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By Sujata Rao
LONDON, Feb 23 (Reuters) - Russian and Ukrainian sovereign bonds sold off heavily on Monday, with the latter now trading around 40 cents in the dollar as continued fighting in eastern Ukraine raised fears for both credits.
The violence, and sanctions imposed for Russia’s role in it, have exacerbated economic problems caused by falling oil prices, with Moody’s cutting Russia’s rating to junk late on Friday.
In Ukraine, the fighting is pushing the domestic economy deeper into recession and is delaying aid from Western lenders, raising fears that an upcoming debt restructuring will inflict bigger-than-expected losses on bondholders.
“There is a vicious circle going on between the currency and the bonds,” said David Hauner, head of EEMEA debt and strategy at Bank of America/Merrill Lynch.
“The hryvnia weakness raises the possibility of a more painful restructuring with haircuts on principal.”
The hryvnia fell 6.7 percent against the dollar on Monday, according to central bank data, adding to over 40 percent losses since it was freed from its peg on Feb 5.
Sovereign bonds now trade around 40 cents in the dollar, with the issue maturing 2017 down almost 3 cents to 41.5 cents, while 2022 and 2023 issues also fell almost 2 cents, according to Tradeweb .
The 2017 bond has fallen 12 cents so far this month.
Ukraine’s yield spreads versus U.S. Treasuries rose above 4000 bps for the first time, the highest on the EMBI Global index. Venezuela, the other credit seen likely to default, trades with a 2,700 bps spread.
Standard Bank analyst Tim Ash noted Ukraine’s budget was based on a 21.7 hryvnia per dollar rate.
“Such an extreme exchange rate move risks payments problems, a deeper recession, bigger budget imbalances, bigger losses in banks, and much lower dollar GDP - hence the big drops in the price of dollar bonds,” Ash told clients.
Russian markets were shut, but bonds and the rouble fell in offshore trading, with the currency down 4 percent to one-week lows.
Moody’s has cut Russia to Ba1 from Baa3, following Standard & Poor’s which relegated it to junk last month. A junk rating makes it costlier to borrow and is likely to accelerate capital outflows from conservative asset managers.
Its 2030 bond fell 1.1 cent to 106.5, the 2043 issue fell 2.5 cents and other bonds shed around a cent.
Hauner said the Moody’s decision was not unexpected but it had come earlier than expected and after a mini-rally caused by oil prices rising off lows.
“The other thing is just the psychology of it. There has been short-covering happening and now some people will take chips off the table,” he added.
As a junk credit Russia faces ejection from Barclays’ Global Aggregate index where its total weight is estimated at $140 billion. JPMorgan will also remove Russia from the investment-grade portion of its GBI-EM index for emerging currency bonds, a portion to which $5-7 billion is benchmarked. (Reporting by Sujata Rao)