ICU Weekly Insight: 25 October 2022

Bonds: MoF and NBU: new round of dialogue about interest rates

The National Bank seeks to maintain a discussion with the Ministry of Finance regarding interest rates for local-currency bonds while the market is making guesses about what further steps the MoF will take.

Last week, the NBU announced that it does not plan to sell government bonds from its portfolio now. They will keep budget financing at up to UAH30bn (US$0.8bn) per month, and kept the key policy rate at 25% (see comment below). The new NBU governor thus revealed his position on the key issues related to the dialog with the MinFin.

At the same time, the Ministry of Finance sold large volumes of bills last week at interest rates between 14‒18.5%, which is 200‒250bp higher than interest rates for similar instruments were earlier (see details in the auction review). The new NBU Chairman praised such a step. Market participants seem to be trying to understand the meaning of last week’s developments and to predict the possible next moves of the Ministry of Finance.

It is clear from the auction results and portfolio changes that a few banks bought paper with higher rates. Their portfolios of UAH bonds increased by UAH6.6bn US$0.2bn) over the past week. Meanwhile, foreigners reduced their investments in local-currency securities. The hryvnia-denominated portfolios of domestic non-banking institutions and individuals continued to grow smoothly.

The placement of bonds with higher rates did not affect the secondary market. The general activity in local-currency bonds increased, but for earlier-sold securities.

ICU view: The messages from the debut press conference of the new Chairman of the NBU indicated that the NBU continues to expect an increase in interest rates for local currency bills and considers such an increase necessary to improve the efficiency of the transmission mechanism. At the same time, all messages were delivered in a soft and constructive manner, so it is most likely that the NBU and the Ministry of Finance will try to avoid heated public discussions about interest rates in the future and will hold talks in a closed format. Given the considerable volume of international aid, the Ministry of Finance can be totally fine with not increasing new borrowings significantly and thus avoid further increases in interest rates in the near future. Therefore, we should not expect a significant activation of the primary market soon.

Tomorrow’s offerings include the usual list of military bills, which the MoF sold last week at unchanged rates of 12‒16%. However, the MinFin may still expand the list of bonds on offer thus shedding some light on its vision of further interest-rate development.

Bonds: Eurobonds drift amid global uncertainty

Prices of Ukrainian Eurobonds continued to decline last week under the influence of general market sentiment.

US treasury yields continued to rise last week. But the spreads of Ukrainian Eurobonds to the benchmark remained broadly unchanged. Hence, increase in their YTMs is comparable to the change in the YTMs of US treasuries.

Accordingly, prices for the shortest Eurobonds lost about 3% or almost 1 cent over the past week, with some of them hitting a new record low. However, price fluctuations for the rest of the papers were symbolic and have not hit the lows of the mid of July. The price of VRIs barely changed, staying slightly above 26 cents per dollar of notional value.

ICU view: Investors have kept their view of Ukrainian risks relatively unchanged amid scarce news from the battlefield. So, Ukrainian Eurobonds remain primarily under the influence of the global mood on the debt markets. 

FX: NBU keeps exchange rate fixed and unchanged

The National Bank announced that it plans to keep the exchange rate fixed at UAH36.6/US$, positively impacting the FX market, especially the cash segment.

The NBU carried out a one-time hryvnia depreciation in late July and kept that official exchange rate unchanged since that time. Last week, the NBU reconfirmed it intends to maintain the fixed exchange rate at the current level. The switch to a flexible exchange rate regime is not on the agenda as of now.

In the official interbank market, demand continues to exceed supply significantly. On some days, imbalances reached almost US$170m, with slight improvement since Thursday. The NBU interventions for the week declined to US$570m from US$603‒608m in the previous two weeks.

However, the cash market reacted very positively to NBU’s statement. The hryvnia exchange rate appreciation sped up at many banks, mostly by UAH0.2-0.4 and bid-offer spreads tightened. In the leading retail banks US$ strengthened to UAH39.89-40.65/US$ last Friday compared with UAH39.92-40.7/US$ a week ago.

ICU view: The cash market has remained relatively saturated for the past couple of weeks. The NBU’s signal that the official exchange rate would not change became another catalyst that reduced negative sentiment and led to cash exchange rate appreciation. But in the non-cash segment of the market, the situation remains tense and may worsen. The needs of importers are growing, especially since the start of the heating season and given the need to restore damaged energy infrastructure. At the same time Russia is also slowing down Ukraine’s export flows through the grain corridor and threatening to terminate the grain agreement in general, which will reduce the inflow of hard currency. The NBU is already spending significant amounts of reserves to keep the official exchange rate unchanged. If interventions grow further, the NBU may have to reconsider the feasibility and possibility of maintaining the official exchange rate unchanged, even amid generous inflows of international financial aid.

Economics: NBU again keeps rate unchanged

At its recent meeting, the regulator decided to keep the interest rate at 25%, which was in line with the expectations.

This decision was the first under the leadership of the newly appointed Governor Andriy Pyshnyy. NBU has provided its new macro forecast where it has confirmed its earlier forecast of the unchanged key rate until the 2Q24.

The national bank will abstain from the idea of selling the bonds off its balance sheet in order to boost the rates on the secondary market.

ICU view: CPI is accelerating, but slightly below the NBU’s forecasts. Yet, a rate increase is still more likely than an early decrease in the rate. The updated macro forecast surprised with the lack of significant downside revision of the key figures despite the massive attack of Russian on Ukrainian infrastructure in October.

RESEARCH TEAM: Vitaliy Vavryshchuk, Alexander Martynenko, Taras Kotovych, Mykhaylo Demkiv

See the full report here.