East European Currency Trade Idea and Implications

The Polish zloty should outperform the Czech koruna. Poland's reported stronger than expected retail sales for May today. The 2.1% decline on the monthly time series is 2/3 of the decline the consensus expected, which was largely a correction to the heady 5% rise in April. The year-over-year rate actually increased to 1.1% from 1.0% (the consensus had expected a 0.5% decline). Poland's central bank delivered the expected 25 bp rate cut yesterday. In an earlier note this week, we commented that Poland's relatively less dependent on EU growth than most other countries in the region, may help underpin the zloty. The Swiss National Bank's aggressive intervention to knock the Swiss franc down is seen as easing the currency mis-match strains that were seen in Poland and Hungary.

The Czech central bank has defied expectations of a rate cut today, leaving the key policy rate, which at 1.5% is easily the lowest in the region. In the run-up to the crisis, some speculators were believed to have used the krona as a financing currency for local trades, but those positions have been unwound. Even though the Czech central bank did not cut rates, it is not clear that this is necessarily the trough in rates, even if that trough is close. Shortly before the rate decision, Czech reported further deterioration in business and consumer confidence. And inflation has decelerated from 1.8% in April to 1.3% in May.

We look for the zloty to outperform the krona and the Hungarian forint. The Czech koruna has been the strongest of the bunch, but technically, the pln-czk looks to be a lower risk way to enter the trade (currently ~CZK5.7750). Stops could be placed just below today's low near CZK5.74, but the key level is really the week's low near CZK5.7060. On the upside, a move, and ideally a close above CZK5.80 would boost confidence that a low is in place. Initially a move toward CZK5.90-CZK6.0 looks reasonable. There is a small bullish divergence in the daily (14-day) relative strength index. The zloty looks set to close above its 5-day moving average against the koruna in two weeks.

Of course, this trade idea is not suitable for every one. However, for investors with regional exposure, the take away message is that our assessment of the fundamental and technical factors leads us to believe that the zloty is positioned to outperform and the koruna poised to under-perform. This would also represent a reversal of the near-term trends.