1Q18 CEE bond market report
Yields due to increase slightly in CEE except for Hungary . Two central banks already in full tightening mode –additional hikes expected this year . Falling public debt ratios increase chances for rating upgrade in CEE this year
In 2018 we expect bond yields to increase in all CEE countries but Hungary. Strong economic growth in CEE, inflation returning to normal and the increase in major market yields should exert upward pressure on government bond yields in CEE. However, spreads on 10Y sovereign bonds over German bunds could remain more or less stable, or even shrink further in Hungary (by about - 30bp, especially helped by the MNB for Hungarian govies), while Romanian spreads could widen by +50bp due to fiscal risks and expected monetary tightening conducted this year.
The Czech and Romanian central banks, two central banks which have already started monetary tightening, are going to deliver another three 25bp hikes throughout the year. The economies of both countries have been booming (posting above 5% growth in 3Q17), wage growth has substantially accelerated and inflation will remain above the target. Poland may deliver its first rate hike in 4Q18, but we think there is a high chance of the postponement of tightening to early 2019. In fact, the Hungarian central bank is the only central bank in the region expected to remain in easing mode via pouring more cheap liquidity into the system, via swaps and a mortgage bond buying program, intending to revive credit growth and keep long-term rates low and the HUF slightly undervalued vs. the EUR. Yields in the Eurozone are going to drift up with the reduction or tapering of the ECB’s government bond purchases. That is going to directly affect Slovak and Slovenian government bond yields, which may edge up by 30-40bp while spreads are expected to remain about the same. Overall, from CEE currencies we expect only the Czech koruna to appreciate vs. the EUR in 2018 (towards 25 EURCZK) in our baseline.
Better fiscal performance, high economic growth and low interest costs have helped CEE countries in their debt reduction and thus credit profile. The regional average is seen as dropping below 53% of GDP, much lower than the nearly 90% of the euro area. No CEE country currently has a negative rating outlook from any rating agency. We see the largest potential for a rating upgrade in Slovenia, Croatia and the Czech Republic – in Croatia, the upgrade by Fitch over the weekend by one notch to BB+ might be followed by a similar one-notch upgrade from the other two major rating agencies this year. This partially reflects very good fiscal performance, as the strongest reduction of the debt ratio to GDP, by 10pp from nearly 45% in 2012 to an estimated 35% in 2017, occurred in the Czech Republic, which has been running a budget surplus for the second year in a row. Croatia, Serbia and Slovenia also did very well, as they reduced their debt to GDP ratio by 5-7pp in the last 2-3 years. We do not rule out an upgrade of Hungary’s rating (BBB- / Baa3), as two rating agencies have a positive outlook on Hungary’s rating. Poland is a little bit of an outlier here, as the debt ratio has been constantly rising there since 2014, when the government delivered a one-off debt reduction by seizing government bonds held in the portfolios of private pension funds. All the debt reduction worth more than 5% of GDP achieved by canceling out government bonds from pension funds is practically gone, as the public debt level is nearly at the same level as before the move (around 55% of GDP).