Two short hours ago Russia shocked everyone [8]with an unprecedented rate hike sending the nation's various interest rates some 650 bps higher. Well, according to the initial sellside responses, as shocking as the move was, it is not nearly enough.
Here is Citi:
Many market participants are looking at Russia’s hike from 10.5% to 17.0% and saying “wow”.
However, speaking with one of our senior RUB traders, the move is likely not aggressive enough for the medium-term. “Hiking the key rate to 17.0% is not enough to get a hold of a currency that can drop 10% in one day,” he says. “On top of that, the FX repo size needs to be much larger than it is at the moment…however, the hike might give RUB a few days of breathing space.”
One wonders just which "chatroom" Citi's FX traders decide what the fair value of the Rub(b)le should be.
And while we wonder, here is JPM which already appears to have exchanged notes in chatroom XYZ with Citi:
The rate hike occurred after today's 10% depreciation of the RUB despite attempts by the CBR to intervene earlier in the day. The decision was aimed at "limiting substantially increased ruble depreciation risks and inflation risks" according to the CBR. This emergency move suggests to us that household deposit dollarisation had increased significantly (official October data had already suggested dollarisation re-accelerated again). Tonight's large rate hike should in the short term help to slow retail dollarisation demand. However rate hikes do little to help the underlying demand for USD from corporates and banks who continue to front load their demand in order to apy their FX debt payments further down the line. With limited access to USD funding markets and oil having yet to find its bottom, the perceptions of local banks and corps on RUB continues to be negative, fuelling this hoarding behavior. In this context, there is a real possibility that even such a significant rate hike may not be enough in the medium run to stem RUB depreciation. The central bank in our view needs to announce a package of measures alongside rate hikes which also aim to lam local fears of USD scarcity. This will most likely involve making available a sizeable amount of FX reserves (we have suggested around USD100bn in our piece) through a combination of deposits in state banks and the CBR's existing repo facility. The CBR however continue to be unwilling to commit their FX reserves, with their focus still primarily concentrated on defending the sovereign balance sheet. As part of a package of measures, the CBE may also look to cap local bank open FX position limit down from the current 20% of capital as well as raise FX RRRs to help stem deposit dollarisation. Further pressure can also be put on corporates to convert their FX proceeds faster.
Bottom line: expect the market to react positively to the rate hike in the short run, but further measures are needed from the CBR for us to turn more bullish on RUB in the medium run, particularly in the absence of improved geopolitical risks and higher oil prices.
But Goldman is less negative on the move: "The decision clearly removes the uncertainty over the CBR's strategy that in our view was a major driver of the recent Ruble volatility and hence is positive. "
What happened: The Ruble traded above Rub72 vs. the basket and for the first time sharply outside our fair valuation metrics at current oil prices. Similarly the Ruble price of oil, which underlies next year's budget (Rub3700/bbl) and is closely tracked by the market, moved to its highest level yet. This was despite the oil price being fairly stable on the day and no significant news around other risk factors. The CBR responded to the sharp Ruble move post Moscow trading hours by raising its key rate from 10.5% to 17%, raising the key rate spread for loans against non-marketable collateral from 25bps to 175bps meanwhile extending their maturity by up to 18 months, though the wording of the CBR's publication is quite unclear on the latter point. Additionally the limit for the 28-day fx repo auction was raised from USD1.5bn to USD5 bn while the CBR also announced that it will hold the 12-month fx repo auction on a weekly basis. This policy response of raising the repo rate to fight the Ruble is against our expectations of the CBR likely to allow much higher interest rate volatility through tight liquidity management and we put our forecasts for rates, growth and inflation on hold and close our conviction views of being constructive on local fixed income assets and Russian credit. The decision clearly removes the uncertainty over the CBR's strategy that in our view was a major driver of the recent Ruble volatility and hence is positive. The key will be, to what extent the market believes that this strategy is credible given the likely impact on growth and the funding cost of the banking sector.
[9]
Why has the Ruble been under pressure? Fundamentally the Ruble is under pressure from sanctions and lower oil prices, and we have laid out our fair value model here (see CEEMEA Economics Analyst 14/35, 17 Oct. 2014). In our view the Ruble has recently been under pressure mostly from expectation-driven local flows. While the sanctions have been a major factor in the weakening of the Ruble earlier, we think fx liquidity in Russia is now ample despite the sanctions. This is very different from 2008/9. The banking system remains a sizeable international creditor (unlike in 2008) and even the corporates' net short-term external debt position is sizably positive, i.e. they hold more fx cash than required for debt repayments in the next year. Not surprisingly onshore short-term fx rates are close to zero. Instead, the private sector is continuing to short the Ruble with expectations heavily driven by falling oil prices. In our view this ultimately required decisive action from the CBR to raise the cost of these flows.
