CEE Macroeconomic and Fixed Income Research

Analysts’ view

HR FX: As the EURHRK exchange rate hit the 7.715 mark yesterday, the HNB decided to step in to tame the pressure on the HRK by selling EUR 326.2 m all the way down to 7.698. The seasonal footprint and uncertainty about how the government will handle the CHF malaise triggered the weakening in the HRK (markets are waiting to hear if the government will opt for LCY or a EUR-linked conversion; the latter is obviously by far a less stressful scenario for FX reserves). The HNB acted swiftly and aggressively, certainly aiming to deliver a clear message. Signals about which direction the government might be heading is expected to drive developments going forwardand we reiterate our view that the LCY conversion is still an unlikely option and keep our forecast of EURHRK around 7.70-7.75 in 1Q15.

RO Bonds: Abundant liquidity coupled with solid investor demand in the local fixed income market allowed the MinFin to raise RON 800 m in T-bills maturing December 2015. The ministry stuck to its issuance target so heavy bidding from investors (1.9 times greater than the actual allocation) pushed the average yield down to 1.36% (vs 1.6% at a similar tender held in mid- December). The recent ECB announcement of full-scale QE and prospective spill-over effects in the region have led us to lower the year-end forecast for 5- year ROMGB yields to 2.3%.

PL Rates: Yesterday’s MPC minutes reveal that the major concern for the MPC is not ongoing deflation but the increased volatility on the FX market. The former, however, does still seem to be a concern as the inflation rate is expected to remain in negative territory for longer. That should convince swing members to vote for a cut. It was also suggested though that a better assessment would be possible after the ECB meeting and the new inflation and growth projection. Both events make the cut more probable and support the bond market (our forecast is for a 10Y yield at 2.15% at the end of 1Q15). ECB’s QE, as expected, strengthened the zloty which supports our scenario of further appreciation toward 4.17 in mid-2015.

Traders’ Comments:

CEE Fixed Income: The immediate market reaction to the ECBs QE announcement was a textbook combination of higher equities, lower yields, tighter yield spreads vs Bunds and a weaker EUR as investors go down the path of least resistance. The critical thing to watch, however, is the shape of the yield curve which flattened. A flatter yield curve is indicative of lower inflation and growth prospects going forwards and this is not the aim of QE.
The big beneficiaries in our region were Poland and Hungary but the strengthening in their respective currencies creates a quandary for policymakers which will force the respective central banks to cut rates. A combination of a stronger currency and higher bond prices will be a bonanza for financial market investors but policymakers will be hoping that as the ECB crowds out investors from Eurozone government bonds, the flattening it has caused is purely technical and not a fundamental signal that QE is futile. The ECB is engaging in a currency war and it will be interesting to see how other central banks will react given that the SNB surprisingly capitulated and Denmark has been forced to cut deposit rates to -0.35%. The knock-on effects are visibly being felt in Croatia as the country grapples with consumers CHF loan exposure and, subsequently, by the banks active in that market. Europe is highly dependent on solid banks for growth so comments like the one from Polish Finance Minister Mateusz Szczurek in Davos yesterday where he remarked that banks should offer CHF borrowers negative interest rates or “the political pressure, the social pressure to change the model toward Serb, Croat or Hungarian solutions will be greater” sound like an ominous threat. Banks are already roiling from increasing NPLs and falling net interest income, so if the cost of credit should really become negative it’s difficult to imagine where future growth will come from. Austrian bank bonds were better bid but there was an evident dearth of real money accounts involved in the buying in spite of the rally in bank equities. Sub debt remains unloved even at yield levels of 10%.