Morning Note /

EMEA Daily: Market sentiment weakens as investors digest Ukraine developments

  • Developments in Ukraine steal spotlight from economic data releases in EMEA

  • Terms of trade in focus as commodities soar

  • Bond markets mixed amid concerns over global stagflationary pressures

Danny Greeff
Danny Greeff

Financial Market Analyst

Daron Hendricks
Edmond Muzinda
Takudzwa Ndawona
ETM Analytics
4 March 2022
Published byETM Analytics

Market sentiment weakens as investors digest Ukraine developments

Talking Points: Developments in Ukraine steal spotlight from economic data releases in EMEA  

South Africa: The economy-wide Standard Bank PMI was unchanged in February, coming in at 50.9. The reading bettered consensus expectations of a decline to 50.3 and pointed to a marginal improvement in operating conditions across the private sector. Survey results show that three of the five sub-components of the index had a positive influence, namely output, new orders and supplier's delivery times. The uplift in sales was the strongest recorded since May last year, despite being muted by export weakness and supply-side challenges. Meanwhile, employment fell for the third straight month while cost pressures remained severe, which led firms to mark up their output charges to the greatest extent for nine months. Encouragingly, the outlook for future activity remained bright, as firmed hoped that the effect of the pandemic would ease over the course of the year. Beyond the pandemic, it is worth noting that there are still lingering risks stemming from the global raw material shortages, higher energy and logistical costs, high unemployment, and structural challenges that could hinder the pace of recovery in the private economy.

Turkey: Data released yesterday showed that consumer price inflation surprised to the upside, coming in at 54.44% y/y for February compared with 48.69%. The latest CPI reading surpassed market expectations of a less pronounced increase to 52.50%, estimated by economists surveyed by Bloomberg. This price growth surge was mainly driven by the weak lira and rising food and energy costs. Supply-side pressures are also contributing significantly to the broader price growth. In February, PPI accelerated to 105.01% y/y versus 93.53% y/y in the trailing month. The continued price growth bodes ill for President Erdogan's re-election bid next year as the cost of living crisis drains some of his support.

Russia: Russian Foreign Minister Sergei Lavrov has said that he believed some foreign leaders were preparing for war against Russia and that Moscow would press on with its military operation in Ukraine until "the end". However, Lavrov assured the world that Russia had no thoughts of using its nuclear capabilities in this war. He added that he believed a solution to the crisis in Ukraine would be found with a new round of talks between Russian and Ukrainian officials set to begin, but said that Russia's dialogue with the West must be based on mutual respect as he accused NATO of seeking to maintain supremacy.

On the ground, the latest news out of Ukraine is that Russian forces have attacked the Zaporizhzhia power station, which is Europe's largest nuclear power plant. The attack on the nuclear station threatens the whole of Europe, just as Chernobyl did, and is therefore being carefully monitored. However, note that US Energy Secretary Granholm indicated that the reactors "are protected by robust containment structures, and reactors are being safely shut down," while Ukrainian officials have also indicated that the plant is secure for now. Nevertheless, the threat to the power station has weighed on financial market sentiment overnight, with tensions running high as ever. 

Hungary: The head of the Prime Minister's Office, Gergely Gulyas, was on the wires yesterday announcing that Hungary will remove the majority of its lockdown restrictions as the fifth wave of the pandemic appears to be coming to an end. The government will do away with the obligation to wear a mask as of next week Monday, except in social and health care institutions. In addition, the government revoked the rule that allowed employers to make vaccination against COVID-19 compulsory and regulation concerning the vaccination certificate will also be cancelled. However, Hungary will maintain the health emergence situation for fear of the risk of a possible sixth wave. The markets will welcome the removal of the majority of its restriction as it boosts business confidence, which supports economic growth.

The data calendar is light today, with only industrial production for January slated for release. Factory output growth improved for the second straight month to 3.60% in December, shrugging off the impact of the lockdown measures implemented after the discovery of the omicron variant in the backend of November. Forecasts compiled by economists surveyed by Bloomberg are for industrial production growth to continue rebounding at the start of the new year, supported by further reopening up of the economy as restrictions ease and recovering economic growth. However, factors on the radar, including supply-side constraints, rising energy prices, raw material shortages and geopolitical risks, could hinder a sustained improvement in factory output growth.

