S&P Upgrade Fuels Hungarian Rally as Door Opens for New Funds

  • Commerzbank, Legal & General see further gains this week
  • KBC sees central bank facing dilemma on forint appreciation

Hungarian Eurobonds extended the biggest rally in more than two years after a surprise return to investment grade opened the way for bondholders tracking low-risk benchmarks to buy the debt.

Bonds and stocks rallied after S&P Global Ratings on Friday became the second agency to place Hungary above junk, allowing funds that can only buy investment-grade assets to start piling into the country. According to Legal & General Group Plc, that means the nation’s local-currency yields will trade in line with Poland, rated three steps higher, and Eurobonds may move closer to Romanian debt.

"More investors will jump on the bandwagon, given you have a double investment grade there now," Simon Quijano-Evans, an emerging-market strategist at Legal & General in London, said on Friday. While there will be "positive spillover," many investors had already positioned for the move, he said.

The upgrade to BBB- unwinds a five-year spell in junk that followed Prime Minister Viktor Orban’s seizure of pension-fund assets to prop up state finances, a move that sent bonds plunging and wiped out as much as $24 billion from the nation’s equity market. S&P, whose decision comes four months after Fitch Ratings took a similar step, said the boost was warranted by a lower debt burden alongside improved budget and growth indicators.

Yields on the government’s dollar-denominated debt due in March 2024 dropped 12 basis points to a record 2.92 percent by 2:44 p.m. in Budapest, extending a 22 basis-point decline on Friday. The forint appreciated 0.1 percent to 307.9 per euro, heading for the strongest level since February. Local-currency bonds also gained, with the 10-year rate falling 13 basis points to 2.82 percent, while the benchmark BUX equity index jumped the most in Europe after the FTSE 100.

The currency has scope to strengthen to 300 by mid-December, according to Guillaume Tresca, a senior strategist at Credit Agricole CIB in Paris. KBC Groep NV sees the forint rising toward the 300-305 range per euro after the upgrade.

That would push the exchange rate beyond the level of about 310, the threshold at which some analysts say the central bank views the currency’s gains as overdone. The monetary authority has said on multiple occasions that it doesn’t have an exchange-rate target. Rate setters are scheduled to announce details of their latest round of unconventional easing on Tuesday, including limits on access to the main deposit instrument. 

"The central bank may find itself in a difficult situation," said David Nemeth, the chief economist at KBC’s Hungarian unit. While a deposit limit "is intended to force foreign investors out of Hungarian bonds and weaken the forint, the upgrade works in the opposite direction and raises the allure of the market."

Hungary’s 10-year local-currency yield fell eight basis point below equivalent Polish bonds that are rated A- at S&P. The yield has the potential to decline to 2.80 percent by the end of the year, according to the median forecast of eight analysts surveyed by Bloomberg.

Since yields have already retreated more than 50 basis points in 2016, there may be limited scope for a sustained rally beyond this week, according to Commerzbank AG.

"Hungarian assets may have already rallied too far in anticipation and there is likely to be only a modest follow-through over the coming month," Tatha Ghose, Commerzbank’s senior emerging-market economist in London, said in a research note. Following a "positive tone" in markets this week, "valuations may eventually settle back near current range," he said.

The S&P upgrade will support passive inflows into Hungarian assets, Goldman Sachs Group Inc. said in an e-mailed note on Monday. The benchmark BUX equity index jumped 1.9 percent, the fourth-best performance among 94 primary indexes tracked by Bloomberg. OTP Bank Nyrt., the country’s largest lender, rallied 2.7 percent while Magyar Telekom Nyrt. climbed 1.3 percent.

"We expect buying pressure on Hungarian stocks," said Monika Kiss, the head of research at the Budapest-based Equilor Befektetesi Zrt. brokerage. "As the market had expected an upgrade only in November, the positive surprise may have a strong impact in the next three to five days."

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