ICU Weekly Insight: March 18 - NBU Surprises With a Rate Cut

Bonds: Investors’ interest shifts to longer maturities

Demand in the primary bond market partially shifted to longer maturities last week. In the secondary bond market, investors mainly purchased instruments maturing in January 2025, and beyond.In the primary bond market, demand was up approximately by a third compared with previous weeks. Expectedly, demand was the largest for a 12-month paper. Bids for two-year bills rose six-fold and four-fold for three-year notes, and they provided the state budget with more than half of last week's proceeds. See details in the auction review.In the secondary bond market, the most traded UAH paper was the one due in July 2027, with a 25% share in total UAH bond deals, while just 22% of deals were with bills due this year. Among FX-denominated bills, most trades were in paper due this September.

ICU view: While reinvesting last week's proceeds from debt redemptions, investors preferred longer maturities, especially notes due in 2027, to lock in current YTMs for the longest possible term. NBU's decision to cut the key policy rate and rates for three-month CDs (see comment below) will likely impact deposit rates and YTMs of UAH bonds within the next month or two. The bond market will probably react to this NBU decision faster than banks. Therefore, the market will likely see high demand for longer bonds, similar to last week.

Bonds: Eurobond rally ends

Ukrainian Eurobond prices declined after a two-week rally, and the price range for papers with different maturities widened.Eurobond prices declined by an average of 2.5% to 27‒34 cents, with the price range widening to 11.2%. The price of VRIs slid by 1.8% to 47 cents of the notional value. The EMBI index declined by 0.8%.

Other Topics of Interest

Allies Work to Strengthen Ukraine Following Aid Gap, But Large-Scale Offensive Unlikely

President Joe Biden’s administration announced that $1 billion in artillery, air defenses, and other hardware would soon be heading to Ukrainian front lines.

ICU view: A week ago, S&P cut the Ukrainian foreign-currency rating to CC with a negative outlook on expected debt restructuring. At the same time, Ukraine signed a memorandum with the EU last week and will receive EUR6bn in March and April according to a new four-year program called the Ukraine Facility. This combination of news stabilized Eurobond prices and some investors locked in gains from the previous weeks. Investors’ mood remains largely positive, as they expect restructuring talks to start soon, probably next month. Further moves in Eurobond prices in the nearest weeks will primarily depend on the progress with the passage of the Ukrainian aid package in the US House of Representatives.

FX: Hryvnia weakens due to worse market balance

FX market turnover declined last week while market balance worsened in the final days of the week. Therefore, the NBU increased interventions and the hryvnia weakened.In the interbank FX market legal entities sold US$932m and purchased US$902m (in four business days). Total turnover in the interbank market declined by nearly 20%. Last Thursday (and probably last Friday) demand exceeded supply in the interbank FX market segment.In the retail FX market, turnover declined by approximately 10%, and net purchases fell to US$84m, the smallest amount since last September.Net hard currency purchases doubled to US$53m compared to previous week. Balance shifted to demand side last Thursday and probably the deficit of hard currency even increased last Friday, as the NBU had to increase interventions. Finally, the NBU sold US$263m, increasing weekly interventions by 68%.The hryvnia exchange rate weakened last week. The official exchange rate weakened by 1.7% to UAH38.8/US$, and the cash rate in systemically important banks weakened by 1.1% to UAH38.4‒39.0/US$.

ICU view: Although the total amount of hard currency trades declined last week, the market balance still worsened. Imbalances were likely caused by FX purchases of government institutions for import contracts. Occasionally, on several days, the NBU had to sell more hard currency, which resulted in larger FX interventions for the week and also a weaker hryvnia exchange rate.

Economics: NBU surprises with a rate cut

The key monetary policy rate was lowered by 50 bps to 14.5%. This surprised the market since the latest macro forecast from the regulator indicated an unchanged rate until July. NBU stated that weakening inflation reached 4.3% YoY in February, FX market stabilized and inflows of foreign financial aid improved.The interest rate on the 3-month certificates of deposits (CDs) and the rate on refinancing loans were lowered by 150bps to 17.5%. NBU will amend the rules that determine the amount of liquidity banks can invest in 3-month CDs to stimulate longer maturities of retail deposits.

ICU view: NBU can extend the current cycle with one or two cautious cuts in 1H24. Regulator will continue doing so in 2H24 in case of lower inflation risks, particularly crop related.We expect smaller banks with above-average interest rates on retail deposits to cut rates after the NBU’s move. Overall, the earlier-than-expected rate cut will spur a quicker decline in deposits interest rates and YTMs of UAH bonds this year.

Read the full report here.