A Currency Disappears Into the Memory Hole
After the excitement caused by the collapsing Russian ruble last December, the ruble has seemingly been forgotten. The financial media have certainly fallen silent on the topic. Luckily, we haven’t forgotten about it. We first mentioned the the fact that the ruble might potentially represent an opportunity on the very day it made what has (so far) been its low, and posted a brief update three days later (see “The Russian Rubble”[sic] and “The Ruble Rebounds” for details). Although there were and still are obvious risks due to oil price weakness, geopolitical concerns and general emerging market worries, panic-like declines in currencies very often price in future risks as well. As we noted in these previous missives:
It ain’t worth much, but it’s worth more than at the end of last year …
“Situations like this one very often turn out to have been great opportunities in hindsight. […] There will possibly be some sort of retest of the ruble’s low at some point, but that is not certain. Let us rather say: if there is a successful retest, then it may well put in a higher low.”
We reasoned that a) money supply growth in Russia has actually reached historically low levels in recent years; b) there was a “technical reason” for the acceleration of the decline in December, as Rosneft needed to buy a large amount of dollars in a relatively illiquid market for a debt repayment and was probably front-run by traders; c) the decline looked exactly similar to those seen in previous emerging market currency panics, and certain patterns could quite often be observed on these occasions.
Obviously, none of this guarantees a particular outcome – at best one can attempt to make a risk-reward assessment and consider probabilities. Let us now look at what has happened since then. The chart below compares the dollar/ruble exchange rate to the price of the active May Brent oil contract.
The Russian ruble vs. Brent crude – click to enlarge.
The expected retest in the form of a higher low (which in USDRUB notation appears as lower high) has come to pass. The blue lines indicate a positive divergence between the ruble and Brent (higher lows in the ruble while Brent continued to decline and made lower lows). The red lines indicate a potentially negative short term divergence that has developed recently. Given strength in crude oil over the past several days, this divergence could well be negated fairly soon.
Of course, the ruble remains a risky proposition for numerous well-known reasons. However, we know from experience that it is usually when the news are extremely bad (as they were late last year) and are moving to page 1 in the papers, important price lows are very often put in. Consider also that Russian assets, such as stocks and bonds are extremely cheap on a relative basis: The stock market is one of the cheapest in the world on several key measures, while Russian bonds still sport quite high yields, although they have come down quite a bit from their recent highs (this is by the way a sign that confidence is increasing – whether this is justified is obviously a different question). Compared yields that range from extremely low to negative in the euro area, one does still get some risk compensation. In fact, the risk in bonds with negative yields to maturity strikes us as greater almost regardless of the perceived credit quality of the issuers. In addition, Russia’s government debt-to-GDP ratio remains well below comparable ratios in Europe. That said, there has been quite a big recovery in Russian bonds, so it may be at least time for a breather. Whether or not there will be one will likely depend on near term news flow.
Russia’s 10 yr. government bond yield – click to enlarge.
Lastly, it is noteworthy that the ruble strengthened even while the US dollar index experienced a blow-off rally amid extremely bullish sentiment. DXY has in the meantime surrendered a few points, but it is still curious that the ruble managed to advance during the recent frenzy in the dollar. This is likely a sign of underlying strength and may actually represent a signal with respect to oil prices as well: Perhaps a larger rebound in oil prices is in store sooner than is generally expected.
The ruble vs. DXY – again, keep in mind that USDRUB shows the number of rubles needed to buy one dollar – click to enlarge.
One should certainly not underestimate the risks that remain, but so far it looks like the ruble is behaving exactly the way other EM currencies have behaved in the past after major lows had been made. Should the secondary low near the 72 level be violated in a pullback, a reassessment would be called for – in that case the probability of a resumption of the previous downtrend would certainly increase. For now though, this looks almost like a text-book reversal.