Investors spooked by Hungary c.bank chief 2w deposit plans

In an interview with state-owned newswire MTI he also said he agreed with a proposal by Hungarian Banking Association President Mihály Patai to transform the two-week NBH bond into deposit again and restrict access of certain banks to the bank’s two-week tool.A market dealer told Portfolio.hu that after the announcement investors started to buy Hungarian assets. The reason for that, he said, is that they expect liquidity to be squeezed out of 2W bills will not be able to find a new “home" abroad (simply because they cannot find a similar asset elsewhere) therefore it will be directed into other Hungarian assets. That is why government bonds, Treasury-bills and swap assets strengthened (yields went down), the dealer said. He added, however, that yields declined primarily on shorter maturities therefore the steepness of the yield curve has increased again.

Today’s bond auctions were also successful.

Asked how this made it possible for the forint to depreciate in the morning, the dealer responded that the planned transformation of 2W bills to 2W deposits created uncertainty on the market. This idea raises a lot of questions and keeps punters guessing because we here more and more comments but no specifics.

The dealer also noted that in the meantime global investor sentiment has turned fundamentally optimistic, with monetary easing back on the centre stage. ECB Governing Council member Jens Weidmann was quoted by the Wall Street Journal as saying that the central bank could ease further if economic data warranted it. "Overcoming the crisis and the crisis effects will remain a challenge over the next decade," Weidmann also said.

Reuters quoted analysts at Commonwealth Bank as noting that while a rate cut in May looked unlikely, it was not impossible if data deteriorated markedly.

“However, should the economy underperform into the summer, with hoped-for recovery looking more distant, further monetary easing looks increasingly likely," the analysts wrote, as quoted by Reuters. “Odds of a June or July rate cut have increased, but ultimately further stimulus remains data-dependent in coming months."

"The underlying objective here is to depress short-term government borrowing costs," said Luis Costa, emerging FX strategist at Citi, in a client note.

"I continue to believe the FX markets are way too complacent with this uber-dovish (central bank) stance," Reuters cited him as saying.

Hungary's government also plans to merge the financial markets regulator into the central bank to enhance its powers of oversight.

Hungary's five-year credit default swaps - the cost of insuring its debt against default - also rose 17 basis points to 323 bps, according to Markit.

Zoltán Árokszállási, analyst at Erste Bank in Budapest told Reuters that liquidity freed from the 2W note could be directed into short government securities or some of it could be pulled out of the country.

Not forint friendly plans

The details of the third leg of the NBH new loan programme are “crucial and are not forint friendly," commented Gábor Ambrus, strategist at 4Cast in Sofia.

He reminded that the official rhetoric is that only those institutions that are lending to the economy should benefit from the yield on 2W deposits. “This in turn is a major burden on the budget and was (or until now it was) expected to create a HUF 80-100bn hole in the 2014 budget given that the budget has the obligation to cover the NBH's losses. These losses mainly stem from interest rate costs on the 2W policy instrument," Ambrus added.

“The measures aim at excluding offshore investment inflows from the short term instrument of the NBH. While de jure this is not a cap on 2W deposits, de facto it is," he said.

The strategist noted that the measure will reduce the total amount deposited at the NBH.

“The excess money previously deposited by non domestic credit institutions will be pushed out to the market where interest rates are set not by CB policy but by supply and demand conditions. As a result, short term market interest rates should drop below that of the 2W NBH instrument. As the 2W NBH instrument then ceases to be a total anchor and will serve as a top rate only, the measure equals to an interest rate cut."

Loopholes will be crucial

Ambrus noted that how big this interest rate cut will actually be will be a key issue not only for the entire plan but also for the forint.

“The impact will depend amongst others on how many loopholes will be in the system - for instance, whether offshore investors will be able to deposit their money in with local banks which then can for a mark up make a deposit at the NBH or whether there will be some backdoor measures against this."

Ambrus believes the programme will be “strongly constructed" and thus will have a “strong impact" on short-term interest rates. He bases this assumption on the fact that the NBH said earlier that it aims at a significant (to the tune of HUF 900 bn, about a quarter of the total) reduction of amounts parked in the 2W policy instrument and also that the NBH is adamant to reaching this target with this policy tool only.

Impact possibly limited

Ambrus believes the impact could be more limited for three reasons:

• “if it is for instance accompanied by increased forint and reduced FX debt issuance by ÁKK - this would naturally reduce the forint supply that can find its way to 2W deposits although in this case there will be a maturity mismatch issue that will be difficult to overcome;
• if the programme is gradually introduced or if the target amount is reduced from HUF 900bn; and
• EU regulations on the free movement on the capital could reduce the NBH's ability to close down loopholes in the system that would allow offshore money to flow back to the NBH. The devil will be in the details."

“Nevertheless, it is clear that de facto a cap-type measure will be introduced, despite earlier indication that there will be no administrative cap. In conjunction with further expected cuts in the base rate -we think potentially down to 4.00%- the programme clearly leaves EUR/HUF biased higher."

The strategist noted that the details of the programme, its pacing, the amounts and the loopholes will be revealed only later and this will show us the exact extent of this bias.

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