CEE markets are vulnerable in the short term unless US rates stabilise.
With the exception of Russia and Turkey there has been a long period of yield compression in CEE where yields have tightened to historic lows but there are headwinds on the horizon.
Unicredit notes in a report on Tuesday:
- First, we don't think the market is fully pricing risk. Second, risk indicators look like they are reversing. Third, inflation in Central Europe looks to be bottoming out.
- As a result, the scope for monetary easing is limited from here on.
- We recommend in fixed income moving duration from the long end to the belly of the curve in high beta countries and in CE3 where the correlation with US yields is typically lower, but will still allow to benefit from any spread compression via ECB QE.
We think the hard currency bonds in CEE are much better value and less risky in a rising US rate environment. This was highlighted by last week's EPFR bond flows where there were strong inflows to hard currency EM bond funds but outflows from local currency EM bond funds.
We think USD and EUR denominated bonds in the long end in Poland, Romania, Hungary and the Baltics will remain well supported.