[10]
What triggered the recent sharp sell-off?: In our view the destabilization had been triggered by confusion about the strategy of the Central Bank. Uncertainty about where the oil price will ultimately stabilize remains high and hence the CBR can in our view not aim at stabilizing the level of the Ruble. However, it needs to ensure that excessive Ruble volatility does not destabilize expectations and potentially the financial system.
We thought this was best achieved by keeping Ruble liquidity very tight through unsterilized interventions. The cost of that strategy would have been to accept significantly higher short-term interest rate volatility, something that the CBR worked hard to dampen in the last few years. The alternative in our view and the one ultimately now chosen by the CBR has been to raise the key rate to a level where it becomes prohibitively expensive to borrow. We thought this would have been the less preferred option due to the economic costs likely to be involved and the pressure this puts on a weak banking system. Another possibility was clearly some kind of constraints on the ability of domestic agents to invest into fx. However, the latter had in our view been credibly ruled out by the authorities and this assessment is confirmed by today's rate decision.
Against the above, the CBR's signals had been difficult to read. The CBR raised its key rate last week by 100bps, as before arguing that it would use the key rate to stabilize inflation expectations. This was largely in line with our thinking, though we had only forecasted 50bps, but clearly far less than what short-term market rates were pricing.
We had forecasted that the CBR at the same time would signal very clearly that it would use liquidity measures to stabilize the Ruble instead and potentially widen the interest rate corridor. However, the CBR did not give any clear guidance apart from the fact that it extended the quantity restriction on the fx swap facility forward in time (the only lending facility that has essentially an almost unrestricted collateral pool, given the amount of fx held by the banks).
With access to the fx swap facility restricted, the way to manage liquidity would have been to allow the restrictions set by the amount of eligible collateral in the repo operations to become binding. This would have easily happened if the CBR intervened in the market without adding to the Lombard list. However, instead the CBR added a large private placement of bonds by a Russian corporate to its Lombard list, expanding the pool of collateral by close to 10% on our numbers. This effectively seemed to signal that the CBR essentially wants to restrict interest rate volatility and instead is willing to accept sizeable fx volatility, which the market duly delivered today.
Today's rate decision now signals that the CBR is willing to use the key rate to limit Ruble volatility while keeping interbank rates close to the policy rate, i.e. it is the most orthodox approach to monetary policy. This will in our view lead to a sharp sell-off in the local bond market, which is anchored by the key rate and where the yield structure depends on expectations of the future path of the key rate. While arguably today's sharp move should flatten the curve or even invert it, this largely depends on the market's perception of the credibility of the move.
[11]
Why such a large hike? A 650bps hike is very large by any metric and is more than the market expected (short-term rate expectations had fallen back to 11-12% from above 17% post last week's rate decision judging from the FRA's. Thus the decision is largely in line with what was priced in prior to last week's rate decision. We also believe that given the limited transmission of policy rates to deposit rates in the banking system, any interest rate based response to the Ruble needed to be outsized to have a meaningful impact on the attractiveness for resident households and corporates to hold Ruble assets rather than fx.
What are the risks? Today's decisive rate hike clearly removes the uncertainty about the CBR's strategy and signals that the CBR is now willing to defend the stability of the Ruble. The decision should also alleviate some concerns about the political independence of the Bank. The risks now mostly are about the ability of the economy and most importantly the banking sector to withstand this shock to their funding cost. Unlike in 2009, a far larger share or in our view around 10% of the banking system's balance sheet is now linked to the key rate, thus today's rate decision has a meaningful impact on the funding costs of the banks. While much of their assets are at floating rates, the impact on their bottom line will in our view be sizeable either directly or through a deterioration in asset quality. For this reason, in our view, the impact of this large emergency rate hike on Russian credit spreads could ultimately prove to be negative.
So get to work, Mrs. Russian Chairwoman, unless somehow the ex-KGB spy is prepared to make good on his recent threat to personally tear off the heads of any and all FX speculators found to be short the RUB.
