Not every market has the same outlook mid-year

Half of 2009 has passed, and for now it seems that the capital markets have temporarily caught their breath after the horrors of January and February. The current rally, which is now in its fourth month, has pushed the Chicago Board Options Exchange volatility index, the VIX, back down to below 25.66 points, which is where it stood before the Lehman Brothers meltdown, the greatest bankruptcy of all time. The index, which in the past few days closed at as low as 25.33 points, has fallen 69% from its October peak, and 37% since the beginning of the year. Nevertheless, the current level is still high, at well over the 20 points that can be regarded as average. Investors are not entirely certain that there will be no more bad developments; they merely suspect that we are over the worst, but the majority remain uncertain about the likely speed of the recovery. And this uncertainty is understandable in the light of the events that have followed similar VIX levels in the past. In 1998 the “fear barometer” plunged to 25.95 points, then over the next two-and-a-half months, as a result of the Russian crisis and the collapse of U.S. hedge fund Long-Term Capital Management, the S&P 500 index fell 11%. At the end of March 2000 the volatility index stood at 25.47 points, following which the bursting of the dot.com bubble (exacerbated by the 2001 terror attacks) sent the bear market into freefall, plummeting 49% by autumn 2002. From then on, a rise of around 20% up to the end of the year was followed by another 15% fall, lasting until spring 2003, and only then was the way clear for a bull market that lasted four years. Another, similarly important gauge of sentiment, the equity put/call ratio, also shows that it is better to err on the side of caution, as after tentatively foraying into “bull” territory, it has today slipped back to the middle of the neutral zone.

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On 2 July the State Debt Management Centre (ÁKK) sold HUF 41.5 billion in 3, 5 and 10-year government bonds at single-digit yields. Encouraged by the success of this auction the ÁKK decided to raise the quantity on offer, and two weeks later sold another HUF 85 billion’s worth at even lower yields. Following this, investors also bought a billion euros’ worth of five-year FX bonds from the Hungarian state. The oversubscription of the forint securities by a factor of 2.5-3, coupled with the marked reduction in yields, points to considerable demand potential. In terms of the quantities sold, if lots of this size were “snapped up” every two weeks, we wouldn’t be so far off the issued volumes of the last precrisis year of 2007. If the sales continue with the most recently announced items (also taking into account the 40% non-competitive issue opportunity), an annual gross bond issue of over HUF 2,000 billion is within reach, and there is a realistic chance that the state will be capable of financing itself without the need to draw down any more IMF funds. (This, of course, does not necessarily mean another, smaller standby loan won’t be necessary at a later date, in order to perpetuate the credit already utilised).

With regard to the structure of the bond issues, events have taken a positive turn (the State Debt Management Centre is correctly making an effort to sell higher volumes at the shorter maturities); however there is still room for improvement, as investors in the MAX reference index need to buy three times as many three-year papers than ten-year ones (and twice as many five-year bonds than ten-year ones) in order to maintain their risk in line with that of the index. Besides this, it is also in the best interests of the state to avoid, as far as it can, continuing to rack up debt at the still-high forward interest rates of over 8%. Another important lesson of the recent period is that the country’s improving credit risk rating is both a cause and a consequence of the decline in distant forwards, and the flattening of the yield curve. Regardless of which came first in this chicken-and-egg scenario, it is now advisable to concentrate bond issues on the shorter maturities, which is precisely what all debt managers are doing, both locally and in the broader region.

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