government bonds

Polish first-quarter GDP shows disinflationary structure, with odds of a rate cut growing. Poland's statistics office has revised the first-quarter GDP estimate to -0.3% year-on-year. In 2023 as a whole, we expect economic growth to be around 1% on the back of the improving foreign trade balance.   Seasonally adjusted GDP rose by a hefty 3.8% quarter-on-quarter in the first quarter of 2023, following a decline of 2.3% QoQ in the fourth quarter of last year. But seasonally adjusted data have shown surprisingly high volatility in recent quarters and should be taken with a pinch of salt.   The composition of the first quarter GDP was also revealed and shows a quite disinflationary picture, with some caveats. Domestic demand contracted by 5.2% year-on-year amid a deepening decline in consumption, which fell by 2.0% YoY, following a drop of 1.1% YoY in the fourth quarter of 2022. Investment activity continues to hold up well, expanding by 5.5% YoY in the first quarter of this year (vs +5.4% YoY increase in the fourth quarter of last year).   As expected, the change in inventories had a negative impact on activity, subtracting 4.1 percentage points from the annual GDP growth rate. This was offset by an improvement in the foreign trade balance. The positive impact of net exports on the change in annual GDP amounted to 4.3 percentage points. The exports of goods and services increased by 3.2% YoY, while imports were 4.6% lower than a year earlier. The GDP deflator reached 15.6%.     With respect to value added, we saw declines in trade and repair (-4.4% YoY), industry (-1.4% YoY) and transport and storage (-1.2% YoY). Most other sectors of the economy recorded increases.   2023 GDP and inflation outlook As expected, the start of 2023 brought a decline in GDP on a year-on-year basis, but on a markedly smaller scale than we had feared. However, this does not mean that the outlook for the year as a whole is markedly better. High-frequency data point to weakness in retail sales, industry and housing construction in the second quarter. At the same time, growth in infrastructure-related construction continues.   This is accompanied by continued elevated levels of inflation, which negatively affects consumers, dragging on the performance of the economy. On the other hand, investment activity will have a positive impact on the economy. Investments will most likely concentrate in large companies and the public sector (including defence spending). We expect that the main driving force of the economy will continue to be the improving foreign trade balance, mainly due to low imports.   The structure of GDP growth should be disinflationary this year due to the weakness of consumption, rising investment and the large role of foreign trade in shaping economic activity. Combined with the eradication of the direct impact of the energy shock, this should favour a further decline in inflation, with its pace being constrained by core inflation. The latter is more sticky than the headline CPI.   One factor in the slower deceleration of core inflation will be a tight labour market and high wage growth. We forecast that by the end of 2023, both the headline CPI and core inflation may moderate to single-digit levels, but the outlook for 2024 is more uncertain.     National Bank of Poland rates outlook Expectations for a cut by the National Bank of Poland (NBP) may rise (we see 30-40% odds in the second half of the year). Theoretically, today's data show an improvement in the inflation outlook: a better GDP structure, month-on-month core CPI slowing, and NBP more vocal on rate cuts.   But the cross-country comparison (especially with the Czech Republic) suggests this could be a premature move.   Moreover, we still see important inflationary risks in the long term: a strong public acceptance of price increases, an election spending race, and strong investment mainly in energy (other sectors are still performing poorly to offset high costs).   In our view, an NBP cut would not help Polish government bonds (POLGBs) with longer maturities.   The premature cut would extend the return of CPI to the target, which is already a distant prospect (in 2025-26).

Unacceptably high core price dynamics will lend a helping hand to ECB officials pushing for a hawkish line The most likely outcome to this week's inflation releases, still unacceptably high core price dynamics, will lend a helping hand to ECB officials pushing for a hawkish line.   Warnings that hikes may have to continue until September will stand a better chance of pushing longer term rates higher even if a subdued economic outlook, and growing doubts about the strength of China's post Covid recovery, should prevent European rates from rising as quickly as their US peers in the coming weeks. Wider USD-EUR rates differentials should only be a temporary development, however, and one resulting from a rise in global rates.   Market participants who, like us, expect lower rates into year-end, should also consider the possibility of US rates falling faster than their European peers, perhaps to sub-100bp levels for 10Y Treasury-Bund spreads.   This is all the more true since European markets have to contend with another dollop of political uncertainty in the form of early Spanish general elections on 23 July. The prime minister called for a vote after local elections defeat at the weekend and the opposition party PP is on the front foot, although it would likely rely on a coalition with another party due to the fragmented nature of the Spanish political landscape.   Spain’s still wide budget deficit (the European commission forecasts 4.1% of GDP this year and 3.3% next) mean a period of uncertainty is an unwelcome development and could lead to underperformance of Spanish government bonds vs peers such as Portugal and Italy.   Early elections mean Spanish bonds are at risk of underperformance vs Italy and Portugal   Today's events and market view Spain kicks off this week’s inflation releases. This will come on top of Eurozone monetary aggregate data and the European Commission’s confidence indicators for the month of May. One theme in European macro releases has been the softening of survey-based data, such as Germany’s Ifo (see above).   US releases feature house prices, the conference board’s consumer confidence, and the Dallas Fed manufacturing activity index.   Bond supply will take the form of Italian 5Y, 10Y fixed rate bonds, as well as 5Y floating rate bonds.    

