The Central Bank of Russia is expected to continue the series of the key rate cut. There is a 100 percent possibility for the CBR to continue cutting its key interest rate, noted Nordea Bank in a research report. Inflation in the country is at the lowest levels since the post-Soviet period. Furthermore, the inflation expectations are trending lower.

In the meantime, the Russian economic growth figures are not positively surpassing expectations at present. Growth in retail sales continues to be negative, while capital construction fell 5.4 percent in the first quarter of 2017. Also, investment activity growth continues to be symbolic. Thus, certain stimulus is required and it can be achieved through easing of the monetary policy.

Firms in Russia do not mention the interest rates as the top thing as the hindrance for business development. Meanwhile, money market rates have already begun pricing in a rate cut.

There are some factors that might prevent the Russian central bank from aggressive rate cuts. There is uncertainty regarding the OPEC/OPEC+ agreement for the second half of this year. If the agreement is not prolonged, oil prices might decline and inflation might accelerate in tandem resulting in depreciation of the RUB. Meanwhile, high consumption growth can also pose as a threat to the inflation. Additional aggressive rate cuts would stand out against the central bank’s cautious rhetoric and earlier take steps, stated Nordea Bank.

EM and risk outlook stays relatively supported but we see risk aversion alert signs across the board. While investors focus on US politics and especially on today’s vote on the repeal act of Obamacare, other developments should, in our view, not remain unnoticed: a research paper published by two Fed economists and released by the Brookings Institute suggesting US interest rates staying low with the Fed tolerating inflation overshooting targets, the ECB’s targeted LTRO allocations, and the continued fall of iron ore futures. Despite equity markets retracing some of the post-election rally, US monetary conditions have become more accommodative with the falling USD contributing most to this easing. Foreign conditions have turned from providing hefty headwinds as experienced from 2012-16 into tailwinds, helping US reflation gain momentum over time. Accordingly, we prepare for putting on FX trades that benefit from a steeper US yield curve. Short EURSEK and long USDJPY fall into this category. While short EURSEK should work from now, USDJPY’s current downward momentum suggests waiting for 109.50 or for a stabilisation above 112.50 before establishing longs.

US vote: Today markets will wait for the outcome of the vote but FX investors should note that the vote is not scheduled for a specific time. At the moment the vote count may be low so the Republican leaders need the time to gather votes, indicating why no specific time is provided. There is even a risk the vote may be delayed if the leaders feel the vote may not pass.

Watching iron ore. The PBOC-run Financial News newspaper highlighted that the recent rise of RMB money market rates should be put into the context of recent money market operations. China seems to be tightening its monetary conditions to deal with excessive leverage. Importantly, tighter RMB lending conditions have sparked China’s USD denominated loan demand, pushing its USD denominated liabilities up again. Should this loan-related USD inflow into China end up into a higher FX reserves (see chart below) – thus providing an additional signal that offshore USD liquidity conditions are on the rise – EM markets should see further inflows. Meanwhile, China has seen the ratio of mortgage loans to total credit of commercial banks reaching uncomfortably high readings. It has been China’s property and infrastructure investment driving commodity – including iron ore – demand. Authorities are now directing growth away from the property market which suggests that commodity prices may ease. Falling iron ore prices will not bode well for the AUD. Within this context we recommend using the AUD as a funding tool for high yield EM longs and for a long GBP position. GBPAUD has moved away from levels suggested by relative forward curves.

 

Ruble strength, fiscal rule and CBR

The gov’t/CBR comments that RUB strength is a temporarily fuelled RUB correction. We do see RUB weaker going forward, but generally in a modest/orderly way. There were several officials’ comments about RUB and CBR policy on Friday, which clearly explain some RUB correction. Specifically, CBR deputy Ksenia Yudayeva commented to Bloomberg with the following points:

 · The RUB is not significantly overvalued, its deviations from fair-value estimates are “within the limits of the norms”, and the hot money inflows are not the only factor driving RUB stronger, so the CBR doesn’t see any threat for financial stability from this and, so, there is no need to react.

  • · Not only the level, but excessive RUB volatility adversely affects competitiveness, which requires removing the dependence from oil in the FX rate, which will likely be achieved through inflation targeting and the MinFin FX buying under the “budget rule”.
  • · The focus stays on CPI/anchoring inflation expectations at the 4% target, which may require higher rates for longer, so the current 4%+ real rate may persist.
  • · MinFin FX buying and the disinflationary impact from the transitory factors of RUB and good harvest leave risks to reaching the 4% target, so the CBR remains concerned that the disinflation trend may slow soon.
  • · The lower and shorter recession in 2015-16 than was initially expected justifies the CBR’s cautious stance.

