Putin’s Saber Rattling Against Kiev Exposes Risks to Bond Rally

  • Amundi to Aberdeen on alert to see how far conflict will go
  • Credit risk surges most worldwide, crossing South Africa

A resurgence in tensions in Crimea has brought political risk back to the table for holders of Russian debt.

The cost of buying default insurance on the government’s bonds increased 21 basis points to 231 through Friday, the most worldwide, since President Vladimir Putin promised on Aug. 10 to respond to what he called Ukraine’s “terror” tactics in Crimea. Amundi Asset Management and Aberdeen Asset Management are ready to sell Russian bonds if the conflict intensifies or leads to a widening of sanctions.

"The big question now is, will it get worse?," said Sergei Strigo, who helps oversee $2.5 billion in emerging-market assets as a money manager at Amundi in London. “Any significant escalation of this will result in some selloff in Russian assets."

The flare-up brings to a halt the relative calm in Russian geopolitics that allowed money managers to focus on credit fundamentals rather than foreign policy, a shift that drove the top bond performance among major emerging markets since a cease-fire came into effect in February 2015. It also exposes the risks that global investors are taking to capture returns in markets where politics can suddenly turn unpredictable.

For a QuickTake explainer on the Crimea dispute, click here

Russian five-year credit-default swaps rose last week as Putin said he would retaliate against the deaths of two Russian servicemen in the Black Sea peninsula he annexed in March 2014. Pro-Russian rebels responded by attacking government troops near the separatist-held cities of Donetsk and Luhansk, according to Ukraine’s military. The contracts recouped some losses on Monday after Russian Foreign Minister Sergei Lavrov called for an easing of tensions during a meeting with his German counterpart.

The spike in CDS took Russian swaps above those of South Africa for the first time in six months and to within 16 basis points of those of Turkey. In the past 12 months Russia has been regarded as the most stable of the three major markets in emerging Europe, the Middle East and Africa as President Jacob Zuma’s regime came under attack for alleged corruption and President Recep Tayyip Erdogan quashed a coup in Istanbul.

“The market has been quite complacent about political risk in Russia recently,” said Anton Hauser, a money manager in Vienna who helps oversee $2 billion at Erste Asset Management. Any selling in the bonds “will depend on the level of the escalation.”

Reflecting how much the standoff has moved off the radar, yields on the nation’s local-currency bonds due in February 2027 are lower now than they were before Putin’s incursion into Crimea in March 2014, an event which triggered sanctions from the U.S. and Europe. Moody’s Investors Service, which rates Russia one step below investment grade, warned on Monday that any increase of fighting would cause sanctions to be extended and undermine investor confidence.

Even now, investors are loathe to part with their Russian bond holdings because of the wider shortage of supply in higher-yielding assets as global central banks prolong years of near-zero interest rates. They are also trying to assess whether the episode last week will result in a full-blown military conflict or whether they can dismiss the threats as bluster.

While they fell on Friday, the 2027 bonds gained on Monday, with yields dropping four basis points to 8.33 percent. The rate declined as low as 8.29 percent last week, down from peaks as high as almost 16 percent at the height of the economic crisis caused by oil’s slide and penalties.

Viktor Szabo, a fund manager at Aberdeen Asset Management in London, said he’s staying put with his neutral position on Russian Eurobonds and overweight call on local debt until the picture gets clearer. Analysts at Raiffeisen Bank International AG including Gintaras Shlizhyus echoed the caution, saying in an e-mailed note on Friday they’re monitoring the situation for a possible change to their buy recommendation on Russia’s hard-currency bonds.

“In emerging markets it’s an advantage if you aren’t making the headlines,” said Szabo, who helps oversee about $10 billion in emerging-market debt. “Russia has fortunately become a relatively boring picture. You just have to hope that they won’t spoil that with a military conflict.”

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