Macro outlook: The past quarter has taught us the perils of post crisis consolidation against a backdrop of elevated debt levels. Aftershocks are unavoidable. In line with a reduction in our growth outlook for the US and EMU, we are marking down our growth forecasts for CEE for this year and next. Following a mixed Q2, we expect H2-11 to be soft, with a gradual recovery over 2012. A number of factors dissuade us from pencilling in a contraction in economic activity. A run down of inventories is much less of a risk this time around, wide C/A deficits have corrected themselves in most countries, lower inflation should boost real consumer purchasing power while at least some of the work on fiscal consolidation has already been done. That said we are revising our forecasts at a time of market stress, with the ultimate impact uncertain. We monitor three sets of data in particular, namely industrial production, short term portfolio flows and bank funding to assess ongoing macro pressures. In this environment, most central banks in the region are likely to keep rates on hold, but with a bias to cut rather than hike. Hungary is the exception. More broadly the current macro environment highlights the need for policy vigilence. Examining FX reserve coverage of short term inflows, some central banks would benefit from new insurance. Greater macro volatility translates greater FX volatility but ultimately central banks will benefit from having more ammuntion to hand to protect against excessive currency shifts in either direction.
FI/FX/Sovereign credit strategy: We believe CEEMEA FI/FX markets are anticipating a challenging quarter and hence it is becoming increasing difficult to achieve positive returns with an outright bullish bias. As a first step we have identified FX trades, which should benefit from the volatile trading environment and potential appreciation pressure on the USD. We believe the CZK is set to benefit from its regional safe haven status and that the TRY is set to outperform CEE currencies. Within CEE we recommend going long PLN vs. HUF. We are neutral on RUB and RON whilst we recommend reducing KZT positions. For local currency bond markets we conclude that selected local currency bond positions would likely show a positive return despite the already a strong performance YTD. We see FX hedged POLGBs, currency unhedged CZGBs and currency unhedged TURKGBs to post positive returns in 4Q. We are underweight HGB and marketweight in the other countries. We see limited scope for outright sovereign credit spread tightening in 4Q. Due to valuation and potential supply pressure we recommend short positions in Rephun and Ukraine vs. CDS. On the back of light positioning and significant underperformance already we recommend O/W Turkey and sell Turkey 5y CDS vs. Sovx CEEMEA. We identified two bearish trades (pay 2y HUF IRS and pay 2y RUB CCS) which are cheap compared to the potential risks.
Corporate credit strategy: We maintain a defensive view on corporate credit in the region. The latest earnings season revealed positive fundamentals, characterised by robust profitability and develeraging but we are unconvinced on a scenario of a lasting decoupling from the EMU sovereign crisis. Against continued EMU uncertainty, we maintain a cautious allocation, with a preference for high grade liquid names.
CEE equities: The risk of a weak patch in commodity prices suggests to us that investors should be neutral Russia, with the market very dependent on commodity prices (both earnings and multiples in Russia are influenced one way or another by commodities). With earnings downgraded and now looking more realistic and the equity market having de-rated, we upgrade Turkey to overweight. We see Poland as relatively resilient; growth is still good, the economy is less dependent on exports and the government has been starting to rein in the budget deficit even ahead of the October elections (although given the debt cap the need for budget discipline could limit the scope for a counter-cyclical fiscal policy). The Czech Republic, the region’s traditional safe haven, has this month been upgraded by S&P and would be defensive in any further sell-off. Sector-wise, we believe it is too late to go strongly defensive. We have recommended that investors to be fully weighted in defensives all year, a call that has been more cautious than the consensus. We continue to advise being neutral defensives versus cyclicals, with a full weighting in telecoms, oils and domestic exposure over exporters.
Click here to read the full report (analysis on 17 countries within CEE):
http://www.easyforexnews.net/wp-content/uploads/2011/09/CEEQuarterly4Q_Final1.pdf
UniCredit Research
UniCredit Corporate & Investment Banking