- There has been significant differentiation in the Russian bond market since Russia’s invasion. Financials and Russian government bonds fell more than 80% in price, while energy and materials fell 69%.
- Liquidity barometers revealed a dramatic reduction in the willingness and ability of dealers to service market-liquidity needs, but market-making activity continued, with expansion of bid-ask spreads varying considerably across sectors.
- Investors continue to consider how additional sanctions and changes in trade policies could have different effects on different sectors.
Through the time of writing (April 26), losses in the Russian bond market have been deep, broad and unsparing. But certain sectors fared better than others, perhaps due to varying degrees of effects from sanctions. Additionally, while there was an overall dramatic deterioration in liquidity conditions, there were still pockets of relative liquidity to be found. An important consideration for many investors now is how trade policy and the sanctions regime may be shifting. Might such developments have a more pronounced impact on those sectors that have shown relative strength to date?
The effects of sanctions on Russian hard-currency bonds
As of April 26, all sectors in the Russian hard-currency bond market were trading at distressed levels.1 Current and potential new import and export restrictions will result in sharply lower economic activity, but they are just one part of the story. Financial-market sanctions and uncertainty about how sanctions may be enforced or changed have created major difficulties in the servicing and trading of debt. Investors in hard-currency Russian bonds now face the distinct prospect of default and the possibility of a long and highly uncertain process to settle claims that could stretch out years, if not decades.2 Following a ban in the EU,3 all three major credit-rating agencies have withdrawn ratings of Russian entities, underlining the uncertainty of a crippled market.
Financials and Russian government bonds were the worst-performing sectors in the market for Russian hard-currency bonds between Feb. 18 (the end of the last week before the invasion) through April 26, as we can see in the exhibit below. With returns of -69%, the materials and energy sectors also had exceptionally poor performance, but still significantly outperformed financial-sector and government bonds. Communication services, the best-performing sector, returned -39%.
Russian bonds’ performance varied across sectors
Dramatic deterioration in liquidity, but market making continued
An important detail that some may overlook is the fact that U.S. financial-market sanctions do not apply to secondary trading of Russian corporate or government bonds issued prior to March 1.4 As shown in the exhibit below, the number of hard-currency bonds with dealer quotes indeed showed only relatively small declines. In contrast, there was a dramatic drop in the number of dealers willing to provide quotes on Russian bonds.
The number of quoted Russian bonds was fairly steady, but the number of dealers quoting fell sharply
Source: MSCI and S&P Global Market Intelligence
Bid-offer spreads also increased substantially, leading to exceptionally high costs of buying and selling.5 Significantly increased complexity in compliance procedures combined with higher market volatility likely pushed up dealers’ hedging costs, thereby contributing to the diminishing of liquidity.
Average bid-offer spreads increased across energy, financials and materials
Source: MSCI and S&P Global Market Intelligence
Looking at both dealer quotes and bid-offer spreads, we can see that the sectors with stronger price performance also tended to have better liquidity. Investors may want to consider these sectoral differences in liquidity when considering trades within their Russian-bond portfolios.
The energy and materials sectors currently comprise approximately 54% of the market value of the market for hard-currency Russian bonds. These sectors have performed better than financials and Russian government bonds. Stronger sanctions and changes in trade policy, however, could weigh on these sectors more than others, as they generate significant revenues from exports.
The EU remains a major importer of Russian energy, but has announced an aggressive plan to reduce its imports.6 Russian government demands, such as payment in rubles, could also result in diminished imports by the EU and reduced revenues to Russian energy companies.7 On the other hand, Russia may find new sources of demand for its exports, which could mitigate the impact of tougher trade policies. Investors are charged with continuing to assess their portfolios by exploring potential outcomes in the face of continued uncertainty.
1All prices used in the analysis are from Refinitiv, and return calculations are from MSCI based on those prices.
2Settlement in the case of Argentina and the Bolshevik Revolution took about 15 and 70 years, respectively. Wirz, Matt, and Saeedy, Alexander. “Bond Markets Forecast Long Financial Freeze for Russia.” Wall Street Journal, March 15, 2022.
3“Ukraine: EU agrees fourth package of restrictive measures against Russia.” European Commission, March 15, 2022.
4Benitez, Laura. “Sanctions Prove No Obstacle to Russian Debt Trading.” Bloomberg, March 30, 2022.
5It is important to note that because the financial sector is in a highly distressed state, the data is not reliable enough to perform a quantitatively precise analysis.
6“REPowerEU: Joint European action for more affordable, secure and sustainable energy.” European Commission, March 8, 2022.
7Kantchev, Georgi, and Wallace, Joe. “Russia stops gas flows to Poland, Bulgaria, deepening economic conflict with Europe.” Wall Street Journal, April 27, 2022.