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Structural Changes in the Economy Increase Inflation Tolerance 21.04.2022

Our preliminary comment on the decision of the Bank of Russia on rates: we expect the key rate to be cut by 200 bp soon, to 15%

Next Friday, April 29, a pivotal meeting of the Russian regulator on the key rate is scheduled. Among other things, the decision will be accompanied by an updated medium-term macroeconomic forecast, which is of particular interest in the current geopolitical situation (primarily in terms of the main items of the balance of payments in the base scenario). The Monetary Policy Report (MPR) will be published later on 11 May.

Our expectations of the outcome of the meeting are consistent both with the consensus forecast of market participants and with the latest rhetoric of the regulator’s representatives, which reflects a “softer” signal. Despite continued inflationary pressures and a growing gap between actual and target inflation, we expect another “wide” move to ease monetary conditions and bring the key rate to 15% (-200 bps).

During her recent speech at a joint meeting of State Duma committees, Elvira Nabiullina expressed concern about the processes of economic transformation, the active phase of which will take place in the second or third quarters of this year. The imposed sanctions will soon begin to affect the real sectors of the economy, which increases the need to provide them with affordable financial resources. In other words, the Central Bank of Russia is now ready to demonstrate flexibility and not use “any methods” to return inflation to the target as quickly as possible (according to the current baseline forecast, this will happen in 2024).

Moreover, the nature of inflation is expected to change in the coming months – a short-term sharp rise in prices against the backdrop of a weakening ruble and, as a result, an increase in consumer demand will be replaced by a longer-term supply shortage caused by depletion of inventories, as well as the restructuring of production and logistics processes. It is likely that this change will lead to a new wave of growth in consumer prices for a wide group of goods in the second half of 2022, while the main stage of the normalization of inflationary processes will take place next year.

Thus, in the short term, we expect a gradual easing of monetary policy conditions, as well as additional measures to stimulate economic recovery at the expense of budgetary funds. For now, the Bank of Russia will be forced to “close its eyes” to negative real interest rates and a probable new jump in consumer prices. At the same time, we do not expect a sharp trajectory for reducing the cost of lending in Russia until the end of 2022. In the context of expected high inflation, such a policy looks ineffective. Our baseline forecast does not yet assume that the key rate will fall below 12% this year. The stimulation of the credit channel necessary for the economy will most likely be achieved through various preferential programs.

Recent developments in the debt market and our recommendations.

The more “soft” rhetoric of the regulator in recent days has given a powerful impetus to optimism among OFZ market participants. Yield of “classic” issues fell sharply against the backdrop of increased trading volumes; in such a way that almost the entire curve began to approach the value of 10% (the only exception is securities maturing in the next year).

It is also worth noting the sharply reduced negative slope of the sovereign curve, largely caused by investors’ reassessment of interest rates in the medium term. Since the resumption of trading in the third decade of March, the price index of government bonds RGBI, after updating the lows of December 2014, has won back all the fall, returning to the value of 125.5 p.p. (+28% from the bottom reached).

According to our estimates, the yield of government bonds with a constant coupon has long since reached the equilibrium level, taking into account our baseline forecast for the key rate until the end of the year. The current price values ​​seem too overbought to us, so we do not see much interest in forming long positions in the “classic” OFZ at the moment unlike high yield corporate bonds. Moreover, taking into account the expectations of growth in annual inflation in the coming months, real yields will increasingly go into the negative zone, thereby becoming less attractive to investors. In this regard, we continue to give preference to high-quality corporate ruble bonds of first- and second-tier borrowers (see our review of 04/01/2022). As for the public sector, inflationary linkers may be of more interest here, even if their prices have also risen markedly in recent weeks.

Spread between 2-year OFZ yield and key rate

Source: Moscow Exchange, ITI Capital

Dynamics of the government bond price index RGBI

Dynamics of the government bond price index RGBI

Source: Moscow Exchange, ITI Capital

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