Russian bonds sag on firm equities market

The Russian bonds tumbled on Thursday as Russian stocks climbed to the strongest level since May 2008. The benchmark 10-year bonds yield, which is inversely proportional to bond price rose 0.65 pct to 9.30 pct and 3-year bonds yield jumped 0.63 pct to 9.520 pct 0940 GMT.

The MICEX Index rose more than 1 pct to 196,075 as Russia’s energy producers Gazprom and Lukoil advanced more than 1.5 pct. Also, the Russian bonds have been closely following developments in oil markets because of their impact on trade balance and inflation expectations. The Brent crude oil, a global benchmark for Russia's main export, was lifted on hopes that key oil producers could agree on a production freeze this Sunday. The International Brent futures rose to $ 43.72 and West Texas Intermediate (WTI) jumped to $ 41.32.

At the start of 2016, projections were made for Russia’s inflation to reach 8% in 2016, said Commerzbank. The forecast was made on the ruble exchange rate weakening with subsequent pass-through effects on CPI, noted Commerzbank.

However, the oil price stabilization, along with lower CPI figures, which were mainly due to base effects, indicates that Russia’s inflation is expected to slow to 8% in 2016, added Commerzbank. Meanwhile, inflation is expected to be slightly lower at 7% in 2017, according to Commerzbank.

The altered projection of inflation will provide the Bank of Russia enough room to cut interest rates. The central bank has already shown a preference for lower interest rates. But the CBR is expected to avoid lower interest rates until the fourth quarter of 2016, though there is a possibility of cutting rates earlier, added Commerzbank. In fact, before beginning a rate cutting cycle, the central bank intends to see a continuous lower CPI prints.

“That being the case we think there is scope for rates to fall by around 50 bps over the remainder of this year, bringing the base rate to 10.5% by year-end”, said Commerzbank in a research note.

Lastly, we foresee that if inflation continues to decelerate in the coming months, easing from Bank of Russia will occur sooner rather than later, pushing bonds prices up.