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Russia, Israel real rates set to make RUB and ILS the stars of EM FX

Recent favourable moves in real short-term interest rates in Israel and Russia mean the RUB and the ILS are poised to appreciate, according to Deutsche Bank strategist Henrik Gullberg.

That means the carry trade, which relies on interest-rate differentials, might be set to play a bigger role in EM FX.

Gullberg says the carry trade might not be functioning if you look at EM FX performance against the majors, because you have to take into account other factors, such as risk-on/risk-off.

“If you remove or reduce the risk-on/risk-off component, then the carry trade is working,” claims Gullberg.

He says relatively high-yielding EM currencies are outperforming the low-yielders, but not yet in the case of the RUB.

“It’s too strong of a conclusion to draw on that basis that the carry is not working,” says Gullberg. “The carry performer has been undermined by a more uncertain risk environment.”

 Real rates matter for EM FX

Source: Deutsche Bank, Bloomberg 

The RUB and the ILS are correlated with the USD, but both currencies share a 10-12 month lag period in correlation with the USD, a fact EMEA FX traders could look to take advantage of in the current environment of continued uncertainty in EURUSD, says Gullberg. During the past 12 months, the RUB has depreciated by around 15% against the USD, despite favourable moves in real Russian short-term interest rates, he says. The RUB depreciation against USD comes after 10 years of a stable rate of correlation between the currencies, seen at around 70% to 75%, but only after a 10-12 month lag.

Meanwhile, the ILS has depreciated by 55% against the USD during the past 10 years, again with a 10-12 month delay in the correlation, says Gullberg.

 Favourable real rates could lift RUB

 Source: Deutsche Bank, Bloomberg


The inflation-adjusted short-term interest rate in Russia is 2.4%, taken from a refinancing rate of 8% minus the CPI rate year-on-year of 5.6%. In Israel, the inflation-adjusted interest rate is 1.5%, taken from the central bank headline rate of 2.5% less the 1% CPI level year-on-year from June. “Recent history provides no reason why the favourable development in real rates over the past six to 12 months in Israel and Russia should not be reflected in the ILS and the RUB going forward,” says Gullberg. Deutsche Bank “remains bullish RUB and ILS versus the EURUSD basket”, he adds.

Gullberg said in an interview that recent regulatory changes in the Israeli economy caused the ILS to devalue, but the effects of those regulations are “slowing down”.

In Russia, recent RUB outflows could be stemmed in the medium-term by acceptance of Russian membership in the World Trade Organization, which could be set for finalization soon, says Gullberg.

“Recent Russian inflows are most likely tied to increasing oil prices and higher demand for oil over the past few weeks” as Brent crude oil has climbed from around $90 per barrel earlier this month to $113/b on Tuesday, says Gullberg.

“If you look at the sell-off in the RUB in May and June, it was in response to the decline in crude oil prices,” he says. “Since then, there has not been much of a rally in the RUB since the end of the decline in crude oil prices, and that is just a lagged impact. As oil prices go higher, RUB inflows will increase going forward.”

Gullberg adds that the ILS and the RUB will likely convert back to real yield during the second half of this year because both currencies represent economies with high value assets, such as fixed income, that the market is willing to invest in.

“Especially with Russia, we have seen a lot of improvements recently in demand for Russian fixed-income assets because of interest rate yields … given that the real yield for Russian bonds is attractive compared to where the RUB is trading at the moment,” says Gullberg.

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