Bank of Russia Hawks Claim Victory as Curve Inversion Shrinks

  • Gap between 2- and 10-year bonds is narrowest since April
  • Nabiullina dismissed bets on ‘lavish’ easing at last meeting

The Bank of Russia’s hawkish message last month may have been quickly drowned out by the U.S. Federal Reserve and OPEC, but there are signs Governor Elvira Nabiullina’s words got through.

By dismissing hopes for a “lavish” easing cycle, Nabiullina sought to reduce Russia’s so-called yield curve inversion, when rates on long-maturity bonds are lower than on short-term debt, pointing to economic weakness. Yields climbed for three days after her statement before tumbling as the Fed spurred appetite for emerging-market assets and the Organization of Petroleum Exporting Countries announced a deal to cut output, boosting the outlook for Russia, the world’s biggest energy exporter.

More than two weeks on from the decision, and the gap between two- and 10-year OFZ bonds has fallen to the narrowest since April, suggesting Nabiullina’s deputy wasn’t exaggerating at the end of last month when she declared the realignment was working. Nabiullina’s decision to focus on the curve came days before the Bank of Japan’s Governor Haruhiko Kuroda and Kazakhstan’s Daniyar Akishev said the same.

“Right now the yields are on the decline again, but it’s all because of OPEC and the ruble,” said Ivan Guminov, a money manager at Ronin Trust in Moscow. “Of course it worked. Investors were told they shouldn’t expect a new rate cut, and they took the profits.”

Unwarranted Expectations

The Bank of Russia made an unprecedented commitment at its Sept. 16 meeting to leave interest rates unchanged for the rest of the year, demonstrating it’s serious about reaching a 4 percent inflation target by the end of 2017. The spread between the long and short bonds has narrowed from a peak of 104 basis points on July 1.

Speaking after the decision, Nabiullina said the inversion was caused by unwarranted expectations that rates would be cut and called the phenomenon a cause for concern because it affected monetary conditions. While the gap between the rates will shrink, the curve inversion will remain, she said.

Russia’s debt curve will stay inverted at least through the end of next year, according to forecasts collected by Bloomberg. The yield on the government’s two-year bonds will end 2017 at 7.6 percent, compared with 7.5 percent for 10-year notes, the median of the forecasts collected as of Oct. 3 show.

The Russian cross-currency swaps curve at present is "exceptionally inverted," and the bond yields curve resembles the swaps curve. This is a remarkable contrast to other emerging markets, according to Credit Suisse Group AG.

"The local swaps curves in Israel and Hungary are particularly steep, and the curves in Mexico and South Africa are as steep as the curve in the U.S.," Kasper Bartholdy, head of global Emerging Markets fixed-income and economic strategy at Credit Suisse, said in a research note.

He recommends a "steepener trade," buying government bonds due February 2019 and selling bonds due January 2028.

“We wanted to realign the market expectations with our own,” Bank of Russia First Deputy Governor Ksenia Yudaeva said in televised comments on Sept. 28. “To realign them we gave this signal. And, by the way, it worked.”

— With assistance by Andre Tartar

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