Morning Note /

EMEA Daily: Russia-Ukraine conflict leaves CEE assets more vulnerable

  • Talking Points: Focus remains on Ukraine war, economic data to be largely ignored

  • Forex: Russian sanctions to weigh on EMEA FX today

  • Fixed Income: SAGBs may look attractive compared to CEE peers

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Takudzwa Ndawona
Edmond Muzinda
ETM Analytics
28 February 2022
Published byETM Analytics

Talking Points: Focus remains on Ukraine war, economic data to be largely ignored

South Africa: There will be several releases in the session ahead, with money supply and credit extension for January, the trade balance and the monthly government budget balance all due. In addition, statistics on liquidations and insolvencies in South Africa will be released as a marker of the business cycle and how corporate South Africa has faired into 2022. The market will most likely ignore the data for now, with domestic macroeconomic developments playing second fiddle to the risks associated with European geopolitics. .

Turkey: The new week will begin with 4Q GDP and trade balance statistics scheduled for release. Turkey's GDP growth slowed down in Q3 as base effects started to subside alongside the impact of soaring inflation and a weaker local currency. Despite the slowdown seen in Q3, GDP growth remains fairly strong compared to the country's long-term average. Market expectations are for GDP growth to rebound in Q4 supported by further reopening up of the economy, the central bank's easy monetary policy, a recovering tourism sector and global demand. However, the underlying weak macroeconomic fundamentals pose some downside risks to the economic outlook, and the growth outlook for 2022 is looking fairly weak at the moment.

Russia: Things are not going as planned in Ukraine. Russia's forces have not made the headway Putin had anticipated. Ukrainian resistance has been far more formidable than expected and has received more support than he would've imagined. Furthermore, sanctions upon sanctions announced over the weekend are aimed at financially carpet-bombing the Russian economy that has funded its war machine, and protests have sprung up in all corners of the globe. The pressure on all countries to respond to Russia's aggression will be taking its toll on the Russian population, which in itself appears to be responding with protest action even within Russia's borders, which is unprecedented.

On the one hand, investors may see it as good news that so much is being done so quickly to pressure the Putin administration to stop its military action. However, on the other, it has forced Putin into retaliatory mode. In response to the actions of Europe and other global leaders, Russia has placed its nuclear deterrent forces on high alert. This further escalation may just be sabre-rattling by a desperate leader trying to scare his opposition to back down, but given his actions so far, any and all scenarios need to be considered.

Hungary: Data released on Friday showed that Hungary’s jobless rate came in higher than expected, rising from 3.7% in December to 4.2% in January, reflecting an increase in the number of job seekers and seasonal effects as people hired during the festive period were retrenched. Notwithstanding the recent increase in the jobless rate, Hungary’s labour market dynamics remain relatively tight compared to historical levels, which will continue to support domestic consumption and, by extension, economic growth. The limited level of slack in the job market on the back of the economic recovery and rising wages will continue to contribute to inflationary pressures in the economy. This, therefore, further supports the argument for the NBH to remain committed to interest rate hiking in the coming months.

Poland: Speaking over the weekend, Prime Minister Mateusz Morawiecki said that he feared a Russian Attack on his country, Finland or Baltic states and urged Europe to double their defence after Moscow invaded Ukraine. The Polish head of government suggested the continent increase defence spending from around EUR300bn up to EUR600bn per year and proposed excluding defence spending from EU public finance rules to allow his country to spend three to four percent of its annual economic output on defence. PM Mateusz told the French daily Ouest-France that the era of peace and international order is coming to an end, and it's a test for the West and the way we react to this test that will determine the future for decades to come.

The NBP posted on its website that the country has sufficient reserves despite some ATMs running out of zloty. Demand for cash in the country has increased recently amid concerns over the fallout from Russia's invasion of neighbouring Ukraine. While delays in the delivery of cash ATMs from logistic centers of commercial banks and cash-handling companies in some locations may be expected, the situation is expected to stabilize within days as Polish banks are stable and there is no risks to people's savings

Czech Republic: The session ahead will feature M2 money supply and a debt management report by the Finance Ministry. The persistent decline in money supply is anticipated to have continued early on in the year and unwinding all the covid-19 relief support. Money supply has fallen for seven straight months, growing by just 7.3% y/y in December, off its peaks of 12% y/y as the central bank has tightened monetary policy settings aggressively from late last year to rein in inflationary pressures. While the central bank has sought to pause its rate hiking cycle, Russia’s attack on Ukraine may force the central bank to consider more monetary tightening to tame inflation expectations, suggesting that money supply growth will be constrained.

