CEE currencies mostly stronger due to decline in risk aversion

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Currencies: CEE currencies mostly stronger due to decline in risk aversion
Fixed Income: Czech bonds in wait and see mode ahead of Thursday CPI figures

Currencies

The Polish zloty got off to a volatile start of the week with the EUR/PLN trading in the 4.0850-4.1550 range. The return of US players to the market was clearly positive for the unit early in the afternoon, as the pair headed down from daily highs to the bottom of the most wider range at 4.08 in late evening trade. If the zloty breaks higher past this point, we could see the pair attempt an attack on EUR/PLN 4.0. Otherwise more volatile trade in the 4.08-4.20 range can be expected as liquidity conditions gradually return to normal in the wake of the holiday season.

The Hungarian forint started the year in a quiet mood and the pair remained within the range of 265 and 268, which market set up in mid-December. The Central bank held a non-rate setting meeting and some market participants highlighted the possibility of another extraordinary 50bp rate reduction, similarly to what we saw in December. However, the Council said that rates were not discussed on yesterday’s event. The governor gave an interview to Reuters and concluded that they are willing to reduce interest rates as fast as possible. The inflation outlook would warrant a significantly lower level, but they would not want to jeopardize the stability of the market.

This could mean that central bank will balance between these two considerations and could therefore continue to meet market’s demand for gradual, but continuous rate cuts this year. The FRA market is looking for an additional 250-300bps rate reduction by around August-September, so almost every month we may see a 50bp rate cut. The currency remained unaffected by this news, while its stability in the last two weeks could open up the possibility of a start of a new trend, although the forint may wait for other major emerging currencies like the PLN or the BRL to find direction.

The Czech koruna started this week optimistically, as it firmed during yesterday’s session from the opening values around 26.80 to 26.45 EUR/CZK. It seems that risk aversion fell with the beginning of the new year. Nevertheless we believe that the mood can change quite soon with new data coming from the domestic scene (CPI on Friday) as well as employment data from the US. Today there are no Czech data scheduled for release thus regional sentiment will be crucial for the Czech koruna. We believe that although optimism should not last for long, it should persist for today and the koruna might extend yesterday’s gains.

Fixed income

Aggressive rate cut expectations along with the slightly stronger liquidity conditions have continued to fuel the end-of-year rally in the Polish bond market. Asset swap spreads have contracted only marginally though and interbank lending rates remain elevated, which reflects the ongoing reluctance of financial institutions to use up excess liquidity. In both cases we should see slow improvement as the MPC continues to cut rates, but for a deeper drop global liquidity conditions will have to improve massively. The week is empty in terms of data releases so core market data and rate setter comments might get some attention. Along with the decision to cut rates by 75 bp in December the latter have recently given a clear cut picture of Polish official interest rates heading from 5.0% currently, to at least 3.5% before the end of Q1. The softening growth outlook and the lack of significant inflation threats seems to support the need for an even more aggressive easing cycle. For now however, in the baseline scenario we see the bottom at 3.5%, with 50 bp cuts likely in January, February and March. As such, even given the liquidity considerations at hand, bond yields in the range between 5.2-5.4% seem unsustainably high in the medium run.

The Hungarian bond market began the year in a lackluster mode as foreign investors are still very cautious after dumping some Ft1trn of bonds in the October- November period. Yields are stable around the 9-9.5% range in the most active midyear segment of 3- and 5-year bonds and local institutional investors may continue to present some demand for the markets as insurance and pension funds receive regular payments.

Yesterday, Czech government bond yields fell both at the short and long end of the yield curve, while the middle segment went in the opposite direction. However trading volumes were still negligible. We expect that the Czech bond market will gradually return to normal trading during this week. Due to the expectations of further easing of monetary policy we see the space for yields to go towards lower values. Nevertheless, the market may stay in a wait and see mode ahead of Thursday CPI figures.

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