- We have been positive on the Czech Republic since the beginning of August via FX unhedged long CZGBs. The main reason for our bullish stance was the regional safe heaven status and very solid fundamental backdrop. Moreover non-resident inflow into the Czech bond market has been significantly less in the past 2years than into other CEEMEA markets (see chart) and in time of significant outflows from the EM bond funds this provides an important cushion. This structurally supportive outlook however does not change the fact that the Czech economy is highly cyclical.
- Recent real economic data shows that the Czech economy is slowing: Data published this morning for August showed that industrial production slowed to 3.5% yoy from 6.8% yoy in WDA terms which is the weakest number since Dec 2009. The mom seasonally adjusted IndOut slowed by 0.6% and the 3m/3m SA index slipped into negative territory for the first time since mid 2009. The August trade balance data was also worse than expected primarily due to worse than expected export performance. The yoy export slowed to 8.4% yoy from 11% yoy while the seasonally adjusted 3m/3m export growth dipped into negative territory. Looking at higher frequency data (PMI slowed to 52.3 in September from 53.4) and market indicators suggest that more slowdown should be expected in the coming months. Mapping simply the GS wavefrront EU cyclical vs. defensive stock relative performance index versus the Czech Industrial production suggest that the 3m/3m SA industrial production data will likely move further into the negative territory in the coming months. Given the Czech Republic is the most open economy in CEEMEA this is not surprising at all.
- If we map EUR/CZK versus the Industrial production data one can notice that Czech monetary conditions are relatively tight particularly if the slowdown continues. This is perfectly in line with the recent dovish stance of the CNB. As a reminder the CNB in the last inflation report assumed 2.2% yoy GDP growth for 2012 and 23.1 EUR/CZK average rate. We currently forecast only 1.6% GDP.
- Bottom line: from structural perspective and given the Czech bond market is much less exposed to potential non-resident outflows than several other markets we think Czech safe heaven status clearly remains in place on a multi month horizon as well. On the other hand given the clear signs of economic slowdown and relatively tight monetary conditions vs. the current status of the business cycle we believe this could disproportionally support rates over FX. Against this backdrop we recommend closing our short EUR/CZK recommendation (with about 0.7% loss). For leveraged investors without exposure in the CZGB market we see logic in adding a long EUR/CZK at current levels. We set a target at 26.00 and stop loss at 24.00.
Click here to read the full report:
http://www.easyforexnews.net/wp-content/uploads/2011/10/EEMEA_Strategy_2_07Oct11.pdf
Gyula Toth
UniCredit Research