US$11bil investor sees risk lurking in bargain Czech debt

PRAGUE: Czech bonds may look like a bargain to foreign buyers lured by a rare combination of safety and some of Europe’s highest returns. The country’s second-biggest investment company is unimpressed.

Erste Asset Management AG’s Czech unit, which oversees the equivalent of US$11.1bil, is more bearish on the country’s domestic notes than any of its other fixed-income holdings worldwide, despite the highest yield premiums in almost a decade.

The debt “isn’t properly priced”, especially for shorter maturities, and may get cheaper as the market underestimates the pace of inflation and central-bank interest-rate increases, said Tomas Ondrej, a portfolio manager.

“Economic growth is very healthy, driven by domestic consumption, and we believe there’s nothing that could prevent further monetary-policy tightening,” he said in an interview in Prague. “The pressure from more rate hikes must hit the bonds sooner or later.”

Czech yields, among the world’s lowest two years ago, have surged above those in most eurozone countries as the central bank started raising borrowing costs ahead of the rest of the continent. But the increase isn’t over, because rapid wage growth and a lack of koruna appreciation will force policy makers to keep cooling the economy, Ondrej said.

The ex-communist country’s three-year securities now yield 1.69%, outshining a rate of approximately zero on comparable debt from Spain or Portugal and negative returns in Germany.

But that’s not enough for Erste and some other domestic investors, who face 2.3% inflation and can deposit money with local banks at a rate that’s just below the Czech National Bank’s 1.5% benchmark, according to Ondrej, 45.

As well as preferring holding cash instead of domestic government debt, the primarily koruna-funded Czech unit of Erste is underweight European fixed income, while overweight stocks and US high-yield bonds.

Ondrej expects the monetary authority, which has raised rates six times since last August, will follow with one more 25 basis-point hike this year and three increases in 2019. That would exceed the policy tightening predicted by most analysts and the central bank itself.

Money-market traders are positioning for another boost to funding costs at the next monetary-policy meeting on Nov 1.

Shorter maturities “should be the most affected by the ongoing growth in interest rates, but demand from abroad is keeping yields down,” said Erste’s Ondrej.

“Czech bonds are very attractive for eurozone investors, given they are safer and higher-yielding than Portugal and Spain. As a result, the market isn’t fully reflecting domestic fundamentals.”