Ukraine: Is the risk really worth it? Assessing expectations in the curve

Santiago Clarens

Santiago Clarens

Co-Portfolio Manager

Santiago Clarens

Santiago Clarens

Co-Portfolio Manager
Santiago joined Trium following the completion of his MBA at London Business School. Santiago previously worked as an Emerging Market Debt Analyst at EMFI Securities in London, during 2020. Between 2015 and 2019 Santiago developed his global macro experience across Trading Desks at Banco Macro in Argentina trading FX and Fixed Income. Santiago is a certified Public Accountant and has a B.Sc. in Business Administration.
Trium Larissa Global Macro
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Since the US Presidential elections, expectations of a 2025 ceasefire have been steadily climbing. Recently, this story is unfolding fast, as the US looks to be engaging this head on, and is arguably moving faster than market consensus. Market focus is now likely to shift toward evaluating the implications of a potential peace agreement.

Although Trump’s statements regarding the main components of a future agreement have been unclear and occasionally inconsistent, we believe the US aims for a lasting deal that will endure throughout his tenure. Our view remains unchanged – a ceasefire is highly possible, and the market has priced this in to a considerable degree. While there are incentives for every side to engage in talks and broadly agree to terms, the probability of a genuine and, more importantly, stable ceasefire is, in our view, somewhat low. Moreover, should we get a ceasefire, the devil will likely be in the details.

Ukraine is trading at a discount to the CCC and the HY space, still pricing in a risk of another restructuring in 2028 in case of no ceasefire. The trade still has upside in case of a stable ceasefire scenario, but the risk-reward on the trade has materially shifted. Given the extent of the move YTD and the implementation tail risks of such an agreement, investors should now be less confident about the value that lies in the Ukraine curve.

Back in September 2024, when assessing risk-reward in Ukraine out of last year’s restructuring, we believed the curve could tighten closer to CCC – similar to the rate curves of Pakistan, Argentina, and Ghana. We now have seen much of that move. As of 21 February 2025, A bonds have increased by 15 points since the 2024 restructuring, achieving the target levels outlined in our ceasefire scenario. The contingent B bonds have outperformed the rest of the curve, rallying 25 points, with the market reassessing the probability of the contingent option being met. The latest bond pricing suggests that the market assumes the probability of the contingent option being met at around 70%.

Yield vs Tenors graph
Source: Trium Capital & Bloomberg

Bonds have been particularly volatile since January, as headlines have been frantically hitting the screens. In our view, price action confirms that market participants were clearly overweight in Ukraine, which has been a well-held long. This technical picture is another reason for caution when thinking about risk/reward here. Absent a stable and cohesive peace plan, Ukraine bonds are likely to trade above 12% yields.

Santiago Ukraine blog chart 2
Source: Trium Capital & Bloomberg

So far, bonds have rallied to 12% yields, with B bonds pricing almost 70% trigger odds. The curve has been consistently inverted, and in our view will remain inverted until the market has more clarity on the next steps.

Contingent B Bonds: Meeting IMF’s ambitious target

Unlike the conventional A bonds, which have similar maturity, two B bonds – 2035 and 2036 – have a contingent feature. It includes a mechanism where if Ukraine’s 2028 nominal GDP, in USD, exceeds the International Monetary Fund (IMF) projections by more than 3%, B bondholders may see a rise in the value of their bonds’ principal.

These B bonds, especially those maturing in 2035 and 2036, are broadly used as a “convexity investment play” in the Ukraine Sovereign space. We slightly disagree with that idea and will cover that rationale in more detail below.

Let’s look at the likelihood of Ukraine meeting the IMF targets. Firstly, Ukraine’s 2028 real GDP would need to reach 2,419 billion Ukrainian Hryvnias (UAH), growing as outlined in the base case scenario of the IMF’s Staff report.

Secondly, for investors in the B bonds to see the step-up benefit, they need to see the conditions in this formula being met (i.e. Ukraine’s Nominal USD GDP needs to exceed IMF’s projections by more than 3%):

(A – B x 1.03) x 0.2787
C

Where “A” stands for the actual Nominal UAH GDP in 2028, “B” stands for projected by the IMF UAH Nominal GDP in 2028, and C is the average UAH-USD exchange rate in 2028. The increase in principle is capped at $2,916bn, which is shared pro-rata between the 2035 and 2036 B bonds. Below, we present our view on how to look at these bonds’ fair value, given the potential principal increase. We see the IMF target as a rather ambitious growth path, which makes it very difficult for the conditions of the bond’s contingent to be met.

