Draghi Cracks East Europe Shield Against Fed Rates as Bonds Drop

  • Disappointing ECB stimulus sparks declines in emerging Europe
  • Selloff to be short-lived as ECB still accommodative: SEB

Mario Draghi planted seeds of doubt that his stimulus measures will shield investors in eastern Europe from Federal Reserve interest-rate increases.

Yields on Poland’s 10-year notes rose the most since September 2014 and Hungary’s forint suffered its biggest loss in a month after the European Central Bank president shocked markets on Thursday. By refraining from expanding the size of a 60 billion-euro ($65 billion) bond-buying program and cutting interest rates by less than some economists forecast, the ECB threatens to spark more outflows, according to Royal Bank of Scotland Group Plc.

The ECB undermined the safety net that investors were using to justify the best bond rallies in emerging markets in the past three months, just under two weeks before the Fed is projected to end a seven-year era of near-zero interest rates.

“It’s the first time Draghi under-delivered, which marks a big change for central and east Europe assets," Gabor Ambrus, an economist at Royal Bank of Scotland, said on Thursday. Carry-trade positions in developing-nation currencies versus the euro will probably be unwound “as the market was very heavy in these on ECB hopes," he said. Ambrus recommends selling the forint against the euro, targeting a 1.9 percent depreciation to 318.95 in three months.

While SEB AB and Landesbank Berlin Investment GmbH predict any selloff in eastern Europe will be short-lived, the ECB’s move on Thursday left investors more jittery following a rally since September that had sent yields on five-year bonds in Russia, Romania, Bulgaria, Slovenia and Poland down the most among 25 emerging markets tracked by Bloomberg.

The rate on Poland’s 10-year securities rose six basis points to 2.90 percent by 4:59 p.m. in Warsaw after jumping 17 basis points on Thursday. The yield on similar-maturity Hungarian securities climbed 12 basis points to 3.64 percent, taking this week’s increase to 26 basis points. Russia’s five-year yields fell three basis points to 10.03 percent after increasing 10 basis points yesterday.

Selling “will continue for a few more days, but not as violently,” said Per Hammarlund, chief emerging-markets strategist at SEB in Stockholm. “The ECB remains dovish, only somewhat less dovish than before.”

Draghi’s plan for stimulus in Europe came as Fed Chair Janet Yellen reinforced expectations for a December rate increase this week, saying the U.S. economy is ready for higher borrowing costs. The U.S. will report payrolls data on Friday, the last major jobs figures before the Fed meeting Dec. 15-16. The Fed has signaled the pace of raising rates will be gradual.

No Mistakes

“If the Fed makes no mistake in the December meeting and communicates the expected first hike in a market friendly way,” then losses will be regained, said Lutz Roehmeyer, who oversees about 1 billion euros in emerging-market debt as director of fund management at Landesbank Berlin.

In its decision on Thursday, the Frankfurt-based ECB said it will extend quantitative easing by six months until at least March 2017 at the current rate and broaden the assets purchased to include local and regional debt. The Governing Council also reduced its deposit rate by 10 basis points to minus 0.3 percent.

"Draghi’s comments change the picture again very quickly," Simon Quijano-Evans, the London-based chief emerging-market strategist at Commerzbank AG, said by e-mail. This "puts the emerging-market focus now fully on the Fed meeting and increases surprise risk too, given extra liquidity support from ECB is not there," he said.

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