Poland: Economic data remains sparse today, and investors will derive market guidance from the ongoing developments on the geopolitical front. Against the backdrop of Russia's invasion of Ukraine, there has been a push to increase the military budget in Europe. Poland, for one, is seeking to raise its defence spending to 3% of GDP as of next year versus the initially planned hike to 2.3% of GDP. Speaking in parliament, Deputy Prime Minister Jaroslaw Kaczynski said that he is optimistic that military spending will be excluded from the 3%-to-GDP EU-wide deficit limit. To finance this increase in military expenditure, part of the spending would fall under budget, while the rest would be financed by long-term debt. In addition, the Polish Defense Minister Mariusz Blaszczak noted that the government will create a special fund at development bank BGK, co-financed by bonds sold by the state or BGK. The raised funds will be used partly to create voluntary military service, which will boost Poland's army personnel to about 300k.

Czech Republic: The Czech Republic's terms of trade are unlikely to be directly impacted by the war in Ukraine due to its small trade links with Russia and Ukraine. In particular, Russia makes up 2.3% of the Czech Republic's share in exports of goods and services, while Ukraine makes up 1%, according to official data by the central bank. In addition, the Czech Republic is not a major importer of goods and commodities from either Ukraine or Russia. However, an overall inflationary impact of the conflict can be expected, mainly through higher prices of oil, natural gas and, indirectly, other energy prices, particularly in the short term. The CZK exchange rate, which is now weaker than assumed in the winter forecast, will also affect future prices of goods and drive consumer prices higher in the short term. 

Forex: Terms of trade in focus as commodities soar   

South Africa: Heading into the final trading day of the week, the USD-ZAR is consolidating with a slight topside tilt amid risk-off trading conditions globally. The ZAR is likely to remain relatively range-bound and resist the temptation to sell-off as it might've done in previous EM crises. It continues to find support in high commodity prices and the fact that the emerging-market investible universe has shrunk with investors avoiding exposure to Eastern Europe. However, a cautious approach remains the best approach, with bouts of severe market volatility still expected as the Russia-Ukraine war progresses.

Turkey: The USD-TRY is trading relatively flat ahead of the local open after rejecting a move higher. The steady performance is a function of the continued intervention in the FX market by the CBRT. However, the bias in the pair remains skewed to the upside given the ongoing geopolitical crisis, surging inflation, deepening negative real rates and portfolio outflows. Looking at the REER basis, the TRY is undervalued by about 49%, which is justified considering the factors mentioned above coupled with deteriorating terms of trade.

Russia: The USD-RUB continues to pivot around the 110.00 mark, with Russian markets still in turmoil due to sanctions imposed over the country's invasion of Ukraine. Although the Russian central bank imposed a 30% commission on foreign currency purchases by individuals on currency exchanges (a move aimed at curbing demand for USD), the impact has not been immediate. The RUB will likely remain volatile in the near term, with market agents likely to avoid exposure to the currency until the Russia-Ukraine war has concluded.

Hungary: The EUR-HUF continued its ascent on Thursday, albeit at a slower pace than seen in previous sessions. The cross advanced by about 0.23% to 381.16 mark, as the aggressive one-week rate hike by the NBH tempered the speed of the rally. In addition, the less hawkish rhetoric struck by the US Fed Chairman during his testimony and the slight drop in crude oil prices also offered some respite for the local currency. Ahead of the local open, the bullish bias remains entrenched, with the EUR-HUF firming by about 0.26% at the time of writing. With the geopolitical risks showing no signs of abating, the cross will likely strengthen further heading into the weekend unless the central bank intervenes in the FX market.   

Poland: The Polish zloty remained under selling pressures on Thursday, the NBP FX intervention notwithstanding. The local currency lost about 0.97% against the EUR, extending its losing streak to four consecutive sessions to end the day at the 4.7989 mark, its lowest level on record since Bloomberg started tracking the time series. The sell-off in the PLN has continued ahead of the local open, with the local unit depreciating by 0.86% at the time of writing. This continuous slide in the local unit could prompt the NBP to intervene again in the FX market.

Czech Republic: The CZK has been weakening sharply against both the euro and the dollar since February 21, a few days before Russia attacked and invaded Ukraine on February 24. Traders have since then dumped the CZK among other currencies of the countries that are geographically close to Ukraine. The CZK finished yesterday at 25.764/EUR, a nine-month low. The local currency has continued to weaken this morning and can be expected to end the week around the 26.000/EUR mark as market sentiment has been rattled by Russia's attack on a major nuclear plant in Ukraine.

Fixed Income: Bond markets mixed amid concerns over global stagflationary pressures 

South Africa: SAGBs have taken on more of a consolidative tone overnight as a sign that selling pressure could have been technically driven or due to portfolio pressures within the investment community. SA's fiscal outlook is poised toward fiscal rebalancing, which favours SAGBs at the margin. Buying the peaks seems the best strategy in this respect, particularly with yields in the ultra-long end trading north of 10.7%.

Despite upside pressure on oil prices and breakeven rates, FRA rates have been mostly consolidative. Risks are building towards fresh paying interest, but will only materialise if ZAR adopts a depreciative tone. However, higher oil prices are becoming a significant short-term inflation risk, which could manifest in higher medium-term rates as the SARB rate hikes would be accompanied by significant upside pressure in the headline inflation index. The fuel price accounts for around 4.58% of the headline inflation index, while around half of that is directly due to the ZAR price of oil.

Turkey: Despite higher-than-expected inflation data out of Turkey, Turkish bonds attracted some mild demand on Thursday as global risk appetite improved through the session. Sentiment has since soured, however, with bond yields paring yesterday's decline through today's early trade. Heading into the weekend, global geopolitics and, specifically, the Russia-Ukraine war will likely be the main driver of Turkish assets today, especially since there is little in the way of market-moving data scheduled for release out of Turkey today.     

Russia: Ratings agencies Fitch and Moody's downgraded Russia by six notches to "junk" status, saying Western sanctions threw into doubt its ability to service debt and would weaken the economy. Sanctions imposed on Russia have significantly increased the chance of the country's defaulting on its dollar and other international market government debt, with this reflected in the meteoric rise of Russian credit default swaps, which are used to insure against default. On the whole, as long as current levels of uncertainty remain, investors are unlikely to add any exposure to Russian debt.

Hungary: At a regular bond auction held on Thursday, the AKK sold a combined HUF 45.5bn of securities, below plan by HUF4.5bn, after primary dealers' bids came in at HUF74.2bn. Looking at individual tenors, appetite for the seven-year floating-rate bonds was softer, with primary dealers' bids arriving at HUF43.4bn versus HUF84.0bn on February 17. This prompted the government agency to sell HUF30.0bn, raising its original offer by HUF10.0bn and generating a bid to cover ratio of 1.44 down from 2.43 two weeks ago when the bond was sold. Demand for twelve-month T-bills also declined to HUF30.8bn (vs HUF88.7bn two weeks ago), leaving the AKK to sell HUF15.5bn of the bills after cutting the original offer from HUF30.0bn. The softer demand seen during the auction is unsurprising given the current market environment where investor sentiment has soured amid the elevated geopolitical risks. During the non-competitive auction, the AKK managed to sell HUF3.5bn of the seven-year bonds.

Poland: With the war efforts still intensifying and OPEC failing to deliver on additional supply, oil prices have surged higher in recent sessions. This has essentially stoked inflation concerns globally, which could pile pressure on central banks to continue tightening monetary policy longer than anticipated, especially in the CEE region, where price pressures were already elevated before the crisis. However, global growth concerns that have arisen due to the Russia-Ukraine war could temper the pace of rate hikes. US Fed Chairman Powell, during his testimony, indicated that the Fed would only lift rates "gradually", signalling that he would support a 25bp increase in March. The gradual approach could be the path that other central banks that were also considering beginning normalising monetary policy will follow.

Czech Republic: With oil prices significantly higher than what was earlier anticipated on the back of recovering global demand and supply disruptions from the geopolitical events, there could be material risks to inflation being higher than what is currently being anticipated. Thus, traders should continue to watch oil price movements carefully and the resultant current account deficit, which could impact the CZK and interest rates, going forward.