Wall Street is betting on Russian debt

The Russian debt settlement associated with Russian President Vladimir Putin’s campaign on Ukraine and the sanctions that have that followed have created a window for a new kind of arbitrage that some in the financial world are gobbling up, seeing as easy money.

The idea is what is known as a negative basis trade, or the purchase of very cheap Russian government or corporate bonds along with credit default swaps that act as insurance against a potential borrower’s default.

Data from the MarketAxess website shows that Russian sovereign debt traded at a volume of $7 billion between February 24 and April 7, up from $5 billion in the same period in 2021, an increase of 35%.

Russian bonds are trading furiously, said Philip M. Nichols, an expert on Russia and social responsibility in business and a professor at the Wharton School of the University of Pennsylvania. “There are a lot of speculators who are buying these bonds that have been severely downgraded and are about to become junk,” he said.

Nichols says he gets constant calls from analysts interested in whether the potential trade makes sense. “The spread on Russian sovereign debt is staggering right now,” he said. “They’re making an unusual amount of money relative to volume.”

The cost of insuring Russian debt rose to 4,300 basis points on April 5, from 2,800 the day before.

At the same time, bond rates fell sharply: bonds due in 2028 are trading at just $0.34 per dollar. That means it could cost just over $4 million to secure $10 million of Russian securities, The Economist reported.
Hedge funds such as Aurelius Capital Management, GoldenTree Asset Management and Silver Point Capital have increased their exposure to Russian markets, mainly by buying corporate bonds, the Financial Times reported in late March.
US financial institutions such as JPMorgan Chase and Goldman Sachs are facilitating these transactions, connecting customers who want Get of their positions with hedge funds that have a higher risk tolerance by risk and less of a moral dilemma about buying Russian debt.

“This is Wall Street,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “I’m not surprised they’ve seen some kind of loophole that they could exploit to make money.”

JPMorgan representatives say they are acting as middlemen, simply looking to help customers. “As market makers, we have been helping clients reduce their risks and manage their exposures to Russia in the secondary markets. None of the trades violate sanctions or benefit Russia,” a spokesman said.

The United States brings Russia to the brink of default

If clients wanted to quickly shed their exposure to Russia, they could look to Russian oligarchs who would happily buy back sovereign bonds, said Robert Tipp, chief investment strategist and head of Global Bonds at PGIM Fixed Income. The sale of Russian debt to US hedge funds prevents accrued interest from falling into Russian hands.

The trades are legal and lucrative, Nichols said, but highly speculative and subject to big swings based on news of the Russian invasion of Ukraine and other sanctions.

It also illustrates an alarming disconnect between Wall Street and the real state of the global economy: Investors would typically base their valuation of Russian debt on whether or not it will be paid, with the likelihood of it being paid depending on strength. and durability of the Russian economy, but that is not happening. New US Treasury sanctions on Tuesday, which blocked Russia’s access to any dollars it held in US banks, significantly increased the chances that Russia would default on its debt and that its gross domestic product, the main measure of a country’s economic strength, will weaken. drop.

The US Congress voted this week to remove Russia’s most-favored-nation trading status, a major economic downgrade that would pave the way for deeper sanctions and import controls on products essential to Russia, such as chemicals and steel. .

Removing that status, Nichols said, would cut off Russia’s integration into the global economy. If Wall Street were associated with the real world, she added, it wouldn’t want to be anywhere near Russian debt.

“Russian debt is big risk-taker territory,” Nichols said, “and institutions should probably stay away.”

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