13.02.09

Since announcing a new upper boundary of the target trading band for the euro/dollar basket at 41 rubles on January 22, the Central Bank has repeatedly confirmed that it is serious about keeping the Russian currency within this corridor. However, for long-term stability of the ruble the stability of the spot exchange rate needs to be followed by a drop in returns on currency futures, which in turn could set the stage for lower ruble interest rates, analysts at Interfax-CEA and Finmarket reckon.

Central Bank goes on the attack

During a recent meeting between Central Bank chief Sergei Ignatyev and Russian bankers, it was announced that the devaluation of the ruble was finished and that the upper boundary of the trading corridor should be taken seriously and would be in place for the foreseeable future.

At the same time, the Central Bank is continuing to raise interest rates on the money market. On Monday, it was announced that interest rates would go up February 10 on credit and deposit operations and direct repo deals conducted by the Central Bank. The move is aimed at curbing inflationary pressure and supporting the stability of the ruble, the Central Bank said.

Most rates have been raised by 1 percentage point, with the rate on one-day deposit operations going up to 7.75%, and rates on standard one-week and spot-week deposit operations climbing to 8.25%.This is the second interest rate hike this month - the Central Bank raised rates on certain creditor operations on February 2.

Central Bank waging unseen battle, currency basket retreats

Analysts began to say in late January and early February that the preconditions were emerging for the stabilization of the ruble. These preconditions were supposed to be realized after the Central Bank demonstrated its determination to keep the Russian currency from falling below 41 rubles against the euro/dollar basket.

Last week the Central Bank was repeatedly seen making billion-dollar offers at a level equivalent to 41 rubles against the basket, which calmed the market, with the basket retreating to 40.8 rubles Friday evening. In early trading Monday the basket sometimes approached 40.8 rubles, though it largely hovered 2-3 kopecks higher, and at around 3:30 p.m. Moscow time it briefly dropped to 40.7 rubles.

There is therefore no battle between the Central Bank and speculators at the threshold of 41 rubles. Speculators are finding a balance themselves, meaning that there are those who want to buy and those who want to sell.

But the Central Bank is still waging an unseen battle for the stability of the ruble. It is moving into the area of interest rates and currency futures, where the stage is being set for the ruble to either demonstrate its long-term stability at around current levels or show that the devaluation has not been sufficient.

Fall 2008 and February 2009: What has changed?

The differences between the situations on the currency market right now and in the fall of 2008 will become clear if we try to answer two questions. First, why was it that when the Central Bank supported an exchange rate of 30.4 rubles for the dual currency basket from early September to November 11 market players bought foreign currency from the Central Bank and the market rate for the basket essentially stuck to the upper boundary? Second, why is that now, when the Central Bank has also named a boundary, is the basket not reaching this threshold.

Analysts think the answer is that last fall the ruble was clearly overvalued and the Central Bank was providing little guarantee that it would not depreciate. Various officials periodically repeated the mantra that there would not be a ruble devaluation, but they were controverted by subsequent policy. It was clear that the Central Bank could retreat at any time and widen the trading band.

But the current situation is different, and its logic indicates that the Central Bank will only retreat from the threshold of 41 rubles in the event of extraordinary circumstances, such as the price of oil falling below $30 per barrel, a further steady deterioration of the situation with the budget or some kind of global corporate collapse. Therefore, the Central Bank should not be expected to retreat in the near future.

Ruble or foreign currency instruments?

As a result, the situation is now such that money market players must choose between further increasing, or at least maintaining, long foreign currency positions, or moving into rubles, even if just temporarily. To do so, one should compare returns on key operations in rubles and foreign currency.

By buying dollars (or euros, or the basket, that is, dollars and euros in the proportions of the dual currency basket) on the spot market and selling them on the futures market (through NDF, for example, although it is also possible to use the corresponding instruments on domestic exchanges), it is possible to earn a fixed ruble return. Interfax-CEA analysts estimate that on operations with March futures on the RTS exchange this return, based on exchange rates as of 2:30 p.m. Monday, would be 8.7% annualized. Traders might see this return as insufficient, since just recently, in the middle of last week, March futures could offer returns of about 20%. However, it is still possible to get an annualized return of about 20% by buying June futures.

The situation with rubles is different. According to the MosPrime Rate, ruble interest rates are holding at about 22% for one month, which is far higher than the potential yield on March currency futures; and the rates for three months and six months are 24.5% and 25.5% respectively. Therefore, the annualized return for four months, which is comparable to the term of the June currency futures, will be about 25%, which is also considerably higher than on foreign currency. Foreign currency operations are therefore less profitable because ruble interest rates are high.

These comparative estimates are very approximate, if only because the foreign currency bought on the spot market and then sold through forwards can be invested in the interim. Then the overall return could easily be comparable to ruble interest rates.

Nonetheless, if the Central Bank does in fact hold the exchange rate for the basket at 41 rubles until the middle of June, some currency traders will suffer losses - those who sold foreign currency at the June forward rate (it is now about 38.2 rubles to the dollar).

What's next?

As the Central Bank gets more comfortable at the level of 41 rubles, one of two things could happen. Either the dual currency basket will fall considerably below the level of 41 rubles, in which case returns could remain high on currency futures, but the ruble will strengthen locally. Or the basket will drop only slightly, but currency futures will slide and their returns will fall from 20% or higher to at least 10% (preferably even further, though even 10% would have a positive impact).

The second possibility would give the Central Bank the opportunity to make a move toward lowering interest rates and set the stage for the recovery of the Russian money market, which has essentially been in a coma since the middle of last fall, analysts reckon.

But the latter possibility will still probably have to be preceded by the former; otherwise the market will not believe in the Central Bank. Therefore one can expect the basket to fall somewhat in the near future, but the drop will not be substantial and it should ideally be stopped by the Central Bank with purchases of foreign currency.

Then, if all goes well, the time will come to reduce the incline angle of the futures curve. And then it will be possible to say in all seriousness that the ruble has stabilized.

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Source: Interfax