Russia’s Fight Against Inflation Is Winning Over Bond Investors

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Russia’s hard and fast battle against inflation is finding favor in the bond market.

Foreign investors are pouring billions into Russian debt, and strategists have started urging clients to open bullish trades. They’re tapping into a belief that the central bank’s aggressive rate hikes will be enough to rein in inflation and there’s less risk of sanctions coming from the U.S.

“Russia was disciplined and did it by the book as usual, and acted early and decisively,” said Wim Vandenhoeck, a fund manager at Invesco Ltd. “The significant difference between Russia and most other emerging markets is that there is policy certainty and clarity.”

Vandenhoeck said he’s moved to an overweight position on the ruble and Russian bonds from underweight. Morgan Stanley’s team has recommended traders buy Russia’s 10-year bonds and sell similar-dated Treasuries.

Sentiment is turning on Russia after months of worry over the severity of U.S. sanctions policy under President Joe Biden. Yields declined in April when the sanctions were seen as mild and then tumbled after the central bank’s rate hike of a full percentage point last month, the sharpest increase since the 2014 ruble crisis. Yields on 10-year notes are now about 7%, compared with 6% at the start of the year.

Surging prices on food and raw materials have helped fuel inflation in emerging markets like Russia and Brazil, and forced central banks into action. The nation’s annual inflation stayed at a five-year high of 6.5% in July and inflationary expectations are even higher, at 13.4%, according to surveys conducted by the central bank.

Forward-rate agreements show that traders expect the central bank will increase rates by about 50 basis points over the next three months, compared with more than 130 points a month ago.

The risk is that the central bank decides to end its rate hikes at a higher level than expected and start easing later, which would dent returns for bond investors. Political tensions could also flare before the State Duma elections in September, said Viktor Szabo, a money manager at Aberdeen Asset Management. Even so, he’s sticking with an overweight position on the bonds.

Foreign investors raised holdings of Russian debt by 169.2 billion rubles ($2.3 billion) in July, the most since February last year, and now make up about a fifth of the market, according to central bank figures.

All the bullishness is even feeding into Russia’s primary debt auctions, where U.S. investors are banned from participating. The finance ministry sold the most debt in four months at a sale this week.

In the eyes of Jens Nysted, an emerging markets fund manager at EMSO Asset Management, longer-dated Russian bonds are some of his favorite bets, as long as the political climate stays stable.

“Inflation is largely under control,” he said. “We see the Russia OFZ curve as one of the most attractive.”

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