Ukraine Bond Rally Best in Region Signals Mounting Risks

Since Ukraine’s territorial integrity started crumbling in March, the nation’s bonds have outperformed regional peers. For Landesbank Berlin Investment GmbH, that’s unsustainable.

“Nobody should buy anything in Ukraine,” Lutz Roehmeyer, who helps manage $1.1 billion of emerging-market assets at the fund manager known as LBB-Invest, said by e-mail June 10.

Ukraine’s dollar debt has returned 14 percent since Crimea’s vote for secession on March 16 escalated the conflict with Russia. That’s the best performance among 13 eastern European nations in the Bloomberg Dollar Emerging Market Sovereign Bond Index, which gained 6.4 percent through yesterday.

While Russia and Ukraine engaged in peace talks, deadly violence rages in the former Soviet republic’s eastern regions and the two countries remain locked in a dispute over vital gas supplies. The conflict has sapped Ukraine’s resources, with a 7 percent economic contraction forecast this year by the European Bank for Reconstruction and Development.

“Risks are not compensated any more,” said Roehmeyer, a director at LBB-Invest, a unit of DekaBank Deutsche Girozentrale, which still holds some Ukrainian bonds.

Ukrainian troops fought a rebel convoy of armored vehicles yesterday, which Interior Minister Arsen Avakov said included tanks brought into the country from Russia. President Petro Poroshenko ordered Ukrainian regions to accept refugees from battle zones as the army repelled attacks on airfields in the Luhansk and Donetsk regions, killing about 40 separatists. Insurgents in the city of Mariupol suffered “heavy losses” today, Avakov said on Facebook.

Relative Strength

Technical indicators used by analysts also indicated some Ukrainian debt has risen too far. With the yield on the July 2017 dollar notes falling to a five-month low this week, a measure called the relative strength index signaled the securities were overbought.

Russia gave Ukraine until June 16 to make payments for natural gas, Alexey Miller, chief executive officer of the gas exporter OAO Gazprom, said after meeting with European Union Energy Commissioner Guenther Oettinger this week in Brussels. Oettinger said he was optimistic an agreement on the gas price can be reached. The Finance Ministry in Kiev didn’t respond to e-mailed requests for comment.

Russian President Vladimir Putin’s drive to gain influence over Ukraine may yet reignite tensions, according to Bank of America Corp.

Potential Flashpoints

“Although the risks of military conflict have de-escalated, potential flashpoints remain,” Alberto Ades and Isidore Smart, New York-based analysts at the bank, wrote in an e-mailed report yesterday.

Ukraine repaid $1 billion of Eurobonds due June 4 with help from a $17 billion aid package from the International Monetary Fund. The repayment, along with the election of billionaire Poroshenko as president last month, helped calm bond investors.

The expectations investors are placing on Poroshenko to improve Ukraine’s credit story are “huge,” Sergey Dergachev, a senior portfolio manager who helps oversee about $10 billion in emerging-market debt at Union Investment Privatfonds GmbH in Frankfurt, said by e-mail yesterday. “The challenges are even higher.”

The yield on Ukraine’s 2017 dollar notes dropped to 8.57 percent on June 9 from 16 percent in February, data compiled by Bloomberg show. The slide kept the relative strength index on the bonds above a reading of 70 since May 23 through June 11, a level that indicates the security is poised to decline. The RSI dipped to 62 as the yield climbed to 9.45 percent by 4:45 p.m. in Kiev today.

Junk Rating

Even after the rally, Ukraine’s bonds offer 4.1 percentage points of additional yield over similarly rated Jamaica’s June 2017 notes. Both share a junk rating of Caa3 rating from Moody’s Investors Service.

While there’s value in Ukraine’s bonds because of the high yield, there’s not much room left for increases in price, Jan Dehn, head of research at Ashmore Group, said in interview in London June 11. The “really big trade” is behind us, Dehn said.

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