Weekly 2017 Week 08 WEEK AHEAD. Market Research Czech Republic & Eurozone. February

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1 Weekly 217 Week 8 MARTIN LOBOTKA, (+42) , MLobotka@42fs.com, Research@42fs.com CALENDAR WEEK AHEAD DAY DATE TIME (CET)* MARKET RELEASE CONSENSUS** 42FS Monday 2-Feb 16: EMU (Preliminary) Consumer confidence, Feb' N/A A week of soft and leading indicators. Tuesday 21-Feb 1: EMU (Flash) Composite PMI, Feb' N/A Wednesday 22-Feb 1: GER IFO Business Climate, Feb' N/A Thursday 23-Feb 8: GER (2nd est.) GDP, 46, q/q SA.4% N/A Friday 24-Feb 9: CZ * LOCAL TIME IS CET ** REUTERS POLL FEBRUARY 217 AUCTIONS Business/Consumer confidence, Feb'17 N/A N/A NAME DATE OF DATE OF AMOUNT MATURES ON AUCTION ISSUE OFFERED COUPON SPP Feb-17 3-Feb-17 5-May-17 CZK -5 bn. N/A CZGB Feb-17 1-Feb-17 1-Feb-2 CZK 6 bn. max.% CZGB * 8-Feb-17 1-Feb Oct-23 CZK 3 bn. max.45% CZGB Feb-17 1-Feb-17 1-Feb-27 CZK 5 bn. max N/A SPP Feb-17 1-Feb Aug-17 CZK -5 bn. N/A SPP Feb Feb May-17 CZK -5 bn. N/A CZGB Feb Feb-17 1-Feb-2 CZK 6 bn. max.% CZGB ** 22-Feb Feb-17 x.x.222 CZK 3 bn. max.% CZGB *** 22-Feb Feb May-3 CZK 4 bn. max.95% SPP Feb Feb Aug-17 CZK -5 bn. N/A And not much is expected of them: IFO, PMI are both expected to stay more or less unchanged on January, as is consumer confidence. Hence, the only interesting release is the structure of German GDP growth in 46. And, possibly, Czech consumer confidence, but only because it might post a new post-crisis high. ANALYSIS OF THE WEEK YELLEN REMINDS ME OF MY HUSBAND. KEEPS OVER-PROMISING AND UNDER-DELIVERING. 42 Financial Services Market Research Weekly 217 Week 8 1

2 WEEK BEHIND Czech growth disappoints in 46 Import prices rise at the fastest rate in 3 years, but only because of energy German, Italy GDP growth disappoints in 46 ECB is far less sanguine about sustainability of inflation than CNB Czech bond yields rise strongly, possibly on foreigners scrapping short EURCZK bets FX Nothing new on the EURCZK. CZECH YIELDS RISE NOTABLY, POSSIBLE ON FOREIGNERS WITHDRAWALS FROM CZ MARKET CZGB 1Y, % GERGB 1Y, % 1-Oct-16 8-Oct Oct Oct Oct-16 5-Nov Nov Nov Nov-16 3-Dec-16 1-Dec Dec Dec Dec-16 7-Jan Jan Jan Jan-17 4-Feb Feb Feb-17 2Y CZ-GER spread, b.b Governor Rusnok just repeated last week that there won t be any exit in 17 and that mid-year exit looks likely. No wonder spot / forward markets remained calm. FI Czech yields rose, spreads widened to levels unseen, on the short end of the curve, since August last year. This could, in theory, be the reflection of unwinding of the speculative positions the build-up of which we ve witnessed this year. In favor of this theory speaks the fact that German yields fell further last week, a consequence of dovish minutes from ECB January meeting. Against it speaks the fact that we don t see anything happening in the forward or spot EURCZK market (which one could expect if foreign speculators were indeed withdrawing from the short EURCZK bets). We won t be much smarter until we see data on foreign residents holdings of Czech government debt for February. The outlook-wise, however, the combination of forward points and higher yields might attract 42 Financial Services Market Research Weekly 217 Week 8 2