The Finance Ministry’s debt management report will likely go some way in explaining the country's fiscal vulnerability, a weak domestic growth outlook, and notably higher lending rates since the lockdown. The takeaway will be efforts to restructure debt this year and realign it with the new government’s sole mandate of restoring sound public finances.

Forex: Russian sanctions to weigh on EMEA FX today

South Africa: Guidance this morning remains similar to that of last week. Adopting any clear direction amounts to little more than speculation for speculation's sake. It is near impossible to gauge direction from one day to the next with some very powerful geopolitical forces at play. The safety of the side lines is appealing for now until the dust settles with the SA economy and the ZAR a passenger on this geopolitical ride. There is nothing SA can say or do to mitigate the effects and very little that will grant local authorities any control of the ZAR's trading behaviour..

Turkey: On Friday, the USD-TRY erased all of the gains that were seen in the previous session as the pair returned to within its narrow trading range. FX interventions by large state banks alongside the improved risk sentiment underpinned the pullback in the pair. However, further movement to the downside continues to be limited by the lingering geopolitical risks and the underlying weak macroeconomic fundamentals. Technically speaking, near-term dynamics still favour the bears remaining in charge, with the USD-TRY stochastic trending lower, but the fundamental outlook and current external market conditions should more than offset this.

Russia: The RUB managed a bit of a recovery on Friday, closing the week at just below 83 to the USD. This morning, however, we expect to see the USD-RUB sure back towards new record highs as sanctions have been dialled up and the war in Ukraine seems to not be unfolding as Putin had wished, which will have a dramatic impact on his own economy. The currency remains untradeable given the sanctions, SWIFT expulsion, and general avoidance of Russian assets by market participants at the moment.

Hungary: The EUR-HUF bucked the two-day rally on Friday as markets found some reprieve from Russia proposing to hold talks with Ukraine amid the ongoing crisis. The cross retreated by about 1.44%, which is almost half of the gains realised in the previous session. However, the cross has managed to recoup some of its losses in the early morning session after rallying by 1.16%, at the time of writing amid concerns that Russia might retaliate after harsh sanctions were imposed by the West and its allies over the weekend. In the session ahead, the geopolitical risks will continue providing directional guidance in the cross given the absence of local data releases on the domestic calendar.

Poland: Tracking the performance seen in other CEE peers, the PLN rebounded slightly on Friday as some calmness returned to the market. The local currency rallied by 1.33%, snapping the sell-off evident in the last six sessions, which erased all the gains recorded in December and January. However, the bid tone has not continued ahead of the Euro open as the local unit has lost about 1.50% against the EUR in the early morning session as risk sentiment soured following harsh sanctions imposed on Russia on the weekend. The ongoing risk-on/risk-off narrative will likely continue to guide the direction for the EUR-PLN going forward. .

Czech Republic: The EUR-CZK closed Friday on the back foot at 24.735, but when reflecting on a volatile week, the pair, alongside its regional FX pairs, bore the brunt of the blow amid the conflict in Ukraine. In particular, the EUR-CZK gained 1.4% last week to only be in the red on a year-to-date basis. It is worth noting that the CZK’s sell-off was significantly less than the likes of the PLN and HUF. The pair has jumped higher at the start of the new week, piercing above the 100DMA and the 25.00-handle. With the topside bias expected to remain intact and the 200DMA resistance at 25.236 to come into crosshairs, last touched in November 2021.

