Op-ed from 12 September 2023 in Börse Express with Ronald Schneider, Head of Bonds, CEE & Global Emerging Markets, Raiffeisen Capital Management

The factors behind last year’s weak performance are quite clear: The geographical proximity to the war in Ukraine had massive negative implications for the region’s markets, along with the high energy costs, which resulted in rising food prices and sometimes double-digit inflation rates, for example in Poland, Czechia, and Hungary. Prices increases in Hungary increased to as high as around 25%. In response to this, the national central banks raised interest rates, with massive negative impacts on the bond markets. The region’s currencies were also hit by the shock and corrected strongly as well.

On the whole, the previous year was a major disappointment for investors in the region, to put it mildly. But the situation has turned around this year. Along with the political measures taken to reduce dependence on Russian gas, the warm winter weather allowed the countries in the region to get through the winter in much better-than-expected shape and it was not necessary to shut down gas supply. The dreaded sharp decline or complete collapse in economic growth did not materialise. Consequently, rates of inflation already fell in the first quarter and have started to gradually normalise.

At present, we are seeing a disinflationary trend that is resulting in the first cuts in interest rates and thus also fostering good performance by bonds as well, even though volatility remains high. Most of the positive performance for the year to date can be ascribed to the bond segment (in local currency), which accounts for some 7% of the roughly 8%. While the currencies have also stabilised in the meantime and appreciated, they were involved in the good performance to a lesser degree (around 1%).

Although the Hungarian forint was the best performer among the CEE currencies and strengthened considerably, the aggregate gain was limited to the above amount. Positive price effects were driven by declines in the high bond yields. Hungary also stood out in a positive light in this regard as well. In H1 2023, Hungarian government bonds were in double-digit territory, followed by Poland and then Romania in the ranking of highest yields in Central and Eastern Europe.

Looking at the current figures overall, the yield level of around 5.8% on local currency bonds still looks quite attractive. Hungary continues to lead the ranking with 7.5%, followed by Romania at 6.7%. While this is still attractive by historical standards, it is far lower compared to the first half of the year. Taking a look at economic developments, the worries about a deep recession failed to materialise. Nonetheless, economic growth has come under strong pressure due to the high energy prices and high base rates.

The clear-cut stagnation in the economy has much to do with the economy in the euro area, which is also struggling to gain any momentum and thus does little to stimulate activity in its nearby trading partners. The lack of expansion is hitting the Eastern European manufacturing sector particularly hard, due to its close ties to manufacturing in Western Europe. In particular, Czechia, Romania, and Hungary – as well as Slovakia, which is already a member of the euro area – all have very close connections to the Western European automotive industry. And with this industry currently facing major changes (one need only consider the push for decarbonisation), there are slim chances for a positive, supportive trend right now.

Additionally, the high interest rates and higher food costs are weighing on consumption in Eastern Europe. Consequently, the economic outlook is rather muted. Anticipations are already running high, as these developments are naturally fuelling discussions about when the central banks may begin to reduce the high interest rate levels. At the global level, this discussion is also occurring in relation to the Fed and – in fundamental terms – it may provide support for the bond markets. At the moment, however, we are in a phase of consolidation. The market has already anticipated and priced in quite a bit. Thus, it is possible that a setback may occur.

External trade, which was a significant cause for concern in 2022 due to the high gas prices, has improved again as prices have normalised, bringing improvements to the trade balances and current account balances in these countries. The outlook for inflation is also positive. However, achieving the inflation targets of 2% to 3% in the immediate future looks questionable. One supportive aspect for the Central and Eastern European countries are the transfer payments of the European Union. The countries that are in compliance with the EU’s regulations, such as Romania and Croatia, are able to take full advantage of these funds and have profited enormously. For Poland and Hungary, these payments are currently suspended due to legal discrepancies with the EU.

Elections in Poland are slated for 15 October 2023. These elections are very important, as the rule of law in the country is also being voted on. At present, the outcome is completely uncertain. Even if the incumbent PiS party secures a relative majority, it may prove difficult to form a coalition. At the same time, believing that everything will be just fine in Poland in the event of a change of government also falls into the category of wishful thinking.

One risk factor for the region is the war. An escalation would have a massive impact on the markets. At present, however, we do not believe that the war will spread to include NATO members. If it does, a very large war would ensue, with enormous consequences. In summary, we still view this region as attractive, even though the earnings opportunities have narrowed somewhat due to the very good performance that has already been seen.