Sovereign Fixed Income - Buy Russia 43 vs Kazakhstan 44

Amid the prevailing economic uncertainty and given the structural shift in the oil market, we recommend Russian Eurobonds over their Kazakh peers. We see Russia as better prepared for a protracted period of low oil prices and expect its bonds to again trade below the Kazakh curve. This trade seeks to exploit the differences between the two credit profiles with a carry-positive and duration-neutral position. This recommendation comes after the drastic shift in major oil producers' policies. As a result of this change in paradigm, we have substantially lowered our Brent price forecasts and now see the benchmark trading at $25-30/bbl in 2Q20 and then averaging $30/bbl and $34/bbl in 3Q20 and 4Q20.Not even taking into account the developments in the oil market, there is a great deal of uncertainty in financial markets. The coronavirus outbreak has had a more dramatic effect on markets than was initially envisaged, and visibility remains limited. This makes relative-value trades especially alluring.Considering the above, we now recommend going long the Russia 43 versus the Kazakhstan 44. We expect Russian bonds to trade tighter than Kazakh issues assuming oil prices remain low. We would like to point out two considerations supporting our view.> Russia's FX regime and monetary framework make it better prepared for external shocks. Since the start of the year, the tenge has taken milder losses than EM peers. It is down a mere 3.3% YTD versus the dollar, while the Russian ruble, Mexican peso, South African rand and Brazilian real are down 9-14%. On March 10, the National Bank of Kazakhstan sold $318.5 mln in the open market and issued a statement saying that it would not allow for a destabilization of the situation in the currency market and would constantly monitor the market, resuming interventions if necessary. Concurrently, the regulator hiked the policy rate from 9.25% to 12% and prohibited state-owned companies from buying FX beyond the amount needed to meet their current obligations.In our view, persistently weak oil prices will test the Kazakh authorities' ability to contain the pressure on the national currency, which could mean foreign investors keep a nervous eye on the country.Similar measures were taken in Russia. The important difference is that they imply a very different extent of the currency's freedom to float freely and help the economy to adjust during times of turbulence. The CBR announced preemptive sales of FX in the market as set out in the fiscal rule (taking into account the current oil prices and their effect on National Wealth Fund operations in April). At the current $35/bbl Urals price, such FX sales could reach $60 mln a day or $1.3 bln by the end of the month. Meanwhile, citing Gazprom Deputy CEO Famil Sadygov, Bloomberg reported that the company is set to resume regular sales of foreign currency.> Russian budget more resilient to low oil prices. While the oil and gas sector generates around 40% of budget revenues for both countries, the breakeven price for the Kazakh budget (around $70/bbl) is considerably higher than Russia's breakeven price ($50/bbl). This is a result of the stimulatory fiscal policy conducted by Kazakhstan over the last few years. Under our economists' base case, which assumes a $35/bbl average oil price this year, they expect a budget deficit of around 5.7% of GDP for Kazakhstan versus just 1.7% for Russia.The Russia 43 closed at 135.9% yesterday (3.6%, Z-spread 290 bps), while the Kazakhstan 44 ended the day at 127.2% (3.3%, Z-spread 255 bps).