Fixed Income: SAGBs may look attractive compared to CEE peers

South Africa: South African fixed income exposure remains relatively attractive against the backdrop of the Russia invasion of Ukraine. Due to geographical and economic distance from Russia, SAGBs will be a better choice than countries in Eastern Europe. Mexico and parts of Latin America may also carry some favour, suggesting that EM flows could become more judicious and defensive

SAGBs strengthened into the close on Friday, with investors likely pricing in increased optimism following the national budget. Geopolitical safe haven status seems likely to support SAGBs at the margin. Barring a full-on liquidity squeeze in global markets, one could expect SAGBs to perform relatively well in particular due to isolated risks from Russia/Ukraine. JSE data does, however, suggest that foreign investors could be selling SAGBs at present with $555mn in outflows posted MTD.

FRA rates, meanwhile, have been trending slightly higher over the last few sessions and could continue just from a risk hedging perspective. The market will remain concerned about another taper tantrum type movement, but if the ZAR manages to hold up, this could ultimately be another receiving opportunity. The 9x12 is pricing in a little over 163bp of rate hike risk, which remains high given the weak economic potential of SA.

Turkey: Turkish bonds rebounded on Friday as global markets stabilized a bit following Thursday's turmoil. This should be short-lived, however, given the current market conditions, which suggest that risk assets will continue to be sold over the coming sessions. Turkey's poor fundamentals, meanwhile, suggest that its markets could be very volatile over the next few days, with some intervention by the authorities looking like a strong possibility. Even with yields currently so high, real yields remain negative given inflation above 40% and with expectations that it will accelerate further in the coming months.

Russia: Russian bond yields continue to surge, with the local currency 2031 tenor topping out at 16.9% on Friday. It is unlikely that we will see any rebounds over the near term, with the markets untradeable at the moment. Dollar bond yields had a bit of a pullback on Friday, but this should be short-lived given the developments over the weekend. Yields will continue to rise and the Russian market will become almost completely isolated from the rest of the world.

Hungary: Hungarian bonds halted their sell-off in the week’s final trading session after some calmness returned to the market following the imposition of sanctions on Russia that were less harsh than what the market was pricing. The local bonds traded relatively flat on the day. However, the broader picture showed that domestic bonds were sold off last week, with a more pronounced jump seen at the short end of the curve. The 2yr HGB yield rose about 40bps to move above the 5.000% mark. Meanwhile, the 5yr and 10yr tenors saw yield drift higher by more than 33bps and more than 32bps, respectively. As a result, the 10v2 spread has compressed to sit north of 7bps, its lowest level since November last year.

Hungary’s risk premiums continue to increase relative to its CEE peers. Looking at the HGB 10yr spread over the comparable German bund, it widened last week by about 28bps to 495bps. This compares with 381bps for Poland and 294 for Czech. Aside from the geopolitical risks being priced in, the political risks, deteriorating fiscal dynamics and NBH rate hikes are also driving risk premiums higher.

Poland: Data released on Friday from the Finance Ministry showed that Poland’s fiscal dynamics improved in January. Poland’s budget balance swung from a deficit of PLN26.33bn in December to a surplus of PLN22.29bn in January as revenue rose more than spending. For context, the report showed that revenue rose 44.2% y/y YTD to PLN58.74bn while expenditure rose 7.2% y/y YTD to PLN36.45bn. It is worth noting that Poland has always recorded a budget surplus in every January since 2016.

In the secondary market, Polish bonds took a breather on Friday as investors assessed the situation regarding the news that Russia and Ukraine will hold talks. However, the broader picture shows that Polish bonds were under pressure last week with yields drifting higher across the curve to reach multi-year highs. A significant increase was evident in the 2yr POLGB yield which jumped by more than 34bps as speculation rose that the central bank will have to hike interest rates aggressively after crude oil prices increased above the $100b/d. This was followed by the 5yr yield which climbed more than 28bps while the 10yr tenor’s yield was up more than 15bps. Given current market conditions, bonds should remain on the defensive today.

Czech Republic: The domestic bond market remained offered into the weekend, with investors remaining cautious about developments in Ukraine, the most recent being Russian President Putin raising its nuclear forces to red alert in response to what he called “aggressive statements” by NATO. The CZK has sold off, as a result, leading emerging market FX losses ahead of the open and implying that local bonds can expect further topside pressure. The rise in yields results in a less inverted curve, but for the wrong reason. In general, the rise in yields is unlikely to enhance CZK bonds' attractiveness due to the geopolitical backdrop.