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Local sovereign debt: in the red as liquidity dries up

Friday's price action in the OFZ market was negative, driven by the rating downgrade and the CBR's rate hike. On average, bonds on the long end lost 2.5-3.0pp, price-wise, with RFLB 28 closing at a yield of 9.70%. On the belly, prices dipped near 2.00pp with RFLB 19 6.80 ending at a yield of 9.28%. Finally, bonds in the front end lost 0.50-0.75pp, in price terms. At the same time, liquidity in the market quickly deteriorated, so Friday's final price action was more of a guessing game rather than trading. Overall, the OFZ curve shifted up 40-50bp in almost a parallel move with the 2s10s spread which remained near 100bp. We consider that the curve will probably see the long-end heading to 10%. Overall, the spread to repo at 250bp in the long-end looks close to the historical average. At the same time, the relatively flat shape of the OFZ curve could stay intact, because the Ministry of Finance is likely to continue to refrain from active borrowing. Overall, the OFZ market looks to be in a stalemate at the moment. On the one hand, local banks are unlikely to increase the bid for local bonds right now due to low premium to the cost of repo, negative spread to XCCY swap curve coupled with lack of new issuance in the belly and front end (bad liquidity wise). On the other hand, international investors are not going to increase the holding of OFZs amid continued political volatility, while FX does not look cheap enough. In addition, th Ministry of Finance would likely continue its policy of zero new issuance, but in 2H14 it would still have to return to the market, at least to refinance maturing bonds.
Maxim Korovin, Anton Nikitin
VTB Capital analyst


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