Inflation-linked debt is back in favour with Russian investors

Inflation-linked debt is back in favour with investors in Russia to protect against a comeback in consumer-price growth after three years of an almost uninterrupted slowdown.The looming turnaround had traders ploughing into linkers at the Finance Ministry’s first auction in two years this week. It attracted bids that exceeded the 20bn roubles ($346mn) of securities on offer by almost seven times, with as much as three-fourths of demand coming from Russian pension funds and asset managers. A debt-market measure of inflation expectations over the next decade known as the breakeven rate – based on the difference between nominal bonds and linkers – stands at about 4%.“The fact that the issue was so popular indicates that investors expect inflation to be likely above 4% on average over the next 10 years,” said Liza Ermolenko, an economist at Barclays Capital in London. “Perhaps Russia’s history of high inflation had an impact here. For the locals, it is still difficult to believe that inflation could remain at current levels over a 10-year horizon.”Except for occasional seasonal pickups, inflation has been on the decline since March 2015, when it peaked at a 13-year high of 16.9%. That may be about to change, with consumer-price growth probably accelerating for the first time since June. Data on Friday showed the annual index rose to 2.4% last month, in line with the median estimate in a Bloomberg survey.The Bank of Russia assumes that inflation, which has been at 2.2% during the first two months of the year, will reach 3% to 4% in late 2018 and remain near its goal of 4% in 2019. That’s close to the view of most economists, who see it quickening to 3.6% at the end of the year and staying at 3.9% at least through the third quarter of 2019.Russia sold its first linkers in July 2015, allowing investors to protect the value of their holdings against inflation through coupons that are reset every three months to mirror price growth. They outperform fixed-rate notes when consumer prices rise faster than the breakeven rate.“Linkers are the only instrument worth buying on the local market,” said Alexey Tretyakov, a money manager at Aricapital Asset Management in Moscow, whose funds have 50mn roubles of index-linked bonds, including the most recently issued notes. “Returns aren’t bad even in the conditions of current inflation, which is seemingly near the bottom and may then rebound to an area of 5% to 7%.”Russian inflation-linked bonds have returned 3.6% so far this year, trailing their fixed-rate counterparts, which have handed investors 4%, according to Bank of America Merrill Lynch indexes. Market-implied inflation expectations “reflect the strength of demand for instruments to protect against inflation,” according to Alexander Isakov, an economist at VTB Capital.The Bank of Russia has said that threats to price growth include risks posed by the labour market, as “the dynamics of wages and unemployment create prerequisites for potentially higher inflationary pressure.” Inflation expectations among households, derived from a survey conducted for the central bank, rose slightly in March to 8.5%.“The auction’s results suggest that investors are expecting inflation could recover already in the near future,” said Denis Poryvay, an analyst at Raiffeisenbank in Moscow.