Swedish Riksbank hikes rates and lifts bond sales amid krona weakness Sweden's central bank has slowed the pace of rate hikes as it walks a fine line between bolstering the ailing krona and avoiding more damage to the fragile housing market. We think another hike is likely in September, but that might be the last.   Sweden’s central bank has hiked rates by another 25 basis points amid ongoing concerns about the weak krona. On a trade-weighted basis, SEK is roughly 3% weaker than the Riksbank had been predicting for the second quarter on average in its last set of forecasts from April.   On paper, there’s nothing hugely surprising about today’s decision, though repeated warnings about currency weakness from Governor Erik Thedeen meant there was a tail risk of another 50bp hike this month, not least because the Riksbank meets only twice more this year. That said, the central bank has opted to increase the pace of its sales of government bonds, from SEK3.5bn a month to 5bn, and by the Riksbank's own admission, this is partly designed to help support the krona.   Unsurprisingly those concerns about a weaker currency, coupled with some resilience in both economic activity and house prices, have also led the committee to upgrade its assessment of future rate hikes. The bank is now forecasting one more hike later in the year, and a 20% chance of another, which would take the policy rate to 4.25%. Unlike at the last meeting, there appears to have been no disagreement on the policy decision among the committee.

Unclear what quicker quantitative tightening means for the krona EUR/SEK has been volatile in narrow ranges after the Riksbank’s announcement today. The positives for the krona are that today’s decision to hike was unanimous and that future rate hikes are promised. What is less certain is what today’s announcement of accelerated quantitative tightening (QT) means for the krona. Recall that back in February the Riksbank announced that it would be shrinking its holding of assets from around SEK800bn to SEK200bn over the next three years. In April, It started reducing its holdings of nominal and inflation-linked government bonds by SEK3.5bn per month. Today it has announced that the pace of sales will increase to SEK5bn per month starting in September. The Riksbank argues that its bond sales will raise yields on government bonds while having little impact on lending and deposit rates. It also argues that by supplying these government bonds back to the market, greater liquidity here will attract foreign investors and support the krona. The hypothesis of QT supporting the krona seems to be untested. So far this year, 10-year Swedish Government Bond (SGB) yields have only traded in a +/- 15bp range against 10-year German Bunds – and serves as a reminder that the ECB is also shrinking its balance sheet at the same time. In all, we suspect that EUR/SEK can stabilise around the current 11.70-11.80 levels. However, with the real estate market proving to be Sweden’s Achilles heel, we doubt that a sustained recovery in the undervalued krona will emerge until much later in the year when there are clearer signs of improvement in global inflation trends. Until that point, domestic risks in Sweden will continue to see the krona trade on a fragile footing.   Riksbank's initial planned sales of government bonds

Czech Republic: Inflation below 10% is not enough for the Czech National Bank The economy has confirmed weak activity in recent months, but the numbers are more in line with expectations. At the same time, inflation is surprising to the downside and the overall labour market picture is more anti-inflationary than expected. Looking ahead, the inflation profile looks comfortable – probably the best in the region. We expect June inflation to fall below the 10% YoY threshold and the disinflationary momentum to continue through the summer months. However, disinflation will slow in the autumn and winter, making it challenging for the CNB to cut rates. We expect the first rate cut in November when the central bank will have a new forecast in hand, but we see a risk of delaying a rate cut until the first quarter of next year. This again makes the CNB the most hawkish central bank in the CEE region. On the fiscal side, we also see a big story. The government recently approved a state budget for next year of CZK235bn targeting 1.8% of GDP, by far the lowest figure in the region. We expect a successful legislative process during the summer months, which implies a reduction of next year's borrowing needs to 60% of this year's level. In addition, June's state budget result showed an improvement for the first time this year. We thus remain positive on Czech assets. Czech government bonds (CZGBs) should maintain strong demand and we expect the market to shift its focus to supply dynamics soon. The Czech koruna has traded at weaker levels than we expected in recent weeks. However, the koruna should benefit most from the EUR/USD recovery and we see room for a reassessment of market expectations for a CNB rate cut.  

