Eastern Europe Lures Bond Buyers as Euro Debt Crisis Obscures Fundamentals
Eastern European debt markets may be falling victim to market volatility sparked by short-term fiscal concerns that ignore the region’s fundamentals, prompting some investors to look for buying opportunities.
“On average, eastern Europe as a region is very little indebted compared to western Europe,” said Lutz Roehmeyer, who oversees about $15 billion at Landesbank Berlin Investment GmbH, in a June 9 e-mailed response to questions. “I do consider this to be a buying opportunity for the long term.”
Of the 10 former communist states that joined the European Union since 2004, eight have public debt ratios that are less than half the euro area’s average 78.7 percent of gross domestic product, the European Commission estimates. That outperformance has yet to be reflected in the region’s debt markets.
“While from a fundamental perspective, many eastern European countries have stronger financial ratios, the current sovereign debt crisis is about fear rather than fundamentals,” said Guy Lebas, chief fixed-income strategist at Philadelphia- based Janney Montgomery Scott LLC, which oversees $44 billion in client accounts, in a June 8 e-mailed reply to questions.
Hungarian officials last week raised the specter of a Greek-like crisis in an effort to persuade voters to accept spending cuts, sending bond yields in the region higher and currencies lower. Though the government has played down those comments, “fear” continues to determine pricing, Lebas said.
‘Fear’ Delays Rebound
The extra yield investors demand to own Hungarian debt over U.S. Treasuries soared to 419 basis points on June 4, the highest since May 2009, before recovering about 90 basis points through yesterday, according to JPMorgan Chase & Co.’s EMBI Global Diversified Index. In Poland, the largest of the EU’s eastern members, the spread to Treasuries rose to an 11-month high of 217 basis points on June 8, before recouping 21 points.
“While spreads on eastern European sovereign debt look attractive relative to fundamentals, fear is likely to prevent an immediate rebound, so we’re looking for spreads to widen further before looking for buying opportunities,” Lebas said.
When investors allow their trades to be driven by fundamentals, recent losses in the region’s bond and equity markets may pave the way for a rebound, said Bhanu Baweja, global head of emerging market fixed-income and currency strategy at UBS Ltd. in London.
“There is certainly some mispricing in the market,” Baweja said in an e-mailed response to questions. “Certain parts of what is considered the emerging market could in fact be a very strong credit and conversely a few amongst what are considered developed safe havens may have questionable debt fundamentals.”
East vs West
The Czech Republic and France are a case in point, Baweja said. Government bonds sold by the Czech Republic, which had debt equivalent to 35.4 percent of GDP last year and a benchmark interest rate a quarter point below the European Central Bank’s 1 percent, yield more than those of France, where government debt was 77.6 percent of GDP last year.
Czech 10-year bonds yielded 4.3 percent on June 10, 125 basis points more than French bonds of the same maturity. That compares with a 48 basis-point spread in the middle of April. The same applies to Slovakia, a euro member since 2009, with a debt-to-GDP ratio of 35.7 percent last year. Its 10-year bonds yielded 86 basis points more than French debt yesterday, compared with 69 points in mid-April.
Czech 10-year debt yielded 81 basis points more than bonds from Belgium, where the commission says debt to GDP last year was almost three times the Czech ratio at 96.7 percent.
The region’s most-indebted nation relative to GDP is Hungary, where government debt was 78.3 percent of total output last year, 0.4 point less than the euro-area average. Its budget deficit was 4 percent of GDP, compared with the euro region average of 6.3 percent.
The government of Prime Minister Viktor Orban last week backtracked after an official compared Hungary with Greece. Ruling Fidesz Party Deputy Leader Lajos Kosa on June 3 said the country has a “slim chance to avoid a Greek situation.” The administration has since called the comment “unfortunate.”
“Hungary stands out in eastern Europe in terms of debt,” said Roehmeyer. Still, in general Roehmeyer says he’s “totally relaxed about the emerging European countries where the bonds are coming from.”
Bulgaria, whose public finance methodology is under EU scrutiny after the government revised this year’s deficit to 3.8 percent of GDP from 2 percent previously, is a victim of “nervousness” that belies its fundamentals, Kristofor Pavlov, chief economist at UniCredit Bulbank A.D., said in a note.
“We see the most recent market reaction as somewhat exaggerated,” Pavlov said in a note today written with fellow economist Matteo Ferrazzi. “Renewed concerns over the credibility of Bulgaria’s national statistics, in our view, reflect general market anxiety over the possible proliferation of the sovereign debt crises in Europe, rather than any concrete alleged wrongdoings of Bulgarian authorities.”
Credit default swaps, an insurance against debt losses with higher rates reflecting higher perceived risk, show investors foresee a convergence of some emerging and developed debt markets. Swaps on Slovak five-year debt have averaged about 10 basis points more than French default swaps since the middle of March, compared with a 64 basis point spread in the same period last year. The difference between Czech and French CDS was about 20 basis points since March 15, compared with 106 basis points last year.
“2010 is the year of sovereign risk, the year when the markets are going to wake up and realize that public finances matter,” said Mohamed El-Erian, chief executive officer and co- chief investment officer at Pacific Investment Management Co., in a May 13 interview with Tom Keene on Bloomberg Radio.
“Debt overhangs matter,” he said. “When you have a debt overhang, and everybody knows it, you don’t get investment. You don’t get growth and ultimately you have to deal with the debt.”