Weekly eurobonds 2009_10_12

Themes of the Week
High-ranking US authorities are becoming all the more brave in their statements about future money market movements. While earlier no one even hinted at raising rates, now it is obvious that if economic recovery is confirmed then rates will begin to go up. T-Bonds will be the first to feel this, with yields having grown on average by 20 b.p. for practically all durations. However, some market participants are sure that the rise in T-bond yields is tied to the primary auctions last week. But this is not correct: the real volume of US government debt does not coincide with auction volumes, and at earlier such auctions T-Bonds were flying out like hot cakes with record 3-fold oversubscriptions.

In our view, all of this offers grounds for a revision in market strategy. In particular, we recommend curtailing investment in foreign currency bonds as a play on compression of sovereign spreads. We think that the long-term trend will be for a rise in yields on risk-free instruments, first of all Treasuries.

Nevertheless, we are greatly optimistic about the current situation with a backlog for the medium term (6 months to a year). As soon as a clear signal is given of upcoming increases in base rates in dollars, we think investors will energetically rush to buy earning assets, indeed, the impetus will appear to more quickly make use of the accessible and inexpensive financial resources.

We expect an immediate correction on Emerging Markets. The benchmark (US T-Bonds), which is pulling along EM sovereign yield curves, is now playing an opposite role, triggering profit taking.

We think sovereign spreads have reached their compression targets too fast – this movement should have taken six months to a year. Excessive speculation is possible here, and in the next few days we will most likely see quotes declining in the most liquid names on the rising T-Bond yields. We consider long positions in the Russian sovereign as extremely risky. Nevertheless, we think that the purchase of corporate bonds aiming for a tightening of yields to the Russian sovereign curve is reasonable. Considering that the majority of circulating Russian Eurobonds are from high-quality, quasi-sovereign or strategic issuers, the spread to the sovereign should not exceed 0.5-1 ppt. to the respective curve, differing only by credit quality (presence of ratings, options, etc.).