November 30, 2017 / 12:26 PM / 16 days ago

Major Western banks recommend buying Russian government bonds

MOSCOW, Nov 30 (Reuters) - Russian government bonds are likely to remain among the favourite picks for global investors next year, despite possible sanctions and a dip in yields in line with falling interest rates, foreign market players say.

Global investors have invested heavily in Russian treasury bonds, known as OFZ bonds, since mid-2015 because of their appealing yields. Those rose above 16 percent in early 2015, and yields of 10-year OFZ bonds are now around 7.6 percent .

That is still above comparable 10-year bonds in India, which carry yields of 7 percent. Yields of 10-year government bonds in China are 3.94 percent. Ten-year benchmark U.S. treasury bonds carry yields of 2.8 percent .

Russia’s superior yields are enough right now to outweigh the risks for major Western investment houses. Lombard Odier, Morgan Stanley and J.P. Morgan are among those who have forecast the OFZ market will grow in 2018.

Lombard Odier, one of Europe’s largest private banks, based in Switzerland, said on Wednesday it recommended buying into fixed-income instruments issued by Russia over the next 12 months.

Russia’s access to Western debt markets is limited by the fallout from the Kremlin’s standoff with Washington. The government has consequently depended on credit raised via the OFZ bonds to cover budget shortfalls.

As of Nov. 1, the share of Russian treasury bonds held by foreign investors reached a record high of 33.2 percent . Any outflow of these foreign investors could hurt the government’s finances.

The vulnerability of Russian OFZs in the face of sanctions has now declined compared with a few years ago, since Russia no longer needs external financing, said Manuell Streiff, head of fixed income at Lombard Odier, presenting the bank’s report on investments into emerging market debt.

But sanctions are a hot topic again, because the United States is considering expanding penalties against Russia. It may impose restrictions on buying OFZs next year.

The Russian central bank has already played down the fallout of such sanctions, saying it could spur some volatility only in the short term.

Morgan Stanley said in a note this week it recommended buying into Russian local bonds.

“We remain long in Russia, where we consider the bullish fixed income story to be intact,” Morgan Stanley analysts said. “The main risk to the trade is OFZs being added to the sanction list.”

Analysts at J.P. Morgan also said in their market strategy on Russia they thought “the bullish trade in Russia’s local markets is not exhausted yet” although most of the returns are likely by mid-2018, when the bank expects oil prices to peak.

“In terms of risks, geopolitics is a concern while oil prices are still an important risk,” J.P. Morgan said.

Given minimal chances of a state default because of Russia’s abundant reserves, OFZs are likely to be in demand even as the central bank cuts its key interest rate to 6 to 7 percent in the next year or two from 8.25 percent now, as it says it will do.

Dmitry Polevoy, chief economist at ING bank in Moscow, said he held 25 meetings with U.S. investors in September. Funds he met with said a targeted rate announced by the Bank of Russia was still high enough to keep OFZ yields attractive. (Additional reporting by Elena Fabrichnaya in Moscow and Sujata Rao in London; writing by Andrey Ostroukh; editing by Larry King)

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