USD/JPY The Bank of Japan unexpectedly purchased 300 billion yen worth of government bonds yesterday in order to maintain low yield on long-term debt securities. This led to yen weakening by 0.86%.     On the daily chart, the price approached a strong resistance formed by three lines: the target level at 142.82, the MACD line, and the embedded line of the price channel. A slight rebound may occur from this area, after which there will be a new and successful attempt to break through it. If the price consolidates above 142.82, the next target would be 144.73, with further potential growth towards 145.90. The Marlin oscillator being in the positive territory indicates a tendency for further price increases.     A strong upward movement can be seen in the four-hour chart. There may be a rebound towards the support at 141.96 (July 21 high), followed by a resumption of the upward trend. The Marlin oscillator, continuing to rise, will likely withstand corrective declines without moving into the negative zone when the price falls.

Romanian National Bank preview: on autopilot for a while The Romanian National Bank (NBR) will announce its latest policy rate decision on 7 August. We expect the key rate to be maintained at 7.00% with no forward guidance. A new Inflation Report will be approved and presented a few days later which should largely confirm the central bank's previous inflation forecasts. With the inflation dynamic largely matching the NBR’s expectations, the central bank’s focus might shift a tad from inflation to growth, with the latter starting to give more and more credible signs of slowing down rather abruptly. Having said that, there is actually not much that the NBR can do here on top of what has been done already, which was to allow a hefty liquidity surplus in the money market and make the deposit facility the de-facto policy rate. Given that there are still no depreciation pressures for the Romanian leu, it is likely the current policy stance will be extended well into the year-end.   Persistent liquidity surplus   A new Inflation Report should reconfirm the previous forecasts Maybe more interesting than the monetary policy decision itself will be the presentation of the May Inflation Report which should take place a few days later and incorporate the NBR’s latest inflation projections. It is most likely to be the second report in a row which doesn’t differ much from the previous forecasts. The NBR currently sees CPI inflation at 7.1% in December 2023 and 4.2% in December 2024, not far from our estimates of 6.9% and 4.1% respectively. We might see the official forecasts getting into the 1.5-3.5% target range at the end of the two-year forecast horizon, while in our scenario it looks most likely to hover around 4.0%. Moreover, core inflation could prove stickier and remain above the headline figure for most of this timeframe.   Stickier core inflation   We believe that the NBR will stay on course on 7 August and for the rest of the year, despite the more frequent dovish statements coming from other central banks in the region. We maintain our view of a first rate cut in the first quarter of 2024 with a key rate of 5.5% by the end of 2024. The easing cycle will be justified by the lower inflation but likely tempered by core and regional yields, as the interest rate differential cannot narrow excessively. On the domestic front, the new fiscal measures announced in order to contain the budget gap are unlikely to meaningfully change the situation on the issuance front, where the Ministry of Finance is in a comfortable position (more on this here).   What to expect in FX and markets The liquidity surplus fell only marginally in June, remaining at a near-record RON25.2bn, indicating scant central bank activity. EUR/RON briefly broke through 4.920 last week, again likely due to high demand for Romanian government bonds (ROMGBs) and has been higher since but still well below any line in the sand set by the central bank. FX implied yields have also risen a bit in the last two months but still remain firmly anchored. We expect the NBR to take the opportunity to withdraw some liquidity from the market if EUR/RON moves higher. In the long term, we expect the NBR to move the bar up for EUR/RON at least once more and we should see the 5.02 level by the end of the year. ROMGBs eased the pressure a bit in July and we see current valuations as more justified. The spread against Polish government bonds has returned above 100bps in the 10y tenor and even against other CEE peers, the levels seem more fair. The funding story remains unchanged. According to our calculations, the MinFin has secured about 82.5% of this year's planned issuance, the highest figure in the CEE region. We also saw strong activity in retail issuance in July, making the overall funding situation the best in the region. On the other hand, we see potential incoming problems on the fiscal side. The government is discussing further measures to improve the state budget and we should hear more in the coming days. Despite the fiscal issues, we should see a reduction in the supply of ROMGBs. However, we expect MinFin to want to stay on the safe side given the uncertainty and if market demand continues the MinFin will be open to issue more than indicated.

