Despite the new round of anti-Russian sanctions and the increase of global turbulence in the first half of August, the OFZ market remains calm. We believe that it still contains fundamental value as inflation continues to slow down in Russia, which creates ground for further rate cuts and this fact attracts a wide range of investors. At the same time decelerating demand for ruble sovereigns from local institutional investors may make OFZs more sensitive to external factors in the near future. If the ruble continues to weaken, we do not rule out that a significant part of foreigners may take profit in OFZs, potentially pushing the yield curve higher even this year.
- Russian institutional investors increased their OFZ holding in 1Q19 by R28 bln. This is better than a year ago (by R2 bln in 1Q18), but the relative share of ruble sovereigns in their portfolios slightly decreased during first three months of the year (from 24.5% to 24.1%). The pace of growth of their OFZ holdings is likely to decelerate further and the net demand from their side may become marginal in 2020.
- The share of international investors on the OFZ market decreased slightly (from 30.8% to 30.2%) in July due to the large technical placement of ruble sovereigns. Foreigners are keeping their positions in OFZ (despite a certain depreciation of the ruble) in anticipation of further rate cuts and due to overall positive expectations regarding global liquidity. However, if, for any reason, the local currency continues to weaken, we may see some foreigners start taking profit and move their money away from the OFZ market. It may create an upward pressure on the yield curve.
- Banks’ holdings of OFZ are still fluctuating around the level seen at the start of the year. However, these investors still hold about R1.5 trln in OBR and these funds could, in theory, be used for OFZ purchases.
- Finance Ministry has very comfortable schedule of the placement for the remaining part of the year, but in 1Q20 the amount of issuance should go up, which may provoke additional volatility of the market.
Demand from Russian institutional investors is weakening
Traditionally, the CBR publishes the data on Russian institutional investors holdings of OFZ with a significant delay. For example, the most recent stats published in end-July describe the situation as of the end of 1Q19. According to the data, the aggregated net purchases of OFZ by non-state pension funds and insurance companies amounted just to R28 bln. This is better than a year ago (R2 bln in 1Q18), but the relative share of ruble sovereigns in their portfolios slightly decreased during first three months of the year (to 24.1% from 24.5%). The latter can be explained by a seasonally high pace of growth of their assets in Q1, which are later distributed from deposits to other assets.
To remind, last year the OFZ holdings growth by Russian institutional investors was registered mostly in 2Q-3Q. However, this year we expect a more moderate increase of their investments into ruble sovereigns than in FY2018 (R718 bln). There are three major reasons for that:
- A slower growth of their assets (6% in 1Q18 vs 3% in 1Q19).
- A saturation of demand for OFZ on the level of pension savings (24% in OFZs).
- Smaller issuance of investment insurance, where OFZs were widely used as a base asset.
Nevertheless, as the regulator continues stress-testing of pension savings and biggest insurance companies, and also as the cash received in 1Q19 is being redistributed, we may see some R200-300 bln additional demand for 2Q-4Q19. However, we suppose that growth of investments in OFZ (76.5% in 2018 and expected 17% in 2019) may decelerate in 2020, potentially making the OFZ market more sensitive to external factors as Minfin’s appetite for issuance is likely to remain strong in 2020, while domestic demand may be more moderate.
Internationals are still buying OFZs
According to the CBR data, international investors were buying OFZs in July, but much smaller than before. Their net purchases of OFZs amounted to just R36 bln last month, the lowest monthly result this year. The share of foreigners on the OFZ market fell to 30.2% from 30.8% due to the technical OFZ placement of R212 bln in favor of VEB. A slower growth of ruble bonds holdings by internationals can be explained, on the one hand, by a moderate supply of the new paper on the primary market. To remind, the Finance Ministry fulfilled the most part of its annual borrowing plan in 1H19 and since the start of the summer it returned to the earlier practice of setting limits for offering in a single auction day. The idea behind this is to distribute the remaining amount of unplaced sovereigns more evenly within the rest of the year. For example, in July – August it offered just up to R20 bln in sovereign bonds every Wednesday. As a result, the amount of issuance contracted significantly (R86 bln in July vs R109 bln in June and R375 bln in May).
On the other hand, the demand from foreigners seems to have been largely saturated. Their OFZ market share of 30% looks reasonable and we do not think it may significantly increase in coming months. Of course, the market expects the interest rates in Russia to move down further as inflation decelerates quickly. At the same time, the market already prices in (as futures are showing) at least one rate cut until the year-end and hence the potential for the further compression of the yield curve is not so obvious. Simultaneously, the ruble started to depreciate, which is not a big surprise, and as we indicated in the previous notes it just rather moved to the more natural range of USD/RUB 65-70. Internationals who were actively buying ruble bonds in March – June, when the exchange rate was fluctuating between 63 and 65,5, are now losing some part of their profit due to the weaker ruble dynamics. However, if, for any reason, this trend continues (let’s say the USD/RUB climbs to 68-69), then we may see some foreigners start taking profit and move their money away from the OFZ market, pushing the yield curve up 30-50 bps due to the selling pressure.
Banks still have potential
Banks’ holdings of OFZ are still fluctuating around the level seen at the start of the year. The latter can be explain by a tight premium the ruble sovereigns are offering over the cost of funding for commercial banks – too small to attract significant demand from their side. However, these investors are still holding about R1.5 trln in OBR (bonds issued by the CBR to manage liquidity issues), which could, in theory, be used for OFZ purchases (if necessary). In our view, commercial banks may be stimulated to invest in OFZ in 2020 if the Finance Ministry faces insufficient demand for these papers.
Comfortable position for Finance Ministry
As we mentioned above, the Finance Ministry placed R212 bln of OFZ (at 18.5% of par) to finance the transfer of Sviaz-bank from the balance sheet of VEB to Promsvyazbank. VEB solely bought the full size of the issue. As a result, the budget raised additional R40 bln and hence the Finance Ministry decided to cut the borrowing program for 2019. To remind, it was initially set at R2.7 trln gross (or R1.7 trln net). After the recent revision of the budget it was cut to R2.3 trln, which means that the government need to borrow about R878 bln in 2H19 (or R813 bln in the last five months of the year).
But this amount needs to be adjusted for the non-execution of the Russia-30 buyback ($4 bln), the R40 bln mentioned above and the proceeds from the sovereign Eurobond placement, which was above the plan (about R213 bln). As a result, the remaining quota for OFZ issuance is lower than R304 bln (or R14.5 bln per every single auction day). The latter seems to be very comfortable for Finance Ministry, which can easily cut the amount of placement during the periods of market instability and in such a way prevent the growth of borrowing costs. Moreover, in the best case scenario the limited supply on the primary market may fuel the activity on the secondary market and even to push yields down.
On the one hand, the situation is favorable for the borrower, which may keep full control over the cost of funding. On the other hand, the amount of issuance should sharply increase in the beginning of 2020, when the new borrowing plan starts. Hence, the risk of a higher volatility may emerge on the market in 1Q20.
Data provider: Cbonds