Weekly Eurobonds_2010_02_15

Themes of the Week
We continue to pursue our previous half-yearly as well as weekly strategies, and so far the market trends are in line with our expectations.

We think this week will be as volatile as the previous ones despite lower VIX Index. Nervousness remains on the markets and risk aversion is gaining momentum.
Formula for the markets goes as following: PIGS history in Europe + monetary policy tightening in China + Fed’s press release = strong US dollar.

We expect the start of the week should be relatively calm, taking into account US markets are closed for President’s Day and weekly holiday in China due to Lunar New Year. Euro might bounce on expectations of firm decision of EU Finance ministers which should clarify the situation regarding Greece debt crisis. This, in turn, may be extrapolated by investors on others members of PIGS/GIPS.

We do not place any hopes for the forthcoming meeting and PIGS/GIPS history may continue and even peak in the first part of 2Q10 – at that very moment, when problem regions will have to meet their obligations. Dubai World theme still has its repercussions. Rumors on business plan (on restructuring), prepared by Dubai state fund, which reportedly stipulated prolonged contracts with Dubai World for additional 7 years and writing-off of 40 cents per each dollar, were rejected later on by an official from emirate’s Department of Finance. In addition, the market was full of speculations, spurred by news on concrete measures on Greece rescue and credit guarantees provided by Germany. Furthermore, Germany along with France expressed their willingness to buy out bond issue. As a consequence, any rumors on Greece rescue swayed euro with its magnitude reaching 400 bps.

US dollar should remain strong and euro weakness is only a backdrop for euro/dollar performance. We see China’s measures to prevent bubbles in economy by gradually credit market limiting and higher reserves requirements along with Fed’s press release on discount window opening and planned quantitative easing program halt as the key drivers for the current trend in “dollar=strong currency”, which is justified by economic updates – 4Q10 GDP estimate, unemployment data, jobless claims etc.

More expensive CDS resulted in higher yield curves of the majority of the bonds with the US is no exception. Bonds issued by Germany looked better among the others over the previous week.

Despite the fact that CDS market partly corrected last week, we believe global sovereign bond yield to continue. In other words, this is some compensation for private sectors risks taken by the countries, consequence of debt burden and budget misbalance.

Treasuries auctions provided the evidence – relatively solid demand regarding its mix and over-allotment (bid to cover ratio) emerged on the other level of yield curve (see the graph on the right).

Base asset yield is under pressure of sovereign rating revision and news on forthcoming monetary policy tightening, but we think it will not occur in the nearest time. Higher discount rate is not able to impact liquidity volume squeeze and to move Interbank rates/LIBOR. More likely scenario is that gradual US recovery will push yield curve higher, but there are no inflationary fears in sight – US vs. TIPs and US-10 vs. US-2 spreads remain mainly stable.

We believe that investors should take wait-and-see approach, as they do on the ruble bond market. This strategy is based on short-dated and not high liquidity instruments but of high credit quality and with attractive coupon income.

One of the riskiest segments over the short-term is long-dated chips. Their performance due to their liquidity might be instantaneous following sovereign Eurobonds movement.

Our top-picks are the same: banking Eurobonds with call-options (for those investors, who were late to reduce positions in PSB-18), old restructured Rosbank-12 issue, Cascade of Nizhne-Cherekskie HPPs-13 and new currency Tatfondbank-12 issue.

Thanks to the offered issues of low liquidity Eurbonds of Russian issuers within our strategies, the downside revaluation, which took place in most of currency chips, was avoided and brought gains in coupon.