Even the Bulwarks of Emerging Markets Quiver Amid Italy Pain

Updated on
  • ‘Path of least resistance’ is for CEE FX to drop: Rabobank
  • Economic strength in Poland, Hungary, Czech offers safety net

A trio of eastern European countries that sheltered investors amid the emerging-nation rout is feeling the contagion as Italy’s populist coalition rattles markets.

Confidence about the economic strength of Poland, Hungary and the Czech Republic had helped mute the pain of dollar gains that battered their developing peers. But on Monday, Italy’s plans to embark on a populist fiscal path landed them among the biggest currency decliners in emerging markets.

The countries’ economies are enmeshed with those of the euro area and the zloty headed for a September low against the euro, while the forint was poised for its weakest level in almost two years. On Tuesday, currencies and most bonds in the region tracked a rebound in Italian assets and the euro-area periphery.

“With the euro zone slowing down so far this year and two anti-establishment parties joining forces in Italy, the incentive to hold central and eastern European assets has weakened,” Piotr Matys, an emerging-market currency strategist at Rabobank in London, said in an emailed report. “The path of least resistance” is for the currencies to weaken versus the dollar and euro “in the coming weeks and perhaps even months,” he said.

Amid the market turbulence, it’s worth taking a look at some of the key economic data from these nations that set them apart from their peers:

The pace of gross domestic product growth in Poland accelerated to 5.1 percent in the first quarter, double the rate of the European Union for the period. Economic expansion in Hungary and the Czech Republic was above 4 percent, more than twice the fourth-quarter pace for developing-nation peers Brazil and South Africa, data compiled by Bloomberg show.

“The strength of macro fundamentals is definitely providing strong support,” said Regis Chatellier, a London-based emerging-market strategist at Societe Generale SA. “If you have to stay in emerging markets, but you are bearish on the market, you would remain in these countries.”

Their solid growth is accompanied by a tame inflation rate, and while Hungary’s price growth is predicted to be faster this year at 2.6 percent, it compares favorably with an expected 10.3 percent in Turkey. And Poland’s 1.6 percent pace is encouraging the country’s central bank to forecast rates will stay at a record low into 2020.

Surplus Countries

Eastern Europe maintains positive external balance as Turkey has deficit

Source: International Monetary Fund, Bloomberg

Note: Polish and Turkish data are IMF forecasts

Poland, Hungary and the Czech Republic all closed 2017 with a positive current-account balance. Turkey, which competes with the three for developing-nation investments, has seen its deficit balloon further, adding to its vulnerability as the U.S. continues to tighten policy and contributing to the lira’s slide to fresh record lows.

Tatha Ghose, a senior emerging-market economist at Commerzbank AG, says the eastern European markets are protected by their investment-grade credit ratings and also their stature relative to peers. “They don’t have the size where investors hold mad amounts and will sell in a panic,” he said.

Still, one potential risk to their fundamentals could come from their ties to Europe and, more specifically, to Germany.

Their growth may be hindered by “the cycle peaking” in the EU’s largest economy, he said.

(Adds market rebound in third paragraph.)
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