Bond Vigilantes Swarm European Economies Where Inflation Is Hot

(Bloomberg) -- Bond markets are famous for pushing their agenda, and in east Europe right now, they’re pushing for rate increases, never mind what central banks have to say on the matter.

Yields on bonds of Hungary and Poland are rising faster than anywhere else in Europe. Hungary’s jumped 32 basis points last week, signaling traders are primed for rate liftoff as inflation roars back to life ahead of widespread economic re-openings this summer.

Like peers in Frankfurt, central bankers in Hungary and Poland have signaled they’re in no rush to curb inflation that may turn out to be temporary, preferring to wait and foster still-fragile economic recoveries from the pandemic.

Traders are less patient. In Hungary, market-implied pricing shows expectations for 130 basis points of rate hikes in two years, according to Bloomberg data.

“The central bank is walking a tightrope here,” said ING economist Peter Virovacz. “If it manages to communicate in a credible way that it believes CPI would return to its 2%-4% tolerance band next year, it can wait out the spike and avoid a hawkish cycle.”

The situation brings to mind the quip by political adviser James Carville that when he dies he wanted to come back as the bond market because “you can intimidate everybody.”

Carville was talking about traders who pushed up yields in protest against a ballooning budget deficit in the mid-1990s, but there are parallels with the Hungarian and Polish bond selloff on concerns that an economic boom will create an inflation spiral.

These latter-day vigilantes may be gaining the upper hand, with strategists at JPMorgan Chase & Co. reiterating their advice to stay underweight bonds in central and Eastern Europe.

A premature end of purchase programs is a big risk for Poland, where the central bank has bought the equivalent of 48% of issuance and in Hungary where it accounts for almost a third of purchases, according to JPMorgan.

QE Conundrum

If Polish policy makers bring forward their timetable for raising rates, the central bank would also have to wind down its quantitative-easing program, potentially removing the current backstop for the market.

One Polish policy maker, Eugeniusz Gatnar, recently called for a rate increase in June. Yet his voice remains in the minority on the 10-person panel. Polish central bank Governor Adam Glapinski has said that rates will stay at their record low until the end of the current policymakers’ term, which ends in early 2022.

Still, the inflation threat may be real: in Hungary the pace of annual consumer prices recently accelerated to 5.1%. In Poland it’s running at 4.3%. Both blew past the upper limit of the central banks’ tolerance range, and compare with an inflation reading of 4.2% in the U.S. that sent markets into a tailspin last week.

“With inflation surprising to the upside and growth on the mend, we think the market narrative will increasingly focus on the sustainability of QE in CEE,” according to JPMorgan emerging market strategists including Saad Siddiqui.

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