Russia remains a headache for EMEA

If 2013 was a very challenging year for emerging markets, 2014 has been even worse. Two topics have dominated the agenda. First, the continued slowdown in Chinese growth and worries about distress in the Chinese financial system, including troubles for the shadow banking sector. Second, the conflict that ‘came out of nowhere’ – the situation in Ukraine and the resultant conflict between Russia and the West.

Both these factors have already had a very negative impact on wider emerging market sentiment. However, we are also of the view that near-term sentiment is likely to be influenced negatively by this and, therefore, continue to see risk of a further sell-off across emerging market FX, fixed income and equity markets in coming weeks and months.

It is extremely difficult to forecast in any reasonable sense how the geopolitical situation will develop in Eastern Europe. Therefore, our forecasts more or less assume that the present status quo is maintained and there is no major escalation of the Ukraine-Russia conflict. In other words, we expect a ‘geopolitical premium’ to continue in Central and Eastern European markets and believe growth has already been negatively hit – particularly in Russia but also in, for example, the Baltic States and Poland. We think it is likely this will be revealed in macroeconomic data in coming months. This macroeconomic weakness is in itself likely to weigh on CEE markets to some extent in coming months.

CEE3 exposed to further escalation in Ukraine-Russia conflict

Geopolitics has moved to centre stage for the zloty and recently the pressure on the Russian and Ukrainian currencies seems to have spilled over to the zloty. Looking ahead, we believe the zloty could come under further pressure as Eastern European geopolitical tension continues to rise. This said, longer term (six to 12 months), the zloty should stabilise at levels moderately weaker than the present level against the euro. Regarding the HUF, we continue to think that Hungary’s fairly strong external position is likely to be supportive of the forint over the medium term. As a consequence, we could even see the forint strengthen against the euro on a six- to 12-month horizon, while the short-term outlook is likely to be dependent on how the ongoing emerging markets ‘storm’ plays out. The CZK is maintaining the status of the ‘safe haven’ currency in the region; hence, when the risk sentiment turns sour the CZK tends to strengthen and the other way around. We maintain our outlook for the CZK and expect it to weaken on all forecast horizons as we expect the CNB to stay dovish. Nonetheless, we have become less aggressive in our expectation of substantial weakening of the CZK by the central bank.

RUB to stay under pressure

In early 2014, the world has seen how significant, fast and unpredictable changes in geopolitics can be for economies and risky assets. Market expectations that Russian troops will move into Ukraine and that Western nations could impose economic sanctions on Russia are putting pressure on the RUB.