Another wave of selling hit the Hungarian FX market and the forint totally lost ground yesterday afternoon. As a result the Hungarian currency plummeted to two-years high as all emerging market’s high-yielding currency went under renewed pressure tracking bonds in core bond markets (especially in the EMU) lower. Hence, like in previous days the selling was triggered exclusively by external factors – rising yields in core bon markets. In such environment the forint becomes extremely vulnerable currency, because of Hungary’s huge twin deficit. Recall that the country’s budget deficit stands between 6-9% of GDP (depending on using accounting methodology), while the current account gap should reach 8% of GDP in 2006.
Looking at the intra-day development: initially, the EUR/HUF was moving only slowly north, but at the end of domestic trading the pair broke the key resistance (256.35), which triggered massive sell-off. The forint then immediately weakened by big two figures and sets new two-year high (259.15).
What next? Given the recent development on both FX and bond markets, it is likely that the NHB will not remain on sidelines. We think that if EUR/HUF brakes above the 260.0 level, verbal interventions from Monetary Council’s members will come. However they should be very cautions and use right words. In our view the central bank can not easily support the FX market by considering rate hikes. Although such a solution might be positive for the forint it might trigger a panic selling in the domestic bond market and re-activate capital flight from the country. All in all, we might expect another volatile session, while the forint might only hope that the recent bearish sentiment in core bond markets will ease in some way today.