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Sanctions Fallout Seen Worsening as Russia Curve Invert

July 30 (Bloomberg) -- Bond investors are signaling the deepest concern for Russia’s economy in at least two years as the U.S. and European Union toughen sanctions because of the crisis with Ukraine.

Russia’s five-year ruble notes yielded more than 10-year debt this week for the first time since June 2012, data compiled by Bloomberg show. Government bonds headed for their worst monthly losses since May 2009, while the Finance Ministry scrapped its weekly debt auction yesterday, the first back-to-back cancellations since April.

Bonds risk extending the worst performance in emerging markets as harsher penalties over Russia’s role in the fighting in eastern Ukraine amid rising interest rates threaten to drive the economy into a recession. The inverted yield curve is signaling investors are expecting relatively high rates in the short term, a headwind for growth, said Fedor Bizikov at GHP Group in Moscow.

“This eliminates the incentive to borrow and spend,” Bizikov, a money manager at GHP, said by phone yesterday. “Eventually it impacts the economic growth rate. High rates kill any economic activity.”

Russia’s local bonds have handed investors a 8 percent loss in dollar terms this month, the most among 31 emerging markets tracked by Bloomberg. Bulgarian debt, the second-worst performer, fell 2.6 percent in the period.

Rising Tension

The central bank unexpectedly raised its key one-week auction rate 50 basis points to 8 percent on July 25, exceeding the latest inflation reading of 7.5 percent. External shocks, including rising geopolitical tension, may threaten the policy makers’ 4 percent mid-term inflation target and persistent risks may trigger another rate increase, it said.

EU governments agreed in Brussels yesterday to bar Russian state-owned banks from selling shares or bonds in Europe and restricted the export of equipment to modernize the oil industry, an official for the bloc told reporters. New contracts to sell arms to Russia and the export of machinery, electronics and other civilian products with potential military uses will also be banned. The U.S. and the EU accuse Russian President Vladimir Putin of supporting the separatists battling Ukrainian troops.

“It’s pure geopolitical risk,” Vladimir Miklashevsky, a strategist at Danske Bank A/S in Helsinki, said by e-mail yesterday. “People with short investment horizons are pulling out.”

Hedging Bets

The ruble weakened against the dollar for a fourth day yesterday. The currency strengthened 0.7 percent to 35.5650 as of 5:33 p.m. in Moscow, paring its decline since the beginning of July to 4.5 percent, the worst performance among 24 emerging-market currencies tracked by Bloomberg. The MosPrime rate commercial banks say they charge each other increased to 9.24 percent yesterday from 8.63 percent at the end of last week.

The yield inversion may signal investor expectation that the central bank won’t keep rates high for long, Jean-David Haddad, a fixed-income strategist at OTCEx in Paris, said in e-mailed comments.

While the world’s eighth-largest economy expanded 0.9 percent in the first quarter, Russian growth will slow to 0.5 percent for 2014 overall, according to the median forecast of analysts surveyed by Bloomberg.

“Sectoral sanctions will reduce access to external funding markets, putting downward pressure on the ruble and upward pressure on rates,” Jacob Nell, an analyst at Morgan Stanley in Moscow, said in an e-mailed note yesterday. “We see a potentially more significant impact on growth from a major increase in uncertainty.”

To contact the reporter on this story: Vladimir Kuznetsov in Moscow at vkuznetsov2@bloomberg.net

To contact the editors responsible for this story: Gavin Serkin at gserkin@bloomberg.net; Wojciech Moskwa at wmoskwa@bloomberg.net Alex Nicholson

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