Expecting Strong Steps in Europe

Vladimir Malinovsky
Head of Fixed Income Research
Otkritie

The upward market trend that was observed in the Russian debt market from January to March transformed into consolidation in April. Despite investors’ quite optimistic market perception, further downside yield movement in the Russian ruble-denominated market was rather limited. Many investors had already formed their investment portfolios and were not ready to buy the notes at yields that sometimes were lower than in pre-crisis times. Thus, investors’ activity gradually declined through April, while the yields of ruble-denominated notes fluctuated within quite a narrow range.

More active movements were observed in April in the Russian eurobond market. Two major factors impacted the trend. Firstly, the placement of Russia’s sovereign eurobonds had a quite positive influence on the notes’ prices. The interest that investors worldwide showed in the placement led to high demand for sovereign eurobonds in circulation, as well as for Russian corporate notes. Particularly, in April, Russia-30’s yield decreased from 5.02 percent at the beginning of April to 4.78 percent after road show presentations were completed, while in the same period Evraz-15’s yield dropped from 7.6 percent to 7.1 percent.

Secondly, throughout April, the situation with Greece and other indebted countries gradually increased its negative influence on the global market. Investors’ concerns were primary connected with the financially weak countries’ potential inability both to refinance their debt in the current market conditions and, thus, to redeem the notes. The above resulted in a global sell-off, particularly of Greece, Portugal and Spain’s notes, while later price correction also reached the notes of other countries, which investors associate with rather high risks. Particularly, the yield of Greece’s two-year notes has grown from 5 percent to about 20 percent in the past two weeks.

Russian eurobonds also experienced a sell-off. Russia-30’s yield rose to 5.20 percent by the end of April after it stood at 4.78 percent at the end of the road show presentations. At the beginning of May, Russia-30’s yield reached 5.7 percent.

In our view, Greece’s situation resulted from market speculations and partly from “black PR.” It is known that many developed countries including European countries, the United States and Japan, have quite high debt burden and refinance their debt by issuing new notes. In the same way, Greece could have earlier placed notes to refinance the old ones, but speculations with the situation frightened investors and made the cost of debt unbelievably high for the country. As a result, Greece had to ask the European Central Bank and the International Monetary Fund for a rescue package in order to be able to issue new notes at an acceptable interest rate.

We assume that in May the situation will be quite nervous and perhaps unstable. The reason is that, to overcome the negative trend in the market, European countries have to make large-scale, principal decisions that may lead to changes in approaches to both decision making and finance management within the European Union. These decisions are not made immediately, may require long discussions and negotiations, may be perceived by investors as insufficient, and so on. The above may result in high volatility for both equity and bond markets. On the other hand, the current complicated situation requires quick operational decisions. Thus, investors should understand the ways out of the current local crisis by the end of May, which in turn will allay investors’ fears and reduce market volatility. We recommend taking a cautious approach now to purchases of the undervalued notes, and we do not rule out that these notes may become more attractive in the near future.