ECB Boost Presents Challenges To Central European Policymakers

The European Central Bank (ECB) delivered on nearly all of the policy options we expected at its June 6 meeting ( see 'Assessing The Aftermath Of ECB Policy Action', June 6) providing emerging market (EM)assets with a boost to risk sentiment. Regional high beta currencies (TRY, RUB) experienced the largest gains, appreciating 1.0% and 0.9% from market close on June 5 to June 9. Turkey and Russia have a much higher tolerance of stronger currencies than other emerging European economies do, having experienced heavy selling pressure and high inflation in recent quarters.

Within Central Europe, the Polish zloty was the biggest gainer (+0.8%), followed by the forint (0.4%). However, stubbornly low inflation means the authorities have a relatively low tolerance of a stronger zloty, and we believe a push past PLN4.00/EUR would prompt serious discussion of monetary easing, capping the potential for a major rally in the currency. The Romanian leu failed to benefit significantly following the ECB's decision, but we expect rising capital flows into RON debt markets to bolster our bullish RON/EUR over the summer. Meanwhile, the Czech Koruna remained unchanged as the Central National Bank (CNB) continues its defence of the ceiling at CZK27.0/EUR. We do not expect the CNB to lift the ceiling until 2015 at the earliest, implying the Czech Koruna will underperform relative to the region in 2014.

Authorities Have Higher Tolerance Of Stronger TRY, RUB
Exchange Rates - Percentage Gain (+)/Loss (-) Against EUR After June 6 ECB Meeting

ECB Boost Presents Challenges To Central European Policymakers

The European Central Bank (ECB) delivered on nearly all of the policy options we expected at its June 6 meeting ( see 'Assessing The Aftermath Of ECB Policy Action', June 6) providing emerging market (EM)assets with a boost to risk sentiment. Regional high beta currencies (TRY, RUB) experienced the largest gains, appreciating 1.0% and 0.9% from market close on June 5 to June 9. Turkey and Russia have a much higher tolerance of stronger currencies than other emerging European economies do, having experienced heavy selling pressure and high inflation in recent quarters.

Authorities Have Higher Tolerance Of Stronger TRY, RUB
Exchange Rates - Percentage Gain (+)/Loss (-) Against EUR After June 6 ECB Meeting

Within Central Europe, the Polish zloty was the biggest gainer (+0.8%), followed by the forint (0.4%). However, stubbornly low inflation means the authorities have a relatively low tolerance of a stronger zloty, and we believe a push past PLN4.00/EUR would prompt serious discussion of monetary easing, capping the potential for a major rally in the currency. The Romanian leu failed to benefit significantly following the ECB's decision, but we expect rising capital flows into RON debt markets to bolster our bullish RON/EUR over the summer. Meanwhile, the Czech Koruna remained unchanged as the Central National Bank (CNB) continues its defence of the ceiling at CZK27.0/EUR. We do not expect the CNB to lift the ceiling until 2015 at the earliest, implying the Czech Koruna will underperform relative to the region in 2014.

BMI Europe Asset Class Strategy
DATE INITIATED ENTRY LEVEL GAIN/(LOSS) RATIONALE
CURRENCIES
Bullish TRY vs RUB 18-Mar-2014 16.4 0.7% Turkey offers a more attractive long-term investment story and positive carry, while lower oil prices will expose Russia's massive economic challenges.
Bullish RON vs EUR 27-May-2014 4.40 0.2% The healthy carry offered by Romanian local debt, an attractive technical picture and robust exports.
FIXED INCOME
NA
EQUITY INDICES
Eurozone Over US Equities (Ratio of MSCI US to MSCI EMU) 15-Aug-2013 17.3 1.0% Though we still like the US, eurozone underperformance has reached extremes, and the eurozone economy is picking up momentum. The MSCI EMU looks attractive on a technical basis and is increasingly cheap versus the US. Targeting a move down in the US/EMU ratio to 14.0x.
Bullish Italian FTSE MIB Index 28-Mar-2014 21,345.5 4.8% Constructive technicals, positive political developments and low relative valuations.
MACRO/INDUSTRY STRATEGY
NA
Source: Bloomberg, BMI
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