From star to shooting star - How Hungary's forint fell from grace again

If a butterfly flaps its wings

In just one week at the beginning of March, two credit institutions in the US closed down. A classic bank panic, to which I think it is fair to utter the familiar meme: "well, that escalated quickly". Although the horror of the 2008-2009 global financial crisis looms large in the minds of many of us, it seems that the US authorities learned their lesson for life then. They have now intervened quickly and effectively, primarily to prevent further bank runs. After all, trust is at the heart of the banking system. If there is no trust, there is nothing.

So for the time being, it seems that another financial market crash has been avoided. Nonetheless, the ripples have gone quite far, all the way to the forint.

But let's start at the very beginning of the domino line. The Fed, in its role as the US central bank, continued to maintain a rather hawkish tone even in early March, particularly after the January labour market data came in. The market had already begun to price in an even stronger cycle of rate hikes, which was to the detriment of emerging market assets. As the data on the resilience of the US economy kept coming in, everyone, even Fed policymakers, started to take a more hawkish tone.

Then the bank failures hit and the markets as a group started to worry that the Fed might have overstretched. But the failure of the SVB is hardly the Fed's fault. It was a bad investment strategy, compounded by a hasty "it seemed like a good idea at the time" solution by the failed bank. This led to the banking panic. Then came Goldman's view that the Fed might be so spooked by this bank failure that it would eventually back off its March rate hike. Investors didn't need any more, they were swift to start pricing out previously priced-in rate hikes and more. Interest rate expectations fell and with them, bond market yields plunged. In just three trading days, the yield on the two-year US Treasury bond fell by more than 100 basis points.

There has been only one example of a similar collapse in US history: Black Monday 1987 and the days that followed.

But it is not only in the US that interest rate expectations have fallen. The same happened with the ECB rate hike cycle and in European markets more generally. And that is where the National Bank of Hungary (MNB) comes in. Investors have, from time to time, played on the idea that the Hungarian central bank would have to ease sooner or later. Now that interest rate expectations have collapsed across the globe, it seemed logical that the market would suddenly price in Hungarian easing. Short-side interest rate swaps, implied yields and bond market yields have started to fall sharply. And in the blink of an eye, money market investors priced in an extra 50 basis points of interest rate cuts (150 basis points in total) by the central bank over the three months ahead.

This is how the forint managed to weaken by 12 units in three trading days. And the Hungarian currency fell in several steps from near 372 levels on 1 March to a total of 6.3% (measured against the 14 March 2023 rate). [Since the original publication of this article, the EUR/HUF exchange rate has risen further, peaking above the 400 mark on 15 March - ed.] Thus passes the glory of the world, and the celebrated star becomes a shooting star.

EUR/HUF

Source: Portfolio-Teletrader Kft.

Where to go from here?

Originally, the article was going to be about how long the forint could remain strong and how long the rally could last. Now it is all about what has happened to the domestic currency in just a few days.

So the question today is quite precisely whether there will be a way back to levels close to 370.

For the time being, there is a great lack of guidance from the Fed. Of course, there was a swift intervention by the US Federal Reserve, but since then everything has been shrouded in fog. I can't remember the last time there were opposing interest rate expectations in the market simultaneously. Indeed, at the time of writing, there are all sorts of ideas circulating among market participants, from a 25 basis point rate cut to a 25 basis point increase, with rates remaining unchanged. And uncertainty is one of the worst possible factors.

The European Central Bank, although only marginally affected according to the information available so far, reacted relatively quickly and indicated that there was nothing to see here. They are proceeding with the rate hike cycle as planned in the short term. It would be nice to have some similar communication from the Fed, or at least for the market to know what to expect. And the fact is that no matter what the Fed says, it will definitely help markets.

• For if it is said that the situation is serious and that the Fed is considering pausing its rate hike, then the market focus will be on a looser monetary policy stance and investor sentiment could improve.
• And if the Fed says that everything is in order according to its investigations and that there is a justification for raising interest rates, then risk aversion may diminish simply because the Fed is projecting strength and confidence and that it has everything under control.

Whatever the outcome, as long as there is no news and no communication, the markets will continue to churn and the forint will continue to toss and turn in the storm. But as I have outlined above, sooner or later (but hopefully sooner) market sentiment will improve and the fortunes of the forint may turn around. And after that, only the usual Hungarian stories will remain in question: what will happen to EU funds, what will happen to the apparent disagreement between the government and the central bank, and partly as a consequence of the above, what will happen to Hungarian interest rates.

The fact is that more and more investors are getting nervous about EU funds.

As we hear more and more from the government that we can do without Brussels money, there is growing doubt in the market that there will be a deal. And this could put a damper on the forint's ability to recover. In addition, there are also growing voices that the central bank will crack under government communication pressure, and the current wave of US bank failures will be a good excuse for this. However, seeing the reaction of the ECB and the weakening of the forint, this does not seem to me at first glance to be a well-thought-out line of argument. This is unlikely to turn into a monetary policy reversal. After all, the MNB has had an important secondary objective since mid-October: to maintain market stability alongside price stability. A financial crisis threatens market stability in the first instance and requires a short-term monetary approach. It is another matter that if the global hard landing scenario is indeed confirmed, a different approach may be required. But we are not there yet.

So for the time being, I think the MNB will continue to keep a cool head and stick to its monetary policy. If this is indeed the case, there is a good chance that the forint could return below 380, once the panic waves caused by the bank failure subside. However, in order to get to levels below 380, it would be necessary for the economic policy branches to avoid settling their differences in the open, even if they do not agree on everything. And, of course, there must finally be a certainty that EU funds will be forthcoming. However, in the absence of the latter positive impulse, let alone news to the contrary, the forint could move once again towards the 400 EUR/HUF exchange rate.

Cover photo: Getty Images