Rally on Draghi Boost to East European Bonds May Fade

By Krystof Chamonikolas and Marton Eder

The bond rally that sent yields to record lows this year in Hungary, Romania, Poland and the Czech Republic is poised to fizzle in 2015 as economic growth in the region picks up and flows into the U.S. climb.
Rates on 10-year Hungarian, Polish and Czech local-currency debt will rise no less than 44 basis points by December 2015, according to market forecasts on Bloomberg. While most analysts predicted a year ago the yields would climb in 2014, the rates have plunged, with Romanian notes returning 11 percent in euro terms, the most among 10 eastern European nations included in the Bloomberg Emerging Markets Local Sovereign Index.
The fortunes of fixed income are destined to change as economies revive, the U.S. raises interest rates and investors adjust to fresh stimulus from
the European Central Bank, according to Dmitri Barinov, a money manager at Union Investment Privatfonds GmbH. Eastern European nations’ debt has benefited from low inflation and cash being moved out of Russia, he said.
“Growth will be stronger next year in most of central and eastern Europe, which means the yields won’t get any lower and may increase,” Barinov, who oversees $2.6 billion of debt, said by phone from Frankfurt two days ago. “Expectations that the ECB will start quantitative easing are mostly priced in, while rising rates in the U.S. will curb inflows from there.”

Liquidity Injection

Bonds from the European Union’s post-communist nations have rallied as economic growth outpaced that of the euro area while prices stayed subdued, with Poland and Hungary now experiencing deflation. The median estimates of economists surveyed by Bloomberg are for an acceleration in inflation next year to 1 percent in Poland, 1.5 percent in Czech Republic, 2.5 percent in Hungary and 2.6 percent in Romania.
BNP Paribas SA expects more gains on eastern European bonds as the ECB is set to provide “a new growth of liquidity,” Michal Dybula, the French bank’s economist in Warsaw, said by phone yesterday. Yields on 10-year notes will fall to 2.70 percent in Hungary from 3.56 percent and to 2 percent in Poland from 2.58 percent, BNP’s projections on Bloomberg show.
The ECB will assess the need for further stimulus in 2015, including the merits of buying government debt, President Mario Draghi said Dec. 4. The U.S. Federal Reserve ended its quantitative-easing program in October as the economy revived.
“The relatively bullish environment should persist” as “we are relatively confident the ECB is going to embark on non-conventional monetary stimulus,” Dybula said. “Once you get it, once you see it, you will have some positive reaction.”

Russia Exodus

Returns on the region’s bonds contrast with a 42 percent loss in euro terms this year in Russia as the ruble fell amid sanctions imposed by the U.S. and EU. Investors have moved some of the funds from Russia into Hungarian, Croatian and Romanian debt, according to Richard Segal, head of emerging-markets credit strategy at Jefferies International Ltd. in London.
“Countries aside from Russia and Ukraine have already benefited from flows out of them, and I don’t expect any additional benefit for eastern European bonds,” Segal said by e-mail yesterday. “If there are additional outflows, these will likely be spread more broadly across emerging markets.”
Record-low yields and shrinking premiums over German bunds are limiting the appeal of eastern European debt and forcing investors to look for higher returns in countries such as Turkey or Indonesia, according to Union Privatfonds’s Barinov.

It’s ‘Tricky’

The rate on Romania’s February 2025 security fell to a record 3.68 percent yesterday before rising to 3.70 percent today by 11:45am in Bucharest. That compares with Indonesia’s debt due March 2024 yielding 8.02 percent, data compiled by Bloomberg shows. Both nations are rated Baa3 at Moody’s Investors Service, the lowest investment grade.
The yield on Hungary’s junk-rated June 2025 notes has slumped 211 basis points since it began trading on Jan. 10, reaching an all-time low of 3.55 percent on Nov. 28. Czech bonds maturing in May 2024, ranked at A1 by Moody’s, the fifth-highest grade, traded at a record-low 0.69 percent today, down 183 basis points this year and the EU’s lowest after AAA-rated Germany.
“For investors focused exclusively on emerging Europe it’s getting tricky,” Barinov said. “Low yields are a real headache.”