Russian Bonds Slump as ‘Nuclear Option’ of Debt Sanctions Raised

(Bloomberg) -- Russia's local bonds fell the most in three weeks on speculation the U.S. could target the nation's sovereign debt with a tougher round of sanctions over the poisoning and jailing of opposition leader Alexey Navalny.

Ruble-denominated notes dropped for the first time this week after Bloomberg reported President Joe Biden would consider imposing sanctions on Russia's bonds if it's again found to commit a major transgression of the international ban on chemical weapons, according to people familiar with the matter.

The threat of penalties has hung over holders of ruble debt, known as OFZs, for years, but after several false alarms, most investors stopped seeing it as a base case. Washington has stopped short of the measure in the past amid warnings it could destabilize global markets.

“The market is well aware of such a risk,” said Piotr Matys, a strategist at Rabobank in Moscow. “Targeting Russia's debt would be a major escalation of tensions between the West and Russia, and could be a step too far for at least some European Union countries.”

The Treasury Department warned in 2018 of global financial market turmoil if Russia's sovereign debt market were sanctioned because of how deeply tied the Russian market is to global indexes.

Since then the California Public Employees' Retirement System, or Calpers, has cut all of its bond holdings in Russia, according to Megan White, a spokeswoman for the largest U.S. pension. In 2018, the fund was one of Russia's 10th-largest foreign creditor, based on publicly disclosed figures.

Foreigners have reduced total OFZ holdings to about $40 billion from $47 billion a year ago. U.S. investors including Blackrock Inc, Vanguard Group and Legg Mason Inc. are still some of the biggest holders, according to publicly available data.

Mild Punishment

Russian bonds snapped a four-day rally, lifting the yield 11 basis points to 6.68% as of 6:24 p.m. in Moscow. While the ruble initially retreated on the news, the currency was one of the few gainers in emerging markets against the dollar on Friday as the price of Brent approached $70 per barrel.

Traders brushed off sanctions announced by the U.S. earlier in the week, which targeted a handful of officials. After multiple rounds of penalties, and continued evidence of Russian hacking and use of chemical weapons, Washington has been left with few options that would have a meaningful impact. A move to ban U.S. banks from buying new issues of Russian Eurobonds in 2019 did little to dent market pricing or the Kremlin's access to foreign funding.

Concern Russia could face tougher sanctions under a Biden administration picked up in June last year. The ruble is 4% weaker against the dollar since then, compared with gains of around 6% for commodity currencies and comparable emerging-market peers, according to Dmitry Dolgin, an analyst at ING Bank in Moscow.

“It's not like some kind of new, hitherto-unknown risks have emerged for the ruble,” Dolgin said. “Rather, we can say that greater foreign-policy coordination between the EU and the U.S. means the sanctions discount on Russian assets is very unlikely to decrease in the near future.”

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