Renewed demand for Russian domestic OFZ treasury bills a barometer of improving sentiment towards Russian assets

Renewed demand for Russian domestic OFZ treasury bills a barometer of improving sentiment towards Russian assets
Russia's MinFin just sold another record $1.3bn worth of domestic OFZ treasury bills, mostly to foreigners, as investors go "risk-on" again
By Ben Aris in Berlin April 11, 2019

Russia’s Ministry of Finance held yet another successful weekly auction of its ruble-denominated OFZ treasury bills. The Ministry planed RUB137bn ($2.2bn) worth of OFZ bonds at a weekly auction of April 10. The ministry sold 10-year OFZ bonds at RUB87bn at 8.34%, and 5-year issue worth RUB50.4bn at 8.13%. The demand at the auctions was at high RUB192bn, even though the ministry proposed no premium to the secondary market on the yields.

The weekly placement of RUB137bn accounts for almost a fourth of ministry's quarterly OFZ sales plan of RUB600bn and set up yet another weekly record beating the previous sale of RUB91.4bn of March 13.

The OFZ market has seen a remarkable turnaround from last year. The high yielding, low risk OFZs were a bond traders' favourite at the start of 2018 but as sanction fears grew there was a big sell off in the bonds over the second half of the year. The share of OFZs held by foreign investors tumbled from 34% in April to end the year at 25% after bond investors sold off some RUB500bn worth of the paper. At the same yields climbed from just over 8% to touch 9% leading Russia’s finance ministry to cancel several auctions in the autumn because of lack of demand, while the ministry was unwilling to increase the yields to the level demanded by investors that would have cleared the market.

However, since the start of this year, and especially since March, the market has picked up significantly as it became clear the US Federal Reserve bank has halted its tightening policy and may even ease US rates this year due to an economic slowdown.

The International Monetary Fund (IMF) reduced its projection for global growth in 2019 by 0.2 pp to 3.3% y/y on April 10, which would be the lowest growth rate since the financial crisis. The 2020 growth forecast remained at 3.6%.

“Both estimates for developed and emerging markets for 2019 were cut on the backdrop of a synchronized slowdown in many markets in H2 2018 and multiple risks going forward (e.g. Brexit, trade frictions),” RZB said in a note.

Combined, these changes have made investors “risk-on” and “yield-hungry” again and given Russia’s rock solid macro fundamentals, Russian OFZ is one of the first port of calls. Russia’s bonds are about as safe a bet as it is possible to have in the bond world as Russia's Fx/gold reserves reached $487.8bn as of April 1, 2019, according to data from the Central Bank of Russia (CBR), their highest level since 2014 when the sanctions regime began. The level of reserves is now so high that Russia for the first time ever can cover its external debt dollar-for-dollar in cash. And that is in a world where many of the leading central banks have interest rates close to zero and are running debt-to-GDP ratios in triple figures.

According to bne IntelliNews' Kremlin sources, the Kremlin is as worried about a fresh international debt crisis in the west as it is about more sanctions, so it has been selling off its US assets and accumulating gold reserves as part of its gross international reserves (GIR) as fast as it can.

All this has been driving foreign demand for OFZs where the auctions have seen record sales in the first months of this year. As the chart shows there has been a sharp upswing in the share of foreigners holding OFZs this year, which is now back to 30% and on course to overtake its previous record of 34% this year.

A further driver of bond investor interest is while big western economies are flirting with recession, growth in Central and Eastern Europe (CEE) is holding up much better. The IMF predicts economic growth in Germany this year will be only 0.8% y/y, which is below expectations. The CEE region will see more balanced growth: the IMF increased its 2019 growth forecast for Poland to +3.8% y/y, Hungary to 3.6% and Bulgaria to 3.3%, while cutting the 2019 expectations for Czech Republic to 2.9%, Slovakia to 3.7%, Romania to 3.1%, Belarus to 1.8% and Russia to 1.6%.

“Overall, the Fund sees Central Europe growth at 3.5% in 2019 and 3.0% in 2020, South-East Europe at 3.1% both in 2019 and 2020, and Eastern Europe (including Russia) at 1.6-1.7% y/y," RZB reported.

Bond investors at this week’s finance ministry auction mainly bought the long dated 10-year bonds, but the ministry also sold RUB50.4bn worth of the shorter dated July 2024 OFZs.

“The repositioning of foreign investors in OFZ helped to boost the investor appetite, which allowed the ministry to sell record amounts of OFZ this time,” RZB said in a note. “We believe that the type of non-residents entering the OFZ market today has changed in favour of more risk-tolerant funds while conservative investors already left the market last year. This helps OFZ rally and explains fewer worries about possible sanctions against the Russian state debt in future.”

RZB says that the expected appreciation of the Russian ruble this year has also help the appeal of the bonds – the ruble is down 7% against the dollar this year and currently trading at RUB64.8 to the dollar, but with oil prices jumping to $71.1 this week on the back of renewed fighting in Libya the rate is expected to rise and will be further supported by a renewed OPEC+ production cut deal expected this month. Taking all this into account, RZB predicts that the yields on OFZs will fall further to approach 8% as the OFZ yields have effectively become a sensitive barometer of sentiment towards Russia that has so far been steadily improving.