After these, MinEco Maxim Oreshkin also commented saying that the recent RUB strength looks temporary, seasonal and not related to fundamentals, so the RUB may see some moderate weakening followed by a stabilisation. All in all, the CBR comments look like a rather hawkish message also making clear that the CBR doesn’t see any need to react from their side to RUB strength. At this point, the probability of rate cuts in Mar-17 is clearly below 50%, but we think it may still change if CPI slows down as in previous weeks, and the RUB stays resiliently strong. As for the RUB outlook, we do share the view that the recent strength looked excessive, so it would be natural to see some retracement back to 59-60/USD levels all else being equal.

Monthly Global EM Outlook, Trump Policies and Inflation

From the current starting point, the near-term inflation outlook is generally unthreatening in most markets that have a large weight in the international benchmark indices for EM local currency debt.

Inflation has risen in some EM countries during the past half year in response to currency depreciation and increases in global oil prices; but the CPI impact of exchange rate weakness has in most cases diminished and the oil price effect is probably about to peak. Beyond the group of EM countries that now have large weights in the EM debt indices, it is notable that core inflation is on the rise in China.

 The current level of core inflation (2.2% year-on-year) is not seriously disconcerting but if it continues to creep upwards then it will eventually become a constraint on China’s monetary policy. This represents a risk for the entire EM/commodities complex, but it is more likely to be a risk for the second half of 2017 than a focal point in the next few months. More imminently, the main risk of abrupt policy rate increases in the EM universe comes from the US in the form of the possibility of a surprisingly large batch of Fed rate hikes during the remainder of the year and/or a border adjustment tax. Either of these shocks could force a swathe of EM central banks to choose between raising their policy rates substantially or having to live with undesirably steep currency depreciation.

Given the current predominantly unthreatening EM inflation trends and residual labor market capacity slack in many countries, a large share of the EM central banks – especially in Asia – look set to be able to leave their own policy interest rates unchanged if the Fed keeps raising rates at a gentle pace and if the US border adjustment tax fades away.

An important source of inflation volatility in the EM world in recent years has EM currency depreciation (in nominal trade-weighted terms) that has led to increases in prices not only for imports, but also for those domestically produced goods that compete against foreignproduced items either in the domestic market or the export market. However, this problem dissipated in most of the EM world during the course of 2016, and only a few of the large EM countries – Mexico and Turkey to be precise – are seeing this problem unfold right now

Two other large EM countries – Brazil and Russia – are in the opposite camp. Inflation has fallen sharply in both countries in the past year. This reflects in part a swing from large-scale currency depreciation in late 2015 and early 2016 to equally forceful currency appreciation during the past 12 months. Deep recession, widening output gaps, and cautious monetary policy in both countries have also helped contain inflation. The view of our Brazil-based economists is that recent currency appreciation will continue to help drive down the country’s inflation in the present year whereas the main drivers of last year’s fall in inflation were a large decline in the pace of adjustment in government controlled prices (in part reflecting currency dynamics and a big change in global oil price inflation), the depth of the recession and, related to this, weakened wage pressure in the labor market.

To be sure, the behavior of EM currencies, inflation and policy rates would be highly likely to become much messier if the Fed were to accelerate the pace of its rate hikes substantially beyond what is currently priced into the US rates curve, perhaps in response to stronger wage data or aggressive future plans for unfunded US tax cuts. There is also, in our view, a very real risk to EM investors associated with the plan of Republican members of US Congress for border adjustment taxation (BAT), or from the possible imposition by the US of other types of import taxation. As we have argued multiple times on these pages, the BAT and import tariffs are likely to be highly dollarsupportive. If Trump’s decides to support either, and if he secures congressional approval, dollar-based holders of EM local-currency-denominated assets are likely to take a hit.

It might seem inviting to think that the BAT would help curb inflation in the EM world, because it would be likely to drive down the dollar price that EM-based importers pay for goods from the US (as US exporters would be entitled to a new subsidy) while also driving down the dollar price that EM-based exporters would obtain from sales to the US (because their sales would be subject to taxation at the US border). But the inflation “benefit” would be eroded by EM currency depreciation against the dollar. EM currency depreciation would most likely be sufficient to drive the local-currency prices for EM countries’ exports and imports (in trade with the US) almost all the way back to their pre-BAT levels.