High 2024 borrowing needs in Poland no longer fundable locally Poland’s government unveiled the 2024 draft budget bill with a cash-basis deficit of PLN164.8bn and record-high net borrowing needs. Next year’s deficit is boosted by a strong rise in spending, while revenues should grow slower due to disinflation. Given the high borrowing needs the Polish budget should become more reliant on foreign financing in 2024.   The budget draft The 2024 draft budget bill approved by the government envisages the central deficit (cash-basis) at PLN164.8bn (vs. PLN92bn targeted this year). The reasons behind the strong rise in the deficit are spending, which grew by 22.5% year-on-year, while total revenues are projected to rise by 10.5% YoY amid further disinflation. What is even more striking is a strong increase in borrowing needs. Net borrowing needs for 2024 are projected at PLN225.4bn (c.6% of GDP). This is up by 55% vs. an already high PLN143bn planned for this year and close to zero in 2020-21. Combined with maturing debt it means that gross borrowing needs are expected to exceed PLN400bn next year.     In 2023 net savings in banking sector covers substantial part of borrowing needs In 2023 the financing of (central budget) borrowing needs is based mainly on local sources, ie, the net savings in the banking sector. It grew fast as high interest rates trimmed demand for new loans, while deposits continued expanding. As a result, the net savings in the domestic banks are expected to cover around two-thirds of the state budget net borrowing needs this year, which are estimated at PLN143bn. Also, the government turned more open to external financing and tapped the Eurobonds markets more eagerly than in the previous year, so overall funding of the budget is very safe.   A strong rise of net borrowing needs requires more external funding on hard currency bonds and POLGBs Net borrowing needs and its financing in 2023 and 2024 (PLNbn)   In 2024 net savings of local banks to grow much slower, while borrowing needs rise and budget requires more external funding than in past years We estimate that in 2024 the net savings in local banking sector may reach an equivalent of about 30% of total borrowing needs, estimated at PLN225.4bn. That is why the Ministry of Finance changed the funding plan, which requires much more external savings. In 2024 the authorities plan to expand Eurobonds issuance by nearly PLN37.8bn vs. PLN13.3bn in 2023 (net). Also, foreign investors’ engagement in Polish government bonds (issued domestically in PLN) may also need to increase as the domestic banking sector may not have sufficient capacity to absorb supply of PLN160.7bn in new PLN-denominated government securities (compared with some PLN62.9bn this year). In detail, the net supply of PLN-denominated government securities is the following: (1) the government intends to sell over PLN54.5bn T-bills in 2024; they will be issued for the first time in a long time (are usually purchased by domestic banks), (2) the supply of POLGBs should reach PLN99.2bn vs. PLN48.2bn in 2023, and (3) the supply of retail bonds is expected at PLN7bn vs. PLN14.9bn in 2023. On the top of that the borrowing needs assumes raising PLN28.6bn from the EU Recovery and Resilience Facility. This source of funds is currently locked due to Warsaw’s conflict with Brussels over the rule of law in Poland.   Summary We expect the Ministry of Finance to keep sizable offers of POLGBs in the second half of the year to take advantage of favourable market conditions. Also, the high cash buffer of MinFin (over PLN130bn at the end of July) will be held and used as a safety buffer to prevent problems with funding. Yet, given that net savings in domestic banks may prove insufficient to cover high government funding in 2024, MinFin is likely to rely on foreign investors, who refrained from increasing holdings of POLGBs in past years.

Rates Spark: My home is my castle After the Belgian success story of its one-year retail issue, Italy yesterday announced the launch of its second 'BTP Valore' retail bond for early October. The large volumes involved have knock-on effects on other marketable debt issuance and are a supporting factor for government bond spreads, especially now that the ECB QT debate could pick up.   A stable funding source for governments: households Belgium has grabbed the headlines in recent days with a €22bn one-year retail issue. Beyond the implications for bank deposits, against which it was advertised as direct competition, the success of the sale also had implications for the country’s government bond and bills markets. The net funding via the bills market was reduced from a contribution of €2.8bn to a planned decline in the bills stock of €4.4bn. Long-term bond issuance (OLOs) was trimmed by €2.9bn to €42.1bn for the year.    Yesterday, Italy announced the launch of its second 'BTP Valore', a five-year instrument targeting retail savers. The first instalment launched in June attracted a total volume of €18bn. Such large sizes attract the attention of markets not just for their knock-on effects on issuance plans, but also as it sets the country on a more diversified and stable funding mix. Historically, Italy has had a larger footprint in the domestic market, but it has specifically tapped into the retail segment to a greater degree with dedicated Futura and Valore issues on top of the BTP Italia. At the end of August, these three types of retail government bonds accounted for €122bn or 5.1% of Italy’s central government debt instruments. Prior to the pandemic, the level stood at €78bn or 3.9% at the end of 2019. But since late 2022, households have started to dip more into government debt, raising their investments from €123bn to €185bn over two quarters through the first quarter of 2023. Italian households dipped into government debt again

