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Bond rally cut back by economy woes

Investors tiptoed back into central and eastern European bond markets this week, but a brutal economic downturn has slammed the brakes on a mass rally that has seen liquidity flood into other regions.

The Slovak republic (rated A+) yesterday attracted E2.8 billion of orders for its E2 billion six-year deal, pricing at a competitive 170bp over mid-swaps. Meanwhile, Croatia will begin roadshows for its first international bond deal since 2005 for a probable E1 billion five-year deal.

As Emerging Markets went to press, Cez, the Czech power company, had attracted E2 billion of orders Thursday to its new six year benchmark euro bond, marketed at 290bp-300bp over mid-swaps.

Revenue-starved Romania and Hungary are mulling new benchmark bonds, sources say. This follows a pick up in risk appetite for central and eastern Europe in recent months after a flurry of policy initiatives to stabilize the regional banking system as well as renewed optimism over the global economy.

Slovakian credit default swaps (CDS) fell from highs of 267bp in mid-February to 90bp this week while Croatian CDS tumbled from highs of 594bp in early March to 211bp yesterday.

But investors are now differentiating between countries in the region with stronger growth prospects and domestic liquidity while some eastern European bond markets have significantly underperformed their emerging market peers.

The JP Morgan Emerging Markets Bond Index Global for euro-denominated sovereign and quasi-sovereign credits (Euro EMBIG) has returned 6.96% from January until the end-of April. In contrast the index for emerging markets credit globally (EMBIG) posted 8.94%.

Eastern European credits have tightened as a “function of greater global liquidity” rather than “confidence in the region’s macro-economic prospects,” said Julian Jacobson, an emerging markets fixed-income portfolio manager at Fabien Pictet & Partners.

He added that investors are failing to snap up juicy double-digit yields from the region since the regional banking crisis is still raging and systemic deleveraging could drag yields down further.

“Those yields would be attractive if there was some source of future capital generation either on a macro level – through economic growth in the region or through outside investments – such as capital inflows,” said Kieran Curtis, fund manager at Morley Investments. “But this is not likely anytime soon.”

Jacobson said investors are gradually shifting cash out of low-yielding instruments, such as money market funds and US Treasuries, to snap up emerging market credits.

But he argued that investors are strategically positioning portfolios towards underleveraged economies in Asia and Latin America, in favour of sovereign and high quality corporate paper.

Robert Parker, vice-chairman of Credit Suisse Asset Management, which manages more than $600 billion, argued strategic asset allocation into the region would take place next year when growth picks up. “Eastern Europe is still in the deleveraging cycle so investors are extremely cautious,” he said.

Michael Ganske, head of emerging markets research at Commerzbank, argued: “after outperforming their peers in Latin America and Asia from the late-90’s as investors banked on eurozone convergence in the region, there is now a divergence and emerging Europe is underperforming.”

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