Ruble Carry Goes Belly-Up as Sanctions Drub Rates: Russia Credit

By Vladimir Kuznetsov

Carry-trade investors betting on ruble gains have seen their good fortunes sour as intensifying sanctions against Russia overshadow the third-highest interest rates in Europe.
Borrowing in dollars to fund purchases of ruble debt posted the biggest losses in emerging markets since June 30, sliding 4.6 percent, after handing investors the third-best returns in the second quarter, according to data compiled by Bloomberg. A surprise interest-rate increase July 25 failed to stem the drop as new U.S. and European sanctions spurred the biggest currency price swings among 24 developing nations.
While the central bank benchmark is 2.5 percentage points higher than before President Vladimir Putin’s incursion into Crimea in March, it hasn’t been sufficient to lure carry traders as the conflict in Ukraine worsened. Local-currency bonds slid the most among peers since the
U.S. imposed harsher penalties on July 16, tumbling 6.6 percent, prompting Russia to retaliate with a food-import ban this month.
“It’s not smart doing carry trades in an unstable country,” Dmitry Kosmodemiyanskiy, a money manager at Otkritie Asset Management in Moscow, said by e-mail yesterday. “An investor will only be willing to do this deal if he’s confident in the stability and safety of his cash.”

Higher Rates

Russia’s central bank raised its key rate to 8 percent last month, higher than all European peers apart from Turkey and Ukraine, according to data compiled by Bloomberg. The ruble has weakened 2.8 percent against the dollar since the rate increase amid the standoff between Russia and the U.S.
Carry traders using the ruble weren’t deterred in the second quarter, earning 5.8 percent, the most after Argentina and Colombia. The trade involves borrowing in countries with lower interest rates to invest in higher-yielding assets. The risk is that currency swings can wipe out the gains.
Rate increases in March and April helped spur buying in Russian assets, sending the nation’s stock index into a bull market and the currency to a five-month high in June. Now analysts project the ruble will to weaken to 36.30 per dollar by year-end, from 35.96 at 12:45 p.m. in Moscow, according to the median estimate in a Bloomberg survey.

‘Absolutely Unpredictable’

Higher rates are still luring some traders, otherwise the ruble “may have been sold off more aggressively,” Vladimir Kolychev, a Moscow-based analyst at VTB Capital, said by e-mail yesterday. “The carry is still working.”
Any substantial drop in the Ukraine risk premium may trigger a “very strong” rally in the ruble, according to Konstantin Artemov, a money manager at Raiffeisen Asset Management in Moscow.
The currency has strengthened 0.4 percent this week as Ukraine signaled it may allow an aid convoy from Russia to enter its war-torn eastern regions. Putin pledged yesterday to work to halt the conflict that’s flared for months between pro-Russian separatists and government forces.
Outflows from Russian mutual funds accelerated to 663 million rubles ($18 million) in July, four times more than June, and are on track for a record this year, data from Investfunds.ru showed yesterday. One-week historical price volatility for the currency climbed 43 basis points this quarter to 8.47 percent today. Only price swings for the Ukrainian hryvnia and the Syrian pound are larger.
The U.S. and European sanctions make the political future “absolutely unpredictable,” Fedor Bizikov, a money manager at GHP Group in Moscow, said by phone yesterday. “This stops investors from making bets.”