Bond Bears Dig In as First Polish Gain in Six Months Seen Ending

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The first rally in six months for Polish bonds might not last as inflation and elections loom.

In a reprieve from the longest losing streak in at least 18 years, the government’s zloty bonds returned 1.4 percent in July as global concern over Greece’s crisis eased and traders pared their bets for domestic interest-rate increases. Yet sentiment is about to reverse, driving 10-year yields back above 3 percent, say Societe Generale SA, HSBC Holdings Plc and the mutual fund arm of PKO Bank Polski, Poland’s largest lender.

“The downward correction in yields has practically reached its end,” Lukasz Witkowski, who manages the equivalent of $1.7 billion in debt at PKO TFI SA in Warsaw, said by e-mail on Friday. “We’re in a new trend in terms of interest rates.”

While the bondholder gloom is testament to expectations that an improving global economic outlook will lead to increased U.S. borrowing costs, October’s election in Poland is also threatening to damp investor confidence. Law & Justice, the opposition party campaigning for increased social spending and bank taxes, has 43 percent popular support, versus 29 percent for the ruling Civic Platform, according to an Estymator opinion poll on July 30.

Inflationary Expectations

Although Polish interest-rate increases are unlikely before 2017, 18-month zloty forward-rate agreements climbed to 20 basis points above the Warsaw interbank offered rate at 3:05 p.m. on Monday from 13 basis points three days earlier.

“There’s perhaps another one or two months before bond yields reverse course,” Phoenix Kalen, a London-based emerging-market strategist at Societe Generale, said by e-mail on Friday. “After that, inflationary expectations in the euro area will likely pick up and yields in Poland will rise.”

Even though euro-area inflation held steady at 0.2 percent in the 12 months to July, core inflation unexpectedly accelerated to 1 percent, the fastest in 15 months, the European Union statistics office in Luxembourg said on Friday. In Poland, deflation is likely to become inflation of around 0.5 percent annually by December, according to analyst forecasts compiled by Bloomberg.

The yield on 10-year zloty notes fell 37 basis points last month and climbed one basis points to 2.94 percent on Monday. The premium over German bunds stood at 229 basis points, 27 basis points below a 13-month high reached on June 29. Polish bonds had negative returns for five months through June, the longest streak since Bank of America Merrill Lynch started compiling such data in 1997.

“The yield on 10-year bonds may drift to 3.5 percent as the pre-election period weighs on investors,” Olaf Pietrzak, the head of fixed-income at Warsaw-based Skarbiec TFI SA, which manages the equivalent of $899 million, said by e-mail on Friday. “Repeating July’s rally is hardly possible.”

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