embonds

Russia Sovereign Credit

 

Russian sovereign credit lagged the rally in oil prices. Russian sovereign credit spreads have “underperformed” the rally in oil prices since late September. In stark contrast to US energy corporates and a few other EM oil credits, Russia’s sovereign credit was almost unchanged since late September (Figure 1). To illustrate how oil prices had little impact on Russia credit we note that on our calculations, the 60-day rolling correlation between Russian Eurobonds spreads and oil prices rose to -20% currently from around – 50% in mid-September.

We suspect that local selling of sovereign bonds was one of the reasons behind recent underperformance. Our understanding is that the recent purchase of state-owned energy company Bashneft by state-own energy company Rosneft could have led to a temporary spike in demand for dollars by local investors. As a result, it could have been that some local investors were looking to sell their Eurobonds holdings. The sharp decline in the rouble’s xccy basis (to -180bp currently at the 5y point from -140bp in endSeptember) could also signal that demand for US dollars funding could have increased recently. Renewed concerns about tighter sanctions from the EU were also probably another reason behind the negative sentiment to this asset class.

There are still near-term headwinds, but a catch-up with oil prices is likely. First, the tension with the West around Syria is likely to remain at least until the US elections (8 November). Specifically, the temporary ceasefire in Syria ended over the weekend and could bring more tension between Russia and the West. Second, we cannot rule out further technical weakness given Rosneft’s part in the purchase of Indian energy company Essar Oil which may also result some local selling pressures. However, based on its historical price action, we expect Russian credit to catch-up with oil prices over time.

On a relative basis, we think that Russian sovereigns start to look attractive against Qatar or Kazakhstan. The z-spread differential between Russia 26s and Qatar 26s rose by 20bp since mid-October to around 93bp currently. In addition, we suspect that Qatar could see some selling pressure as some holders potentially switch to the new issuance of Saudi Arabia (see more details on this issuance in the next page). Meanwhile, the zspread differential between Kazakhstan 25s and Russia 26s fell substantially to -38bp currently from close to flat at the time of Russia 26s issuance.