Standard & Poor’s downgrade looks set to have little immediate impact on central bank reserve managers’ fondness for US Treasuries.
Despite China’s posturing, it – and others– look set to remain big holders of Treasuries for now. Japan – the second largest international holder of US debt after China – has said it thinks “there is no problem regarding the creditworthiness of US Treasuries and US government bonds will continue to be attractive assets.” Russian and Middle Eastern officials have said likewise.
Against expectations, Bank Rossii held rates on Friday, though it did raise reserve requirements. Following similar moves for February and March, Russia’s central bank raised reserve requirements by a percentage point for banks’ liabilities to non-residents (charted, right) and half a point for other liabilities. The proportions of deposits banks need to keep with the central bank now stand at 5.5 per cent and 4 per cent, respectively.
While there are signs that inflation is rising less quickly than previously, prices have still risen 3.6 per cent since the start of the year according to weekly data, making the annual 6-7 per cent target tough to achieve. Most view further rate rises as likely.
Inflation is beginning to slow in Russia, after one rise in bank reserve requirements in January and another one in February – the latter complete with the rate rise markets had been expecting for months.
A Reuters news flash tells us inflation slowed to 0.1 per cent in the week to February 28, bringing the price increase for the month as a whole in at 0.8 per cent, under expectations. Annual inflation has been rising steadily from a low of 5.49 per cent in July of last year, standing at 9.58 per cent at the end of January. The latest data should mean annual inflation to February fell slightly to 9.56 per cent.
Russia’s finance minister has indicated a preference for a hike in interest rates when the board meets on Friday. Governments are often pro-growth, with central banks taking the unpopular – and sometimes anti-growth – decisions needed to fight inflation. Not in this case. “The central bank is independent, but I think it is the time to take additional measures,” Russia’s finance minister Alexei Kudrin told the BBC, Reuters news wire reports.
Bank Rossii surprised markets (and us) in January by following bullish hints with a raise in reserve requirements instead of a rate rise. Prices have risen 2.9 per cent in the first six weeks of 2011: at that rate, annual inflation for 2011 would be 25 per cent.
Russia has surprised markets by holding rates after a number of bullish hints in recent months. The central bank has, however, raised reserve requirements, joining a long list of emerging markets adopting this as their favoured tightening tool.
Bank Rossii is targeting hot money with the move: it has raised the reserve ratio more sharply for corporate non-residents than for ruble-only, individual or other types of liability. From February 1, banks will have to store 3.5 per cent of non-resident rouble and forex corporate liabilities with the central bank, a 1 percentage point increase. Other types of bank liability – such as those in roubles from individuals – will be raised half a point to 3 per cent. Use the dropdown on the chart below to explore historical reserve requirements at the Bank of Russia.
Bank Rossii chairman Sergei Ignatiev has told reporters that rates might be raised at next Monday’s meeting, Bloomberg reports. Mr Ignatiev hinted in December that rising inflation might lead to a rate rise in the first quarter, and that he was not scared of a stronger ruble.
A rise in the discount rate would be the first since the financial crisis, taking interest rates from their near-year-long record low of 7.75 per cent.
China and Russia sold off substantial amounts of US debt during December – a month that saw the biggest treasuries sell-off since the collapse of Lehman’s. Market commentators entered denial mode: this was “not necessarily the start of any particular trend,” said one. “It’s too early to infer that China is shifting its diversification stance,” said another.
All this denial suggests the market is waiting for bad news – a theory backed up by volatility futures, which suggest a great deal of volatility is constantly expected roughly two months away. Whatever the date, Bad News is due in roughly two months’ time (these are VIX futures, and yes, you can buy a future on just about anything). Are these connected? Here’s one theory.
US borrowing costs have been kept artificially low for years, thanks to demand for US treasuries by world investors. The fact that the dollar is a reserve currency, and is considered safe, has kept demand for the debt high even when it is not a profitable investment. The normal laws of supply and demand are distorted. The people buying and the people selling are doing so for different reasons.
This asymmetry should be a cause for concern.
Interest rates could rise in the first quarter of next year, Bank Rossii chairman Sergei Ignatiev has indicated, saying he is not afraid of a strengthening rouble. “Inflation is beginning to worry us,” Bloomberg reports him saying. Annual price growth is set to reach 8.4 by year end, he estimated, having hit 8.1 per cent in November.
A weaker rouble in recent months has not helped, the chairman observed. A weaker rouble will make imports more expensive, driving up the price of imported goods. Today, however, the rouble closed at its strongest for two months against the euro-dollar basket, after Mr Ignatiev said the regulator wasn’t “afraid” of a stronger currency and would use interest rates to curb inflation. Rising interest rates make the rouble a more attractive purchase for investors.
** Updated: 16.54 – Confirmed by first deputy chairman Alexei Ulyukayev, according to Reuters, who said the move from 3 to 4 rouble-width boundary was part of the course of moving towards a policy of inflation targeting and a more flexible rouble exchange rate. He also said the central bank had reduced the size of interventions at the corridor’s boundaries to $650m from $700m.
Traders are reporting a widening of Russia’s exchange rate boundaries, as the currency hits an eight-month low. Bank Rossii, the country’s central bank, has been defending a ‘floating corridor’ of 33.4-36.4 roubles against a euro-dollar basket. To defend the range, the Bank would sell foreign currency when the exchange rate is in the upper third, 35.4-36.4 .
Bloomberg reports traders saying that Bank Rossii is no longer defending the 36.4 limit. Two traders are quoted as saying the corridor has been widened 50 kopeks in both directions, to 32.9-36.9. The Russian currency has weakened to 42.1875 against the euro in intraday trading, the lowest since early February (see chart).
Authorities wanting to kick-start the economy using debt, take note: Russian shareholders dislike debt-financing, unlike their developed market peers. This is the implication of research from the Finnish central bank, which seeks to explain low levels of debt-financing in Russian companies.
The research considered company stock performance on days when the company announced debt financing. Most research on this subject has considered developed markets only; typically, these stocks respond positively to such announcements. Debt financing confers tax benefits – and also removes the need for potentially dilutive equity issuance.
Russian stockholders react in an equal and opposite way, however. Controlling for normal movements of the stock market index (RTS), the study finds that Russian company stocks fall by roughly the same amount that Western stocks rise, when a debt announcement is made. Why the debt-aversion? The authors point to perceptions of risky behaviour associated with taking extra debt, and recommend improved corporate governance: