Emerging Europe: New Challenges From Tighter Liquidity
The combination of rising real US yields and speculation over the end of US quantitative easing has seen widespread capital flight from emerging market assets since May, and Emerging Europe has been no exception, with currencies, government bonds, and equity markets falling sharply. From a strategic perspective, we have been neutral towards both regional debt markets and currencies since the start of 2013, and as a result have not been forced to make any substantial changes to our asset class strategy tables. However, with capital inflows into Emerging Europe unlikely to be as strong as in recent years, we see growing risks that regional currencies could be set for a period of extended depreciation as a result. This has serious implications for economies in the region, although we emphasise that the risk is far from evenly spread. To get a better gauge of FX vulnerabilities, we analyzed three factors:
1. Dependency on external financing
2. Capacity to tolerate a weaker currency
3. Ability of the central banks to manipulate the exchange rate
Taken together, these three factors offer us a useful insight into the extent of FX vulnerability within the region, and create some insight into the probable policy response from the authorities. Overall, we believe Turkey and Poland remain most exposed to a slowdown in capital inflows, although Turkey’s lower tolerance for currency weakness implies a higher probability of central bank intervention. On the other hand, we expect that Russia and the Czech Republic, while less reliant on external financing, are also most likely to favour a weaker currency, and expect their central banks to adopt more dovish stances relative to the region.
Our full article on the impact of rising US yields on Central & Eastern Europe’s financial markets is available to subscribers at Business Monitor Online.
This Week’s Trivia Question
For last week’s question, the theme of Croatia, which is about to join the EU. We asked, what item of clothing does Croatia claim credit for inventing? And which famous European explorer is claimed by Croatia as one of its own? The answers are, a) the neck tie, and b) Marco Polo. (Click the links for the explanations.)
For this week’s question, the theme is anniversaries. What world changing event took place on this date (28 June) 99 years ago? And relating to the same region, what historical event, which still resonates for the country in question, took place in 1389 and is commemorated on this date? Finally, what extraordinary event took place in Siberia 105 years ago this weekend?