MacroScope

Austro-Hungarian troubles

January 6, 2012

Concerns about Austrian banks’ exposure to Hungary have continued to put pressure on Austrian bonds in recent days, driving 10-year Austrian government bond yields to their highest in over a month on Friday.

In focus is Hungary’s dispute with the IMF and the EU over its financial aid package. Hungarian Prime Minister Viktor Orban’s government has been chided over its stance on a law its lenders view as infringing central bank independence. That has jeopardised negotiations for a much-needed loan deal.

The concerns have led to a sell-off in Austrian government bonds, leaving the spread between their yields and those on Germany bunds within sight of a euro lifetime high hit in November. Richard McGuire, senior fixed income strategist at Rabobank explains the linkage:

Austria’s exposure to Hungary is greater then its total exposure in terms of banking sector claims to the broader periphery, so this is Austria’s periphery.

Indeed, Austrian banks are the most exposed to overall Hungarian debt, according to the latest data from the Bank for International Settlements, with $41.6 billion on their books, followed by Italy with $23.4 billion and Germany with $21.4 billion. Italian and German banks, in turn, are the most exposed to Austrian debt with $110.9 billion and $90 billion respectively.

Key to the Hungarian situation is how the negotiations develop. The government has backtracked from its initial insistence on sticking to legislation disputed by the EU and IMF and has made some concessions to lenders in order to be able to start talks quickly and secure a new financing deal .

But risks remain. Fitch Ratings on Friday became the third agency to rate Hungarian sovereigns as”junk”.

Peter Attard Montalto, emerging markets economist at Nomura says:

The likelihood of an ultimate package is still as far away as it ever was. The prospect of actually getting from talks about talks to actual talks perhaps is slightly closer but (it’s) semantics.

The next test for Austria, a bond auction next week. Let’s hope investors are hungry.

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