Forint mixed on interbank market

The Hungarian currency continued to oscillate in a relatively wide range versus the euro, with a slowly strengthening pattern for a third day on Tuesday, while it fell back versus the dollar and the Swiss franc.

The main driver of the forint was again the euro/dollar cross, with the euro losing nearly half of its 1.06% Monday gain against the US currency in constant attempts to fine-tune bets ahead of the Fedʼs policy meeting that ends on Wednesday.

Hungaryʼs government sold more three-month Treasury bills than planned at a regular auction on Tuesday on strong demand with mixed results. Auction yield fell 1bp compared to a week ago, but the yield shot up 7bps compared to the secondary market benchmark, illustrating volatility in view of uncertain Fed prospects and Hungarian central bank policies.

An expected tightening of monetary policy by the Fed later this year could reduce foreign capital inflows into riskier assets. No move on rates is expected this week from the Fed, so close attention will be paid to whether the Fed signals September or December as the most likely date for its long-awaited "lift-off".

"Central European short-end rates and yields are to remain well anchored in the short run, whilst foreign bond market inflows are likely to continue to abate with expected Fed tightening coming closer," Raiffeisen said in a note.

Domestic buyers of government papers in Hungary and Poland are able to offset the decreasing foreign inflows for the time being, but the US monetary policy outlook will be a key driver for local fixed income markets this year, Raiffeisen added.

Announced a week ago by the National Bank of Hungary (MNB), the end of rate cuts in Hungary anchored the short end of the Hungarian yield curve, while foreignersʼ holdings of forint-denominated government bonds have been declining.

The MNB will tweak its monetary policy tools from September by making three-month deposit to be its benchmark tool in place of the present two-week deposit, to encourage domestic commercial banks to buy more bonds, which could reduce risks from a Fed tightening.

It will also launch a new, 10-year preferential interest rate swap (IRS)facility for banks to increase local banksʼ holdings of local sovereigns by taking over duration risk.

"We expect the MNB to continue to support local bond markets with decent subsidy on the IRS facilities if portfolio debt outflows should continue," Citigroup said in a note on Tuesday.

Citigroup expects that the first 10-year IRS auction may take place after the next 10-year benchmark government bond auction on 6 August.

The IRS tool offered to local banks has been introduced in June 2014 with 3-year and 5-year tenors as part of the MNB’s Self Financing Plan and the MNB announced on 7 February that it would extend the facility to the 10-year tenor.

Total utilization has reached HUF 755 billion so far, helping to offset the decline in off-shore investors’ position in local bond markets. The central bankʼs existing 3- and 5-year IRS swaps carried a subsidy of 11 bps to 70bps since June 2014, "providing a flexible tool for the central bank to support local government bonds, depending on market conditions,", Citi said.

However, as a result of foreigners still holding a large share of Hungarian government bonds, any major external shock may trigger more forint volatility, ING said in a note on Tuesday. ING Bank projects that the forint will continue to trade in the 307-312 range to the euro as forex market liquidity will likely dry up and currency volatility decrease in August.