Russian Bonds Retreat Before Long-Awaited U.S. Sanctions Report

(Bloomberg) -- Russian bonds slid, with some yields climbing to the highest in two months, and UBS Group AG recommended taking profit on the ruble before a U.S. Treasury report gauging the impact of possible sanctions on the nation’s sovereign debt.

The review due Monday has been the biggest headwind for investments in Russia’s $120 billion ruble debt market since it was reluctantly commissioned by Donald Trump in August as allegations of Kremlin election meddling swirled. While the report could serve as a basis for what M&G Ltd. has called the “nuclear option” for U.S.-Russia relations, most investors attracted by Russia’s outsized real rates don’t see debt sanctions as a base case scenario.

“During our trip to Moscow at the beginning of the year, nearly every single meeting contained some discussion of the potential expansion of U.S. sanctions in the nearest future,” Vladimir Osakovskiy, an analyst at Bank of America Merrill Lynch said in a research report last week. But “the risk of an escalation of sanctions is currently perceived as low,” he said.

The yield on Eurobonds maturing in June 2027 increased 10 basis points to 3.97 percent, the highest since Nov. 29. Ruble bonds also slid, with the yield on 5-year notes climbing two basis points to 7.01 percent. The cost of insuring Russian debt through five-year credit-default swaps rose for a second day, and the ruble retreated.

UBS Strategists Jonas David and Michael Bolliger shifted their ruble recommendation on Monday from overweight to neutral, citing the sanctions report, which they said could trigger “some market volatility.” They also said that the currency could be hurt by foreign currency purchases by the finance ministry and a correction in oil prices.

Politically Damaging

As well as the state debt report, the Treasury is also due to release a list of Kremlin-connected businessmen, which is expected to amount to a blacklist of Russia’s elite. “We’re going to move forward on the sanctions legislation and meet our statutory obligations,” White House spokesman Raj Shah said during an interview on CNN.

Restrictions could hurt foreign investors who hold more than a third of Russia’s local and international sovereign bonds. BlackRock Inc., Stone Harbor Investment Partners and JPMorgan Chase & Co. are the three biggest holders of ruble debt with investments totaling about $4.9 billion, according to data compiled by Bloomberg.

“The Treasury may conclude that sanctioning Russian government securities would be too damaging politically to the U.S.–Russia relationship as well as to U.S. investors and businesses,” Otilia Dhand, an analyst at Teneo Intelligence said in a report last week.

Limiting Fallout

Russian officials have sought to downplay the possible fallout from potential penalties. Foreign investors can easily be replaced by local buyers in the event of sanctions, central bank Governor Elvira Nabiullina said in November. A month later she said the lender could purchase bonds itself to limit damage.

A mild report could put Russian bond markets in the clear to continue a rally fueled by rising oil prices last year. Moody’s Investors Service raised its outlook for Russia to positive from stable on Thursday, raising the prospect for an upgrade out of junk if the sanctions threat is removed. S&P Global Ratings also rates Russia one notch below investment grade and is due to review its assessment next month.

“There should be no extension of sanctions to sovereign debt and this should fuel moderate support for the OFZ bond market,” said Sebastien Barbe, the Paris-based head of emerging-market research and strategy at Credit Agricole CIB, referring to Russia’s ruble bonds. Barbe is the most accurate ruble forecaster in the past three quarters, data compiled by Bloomberg show.

To contact the reporters on this story: Ksenia Galouchko in Moscow at kgalouchko1@bloomberg.net, Natasha Doff in Moscow at ndoff@bloomberg.net.

To contact the editors responsible for this story: Celeste Perri at cperri@bloomberg.net, Dana El Baltaji at delbaltaji@bloomberg.net, Alex Nicholson, John Viljoen

©2018 Bloomberg L.P.