OFZ Market - Finance Ministry Closes Out Issuance for 2017

> In its last auction of the year, the Finance Ministry today placed R32 bln out of R35 bln on offer, thus nearly fulfilling its plan to place R1.24 trln net in 2017. In 4Q17, it increased short-dated OFZ issuance from 4% of the total quarterly plan to 26% and long-dated issuance from 14% to 27%. Although it decreased mid-dated issuance, such issuance was still high both in absolute and relative terms.
> The higher supply of short-dated OFZs was absorbed by local banks, which have increased OFZ holdings ahead of the new LCR requirements taking effect on January 1. Also today, R200 bln in floating-rate OFZs was redeemed, which buoyed local demand for short-dated OFZs and other floaters. The increased demand will carry over into January. The rate cuts have spurred demand at the short end and pushed yields lower, which is good for the Finance Ministry.
> Rising supply of long-dated OFZs has made the curve positive. On one hand, inflation might have already bottomed out in December. Weak demand from abroad due to year-end profit taking, rising rates in developed markets (and therefore overall worse perception of EM risk) made foreigners reluctant to buy long-dated OFZs. Also, some investors (mostly Russians) preferred to avoid the long end of the curve ahead of the looming CAATSA report. In the absence of natural buyers, yields on long-dated OFZs remained in the high 7% area.
> The belly was the biggest winner in 4Q17, mostly in December. A surprisingly strong CBR rate cut with very low intermediate supply led to yields falling and OFZs maturing in 4-6y closing out the year with almost the same rates as on short-dated paper.
> We expect supply to increase in 1Q18. We currently forecast USD/RUB averaging 60.5 in 2018 and R1.1 trln in net OFZ issuance, while the ministry plans R0.8 trln net at 64.8. The difference in the forecast exchange rates is due to the Finance Ministry's very low oil price forecast. If this is not amended then it will most likely plan R0.4 trln in issuance in 1Q18. If the forecast is moved closer to ours, plans could be for as high as R0.5 trln. The looming sanction report will most likely restrain demand for long-dated OFZs, while paper with maturity in less than 10y will be in demand. We think that the ministry will take advantage of this and increase supply in the belly, i.e. by placing relatively shorter-dated OFZs in 1Q18.