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CEE & Turkey

Brexit, not Fed, a concern for Europe’s emerging markets

Although emerging markets like Turkey reacted positively on expectations that the US Federal Reserve is unlikely to raise rates this month, many EMs have already factored in such risk and only a higher frequency of hikes would likely affect them. The larger threat to European EMs is the risk of Brexit, which is already weighing on countries such as Poland, and could lead to a much larger fallout.

Jun 6, 2016 // 5:17PM

Growing speculation that the Fed is unlikely to raise interest rates later this month after weaker than expected employment data has led to a small emerging market rally.

“By not raising interest rates, the Fed is certainly supporting emerging markets across the sector,” said Regis Chatellier, Senior Emerging Market Credit Strategist at Societe Generale.

The Hungarian forint and Polish zloty strengthened last week, reaching multi-week highs against the euro, up 0.2% and 0.4% to 311.30 and 4.371 against the euro respectively.

10-year Romanian bonds saw their yield bid fall 8bp to 3.61%, with the country’s leu gaining 0.1%.

Turkey’s 10-year government bonds also saw yields fall 25bp, extending a fall that has amounted to 43bp last week, leading to a yield of 4.423%.

The lira rose over 1.3% and reached 2.90324 to the US dollar at the end of the week, and currently resides at 2.90815 to the dollar.

Yields on Turkey’s lira-denominated debt are expected to fall to 8.5% over the course of the year according to strategists at a Turkish bank, whilst also predicting that the currency will remain stable.

Although the markets reacted positively to the fact that there is less of a risk of a rate hike, to some extent it has already been priced into the markets, and whilst the risk is low in the short term, long term Fed action could still negatively impact EMs.

“An increase in the frequency of interest rate hikes could impact emerging market fundamentals.”

However, whilst the Fed’s actions may not immediately have a large impact on Europe’s emerging markets, the possibility of Brexit could have a significant impact for countries such as Hungary and Poland in comparison to Turkey.

Poland would be significantly affected as it is the main benefactor of EU funding, although analysts at Citi stated that the forint would also prove vulnerable to the risk of Brexit.

Polish 10-year government bonds saw yields rise 7bp to a 4-month high of 3.185% and Hungarian bonds have also seen their yields rise around 1bp to 2bp this week as a result of Brexit concerns.

The possibility of Brexit could have other implications than just raising the yields on Eastern European debt.

“We haven’t seen a recession recently, and historically we have one every 7 to 8 years. Statistically we are due for one, but Europe is still pretty fragile; the banking sector is weak and debt levels are higher than before. A Brexit could be the catalyst for something much bigger,” Chatellier stated.

CEE & Turkey Macro Europe

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