The government bond market: who is in it and why

The OFZ market brings together a borrower that needs money for longer than a budget year and holders of liabilities that need a rouble asset free of credit risk. There is one borrower, the Ministry of Finance, and it sells its issues at auctions. The buyers fall into several groups, and each has its own motive: banks need collateral and a liquidity buffer, pension funds and insurers need long paper to match long liabilities, asset managers need an instrument that provides the "risk-free" reference point for everything else, and the retail investor needs a predictable cash flow. It is this divergence of motives that produces what later looks like the OFZ yield curve.

The Ministry of Finance: an auction, not a price list

The state does not post a rate at which it is willing to borrow. It announces an issue and collects bids on the primary market, and then cuts off those that demand too high a yield. The key feature of this mechanism is that the Ministry of Finance has the right to declare an auction void or to satisfy only part of the demand. That is why "the market is asking a high price" does not show up as an instant jump in the rate, but initially as a reduction in the volume placed: the ministry prefers to borrow less rather than lock in an expensive yield for years ahead.

The opposite situation is just as readable: when demand is strong, the placement goes through with a smaller premium to the secondary market than usual. Auction days and the announced guidance are published in advance, and it is convenient to follow them in the events calendar.

Banks: the main buyer for structural reasons

The bulk of OFZ ends up on bank balance sheets, and not because of any view on rates. Inside a bank, a government security performs several functions at once: it is accepted as collateral in repo transactions, which means it can be turned into cash without being sold; it counts towards the buffer of high-quality liquid assets that the bank is required to hold under the prudential ratios; and it does not require provisions for credit risk in the way a corporate loan does. This is why a bank may buy OFZ even when it considers them expensive: what it needs is not the yield but the quality of the asset.

The practical consequence for the retail investor is that part of the demand in this market is insensitive to price. This smooths out fluctuations, but it also means that auction signals have to be read with care, because there is not always a market opinion about the future behind them.

Funds and asset managers: demand for maturity

Pension funds and life insurers have liabilities that stretch over decades. For them a short-dated security is a risk rather than a protection: it will have to be reinvested at a rate nobody knows in advance. Hence the steady demand for the long end of the curve, and the reason why long issues live a life of their own relative to the key rate. Managers of index strategies buy issues according to their weight in the index rather than out of conviction, and the logic is the same as in the index approach.

The retail investor: where they really are a participant

An individual buys OFZ on the secondary market, in the order book, on equal terms with everyone else. Here it is important to tell the issues apart: the liquid "benchmark" securities trade in a dense book, while certain issues, especially those with an indexed face value and those with amortisation, behave like a thin market, where the spread makes getting in and out noticeably more expensive than the yield itself. Large trades in illiquid issues often move to the over-the-counter segment.

Issue types are different bets on one and the same state

The credit risk of OFZ-PD, OFZ-PK, OFZ-IN and OFZ-AD is identical. What differs is the thing you are insuring yourself against. A fixed-income security locks in the rate and delivers it through the repricing of the bond. A floating-coupon security is tied to money market rates and its price barely moves, so it is a bet that tight policy will last. A security with an indexed face value shifts inflation risk onto the issuer, and it is bought not for the coupon but for the real yield. An amortising issue returns the face value in instalments, which in practice shortens the term of the investment.

Non-residents and an honest caveat

Until 2022, foreign funds were a notable group at the long end of the curve, and their behaviour accounted for part of the volatility. After the restrictions the ownership structure changed: the role of non-residents shrank, and demand was redistributed towards domestic participants. I do not give an exact ownership share by investor category here, because the platform's data contains no such indicator, and filling it in "from memory" would mean making it up. It is worth checking against the Bank of Russia's statistics and the OFZ section.

How to read this market step by step

The first step is the shape of the curve: it shows what the market thinks about the future rate. The second step is the auction results: how much was borrowed and at what cut-off. The third step is the type of issue that fits your task, rather than the highest yield figure. If the task is not to guess the rate at all, a bond ladder does the job. Definitions of the terms are collected in the glossary.