Russian Fixed Income Daily
- US10Y: new month - new yield high
- Euro more upbeat than we expected
- SibTel-5 and UrSi-6 - most interesting among regional telecoms...

FX and money market

Last week, the rouble continued to follow the euro’s rise against the dollar and appreciated by 17 kopecks to RBL/USD27.27, with the most notable jump of ten kopecks on Friday. Friday’s US 1Q06 GDP data (slightly below expectations) did not support the dollar, which approached USD/EUR1.26 and during the long Russian weekend fell as low as USD/EUR1.268. This morning the dollar is trading at USD/EUR1.259. In general, market sentiment regarding the prospects of the dollar remains negative, especially after Federal Reserve officials gave a signal that a pause in rate hikes is possible.
In the Russian FX market, dollar sales also prevailed with additional sales on the back of the tax payment period and the end of month effect; at the end of last week total volumes reached USD5bn. The CBR is keeping the rouble stable against the bi-currency basket while the local currency continues to move parallel to the euro/dollar exchange rate. Today, we expect to see the rouble in the range of RBL/USD27.22-27.27.
On Friday in the money market, interbank overnight interest rates rose to 7-10% and the CBR’s two repo auctions were again in demand with a total volume of RBL27.3 and average interest rates of 6.03 and 6.23%. This morning, short-term interest rates have returned to 3%, and in the coming days rouble liquidity should stabilise, especially after the notable recent dollar sales.

Olga Golub, Moscow (7 495) 755 5176


Rouble bond market

The previous trading day on the domestic bond market was last Friday, when long-term OFZs fell weakly and the municipal and corporate sectors on average remained stationary on the background of average trading activity.
The spread of Russia’30 over US10Y is currently 101(-1)bp (close to fair now, with a compression potential of 10bp from an historical standpoint), while the spread of OFZ 46018 over Russia’30 is 84(-5)bp (wide in the medium-term perspective, our target for it is 50bp).

US10Y: new month – new (yield) high
On Monday, when Russia and many European countries celebrated the first of May, strong economic data in the United States pushed US Treasuries upward in yield, establishing a new yield high last seen in May 2002 - almost exactly 4 years ago.
The sharp price decline in US10Y began after the March personal income and spending report. This was strong in itself, having shown solid growth both in income and consumption, but also demonstrated that the core personal consumption deflator had increased more than had been expected – by 0.3% compared to the market consensus of +0.2%. As the PCE deflator is one of the inflationary determinants used by the Fed in assessing the price pressure in the economy, this strong release was immediately linked to the question of when the Fed was planning to stop the rate hikes and was perceived as an argument for a tighter policy, i.e. increasing the probability of the target rate reaching 5.25% in June.
As a result, within several hours after the publication of the data, US10Y jumped up in yield from 5.05 to 5.14%, where it is located now.
We believe that the upward correction of the current fall of US Treasuries would have already started if not for the threat that the Fed may continue raising the target rate beyond the 5.25% point. This scenario is believed to be of low probability by the majority of analysts, but until there’s any clarity on this topic, US Treasuries will remain vulnerable. The most probable point at which things might become clear is the FOMC meeting on 10 May.

Euro growth surpasses our expectations
Last Friday, the single currency managed to break the USD/EUR1.2589 resistance and in subsequent trading on Monday reached as high as USD/EUR1.2690. It is very interesting that the recent active euro growth actually took place on the background of the same news that caused a parallel decline in US Treasuries, indicating there’s a significant demand for the euro on international markets independent of the strong US economic data.
Previously we believed that the euro-dollar exchange rate would encounter problems in passing the USD/EUR1.25-1.2589 band, which would likely cause a temporary downward correction. In spite of the fact that this intermediate correction remains possible, clearly this band is not a problem anymore, so the target for euro’s uptrend has now changed to higher values, most probably the USD/EUR1.3-1.3125 band where USD/EUR1.3 is simply an important figure, and USD/EUR1.3125 – an important price top last seen in April 2005.

