Rates Weekly - May 12, 2020

RUBLE LIQUIDITYOVERNIGHT RATES COULD HOLD IN PLACE THIS WEEK BUT ARE LIKELY TO DROP IN THE COMING MONTHS AMID SIGNIFICANT LIQUIDITY INFLOWSAt the end of April, O/N rates rose significantly, as we had expected, to about 40 bps above the key rate. This owed to a ruble liquidity deficit, which was in turn due to tax payments, growing cash in circulation and the CBR's FX sales. Despite this, the CBR conducted a deposit auction on April 28 where it absorbed R400 bln in liquidity. It thus had to conduct a repo auction ahead of the May holidays in order to inject R500 bln of liquidity. In order to ensure ample liquidity, the CBR increased the limit at its fine-tuning repo auction last Wednesday to R1 trln, of which banks took around R780 bln. This turned the ruble liquidity deficit into a surplus ahead of the upcoming reserves averaging period, and the RUONIA rate fell to 5.19% on Friday, 31 bps below the key rate. The CBR therefore had to conduct a fine-tuning deposit auction today, through which it absorbed R540 bln of excess liquidity, causing O/N rates to return close to the key rate. This week, the CBR has so far refrained from repo operations, but it did move to boost liquidity by canceling the planned issuance of new coupon bonds: it sold about R200 bln of previously issued bonds maturing in June, while tomorrow more than R600 bln in another issue of CBR coupon bonds will be redeemed. The structural liquidity surplus of about R1.5 trln is currently being fully absorbed by the CBR's outstanding coupon bonds. We believe the central bank would prefer for this liquidity to be absorbed more evenly via both bonds and weekly deposits. Despite the liquidity inflow from the CBR's operations, we would expect a mild liquidity deficit of about R200 bln to emerge over the upcoming week as the new reserves averaging period gets underway, mainly because Federal Treasury deposits and repo will be redeemed with no new operations scheduled thus far. So, O/N rates will likely stay near the key rate in the coming week. However, we expect a significant liquidity inflow over the upcoming month. First, it is likely that cash in circulation will stop growing (since the beginning of March, it has grown by R1.3 trln, which is more than it grew in December 2014) due to the easing of quarantine measures and the resulting recovery of the Russian economy. About R1 trln of this cash could return to the banking sector. Second, in light of the recent anti-crisis measures, we would expect the Finance Ministry to actively spend money, including about R1 trln of the CBR's proceeds from the sale of the stake in Sberbank, while collecting much less tax revenue (the latest data suggests that non-oil and gas budget revenues are down 20-40% compared to last year). Third, in May-June the CBR will introduce 1m and 1y repo, which could total R0.5-1.5 trln. Fourth, given that the Urals price is currently above $25/bbl, the CBR's additional FX sales have likely fallen to zero. Against this backdrop, over the next several months we expect the liquidity outflows to ease, while the inflows are likely to intensify, potentially boosting liquidity by more than R3 trln. If this happens, the structural liquidity surplus would expand to about R3-4 trln on average and O/N rates could stabilize 20-30 bps below the key ZS AND RATESFOLLOWING PUTIN'S COMMENTS SUGGESTING ECONOMIC IMPROVEMENT IN JUNE, RATES COULD RISE 25 BPS OR SO OVER THE NEXT WEEKCBR Governor Elvira Nabiullina's comments on Friday did not trigger an immediate rally in rates markets. However, offers for rates began to build up following the publication of the US jobs report for April, as investors began to price in expectations of further stimulus in both Russia and abroad. Nabiullina's remarks about the CBR considering larger cuts caused investors to price in a 75-100 bp cut to the key rate in June in the FX swap market. Nonetheless, we do not think that the CBR's economic forecasts are dire enough to warrant a 100 bp cut in June. Furthermore, we do not expect the economy to be as weak in June as it was in April. Our view was bolstered by President Vladimir Putin's comments on May 11. In particular, he announced that the lockdown measures in the country would gradually be lifted starting this week. It is therefore quite possible that economic activity will bottom out in the month of May. While the CBR will most likely continue to lower the key rate, we do not yet see grounds to assume cuts of larger than 50 bps in our base case.Following Putin's comments suggesting economic improvement in June, rates could rise 25 bps or so over the next week, wiping out the recent rally at the short end.In the CBR's view, there are several reasons for the recent decrease in ruble liquidity and rise in money market rates. During the press conference, Nabiullina announced that the CBR would conduct the first 1m repo auction at the end of May and the first 1y repo auction at the end of June. These auctions will be held once a month, with rates linked to the key rate. Nabiullina stressed that the main reason behind conducting these auctions is to help banks fill gaps in liquidity. The volumes to be offered were not announced, but we expect them (combined 1m and 1y) to be close to the average weekly repo volume, which is now near R0.5 trln.The Finance Ministry has announced that it will offer the new 15y OFZ 26235 (July 2035) at tomorrow's auction. The issue was registered in February but has not been placed yet. We think the demand will most likely be moderate, as the paper will have low liquidity after the auction. The ministry will most likely place around R40 bln. To sell more it may opt to provide a premium of some 2-3 bps to the secondary market. In that case, the average yield at the auction might be around 6.17%. The 5y OFZ 26229 (November 2025) will also be offered tomorrow. We expect demand for this issue from local banks to be rather high. We think R60 bln may be