3 foreign buyers eventually (=at the end of 17 when hard commitment of CNB expires). This is, thus, unlikely the beginning of the long upward trend in yields everybody s been waiting for for years. CZECH ECONOMY CZECH GROWTH REMAINED SLOW IN 46 Czech % q/q GDP, (SA,WDA, real) Czech economy grew just.2% q/q in the final quarter of 216, just as in 36 and thus markedly slower than in 1H16. And also markedly slower than over 2H The growth for the entire 216 was thus 2.3%, in line with my expectation of 2.5% from December 215 (see December 31, 215 Quarterly report). As for the structure, 46 details have not yet been released but since the growth in 2 nd half of the year was slow (.2% q/q in each quarter), what held in the 1H16 will be valid for the entire 216. In other words, household (and government) consumptions were the most positive factors while fixed investments (i.e., construction on the supply side of the economy) were a drag. Inventories are probably behind weak 46, then. This year, I expect about the same growth, and the dominant factor will be the same: household demand. Although inflation did rise recently, lowering real wage growth, and despite the fact that unemployment (being at the natural level) won t fall much further, ongoing decline of interest rates, high consumer confidence and expansionary fiscal policy (built-in 217 budget) will counteract these. It s getting close to the elections, that s for sure. Czech Social Democrats (CSSD) resurrected the idea of taxing banks more which is the same promise the campaigned on before 213 elections, with the change that they don t want to slap special tax on utilities and telecoms like they wanted to back then. Furthermore, PM and CSSD leader Sobotka also said that the so-called Bohumin declaration of 1995 proscribing the cooperation between CSSD and 42 Financial Services Market Research Weekly 217 Week 8 3

4 HUGE NET INFLOWS OF THE PORTFOLIO INVESTMENTS SEEN IN THE FINANCIAL ACCOUNT IN DECEMBER Dec-8 May-9 Portfolio investments, balance, CZK bn. (minus denotes net inflow) 12-month sum, CZK bn. Oct-9 Mar-1 Aug-1 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15 Aug-15 Jan-16 Jun-16 Nov-16 THE GAP BETWEEN CURRENT ACCOUNT SURPLUS AND SPECULATIVE MONEY INFLOWS REMAINS LARGE Cumulative current account surplus (without reinvested earnings) and cumulative FX interventions of CNB since November 213, CZK bn. XI-13 III-14 VII-14 XI-14 III-15 VII-15 XI-15 III-16 VII-16 XI-16 extremist parties (incl. importantly also Communist party, KSCM) is obsolete and that he can imagine forming a government with KSCM after the elections in the Fall. Zdenek Fierlinger s name comes easily to my mind when reading his words Both of these things are a reflection of CSSD s impuissance vis-à-vis the Minister of Finance Babis party (ANO 211) which leads the polls. This fact, and the CSSD overtures to Communists, make, barring miracle, for pretty much lose-lose 217 elections. Current account ended up in a surplus of CZK 73.6 bn. in 216, i.e. about 1.7% of the forecast 216 nominal GDP. Without reinvested earning, the surplus was CZK bn., i.e. 3.5% of forecast nominal GDP. In December alone, the current account was in large deficit (CZK -22 bn.) which was caused by large outflow of dividends, something that is unusual for December. In the financial account, the portfolio investments saw a huge net inflow (almost CZK 17 bn.), a result of (the combination of) the balance sheet optimization of local banks at the end of the year (associated with Resolution fund) and the speculative inflows into CZK that CNB sterilized. All in all, since November 213, the CNB bought almost CZK 9 bn. worth of FX currency. The cumulative surplus of the current account over the same period was just one third of that. This illustrates you just how much did the speculators get ahead of the real economy did IMPORT PRICES ARE RISING Import prices, % m/m, 3M average Import prices show we re still not importing any demand inflation form Eurozone. To be sure, import prices are rising: import prices rose 1.3% m/m in December, fastest rate in three years. Imported demand inflation banging on our door? Not really: 1 pp of that monthly growth is accounted for mineral fuels, materials and food. Looking at the y/y evolution of major subsectors of import prices confirms that: import prices of consumer goods are 42 Financial Services Market Research Weekly 217 Week 8 4

