Will it pay off to wait for a weaker koruna?
The euro is trading most expensive against the koruna since 2009, up 16% since summer 2011. It largely paid off to wait with selling euros due to weak Czech economy. The chances for further weakening of the koruna are declining because the Czech economy is beginning to over-perform EMU and the koruna is already undervalued. We offer FX forward and strategies how not to bet on further CZK weakness. With FX rate closer to 28, think about KO-forward, giving better hedging rate than plain forward.
The summer is over and kids are back to school. The end of the year is still a couple of months away but it is the time for next year plans, including budgeted exchange rates. This brings a crucial question: to sell euros from future exports already now or to wait for better exchange rate? The euro-koruna is trading closer to 28, 16% above lows in the summer of 2011. In recent three years, it largely paid off to wait with selling the euros. Will it remain the case? It depends mainly on relative performance of the Czech economy compared with the Eurozone because the relative performance is most influential factor behind trends of the euro-koruna.
The Czech economy was not doing well in previous five years. Look at the key figures. In 1999-2008, the Czech GDP rose 30 percentage points more than the one of Eurozone. But in 2009-2013, the Czech economy shrank 3.4 percentage points, even more than 2.7% decline of Eurozone. That was driven by painful fiscal consolidation besides temporary decline in export markets, weak credit growth and slowdown in the inflow of foreign direct investments.
The Czech economy is beginning to over-perform Eurozone again (real GDP growth in % y/y)
Source: Erste Corporate Banking, CSO, Eurostat
The CNB beefed-up the impact of weak economy
It largely paid off to wait with selling the euros in recent years mainly thanks to central bankers’ decision to intervene on FX market. However, the CNB’s policy is rather amplifying the impact of sluggish economy than a factor on its own. Remember that the CNB mostly let the koruna to find its proper rate and rather modified its interest rate policy. Long second recession has changed the mind of majority in CNB Board.
Nowadays, central bankers proclaim to keep the barrier 27 till 2016, the protected level of 27 is okay, and once they abandon the level of 27, they will not let the koruna appreciate too much. However, these are proclamations. The decisions and action will depend on macro-economic figures and circumstances. These will depend on inflation, as the CNB is inflation targeting bank, but much more on how the Czech economy will be doing. Inflation is a lagging indicator.
Will the Czech economy continue to under-perform?
Despite poor performance in previous five years, the Czech economy has a good potential to do better than Euro-area. There are no sizable macro-economic imbalances. Previous budget deficit cuts put the Czech economy into a better position than most of Eurozone countries not only in the environment of expansion but also in the environment of mediocre growth in Europe or even a new recession.
Moreover, undervalued currency talks against expectation of further economic underperformance. Price level in the Czech Republic was 68% of Euro-area’s average in 2013, down from 75% in 2008 when the koruna was overvalued. Soft data from exporters and hard statistical figures, such as rising trade surplus, show that the Czech economy would be able to live with much stronger koruna without seriously endangering price competitiveness.
How not to bet on a weaker koruna
It is possible the growth underperformance and currency weakening continue. But is it wise to bet on it with your whole open euro-koruna position in the time when the Czech economy is starting to be doing better and the currency is already undervalued?
If you want to close at least partially your open FX position, we offer FX forwards but also strategies incorporating expectation that the CNB will limit koruna gains for long, even after abandoning the barrier of 27.
The euro-koruna is trading further from the floor set by central bankers in recent weeks and is more floating currency pair than till July. In the situation of weakened koruna and slightly higher implied volatility hedging strategy that gives no participation but better hedging rate than plain forward start to be interesting, such as Knock-out forward.
KO-forward will hedge future sale of euros at better rate than plain forward because the hedge is limited, e.g. at 27.20 in 2015. If the spot rate drop through predetermined level in the time of expiration, the hedge is switched-off. Yet, the risk can be acceptable and it looks as a good trade-off for better hedged rate when the CNB is on guard in 2015.