Article / 14 March 2014 at 8:58 GMT

Bond Update: Market on alert over Ukrainian crisis

Head of Fixed Income / Saxo Bank

• Bunds are crucial indicator as Ukraine crisis unfolds
• Monitor USDRUB and Russian equity/bond markets too
• MICEX is trading at a four-year low

By Simon Fasdal

We're entering a tense situation this weekend, with a referendum on Crimean independence on Sunday and rumours of troops mobilising on Ukrainian borders. The war of words and the warnings of serious actions on Monday have also added to the recent sell-off in markets. 

German bunds are the primary instrument to monitor as they will be first indicator on any headline risk. We can easily see spikes on the upside on actual warfare headlines, but also mind the gap if the situation comes closer to a solution as we are trading with at least 1.5 full points risk-off premium at moment.

USDRUB is another key indicator, and we are trading at the weakest level since spring 2009. Russian equity and bond markets are the third crucial indicator. Although it is a very low possibility, do watch out for a lack of liquidity in any asset class, as this is the potential panic trigger, which could also hit European and US markets severely. Having said that, there is a huge upside potential in Russian equities, should a solution emerge as the Moscow stock index (MICEX) is trading at a four-year low. 

Russian Equities & RUB
Source: Bloomberg and Saxo Bank

As this graph shows, there has already been a significant reaction in Russian equities and RUB, and a lot of risk premium is priced in. It also shows that the slight response we have seen in other markets is nothing compared to what would be seen should matters escalate. Financial markets are both integrated and connected globally, so it would not be an isolated event. Besides all the talking, the hard fact is that having European (especially French) banks drawn back into a financial crisis is on no European politician's wish list.

On the European side we begin to see old risk-off patterns emerge in bonds, where peripheral European bonds begin to trade like a pair of detached rocket boosters hit by gravity, and bunds as the space shuttle leaving orbit. 

European high-yield corporate bonds are also trading softer, with the Itraxx Xover index heading towards 300, indicating higher credit premiums. Newly issued CoCo bonds from Santander, BBVA and Danske Bank, are all trading below the  issuance price (remember these bonds was oversubscribed 9-14 times).  In the long term these will still be popular, but for now they're on sale! Russian Sberbank issued a CoCo as well in February, which is now trading 10 percent lower, yielding close to 8 percent for a BBB bond. We are quickly approaching yield levels critical for future issuance.

Emerging market bonds overall are somewhat mixed, but with a defensive trading pattern.

On further escalation, European equities would be hard hit, especially corporates with large exposures to Russia, but also banks with balance sheet involvement in Eastern Europe and Russia would be vulnerable. 

The conclusion of what to expect is this: with the spectre of severe impacts on global financial markets, the best guess is that politicians on both sides will do their utmost to find a solution before push comes to shove. 



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