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Erste Group on Polish Bond Market: Too good to be true?

December 11, 2012
The rally on the Polish bond market started during the summer. Since then, yields have been systematically dropping and recently reached all-time lows. Is the situation on the market so good that it will continue? Or it is too good to be sustainable in the long term?

The rally on the Polish bond market started in the summer. The yield curve has visibly shifted downward over the last few months, strongly surprising the market in recent weeks. Two factors played a major role: increasing interest on the part of foreign investors in holding Polish debt and the expected monetary easing cycle, which finally began in November. Assuming that the EMU debt crisis is resolved and the Eurozone will slowly return to the path of growth starting from 2H13, Poland is broadly expected to grow below 2% next year. The public finance situation will remain stable. Even if the deficit and public debt figures will slightly overshoot the assumptions, Poland will remain an attractive place for investment, with its positive interest rate differential and rate of growth. In the medium term, we expect the curve to move further downward due to the weak economy and for the monetary easing cycle to continue. Any turbulence in the Eurozone and a switch in perception of the Polish economy (from the current sort of “safe haven” to risky “emerging market”) will lead to an increase in the level of yields. Substantial overshooting of the public debt-to-GDP ratio and budget deficit figures brings the risk of loss of investor trust, withdrawal of funds and consequently yields at a higher level.

After a long period of increased risk aversion among investors (response to turbulence in the Eurozone and unresolved debt crisis) which kept yields of Polish bonds at high levels, the summer months brought a change in the trend. Since July, yields have been steadily dropping (overall by almost 100bp) and they recently reached an all-time low – 2Y were at the level of 3.40%, 5Y were at the level of 3.60% and 10Y yields reached 4.11%. The yield curve has visibly shifted downward since the beginning of July.

The cause of the downward shift of the curve is a combination of two factors: increasing interest on the part of foreign investors in holding Polish debt (increased demand drives yields down) and the monetary easing cycle. The overall cut of 100bp is mostly priced in. In the medium term, we see 2Y yields at the level of 3.1%, 5Y at the level of 3.35% and 10Y at the level of 3.97%. We expect yields to bounce back in 2H13 when prospects for economic growth improve.

The monetary easing cycle began in November. After a long period with a high inflation rate, this is no longer a concern in the face of a weakening economy. The inflation rate has been steadily dropping for the last few months and is expected to reach the target of 2.5% at the end of 1Q13. Moreover, the slowing economy has recently become of increasing concern to some central bankers, who are ready to deliver cuts to stimulate growth.

The domestic factors seem recently to outweigh the importance of the foreign debt holders – the other factor behind the recent rally. Their recent increasing demand for Polish debt has steadily driven the price up.