Options Show Zloty’s Brexit Slump Turning to Small Bremain Gain

  • Traders bracing for most turbulent zloty swings since 2011
  • Domestic risk to curb relief rally if U.K. votes to stay in EU

Brexit or not, financial derivatives show the damage is done for Poland’s currency.

The zloty has weakened 3.3 percent per euro since March 31, more than all but one of its emerging-market peers, amid concerns that Poland is vulnerable to the U.K. voting to leave the European Union. Yet even as opinion polls increasingly predict Britain staying in the 28-nation bloc, the probability of the currency recouping these losses over the next month is 23 percent, according to options data calculated by Bloomberg. Meanwhile, derivatives show a 27 percent chance of the zloty’s decline doubling.

As the U.K. prepares to vote on Thursday on whether to stay in the EU, here are the main scenarios for the zloty, the proxy currency for emerging-market investors seeking to bet on how the referendum turns out:

BREMAIN

* Base case for most analysts; bookmakers put probability of U.K. voting to stay at 80%
* Zloty seen gaining to ~4.30/EUR from 4.3873 at 11:21 a.m. in Warsaw, according to strategists at banks including Erste Group Bank AG, Raiffeisen Bank International AG and Danske Bank A/S; Goldman Sachs Group Inc. forecasts the zloty appreciating to 4.32
* Zloty faces “asymmetric risks,” with smaller scope for gains in case of “Bremain” vote than for depreciation in Brexit scenario, says HSBC Holdings Plc
* “The appreciation impulse is behind us,” says MBank SA, while ING Bank Slaski SA warns that gains in Polish bond may be temporary as 2017 fiscal challenges and large supply of new debt looms over the market

BREXIT

* Zloty will slump beyond 4.50/EUR, weakest in more than 4 years, according to Erste and Raiffeisen; with the latter concerned about potential “spikes” toward 5/EUR, which can trigger verbal or market interventions by Poland’s central bank
* Central bank Governor Adam Glapinski said this week Poland’s economy wouldn’t take any big hit from Brexit, although the zloty may be affected; fellow rate setter Jerzy Kropiwnicki said the zloty’s drop toward 5/EUR would be “acceptable
* Finance Minister Pawel Szalamacha said Poland is ready for “any outcome” of the referendum and won’t be forced into any “feverish moves,” having financed 70% of this year’s borrowing needs and armed with a 60 billion zloty ($15 billion) cash cushion

THE TAKEAWAY

Options show bets on choppy zloty trading until the referendum and right after it. One-week implied volatility against the euro jumped to 18 percent on Friday, the most since November 2011, from 7.8 percent a week earlier. The measure of expected exchange-rate swings is the highest for east European currencies after those for the Russian ruble.

Poland’s domestic sovereign bonds have been the worst performers this quarter among 10 east European nations included in the Bloomberg Emerging Market Local Sovereign Index.

Britain is the third-largest net contributor to the EU budget, while Poland is set to be the biggest recipient among the bloc’s 28 members through 2020. It’s unclear, however, how quickly the U.K. could negotiate a way out of the block and whether it would pull its funds from the common budget. Brexit may have bigger political implications by questioning “the irreversibility of the economic and political integration of central and east European countries within the EU,” Erste analysts, led by Henning Esskuchen, said last week.

While the zloty would be among the biggest victims in a Brexit scenario, the boost it could get from a vote for Bremain is limited by domestic political risks, according to Erste and HSBC. The median estimate of 47 economists polled by Bloomberg in May and June, based on the assumption the U.K. stays in the EU, is for the zloty to trade around 4.30 per euro until June 2017.

Polish assets underperformed peers even before Brexit concern started roiling global markets as the new government in Warsaw imposed the EU’s highest taxes on banks, threatened to saddle lenders with costs of converting Swiss franc-denominated mortgages and battled with European partners over democratic standards, contributing to the nation’s first-ever ratings downgrade in January.

“The Polish government is not doing the zloty any favors,” Tatha Ghose, an economist at Commerzbank AG in London, said last week. “The conflict between the European Commission and the Polish government has not eased in the slightest. In fact, it is set to escalate noticeably in the coming months.”

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