5 BUT NOT DUE TO IMPORTED DEMAND INFLATION Import prices of mineral fuels, raw materials, food and consumer goods (y/y, %) st CNB FX intervention GERMANY, ITALIAN GROWTH DISAPPOINTED IN MARKETS Germany, GDP,% q/q France, GDP, % q/q Spain, GDP, % q/q Italy, GDP, % q/q BUT LEADING INDICATORS, ESP. IN INDUSTRY, ARE SLIGHTLY MORE OPTIMISTIC Non-Mfg PMI Germany Non-Mfg PMI Italy still falling, as has been the case throughout the year. Moreover, the primary reason why these only fall at.4% y/y rate in December (as opposed to - 4% y/y in last April) is the base effect. As I said many times: it ll be some time before we truly import demand inflation from our largest trading partner. Not that CNB cares EUROZONE ECONOMY German and Italian growth undershot the expectations in 46. The former I did expect, the latter I did not. Germany grew.4% q/q in the final quarter, Italy.2% q/q. The 216 growth was thus 1.9% and 1%, respectively: nothing stellar but not dramatically different from US growth in 216 (1.6%) where FED still expects three hikes. As in Czech Republic (or, more accurately, as Czech growth reflected), German growth in 2H16 was much slower (.1 and.4% q/q, respectively) than in first two quarters of the year (.7% and.5% q/q). As regards Italy, two halves were equal (-lly weak):.4% and.1% q/q in first two quarters and.3% and.2% q/q in the last two. But, hey, the economy s been growing since 15. That s something Structure wasn t released but German Statistical Office said household consumption and investments were positive contributors to 46 growth while net trade wasn t (likely more due to imports). In Italy, we know nothing just yet. As regards the outlook, leading indicators improved, predominantly so in industry (which weight in the economy, however, isn t decisive), but I don t expect much faster growth in 1H17 than we saw in the final quarter of 216. Somewhat faster yes. ECB s way less sanguine about the sustainability of the recent inflation rise than CNB and thinks substantial degree of 42 Financial Services Market Research Weekly 217 Week 8 5

6 Mfg PMI Germany Mfg PMI Italy monetary accommodation is still needed ECB said that the recent inflation rise was primarily due to energy (true), that the underlying inflation pressures were still weak (true) and that the progress towards a durable and self-sustaining convergence in the path of inflation consistent with the Governing Council s inflation aim is insufficient. In other words, nothing changes in the monetary policy, assets will continue to be bought. I understand CNB desires to leave the annoying intervention regime, but for the record: what ECB said is equally valid for Czech inflation too. Anyway, to strengthen the dovish message ECB said there is no room for complacency and that it is so mainly because of political risks at the global level and within the euro area. In other words, we fear Trump and Le Pen and Brexit. As is customary, strong call was mode on other policymakers to do their part and support Eurozone recovery. That s you, Italian and French governments. As outlined above, German yields fell and the EURUSD, rising up to that point to almost 1.7, reversed. The reversal was further compounded by another communication misstep (as it will turn out, just wait) of Yellen. Speaking in Congress last week, she again, just like in early 216, managed to corner herself with a promise to raise rate quickly, this time saying that waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession. Not only do three hikes look increasingly unlikely against the background of mediocre data that ve been coming out recently (and 216 growth of 1.6% wasn t anything to write home about either ), but she ain t too consistent, if you ask me: half a year back she was telling Congress that it was all asymmetric, that Fed could err on the side of waiting too long rather than acting prematurely. Why the change now, with weak-ish data, I don t know, but she s likely to have to break this promise too 42 Financial Services Market Research Weekly 217 Week 8 6

7 Fewer hikes in US, better growth and eventually talk of tapering in Eurozone = I continue to see strong EURUSD upside (unless Le Pen wins ). 42 Financial Services Market Research Weekly 217 Week 8 7

8 MARKETS MM / IRS % bps. % ASW spread* CZGB** FX 3M PRIBOR 6M PRIBOR 2Y 5Y 7Y 1Y Actual M M M Y 3Y 4Y 5Y 7Y 1Y Actual M M M Y 3Y 4Y 5Y 7Y 1Y Actual M M M EURCZK EURPLN EURHUF EURRON EURTRY EURUSD Actual M M M Act ual M -6M M 6M 2Y 5Y 7Y 1Y PRIBOR PRIBOR Act ual -3M -6M Y 3Y 4Y 5Y 7Y 1Y Act ual -3M -6M -.6 2Y 3Y 4Y 5Y 7Y 1Y 27.2 EURCZK As of today * Spreads to generic bonds ** Generic bond CONTACTS RASTISLAV ZIVOR, CHIEF EXECUTIVE OFFICER MARTIN LOBOTKA, ANALYST RESEARCH (+42) , RZivor@42fs.com (+42) , MLobotka@42fs.com Research@42fs.com AVAILABLE AT THOMSON REUTERS EIKON MESSENGER PREVIOUS ISSUES OF WEEKLY AND OTHER REPORTS ARE AVAILABLE HERE 42 Financial Services Market Research Weekly 217 Week 8 8

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