February Ruble/FX Flows

The ruble remains at the mercy of political factors, which could be in place until autumn. Nevertheless, it still should get a moderate boost in February and later this year from positive risk sentiment.The ruble started this year on a positive note and appreciated to 73 by mid-January, thanks to a stronger oil price, which settled around $55/bbl following the additional OPEC+ production cuts. This happened despite the global dollar appreciation amid rising nominal and real UST yields after the Democrats took the Senate - meaning greater prospects for more fiscal stimulus. This, in turn, boosted fears of higher inflation in the US and thus elicited concerns that the Fed could turn hawkish.However, in the second half of January the ruble fell to USD/RUB 76 and finished the month 2% lower, which was more or less in line with peers. This was mainly due to rising geopolitical and domestic political risks following the return and arrest of Alexey Navalny and protests in Russia. As a result, according to our estimates, the geopolitical premium in USD/RUB has risen to 16%, a level last seen in early November just ahead of the US elections. For now, it seems that the ruble has stabilized around 76 and that the geopolitical premium is unlikely to rise further. First of all, it seems that no serious sanctions from the US are imminent, as the Kremlin and Biden's administration have established relations and agreed to prolong the nuclear arms treaty. Moreover, Russia's domestic political situation still seems stable, with the protests possibly set to wane.Meanwhile, we would expect global risk sentiment to rebound after the deterioration in late January, as the situation with the coronavirus has started to improve in the eurozone, US, UK and Israel (the latter two are currently the leaders in vaccination). This could indicate that the vaccinations are in fact effective despite the new strains that are emerging. The efficacy of vaccinations, if finally confirmed, would be very positive for markets.An improved situation with the virus would result in an easing of quarantine measures in Europe, which should support economic growth and the euro, which we expect to return to EUR/USD 1.23 in February. Moreover, the Fed has promised to be very dovish for the foreseeable future, which keeps supporting EM FX. As a result, we believe the ruble could recover to 74 in February.Flow-wise, the ruble will be also supported. In January, FX purchases by the Finance Ministry unexpectedly rose to R105 bln, or about $95 mln in daily terms, which was likely due to one-off factors. In February, we expect them to rise even more, to R136 bln, based on a higher oil price in January, although the daily volumes will stay unchanged (due to there being one fewer working day in January than in February due to the New Year holidays). Meanwhile, we expect O&G taxes and duties to be $1 bln higher in February than in January. Moreover, as we had expected, in January retail FX purchases significantly decreased versus November-December, when, according to the CBR, the population bought $4.7 bln. This was an important supportive factor for the ruble and we expect it to stay so in February. However, after the recent political events, we are now less bullish on the ruble this year. We believe that the geopolitical premium will stay quite high in USD/RUB at about 15% and likely won't sustainably decline before the September parliamentary elections, which will be the key political event for Russian assets this year. We still see potential for the ruble to appreciate to 70 by end-2Q21, when the pandemic may well be under control and market optimism could be strong. But in 3Q21, we would expect the ruble to fall back to 75, due to risks of political tensions and an increase in international travel, which would mean higher demand for hard currency (see our report). Only in 4Q21, if the political risks are contained, do we see substantial potential for the geopolitical premium in USD/RUB to decline and hence the ruble to recover to 70 by year-end.