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‘Print and hope’ in progress


In 2012 a further several hundred billion dollars, euros, pounds and francs, and trillions of yens, were injected into the world economy through various forms of monetary stimulus, such as QE3, Operation Twist, LTRO, OMT, EFSF, or ESM. All these acronyms and code names mask the same old response invariably adopted to tackle major crises: print money and hope for the best. This solution has never worked, but surely “things will be different this time around”.

Throughout 2012 the central banks of the United States, the European Union, Great Britain, Switzerland, China, and Japan made repeated attempts to support their economies. Unfortunately, interest rates – the simplest and most readily available tool of economic stimulation – have been at record lows or even zero for almost four years, and further cuts are either aimless or impossible. Under these circumstances, the main recourse has been to print money, in the belief that a weakened national currency will help exports, thus boosting overall economic growth. But because almost everyone hit upon the same idea and got busy printing, the pile of empty money has grown without the desired effect on exchange rates. The issuance of fresh money continued apace through the last three months of 2012. After the September announcement by the Fed that it was embarking on a third round of quantitative easing (QE3), and after the decision by the European Central Bank (ECB), also in September, to approve an unlimited bond buying programme known as Outright Monetary Transactions (OMT), in October the Bank of China stepped in with a cut in the mandatory reserves rate for banks and a relaxation of credit conditions. In November and December it was the turn of the Bank of Japan, which announced that it was expanding its asset purchasing programme by at least JPY 10,000bn (€88bn). And towards the end of 2012 the Fed acted again with Operation Twist, a sterilised purchase of bonds, or in other words a commitment to print a further $45bn (€34bn) a month.

“Buy and hold” used to be a well-known strategy for risky assets. After 2008 it was replaced by a grimmer maxim: “buy and hope”. From Q4 2012, the prevailing version seems to be “print and hope”.

If we evaluate 2012 by looking at the EUR/USD rate − the most accurate economic barometer − and compare its values at the beginning and at the end of last year, we might conclude, incorrectly, that it was a period of calm. In fact 2012 brought no shortage of emotions, due to two major twists and turns. The first came when, after a benign first quarter, the problems of the eurozone set the single currency on a downward trend that lasted for the whole of Q2. The other twist came in Q3, or more precisely in July, when ECB governor Mario Draghi declared that the bank would do its utmost to save the monetary bloc from implosion. The euro’s performance has improved steadily since and, following an October announcement from the Fed that it would increase its asset buying programme, the EUR/USD pair ended the year at a level similar to the one it was at the end of 2011.

There is no doubt that 2012 also proved to be a good year for the zloty, which gained about 8% to the euro and more than 10% to the US dollar compared with the end of 2011. Although the gains were not uninterrupted (Q2 saw a depreciation of the zloty), Poland’s positive real interest rates and investors’ confidence in the strength of its economy made the country’s currency a popular choice.

Zloty’s strength fuelled by inflows into domestic bonds

Over the past two years Poland’s central bank has pursued the most restrictive monetary policy in Europe. The country’s main interest rate has risen by 50 basis points during this period, and for a long time the difference was +100 basis points. Such a policy stance was not, however, a reflection of any exceptional strength of the Polish economy. Rather, it was a result of the unshaken belief of the Monetary Policy Council (RPP) that the country was in for a mild slowdown only, a scenario that did not play out after all.

In an environment of globally low interest rates and negative bond yields in the biggest countries, two Central and Eastern Europe (CEE) nations, Poland and Hungary, became popular destinations for bond investors looking for meaningful returns. It is small wonder, therefore, that the proportion of Poland’s local-currency debt held by foreign investors has more than doubled over the past three years to surpass 35% of the total, up from 17%, while the nominal value of foreign-held domestic bonds jumped by PLN 108.5bn (€26.6bn) to reach PLN 187.1bn (€45.9bn). The enhanced global appeal of Poland’s local denominated debt has contributed to an appreciation of the zloty, as investors had to buy the local currency to invest in the country’s domestic bonds. This structural shift will have an impact in the coming quarters.

