BNY’s Bob Savage highlights that Central and Eastern European (CEE) currencies such as Hungarian Forint (HUF) and Polish Złoty (PLN) have held up relatively well into the fourth week of the conflict, supported by high real rates and liquidity. However, he warns that deteriorating fundamentals, energy and labor dynamics, and aggressive Western Europe rate hikes mean CEE central banks may need to pivot quickly to preserve real rate buffers and FX resilience.

High yields offset growing policy risks

"We see tomorrow’s MNB (central bank of Hungary) decision as another test of resilience for high-yielding currencies, which are embarking on the fourth week of the conflict in relatively good holdings shape, despite deteriorating fundamentals. Surprisingly, HUF flows have been solid over the past week; except for some strong outflows at the beginning of the conflict, it remains one of the best performers in EMEA (Europe, the Middle East, and Africa). That holds true across different asset classes, despite the Hungarian government being one of the first globally to enact energy price guarantees, thereby risking severe erosion of fiscal credibility."

"The MNB is expected to keep rates on hold, and assuming that near-term CPI figures conform to the prior outlook, a 300-400bp real rate buffer is considered sufficient to limit outflows. However, as is the case for much of the CEE, this is probably the bare minimum that is needed, as energy and labor supply dynamics could force down real rates very quickly. Given that aggressive hikes are now expected in Western Europe, we believe CEE needs to pivot quickly as well, especially in the near term."

"Overall, CEE FX flow remains a microcosm of how EM FX flow is behaving in general. PLN and HUF offer liquidity and real rates, even if we believe policy risks are growing in the current environment. For now, the real rate view is sufficient to offset or compensate for very strong fiscal impulses; if the energy crisis worsens, however, then markets may need to revisit their current exposures."

"Meanwhile, RON and CZK are continuing to underperform. The latter has never been seen in a strong carry context, while the former is now one of the worst-performing currencies in iFlow, simply because it has one of the lowest current real rates of all the currencies we track. RON was the first of the main carry names in EM FX to move into a materially underheld position."

"It is now being joined by currencies with stressed balances of payments, where currency weakness will also feed into a poor real rate position."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)