World's Fifth-Lowest Yields Lure Buyers Betting on Koruna Rally

  • Foreign holdings of domestic bonds rose to record in December
  • Appreciation would compensate investors for negative yields

If Czech central bankers are trying to persuade investors that they can stop a surge in the koruna once they drop their Swiss-style cap, it isn’t working.

Foreign holdings of local-currency bonds jumped to a record in December even after yields on short-maturity debt turned negative along with havens like Switzerland and Japan, according to Finance Ministry data released Friday.

Investors are comfortable paying to lend to the Czech government because they expect to be compensated once the central bank abandons a cap that’s barred the koruna from appreciating beyond 27 per euro for more than two years, according to ING Groep NV.

“Foreigners’ willingness to buy koruna assets with near-zero or negative returns shows they expect to make enough profit on the currency’s gains,” said Jakub Seidler, chief economist at ING’s unit in Prague. “Policy makers obviously have to say the exchange rate won’t appreciate much, but it’s really hard to imagine it wouldn’t.”

Accelerating capital inflows into the former communist nation of 10.5 million are defying repeated pledges by the Czech National Bank that it intends to stop "excessive" appreciation once the cap is removed. It purchased $8.3 billion of foreign currencies since July to defend the limit, which policy makers say will probably stay for most of this year.

Bond investors are undeterred by the assurances. Non-resident holdings of domestic sovereign debt soared 50 percent in the year to Dec. 31 to 295 billion koruna ($11.9 billion), 21.3 percent of the total, according to data on the Finance Ministry’s website.

‘Clear’ Bet

Yields on maturities of five years or less held below zero for all of December after falling to records early that month. Benchmark 10-year yields are currently the lowest worldwide after Switzerland, Japan, Germany and the Netherlands, data compiled by Bloomberg show. The rate on those securities was 0.61 percent on Monday, 28 basis points above German debt with similar maturity.

The central bank weakened the koruna and imposed the cap in November 2013 to stave off deflation and shore up economic growth after the currency traded at an average of 25.7 per euro in the previous 12 months. In December last year, policy makers reiterated their pledge to keep the limit in place at least until the second half of this year and that they will probably abolish it at around end-2016.

The koruna has gained 2.7 percent against the euro in the past 12 months, making it the best performer in emerging Europe. It’s held above the 27 mark for three months now, trading at 27.03 per euro as of 9:58 a.m. in Prague.

“Investors betting on koruna appreciation don’t really care that much whether this happens in the third quarter of this year or the first quarter of 2017,” ING’s Seidler said. “The direction is clear. The magnitude of gains will depend on how much the central bank will intervene before and right after the exit.”

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