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Can Russia’s rouble swim against the falling tide of EM currencies?

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With new US sanctions looming over Russia and the effects of higher oil prices largely already priced in, will the Russian rouble sink or swim as we approach the end of 2018?

By: Anna Fedorova

Over the last three months, the Russian rouble has outperformed many emerging market currencies, buoyed by rising oil prices and an accommodative central bank, but it continues to suffer under the pressure of potential fresh US sanctions against Russia.

A fresh round of sanctions could block US imports of Russian oil and ban international bank loans to the country, and could come in as early as next month, according to reports. Earlier this year, the US initiated a first round of sanctions that stopped the sale of arms and exports of national security-sensitive goods and technology to Russia.

Yet, the currency has held up better over the last quarter than some of its EM counterparts, falling just 5.2% against the US dollar, according to JPMorgan, and outperforming the Turkish lira (-17.9%), Argentine peso (-25.6%) and South African rand (-8.2%).

A key driver for this outperformance has been rising oil prices; Brent crude is up some 14% this year, to trade at $76 a barrel as of October 24. The price is expected to go higher.

In their latest monthly forecast, JPMorgan’s commodities analysts have increased their Brent price target for the fourth quarter 2018 to $90 a barrel, leading to a 5% increase in their forecasts for the rouble over the next three quarters.

Undervalued

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At current levels, JPMorgan sees the rouble as undervalued, meaning the currency could strengthen in the coming quarters. The analysts upgraded their six-month targets by 3% on the back of near-term stress alleviation and fundamental drivers: they expect the rouble to be trading at 65.50 against the dollar by the first quarter of 2019, up from a previous target of 69.

According to the bank’s global FX strategy and EM markets team: “Valuations remain supportive against a favourable oil backdrop. In our preferred methodology to take into account the budget rule, our Beer FV model relies on a weighted average between the current oil price (1/3 weight) and the budget oil price (2/3 weight; Brent at $42.8 a barrel). Such an adjustment to the model leaves RUB currently 8.3% cheap to fair value.

“However, with the Central Bank of Russia extending the pause in its FX reserve accumulation program until year-end, oil prices could have a more pronounced impact on RUB in line with historical betas. Relying on actual oil prices in our fair value model would show RUB as substantially undervalued, by 15.6%.”

Positive drivers

According to Kit Juckes, macro strategist at Société Générale, there are a number of positive drivers that could help the rouble continue “against the prevailing tide”.

“There are lots of things going for the rouble,” he says. “The current account surplus and an independent central bank are two big ticks. It is probably the one major EM currency where there is an aspiration for it to outperform.”

A key area to watch is the action of the central bank over the coming months. In September, the central bank raised its main interest rate by 0.25% to 7.50%, but it is unclear if another hike is imminent.

Ed Al-Hussainy, senior rates and currency analyst at Columbia Threadneedle Investments, says: “This would help support the rouble by giving investors additional compensation for the geopolitical risks surrounding sanctions.

“The problem for the rouble – and other emerging market currencies – is that the US Federal Reserve is also raising rates, and doing so more aggressively. So the question becomes: how quickly will the difference between US and Russian interest rates shrink, and will it be enough to support the rouble?”

Geopolitics

However, valuations in Russia are highly dependent on geopolitics, and volatile relations between the US and Russia are putting continued pressure on Russian assets. With the threat of new US sanctions on the horizon, the direction of currency movement is hard to predict.

Al-Hussainy says: “The threat of sanctions continues to be a bit of a wild card. More sanctions are likely to be imposed by the US in November. If they were to include limits on the purchase of Russian sovereign debt, then all bets would be off, as that would cause foreign investors to flee from the rouble.”

Some investors consider the uncertain geopolitical situation to be simply short-term noise that creates investment opportunities.


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Raphaël Marechal, 
Nikko AM
Raphaël Marechal, head portfolio manager for emerging market debt at Nikko Asset Management, says:“Russia remains an interesting investment case for us at the moment. It is a contrast between one of the best fundamentals in EM and an ever-present risk of additional sanctions. We have decided to remain tactical and use short-term noise (sanctions) to top-up our exposure on a fundamentally sound story over the long term.”


The Nikko AM EM Local Currency Bond fund had an allocation to the Russian rouble of approximately 6% as of September 28.

Asymmetric risks

However, others are not as sanguine on the prospects for the rouble, fearing that bad news headlines could easily send it into freefall.

Paul McNamara, investment director at GAM Investments, says:Russia is cheap. With the oil price up you can argue it is really cheap, but the threat of sanctions is a problem. The nuclear option is if the US goes after the ability to own Russian government debt, which will also have a knock-on effect on anyone who does business in the States. This would send the rouble significantly lower from here. 

“The returns are so asymmetric: if America does not go nuts, the rouble goes up a bit, but if it does, it will sell off a lot. As a result, we are reducing our weighting in Russia.”

SocGen’s Juckes agrees that the threat of sanctions is making the rouble look less attractive. He adds that it must also be viewed against the backdrop of the general downward trend of EM currencies.

“The tide is going out from most EM currencies as global monetary policy gets tightened and liquidity gets taken out of the system in general,” he says, “so it is hard to get bold about [the rouble].

“It is hard to think the rouble will go a long way against this tide. It has outperformed against Turkey, Argentina and South Africa over the last three months, but I don’t know if you can expect it to do much more than that.”