Investors enticed by high yields, strong zloty
With the Warsaw Stock Exchange (WSE) up 20% since the start of the year, equities may be dominating the headlines, but debt investors are enjoying their own bull market.
Worsening inflation, which has prompted three interest rate hikes since last September, has pushed yields up to their highest level in nearly a year and brought hefty profits to short-term debt investors.
At the same time, these high yields have brought foreign investors pouring into the debt market, causing the zloty to strengthen and bringing further opportunities for trading gains.
"It's a common theme, high yields and an appreciating currency scenario, which is irresistible to investors," said Krzysztof Rybinski, chief economist at ING Barings.
Debt investors think the good times will keep rolling for a while. With a potential rate hike on the cards at the Monetary Policy Council's (RPP) March 29 meeting, many investors think yields haven't topped out yet. Interest rates are now at 20-21.5%.
For domestic institutions, this means there's still more time to buy. Then if inflation starts to buckle under the RPP's tightening, they can sit back and reap even higher real returns as the year goes on, said Mariusz Pypec, a fixed-income analyst at CA IB Securities.
These domestic debt investors, primarily banks, are pouring into short-term instruments to take advantage of this scenario. While year-on-year inflation was 10.1% in January, yields on 52-week Treasury bills rose to 18% on March 7, compared to 16% at the end of last year and 12.3% last August.
Foreign investors have also gotten in on the game in increasing numbers, spurring the zloty's appreciation. Two weeks ago, the zloty rose to 6% above the parity level set by the central bank, before settling back to 5.5% earlier last week. (The zloty devalues at a set rate of 0.3% against a basket comprised of the dollar and the euro. The currency is then allowed to trade in a ±15% range against the parity level.)
"Foreign investors are coming to the short-term market," Pypec said. "They open their positions and close them in one day, speculating on the currency's present strength."
He added that these investors buy T-bills at auction for the highest possible yield the Finance Ministry will allow. They then resell these bills to other investors who either missed out on the auction or who bid for even higher yields which were not accepted. These buyers are prepared to accept lower yields as a compromise, bidding up the price of the bills as compared to the auction.
"You buy it for a lower price relative to high yields and sell at a much higher price related to the lower yield," Pypec said.
Jacek Lukowski, deputy head of the treasury division at Bank Austria Creditanstalt gave an example of the trade: An investor buys a T-bill for zl. 84.753, which gives an 18.04% yield. The investor then sells it for zl. 84.832, which carries a 17.97% yield. "If the investor bought zl. 10 million ($2.44 million) of T-bills, he could make a 21.62% return on a yearly basis," he said.
But the short-term portion of the debt market isn't the only action. Three and 10-year floating rate bonds are also garnering interest, due to the fact that their yields are tied to 13-week and 52-week T-bills respectively, Pypec said. At present, zl. 6.5 billion ($1.5 billion) is tied up in 10-year 'floaters' and three-year vehicles have attracted zl. 10 billion-zl. 11 billion ($2.44 billion-$2.68 billion) in investment, said James Owen, an economist at SG Bank.
"The yields of those bills are very high at the moment, and if the situation doesn't change, the next coupon carried by those bonds will be very high," Pypec said. With the possibility of a further short-term rate hike on the cards if Poland's inflation continues to rise, 52-week yields could even hit 19%, economists said. That would benefit both the long- and short-term instruments.
The wild card is upcoming inflation figures and the worsening current account deficit, which hit $1.2 billion last January. February inflation figures could hit 10.5-10.6% due to recent rises in food and oil prices, according to Citibank (Poland). But inflation is expected to fall after March.
This would be good news for those domestic investors who buy short-term instruments at the peak. But calling the top is difficult because the macroeconomic situation is so uncertain at the moment, Pypec said.
If inflation settles down and shows signs of heading toward the government's year-end target of 7.5%, foreign investors will turn increasingly toward long term two-year, five-year and 10-year treasury bonds (T-bonds), Owen said. The RPP may give further impetus for this possibility if it again hikes rates. This scenario was given added impetus last week when Monetary Policy Council (RPP) member Marek Dabrowski said he could not rule out another rate hike this year.
Economists said any hike would not likely be higher than 1%, and from June onward the market expects rates to decline. This prospect, of a rate turnaround, has not been built into present yields, said Mateusz Szczurek, an economist at ING Barings.
However, economists said the rate hikes are likely to have taken effect by now, making the year-end inflation forecast a likely scenario. "Seven point five percent is feasible, and the most recent estimates see inflation falling quite significantly," said Szczurek.
Yields on the long-term debt market have also risen substantially due to the recent rate hikes, with two-year, five-year and 10-year T-bonds rising from 14.6%, 12.2% and 9.4% Jan. 5, to 16.5%, 13.4% and 10.8% March 7 respectively.
However, the situation is merely temporary and the bond market is less susceptible to rapid fluctuations, Owen said. "There should be a rally on the bond market once it is clear that official interest rates are near to peaking." Indicative of this is the marked foreign interest at the most recent two-year and five-year bond auctions, he said. The only uncertainty remains as to whether the Monetary Policy Council (RPP) decides to hike the rates again if the inflationary picture continues to deteriorate, he said.
Moreover, the supply of T-bills has decreased at the expense of rising levels of T- bonds, he said. While the Finance Ministry issued zl. 29 billion ($8.29 billion) in T-bills in November 1998, the number had fallen to zl. 26 billion ($6.67 billion) in the same month last year. By contrast, while zl. 8.8 billion ($2.51 billion) and zl. 16 billion ($4.57 billion) was issued in 2-year and 5-year T-bonds in November 1998, this number had jumped to zl. 10 billion ($2.56 billion) and zl. 22 billion ($5.64 billion) respectively a year later, Owen said.
