The Return of FX Fusion

After several significant life changes (for the better!) I am ready to start what I hope will be a steady stream of FX commentary.  Lot's of exciting things have happened in the foreign exchange and capital markets.  I face the future, both in a person and professional sense, with more confidence than ever.  So without further ado, let's get to work! 

 The National Bank of Hungary issued a surprisingly upbeat assessment of internal economic conditions its statement which accompanied its interest rate decision. The base MNB policy rate, or the rate paid on HUF deposited for two weeks at the Central Bank, was left unchanged at 2.10 percent.  The bank referenced relatively robust growth when compared with the rest of Europe, noting growth rates of 3.7 and 3.9 percent in the first and second quarters respectively.  The Bank expects this trend to continue.  Of particular note is the gradual recovery of the consumer sector, as well as the large public investments in infrastructure.  Hungary also continues to benefit from EU development funds intended to bring living standards in less developed member States.   Nonetheless, these funds only amount to 0.3 to 0.4 percent of GDP.

On the inflation front, the Bank believes the low inflation environment in the rest of Europe, as well as falling commodity prices, are responsible to historically low Hungarian inflation despite a relatively strong domestic economy.  The Bank also highlighted the Funding for Growth Scheme, which is similar to the BoE funding for lending program. The Bank also noted the reduction of foreign debt, and the re-domination of EUR and CHF loans into HUF, aided both by the initiatives of the central government and the FGS. Both these developments have reduced Hungary's once problematic external vulnerabilities. 

On FX, the HUF remains a carry trade candidate, but only against the EUR or CHF.  Several factors however should caution investors from jumping in with both feet.  Most importantly, in times of Eurozone stress, the currencies of developing European economies have tended to depreciate against EUR and CHF even despite the factor that these countries are presumably somewhat better insulated from Eurozone troubles precisely because they have opted to retain monetary sovereignty.  Panic selling of risky assets, especially those with exposure to Europe, is the likely explanation.  In other words, it seems unlikely that the market will differentiate between the weaker and stronger EM currencies in the event of adverse shocks.  Secondly, HUF only yields 2.1 percent, one of the lowest rates in the entire EM space.  Third, European weakness will likely be a major theme going forward, and this trade is essentially neutral Europe.  Selling EUR or CHF against KRW, MXN or even COP will both earn more carry, but also allow investors to capture capital appreciation derived from stronger growth of the rest of the world vis a vis Europe.