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Short Czech bond yields on slow march up to zero after crown float
April 7, 2017 / 3:24 PM / 5 months ago

Short Czech bond yields on slow march up to zero after crown float

* Czech c.bank scrapped FX cap this week

* Investor bets had positioned heavily in bonds

* Could take months for shorter yields to get above zero

* Local funds waiting for yields to normalise

* Graphic on crown, interventions: tmsnrt.rs/2jipWYu

By Jason Hovet

PRAGUE, April 7 (Reuters) - Czech short-dated bond yields may have jumped when the central bank scrapped its currency cap but they are unlikely to get above zero anytime soon as the market remains awash with crowns and investors are awaiting stronger FX levels to cash out bets.

The Czech National Bank abandoned a cap on the currency on Thursday, letting the crown float freely. That prompted some investors to start unwinding positions betting on a stronger crown estimated by some analysts at up to 60 billion euros.

The spot market reaction has been muted, with the crown only firming 1.7 percent past its former cap to 26.57 per euro. The bank had weakened the crown by more than 5 percent when it launched interventions to support the cap in 2013.

Foreign investors started betting heavily on the crown in mid-2016, raising flows into Czech bonds and pushing shorter-term yields deep below zero.

That pushed out local investment funds that had long been big buyers of state debt but which could not make negative yields profitable with cheap financing through FX swaps.

While some foreign players have cashed in bets, dealers say more are holding their positions and waiting for the crown to strengthen. “There is still a big chunk of crowns lying around,” one dealer said.

An illiquid bond market is also a disincentive.

“We have not seen any strong buyers nor sellers. (Investors) may prefer to stay in the yield they locked up because liquidity on the bond market is pretty poor at the moment,” Komercni Banka trader Dalimil Vyskovsky said. “I am not expecting yields to turn too positive anytime soon.”

Local investment funds which left the short-term debt market as yields sank past zero are expecting much the same.

Foreign accounts held 42 percent of about 1.4 trillion crowns ($55.98 billion) of Czech domestic bonds in February, double the proportion at the end of 2015.

The yield on the two-year bond , which fell to -0.83 percent in January, has risen more than 20 basis points since the cap exit and hit an eight-month high of -0.02 percent on Friday.

It was later bid at -0.066 percent but with a big gap to offers of -0.329, showing little interest on either side.

CAUTIOUS APPROACH

While sellers are reluctant, the market also lacks demand.

“We will apply a quite cautious approach and not be in a hurry to get back into the local market,” said Martin Rezac, the head of Erste Asset Management’s Czech branch, which manages 190 billion crowns. “There will be (market) volatility even if it is muted now ... It still may take months for yields to normalise.”

Rezac said his funds had sold out of short-term durations in the last two quarters and cut their share of Czech government bonds, shifting largely to cash and also some high-grade bonds.

Two other fund managers told Reuters they were underweight Czech debt.

“We have moved out of Czech government bonds and are just mostly in cash and other stuff. It is nonsense for us to buy bonds with negative yields,” said one portfolio manager, who asked not to be named.

Yields will eventually normalise, with investors focusing on how soon the central bank might raise its key two-week repo rate, at 0.05 percent since 2012.

Supply pressures are unlikely to be a factor as the finance ministry has issued lots of short-dated paper in recent years to take advantage of negative yields, effectively getting investors to pay to lend the state money.

Since August 2015 it has issued around 247 billion crowns ($9.90 billion) of bonds with yields below zero, or two-thirds of total issuance in that period.

The ministry’s average debt maturity dropped to 5.0 years at the end of 2016, from 5.5 three years earlier.

$1 = 25.0070 Czech crowns Editing by Jan Lopatka and Catherine Evans

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