The idea is what’s called a negative basis trade, or buying cheap Russian government or corporate bonds with credit default swaps that act as insurance against the potential default of a borrower.
Data from the MarketAxess website shows that Russian sovereign debt traded at a volume of $7 billion between February 24 and April 7, compared to $5 billion in the same period of 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 at the University of Pennsylvania. “There are a lot of speculators buying these bonds that have been severely downgraded and are on the verge of becoming junk,” he said.
Nichols says he receives constant calls from analysts interested in whether the potential trade makes sense. “The spread on Russian sovereign debt is amazing right now,” he said. “They are making an unusual amount of money relative to the volume.”
The cost of insuring Russian debt rose to 4,300 basis points on April 5, from 2,800 the day before.
“It’s Wall Street,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “It doesn’t surprise me that they saw some sort of loophole that they could exploit to make money.”
JPMorgan representatives say they act as middlemen, simply seeking to help customers. “As a market maker, we help our clients reduce their risk and manage their exposures to Russia in secondary markets. None of the transactions violate sanctions or benefit Russia,” a spokesperson said. .
If clients wanted to quickly offload their exposure to Russia, they could turn to Russian oligarchs who would gladly buy sovereign bonds, said Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income. Selling Russian debt to US hedge funds keeps any accrued interest out of Russian hands.
Trading is legal and lucrative, Nichols said, but highly speculative and subject to wild swings based on news of Russia’s invasion of Ukraine and new sanctions.
It also illustrates an alarming disconnect between Wall Street and the real state of the global economy: typically, investors would base their assessment of Russian debt on whether or not it will be repaid, and the likelihood that it will being repaid would depend on the strength and sustainability of the Russian economy, but this is not the case. New U.S. Treasury sanctions on Tuesday, which blocked Russia’s access to all dollars it held in U.S. banks, dramatically increased the odds that Russia would default on its debt and gross domestic product, primary measure of a country’s economic strength, fall.
The U.S. Congress this week voted to remove Russia’s most-favoured-nation trade status, a major economic downgrade that would pave the way for tougher sanctions and controls on imports of goods essential to Russia like chemicals and steel.
Removing that status, Nichols said, would break Russia’s integration into the global economy. If Wall Street were associated with the real world, he added, it wouldn’t want to be close to Russian debt.
“Russian debt is the domain of high risk takers,” Nichols said, “and institutions should probably stay away.”