2018 marks a turning point for the Russian ruble as foreign capital inflows supporting it amid sanctions and falling oil prices dry up in coming months, with outflows expected next year. Leading global investment banks surveyed by Bloomberg predict this shift.[/p]
Ruble Risks Losing Investment Appeal
Foreign funds holding about $15 billion in Russian OFZ bonds will lose interest in ruble assets in 2018, closing positions, selling rubles, and exiting carry trades.
Main triggers for capital flight include low oil prices, expanding sanctions, and US Federal Reserve rate hikes.
Thanks to Russia’s tight monetary policy, the ruble became a speculator favorite. Traders borrow in dollars or euros at around 1% annual rates to buy ruble-denominated OFZ bonds yielding 7.5% or more. A stable or strengthening ruble allows profitable exits with high currency gains by global standards.
However, as Russia’s Central Bank cuts rates while the Fed raises them, the interest rate differential narrows, reducing ruble asset appeal.
After its September meeting, the Fed signaled a December rate hike and three tightenings in 2018, plus balance sheet reduction to curb excess dollar liquidity from post-2008 crisis measures. Meanwhile, Russia’s Central Bank cut its key rate to 8.5%—a three-year low—and hinted at further cuts soon.
Ruble Carry Trade Math Explained
Pressure mounts on emerging market assets and currencies. The largest US ETF investing in EM debt and currencies saw steady outflows from July, with clients withdrawing $1.2 billion and forcing position closures.
Falling demand likely persists as global players exit EM papers amid Russia geopolitics. This erodes ruble carry trade attractiveness.
Russia’s real interest rate ranks among the world’s highest at 5.3% annually—the Central Bank’s key rate minus inflation. The Fed’s rate trails US inflation, yielding a negative real rate.
The current real rate gap between Russia’s Central Bank and the Fed stands at 5.85 percentage points. A drop to 3.5 points makes Russian assets unappealing.
In short, carry traders could exit rubles without Central Bank cuts if the Fed hikes five times and Russian inflation hits 4.4%.
Ongoing Currency Risks for Ruble
Ruble investment risks remain. Dollar revenues in Russia tie 60% to oil prices, making some Central and Southeast European assets more attractive despite 1-2% smaller rate gaps due to lower currency volatility.
New US sanctions fully banning investment in Russia’s debt market pose a key ruble risk.
The US Treasury was tasked by March 2018 to prepare such rules. Enactment would instantly halt carry trades and trigger massive outflows.
Ruble threats extend beyond sanctions and oil: North Korea tensions, Ukraine, and Russia’s presidential elections add pressure.
Key Takeaways
Russia’s Finance Ministry long-term budget forecast assumes chronic ruble depreciation starting in 2018, with a base 10% drop every five years. Dollar could hit 70 or 80 rubles faster if US sanctions target state debt investments.
FAQ
What is ruble carry trade?
Borrow low-rate USD/EUR, buy high-yield Russian OFZ bonds; profit from rate gap plus stable ruble.
Why might carry trade end in 2018?
Fed rate hikes narrow differentials with Russia’s cuts; real rate gap falls below 3.5 points, plus sanctions risks.
What are main ruble downside risks?
Low oil prices (60% revenue link), new US debt sanctions, geopolitics like Ukraine and elections.
