism of government guarantees will result in additional US$13.6bn of investments

In 2006, a government investment fund will be established and receive RBL70bn (US$2.5bn) from the budget. This fund should be used to increase investments into infrastructural projects. Now the government went further and developed the new mechanism of government guarantees, which should help to expand these investments. According the instruction on the investment fund, the government will guarantee up to 60% of loans for investment projects. The government will also reserve 30% of each issued guarantee. This guarantee scheme will help to expand investments more than in the case of the direct government financing of projects. For example, if the project is estimated US$1bn, the government will guarantee US$0.6bn. Taking into account the reserve rate of 30%, the investment fund will actually spend US$0.18bn. This simple calculation shows that having RBL70bn (US$2.5bn) in investment fund in 2006, the government could boost investments by RBL389bn, or US$13.6bn.

Although we welcome the mechanism of guarantees in general, which potentially may very significantly increase investments, all problems related to the government investments remain in place. It is not clear how the government will select projects for the new scheme and whether these projects will be the most efficient ones. In addition, inflationary consequences could also be substantial.

Investment implications: The new scheme of government guarantees could help to boost investments already in the short-run by 10-12% of their total volume. However, currently it is not clear whether the government will manage to improve its efficiency as an investor (past experience has been rather poor). In addition, as the government creates the investment fund on the expense of the stabilisation fund, inflationary consequences are unlikely to be avoided.

Julia Tsepliaeva, Moscow (7 095) 755 5489