Next to Italy, Portugal has also been ramping up its funding via the retail sector, although to a greater degree via short-dated instruments – savings certificates. From mid-2022 until mid-2023, their outstanding amount has increased from just over €30bn to almost €46bn. That does not appear much in absolute terms, but it means that the retail segment went from making up 11% to 15.6% of direct state debt. The last time we observed a share that high was in 2008.   Portugal ramped up its share of (short-term) retail debt instruments   It is likely no coincidence that the outperformance of Portuguese government bonds versus Spanish bonds or the overall resilience of Italian spreads versus Bunds occurred alongside a larger reliance on domestic households for funding. To be sure, it is not the only driver as for instance in the summer of 2022, the European Central Bank also revealed its Transmission Protection Instrument. But it can also be a supportive factor going into a renewed debate around the speed of the ECB's quantitative tightening.     Next week: ECB meeting and US inflation Next week is a busy one for markets, the key event being the ECB meeting on Thursday. It will be a close call, but overall we think the chance that we get another hike is greater than markets think. The upside for rates still seems somewhat limited, because it would be pulling forward the hike that markets currently view as happening before year-end with a chance of roughly 70%. We doubt that markets would readily embrace the idea of further tightening on top of that. They could sense that this is the likely end of the cycle as concerns about macro weakness gain more weight, also in the ECB’s own deliberations. Still, the ECB will probably want to counter the notion that this is the definitive end. The degree to which this is successful will determine how much of a bear flattening we could get in the case of a hike. A renewed focus on QT, in particular, could help prop up longer rates. In the US, the upcoming week will be about inflation dynamics. The CPI release is the key event here ahead of the FOMC meeting the following week. The headline is seen picking up to 3.6%, but we think that is largely in the price already. More important is what happens to the core rate, which is seen dropping to 4.3% from 4.7% year-on-year, with the month-on-month rate steady at 0.2%. We will also see the release of producer and import prices as well as the University of Michigan consumer sentiment survey with its reading on inflation expectations. The ISM services this week has highlighted lingering inflation risks, even if the overall dynamics are gradually improving. In terms of market impact, the inflation narrative seems to be driving the curve more from the front end as it determines whether more near-term action from the Fed is required.   Today's events and market view The ECB is already in its pre-meeting blackout period, and the Fed will follow this weekend. The data calendar is light today which may leave markets with more room to contemplate the busy week ahead with a US inflation theme and the chance for another, possibly final ECB hike. We think markets are still trading with an upward bias to rates. The different backdrops against which the next policy meetings are held, a position of macro strength versus a position of growing weakness, has seen UST rates more buoyant again, with the 10-year yield gap over Bunds creeping wider again to 166bp.   

oday, Italy will sell EUR 3.5-4bn of the new BTP 4% Nov30 and will reopen BTP 3.85% Sep26 for EUR 2.75-3.25bn, BTP 4.5% Oct53 for EUR 1-1.5bn and BTP 5% Sep40 for EUR 0.75-1bn. The auction size will be EUR 8-9.75bn, in line with its endof-August auction. Reopenings for specialists worth EUR 2.4bn will be particularly valuable due to tomorrow’s ECB meeting. Yesterday, BTP Nov30 was trading at 4.15% on the gray market, 6bp higher than the previous benchmark (BTP 3.7% Jun30). We like the new 7Y benchmark in a 5/7/10Y fly, whereas a 3/5Y steepener is appealing in a medium/long-term horizon. With respect to extra-long bonds on auction, BTP Oct53 remains cheap in relative-value terms, reflecting future supply pressure and lower convexity, while BTP Sep40 is fairly priced. A 10/30Y flattener remains an interesting defensive trade from a tactical perspective, especially after the recent steepening. For further information on the auction, see our Primary Market Focus – Italy issues new BTP Nov30 in an appealing area of the curve. Today, Germany will reopen Bund Aug52 and Bund 1.8% Aug53 for a total of EUR 2.5bn. Bund Aug52 was last sold via auction a month ago, whereas Bund Aug53 was last tapped via syndication on 29 August. The deal worth EUR 3bn was well received. Indeed, Bund Aug53 was sold at Bund Aug52 +7.5bp and is now trading 6bp higher, in line with the spread before the transaction. On the other hand, the extra-long end of the Bund curve has underperformed over the past month, with the 10/30Y spread steepening by 5bp to 12bp. Today, Portugal will reopen PGB 1.65% Jul32 and PGB 0.9% Oct35 for EUR 0.75-1bn.    

Why India is bucking the global slowdown trend India is the fastest-growing major economy this year. While others in the region look to be struggling, there are few clouds on the horizon for India. Inflation is high, but falling, and the rupee is one of the strongest currencies in the region, which will be further helped as Indian government bonds are set to be included in global indices next year.   Economic growth - firming, not stalling In the second quarter, India recorded a growth rate of 7.8% YoY, which was a marked increase over the 6.1% rate of growth recorded for the first quarter. This makes India the fastest-growing major economy in the world and leaves growth on track to achieve 7% for the full year. India’s growth momentum is in stark contrast to the rest of the Asia Pacific region, where economic growth is generally slowing – a response to the slowdown in the West, and more importantly in recent months, to the slowdown in China, topped off with weakness in the global semiconductor industry, which is an important driver for many regional economies. Growth is coming mainly from domestic demand and is spearheaded by capital investment. This bodes well for future growth too, with investment likely to raise India’s non-inflationary growth potential. Net exports aren’t helping much, but weaker imports have helped offset falling exports.   Contribution to GDP growth (pp)   Household consumption is also holding up well too, helped by improvements in the labour market, falling unemployment, rising labour participation, and falling inflation. Government spending is not directly adding anything to growth, but as we shall shortly explain, indirectly, targeted spending is helping.   India unemployment rate and labour force

