Why The Ruble Rally Has Run Its Course

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Includes: BIK, BKF, EEB, EMDD
by: The Panoramic View

Summary

If the ruble rallies further, Russia will lower interest rates to stimulate its economy. A lower interest rate means a weaker ruble.

The Russian government doesn't want a stronger ruble, because a weaker currency helps its exports.

Because of Western sanctions, a lot of capital that would have gone into Russia is locked out, thus weakening the ruble.

A few months ago, it seemed like Russia was doomed. The West had just imposed sanctions, crude prices crashed, and the Ukrainian situation deteriorated. Because of all the concerns, capital left Russia en masse and the Russian ruble cratered, going from 35 rubles to the dollar to 80 rubles to the dollar.

Today, the ruble is one of the best performing currencies in the world, having rallied 15% against the dollar year to-date. Because of the rally, Russia's currency now trades at a respectable 53 rubles to the dollar.

One big reason for the rally is that the Russian economy is doing better than expected. Despite the plunge in crude prices from August to December, the economy grew a surprise 0.4% in fourth-quarter 2014. Because crude prices have since stabilized, Russia's GDP won't shrink as much as expected in 2015, while many economists expect the Russian economy will expand in 2016.

Another reason for the rally is that capital is flowing back into Russia. Because the ruble has done so well, bond managers feel that they have to buy the Russian bonds in their chase for performance.

The ruble's rise may soon end, however.

If the currency's rises further, the Russian government will cut interest rates to help its economy. A lower interest rate, all else equal, means less demand for the ruble as foreign yield seekers chase returns elsewhere.

The Russian government does not want a stronger ruble, either. A weaker ruble attracts FDI needed to diversify the economy away from commodities, and supports export industries that create jobs in Russia's recessionary economy. A weaker ruble also helps Moscow balance its budget, given that the government's expenditures are in rubles and Russia's export income is in dollars.

Given that Brent and the ruble are closely correlated, there is also a strong probability that the ruble will depreciate because it has overshot Brent. Furthermore, a slow Brent recovery means a slow ruble recovery. While most experts believe Brent will rise, most believe it will be a slow and meandering rise, with a lot of corrections along the way because of all the shadow inventory waiting for higher prices (such as Iran's 30 billion barrels).

Most importantly, the Russian ruble will remain weak because Western sanctions are still in effect. As long as they remain in effect, capital that would have gone into Russia (such as Western oil & gas investments in the Arctic) will be locked out, thus preventing the ruble's rise.

Because the ruble rally has run its course, many Russian stocks that have rallied because of the ruble's recovery do not have as much upside as most people expect in the short term. Most Russian stocks will not recover back to their previous levels, because the country is still in recession. In the long term, however, the leading Russian equities are still good buys, as the economy will recover and successfully diversify away from commodities.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.