Careful with the Zloty

The Polish zloty has been a market darling. We have liked it as well. It is among the best emerging market currencies over the past week, gaining nearly 2.25% against the dollar and nearly 2.75% against the euro. Caution is in order now. After funds poured into Poland, one of the few countries to avoid an outright recession, the market is now vulnerable to less favorable news.

The attention is on the EC's review of Greece's proposals, but it some not very favorable things to say about Poland too and this is enough to spark a potential reversal in the zloty against the euro. The euro had earlier extended its recent losses against the zloty, amid follow through selling after the PLN4.0 level gave way on Monday. A break back above PLN4.0 could help shake out some of the last zloty longs/euro shorts making a PLN4.05 initial target reasonable.

The EC said that Poland needs to take "sizeable" measures to achieve the 3% deficit to GDP target by the end of 2012. It also identified "considerable risks" to Poland's fiscal strategy, even taking into account the stronger than expected growth prospects. Poland's deficit was about 6.5% of GDP last year and could widen to 7.5% this year.

One of the difficulties in Poland stems from the domestic political configuration and the reluctance of a member of governing coalition to support the fiscal austerity that Prime Minister Tusk is committed to. An approved euro convergence plan was to be unveiled earlier this week and is still has not been. There has been some indication it will not be ready until Feb 9th.