LONDON, April 11 (Reuters) – Some of the world's highest inflation-adjusted returns may not be enough to protect Russian bonds from the sale of rubles that has seized the markets since the United States imposed new and harsh penalties.
The ruble fell almost 10 percent since the end of last week and yields on 10-year bonds rose around 60 basis points, leaving investors exposed to Russian OFZ, as Treasury bonds are known, licking his wounds.
The trade was popular: before the mass sale, more than 70 percent of emerging debt funds were OFZ "overweight" in relation to the weight of Russia in the GBI-EM bond index, and 95 percent One hundred were overweight the ruble, Morgan Stanley estimates.
Foreigners owned 65 to 80 percent of long-term Russian debt, the bank said, while Russian central bank data from early February showed that non-residents held about 34 percent of the market, with a value of almost $ 40 billion.
The bonds were popular among foreigners due to a "real" yield of more than 450 basis points, the highest among the large emerging economies. Despite the decline in Russia's inflation, now well below the 4 percent target of the authorities, the central bank has reduced interest rates very gradually to 7.25 percent.
Those yields had helped investors obtain dollar-based yields of around 4.5 percent at the end of March, according to JPMorgan data. But the defeat of this week's ruble will erase them.
Analysts say that emerging market investors are unlikely to have hedged the exchange exposure, first, because they expected the ruble's appreciation to increase total returns and second, because the hedging costs would have eroded significantly the "carry" that were earning high yields.
"Given the stability of the ruble in recent months and the strength of Russia's external balances, many investors would have entered the market without coverage, which is probably the reason why they are seeing this reaction: a lot of exposure not covered, "said Kiran Kowshik, strategist at Unicredit.
"Yes, there is a yield cushion, but it assumes there are no losses in its capital, that loss can come from the side of the ruble if they kept the bonds uncovered."
Morgan Stanley observed that the instinctive reaction of investors had been the first to cut monetary positions, since that was the main detractor of performance, and predicted that "the next reduction could occur in OFZ "
It was eliminating its long-standing positive position in OFZ, he said, while another bank, JPMorgan, told clients that it had put its "structurally bullish view on (Russian bonds) and FX on pause."
The Russian Ministry of Finance, possibly fearing a lackluster absorption of investors, canceled its weekly bond auction on Wednesday.
So, how big could the damage be?
If all foreign money is rescued, yields will rise from 100 to 150 basis points, according to a note last December from the Bank of America Merrill Lynch, which had highlighted the extended sanctions as a "black swan" risk by 2018
Some see fears as exaggerated. Renaissance Capital said the ruble to 60 per dollar would add 0.4 to 0.5 percentage points to overall annual inflation, leading to a figure by the end of 2018 not out of date with its original 3.5 percent forecast.
It really comes down to the ruble. The currency is 11 percent cheap in terms of REER, against the currencies of trading partners and adjusted for inflation, JPMorgan acknowledged. But he also noted that emerging market losses tended to outstrip and declines widened.
One reason why the sale could be deepened is that unlike the previous sanctions, which only focused on new debt and capital, the latter prohibit investors from maintaining existing titles in sanctioned companies. That is causing fears that the government debt is next in line.
And if the weakness of the ruble passes to inflation, the central bank will have to stop, if not reverse, its rate reduction cycle. Finally, the authorities have effectively indicated that they will not stay in the way of their floating currency.
Paul Greer, deputy portfolio manager at Fidelity International, said traders in a declining Russian market had no choice but to quickly sell the largest amount of liquid assets to minimize losses: the currency.
"The tail risk (sanctions to the sovereign) has increased and that change has been reflected in market prices," he said.
"Then investors will continue to cover selling the currency, I hope the ruble depreciates and local yields on the debt continue to rise to reflect the higher risk premium in Russia."
Information of Sujata Rao; graphic by Ritvik Carvalho; edition
by Larry King