 

Russian USDRUB Intervention Mechanism, FX Purchases explained by CS

? In our view, it makes sense to resume regular FX purchases due to (1) the strengthening of the rouble in REER terms, (2) the decision of the government to save windfall oil and gas revenues, and (3) higher oil prices.

? We expect the mechanism of regular FX purchases in 2017 to replicate the fiscal rule (which will be approved by parliament in 2018), with the parameters of the FX purchase mechanism being reset on a monthly basis.

 ? The CBR is likely to be in charge of regular FX purchases in 2017, while the Finance Ministry is likely to take over in 2018-2019, if the Brent oil price stays above $50/bbl.

 The rouble’s response to the announcement of the details of FX purchases will depend on the amount of daily FX purchases. In our view, a daily volume of $50mn (as was noted by unnamed government officials on Bloomberg today) would not have a major negative implication for the rouble in 1Q due to the expected favorable balance of payments dynamics during that period.

? In the longer run, during the course of this year, we expect the rouble to converge towards our annual average forecast of 62.5 against the dollar.

? We also expect the intervention mechanism to reduce the rouble’s volatility, which would make it even more attractive as a carry trade, in our view.

 ? The decision on interventions will be either neutral or marginally more favorable for the monetary policy, in our view. We are not changing our expectation for a policy rate cut by the CBR at the second meeting of 2017, on 24 March.

Russian USDRUN Intervention Mechanism, FX Purchases explained by CS

? In our view, it makes sense to resume regular FX purchases due to (1) the strengthening of the rouble in REER terms, (2) the decision of the government to save windfall oil and gas revenues, and (3) higher oil prices.

? We expect the mechanism of regular FX purchases in 2017 to replicate the fiscal rule (which will be approved by parliament in 2018), with the parameters of the FX purchase mechanism being reset on a monthly basis.

 ? The CBR is likely to be in charge of regular FX purchases in 2017, while the Finance Ministry is likely to take over in 2018-2019, if the Brent oil price stays above $50/bbl.

 The rouble’s response to the announcement of the details of FX purchases will depend on the amount of daily FX purchases. In our view, a daily volume of $50mn (as was noted by unnamed government officials on Bloomberg today) would not have a major negative implication for the rouble in 1Q due to the expected favorable balance of payments dynamics during that period.

? In the longer run, during the course of this year, we expect the rouble to converge towards our annual average forecast of 62.5 against the dollar.

? We also expect the intervention mechanism to reduce the rouble’s volatility, which would make it even more attractive as a carry trade, in our view.

 ? The decision on interventions will be either neutral or marginally more favorable for the monetary policy, in our view. We are not changing our expectation for a policy rate cut by the CBR at the second meeting of 2017, on 24 March.

Russian Oil Revenues, Budget Outlook and USDRUB levels

Inflation in the week to 16 January slowed to 0.1% wow, from 0.3% wow in the first nine days of January. On our estimates, headline inflation was 5.3% yoy as of 16 January, down from 5.4% yoy in the previous week. We expect headline inflation to drop to 5.1%-5.2% yoy in January. In its meeting last Monday (16 January), the government decided not to spend windfall oil and gas revenues. According to Finance Minister Siluanov (who revealed this news yesterday), the government made a decision to save extra oil and gas revenues from higher oil prices, instead of spending it. According to the government estimates, the government will receive additional RUB 1tn (1.1% of GDP) with the average Urals oil price at $50/bbl, or RUB 1.4tn (1.6% of GDP) with the average Urals oil price at $55/bbl. (In the federal budget law, the government assumes average Urals oil price at $40/bbl in 2017- 2019.)

The decision to save windfall oil and gas prices is favorable for the prospects of the policy rate cut by the central bank (CBR) and for sovereign credit (as Russia would not use its declining fiscal reserves for financing the deficit). Although the government is unlikely to reduce net OFZ issuance in the local market (according to the law the government will increase net issuance to 1.2% of GDP in 2017 from 0.5% of GDP in 2016), the CBR’s more accommodative policy will support demand for OFZ from local investors. In our view, the decision should be taken positively by fixed income investors. Another near-term implication of this news is that the market should price in a policy rate cut as early as in the next rate-setting meeting (on 3 February).

We are not saying that the CBR will cut the policy rate at that meeting but the likelihood of such an outcome has increased to around 25%, in our view. We are still expecting the first policy rate cut in the second meeting of 2017 (on 24 March). The CBR may consider regular FX purchases for the replenishment of Russia’s FX reserves, if the scenario with higher oil prices materializes. Such FX policy will be coordinated with the Finance Ministry, in the absence of a fiscal rule. Although this news (revealed yesterday) is in line with our expectations, it does not provide us with any new information about the conditions under which the CBR will resume regular FX purchases. However, we reiterate our view on that issue.

