Global Investing

A (costly) balancing act in Hungary

A bond trader in London is still marvelling at the market’s willingness to snap up a Eurobond from Hungary, calling it a country with “a policy mix so unorthodox even Aunty Christine won’t lend to them”.  But Hungary’s probable glee at bypassing the IMF and “Aunty Christine”  with $3.25 billion in two bonds that were almost four times oversubscribed, is probably short-sighted.

Hungary needs to raise the equivalent of $23.4 billion this year to repay maturing debt. The bond placement will enable Hungary to easily meet the hard currency component of this, and it has been enormously successful in luring buyers to domestic debt markets.  Such has been the demand for Hungarian bonds in recent months that foreigners’ holdings of forint-denominated government debt are at a record high of over 45 percent.

The success does not necessarily represent a thumbs-up for Prime Minister Viktor Orban’s policies but is more likely due to the yield Hungary paid — well over 5 percent for five and 10-year cash. In dollar terms that is not to be sneezed at, especially at a time when liquidity is abundant and the yield on mainstream dollar assets is low. The same reason is behind the demand for forint bonds, where Hungary pays over 5 percent on one-year paper. An IMF loan would have been far cheaper. (The rate for a standby loan of the kind Hungary had is tied to the IMF’s Special Drawing Rights (SDR) interest rate. Very large loans carry a surcharge of 200 basis points)

The dollar bond sale is forcing Budapest to pay lenders roughly double what it would have paid for an IMF standby loan, says William Jackson at Capital Economics:

Of the Hungarian government’s 5.1 billion euro of maturing hard currency debt this year, 3.6 billion euro consists of IMF loan repayments, which carry a much lower interest rate than the Eurobonds. By rolling over these repayments with Eurobonds, debt servicing costs will rise. Note too that the new dollar bonds add to Hungary’s underlying FX debt problem.  Around half of government debt is hard currency-denominated (c. 36% of GDP). And Hungary’s economy has contracted in  dollar (and euro) terms over the past five years – increasing the burden of dollar (and euro) debt in local currency terms.

A yen for emerging markets

Global Investing has written several times about Japanese mom-and-pop investors’  adventures in emerging markets. Most recently, we discussed how the new government’s plan to prod the Bank of Japan into unlimited monetary easing could turn more Japanese into intrepid yield hunters.  Here’s an update.

JP Morgan analysts calculate that EM-dedicated Japanese investment trusts, known as toshin, have seen inflows of $7 billion ever since the U.S. Fed announced its plan to embark on open-ended $40-billion-a-month money printing.  That’s taken their assets under management to $67 billion. And in the week ended Jan 2, Japanese flows to emerging markets amounted to $234 million, they reckon. This should pick up once the yen debasement really gets going — many are expecting a 100 yen per dollar exchange rate by end-2013  (it’s currently at 88).

At present, the lion’s share of Japanese toshin holdings — over $40 billion of it — are in hard currency emerging debt, JP Morgan says (see graphic).

Risks loom for South Africa’s bond rally

Investors are wondering how much longer the rally in South Africa’s local bond markets will last.

The market has received inflows of over $7.5 billion year-to-date, having benefited hugely from Citi’s April announcement that it would include South Africa in its elite World Government Bond Index (WGBI).  But like many other emerging markets, South Africa has also gained from international investors’ hunger for higher-yielding bonds. And the central bank’s surprise rate cut last week was the icing on the cake, sending 5-year yields plunging another 30 basis points.

There are some headwinds however. First positioning. Around a third of government bonds are already estimated to be in foreigners’ hands. Second, markets may be pricing in too much policy easing (Forward rate agreements are assigning a 77  percent probability of another 50 bps rate cut within the next six months).  That’s especially so given local wheat and maize prices have been hitting record highs in recent weeks.

Three snapshots for Wednesday

On Friday 283 companies in the S&P 500 had a dividend yield higher than the 10-year Treasury yield, at yesterday’s close this had fallen to 266 but remains very high compared to the last 5-years.

Italian consumer morale plunged to its lowest level on record in May as Italians’ pessimism over the state of the economy plumbed new depths.

Germany set a zero coupon on its new Schatz, the first time it has done so on debt of such maturity. The bid to cover ratio for the new bond at the auction was 1.7, compared with 1.8 at a sale of two-year debt on April 18.

Russia’s new Eurobond: what’s the fair price?

Russia’s upcoming dollar bond, the first in two years, should fly off the shelves. It’s good timing — elections are past, the world economy seems to be recovering and crucially for Russia, oil prices are over $125 a barrel.  And the rise in core yields has massively tightened emerging markets’ yield premium to  U.S. Treasuries, offering an attractive window to raise cash.  Russia’s spread premium over Treasuries hit the narrowest levels in 7 months recently and despite some widening this week it is still some 75 basis points below end-2011 levels.

Initial indications from the ongoing roadshow are for a two-tranche bond with 10- and 20-year maturities, possibly raising a total of $3.5 billion.

But market bullishness notwithstanding, investors say Moscow should resist temptation to price the bond too high, a mistake it made during its last foray into global capital markets in April 2010. Fund managers have unpleasant memories of that deal, recalling that Russia unexpectedly tightened the yield offered by 25-28 bps, making the bond an expensive one for investors who had already placed bids. The bond price fell sharply once trading kicked off and yields across the Russian curve rose around 25-30 basis points. Jeremy Brewin, a fund manager at Aviva said:

Three snapshots for Wednesday

Most U.S. banks passed their annual stress test driving shares higher. Where does this leave their valuation? Looking at price-to-book value in aggregate (1st chart) they are only just trading above a ratio of one, looking cheap compared to a 15-year average ratio of two.  However a premium is opening up over European banks which are still trading below book value, and analyst forecasts for return on equity suggest banks are in a very different environment to the last 15-years (2nd chart)

The UK could start issuing 100-year bonds as it seeks to lock in current low interest rates. Recent sales of long-dated UK gilts have met with strong demand, and  as the chart below shows yields on 50-year gilts hit a record low of around 3 percent in January.