Bonds: Strong demand for short-term bills
Last week, the MoF increased local-currency borrowing to the maximum amount since mid-July. However, the focus of the remaining auctions in October will likely be on USD-denominated bills to refinance the US$700m redemptions due this month.At last week's primary auction, the Ministry attracted almost UAH12bn, selling bonds with maturities from one to three years. Thanks to the cap and large demand for 12-month paper, the MoF decreased interest rates to 17.55%. This is 25bp below the cut-off rate before the NBU reduced the key policy rate to 20% in September. The yield on bonds with other maturities that the MoF sold last week remained unchanged after the reduction of the NBU key rate. See details in the auction review.The volume of trades in the secondary market decreased to UAH5.3bn, or by 26% compared with the previous week. More than a third of the deals were with bills due in the next nine months, which MoF does not currently offer at primary auctions.Last week's USD-denominated bills redemption for US$356m had the largest impact on individuals' portfolios, which decreased by UAH3.8bn (US$103m).
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ICU view: The Ministry of Finance continues to refinance current redemptions and raise additional resources to finance the budget deficit. For this week’s auction, the MoF set the cap for USD-denominated paper at US$300m, which, if there is enough demand, will allow refinancing of most of last week's redemption. Tomorrow, the Ministry will offer a new UAH note maturing in September 2026, which will become a designated reserve bond later this month. At the same time, non-banking investors who prefer local-currency instruments can focus even more on short-term securities in the secondary market, which they cannot buy at primary auctions.
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Bonds: Eurobond prices continue to decline
Ukrainian Eurobond prices fell further last week due to increased uncertainty with US financial aid.Eurobond prices fell last week by an average of 10%, to 24‒32 cents per dollar. The price range for instruments with different maturities has widened to more than 15%. The price of VRIs slid by almost 4 cents or almost 9% to below 42 cents per dollar of notional value.
ICU view: Global sentiment towards emerging markets worsened last week, with the EMBI index down 2.7%. Increased uncertainty about financial aid to Ukraine from the US exacerbates the cautious sentiment towards Ukrainian Eurobonds. The dismissal of the House of Representatives speaker has suspended the legislative process in the United States, so financial aid to Ukraine will not be discussed in the coming weeks. We expect the price volatility of Ukrainian Eurobonds to remain high.
FX: NBU abandons fixed exchange rate
Since last Tuesday, the NBU abandoned the fixed-exchange-rate regime that had existed for 18 months and switched to a "managed flexible" exchange-rate regime.As we expected, the demand for hard currency increased. On the interbank market, bank clients (legal entities) purchased US$1.4bn of hard currency in four business days or 44% more than during the same period of the previous week. At the same time, the supply of hard currency from bank clients (legal entities) decreased. They sold only US$629m in four days, which is 14% less than in the same period of the previous week.The growing imbalance in the market required larger NBU interventions. Over the past week, the NBU sold almost US$1.2b from international reserves, the largest weekly volume of interventions since May 2022. NBU sold approximately US$520m on Tuesday and US$240m on Wednesday, which allowed the central bank to keep the official exchange rate almost unchanged compared with the previous week.The retail FX market also reacted to the transition to flexible exchange rates and individuals increased daily non-cash FX purchases to US$86m last Monday, the largest volume since the beginning of the russia’s full-scale invasion.
ICU view: The NBU's transition to managed exchange-rate flexibility expectedly led to larger central bank interventions to prevent significant depreciation of the official hryvnia exchange rate. We expect the central bank will prioritize hryvnia stability over other goals in the next couple of months, and we expect only symbolic hryvnia weakening by the end of the year. However, the market will likely remain nervous in the coming weeks before businesses and households gradually adapt to new realities.
Economics: NBU reserves decline second month in a row
The NBU gross international reserves declined 1.7% in September to US$39.7bn. This is the second consecutive month of decline after they had grown steadily in March‒July.The decline in reserves was driven by significant NBU interventions as the central bank sold US$2.7bn to maintain market balance, which is the largest volume since January. The second largest drag was repayment of IMF loans totaling US$0.9bn. Meanwhile, reserves were replenished with an EUR1.5bn loan from the EU, a US$1.25bn grant from the US, and a US$0.1bn loan from the World Bank.
ICU view: The central bank’s reserves will remain under pressure in October as the NBU has to significantly step up its FX sale interventions after it transited to a managed, flexible exchange-rate regime. The NBU sold net US$1.15bn in the first week of the month. Yet, we expect the sale of FX will be to a significant extent offset with the inflow of foreign financial aid. Looking through end-4Q23, the key risk to reserves is disruptions of financial aid provided by the US. The prospects and timing for approving a new aid package for Ukraine remain highly uncertain due to political deadlock in the US Congress.
Research team: Taras Kotovych, Vitaliy Vavryshchuk, Alexander Martynenko.
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