BUDAPEST: Hungary's 10-year government bond yield has surged in May, closing a wide gap with Poland for the first time in at least a year, which investors say put the dovish Hungarian central bank into a precarious position as it has pledged to curb yields.
Long-term yields have jumped, with bonds giving up the big gains they made last year, as Hungary has boosted debt issuance in recent months to help finance a widening budget deficit.
The swelling of the deficit is likely to be temporary as the government has pre-financed projects sponsored by the European Union and should be refunded by Brussels as the projects are completed later this year.
But that surge in Hungarian bond sales, combined with a sharp rally in US bond yields, has undermined the National Bank of Hungary's (NBH) commitment to keeping yields low.
"The (Hungary-Poland) spread's vanishing was spectacular," said Viktor Szabo, portfolio manager for emerging market debt at Aberdeen Asset Management. "This occurred even though the Polish central bank rhetoric (to keep policy loose) got quite similar to Hungary's."
The Polish central bank does not have a similar yield objective although its interest rates are also at a record low and policymakers expect them to remain there throughout 2018.
The 70-basis-point jump in the Hungarian 10-year yield in May was a surprise to investors after the NBH's pledge and its new long-term interest rate swap tool helped the spread against Polish debt widen to more than 100 basis points by January.
The gap closed last week amid a sell-off in emerging markets caused by a rally in the dollar and US yields.
The Hungarian yield surge compared with a rise of only 25 basis points in Poland.
Its spread over Bunds has doubled since early this year, rising to around 280 basis points, even though the NBH had a commitment to keep the spread over core market yields steady.
The Hungarian central bank has declined to comment directly but at its meeting on May 22 it noted the yield rise, reiterated its dovish message, and said sentiment in financial markets has been "highly volatile".
Foreigners' Hungarian bond holdings remained steady in May after some selling in April.
Szabo said Hungarian bonds gave up price gains made last year, when they outperformed peers in Europe's emerging east.
Due to the pre-financing of EU sponsored projects, the rolling 12-month deficit has reached 7 percent of economic output, Citigroup analyst Eszter Gargyan said in a note dated May 23. This has boosted debt supply.
"There is no liquidity shortage but local banks might have reached credit limits to increase government debt exposure further," she added.
As US yields have retreated since last week, the Poland-Hungary spread has reopened to about 6 basis points, with the Hungarian paper trading at around 3.15 percent.
But risks abound. US yields may rise further and Italy's political turmoil could push euro zone yields higher.
If market jitters return, eyes will be on the NBH ahead of a big Hungarian bond expiry worth 323 billion forints on June 22, analysts said. The next interest rate meeting is on June 19.
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