Time running out for Hungarian bonds?
Could Hungary’s run of good luck be about to end?
Despite controversial policies, things have gone the country’s way in recent months — the easing euro crisis and abundant global liquidity saw investors flock to high-yield emerging markets such as Hungary and also allowed it to tap international capital for a $3.25 billion bond. It has slashed interest rates seven times straight, cutting them this week to a record low 5.25 percent. The result is an increased reliance on international bond investors. Foreigners’ share of the Budapest bond market is almost 50 percent, among the highest percentages in emerging markets.
But analysts at Unicredit write that both markets and economic data had validated rate cuts in 2012, which may not be the case any more. Annual headline inflation fell from 6.6% in September 2012 to 3.7% in January 2013 while the economy contracted 1.7% last year. As a result, net foreign buying of Hungarian bonds rose in the second half of 2012 to 837 billion forints (an average daily rate of almost 6 billion forints), they note. Markets are pricing at least 3 more cuts, that will take the rate to 4.5 percent.
But support from foreigners is ebbing. Since the beginning of the year, Unicredit points out, foreign investors have cut holdings of government bonds by 236.8 billion forints (average daily outflow of 6.1 billion forints). Moreover, the most recent rate cuts have failed to fully translate into bond yield corrections, they say. While the short-dated 2-5 year segment of the curve dropped 23-40 basis points, the belly (the middle) of the curve dipped by only 9-24 bps and longer-dated yields over 10 years have risen by around 18 bps. And the fall in inflation too could be a thing of the past if the government resorts to tax hikes in order to meet the deficit target of 2.7% of GDP — that would persuade the European Union to lift the excessive deficit procedure it has triggered against Hungary for repeated budget deficit overshoots.
The biggest complication could be the upcoming leadership change at the central bank, which is expected to tightly align monetary and government policies. That has contributed to the forint’s 1.5 percent weakening this year (after 11 percent gains in 2012) and many reckon portfolio flows could be seriously undermined. Peter Attard Montalto, an economist at Nomura, calls outgoing governor Andras Simor “a level-headed defender of financial stability, the currency, inflation and central bank independence even against unimaginable pressure from the government”. Montalto adds:
Foreign investors will find the institution much more closed and no longer the ‘safe haven’ for information and analysis. That may well be even more damaging in both the short and long run than any policy unorthodoxies.
The new governor is to be named on Friday and the front-runner is Gyorgy Matolcsy, widely seen as the architect of Hungary’s unconventional policies.