Crowded Trades Eyeing Koruna Gain Imply Scope for Disappointment

  • Derivatives price higher koruna volatility but limited gains
  • Swiss-style currency cap in final stretch as inflation returns

Betting on appreciation in the Czech koruna is one of the most popular currency plays this year, yet charts suggest it may not strengthen a whole lot.

Policy makers in Prague say they may remove a Swiss-inspired cap on the currency any time after March 31, after inflation headed back above the Czech National Bank’s 2 percent target. As of January, foreign speculative capital in local assets totaled about 35 billion euros ($38 billion), including in government bonds with negative yields, as investors seek to make a profit from any koruna rally when the cap goes.

Rate setters are meeting on Thursday for the last time before the end of their pledge to maintain the limit, which prevents gains beyond 27 koruna per euro. Their policy announcement is scheduled for 1 p.m. local time, followed by a press conference at 2:15 p.m.

Below are five charts investors should keep an eye on as a floating exchange rate nears.

Bets on future koruna appreciation spiked in early January as accelerating Czech inflation and the approaching end of the central bank’s formal pledge to intervene lured a record amount of foreign inflows. Since then, currency derivatives show a reduction of those wagers after policy makers and some analysts warned the accumulated speculative position was so large that investors may struggle to find koruna buyers after the cap is removed.

Euro-koruna forwards now price in a mere 0.8 percent appreciation three months from now and a 1.1 percent gain in a year. That trails median analyst forecasts compiled by Bloomberg for the exchange rate to jump 3.5 percent to 26.1 by the end of the year and 4.3 percent to 25.90 in March 2018.

“Foreign positioning in the koruna remains heavy, which raises concerns about a lack of counterparties to the short euro-koruna trade at the time of the removal of the floor,” said Goldman Sachs Group Inc. analyst Sara Grut.

The central bank bought 47.8 billion euros in the four years through January, compared with 12.8 billion euros of natural inflows visible in the country’s balance of payments. ING Groep NV analysts Petr Krpata and Jakub Seidler say the koruna “looks overbought” and this may contribute to a “large degree of volatility” in both directions after the cap is removed.

“Market participants are now fully aware of the stretched positioning and they are likely to adjust their investment strategies accordingly,” Krpata and Seidler wrote in a March 23 report. “The structure of inflows has changed, with a ‘two-way’ market emerging amongst the speculative community.”

Consumer price growth has been overshooting the central bank’s goal for two months, boosting bets on an early end of the intervention regime. But policy makers in Prague keep saying the inflation target needs to be sustainable before they switch off the extraordinary stimulus, to make sure they don’t need to ease policy again anytime soon.

That is why 13 out of 22 analysts polled by Bloomberg last week expect the currency limit to stay in place until May, when the monetary authority will have fresh quarterly economic projections. Eight respondents said the board will probably discontinue the cap at the scheduled May 4 policy meeting.

“While there’s a significant risk of an earlier exit, we believe the CNB will prefer to wait for the new forecast as more solid evidence that it really is the right time to pull the plug,” said Viktor Zeisel, an economist at Komercni Banka AS.

The waning prospects for koruna gains and the spike in inflation have curbed foreigners’ appetite for Czech government debt at negative yields. The country’s shorter-dated bonds, a preferred asset for investors betting on the end of the intervention regime, briefly became the world’s most expensive when inflows into the koruna peaked in October and January and investors speculated the central bank could cut interest rates below zero.

Volatility Returns

While investors, analysts and central bankers may have different views on the timing of the exit and the longer-term outlook for the koruna, there’s one point they all agree on: the first hours, days and possibly months after the currency is re-floated will be turbulent. Governor Jiri Rusnok said earlier this month policy makers won’t be “overly sensitive” to initial swings, which could be in either direction, and will let the market find a new equilibrium before they decide whether intervention is needed to “correct” the exchange rate.

The koruna’s implied-volatility surface -- depicted as a function of strike price and maturity -- shows investors betting on increased exchange-rate swings against the euro starting in April and rising through May. That’s in line with policy makers’ commitment not to end the currency regime before the end of March and with analysts predicting the cap will be removed five weeks later.

— With assistance by Peter Laca

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