Draghi Can't Stop East Europe Bond Rally Buoyed by BlackRock

(Bloomberg) -- Not even Mario Draghi can stop the comeback this year in eastern European bond markets.

Local-currency bonds from Poland to Hungary have advanced this month in the face of growing concern the European Central Bank is on the cusp of reducing its unprecedented stimulus. The rally extends a 6.7 percent return for the region’s debt in the second quarter, the best in emerging markets.

Improving economic data and yields on average four times higher than those on offer in Germany are luring investment back to the region a year after some of the world’s biggest bond investors pared holdings to seek higher returns elsewhere. Investors at BlackRock Inc. and Allianz Global Investors GmBH said they see value in the bonds and analysts at Morgan Stanley and Credit Agricole SA last week named eastern European currencies among their top picks.

“Eastern Europe is a place that we like because the fundamentals are improving,” Sergio Trigo Paz, the head of emerging-market debt at BlackRock said on Bloomberg television this week. "At the same time, the rate story is still paying you some yield while Europe starts to normalize.”

Closing In

Yields on German bonds have surged to an 18-month high of 0.6 percent since June 28 when Draghi said the reflation in the euro-area economy creates room to pull back the central bank’s 60-billion euro ($68.5 billion) monthly bond purchases. The rout reduced the spread between German and Hungarian 10-year notes to the narrowest in two years and trimmed the premium investors demand to hold Polish debt over bunds to an 11-month low.

Although emerging European economies are among the biggest beneficiaries of the stimulus, their falling debt levels and improved terms of trade will help mitigate any negative impact from tighter monetary conditions, according to Daniel Bebesy, a money manager who oversees $2 billion in assets at Budapest Alapkezelo.

Still, it’s too early to assess the impact of a decline in liquidity for the region, Bebesy said. The ECB probably won’t make any moves to unwind stimulus at a meeting this week, according to a Bloomberg survey, but respondents are split on whether officials might set the tone by dropping a pledge to boost quantitative easing if needed.

Eastern European economies grew 2.85 percent in the first quarter, the fastest pace in more than three years, while unemployment dropped last year to the lowest level since at least 1999, data compiled by Bloomberg show. Despite a surge in wages, inflation is set to stay below central bank targets, giving policy makers more time to keep rates at record lows.

Read more: Slimmest Bond Goal Since Lehman Shields Poland From Taper

The strengthening euro is also good news for currencies in the region, which will probably continue to strengthen versus the U.S. dollar, according to Naveen Kunam, a London-based senior portfolio manager at Allianz Global Investors. The Polish zloty, Czech koruna and Hungarian forint have surged more than 10 percent against the dollar this year, lagging only the Mexican peso in emerging markets.

“As developed market yields get repriced, central and eastern European debt will remain resilient due to strong macro factors,” Kunam said. “I expect to see the outperformance continue.”

--With assistance from Mark Barton and Vonnie Quinn

To contact the reporters on this story: Marton Eder in Budapest at meder4@bloomberg.net, Adrian Krajewski in Warsaw at akrajewski4@bloomberg.net.

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Natasha Doff, Alex Nicholson