Russian Fixed Income Daily
- New yield high in US10Y
- Euro still strong
- SibTel-6 now one of the cheapest regional telecoms...

FX and money market

Last Friday, the rouble jumped by some 16 kopecks and broke through the psychologically important level of RBL/USD27 (the tom rate reached RBL/USD26.9252) as the euro appreciated above USD/EUR1.29. Although the CBR and government have for the first time expressed concerns about the national currency’s quick appreciation, we do not expect any immediate reaction from them. The rouble remains linked to the bi-currency basket, so if the euro appreciates further, we will see more appreciation of the rouble. Market sentiment is positive regarding appreciation scenarios for both the euro and the rouble, which is reducing the inter-week volatility of their exchange rates. Nevertheless, the rouble is unlikely to be allowed to appreciate against the bi-currency basket for the rest of 2006. This week, we expect it in the range of RBL/USD26.85-27.05 and today it is likely to be around RBL/USD26.89-26.95.
In the money market, the situation remains stable. Overnight rates have even dropped below 1% (they were at 1.5% throughout last week) and we do not expect any turbulence, although some liquidity squeeze is possible in the middle of the week due to big tax payments.

Julia Tsepliaeva, Moscow (7 495) 755 5489


Rouble bond market

Friday showed strong investor optimism in the government sector that was directly powered by the appreciating rouble and its excess liquidity. On the other hand, although the tendency in the corporate and municipal sectors was also positive, price gains there were much more modest. At the same time, trading activity was above average in all three market sectors.
The spread of Russia’30 over US10Y is currently 114(+9)bp (very wide, with a compression potential of 25bp from an historical standpoint), while the spread of OFZ 46018 over Russia’30 is 51(-17)bp (a new historical low, fair in a medium-term perspective).

New yield high in US10Y
The story of the weak dollar, which has recently been grasping everybody’s minds, hurt US Treasuries on Friday with 10-year notes demonstrating a new yield high reaching 5.2% - a level not seen since May 2002.
On the other hand, even without the currency motivation, such dynamics are quite natural as market participants are currently not sure if the Fed will raise its target rate one more time to 5.25% on 29 June. If another hike is made, the present level of US10Y will be even too low, so if the certainty about further policy tightening increases, we should see further losses in US Treasuries, perhaps to the 5.35-5.5% band for 10-year notes.

Euro still very strong
The single currency traded as high as USD/EUR1.2973 earlier today, which is exceptional taking into account that the euro managed to grow that high after the very good (for the dollar) March US trade balance release. This simply proves that the weak dollar story really is the dominant idea now, and that in these conditions even strong adverse factors cannot prevent the euro from strengthening.
From a technical standpoint, we continue to believe that the euro should find, if not a reversal, at least a consolidation point in the area of USD/EUR1.3-1.3125, where 1.3 is simply an important figure and 1.3125 – the price top seen in April 2005.