We expect the CBR to resume FX interventions (to buy FX) in 1Q 2017, as it did in 2015, when the rouble strengthened beyond 50 against the dollar. Our view is based on the idea that, in real effective exchange rate terms, the rouble is trading as strong as in 2015. In 2015, the CBR held volume-based intervention in the amount of $200mn a day (for more than two months) and purchased roughly $10bn in the local FX market. In our view, both, the CBR and the government are quite sensitive to potential further strengthening of the rouble (especially in real effective exchange rate terms). In our view, the CBR will be reluctant to allow the rouble to strengthen beyond 57-58 against the dollar.

G10 FX, USD Strength, EURUSD and Oil Currencies

USD: Higher longer dated UST yields benefiting USD against EM FX The focus of the week is on the Dec FOMC meeting (Wed) which should be neutral / modestly positive for USD. The 25bp rate hike is all but priced in, hence the price action will be largely driven by the new set of FOMC forecasts and Chair Yellen’s press conference. Should the Fed convey the message that it is willing to run the economy hot (with higher growth and inflation projections, yet largely unchanged interest rate forecast), this would likely add to upward pressure on longer dated UST yields and benefit USD particularly against higher yielding currencies, as well as JPY where the BoJ yield curve control allows for a clear policy divergence. US Nov CPI (Fri) should also help the USD as prices are expected to increase to 1.8% YoY. As for today, higher oil price translating into higher UST long-end yields should be USD positive against most of EM FX.

EUR: Consolidation after last week’s large decline We expect EUR to consolidate today following the large decline after the ECB December meeting last week. The news that the Italian Foreign minister Paolo Gentiloni was asked to form a government is modestly EUR positive to the extent to which it shows a commitment to resolve the current political uncertainty without a delay. Yet, the focus still remains on the Italian banking sector particularly after the ECB reportedly rejected Bank Monte Paschi’s request for more time to raise capital. This in turn should prevent any EUR rally at this point.

Oil currencies: Non-OPEC and Saudi production cuts benefiting oil FX The spike in the oil price following (a) the agreement of non-OPEC countries to join OPEC and cut output next year; (b) Saudi Arabia commitment to a larger cut than previously agreed have benefited oil exporting currencies such as NOK, RUB or MXN. For NOK, the another leg in oil price higher all but rules out any easing from NB this week. 

resim2
Russian Central Bank keeps interest rate unchanged, likely to slash rates early next year
Russian central bank kept its key interest rate on hold at the monetary policy meeting held Friday, but said it might cut rates in the first or second quarter of next year.

Russia’s central bank decided to hold its key interest rate unchanged at 10.00 percent, the bank said in a statement on its website on Friday.

“The Bank of Russia will assess inflation risks and compliance of economic performance and inflation with the baseline scenario when it makes its key rate decision in the upcoming months,” Reuters reported, citing the statement of the Bank of Russia.

With moderately tight monetary policy, the bank forecasts that annual growth in consumer prices will be less than 4.5 percent in October 2017, dropping to its target of 4 percent by the end of that year.

But the bank warned there was still a risk that its target might not be met because of domestic inflation expectations, a possible weakening in household saving, and higher real wages not supported by any rise in labour productivity, Reuters reported.

Meanwhile, the next rate setting meeting will be accompanied by a news conference with Elvira Nabiullina, the central bank governor, and is scheduled for Dec 16.

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Central Bank of Russia This Week and the RUB

 

This week the main event is the central bank’s (CBR) rate-setting meeting on Friday (28 October). We do not expect the CBR to cut the policy rate this year, in line with the CBR’s previous statement, in which it ruled out further policy easing until 1Q-2Q 2017. Although the CBR has ruled out any policy action in 2016, it does not mean the meeting will not be watched closely by investors. In our view, in its statement, the CBR has to find the right balance between the impact of higher oil prices, recent recovery in consumer demand indicators (especially against weak supply-side data) and the recent fiscal policy discussions (that eventually may not be as favorable for the CBR’s 4% inflation target). We believe the CBR is going to play down the sustainability of the recent recovery in oil prices while focusing more on the latter two factors (real sector data and fiscal policy discussions) as a significant risk to its 4% inflation target in 2017. In our view, the impact of the actual inflation data on the CBR’s stance should be either neutral or negative, mainly because there was no favorable pass-through to inflation from the stronger rouble. Overall, we think that the CBR’s statement will be more hawkish than the previous one.