Inclusion of government bonds into global indices to provide further support Along with a consistent inflow of foreign direct investment, the category “other investment,” makes up much of India's financial account inflow. This category is made up mainly of American and global deposit receipts (ADR and GDRs) and shows that overseas equity listings have been a reliable source of foreign exchange receipts over the last 18 months. Portfolio flows have been more erratic, as one would expect, but the direct and “other” investments should be fairly sticky, which is a comfort when a currency is artificially held away from where the market would like to take it for some time, and where the trade picture looks challenged. Looking ahead, the recent announcement that JP Morgan will include Indian government bonds in its Emerging Market Bond Index, from 28 June next year, will support further portfolio inflows. This move has been long-awaited after being delayed several times in recent years. Estimates vary, but substantial inflows of foreign capital of between $25-40bn are thought likely to be attracted to Indian government bonds as a result.  It remains to be seen whether the JP Morgan decision will spur others, such as the FTSE Russell to follow suit. Either way, as well as supporting the INR, the decision should also help to reduce government bond spreads over US Treasuries, and also pass through into lower corporate bond rates.  That said, with US inflation heading lower over the next year and Indian inflation likely to stabilise at something around the 4%-4.5% level, we would expect the INR to eventually resume its trend nominal depreciation at about a 2% annual rate in line with maintaining a stable real exchange rate, after first benefiting in the short term from a shift in market expectations for US Federal Reserve rates to price in more easing in 2024/25.   With the currency currently supported in a narrow range, and not having seen the amount of depreciation evident in other regional currencies, we think that the scope for some INR appreciation when the USD finally does turn weaker is more limited than some other currencies, and we’d expect to see the Australian dollar and Korean won doing better if this turn ever does materialise.   Inflation and the Reserve Bank of India Earlier this year, Indian inflation came down within the RBI’s inflation target range of 2-6% and looked as if there might be scope for policy rate easing before the end of the year. But erratic monsoons have hit agriculture and pushed up seasonal food prices sharply, and that has lifted inflation back above the RBI’s target, though it is beginning to ease lower again now. We expect inflation to keep moving lower over the second half of the year, as the government shields households from rising energy prices, and we could see inflation back within the inflation target as soon as next month, and close to the mid-point of the target with the release of October data.   India's inflation and rates outlook   That will keep real rates elevated and will make a strong case for some reduction in rates in early 2024. At 6.5%, India’s policy rate spread over the US is 100bp, which is helping support the INR. That is a bigger spread than some of its Asian peers. The main risk to our rates outlook is if the US economy continues to defy logic by failing to slow, keeping the USD strong.   India is delivering very solid economic growth currently, and there isn’t much in the current run of data to suggest that this shouldn’t continue to be the case. Inflation has spiked higher and that means that we probably aren’t looking at an immediate easing of policy rates and indeed, this will probably not take place until next year. That said, and notwithstanding what is obviously some direct support for the INR from the Reserve Bank of India, the support for the currency from overseas direct investment and equity listing would probably have seen the INR outperform its peers anyway and will take a further boost from the inclusion of Indian government bonds into global bond indices next year. That also removes an impediment to eventual easing, where some other regional peers are deliberately keeping policy tight despite better inflation credentials to offset currency weakness. 2023 should see the economy return close to a 7% growth rate overall, a return of inflation within the RBI’s target range, and sow the seeds of some policy rate easing in 2024, which will help underpin strong growth for another year.    Summary table

