It's Never Early for Bond Traders to Hedge Russian Inflation
(Bloomberg) -- Inflation-linked debt is back in favor with investors in Russia to protect against a comeback in consumer-price growth after three years of an almost uninterrupted slowdown.
The looming turnaround had traders plowing into linkers at the Finance Ministry’s first auction in two years this week. It attracted bids that exceeded the 20 billion rubles ($346 million) of securities on offer by almost seven times, with as much as three-fourths of demand coming from Russian pension funds and asset managers. A debt-market measure of inflation expectations over the next decade known as the breakeven rate -- based on the difference between nominal bonds and linkers -- stands at about 4 percent.
“The fact that the issue was so popular indicates that investors expect inflation to be likely above 4 percent on average over the next 10 years,” said Liza Ermolenko, an economist at Barclays Capital in London. “Perhaps Russia’s history of high inflation had an impact here. For the locals, it is still difficult to believe that inflation could remain at current levels over a 10-year horizon.”
Except for occasional seasonal pickups, inflation has been on the decline since March 2015, when it peaked at a 13-year high of 16.9 percent. That may be about to change, with consumer-price growth accelerating for the first time since June. Data on Friday showed the annual index rose to 2.4 percent last month, in line with the median estimate in a Bloomberg survey.
The Bank of Russia assumes that inflation, which has been at 2.2 percent during the first two months of the year, will reach 3 percent to 4 percent in late 2018 and remain near its goal of 4 percent in 2019. That’s close to the view of most economists, who see it quickening to 3.6 percent at the end of the year and staying at 3.9 percent at least through the third quarter of 2019.
But in a sign that price pressures remain muted, core inflation -- which excludes volatile components like food prices -- unexpectedly decelerated in March to an annual 1.8 percent, a record low. That was below every forecast in a Bloomberg survey, whose median estimate was for 2 percent.
Russia sold its first linkers in July 2015, allowing investors to protect the value of their holdings against inflation through coupons that are reset every three months to mirror price growth. They outperform fixed-rate notes when consumer prices rise faster than the breakeven rate.
“Linkers are the only instrument worth buying on the local market,” said Alexey Tretyakov, a money manager at Aricapital Asset Management in Moscow, whose funds have 50 million rubles of index-linked bonds, including the most recently issued notes. “Returns aren’t bad even in the conditions of current inflation, which is seemingly near the bottom and may then rebound to an area of 5 percent to 7 percent.”
Russian inflation-linked bonds have returned 3.6 percent so far this year, trailing their fixed-rate counterparts, which have handed investors 4 percent, according to Bank of America Merrill Lynch indexes.
The Bank of Russia has said that threats to price growth include risks posed by the labor market, as “the dynamics of wages and unemployment create prerequisites for potentially higher inflationary pressure.” Inflation expectations among households, derived from a survey conducted for the central bank, rose slightly in March to 8.5 percent.
“The auction’s results suggest that investors are expecting inflation could recover already in the near future,” said Denis Poryvay, an analyst at Raiffeisenbank in Moscow.
©2018 Bloomberg L.P.