EUR/PLN exchange rate vs. 10-year Polish bond yield, 2010-2012

2013: a year of hope and… fat left tail risks

One consequence of the increased exposure of foreign investors to Poland’s local currency debt will be an ever closer dependence of the exchange rate of the zloty on sentiment on the bond market. Even a small bit of profit-taking by foreign holders or a minor reallocation will create a large supply of bonds and of the zloty on the market without a corresponding increase in demand. Maintaining positive sentiment among bond investors will require a constant supply of good news. And what are their expectations for the coming quarters? First and foremost, they are counting on swift interest rate cuts and the reduction of the main rate to below 3.25%, i.e. by a further 100-plus basis points. Such a monetary loosening is already priced in by the bond market. From a purely theoretical perspective, cuts of this order are possible, as the consumer price index (CPI) is likely to run below the central bank’s target (2.5% y-o-y) during the first two quarters of 2013. However, the RPP members are noted for their conservatism, and it would be a gigantic surprise if they were to take such sudden action to stimulate the economy.

Another source of hope is the prospect of Poland’s debt rating being upgraded by a notch from the current level of A-. This would definitely act as a magnet for global institutional investors with sufficient resources to push bond yields lower and send the zloty firmly below PLN 4 to the euro and PLN 3 to the US dollar. However, such a scenario is not very likely due to a growing risk of an “unexpected” increase in the budget deficit. In fact, in the second quarter of 2013 the deficit could overshoot the government’s target by as much as PLN 10-12bn (€2.5-2.9bn), or 30%. In my view, a funding gap of this magnitude would be hardly surprising, given the coincidence of two factors:

  • lower-than-forecast tax receipts in 2012 (the shortfall is already running into several billions of zlotys);
  • overly optimistic assumptions in the 2013 budget regarding the rate of GDP growth (2.2%) and budget revenue growth.

From a budgetary perspective the problem can be solved very easily: because by the end of 2012 the Ministry of Finance had pre-financed 30% of its borrowing needs for 2013, it could simply reclassify the missing amount. The question, however, is whether investors will be equally relaxed about bonds issued today to pre-finance future needs being turned into yesterday’s debt. The bond market is not pricing in negative surprises of this kind at the moment.

It is also possible that 2013 will see a continuation of the “search for real yield” strategy on the bond market, in line with the old market maxim that “the trend is your friend”. However, any realistic analysis has to take account of the fact that another year of similar gains for Poland’s five- and 10-year bonds would mean that they have become equally trusted and respected as the German Bunds, i.e. the government securities of the biggest and most reliable economy in Europe and the guarantor of stability in the eurozone. It is hard even to imagine such a scenario, especially since in the first half of 2013 Poland will be grappling with a major deceleration of economic growth, and the main challenge in Q1 will be to keep growth from falling below 0.5% y-o-y.

Under these circumstances, continued strong inflows of capital into Poland’s local currency debt – and the consequent appreciation of the zloty – will depend on whether the prospects of a dynamic recovery beginning in H2 2013 do not come under threat. And there are several sources of downside risk to growth in the near term: political tensions in Europe (general elections in Italy and Germany), the need to extend financial support to Spain, and the major deterioration on Poland’s labour market, which will weigh down on consumption (in Q1-Q3 2012 consumer spending in the country grew by a meagre 1% y-o-y). There are also the risk factors outside Europe, notably the “fiscal cliff” issue in the US and uncertainty over the strength of the recovery in China. Thus there will be no shortage of concerns throughout Q1, and the chances of positive surprises appear slim.

My personal view is that a much more trivial factor could set off a correction on the Polish bond market and a resulting depreciation of the zloty in H1 2013, namely the natural cycle of asset allocation in the global financial markets. With interest rates persisting at ultra-low levels and with growing risks to government debt, investors’ attention is likely to shift towards equities. During the past five years we observed the following shifts: in 2007 to equities, in 2008 to industrial commodities, in 2009 to cash, in 2010 to agricultural commodities, in 2011 to gold and in 2012 to bonds. This suggests that equities are the next stop, which could take some of the speculative money out of the bond market. And while the consequences for the zloty would be negative, the economy would benefit after one or two months, enabling it to post growth of about 1.7% in 2013 as a whole. For experience shows that the zloty follows developments on the Polish stock market with a lag of not more than several weeks.

EUR/PLN exchange rate vs. WIG index, 2010-2012

A major factor arguing for a stock market rally is the large pile of idle cash in the economy. According to data from the National Bank of Poland, at the end of September 2012 the value of bank deposits of Polish households reached PLN 503.4bn (€123.6bn), an all-time high. With bank interest rates below inflation, and with bond returns falling, this huge amount of cash has the potential to generate a new bull market as it begins to flow into the Warsaw Stock Exchange. This process will definitely not begin before Q2 2013, so while the markets are already high, late comers still have time to accumulate equities.

This article expresses the personal views of the author.

Paweł Cymcyk

Investment Communication Manager at ING IM (Poland)

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