Secondary trading
Price changes of high grade rouble bonds: OFZ 46018 +48bp, OFZ 46020 +39bp, Moscow-39 +14bp, Moscow-44 -2bp, FSK UES-2 +16bp, Gazprom-4 +7bp, RZhD-6 +9bp.
Second-tier papers: MosReg-6 +11bp, CenTel-4 +12bp, Kopeika-2 +6bp, Magnit -12bp, Megafon-3 +4bp, Mosenergo-2 +24bp, UTK-4 -24bp, VolgaTel-3 -6bp, WBD-2 +2bp.
Among the long-term papers a bond of Rosselkhozbank, a quasi-sovereign entity specifically created by the Russian government to finance the agricultural sector, RSHBank-2 appears to be trading far above its fair yield. Currently, RSHBank-2 is at 7.98% to maturity in five years, while its fair point in current market conditions is probably 7.75% and possibly lower in a long-term perspective. Even in adverse market conditions, this bond appears to be quite a relatively safe investment from the standpoint of interest-rate risk. Rosselkhozbank is rated Baa2/BBB- by Moody’s/Fitch.
On the curve of Russian Railways, RZhD-6 is currently the most undervalued paper. This bond was yesterday trading at 7.33% to maturity in 4.5 years, but its fair YTM based on the credit spread of its neighbours, RZhD-3 and RZhD-5, is most probably in the range of 7.2-7.25%. Russian Railways are rated BBB-/Baa2/BBB by S&P/Moody’s/Fitch.
Among somewhat shorter papers, SibTel-6 is currently one of the highest-yielding telecoms bonds in the corporate sector, being located at 8.5% for 29 months. We can not say that this paper would offer immediate upside, but it is definitely very well positioned to compensate holders for its credit risk. Sibirtelecom is rated B+ by Fitch.
UrSI-6, which we previously recommended instead of SibTel-6, recently shifted 30bp up in price and is now located at 8.33% to put in 31 months. At this point, the immediate price upside of the bond is becoming less certain, so we advise to stop accumulating it, but continue holding the paper on position. Uralsvyazinform is rated B+/B+ by S&P/Fitch.
We continue to recommend bonds of Russian Standard bank. Market participants should take a look at the RBL3bn RSB-4 located at around 8.35% to maturity in 23 months. We believe that this paper is at least 15bp above its fair point. Russian Standard bank is rated B+/Ba2 by S&P/Moody’s.
RusAl-3 was quoted yesterday at 7.75% 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.
TMK-3, a bond of the Russian tube industry leader TMK, was on Friday trading at 8.25% to put in 22 months. We believe that this bond is attractive as far as it pays a premium to the outstanding paper of its direct competitor, OMK-1 (located at 8.15% for 25 months). In our opinion, the medium-term fair value of TMK-3 is 8% YTP, so we continue to recommend accumulating this paper.

Short-term market view
Today the Friday fall of US Treasuries will put pressure on long-term government bonds, so taken together with the usual low Monday activity, the rouble bond market is unlikely to demonstrate a positive tendency. On the other hand, our long-term view for the market is positive based on the expectation of further spread compression between Russia’30 and US Treasuries as well as between long-term OFZs and Russia’30 in the long run (until the end of 2006). The pending removal of restrictions on foreign ownership of rouble bonds only strengthens this outlook. So far, our recommendation for long rouble bonds remains a Hold in expectation of further short-term capital gains due to excess rouble liquidity and the inflow of foreign funds in response to President Putin’s parliamentary address.

Dmitry Dudkin, Moscow (7 495) 755 5480


Putin’s afterword
Putin will announce his successor in 2008 to smooth that year’s transition of authority.
Last Saturday, President Putin continued to comment on his Wednesday address to the Federal Council. As his announced programmes are estimated to take at least a decade, rumours on changes in the Constitution and Putin’s third term were immediately revived. Previously, the president said that he would not comment on such rumours as he has repeatedly stressed that he is going to leave the Kremlin in 2008. Nevertheless, taking into account his popularity (his public approval rating remains above 70%) and the potential disorganisation of the transition period, a third term scenario cannot be fully rule out - although we do not consider it the most likely scenario. Last Saturday, Putin said that he would propose just one candidate to be his successor in 2008, so resolving the current dualism between Medvedev and Ivanov, who are currently considered as the most likely contenders. Although Putin again stressed that the people and their votes would determine the new president, it is clear that Putin’s “recommendation” will provide strong support – absolutely sufficient to win the vote. We would not at all be surprised if the candidate were a virtual unknown within the present administrative power structures.
Putin also commented on last week’s massive dismissals from the Federal Customs Service, which is one of the most corrupt government structures in Russia. He acknowledged this fact and said that he would continue to implement aggressive anti-corruption measures. Although we do not expect any immediate improvements or a dramatic reduction in corruption, any anti-corruption measures (in particular those eliciting a resonance with the public) will strengthen Putin’s popularity further, which in addition will ease the successor problem.
Investment implications: We welcome efforts to ease the 2008-successor problem, but expect even more speculation on the issue in the near future. We believe that the most likely scenario is that Putin will not sit for a third term and will ‘appoint’ a friendly successor.

Julia Tsepliaeva Moscow (7 495) 755 5489