Road Ahead

Instead of presenting wild assumptions about the economic model after or when the conflict ends, we ran a Monte-Carlo simulation. However, before running it, we need to understand what distribution we are looking at for Ukrainian economic growth in the next 5 years. For that purpose, we take all annual historical real GDP growth rates in Ukraine from 1992 to 2022, excluding all years with negative growth from this data set. In our view, this set of numbers should give us the proxy for a potential recovery. We are also not fitting a normal distribution around this set of real GDP growth, instead, we will fit a Chi-square distribution that, in our view, better reflects the Ukrainian growth trajectory. Therefore, when running the Monte-Carlo simulation for real GDP growth trajectory, we take random numbers from the Chi-square distribution fitted to above zero real GDP growth before 2022.

Santiago Ukraine blog 3
Source: Trium Capital

Even considering our set of somewhat optimistic assumptions for real GDP growth distribution, the chances of Ukraine meeting the IMF’s base-case target are rather slim – actually less than 50%.

Source: Trium Capital

Furthermore, B bondholders looking to get the step-up benefit still need Ukraine to meet the second condition – USD nominal GDP surpassing the IMF target by 3% in 2028. To estimate the size of the nominal GDP in 2028 in USD terms, we don’t need to know the future exchange rate of the Ukrainian Hryvnia. We note that the Ukrainian nominal GDP future path depends not only on real GDP growth but also on domestic inflation, as well as the Hryvnia exchange rate, which rests on the relative price growth within the domestic economy and abroad.

Therefore, instead of guessing what the nominal GDP would be in 2028, we will simply bring it forward to the end of 2023 by adjusting it for the future path of the deflator (taken from the IMF’s Staff Report). By doing so, we will get rid of future nominal growth numbers and focus our analysis on the real GDP growth path that genuinely defines the step-up option of the bond. There could be periods when Hryvnia would be weakening faster or slower than suggested by GDP deflators. However, on the horizon of five years, the exchange rate should be broadly in line with the deflator’s path and in numerous simulations, this issue would not have any impact on the probability-weighted estimate of step-up.

From our Monte Carlo simulation, we took all possible values of real GDP in 2028 and compared them with two conditions set out in the prospect of the B bonds. If our simulated real GDP estimate fails to meet those two conditions, we set the potential payout to zero. If both conditions are met, we calculate the payout and make sure it does not exceed the cap. In the end we have a distribution of potential increase in bonds’ principle. The mean of this distribution would be a probability-weighted size of an increase in the bonds’ principal. Our estimate suggests the total principal increase would be around $0.6bn from 2028. Having this estimate in mind, we calculate bonds’ value for different exit yields.

Santiago Ukraine blog 5
Source: Trium Capital
Santiago Ukraine blog 6
Source: Trium Capital

In the Exhibits above, you can see our matrix of possible prices for Eurobonds with step-up option for the B bonds maturing in 2035 and 2036. This simulation implies the current price of bonds (around 43 handle) is higher than suggested by our valuation, in which we assumed an exit yield of 16.0%. Therefore, either the market is more optimistic about the exit yield, or it implies a much higher step-up than we see in our simulation exercise. There is a common view in the market that a lower exit yield implies a higher increase in step-up size. We disagree with that narrative as we doubt that a conflict resolution would automatically increase the probability of hitting the first condition on real GDP growth path (which already looks rather optimistic to us).

Moreover, we think that any delay in the ceasefire would have an adverse negative impact on the chances of achieving the economic growth path outlined by the IMF’s report. Therefore, looking at the bond pricing in this matrix, a ‘humble’ investor should be looking in the direction of lower yields and zero step-up increase. In other words, we think the pricing of contingent bonds would be consistent with an eventual ending of the conflict within the next 5 years but with a very low chance of an increase in the bonds’ principal.

Conclusion and Outlook

Santiago Ukraine blog 7
Source: Trium Capital

We believe the curve will continue to un-invert, as markets see diplomatic steps being taken and default premia gets priced out. In the best case scenario, we can see the current curve bull steepen to 11% yield, with the front end un-inverting, and contingent B bonds pricing 80% trigger odds. The table above shows broadly how we think about scenarios and targets. The worst-case scenario would be a meaningful escalation, peace talks breaking down, and bonds heading to their 2-year lows. The market will just price another credit event and subsequent restructuring by 2028.

Given our analysis, we remain sceptical about the prevailing market narrative that the B bonds offer an attractive convexity play. We believe that investors may be overpaying for the optionality embedded in these instruments and that should a ceasefire implementation get delayed, this optionality will decay fast. Instead, we see greater value elsewhere on the Ukraine curve, where risk-reward dynamics are more favourable, and yields better reflect the country’s macroeconomic uncertainties. For convexity, 29As may even be a better expression for slower peace ceasefire implementation. For investors wanting a less aggressive stance on Ukraine risk, the 34 and 35As are perhaps better.

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