Fixed Income Daily: Meanwhile, moderate UST yields should provide good grounds for further Russian country spread narrowing

EXTERNAL DEBT MARKET
Against the background of the 10Y UST yield stabilization at 4.07%,
Russian Eurobonds continued rallying. Long Sovereign issues, the
Gazprom and the Aries added 1.125-1.75%, while the Russia-30 spread
has practically decreased to historic lows of 257 bp. Over the last week,
Russian Eurobonds have increased some 1-2%. The Russia-30 firmly
holds above 100, having grown from 100.00 to 101.675-101.7. During this
period, its spread has narrowed by 18 bp from 280 bp to 255-260 bp. Over
the last two months, the Russian Eurobond market has demonstrated
serious growth, which took place exclusively due to spread narrowing to US
Treasuries. For example, the 10Y UST yield was 4.11% on September 1
and is 4.06-4.10% now. Thus, against the background of sideways trading
in the UST market (with fluctuations within a range of 3.93-4.2%), Russian
Eurobonds have increased some 5-6% at the long end, while the Russia-30
spread has narrowed by 65 bp, from 325 bp to 260 bp. Thus, all this growth
of Russian papers took place on reassessment of the Russian risk by
investors. However, it should be noted that UST yields have remained quite
low during the period, allowing Russian bonds to rally. Given narrowed
spreads to UST, correlation of Russian Eurobonds with UST may increase
again in the near future, although we expect the Russia-30 spread to not
exceed 250 bp by the end of the year, i.e. we expect the spread to continue
narrowing. The arguments are the same, as huge monetary liquidity of the
government and the Central Bank makes Russia a country with no external
debt. At present, the external debt of the Russian government is $115 bn,
while the Central Bank’s foreign reserves are $107 bn, and the Stabilization
Fund is $20 bn, both making some $127 bn. In the terms of debt
parameters, Russia looks even better than ААА-rated countries. Therefore,
Russia’s reassessment by investors is likely to go on. What concerns the
UST market, the situation is rather complex, but it looks like a sideways
trend in yields may continue over the next few months. On the one hand,
the US economy is not demonstrating too fast growth now, as the US GDP
has increased only by 3.7% in 3Q04 compared to 4.5% in 1Q04, while high
oil prices should slow down the rate of economy growth over the next few
months. Therefore, investors’ expectations of interest rates hikes by the US
Fed are now moderate. On the other hand, a record high budget deficit of
$412 bn has been reached in the US in 2004, and the budget deficit is
likely to remain high in 2005, suggesting huge borrowings by the US
Treasury, which should push UST yields higher. Given these two factors
(low growth rates on the one hand and massive borrowings on the other
hand), we believe that the 10Y UST yield is likely to remain in the range of
4-4.3% over the next 2-3 months. Meanwhile, moderate UST yields should
provide good grounds for further Russian country spread narrowing.
LOCAL DEBT MARKET
Investor activity somewhat increased in the OFZ sector, with the OFZ
27021 seeing the most turnover. The long OFZ yield curve remained at
7.55-7.82%. Significant yield downside in the government bond sector is
limited because of generally inefficient pricing in the sector. In Moscow
municipals, the majority of issues appreciated by 0.2-0.4% against the
background of above average investor activity. Most demand was observed
in short issues with high current yields, and medium-term bonds trading at
a 50-95 bp spread to government bonds. Long-dated issues appreciated
only by some 0.2%, while their spreads to OFZs narrowed by 10-15 bp.
The yield curve of corporate blue chips did not change significantly, with
the Gazprom-3 traded the most actively. The new URSI bond placement
was rather successful for the issuer, as forward quotations increased to
100.4-100.6% after the auction.