Fixed Income Comment: At the same time, the longer duration VTB credits also benefited from the dual investment grade status and outperformed its banking sector peers

Despite Russian eurobonds reacting positively to the announcement that Lehman
Brothers are to change the inclusion rules for its global family of bond indices, such
gains were largely reversed as UST weakened in late trading. Both a stronger US
consumer confidence reading and disappointing auction of US$8 billion 20-year
TIPS were cited as providing the selling impetus. Indeed, the latter managed to
attract only 37.9% of indirect bids, which includes foreign central banks, compared
to 47% in the previous auction and supports the view of waning foreign interest in
US government securities, evident in the recent US$15 billion auction of 5-year
UST notes. As a result of such moves, the Russian EMBI+ increased 0.12%
yesterday with the spread tightening by a further 6 bps to 208 bps and in line with
the wider EM debt class. Volumes improved markedly at the long end of the curve
and the benchmark RU30 initially traded higher from an opening level of 1041/2 to a
new-all time high of 1047/8 before late selling pressures took hold and
subsequently closed in New York at 1041/16. Although the RU30 spread over 10-
year UST was relatively unchanged over the day at 220 bps, intra-day movements
witnessed the spread trade at 216 bps, its tightest level to date. Elsewhere in
Russia, the MinFin and ARIES curve were also well supported and the more liquid
ARIES ’14 traded higher at 124 with the spread over RU30 remaining flat at around
-1 bps. Russian corporates and banking sector bonds were also bid higher with
the more liquid credits such as Gazprom ’13 and ’34 benefiting most. At the same
time, the longer duration VTB credits also benefited from the dual investment
grade status and outperformed its banking sector peers.
Russia has opened this slightly weaker following the disappointing UST close and
RU30 currently trades in a 1037/8-1041/4 range (+221 to +217 bps over UST). In
the absence of any significant economic data releases and with Russia still close
to historic highs we expect the market to remain vulnerable to further bouts of profit
taking. Nevertheless, in view of improving fundamentals compared to its EM peers
we consider any retracement in spread levels as a buying opportunity. At the
same time, Lehman’s recent decision appears to have eroded the importance
assigned to Russia’s anticipated S&P upgrade and now the significance of such a
move is merely a matter of timing.