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Czech koruna: The direction of the Czech koruna is still uncertain. On Monday attention was focussed on euro strength against the dollar. The European currency rallied to Eu91.75/$, increasing the pressure on the koruna, which weakened as far as Ck30.68/Eu.
But over the week the koruna bounced back to levels around Ck30.30/Eu, leaving the impression it would strengthen further.
Industrial output in March rose by 4.1% year-on-year, which was substantially stronger than expectations of a 2.5% increase. Although this was surprising, even more so because of the strength of the koruna during March, the reaction in the bond market was muted.
Obviously recent koruna weakness will help further growth, and this should have initiated some profit-taking, especially as some locals awaited further cuts. In addition, the likelihood of interventions, verbal or physical, is high, as a pre-emptive move would catch the koruna before it builds up momentum again.
However, bonds surprised, with absolute and relative outperformance in yields again. February 2003 to April 2010 government bonds trade well below Bunds, some by as much as 20bp. Although Fitch affirmed the Czech republic's BBB+ long term foreign currency rating, these levels are far too tight from a relative value point of view.
Unfilled demand in the two year auction proved again how desperately domestic liquidity is seeking investment. Nevertheless, the 20bp spread through Bunds remains questionable.
Local participants are already preparing a more defensive strategy, as implied by the increased issuance of short term bonds and FRNs.
Hungarian forint: The week started on a less negative note after last Thursday's (May 9) modest auction tender announcements. It was followed by some upside in bonds, as the market was no longer worried about this week's supply.
Rumours that the Socialists were prepared to scale back planned infrastructure spending also encouraged the market to calm down.
Last week's NBH warning over growing inflation seemed forgotten until Tuesday's release of April CPI. An increase of 6.1% year on year, when 5.7% was expected, reversed the trend fall, and initiated strong selling across the curve again.
Bond yields rose as much as 30bp in the weakest trading session of the year, followed by more yield upside in subsequent sessions.
There was some light bottom-fishing, but the overall negative sentiment could not be turned until late yesterday (Thursday), when the curve rallied strongly to recover most of its losses.
FRAs implied nearly 50bp of rate cuts a few weeks ago, but now many participants fear the NBH might raise interest rates to prevent further deterioration in the inflation trend.
Yesterday's bond auction did not help clarify further direction, as bids came in on the high side of expectations, with an uptake of 160% in H05s and 235% in D07s.
This contrasted with yields that had risen nearly 60bp at the short end, 90bp in medium, and up to 35bp in long maturities, before sentiment reversed in the afternoon session yesterday. Obviously medium maturities suffered most, as the long end is covered mainly by buy and hold investors.
The currency itself looks relatively solid, as it did not suffer too much in the recent turmoil, despite the zloty's heavy beating. Analysts believe that the forint is undervalued, and as long as buy and hold money in bonds does not get scared off, the currency should perform further.
On bonds, there is good value developing in medium maturities, as they look cheap after the recent weakness.
But there is still a probability of another rate cut over the next month, if and when CPI calms down. The Monetary Council meets on Tuesday again, and will hopefully comment on the recent weakness.
Polish zloty: The week started as last week ended - ongoing comments by Polish finance minister Marek Belka reiterating that the zloty is overvalued.
He stressed the point by saying the government intends to talk to the NBP, implying a return to a managed float again, if the MPC does not see any room for rate cuts.
Additionally, other politicians stepped into this anti-zloty rhetoric, admitting that the government is in serious discussions about changing the FX regime to control the zloty, while calling for rate cuts and FX interventions.
The NBP's Boguslaw Grabowski stated that, "interventions at present were not acceptable," and would be like, "standing in front of a train," because they are "costly and ineffective".
Other NBP members criticised the government for campaigning in the media, rather than approaching the central bank directly.
Nevertheless, it is estimated an exchange rate policy change would probably take the government at least several months to implement, while the impact on relations with the EU would have to be monitored closely.
The overall belief is that the situation points towards an ERM II style band, with generous ±15% bands, among the many legally possible scenarios.
Yesterday, the MPC arranged an extraordinary meeting to discuss the situation, while the government gave an assurance that it will seek an agreement with the central bank not threatening to its independence.
Although this was a positive move, the whole situation is dubious, creating even more volatility, with the zloty trading as low as Z3.76/Eu and Z4.13/$. One has to expect the market to remain nervous while uncertainty persists.
On the other hand, bonds suffered only marginally into the political row at the beginning of the week. Later anticipation of possible further rate cuts initiated both foreign and domestic buying.
Additional support came from April inflation, falling to 3% year on year (3.3% in March), which was at the bottom end of expectations, and the lowest since the fall of communism in 1989.
Although the budget deficit figure for January-April implied reduced government supply in the second half (nearly 50% of the annual target, versus 57% this time last year), the central bank has cited loose fiscal policy, which could result in higher inflation later this year.
April unemployment figures fell slightly to 17.8% from a record high in March of 18.1%, still hovering at politically unacceptable levels. These data support the view that there is scope for a rate cut of at least 50bp in May or June.
The recommended strategy is to maintain a position in the middle of the curve (2005-2007) into currency weakness and possible post-rate cut curve disinversion.