Polish bonds hesitant to follow the zloty higher

Headlines

Currencies: CEE currencies might weaken again at the end of the week
Fixed Income: Polish bonds hesitant to follow the zloty higher

Currencies

The Polish zloty had yet another volatile session on Thursday. The EUR/PLN pair first extended the gains following the government intervention on Wednesday, and then gave back all of the gains late in the session as risk aversion returned to the region and global equity markets struggled to stay above key support levels. The government action seemed effective at first, and while its safe to say that if more EU funds were to finds their way to the market this would have profound impact on the exchange rate, yesterday’s price action suggests that concerns regarding the financial sector and the economy in the region will continue to weigh on the sentiment. This said, volatility is set to remain elevated in the foreseeable future – the PLN might even retest recent highs and intervention could become a real issue again if it does.

The Czech koruna tried to re-gain further below 29.00 and touched 28.53 EUR/CZK in the middle of the session. Nevertheless the spike in global risk aversion pushed the pair back to the 29.00 area. We believe there is space for more weakness of the koruna at the end of the week. First of all the verbal intervention of the Central bank has gone off. Secondly, more importantly, the Czech PM was quoted as saying the Czech Republic might need outside assistance because investors link it to neighboring countries, who are objectively much more hit by the crisis. There was no specification on what kind of assistance and why the Czech Republic may need it, given its solid external balance, very low foreign debt and huge FX reserves. Even though we believe the Czech Republic does not need any assistance (in liquidity terms), the market may react negatively during today’s session.

The Hungarian forint tried to break through the key 300 level, but a worsening global backdrop made it more difficult in the afternoon and at the end of the day, the market closed just below this important level. Some London banks have also started to change to a less pessimistic tone and suggested profit-taking on CEE currency short positions. Monday’s central bank meeting will be the next key issue as the market is looking for 50-75bps hike for the next 3-6 months, while analysts expect no change. Inflation is low, but financial stability is a concern, thereby strong arguments could be formulated with respect to both and weighing all factors could be a complex issue. We would welcome a more hawkish tone from MNB, but the council has a relatively dovish track record, which will make the current situation highly uncertain.

Fixed income

Economic evidence is compelling for a rate cut in Poland already this month. Yesterday’s IP reading confirmed that the activity in the sector had fallen off a cliff in January – headline output was down by 14.9% y/y, with production in export related industries down by 30-40% y/y. Meanwhile yields remain elevated as the market still puts the verdict at no-change, largely due to the weak zloty and concerns regarding the refinancing capabilities. While the risks are for a weaker currency in the run up to next week’s meeting, we think there is a decent chance that the MPC will at least go for a 25 bp cut in light of the revised (and most likely extremely weak) staff inflation and growth projection and the softer than expected hard data already flowing in from the economy. Were the PLN to head higher again, a 50 bp hike would again become a real option. In any case the vote will again be a close call this month, given that already in December (and most likely also in January) the result was 5-5 with the chairman’s vote tipping the scale toward a 75 bp move lower. Regarding today’s trading the zloty will be eyed closely, which means we could see bonds shed the most recent gains ahead of the weekend.

Czech bonds tracked the eurozone bond market lower no matter that the koruna firmed significantly. Particularly, the short end of the curve went up (by around 10 bps), which is clearly a result of hawkish comments of CNB Vice governor Singer, who defended the currency by threatening the market with rate hikes.
Since, the S&P index has now entered a critical technical support area (790-741) which if lost, would signal the market is making itself up for a depression. This will not be positive environment for Czech bonds. So, we can expect ongoing pressure on CE currencies (including the koruna), which will push Czech yields higher since the natural defence against this contagion means higher (official) rates. Interestingly, the yield of the 10Y benchmark will probably break above the 5.0 level, which might become attractive for domestic pension funds.

The Hungarian bond had market performed well as usual with the currency and record high yield levels above 14% have started to disappear. The 5y5y forward spread also narrowed back to below 400bp, but investors are still widely concerned about the sustainability of Hungary’s macro path.

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