Fixed Income Comment: The lack of conviction inconsolidating above par value suggests that prices are likely to driftover the near-term

As a result of both profit taking and a retracement in UST, Russian eurobonds suffered yesterday and the Russian EMBI+ spread widened 5 bps to reach 265 bps. Indeed, amid low volumes suchselling pressures led to the benchmark RU30 trading lower from around 1005/8 at opening to close at 997/8 in New York with the spread over 10-year UST widening from 280bps to the upper level of its recent trading range at 286 bps. Similarly, the ARIES curve also weakened and with the longer dated ARIES ’14 underperforming the wider market, the spread over RU30widened to 40 bps. In contrast to the weakness across most sovereign issues theRU28 remained resilient and the spread over the benchmark RU30 broke through its recent rangebound level of 59-60 bps to 55 bps. Volumes were relatively subdued across the corporate and banking sector eurobonds and the more liquid longer duration credits such as the Gazprom cluster and Severstal ’14 registerednotable losses. Russia has opened this morning with RU30 trading in a 993/4-7/8range (+286 bps over UST on the offer side) and in the absence of any Russianevent driven news price direction is likely to be dominated by movements in UST. While we continue to favour the RU30 spread trade over the medium term, the lack of conviction inconsolidating above par value suggests that prices are likely to driftover the near-term. The recent strengthening in Russia’s exchange rate has gathered further momentum with the RUB trading through the 29.0 level against the USD to tradebelow the 200-day moving average at 28.77. With the CBR once again reportedly absent from supporting the USD bid this latest move increasingly suggests a late move by the authorities to contain rising inflationary pressures and attain credibility in the inflation targeting objective. Surprisingly, the realignment in the RUBcontradicts official rhetoric and the need to protect domestic competitiveness, particularly during a period of slowing industrial output. While the CBR is unlikely to permit a adverse advance in the RUB, in view of latest developments we now envisage an end-year RUB/USD rate of 28.5. In contrast, the recent rally in the EUR/USD rate has contributed to the RUB weakening to its lowest level in over nine months against the EUR and currently trades at around 36.815, amove that bodes ill for Russia’s rising import bill.