Rousing Ruble

Predicting movement in Financial Markets is tough, try Ruble

Russia’s currency, the Ruble, went from the world’s worst to the best performer in the first three months of 2015. It has most certainly caught even the most avid forecasters off guard.

The Rise

The Russian currency strengthened on Thursday, April 16, 2015, bolstered by a recent rally which had been driven by greater confidence in the ruble, easing international tensions over Ukraine and oil price stability.

Source: Bloomberg/WSA Please Click to Enlarge
Source: Bloomberg/WSA
Please Click to Enlarge

The ruble had strengthened below 50 against the dollar on Wednesday, April15, 2015 for the first time since November 2014. The Russian currency has climbed 34 % against the greenback since mid-January and 7.6 % in April so far.

Back in 2014, as sanctions were being imposed on Russia by the European Union and the U.S., the Ruble found itself in laggard territory as the world’s second worst performing currency. But 2015 looks promising as the ruble recovered 21.78 %since the new year, and more than 55 % since December 16, 2014 – a date dubbed ‘Black Tuesday’ as the ruble bottomed out against the dollar at nearly 80 rubles per dollar, recouping part of its 46 % slump in 2014

The Fall

In the fall of 2014, sanctions on Russia, collapsing oil prices and heightened geopolitical factors scared international investors out of the Russian economy; the Russian ruble took a hard hit.

The Benchmark Russian equity index RTS dropped 55 % from June to December 2014. The ruble followed the trend, losing 45 % of its value against the dollar in that time period.

Russia’s economy is heavily reliant on oil export, and it cannot subsidize much when oil prices are hovering at $48 per barrel. A slump in oil prices meant that Russian companies had fewer dollars to turn into rubles. Much of the ruble’s weakness in late 2014 and earlier this year were due to large debt payments due to foreign creditors by Russian companies which were unable to roll over loans after U.S. and European Union debt markets were closed to Russian firms in the wake of sanctions related to the ‘Russia-Ukraine’ conflict.

The government tried everything it could to prop up the ruble, spending some of its $355 billion cash reserve. The Russian central bank increased interest rates from 10.5% to 17% with the hope of encouraging the population to hold their money in rubles which would pay them better interest instead of the dollar. The rate hike ’convinced’ state-owned exporters to sell their foreign currency for rubles in what amounted to kinder and gentler capital controls.

The central bank’s strategy was enough to halt the ruble from its freefall, but it did not offer a cushion to regular falling as long as oil was concerned. Thus even after the ruble stabilized from what was a catastrophic loss of confidence, Russia’s currency was spiraling down once more at the start of the year.

And then Things started Changing

Basically, the ruble became too cheap to ignore as the worst case scenarios over oil, cash reserves, economy and geopolitics did not materialize. Oil prices have been recovering and stabilizing as they currently hovered around $56 a barrel. The Russian economy and the regional geopolitical situation while still tense have not deteriorated beyond expectations.

Legend: CL1 - Brent Crude Source: Bloomberg/WSA Please Click to Enlarge
Legend: CL1 – Brent Crude
Source: Bloomberg/WSA
Please Click to Enlarge

As they overcame uncertainty about international sanctions, the markets started buying Russian’s stocks again. The Russian Index is up 34.26 % for 2015, and the biggest appreciation in market capitalization happened in February 2015, right after the ruble bottomed at the end of January 2015.

Source: Bloomberg/WSA Please Click to Enlarge
Source: Bloomberg/WSA
Please Click to Enlarge

The real reason buying the rubles’ grab from investors is to get into the Russian bond market which has been posting high returns compared its European counterpart. The only way to participate in this rally is to buy the ruble-denominated bonds, and in order for investors to do this, they have to sell dollars and buy rubles. In short, lower bond prices push investors to get into the game, which in turn push up the ruble. In a global investment climate where central banks are cutting rates to zero, Russia provides investors with an opportunity, although fraught with risk to make attractive returns.

Treasury bonds, known as OFZs on the Russian market, have been fetching yields in the ballpark of 12.5 % in weekly bond auctions after hitting premium value of 15.5 % on January 11, 2015. Interest rates on ruble are providing double digit returns in an environment where the Swiss issued a 10-year bond at a negative interest rate.

Advantage Russia?

The surge in Ruble has left Russia with a problem it never would have imagined having a few months ago; a ruble that is too strong. Even though Russian economy did better than expected at the end of 2014, there are signs of it going into recession for the next couple of years. Oil prices are still too low and interest rates are still too high for Russia’s economy to do better than the 3% growth economists have projected. This means Russia needs a weak, but stable ruble to export its way back to health. And that is why, for the second time in as many weeks, its central bank has tried to stop the ruble from rising further by making it harder for Russian companies to borrow dollars.

Where now?

It is very difficult to predict where the currency will be heading, given the multitude of factors involved. Oil prices are likely to be a big influence on the currency if they move sharply in either direction. The same is true for regional geopolitics. Consumer price inflation is close to peaking and the price pressure will obviously fall as a result of the stronger currency. Additionally, the ruble will be affected by what happens in the US. The delayed yet expected timing of the first rate hike by the US Federal Reserve is already having an impact on the financial markets around the globe and it is likely to influence the Russian currency.

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