USDHUF: Could central bank strengthen forint?

Summary:

• Hungarian central bank announces slightly less expansionary monetary policy since the beginning of 2019

• Inflation is projected to stay within the tolerable limits

• Wage growth remains robust signalling upside risks to the inflation outlook

• Despite firm economic growth the country keeps running at a current account surplus

• A conflict with the EU appears to be unlikely to dent the forint materially

• HUF looks undervalued, any declines fuelled by a heightened degree of risk aversion could prove temporary

The Hungarian forint has been among the worst performing currencies in the EMEA block since the beginning of this year. The loss has totalled almost 6% against the US dollar and 4% against the shared currency. In both examples the forint has performed clearly worse than its major peers such as the Romanian leu, the Bulgarian lev, the Czech koruna and the Polish zloty (in the descending order in terms of a rate of return). Obviously, there were reasons to stay bearish on the HUF as the Hungary’s central bank (MNB) was by far the most dovish one in the region but something has changed lately and therefore investors may look at the forint more eagerly before long. In today’s analysis we are presenting a handful of information why the Hungarian currency could become more attractive from the investment’s viewpoint.

Hungarian price growth has recently moved above the target. Real wage growth remains robust signalling upward risks to the inflation outlook. Source: Macrobond, XTB Research

Compared to its peers the Hungarian central bank has been conducting very dovish monetary policy equipped with a set of unconventional tools. Among them we can find those affecting long-term as well as short-term yields. The former group includes quantitative restrictions on the 3-month deposits, the asymmetric corridor for interest rates, the BUBOR (money) market reform, liquidity provided by FX swaps or a reduction of the reserve requirement ratio. Unlike the means aimed at lowering short-term yields, a set of tools concerning long-term yields - the interest rate swap facility and the mortgage bond purchase programme - will be ended till the end of this year. These changes were announced during the meeting last week and the central bank also decided to launch the Funding for Growth Scheme Fix (FGS fix) in early 2019. The prime goal for this programme is to increase the proportion of long-term, fixed-rate lending to SMEs to (as the bank wrote in the statement) an adequate level. From the monetary policy point of view it sounds reasonably as the Hungarian central bank wants to improve to composition of lending among SMEs before it switches to a bit more hawkish stance. While the first rate hike is unlikely to take place until the last quarter of 2019, the changes announced last week are the early signs the central bank begins setting the stage for a shift in monetary policy. Let us point out that the central bank in Hungary keeps the most expansionary policy (0.9%) in the region except the Bulgarian central bank where the main interest rate stands at 0%. Nonetheless, the degree of interest rates combined with a lot of unorthodox tools makes the MNB undoubtedly the most dovish monetary authority in the EMEA region.

At the same time the MNB projects that inflation will remain within the tolerable bands (2% +/- 1 percentage point) in the quarters to come. On top of that, the robust pace of wage increase signals upward risks to the inflation outlook. It needs to be said that despite the fact that the positive impact on wage growth coming from a hike of minimum wages since 2017 already vanished, the pace of growth has remained at relatively elevated levels mirroring the sound labour market. For instance, the jobless rate fell in the three months through July to 3.6% whereas the labour force participation rate reached 62.5% in June - do note that this rate has been steadily rising there since 2013 unlike to rates in Poland, Romania or Slovakia (only the Czech Republic has seen constant growth in the corresponding period of time).

The Hungarian economy has seen a rising current account balance in recent years. Even as the surplus has shrunk slightly due to solid domestic demand and rising oil prices, it seems reasonable to assume the country should continue operating at the surplus. Source: Macrobond, XTB Research

Furthermore, economic growth in Hungary has been impressive easily exceeding 4% in annual terms over the last three quarters, and what’s important this growth has not occured at the cost of external imbalances (unlike in Romania). In fact, the Hungarian economy keeps operating at the current account surplus. Taking into account that the peak in the current business cycle has been already reached (across European economies), one may suppose that Hungary will continue operating with the C/A surplus meaning lower sensitivity to foreign capital flows.

What are the risks related to the Hungarian economy? These risks lie rather outside of economic factors per se and they concern more politics -  a conflict with the European institutions. Let us recall that the European Parliament voted to trigger the article 7 against Viktor Orban’s government earlier this month for breaching the EU’s core values. While it may entail far-reaching consequences (for one, some subsidies could be ultimately halted) if the dispute deepens, it could take a lot of time and when time passes more emphasis should be put on monetary policy leaving the conflict with the EP on the sidelines.

Based on the real, effective exchange rate (REER) the forint looks undervalued. Source: Macrobond, XTB Research

Underperformance of the Hungarian forint this year has added to its undervaluation based on the REER. As depicted at the chart above, the HUF TWI approached the 2nd standard deviation (the green line) and then saw a shy bounce. However, this increase did not turn out sustained and as a consequence the price moved lower. This in connection with the fact that the central bank should slowly gearing up for a rate increase at the end of the next year could limit further downside for the forint. Let us finally take a look at the weekly chart of the USDHUF.

The pair saw an incredible surge between April and early July spurred by the broad-based rise in the US dollar. The USDHUF has consolidated since then being unable to either stay for longer above 281 or below the 50% retracement. Having in mind that the Hungarian central bank should continue setting the stage for a policy shift in the foreseeable future we reckon that the pair could constitute an interesting investment opportunity. As a consequence we recommend to place a sell limit order at 281 with a stop order localized at 288.50 believing that any spikes could be faded. We decide to determine two targets: 268 and 260 with advice to close a half of the position when the pair strikes the first price target. Source: xStation5