Russian state bonds were the big winners from the reforms to the capital market put in place in 2012 when Russia’s capital market was hooked directly into the international capital market and settlement and clearance through Euroclear became possible. Between 2012 and the end of 2013 the foreign-owned share in the OFZ (Obligatsyi Federalnovo Zaima, or Federal Loan Obligations) market skyrocketed from 4% to 27%.

The foreigner share of the OFZ issued declined from about 26% to 24% in the first quarter of 2014 as tensions over Ukraine and especially after the annexation of Crimea worried investors. Demand by foreigners was just starting to recover when there was fresh panic selling after the EU and US imposed sanctions on Russia.

But in a zero interest rate world, the 11% yield on Russian bonds remained too tempting and by the end of 2015 the non-resident share was back to 31%, the emerging market average, after an extremely strong rally in the last two months of last year that was strong enough to depress yields to 9.5% at the end of December. VTB estimates that $1.5bn of investment flowed into Russian sovereign ruble bonds in those two months alone from abroad. However, as the new year opens, analysts are speculating that the rally may have run out of steam.

"We feel that the pace of international inflows is set to moderate as 1) the bulk of accounts seem to have a market-weight positioning in OFZs, and 2) the case for being overweight [expecting aggressive interest rate cuts in 2016] has become less convincing because of the latest leg of crude oil weakness," Maxim Korovin, an analyst with VTB, wrote in a report on January 4.

Oil prices dropped dramatically in the first week of January to reach an 11-year low of $32 as of January 7, which is significantly worse than forecasts and will undermine Russia's economic recovery in 2016.

While foreign investors remain very important to the Russian bond story, Russian investors – mostly big banks – hold the largest part of the bonds. Here the pain that banks are feeling has squashed demand for more bonds.

Domestic banks took advantage of the end of year rally to sell their holdings and remain very sensitive to the cost of the carry trade with bonds: most of Russia’s long-dated bonds have yields that are half of the Central Bank of Russia (CBR) overnight rates. With the hopes of dramatic cuts in the policy rates fading with the fall in oil prices, banks are unlikely to bid on new bonds until the CBR has managed to close the gap between its policy rate and the yields on bonds to something more manageable.

Another big buyer of OFZ are the pension funds but as the government decided to freeze the transfers to pension funds there will be little new money going into the bond market from this source for the moment.

"There will be some flows from the State Pension Fund (PFR) to private funds in 2016 as the ‘pick-your-manager’ campaign was due to end this year," writes Korovin, "however, Pillar II pension managers tend to be underweight OFZs (only 5% of the portfolio) vs. 18% in PFR’s case."

All in all, local investors seem reluctant to add new bonds to their portfolio, while foreign investors enthusiasm for OFZ is fading, concludes VTB.