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‘Free Hand’ on Rates Means Best of Bonds Over: Russia Credit

Traders are boosting their bets on higher Russian interest rates, pricing in the biggest increase in borrowing costs for two years as the central bank battles inflation, according to futures contracts.

Benchmark rates will rise by 217 basis points over the next nine months, the largest increase priced in since October 2008, forward rate agreements tracked by Bloomberg showed on Nov. 29. The prospect of higher borrowing costs precipitated a decline in Russian ruble debt, with bonds due 2012 sliding the most for four months in November, pushing the yield 18 basis points higher to 5.06 percent. An index of ruble corporate bonds traded on Russia’s Micex exchange dropped by the most since May.

“It’s never a good thing to have higher rates and the question is how much they are going to hike,” Eugene Belin, head of fixed income at Citigroup Inc. in Moscow, said in a telephone interview on Dec. 2. “We’ve definitely seen the best of the bond run as everything will be affected.”

Bank Rossii lowered its key interest rates 14 times to revive a banking sector hobbled by recession and the global credit crisis. The central bank now has a “free hand” to start raising borrowing costs, First Deputy Chairman Alexei Ulyukayev said Nov. 29. The government expects the annual rate of inflation to exceed its 8 percent forecast this year. Policy makers last raised Russia’s key rates in November 2008.

Brazil has raised its benchmark interest rate three times since April 28, to 10.75 percent. The yield on 2012 sovereign real debt has risen 60 basis points since July 30 to 12.15 percent, according to data compiled by Bloomberg.

The yield on the comparable Russian Finance Ministry’s OFZ bond rose 17 basis points, or 0.17 percentage point, to 5.08 percent in the same period.

‘Definitely Negative’

Russia’s refinancing rate has been at a record-low 7.75 percent since June, along with the 5 percent rate charged on overnight repurchase loans and the 2.5 percent deposit rate, the cost of interest earned by banks that store money with the central bank overnight. Unlike Brazil, Russia doesn’t have a single benchmark rate.

“The risk of rate hikes is definitely there, especially after Ulyukayev’s comments,” Aleksandra Evtifyeva, an economist at VTB Capital, the investment banking arm of Russia’s second-largest lender, said by telephone in Moscow on Dec. 2. “The first effects will be felt in the bond market where prices will decline. For the bond market it’s definitely negative.”

Russian inflation was 8.1 percent in November, the highest rate since December 2009 and versus 5.2 percent in Brazil and 4.4 percent in China, Bloomberg data show.

Ruble, Swaps

The ruble strengthened 1 percent to 30.99 per dollar by the 5 p.m. close of trading in Moscow today, the strongest since Nov. 15. Non-deliverable forwards, or NDFs, which provide a guide to expectations of currency movements and interest rate differentials and allow companies to hedge against swings, show the ruble at 31.2719 per dollar in three months.

The yield on Russia’s dollar bonds due in 2020 fell 11 basis points to 4.71 percent today, the lowest since Nov. 15. The price of ruble notes due July 2015 fell for the first day in six, pushing the yield up 2 basis points to 7.23 percent.

The cost of protecting Russian debt against non-payment for five years using credit-default swaps fell 5 basis points to 144 points today, according to data provider CMA. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to pay.

Credit-default swaps for Russia, rated Baa1 by Moody’s Investors Service, its third-lowest investment grade, cost 21 basis points more than similar contracts for Turkey, which is rated four levels lower at Ba2. Russia swaps cost as much as 40 basis points less on April 20.

Extra Yields

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries fell 15 basis points to 203, JPMorgan Chase & Co. EMBI+ indexes show. The difference compares with 131 for debt of similarly rated Mexico and 166 for Brazil, which is rated two steps lower at Baa3 by Moody’s.

The yield spread on Russian bonds is 28 basis points below the average for emerging markets, down from a 15-month high of 105 in February, according to JPMorgan indexes.

While analysts at UniCredit SpA and Credit Agricole SA said Bank Rossii may raise rates as soon as this month’s review, the government is concerned higher borrowing costs may slow the economic recovery.

The central bank shouldn’t raise rates yet even as inflation accelerates, Deputy Economy Minister Andrei Klepach said Nov. 30, according to Interfax. Economic growth is still “very fragile” and it’s not the right time to tighten monetary policy, the newswire reported him as saying.

Shrinking Economy

After contracting a record 7.9 percent last year, the economy of the world’s largest energy exporter grew at an annual rate of 2.7 percent in the three months to the end of September, the slowest quarter of growth this year.

Official borrowing costs will remain at record lows until at least the middle of next year, said Herbert Moos, deputy chairman of VTB Group, Russia’s second-largest bank.

“We don’t see a reason to forecast a rate hike before mid-2011,” Moos told reporters in Moscow Dec. 2.

Hungary became the first country in the region to lift borrowing costs, raising its benchmark rate by 25 basis points, to 5.5 percent on Nov. 29, after 14 cuts since October 2008. The yield on the country’s five-year forint-denominated bonds hit a 15-month high of 8.34 percent the day after the increase.

For the next three months, traders were pricing in 82 basis points of increases to Russia’s key rates at the beginning of last week, the most since November 2009, according to forward rate agreements.

The yield on government ruble bonds due August 2012 jumped 18 basis points in November, the most since July, and has gained 5 basis points since the Nov. 26 rates decision, according to data compiled by Bloomberg.

Two-year ruble debt of OAO Gazprom, Russia’s monopoly gas exporter, yielded 6.52 percent today, up 37 basis points since Nov. 26. The Micex index of ruble corporate bonds lost half a percentage point last month, the most since May.

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