markets and we therefore recommend taking off some risk from the books and reducing exposure to the EMEA FX markets. Most at risk according to the Scorecard are the Hungarian forint and the South African rand.
Why has the EMEA FX Scorecard turned negative?
1) Carry protection is disappearing. As we stated in New Europe Weekly published on Friday markets have aggressively been pricing rate cuts across the EMEA region recently. Hence, investors are no longer being paid any significant carry to be long in any of the EMEA currencies.
2) Technical factors are turning negative. The technical score in our Scorecard is turning negative for a number of currencies as key technical levels have been broken and are weaker than or close to key moving averages for a number of the EMEA currencies. EUR/PLN, EUR/CZK, USD/TRY and USD/ZAR have all moved higher than their 20 and 50-day moving averages and EUR/HUF is closing in on the 50-day moving average as well. EUR/CZK is moving closer to the 200 days
3) Global conditions turning less supportive. Even though our score for global economic and financial conditions remains positive for all EMEA currencies, the signs of softness in the US stock markets are reducing these scores. Furthermore, US government bond yields have been inching upward recently, which reduces the support for risk assets like EMEA currencies. That said, it should be noted that global macro conditions remain supportive for the EMEA FX markets.
Additional warning signs
It is not only our EMEA FX Scorecard that indicates that we could be in for a correction in the EMEA currencies markets. We especially note increasing concerns about Ukraine’s, Romania’s and Latvia’s IMF deals. In all three countries the relationship with the IMF is under pressure due to political turmoil and uncertainties and the IMF might be forced to pull the plug on one or more of these countries. For now at least it looks very likely that the IMF will decide to postpone the pay-out of the next tranches to Ukraine and Romania due to political uncertainties in these countries. Looking further ahead, some investors might begin to worry about the political situation
across the region as elections in a number of Central and Eastern European countries are on the cards in 2010. We however want to stress that the short-term (1-2 months) political risks does not seem to be elevated – in other countries than the three mentioned above.
Over the last couple of days there have been some signs that the markets are losing some appetite for EMEA assets. Most notably we have seen Turkish yields and rates increase quite a bit and yesterday a Romania government bond auction failed.
Small or large correction?
If one trusts our EMEA FX Scorecard – and we do – then there is reason to believe that we are getting closer to a correction in the EMEA FX markets and the region’s currencies might come under some pressure.
The question is whether the expected correction will be large or small. Our EMEA FX Scorecard does not provide an answer as it is designed to be directional. There are certainly reasons to argue that the possible correction will only be minor and should not worry long-term investors. The recovery in the global economy seems to continue and overall the markets are still afloat in liquidity.
However, it could also be argued that the correction in the EMEA FX markets will be large due to a string of worries about the situation in especially Central and Eastern Europe – most notably a fragile recovery, continued serious worries about the health of the CEE banking sector and finally rising concern about the political situation across the region.
We leave it up to investors to decide whether this will be a small or a large correction, but for now we will trust the signals from the Scorecard and recommend being positioned for weakness in the EMEA currencies, especially the currencies that scores most negatively on the Scorecard: HUF and ZAR. Given the fact that we expect the correction in the EMEA currencies to be broad based, it is hard to see any “safe havens” in the region.
However, our Scorecard is still in positive territory for the Polish zloty, which justifies being at least overweight in the zloty relative to the other currencies in the region. The only problem with this strategy is that the zloty has often been used as a proxy trade for the entire region. Therefore, if investors exit long positions in the region, it is hard to believe that the zloty will avoid coming under pressure.