USD ESG bond market to see weaker growth momentum in the wait for policy clarity The year ahead will be an interesting one for the USD ESG bond market, especially in the US. Given uncertain economic conditions and higher-for-longer interest rates keeping borrowing costs high, we expect to see continued caution from issuers. The ongoing anti-ESG movement adds additional complexity. The upcoming presidential election in 2024 could also lead issuers who have been keen for more policy clarity to take a ‘wait and see’ approach until there is higher medium-term ESG policy certainty. Despite these headwinds in the USD ESG bond market, there are also several encouraging factors, such as more clean funding announced and more tax credits guidelines released under the Inflation Reduction Act (IRA). The markets should see US$240 billion (€225bn equivalent) of green, social, sustainable and sustainability-linked bonds in the US dollar in 2024. Given the complexities of the domestic market, we forecast that USD ESG bond market supply in the US in 2024 will be around US$100 billion, lower than our estimated 2023 level of US$103 billion and the 2022 level of US$110 billion. We expect the majority of USD-denominated ESG bonds to continue to be issued outside of the US and total $140 billion in 2024, higher than the 2023 level of US$137 billion and the 2022 level of US$131 billion. This leads to an estimated US$240 billion globally in USD-denominated ESG bond issuance, at the same level as 2023 and 2022. Much of the growth in USD ESG bond supply will be driven by governments. In 2024, we expect USD ESG bonds from governments and US municipals to reach US$125 billion, slightly higher than our 2023 estimate of US$121 billion. Corporates, however, will likely see a decline in issuance volumes to US$49 billion in 2024, down from US$52 billion in 2023 and US$79 billion in 2022. The weaker momentum will likely be observed in both investment grade and high-yield USD ESG bonds. The decline could be higher among corporates within the US jurisdiction than elsewhere. In 2023, the energy sector has been the only sector that has seen USD ESG bond issuance growth compared to last year (albeit at a relatively low absolute volume), partly because the IRA is incentivising more producers from the sector to finance energy transition activities. Nevertheless, in 2024, the potential risks from economic conditions, climate disclosure rule delays, and election uncertainties could soften companies’ determination to issue ESG bonds.   ESG bonds issued in other currencies to slightly expand ESG bonds issued by governments, agencies, banks and corporates in the pound sterling, Japanese yen, Chinese renminbi, Canadian dollar, Swedish krona and other currencies showed robust growth between 2020 and 2022 from €30 billion equivalent to €220 billion. The segment should add another €260bn this year, according to our expectations. China has been one of the leaders in previous years but has lagged behind in 2023 so far. Including China, we forecast the “other currencies” segment to print €270 billion in 2024, showing smaller growth than in earlier years.

Borrowing needs will fall this year, meaning a lower supply of LCY bonds, but there is still a long way to go given the slow fiscal consolidation. Central and Eastern Europe should remain more active in the FX market than pre-Covid, while a busy January and the broadening of funding sources offer flexibility for the rest of the year Borrowing needs this year will be down on last year in the whole CEE region, with the exception of Poland. The decline is due to both lower budget deficits and redemptions. In contrast, in Poland, both have increased year-on-year. Overall, the supply of local currency bonds should fall but remain well above pre-Covid levels. Given lower yields, this supply may prove more difficult to place in the market compared to last year, which saw strong market demand despite record supply. This time is different, and we expect financial markets to be tougher and punish more budget overruns and additional issuance. Local currency issuance: Improvement but still a long way to go From a positioning perspective, we find the Romanian government bond (ROMGBs) market to be overcrowded after the significant inflows last year. On the other hand, the significantly underweight Polish government bond (POLGBs) market should help cover the historically record borrowing needs. Czech government bonds (CZGBs) and Hungarian government bonds (HGBs) remain somewhere in between with steady foreign inflows into the market. On the sovereign ratings side, all the obvious changes happened last year and should stabilise this year with only some adjustments in outlooks in the pipeline, unless a more significant shock arrives. On the local currency supply side, we see a clear improvement from last year in the Czech Republic, as it was a bright spot in the CEE region with credible public finance consolidation. In addition, we see it as the only country in the region with positive risks of a lower supply of CZGBs than the Ministry of Finance indicates. Hungary has also made great progress here, of course, with the traditional broad diversification of funding sources that should keep the pressure off the HGB market in the event of an overshoot of the projected deficit. In contrast, we see only a relatively small improvement in Romania, where the supply of ROMGBs will fall only a little. The supply of Polish government bonds, meanwhile, was already at a record-high last year and is set to rise a little more this year. In addition, the use of additional sources to avoid flooding the local currency bond market will increase significantly, which we believe represents the biggest challenge for the bond market in the CEE region this year.   FX issuance: Fast start and diverse funding sources offer flexibility On the FX side, CEE sovereigns are set to remain active in the Eurobond primary market in 2024 and beyond, with the overall trend driven by recent external shocks from Covid and surging energy prices, along with structural factors such as the energy transition in Europe. A key theme that unites regular issuers Romania, Poland, and Hungary is the diversification of funding sources, with more consistent interest in the US dollar, as well as alternative currencies such as the Japanese yen and Chinese yuan, alongside the more traditional euro for the region. The growing green bond market is also an area of focus, with Hungary leading the way, and Romania set to follow this year. At the same time, 2024 should see some divergence, with Poland taking the lead in the region for Eurobond issuance and set to be one of the largest EM sovereign issuers globally this year. Hungary should see a slight reduction in Eurobond supply compared to recent years, with its strategy of diversifying funding sources and front-loading supply providing plenty of flexibility for the rest of the year. Romania should retain its position as a regular issuer, although net supply will be lower this year, while catching up with Poland and Hungary in terms of diverse funding sources via green issuance and alternative currencies. A strong start to the year, with almost $15bn in issuance for CEE in January so far, should mean less pressure on the region to issue later in the year if market conditions turn.  