Secondary trading
Price changes of high-grade rouble bonds: OFZ 46018 -16bp, OFZ 46020 -10bp, Moscow-44 +19bp, FSK UES-2 +3bp, Gazprom-4 +24bp, Lukoil -3bp, RZhD-6 -5bp.
Second-tier papers: MosReg-6 +2bp, CenTel-4 +9bp, Magnit +15bp, Megafon-3 +35bp, RSB-6 +5bp, SibTel-4 -2bp, UTK-4 +12bp.
Today we continue drawing the attention of market participants to medium-term papers, many of which currently look very attractive.
TMK-3, a bond of TMK - one of the world leaders in tube production, on Friday was quoted at 8.75% to put in 28 months, which in our view is too high for this high-quality borrower. TMK-3’s spread over the OFZ curve is close to 235bp, while shorter TMK-2 is now at 7.9% to put in 11 months, 215bp over the curve. We estimate a fair YTP point of TMK-3 at 8.5% and recommend accumulating the paper, which is currently offering good value as a passive investment, but does not lack speculative upside should market sentiment change for the positive.
UrSI-6 continues looking quite interesting, being currently located at 8.45% for 32 months. It is one of the highest-yielding telecom bonds in the second-tier band, although this is ungrounded from a credit standpoint. We believe that a fair level for the paper’s YTP is 8.25% and recommend accumulating it. Uralsvyazinform is rated B+/B+ by S&P/Fitch.
Also among regional telecoms, SibTel-5 appears quite attractive with its 8.27% to maturity in 24 months. The paper is paying a 25bp premium over its peer UrSi-5 (8% to maturity in 24 months), and is also yielding the same as the longer SibTel-6, which is now at 8.75% to put in 29 months. Sibirtelecom is rated B+ by Fitch.
We continue to recommend the bonds of the Russian Standard bank. Market participants should take a look at the RBL3bn RSB-4 located at around 8.5% to maturity in 23 months. On Friday, the peer bonds of RSB-4, RSB-6, demonstrated significant turnover and traded close to their fair level of 8.25% for 16 months compared to 8.4-8.5% previously, so similar behaviour should be expected from RSB-4, which is still about 15bp above its fair level. Russian Standard bank is rated B+/Ba2 by S&P/Moody’s.
RusAl-3 traded on Friday at 7.81% YTM for 29 months. We estimate the long-term fair point for the paper to be 7.5%. Apart from simply having an attractive yield, we believe that RusAl-3 promises additional upside due to the expected transparency increase in 2006-2007 that Russian Aluminium promised investors in 2005.
Megafon-3 jumped up 35bp in price on Friday, reducing its yield from 7.89% to 7.69% to maturity in 24 months. As we perceive a YTM of 7.6-7.65% as fair for this paper, our view for Megafon-3 at its current level changes from positive to neutral. Megafon is rated BB-/BB by S&P/Fitch.

Short-term market view
The first half of May should see excess rouble liquidity due to its usual accumulation at the beginning of the month and also because of the rouble’s appreciation against the US dollar. Unfortunately, at the moment we cannot exclude a continuation of the fall of US Treasuries, but even if this happens, it is very likely to be compensated by the spread compression between Russian Eurobonds and US Treasuries, and long-term OFZs and Russian Eurobonds. As a result, our general recommendation for long rouble bonds remains a Hold.

Dmitry Dudkin, Moscow (7 495) 755 5480


Paris Club deal of 2006
Russia offers to pre-pay more, including securitised debt to Germany
Last week, Russia confirmed its intention to pre-pay its Paris Club debt even more quickly than planned. Previously, Russia had planned to pre-pay US$12.5bn in 2006 – not including its debt to Germany or any debt originating later than 1991, as the agreement between Russia and the Paris Club of May 2005 easily allowed Russia to offer the deal under the same conditions as the pre-payment at par of US$15bn in 2005. Now, Russia has expressed an interest in pre-paying US$9.5bn to Germany, including the part which had been securitised into Aries (EUR5bn). Finance Minister Alexei Kudrin, who suggested this idea, sounded quite optimistic about the prospects of reaching agreement, while President Putin offered his support at the Russia-Germany summit in Tomsk last week.
We strongly believe that the extended pre-payment will be very beneficial for Russia as it will reduce the temptation to spend stabilisation fund resources domestically, help to optimise interest payments, and eliminate the non-tradable portion of sovereign foreign debt. Nevertheless, this part of the deal will only be possible if Russia offers Germany a premium, at least to cover Germany’s interest payments on Aries.
In 2005, when the issue of possible premiums appeared, the government found it very difficult to market this idea in the Duma. Fortunately, in 2005 Russia, successfully reached a compromise with the Paris Club and pre-paid on par, which ended any tough debates in parliament. At the same time, the extreme loyalty of the current parliament to the Kremlin will push the issue into the political sphere and makes the project realistic should the Kremlin and Putin personally, as is very likely, strongly support it.
Any further foreign debt reduction would indirectly imply buybacks of tradable debt, although the government is unlikely to openly acknowledge this intention. Any way, according to the finance minister, Russia will not direct buy-back Aries as it has no sense in the framework of the Russian foreign debt reduction.
Investment implications: We welcome the idea of more extended pre-payments of the Paris Club debt as they could help Russia to reduce her foreign debt more and avoid domestic spending of the Stabilisation fund. If the deal is successful (which is very likely), the probability of a further upgrade in Russia’s sovereign rating will increase. With the pre-payment, no Russian risk will be included into Aries.
Julia Tsepliaeva Moscow (7 495) 755 5489