Regional bond markets: how big is the liquidity premium?

Gábor Orbán
Macroeconomic analyst and Head of CEE Fixed Income

An important element of the investment process is deciding whether what we’re buying or selling is cheap or expensive. Determining “valuation levels” in the case of bonds usually entails examining a certain premium or other, which means that we attempt to assess prices and yields in the light of the fundamentals, and assume that the fundamentals will change at a slower pace than the prices themselves. For this reason, we usually compare the yield on bonds with swap yields of the same currency and yields on bonds in other similar countries, as well as those of risk-free countries such as Germany. Often the deviation of the yield curve from normal is indicative of a degree of misvaluation, and consequently it is worth paying attention to how spreads between the various maturities, and forwards, develop. The most common cause of misvaluation is a very rapid change in market sentiment or the appearance of significant liquidity premiums, which may come about when substantial lots exchange hands relative to the depth of the market. These anomalies present opportunities particularly for long-term investors.

The ten-year bonds and premiums that we most frequently monitor developed as seen in the graphs below on three Central and East European markets in mid-May…

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