Czech inflation may surprise on the upside

Headlines

Currencies: The CEE currencies profit from stock market rebound
Fixed Income: Czech inflation may surprise on the upside

Currencies

The Hungarian forint finished the week on a positive tone and the EUR/HUF currency pair slipped to 288/€. Industrial production however collapsed in December. The unadjusted annual growth pace was -23.3% Y/Y. The recession could thus be deeper than anticipated until now and a bigger slowdown could mean additional risk for the budget. Government has already revised macro projections and is planning further measures to keep the budget deficit on track to meet the 2.6% of GDP target. A deeper recession could require really painful measures and the market may not react positively to this prospect. In short, we may see a relief rally in the short-term, but this may be followed by renewed weakness once the market realizes that the fiscal challenge has become significantly larger.

The zloty managed to regain its composure after an unconvincing start to the session on Friday, as the EUR/PLN edged back toward the 4.50 mark on the closing. The improvement in risk appetite was at the core of the rebound, as US equity markets rallied on hopes that the stimulus package will be passed in the Senate today before the Obama administration presents the keenly awaited bank bailout plan tomorrow. While technically, we would look for more gains (below EUR/PLN 4.50) before becoming outright zloty positive again, if the improvement in the shaky global/regional sentiment is confirmed, the EUR/PLN might attempt to break out of the recent uptrend. Speculation on the possible intervention talk, partly confirmed by the PM Donald Tusk on Friday evening, might be the decisive argument in support of the until-recently besieged zloty. News that Poland might consider making use of the IMF short term liquidity facility to secure financing for the PLN 40 bn borrowing needs this year, might support the zloty as well. On the downside in a daily perspective though, we see the soft performance in Asian equities, which suggests that the EUR/PLN might consolidate around the 4.55 instead at the start of the week.

The Czech koruna tried to gain further below 27.70 EUR/CZK on Friday. At the beginning of the session, the Czech currency took profit from the news that the Hyundai factory runs at full capacity and that demand for small Skoda cars is growing surprisingly fast. Nevertheless the pair failed to break to stronger levels and gave up some of the gains despite the rally on the equity markets and on the neighboring CEE currencies. Today we believe the Czech koruna could give up some of the recently gained positions. Nevertheless we remain optimistic in a one-week horizon and we believe the pair may test 27.40 EUR/CZK in the near term horizon.

Fixed income

The Hungarian bonds suffered again and yields rose to above the 11% level for the 3- and 5-year maturities. Market has been correcting back to the October-November yield levels as the recent ‘rate cut hype’ disappears and investors are facing the risk of a higher budget deficit due to the deeper recession.
The only good news here is that the 5y5y forward spread over the euro narrowed a bit to 310bp from 320bp. Convergence of long-end forward spreads was the first sign of market stabilisation during previous selloffs, like in 2003 or 2006. This has been usually followed by yield adjustment to higher levels in order to compensate investors for the higher risk, so the bond market may see a volatile period in the coming days, while October record high levels are not too far from here.

Polish bonds, which were reluctant to capitalize on the zloty’s gains last week, might start to catch up with the currency in the days to come. For this to happen, the PLN would have to manage to keep its composure this week, as investors have until now been skeptic on the strength of the most recent rebound in the FX market. The possibility of more FX intervention talk along with the possibility of securing an IMF loan (worth up to USD 10 bn) should be supportive for the fixed income market though, ahead of the barrage of domestic data, starting with the CPI numbers on Friday.

The Czech bond market tracked the sell-of in core bond markets and the whole yield curve moved up more 10 bps. Hence, the fixed income market shrugged off the strengthening of then Czech currency.
Today, the main item for the Czech market will be the January CPI figures. We think that the actual figure could surprise on the upside this time, because of a high contribution of growth of regulated prices. Hence, the domestic bonds might extend their losses, particularly at the front end of the curve.

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