What financial instruments help in the fight against rising rates

The tightening of the monetary policy of the Bank of Russia has a negative impact on the debt market. In such conditions, the need for protective tools is growing. These include bonds with a floating rate or face value. However, these securities are not very liquid, and in the event of a weak growth in rates, they can lose to classic OFZs. More liquid shares of credit institutions or commodity companies can also act as protection, but they are subject to both internal and general market risk.

Regulator hard line

The Bank of Russia embarked on the path of a tough fight against inflation. On July 21, the regulator sharply raised the key rate, but not by 50 basis points (bp), as most analysts expected, but immediately by 100 bp to 8.5%. In addition to this, the tone of the press release and statements by the head of the Central Bank Elvira Nabiullina following the meeting of the board of directors was tightened. The head of the regulator did not rule out the possibility of further rate increases at the next meetings. This week, Deputy Chairman of the Central Bank Alexei Zabotkin twice noted the possibility of raising the rate at the upcoming September meeting of the regulator. On Friday, he recalled that the average annual forecast for the key rate, which in 2023 was previously 7.9-8.3% per annum, was increased to 8.5-9.3% per annum.

According to the chief analyst of Sovcombank Mikhail Vasiliev, new statements by the representative of the Central Bank may indicate that the regulator is no longer discussing whether to raise or not to raise the rate at the next meeting, but rather chooses the step of lifting.

In his opinion, in September the Bank of Russia will raise the key rate by another 100 bp, to 9.5%, and by the end of the year will bring it to 10%. “We are targeting a range of 10.0-10.5%, but the risks are shifted towards a weaker ruble, higher inflation and a higher key rate,” notes Mr. Vasiliev.

In such circumstances, the debt market experienced a strong increase in rates. Short-term OFZ yields increased by 45–51 bp to 9.5–10.4% per annum, medium-term ones — by 13–34 bp to 10.5–10.9% per annum, long-term ones — by 5 -22 bp, up to 11.10–11.28% per annum. As a result, the Moscow Exchange government bond index RGBITR fell below 617 points, the lowest level since the first ten days of April. With an increase in interest rate risk, investors have two options to protect their investments, says Vladimir Evstifeev, head of the analytical department of Zenit Bank, “this is the purchase of bonds with a floating rate (floaters) and a floating par value (linkers).”

floating protection

The most famous floater on the Russian market is government bonds with a variable coupon (OFZ-PK). The coupon rate depends on the RUONIA rate (indicative rate for overnight ruble loans on overnight terms). Corporate borrowers also have similar securities, the rates on which can be linked to various debt indicators, including the key rate.

“When the key rate grows, coupons on such bonds increase, and the price remains stable, which is one of the main advantages of floaters,” explains Vladislav Danilov, senior analyst at Pervaya Management Company.

In the case of inflationary OFZs, the nominal value changes depending on the consumer price index, which was recorded with a lag three months ago. In addition, the bonds pay a coupon of 2.5% per annum. “Given that the Central Bank is pursuing an inflation targeting policy, it raises the key rate in response to rising inflation or inflationary risks.

In other words, inflation and the key rate, as a rule, move in the same direction and, therefore, inflationary linkers also protect investors from a key rate increase,” notes Vladislav Danilov. But, as Vladimir Evstifeev notes, the more actively the Bank of Russia is fighting inflation now, the less the risk of higher inflation in the future.

Limited opportunities

At the same time, investors should take into account the low level of liquidity in such securities, since they are bought mainly before maturity, which means that the spreads between the purchase and sale prices in secondary trading may be widened.

In addition, investors should remember that sooner or later the Central Bank will complete the rate hike cycle and start cutting it. In such a scenario, floaters and linkers will show lower returns than classic fixed-coupon issues. “Currently, the key rate is at the level of 8.5%, and OFZ-PD with a maturity of one year offers a yield of about 9.5% per annum. This means that even if the Central Bank raises the rate to 9.5%, the actual return on the horizon of one year on the floater of OFZ-PK and OFZ-PD with maturity of one year will be comparable, despite the increase in the key rate,” notes Vladislav Danilov.

Bank game

Another possible strategy to protect against a rate hike could be bank stocks, which increase the opportunity to win on the difference in interest between loans and deposits, the spread between which widens during such periods. At the same time, as Mikhail Bespalov, an analyst at KSP Capital Asset Management, notes, a decrease in lending volumes at high rates may have a negative effect on the results of the banking sector.

Shares of commodity companies that supply raw materials abroad and benefit from an increase in the exchange rate, as revenue in rubles increases faster than ruble costs, can also partially protect savings from a rate hike.

“But we should not forget that if a company is heavily indebted, then an increase in the key rate and an increase in the cost of borrowing can negatively affect its activities,” Bespalov notes.

In addition, when investing in shares, one should take into account their high volatility and the strong influence of corporate events on their price, which can negate all the advantages of a business from an increase in the key rate or the weakness of the ruble. Mikhail Bespalov points out that when interest rates rise, shares of value companies may come under pressure, as their dividend yield becomes comparable to or lower than the yield to maturity of corporate or even government bonds, which are less risky, and the limited upside potential of such shares in such conditions makes they are less attractive than bonds.

Vitaly Gaidaev