Junk Russia Bonds Mirror Ruble Drop as Sanctions Bite

(Bloomberg) -- Russia's bonds resumed declines as fresh sanctions on the nation's central bank and a downgrade of its credit rating to junk sent investors rushing for safety. 

Yields on some of the nation's biggest dollar debt have doubled this month, while bond traders have been hampered by wide price gaps in the market. The turmoil was mirrored in the ruble, which plunged nearly 30% as traders struggled to price the currency amid an initial lack of liquidity. Quotes were infrequent and volatile at the start of the session, and traders warned that low liquidity was making it difficult to match buyers and sellers. 

Sweeping sanctions and capital controls have wiped billions from the value of Russian assets and fueled volatility in trading. Russia more than doubled its key rate to 20% on Monday and banned residents from transferring hard currency abroad. 

Russia has become “an investment pariah,” said Timothy Ash, strategist at BlueBay Asset Management, which slashed its Russian debt holdings before the Ukraine invasion. “How can they intervene, given a lot of reserves are now caught up in sanctions? The only option is massive rate hikes.”

Bond Stress

The yield on Russia's $7 billion dollar debt due in 2047 jumped to 8.3% on Monday, doubling from levels seen at the start of February. Yields on bonds due in 2035 topped 18%, the highest since they were issued nearly three years ago. 

Meanwhile, Russia's $1.25 billion bond due 2032, which last traded on Friday at 66 cents on the dollar, has indicative bids that have plummeted to the high 30 cents on the dollar, while offers range from the mid 40s to 70 cents, according to data compiled by Bloomberg. 

Upcoming coupon payments will also be in focus for any clues on Russia's ability to service its debt. The next payment is due March 31 for the March 2030 bond, while one for its $7 billion June 2047 securities -- the biggest among the nation's outstanding dollar-denominated bonds -- is due on June 23. 

Another risk is that Russian bonds get removed from JPMorgan's Government Bond-Emerging Markets Index, a key benchmark used by institutional investors. Goldman Sachs Group Inc. said it's possible given potential additional sanctions on Russian banks' access to SWIFT as well as on the central bank, strategists including Danny Suwanapruti wrote in a note. The JPMorgan EMBI Global Diversified Russia Index plunged more than 30% last week. 

Russian stocks' exclusion from indexes is already up for discussion. MSCI Inc. is consulting with clients to understand the implications of sanctions against Russia on markets, said Dimitris Melas, MSCI's head of index research and chair of the Index Policy Committee. While no decisions have been made yet, one possible outcome could be removing Russian assets from MSCI indexes and making it a standalone market

The cost of insuring Russia's government debt spiked to a record, with credit-default swaps insuring $10 million of the country's bonds for five years signaling around 56% likelihood of default, according to ICE Data Services. ICE is the main clearing house for European CDS.

Russian Swaps Signal Record 56% Chance of Default on Sanctions

Trapped by Sanctions

While Russia's efforts to limit dollar exposure in its economy and financial markets have blunted previous sanctions, investors said moves to limit the nation's access to SWIFT and to target the central bank's assets may end up being far more damaging. 

Russia has amassed record surpluses, as well as a war chest that includes gold reserves and liquid wealth of about $1 trillion, according to estimates by Credit Suisse Group AG strategist Zoltan Pozsar. 

SWIFT Russian Ban Could Force Fed to Step In, Credit Suisse Says

He estimated that about $300 billion is held in foreign-exchange swaps and deposits in foreign banks, and could be potentially trapped by sanctions. That may further restrict the country's ability to access funds.

“Sanctioning central bank reserves can turn a surplus agent into a deficit agent overnight,” Pozsar wrote in a separate note Sunday. “The Bank of Russia has neither Treasuries to repo with the new FIMA repo facility, nor dollar swap lines with the Fed, and if its assets are frozen, it can't raise dollars to provide for its domestic banks.”

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