Ignore The Flu And The Russia Problem, And Keep Gambling On The Ukraine

ukraine swine flu yulia

What, you’re worried about the mutant Ukraine black lung epidemic, and the continued tension with Russia? Forget about it. Morgan Stanley recommends you keep buying Ukraine.


We believe that Ukraine external debt is likely to remain volatile in the short term; however, we do not anticipate an extreme credit event in the sovereign sector. Although we cannot rule out further upward pressure on yields and spreads in the coming three months, we still see value on a medium-term basis, particularly at the long end of the curve.

Strategy implications

  • Short-end attractive on a medium-term basis. The short-end of the curve (i.e. 1-2Y sector of bonds and CDS, around 17% yield and 2,100bp CDS spread respectively) seems to overestimate the effective probability of default, and looks attractive, in our view. Diminished liquidity towards year-end and uncertainty related to next year’s presidential elections could keep this sector under pressure, however, and we would see further sell-offs as an opportunity to either enter or increase exposure.
  • Extend duration from belly for more attractive risk/reward. Investors exposed to the belly of the curve (3-5Y) should extend the duration of their portfolio, as the 3-10Y sector of the curve has disinverted considerably since the peak of the crisis (Chart 1), and longer bonds offer an attractive combination of cash reduction and duration increase. The former feature would protect portfolios from unexpected extreme credit events (very low probability), while investors would benefit from the latter if the market were to recover in the medium term (our baseline scenario). The cheapness of Naftogaz 9.5% 2014 represent an additional weight to this part of the sovereign curve, in our view (more below).
  • Bond-CDS basis to narrow. The bond-CDS basis is still trading at notably high levels (i.e., around 350bp at the 5Y sector), as investors have used this asset class to hedge against broader country risk and specific corporate transactions (i.e., Naftogaz restructuring). We expect the bond-CDS basis to converge towards long-term fair levels (about 50bp) in the medium term (Chart 2).
  • Favour Naftogaz 2014. Naftogaz 9.5% 2014 (issued during the recent restructuring) has suffered lately and its yield spread over Ukraine 2013 has increased from 175bp to 240bp. Although the market is likely to take some time to digest the USD1.6 billion issue, we consider it attractive at the current spread over the sovereign, particularly considering the potential technical bid once the bond enters the main EM bond indices early next year. In fact, we favour Naftogaz 2014 to the respective sovereign bond. 

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