Fixed Income Daily: Russia’s reassessment by investors is likely to go on

R30\'s working their way back up again. My recommendation to lighten up was hardly worth following, but you have to test the market once and awhile. Our strategist, who has been spot on in calling for the spread narrowing we have seen, is sensing resistence at 250 at least until the New Year. While I wouldn\'t bet against him, I wouldn\'t be surprised to see it trade through 250 in the secnd half of December as investors position themselves for the traditional January rally. Corporates continue to be well bid.

EXTERNAL DEBT MARKET

Investor activity in the Russian Eurobond market was low due to a holiday
in the US. This morning, the Russia-30 opened at 100.25-100.5 and
reached 100.5-100.625 by 11:00 MSK, while its spread to the 10Y UST
narrowed to 253-254 bp. Today, important enough US October retail sales
and preliminary Michigan University consumer sentiment data for
November are to be published. Despite positive data published recently,
especially in the labor market, the US economy is not showing high growth
rates, while high oil prices are unlikely to let the American economy speed
up over the next few months. 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. 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.

LOCAL DEBT MARKET

Stabilization (at least temporary) in the ruble exchange rate and absence of
support from the Eurobond market caused further non-aggressive selling in
the most liquid ruble bond issues.In the government bond sector, the OFZ
46002 was the leader in turnover and lost 0.2%. In other issues, trading
was thin. The yield curve of long issues remained at 7.55-7.85%. The latest
Sberbank statements (see the News) yet more strengthen our opinion that
considerable decreases in government bond yields are neither in the
interests of the State, nor in the interests of the main market participants.
Hence, potential upside in medium- and long-dated Moscow municipals
and corporate blue chips is limited with their spreads to OFZs, which have
already narrowed to minimum levels. In the Moscow municipal sector, the
Moscow-40 was the leader in turnover, losing 0.3%. Other issues fell 0.2-
0.5%. At the long end, spreads to OFZs widened to 23-28 bp. Corporate
blue chips and telecom bonds were mixed, changing some 0.2%. Trading
in other corporates was choppy amid low investor activity. The ruble bond
market is in equilibrium. On the one hand, expectations of the ruble to
strengthen further are strong enough, and the level of ruble liquidity is
constantly growing. There are still no grounds for a significant correction.
On the other hand, the upside is limited, as the government bond yields are
stable, while a rally has already taken place in non-government bonds,
having brought their spreads to government issues to historic lows. Despite
an obvious lack of drivers in the market, the current situation suits the
majority of large investors, for whom the year has been good enough. If no
drastic changes take place in the currency market and in the external debt
market, the yields of ruble bonds may remain at their current levels.