Eurobonds weekly . November 30, 2009

Themes of the Week
Foreign currency bonds had their durability tested despite most serious investors taking a break due the Thanksgiving holiday in the US. Benchmark quotes reflected demand for foreign currency bonds, the majority of which increased in yield.

Nevertheless, EM sovereign bonds rode a wave of panic, however, it would be difficult to call this a massive sell-off. The market was stumbling more than collapsing. Russia-30 quotes fell to 111-112%, however, we are not aware of a large-scale sell-off in this segment in the final trading days of last week.

We are very skeptical about the news from the UAE for a number of reasons: at a minimum, the market reaction to the news of Dubai’s intention to restructure its debt was delayed; secondly, the problems with, for example, the Ukrainian state railway company Ukraliznitsya servicing its debt and the similar request for debt restructuring, although for a significantly less amount ($440 mn), did not provoke such a huge reaction from investors.

In relation to the panic of the second half of last week, caused or influenced by the negative news from the Mid-East developer, or expectations of a second wave to the world crisis, or simply some profit-taking in advance of the year-end, the large-scale US T-Bond auctions last week were insignificant, although we think they should have drawn attention.

Three fairly short issues were placed: 2-, 5- and 7- year bonds, each with a volume of about $40 bn. All were certainly oversubscribed, however, not so heavily as at previous auctions. For example, the 2-year bond was oversubscribed by 3.6 times, vs. 3.63 at the previous auction. Moreover, we note that the longer the issue, the more foreign buyers appeared. About 40% of buyers of the 2-year bond were foreign, while 65% the 7-year bonds went overseas.
If we assume that there is not problem with dollar liquidity, at least so far as the financial authorities of a respective region are not now “turning the screw”, then this behavior by investors could indicate some form of readiness to move to lucrative markets (meaning risky and/or emerging).

In our view, some potential in spreads has again appeared. On the back of last week’s selling, potential of 20 to 30 b.p. appeared in the RUS-30 – UST-10, which we could catch already this week. Our target for the RUS-30 – UST-10 spread is around 200 b.p.; the target from six months is 130-150 b.p.. As for terminal prices for the RUS-30, we consider quotes above 113-114% of par as appropriate for closing long positions.

Corporate bonds are another matter. Betting on frontal growth in quotes (a decline in yields) will not be so safe in view of the end-of-year market risks, when technical factors quite persistently prevail over fundamentals. For example, from a fundamental point of view, Treasuries should rise: easy monetary policy, excess dollar liquidity, and, consequently, a weakening dollar, all play into the hands of risk-free instruments. Nevertheless, yields continue to smoothly decline, even not taking into account purchases from last Thursday and Friday. We do not rule out that major participants are readying to rebalance portfolios. Moreover, the demand is partially explained by the use of risk-free dollar bonds in carry trading and/or the banking sector to make money on the difference between the overnight and benchmark rates. But once again, this reasoning is justified only in the near future while money market rates are not rising.