Yields on Russian Federal loan bonds (OFZ), which on the background of aggravation of the conflict in Ukraine and falling oil prices jumped to January 2015 to nearly 14%, with a decrease in geopolitical and macroeconomic risks have returned to pre-crisis levels. By 2017, depending on the policy of the Russian financial authorities the yield on government bonds may fall below 8%, analysts expect Citi Research.
It all depends on the Finance Ministry
As experts explain, the decrease in the yield of OFZ due to current monetary policy. On the stabilization of inflation and weakening inflation expectations and risks in 2015, the Central Bank lowered its key interest rate from 11.5% to 11%, and in June of 2016 — 10.5%. Despite the fact that in July, the rate remained at the same level, Citi analysts expect its significant reduction by the end of 2017. “We continue to believe that the macroeconomic environment promotes the continuation of the policy of low interest rates by the end of 2016 and beyond. In particular, by the end of 2016 the rate will be reduced to 9%, and at the end of 2017 — up to 7%”, — expect they.
The second factor reducing the return — intention of the Ministry of Finance to increase borrowing on the domestic market in 2017, to obtain funds to cover the budget deficit. “Despite the successful adaptation of the Russian economy to low oil prices, the financial risks remain the most serious in the current environment”, says the Citi study. In 2015-2016, the main source of maintenance of the budget was the Reserve Fund, but by the end of the year, it may dwindle, and to reduce the budget deficit in 2017, the Ministry plans to increase borrowing to more than four times — up to 1.3 trillion rubles, 300 billion rubles in 2016. “This broad increase could exert excessive pressure on the OFZ market in the next year,” predict analysts at Citi.
They note that the Finance Ministry can still resort to other methods of covering the budget deficit. If it deems that the borrowing will cause a too strong impact on the profitability of long-term bonds, the Finance Ministry may try to use the national welfare Fund (NWF). In addition, the “pleasant surprise” for the Agency may be income from privatization deals, experts add Citi.
“The struggle between the expected massive reduction of the key rate and the serious increase in domestic borrowing creates uncertainty about the level of interest rates in the long term. Even if the Ministry of Finance will be able to find alternative sources of covering the budget deficit in 2017, not to increase the volume of borrowing on the domestic market, we believe that due to the almost complete depletion of the Federal reserve and increasing deficit in 2017, the Ministry of Finance in any case have to increase the amount of accommodation. This should be taken into account when estimating the probability of a decline in the yields of OFZ bonds in 2017,” the Citi analysts conclude.
The baseline scenario
In the case of a phased reduction in the key rate to 7% by the end of 2017, increasing the volume of borrowing on the domestic market in 2017, four times (up to 1.3 trillion rubles) and a slight increase in the US yields (up to 1.65% by the end of 2017 OFZ yields will be reduced from 8.42% at the moment to 8.13% by the end of 2016 and to 7.98% by the end of 2017, analysts estimate.
The smallest decline
With this scenario, the “less persistent” monetary policy easing than in the baseline. “If the Central Bank will not reach the target inflation of 4% by the end of 2017, we expect that it will lower its key rate only to 10% by the end of 2016, and to 9% by the end of 2017,” the analysts explain. This scenario is possible during the next rise in oil prices and, as a consequence, the weakening of the dollar and deflationary processes. It is also possible, if the monetary policy easing will provide for an increase in budget expenditures in the upcoming parliamentary and presidential elections in 2016 and 2018.
In this case, the price of OFZ will not change, and their profitability will remain at previous levels by the end of 2016 it will be reduced only to 8.23% (8,13% at baseline scenario), and by the end of 2017 will return to the level of 8.42% (7,98% — when the baseline scenario).
The largest drop
Citi analysts consider this scenario under the condition that the volume of net borrowing on the domestic market in 2017 will remain at 2016 year — RUB 300 bn. In this case, the yield of OFZ reduced to 8.06% by the end of 2016 and to 7.21% by the end of 2017.
These scenarios are too conservative, says principal analyst debt markets Bq Region Alexander Ermak. In his opinion, in a favorable external environment on the long end of the curve OFZ yields could fall below 8% this year and by the end of 2017 to be 6.5–7%.
In the UK of the savings Bank expect a sale on the OFZ market before the end of the year. Head of division management securities with fixed yield “Sberbank asset Management” Evgenie Korovin has noted that retains concerns about oil, the rouble and dollar rates and global risk appetite. “The majority is sometimes wrong,” said Bloomberg, commenting on the actions of putting on the continuation of the rally in emerging markets investors.
