Key Updates on Russian Government Bonds (OFZ)
The recent unexpected hike of the key rate by the Bank of Russia to 21% in October 2024 and the potential for further increases to 22–23% necessitate adjustments in mid-term macroeconomic forecasts and recalculations of OFZ potential returns. The Central Bank’s aggressive tightening underscores a commitment to curbing inflation, though it limits opportunities for monetary easing in the near future. Here’s a comprehensive look at the revised forecasts and implications for the Russian bond market.
Macroeconomic Forecasts
- Key Rate Projections:
- 2024: Key rate expected at 22% by year-end.
- 2025: Gradual easing to 18% by year-end in the base scenario.
- 2026: Further decline to 13%, aligning with inflation stabilization.
- Inflation Forecasts:
The Central Bank raised its inflation forecast for 2024 to 8.0–8.5% but projects a sharp drop to 4.5–5.0% in 2025. Analysts suggest actual inflation may fall below 8% in 2024, providing room for softer central bank commentary at the upcoming December 20 meeting.
Base and Stress Scenarios
Base Scenario: Gradual Easing
- Key Rate Trajectory:
Gradual reduction from 22% in 2024 to 18% in 2025 and 13% by 2026.- The yield curve retains its inverted shape through 2025 but flattens by the end of 2026.
- Fixed-coupon bonds experience minor price declines by the end of 2024, with coupon income compensating for losses, resulting in flat total returns for the year.
- Performance of Floating-Rate Bonds (Floaters):
- Floaters are expected to outperform fixed-coupon bonds in 2025 with returns around 2.7% in 2024 and cumulative returns of 36% by 2026.
- Fixed-coupon bonds maturing in 5–10 years could achieve total returns of 35–41%, narrowing the performance gap.
Stress Scenario: Prolonged High Rates
- Key Rate Trajectory:
Key rate remains at 23% throughout 2025, declining only to 15% by the end of 2026.- Fixed-coupon bondholders face significant pressure, with returns reliant solely on coupon payments.
- 2025 Performance: Total returns for fixed-coupon bonds range between 2–5%, while floaters deliver 26%.
- By 2026, floaters maintain a strong lead with total returns around 44.5%, compared to 20–32% for fixed-coupon bonds.
OFZ Market Dynamics
Floating-Rate Bonds Under Pressure
- Recent Price Declines:
Floaters saw price drops of 1–3% since late October, driven by technical factors, higher funding costs, and pressure from Ministry of Finance auctions.- Notably, the OFZ-PK series 29025 saw its price decline from 97.5% to 92.0% of face value between June and October 2024.
- Future Outlook:
While further price declines for floaters are possible due to anticipated large-scale bond placements by the Ministry of Finance, their relative attractiveness remains strong, supported by higher yields compared to fixed-coupon bonds.
Fixed-Coupon Bonds
- Inversion of Yield Curve:
The negative slope of the yield curve persists through 2025, impacting long-term fixed-coupon bonds.- Bonds with maturities around 10 years could show better performance as the curve flattens by 2026.
- Returns remain under pressure in the stress scenario but could recover with a softer monetary stance.
Key Considerations and Recommendations
- Preference for Floaters:
- Floaters offer resilience in a high-interest-rate environment and are expected to outperform across most scenarios.
- The recent price correction presents an attractive entry point, particularly for longer-maturity floaters like the 29024 series.
- Fixed-Coupon Bonds:
- Despite near-term headwinds, bonds maturing in 5–10 years remain competitive under the base scenario.
- Investors should monitor inflation trends and key rate dynamics closely for potential reallocation.
- Market Sentiment:
- Optimism following the October rate hike appears premature. A high-rate environment through 2025 remains the most probable outcome.
- The Ministry of Finance’s aggressive issuance strategy could weigh on prices, presenting selective opportunities.
Conclusion
As the Bank of Russia maintains its hawkish stance to combat inflation, the bond market faces significant challenges. However, opportunities remain for discerning investors, particularly in floating-rate bonds and selected fixed-coupon instruments with medium-term maturities. The evolving macroeconomic landscape underscores the importance of strategic positioning in the OFZ market to navigate volatility and capitalize on potential returns.
Source: Sinara Investment Bank
