Russia: Buyers shun deeply discounted rouble

By:
Solomon Teague
Published on:

Russia has been caught in the eye of a perfect storm. Battered by falling oil prices, US and EU sanctions and a dramatic market correction as the rouble was allowed to float, the currency has been in free-fall and liquidity has largely evaporated, with many brokers ceasing rouble trading altogether.

rouble

In late 2014, as the impact of the depressed oil price began to bite, investors were dumping their roubles in droves.

The Central Bank of Russia’s (CBR) attempts to defend the currency were costing it billions, steadily eating away at its FX reserves. In November it pulled the plug on the policy of maintaining the rouble band of nine roubles to a basket of dollars and euros.

The decision turned a steady decline into a rout, which lasted through much of late November and December. And while the decline of the dollar has slowed in recent weeks, few are interpreting this as the end of Russia's problems.

"It feels less like a period of calm than a brief respite," says Ilya Spivak, currency strategist at FXCM.

The CBR's decision to float the rouble has been widely praised.

Having tightly managed the rouble for so many years, holding the currency up at an artificially high price, there was bound to be some drama when it let go of the reins and the rouble sank to a level more in line with real-market fundamentals.

Most believe it was still the right decision and Russia will ultimately prove more stable with a floating rouble.

In the short term, however, the CBR’s execution of the float has arguably added to the sense of anxiety among traders. Although its systematic interventions have ended, it has indicated it will still make interventions, leaving traders at risk of being steamrollered.

Its last intervention was on December 15, weeks after it announced the rouble would float.

Senior executives have publicly announced they have given instructions to traders not to trade on their own bank book
Sergey Romanchuk

Spivak says: "The CBR wanted investors to think it could still intervene but at unknown times and sizes. It was a message to investors to be careful shorting the rouble and that has only increased pressure to avoid the currency."

As the rouble has fallen, so too has liquidity dried up, with volumes going into precipitous decline since around October.

"The market remains fragmented and driven by customer orders, as well as high-frequency traders," says Sergey Romanchuk, president of the Financial Markets Association (ACI) in Russia. "Market risk is very high and there are only a few liquidity providers out there."

Speculators were deemed to be partly responsible for the excessive movement in the currency, says Romanchuk, and some Russian banks have since ceased trading the rouble for their own accounts.

"The largest Russian banks have been directly instructed by their managers and heads of desks not to speculate – in fact, some senior executives have publicly announced that they have visited dealing rooms and given instructions to traders not to trade on their own bank book," he says.

While it is impossible to gauge spot volumes accurately because of market decentralization, CME rouble futures serve as a good proxy for market sentiment, and have seen substantial declines. This market has been impacted by some clearing brokers closing their business with Russian customers, says Romanchuk.

This has had implications on execution and transaction costs for rouble traders. Romanchuk says clients have seen spreads inflate by between two and 10 times their previous levels as a result of this illiquidity.

A number of brokers – including FXCM – have ceased offering rouble pairs. According to the Commodity Futures Trading Commission’s Commitments of Traders report, the rouble saw record-setting net speculative short-positioning in November. The market has now moved to net longs, but the fact net shorts have fallen as open interest drops implies a loss of interest in RUB, rather than a positive shift in investors’ outlook, is driving the unwinding of shorts, say analysts.

rouble futures


As a direct consequence of the sanctions placed on Russia, the forwards market has split between Russian onshore and international offshore counterparties, says Romanchuk. Even spot FX has changed dramatically.

"There are no prime brokerage services offered directly to Russian names in roubles," he says.

OTC and exchange-traded markets have shrunk in volume twice in the past month, adds Romanchuk, with the OTC market now virtually non-existent.

The cheaper rouble has also left Russia importing more inflation, which was most recently recorded as 15%, and is likely to remain in double digits for some time, while growth is non-existent. The absence of any impetus at the government level to push through the reforms necessary to reverse these trends feeds fears they will remain entrenched.

FXCM’s Spivak says: "Russia is approaching a 1998 kind of scenario," referencing the collapse of Long-Term Capital Management, which required a bailout to prevent a systemic event, and considerable EM contagion.

"Today the market is still in recovery mode following the 2008 crisis," says Spivak. "Governments don’t have much room for fiscal stimulus and central banks are very close to the zero bound.