Central Europe Bond Outperformance Drawing To An End
Local long-end debt has been the star asset class within Central Europe in the post-crisis period, benefitting from sustained interest rate easing cycles, stable FX performance and a global hunt for yield that has pushed investors towards riskier asset classes. Foreign-ownership of domestic debt within Central Europe (CE) has soared in the last five years, reaching 39% of total outstanding debt in Poland and 42% in Hungary in Q214. Comparatively, equity performance during this period has been rather weak, even after adjusting for dividends.
Nonetheless, this trend seems unlikely to be sustained. Bond over equity outperformance in Poland, the Czech Republic and Hungary is close to reaching previous highs, with monetary easing cycles close to an end. While expectations for further rate cuts in Poland may sustain local debt over the coming quarter, we expect that a combination of low nominal yields and limited scope for further easing will drive a gradual reversal in this trend towards the latter half of 2014. Should deflationary pressures in the eurozone persist, this could push euro area yields lower, keeping CE local debt yields attractive in relative terms. However, we are not forecasting a significant decline in eurozone inflationary pressures and expect price growth to accelerate in CE towards the end of the year. As a result, the probability for spot losses on local bonds seems quite high, and low yields will reduce the ability of coupon payments to offset the impact of spot losses on total returns.
|Limited Scope For Further Bond Outperformance|
|Poland and Czech Republic - Equity vs Long-End Bond Performance, %|