As Russian Economic Travails Fade, So Do Returns on These Bonds

  • Linkers turn to loss as inflation slowdown diminishes interest
  • CPI and Ruonia bonds favored by government in hard times

Not everyone in Russia’s bond market is celebrating the end of double-digit inflation.

Holders of notes linked to consumer prices are losing money on a monthly basis for the first time this year and are trailing returns of investors in plain-vanilla bonds for the second consecutive month, according to data compiled by Bloomberg and Bank of America Merrill Lynch indexes. The last sale of so-called linkers on March 30 failed to generate the targeted demand, signaling investors are growing wary of a bet on insurmountable inflation.

“We have a negative view on them,” said Alexey Korolenko, money manager at UralSib Asset Management in Moscow, which oversees 20 billion rubles ($302 million). He soured on linkers in March when inflation fell to the lowest in two years, and has cut holdings to almost zero from about 8.5 percent in fixed-income funds. “Fixed-coupon bonds look more interesting."

The notes compensate holders for the risk of rising inflation through coupons that are reset every three months to mirror price growth. After the consumer price index reached a 13-year high of 16.9 percent in March 2015, investors could expect more interest and price appreciation. Annual inflation has already slowed to 7.3 percent, lower than where economists expected it would end the year, and that’s weakening the investment case for linkers.

During Russia’s economic travails, the debt proved popular as a way for investors to capture rising price growth caused by turmoil in the oil market and the ruble. Sanctions imposed in 2014 over Russia’s role in the Ukraine conflict had cut off foreign borrowing to the government at a time when a crash in the price of oil, its main export earner, left the budget with the widest shortfall since 2010 last year. To raise money at home, Russia paid as much as 14 percent at weekly bond auctions.

That prompted the government to start offering alternative securities to cover the fiscal gap. In January 2015, it introduced floating-rate notes tied to Ruonia money market rates, followed by the linkers in July. The two types of indexed notes now account for 32 percent of 5.17 trillion rubles of outstanding government debt known as OFZs.

Now, with Russia’s economic outlook brightening and the slowdown in inflation heaping pressure on policy makers to restart monetary easing, both types of debt have become less attractive. A recovery is expected to pull the nation out of recession by the first quarter of next year as inflation slows to 6.6 percent. The last auction of inflation-linked notes on March 30 raised 2.01 billion rubles compared with a target of 3.95 billion rubles. The outstanding notes due August 2023 traded at a price of 100 percent at 11:09 a.m. in Moscow, down from a peak of 103.38 on March 4.

Policymakers have dropped hints rate cuts are back on the table left after leaving the benchmark unchanged at 11 percent at every meeting since Sept. 11 to avoid sparking price growth. The key rate will fall to 9.5 percent by Dec. 31, according to the median estimate of 23 economists surveyed by Bloomberg.

"Inflation in the next 12 months will continue to slow down, which will hold back any price growth in the linker,” said Nikolay Minko, fixed-income analyst at Sberbank CIB in Moscow.

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