Shining Star of Emerging Debt Dims With Russia Carry Allure

  • Overseas investors seen trimming Russian bond holdings: Survey
  • Rate cuts, reduced chance of ruble gains curb appeal of OFZs

Once the darling of emerging debt markets, Russia’s local bonds are getting the cold-shoulder treatment from foreign investors.

Carry returns are dwindling, oil rarely ventures above $50 per barrel and U.S. sanctions are a signature away from being enshrined in law. After hitting a record 31 percent of the local debt market in May, foreigners’ holdings started to drop in June. That share will continue to shrink over the next 12 months, according to almost half the respondents in a Bloomberg survey.

The appeal of carry bets, in which investors borrow where rates are low and invest in higher-yielding securities, is poised to diminish further, according to Moscow-based Promsvyazbank PJSC. The return earned from selling dollars to buy rubles fell by more than half in the year-to-date period to 7 percent and the Bank of Russia plans to push on with an easing cycle after Friday’s pause. Goldman Sachs Group Inc. recommended investors exit the trade because the ruble is unlikely to strengthen further.

"Risks of unwinding carry-trade capital inflows remain high,” said Sergey Narkevich, an economist at Promsvyazbank. “A negative shock such as a precipitous fall in oil prices, new, tougher U.S. and EU sanctions or other foreign policy events could trigger a sudden change in investor sentiment.”

Read more: Sanctions and Cheaper Oil to Threaten Russia Bond Appeal: Survey

Russian local bonds maturing in 10 years ended three months of gains in June, when the U.S. Senate voted for a bill that would make it harder for President Donald Trump to ease or lift sanctions against Russia. The House approved a version of the bill last week, prompting Russia to respond by ousting nearly two-thirds of the staff at U.S. diplomatic missions.

Ruble bonds are the third-worst performers in developing markets this quarter, with a 0.1 percent loss, according to data compiled by Bloomberg. The ruble slid 0.9 percent versus the dollar as of 6:18 p.m. in Moscow, the second-biggest drop among peers.

Andreas Schwabe, an economist at Raiffeisen Bank International AG in Vienna:

  • "With the U.S. authorities being hard again on Russia by imposing new sanctions, political risk sentiment for Russian debt is deteriorating”

Dmitri Barinov, a portfolio manager at Union Investment Privatfonds GmbH in Frankfurt, which oversees about $200 billion in assets, reduced his holdings of so-called OFZs last week because he was above benchmark:

  • “Russian bonds aren’t the star anymore, they’ve performed pretty well already”

Paul McNamara, a money manager at GAM UK Ltd. in London, where he oversees $4.5 billion in emerging-market debt, including Russian local-currency bonds:

  • “The star has faded a bit, what with the tone of the central bank changing and efforts to stop currency appreciation”

Lutz Roehmeyer, the director of fund management at Landesbank Berlin Investment:

  • “Oil has topped out, we do not expect any positive foreign-currency performance anymore. Russia is getting more and more uninteresting”
  • “It’s all a matter of your relative perspective. Relative to German bunds it is high, but Russia is competing with other local-currency markets like Turkey (double digit yields) or Brazil”

Richard Segal, a London-based analyst at Manulife Asset Management:

  • “They have lost some of their glimmer, which I’d attribute to the new oil-based currency intervention policy and the uncertain impact of the new sanctions”
  • Current entry levels are “attractive, but it’s now more for the carry than the capital and currency appreciation”
  • Segal expects the share of foreigners in OFZs to drop to as low as 25 percent over the coming year
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