EM FX Insider (Daily): No Hunger for Hungary

The first 3 trading days of 2012 have been booked and most G10/USD pairs remain confined within recent range boundaries. However, EM FX has been decidedly more volatile and independent for that matter as significant domestic developments are driving unilateral price action for the respective currencies of a number of emerging market economies; most notably Hungary which saw EUR/HUF strengthen to record highs.

Hungarian Forint strength (HUF) seen late November ’11 and sporadically through December on reports of impending IMF aid have so far proven to be no more than mirages (see 26 Nov. 2011 EM FX INSIDER: SUBMERGING EM currencies). Negotiations between Hungary and the IMF regarding potential bailout funds have broken down as recent constitutional provisions have threatened the independence of Hungary’s central bank (NBH).

Speculation that the Hungarian government could be seeking control of the NBH’s (Hungarian central bank) reserves have sent even the vulnerable EUR to record highs against HUF. Financial instruments across Hungary have been in a state of paralysis, with the exception of FX and CDS which also hit record highs above 700bp, as the combination of anemic growth and potentially devastating consequences from its government’s defiance of EU and IMF bailout conditions have put its economy teetering on the brink of complete insolvency.

In the short to medium term picture, HUF is likely to continue to underperform as political discord will likely delay or potentially even terminate any potential EU/IMF aid package for Hungary. Upcoming talks in Washington are likely to be pivotal but it’s difficult to see any progress made as things currently stand.

Accordingly, we think HUF weakness may continue in the medium term but ultimately believe a weaker Forint may help boost growth prospects on the condition that the EU debt crisis begins to stabilize. As things stand, a comprehensive rescue package does not seem to be attainable in the foreseeable future which may see HUF under-performance continue a while longer, specifically against EUR.