Fixed income market update - Key macro numbers

Key macro numbers


Czech growth set decelerate in Q2
There are plenty of economic releases in the Czech Republic next week. The biggest attention will undoubtedly be on the release of preliminary Q3 GDP. We expect GDP growth to surprise somewhat on the downside at 2.2% y/y. This would represent a moderate decline from Q2’s 2.4% y/y. We will not get a detailed breakdown of the number, but it is very likely that the export-orientated manufacturing sector will be one of the main drivers of growth again in the third quarter, although private consumption might contribute positively to growth as well. Overall, the risk to our annual 2010 GDP estimate of 1.9% y/y is skewed to the upside.

Czech inflation for October is also due for release next week. We expect moderate a rise to 2.1% y/y, up from September’s 2.0%, but less than the consensus expectation of 2.2%. Overall, the outlook has not changed and we continue to see inflation in the Czech Republic well under control, with no demand-led inflationary pressures over the next two years.

Growth and inflation accelerate in the Baltics
Latvian and Estonian Q3 GDP figures will be published next week. We expect to see a relatively strong outcome in Estonia T 4.4% y/y, on a robust export-orientated industrial performance. Estonian industry is growing at an exceptionally strong rate, and the main Estonian export markets – the Nordic countries – are showing a sustained recovery trend. We have already increased our forecast for Estonian growth this year. At least for the present, we can say that all risks to our forecasts are on the upside.

We expect the Latvian recovery to accelerate in Q3 10 as well, but we remain cautiously optimistic on Latvian growth and still expect a small negative reading (0.3% y/y). Latvia's export industry is recovering fast enough, but this may not be enough. Export potential in Latvia remains the lowest of the Baltic economies. Also, the recovery in domestic demand is still weak, so we expect to see a negative growth this year and a fairly modest recovery in 2011.

We expect an acceleration of CPI inflation in Lithuania in October. Continually rising prices of food and non-alcoholic beverages and increased prices for the new autumn collections of clothing and footwear should have the largest impact on CPI inflation in October in both countries. We see some rise in housing costs due to the opening of the heating season. Other consumer goods and services price changes are likely to be negligible and will have little impact on the dynamics of CPI inflation.

Fixed income market update

Fed’s QE2 and implications for EMEA monetary policy
Much of the attention in the past two weeks globally has been on the exact make-up of the Federal Reserve’s second round of quantitative easing measures. While the Fed announcement of USD600bn purchases of longer-term US Treasury securities did not deviate significantly from the market’s expectations, the result so far has been positive in a wide range of risk barometers, and EMEA markets are no exception. In particular – and not surprisingly, considering the historical reactions in similar circumstances – the risk-driven, USD-paired currencies such as the Turkish lira and South African lira, and to smaller extent the Mexican peso, are among the largest beneficiaries of the new round of US liquidity action. While the pick-up in global risk naturally extends to the CEE region, we expect the impact to be somewhat more moderate than in the higher-yielding peer countries.

We would also draw attention to the fact that currencies such as ZAR and TRY, which are already in overbought territory compared with their longer-term fair valuations, are likely to become even more expensive on a short-term horizon, adding to the risk of potentially sharp corrections, in an environment where troubles in PIIGS countries continue to provide for potential triggers in risk aversion.

Hawkish Polish central bankers signal rate hike in November
This week, Jan Winiecki and Anna Zielinska-Glebocka, both Polish Monetary Policy Council (RPP) members, have been calling for rate hikes in Poland. This is a key development, as both voted against a rate hike in August. If Mr. Winiecki and Mrs. Zielinska-Glebocka were both to vote for a rate hike at the next RPP in November, then there most likely would be a six-to-four majority in favour of a hike. Therefore, we have decided to change our forecast for Polish monetary policy, and we now see a 25bp hike at the November RPP meeting. This is despite the fact that we find it difficult to understand why this is necessary, given the current global environment and inflation being pretty well under control in Poland. If the RPP were to hike rates, this could easily trigger a strengthening of the zloty, which in itself would be disinflationary. Therefore, we still do not see this as the initiation of a tightening cycle, but more a one-off “adjustment” of rates.

So, even though we are now forecasting a 25bp rate hike in November, we do not see a series of rate hikes that could bring the key policy rate to, for example, 5% – as some market participants seem to expect. Overall, we therefore continue to think that we will not see a spike in Polish bond yields going forward, and we still see the risk in market yields as mostly to the downside. That said, near-term we are likely to see a rate hike in November, and this will keep the short end of the Polish yield curve elevated. But on the other hand, higher rates are likely to reduce inflation expectations (at least at the margin) and any rate hikes could also lead to a strengthening of the zloty, which in turn should help to keep long-term yields down. Therefore, we would now see value in moving further out on the yield curve than we have recommend until now. Furthermore, we note that if the zloty were to take off, then that in itself would reduce the (perceived) need for monetary policy action in Poland.
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