Czech National Bank Preview: Time to catch up We expect the pace of cutting to accelerate to 50bp, which will push the CNB key rate to 6.25%. The main reasons will be low inflation in the central bank's new forecast, which should allow for more cutting in the future. For year-end, we see the rate at 4.00% but the risk here is clearly downwards.   Optimistic forecasts could speed up the cutting pace to 50bp The Czech National Bank will meet on Thursday next week and will present its first forecast published this year. We are going into the meeting expecting an acceleration in the cutting pace from 25bp in December to 50bp, which would mean a cut from the current 6.75% to 6.25%. This means a revision in our forecast, which previously saw an acceleration taking place in March. Still, it's certain to be a close call given the cautious approach of the board – and that could bring a 25bp cut.   The board will have a new central bank forecast, which is likely to be a key factor in decision-making. Here we see the need for revision in a few places, but overall everything points in a dovish direction. On the global side, compared to the November forecast, we expect the CNB to revise down both GDP growth, rates and oil prices. On the domestic side, inflation has surprised downwards only slightly in the past three months for both headline and core inflation. Still, we expect some downward profile shift due to a better outlook for food, energy and oil prices. As for GDP, the CNB was the most pessimistic forecaster in the market in November and the incoming data was rather mixed in this regard, so we expect only modest changes here. The CZK was 0.35% stronger than the central bank's expectations in the fourth quarter of last year. On the other hand, it was slightly weaker in January. Overall, we do not see any significant impact on the new forecast here, but the lower EURIBOR profile after the revision may indicate a stronger CZK in the new forecast, or allow for faster rate cuts in the CNB model. The November forecast indicated roughly a 50bp cut in the fourth quarter last year and reaching 3.50% by the end of this year, delivering a total 350bp of rate cuts. As we know, the CNB delivered only 25bp last year, which will need to be reflected in the new forecast. Overall, we expect a slightly steeper rate path again with a 3.00% level at the end of 2025, which should have a dovish outcome for the market in our view. As always these days, we can also expect several alternative scenarios, one of which will be the board's preferred scenario, showing a slightly slower rate cuts profile than the baseline.   Inflation nowcast will be key to the decision We see from public statements that the dovish wing of the board (Frait, Holub) will push for a faster pace of rate cuts given inflation numbers indicating a quick return to the 2% inflation target this year and will be open to more than 50bp of rate cuts. For the rest of the board, we think the inflation indication for January and beyond in the central bank's new forecast is key. We are currently expecting 2.7% for January headline inflation, with room for it to come in lower if the anecdotal evidence of January's repricing is confirmed. This, in our view, will give the rest of the board the confidence to accelerate the pace of cutting as early as this meeting.   4% at the end of the year or lower depending on core inflation Looking forward, we believe the favourable forecast for the coming months will allow the 50bp pace to continue. Here, our forecast remains unchanged and we think core inflation will still prevent the board from going faster later. We therefore still assume a 4% key rate at the end of this year. But if core inflation continues to surprise to the downside, we find it easy to imagine lower levels here.     What to expect in FX and rates markets The CZK has weakened in recent days following comments made by Deputy Governor Jan Frait and touched 24.90 EUR/CZK, which is basically the weakest level since early 2022. If the CNB delivers a 50bp rate cut, it's obviously negative news for the CZK. But on the other hand, we believe that the market positioning is already heavy short and rates are already pricing in the vast majority of CNB rate cuts. That's why we see the cap at 25.20 EUR/CZK. A minor cut, however, could bring a temporary strengthening towards 24.70 given heavy dovish expectations. In our base case scenario, we think that after the 50bp rate cut and January inflation, the market should have hit the limit of what can be priced in and the CZK should start appreciating again later this year thanks to the economic recovery, good current account results and falling EUR rates improving the interest rate differential. The rates market fully priced in a 50bp move recently and expects another 50bp move for the next meeting, which is close to our forecast. However, the terminal rate is already priced in at 3% at the end of this year, which we don't have on paper until next year – but we still see this as a possible scenario if inflation remains under control. If we do see the CNB's forecast, the market can easily get excited for a lower terminal rate and overshoot market pricing. Therefore, we expect the combination of the 50bp cut and the dovish forecast to push market rates further down, resulting in further steepening of the curve. In the bond space, we maintain our positive view here going forward. Czech government bond supply has fallen significantly as we expected and, combined with the inflation profile and central bank cutting rates, offers a perfect combination in the CEE region. Here, we continue to prefer belly curves and see more steepening.