Czechs on the way to political compromise

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Currencies: Czechs on the way to political compromise
Fixed Income: Hungary downgraded by Moody’s

Hungary

Moody’s followed S&P yesterday and downgraded the country’s sovereign rating to Baa1 from A3 and kept the negative outlook. The Hungarian forint tried to weaken to 310 on the back of the announcement, but the better regional sentiment helped it to maintain its level around 308.

The 4th quarter current account data were bigger-than-expected at €2.5bn and the full-year gap was also wide at 8.6% of GDP. The external gap was thus widening in the second half of 2008 despite the government was able to cut the budget deficit to 3.4% of GDP. Private sector borrowing was so large that it counterbalanced the narrowing budget gap and lead to a wider overall financing need of the country. This however does not change much on the outlook because the household sector has basically stopped borrowing in euro in recent months, which will improve the country’s saving rate significantly and eventually lower the external gap.

The short-term outlook is neutral for the currency and market participants seem to wait on the sideline before the new government is sworn in, while the medium-term outlook could be more positive if upcoming inflation news will show that the current level of the exchange rate is too weak.

The Hungarian bond market had another bad day with yields rocketing up by as much as 50bps. The whole curve shifted higher and investors seem to demand these higher yield levels because of the political uncertainty and fundamental challenges, while authorities have been trying to push down yields via buyback auctions.

The 5y5y forward spread widened to 400bps, close to the historic high level, thus for those who believe that the new package will improve the long-term outlook, long-term bonds may become more attractive again. The 3- and 5-year part of the curve is now yielding about 13%, also close to the historic high levels from March and implying some 130bps rate hike for the next months. Overall, the short-end may remain vulnerable given the rate hike expectations, while the long-end may have reached extreme levels because the market has incorporated lot of bad news, so some may consider the current levels around 12% as attractive.

Czech Republic

The Czech koruna posted solid nearly 1% gains on Tuesday. This was mainly due to better sentiment on global equity markets that triggered to move to the EUR/CZK 27.30 level. Nevertheless the gains were still smaller compared to the neighboring zloty and this could have been partly due to continuous political instability in the Czech Republic. This can change in the upcoming sessions as we see some progress in political talks. Leaders of four major democratic parties - ODS, ČSSD, KDU and the Greens - agreed late last night on an interim government and early elections in October. All four parties should nominate people to a 16-member technocratic cabinet. Current PM Topolanek said the current government may remain in place for all of April but definitely should not finish the EU presidency. The opposition leader Paroubek said that a final agreement on the program of the new government, and perhaps the makeup of it, should be ready within a week. It seems to us that the political parties are fortunately hurrying to reach an agreement so that the President Klaus is not the one who chooses the next premier.

The main driver on the Czech FX market should still be the sentiment on the global equity markets. The domestic politics rather contribute to whether the Czech koruna underperforms or outperforms the regional counterparts, notably the Polish zloty.

The Czech yield curve steepened in a bearish fashion in soft trading yesterday as yields bounced by 8 bps at the long end of the curve. There were no domestic eco data which could declare price action, but bonds could have suffered because of another downgrade of Hungary’s sovereign ratings. Some prepositioning ahead today’s auction could be another negative factor. Negative regional sentiment could still weigh on Czech bonds despite central bank’s verbal (written) comments, which should show that the Czech macro situation differs much from Hungary’s position. The latest example of such an effort could be an article of CNB Vice Governor Singer in yesterday’s Wall Street Journal.

Today, the main event for the domestic market will be an auction of a 15Y government bond benchmark. The MinFin is ready to issue CZK 8 bn this time. An outcome of the auction is highly uncertain as pervious auctions brought mixed results. We think that even though there could be sufficient demand for the 15Y benchmark, the bids will not be strong and this could send another negative signal to the secondary market.

Poland

The Polish zloty posted solid gains on Tuesday. The pair is nearly 2% stronger mainly thanks to improving sentiment on global equity markets. The Polish currency managed to ignore the worsening outlook of the World Bank for Polish economy as well as the second downgrade of Hungary in a row. Slightly supportive on the other hand could have been the comments by the Central bank governor Slawomir Skrzypek, who said the easing in the currency was temporary and caused no concerns. Despite yesterdays rally we remain cautious about zloty in the near term as we are still above important 4.60 EUR/PLN and further gains are heavily dependent on the sentiment on the equity markets.

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