Rollercoaster rouble freaks analysts

This year has been a rollercoaster ride for the rouble, as it plummeted in value at the start of 2014 – amid the broad-based emerging market (EM) currency sell-off and Russia’s territorial conflict with Ukraine – briefly recovered in June, and now faces its toughest test yet as geopolitical and economic risks mount. USD/RUB was trading at 32.86 at the start of the year before falling to 36.90 in early March, as investors reeled from the US Federal Reserve shrinking its quantitative-easing programme to $45 billion a month. Russia’s conflict related to the Crimea in Ukraine only added fuel to the fire.

However, the rouble staged a rally in June, rebounding against the dollar to 33.69 on June 27, as investors overcame their anxieties over tapering and the conflict.

“There was some bearishness fatigue and investors started to think the [Russia-Ukraine] crisis is not the end of the world,” says Benoit Anne, global head of EM strategy at Société Générale. “The rouble started catching up with its [EM] peers and there was a big rebound during that period.”

However, events have since taken a turn for the worse. The US and the European Union have responded to the crisis in eastern Ukraine and the annexation of Crimea by imposing a series of sanctions on Russian companies and key individuals in Russian president Vladimir Putin’s government.

The US has sanctioned 16 Russian government officials, including Gennady Timchenko, who founded commodity trading company Gunvor, which the US says Putin has an investment in. Igor Sechin, former intelligence officer and chairman of state-owned oil giant Rosneft, has also been sanctioned, according to the US Treasury announcement from March 20.

The most recent sanctions restrict some of Russia’s largest companies from sourcing financing in US debt and equity markets, which raises refinancing concerns that negatively impact currency markets over the long term, says Manik Narain, currency strategist at UBS.

Russian companies that have previously issued debt in US dollars that is due to rollover could face more challenging refinancing conditions.

“This puts pressure on Russian companies to deliver, and puts pressure on the currency,” says Narain. “These impacts are currency-negative, but are not necessarily immediate.”

The threat of even more aggressive sanctions from Europe remains a risk for markets, and a recovery of the rouble remains unlikely, say Morgan Stanley EM currency strategists in a note published on Wednesday.

“A recovery to levels seen prior to the announcement of new US sanctions last week to below 34.50 looks unlikely to us,” reads the note.

In addition, geopolitical risk is back on currency investors’ horizon in the wake of the Malaysian Airlines flight MH17 crash on July 17, which was reportedly caused by Russian-funded rebel separatists in Ukraine.

The cost of buying insurance against a Russian default on its debt has crept up during the past year and has soared since the plane crash. CDS spreads on five-year Russian debt hit 203 basis points on Wednesday, up from 163bp exactly a year ago and 183bp the day before the plane crash, according to data provider Markit.

This means that the cost of protecting $10 million of senior Russian debt rose to $203,000 per year, for five years.

The long-term fundamentals do not bode well for Russia and its currency, say analysts. Russia is experiencing a surge in capital outflows, and the IMF cut the country’s 2014 growth forecast for the fourth time in a row in April to just 0.2%, citing “considerable downside risks”.

“Russia still has a lot of work to do in terms of raising competitiveness, reducing labour costs, expanding privatization and improving the investor climate,” says UBS’s Narain.

Furthermore, Russia’s central bank is reducing its footprint in the currency markets by intervening less to support the rouble, as the currency transitions to a free float next year.

“It is more sensitive than in previous years to structural capital outflows and deteriorating balance payments,” says Narain.

Anne at Société Générale is recommending clients buy South African rand and sell the Russian rouble, as South Africa is now a “geopolitical safe haven”.

Meanwhile, Narain is recommending that clients simply hold off from purchasing rouble and wait for further weakening of the currency, which will provide ample buying opportunities.