True to recent form, politics continued to command a dominant position throughout the week as the French presidential election is shaping up to be a bit of an odyssey, and it is yet to even get to the first round of voting. Let’s not forget the UK’s ongoing attempt to extricate itself from Europe, along with elections also due in the Netherlands (March) and Germany (September) and discussions over Greece’s terms and size from international lenders for the third installment of emergency loans. Not forgetting Mr. Trump’s recent victory, 2017 is certainly panning out to be a very interesting year!
One country that has certainly benefited from a more benign focus (at least from a bond market perspective) is Russia, where the 5-year CDS has rallied from the extremes of 607 basis points (bps) in 2015 to today’s level of 171. Pre Crimea (but post the 2008 crisis), the spread had touched 120 bps at its tights.
Indeed, recently Moody's Investor Services raised Russia’s outlook to stable from negative adding Russia’s strategy ‘reflects an ambitious fiscal consolidation strategy incorporating conservative spending and revenue assumptions’. Russia’s Economy Minister Maxim Oreshkin, said there are ‘objective grounds’ for a ratings upgrade.
Moody’s cited an improvement in the economy as well as a fiscal consolidation strategy that should help wean the country off its dependence on oil. That means that all three major agencies have now confirmed the economy is stabilising after almost a two year long recession, the longest in almost two decades. The Economy Ministry expects growth to reach 2% in 2017 while its 4% inflation target is also within reach, currently at 4.7%. Steady oil prices, the Russian budget has $40 per barrel built into it, improving mining, agriculture and manufacturing data all are contributing to the improved outlook.
This news has benefited our Russian holdings although there is no sign as yet of an upgrade with Standard and Poor’s and Moody’s retaining their non-investment grade rating; with Fitch the only one of the three that held their BBB- investment grading during Russia’s economic and political problems. By way of an example our holding of Gazprom 8.625% maturing in April 2034, a USD denominated issue, is now priced around 130.75 which is a spread of 311 bps off of the US Treasury curve. If we utilise the Fitch rating, the better of the three agencies, this equates to a price which makes the bond 2.4 credit notches cheap to our fair value spread of 203 bps and offers us a return plus yield of 15.7%. Should this bond trade into its fair value spread it would rally around 15 points in price terms.