Hungary’s forint and rate cut expectations

December 18, 2012

A rate cut in Hungary is considered a done deal today. But a sharp downward move in the forint  is making future policy outlook a bit more interesting.

The forint fell 1.5 percent against the euro on Monday to the lowest level since July and has lost 2.6 percent this month. Monday’s loss was driven by a rumour that the central bank planned to stop accepting bids for two week T-bills. That would effectively have eliminated the main way investors buy into forint in the short term.   The rumour was denied but the forint continues to weaken.

Analysts are not too worried, attributing it to year-end position squaring. Benoit Anne, head of EM strategy at Societe Generale, points out the forint is the world’s best performing emerging currency of 2012 (up  11.3 percent against the dollar). Given the state of the economy (recession) and falling inflation, the forint move will not deter the central bank from a rate cut, he says.

His counterpart over at Citi, Luis Costa, says cross-currency euro/forint rates were too low anyway to compensate for Hungary’s risks and finds the sell-off unsurprising.  He reckons though that the forint’s weakening is a reality check for people betting on swingeing rate cuts in coming months, because they must now stop and evaluate what currency level could derail the policy easing. (The swaps market is pricing some 100 bps of rate cuts in Hungary over the next 6 months)

There is one more issue — the local bond market which has benefited from the easing expectations. Hungarian yields have fallen more than 200 basis points this year and foreign ownership levels of almost 40 percent are among the highest in emerging local bond markets. That’s not surprising — five-year yields are around 6.2 percent; around 70 basis points higher than the EM average. This trade has been sweetened by the forint’s gains this year but that may not be the case from now on. JPMorgan in a note on Monday predicted the forint would slip to 299 per euro from current levels around 285. Citi’s Costa writes:

A pause on the easing cycle (possible on the back of further collapse in the forint) would cause an abrupt selloff in the front-end of the curve, and a serious flattening in 2 year vs 5-year (swap and bond rates) and 2 vs 10s . The curve is just not prepared for that, as it still prices-in back-to-back policy rate cuts for the next 5 months. In the new scheme of HUF risk, we believe the more dovish the central bank sounds going forward, the more pressure there will be in the forint.

The rate decision will be announced at 1300 GMT.

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