Putin’s Crimea Playbook Condemns Bonds to Losses: Russia Credit

Russian government bonds, among the casualties of President Vladimir Putin’s maneuvering in Ukraine, are set to extend declines that have made them the world’s worst performers.

Ruble-denominated bonds, known as OFZs, have lost 14 percent in dollar-terms this year, the most among 31 countries in the Bloomberg Emerging Market Local Sovereign Index. The yield on the benchmark February 2027 security climbed 16 basis points today to a record 9.57 percent, extending its increase this month to 121 basis points as pro-Russian forces gained control of Ukraine’s Crimean peninsula.

Worse is in store for the debt, as Putin risks relations with the West by threatening to annex Crimea from Ukraine, according to Aberdeen Asset Management Plc and GAM U.K. Ltd. As the U.S. and the European Union weigh sanctions, Goldman Sachs Group Inc. cut its forecast for Russian economic growth this year to 1 percent from 3 percent, writing in a report yesterday that “political tensions” are harming confidence.

There’s “more pain to come for all Russian assets, Putin seems not to care about the financial consequences,” Max Wolman, who helps oversee more than $10 billion in emerging-market debt, including OFZs, at Aberdeen in London, said by e-mail two days ago. “Demand for OFZs by foreigners is going to continue to decline.”

Bearish Environment

The yield implied from 12-month non-deliverable ruble-dollar forwards jumped 28 basis points to 9.66 percent, the highest since 2009, data compiled by Bloomberg show. The ruble’s 10.4 percent slump against the greenback this year is the worst performance among emerging-market currencies tracked by Bloomberg after Argentina’s peso.

There is a 66 percent probability the currency will weaken 1.5 percent to 37 against the dollar by the end of the year, options data compiled by Bloomberg show. The ruble declined 0.2 percent to 36.6620 per dollar by 6:32 p.m. in Moscow, heading for a record-low close.

“An environment is being created where foreigners want out,” said Paul McNamara, a London-based investment director at GAM, which has $6 billion of emerging-market debt and sold all its OFZ holdings in January. Russian asset prices “can go lower,” he said by e-mail two days ago.

Putin, a Cold War spy who in 2005 called the Soviet Union’s collapse “the greatest geopolitical catastrophe” of the 20th Century, is risking sanctions that may weaken his nation’s economy as he undermines Ukraine’s territorial integrity by backing Crimea separatists who seek to join Russia.

Crimean Referendum

The day after Crimea votes to become part of Russia on March 16, EU foreign ministers are scheduled to weigh asset freezes and travel bans on Russian politicians and businessmen they consider responsible for events in the Black Sea peninsula.

There will be a further “selloff” in Russian assets after Crimea’s referendum, Jean-David Haddad, an emerging-markets strategist at OTCEx Group’s fixed-income arm in Paris, said by e-mail two days ago. Still, Putin “needs foreign investment” and won’t cut links with the international community, he said.

Any de-escalation would see a “violent rally up, which probably would be the best time to pick Russia,” he said.

While the threat of Western sanctions undermines the economy, whose expansion slowed to a four-year low of 1.3 percent last year, Iran-style retaliation is being treated as an unlikely worst-case scenario by the Russian government, according to four people with knowledge of the preparations.

Capital Outflows

“Economic activity in Russia is likely to be strongly affected by the current political tensions,” Clemens Grafe and Andrew Matheny, economists at Goldman Sachs in Moscow, said in their note. “A shock to domestic confidence, resulting in lower investment,” will lead to “a continuation of the destocking cycle and higher capital outflows,” they wrote.

Goldman Sachs estimates that almost $45 billion in capital has left Russia this year, about 60 percent more than the “elevated” level from the first quarter of last year.

Bank Rossii increased interest rates 150 basis points on March 3 to shore up the ruble and kept the main rate steady at 7 percent at today’s meeting, saying in a statement it doesn’t intend to reduce official borrowing costs in the coming months.

Flagging demand for Russian debt may fuel further rate increases to help “defend” the ruble, Aberdeen’s Wolman said.

Foreigners poured into ruble debt last year when Euroclear Bank SA, which runs the world’s biggest bond-settlement system, was given access to the Russian market. The yield on the 2027 notes dropped as low as 6.77 percent in May, 285 basis points, or 2.85 percentage points, below today’s level.

Dark ‘Tunnel’

“Russian local bonds entered the recent crisis period looking dramatically overvalued,” Michael Gomez, the co-head of emerging markets at Pacific Investment Management Co. LLC in Newport Beach, California, said by e-mail yesterday. “The recent correction in the local market, and the surprise tightening from the CBR, have started to restore value.”

The yield on the government’s April 2042 dollar bonds fell six basis points to 6.49 percent today. The extra yield on Russia’s dollar debt over Treasuries increased four basis points to 350, indexes compiled by JPMorgan Chase & Co. show.

“It is too early to talk about where this situation could take financial asset prices,” Ogeday Topcular, who oversees $300 million of assets as a money manager at RAM Capital SA in Geneva, said by e-mail March 12. “I can’t see the light at the end of the tunnel.”

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