FxWirePro: Constructive Polish zloty now seems little edgy as EU likely to impost political stress – Stat short in EUR/PLN with astute risk profiling

We have now turned modestly constructive on the Zloty, given strong data momentum.The central bank’s dovish stance is unhelpful, but data may challenge it over coming months.

Short-term valuations look cheap, demand for local bonds remains strong and the market is likely to discount political risks without any clear path for EU to impose Article 7 sanctions on Poland. We still acknowledge that PLN screens overvalued in our BEER FV framework.

Improving fundamentals and diminishing political risk premium PLN has been under pressure since May. Ongoing political tensions with the EU regarding the country’s overhaul of the judiciary have raised the specter of Article 7 sanctions.

Additionally, dovish rhetoric from some MPC members of the National Bank of Poland (NBP) has sowed doubt regarding materialization of interest rate hikes in 2018.

More recently, rates in core developed markets have corrected higher, weighing broadly on EM currencies.

Trade recommendation:

Contemplating above aspects, we advocate shorting EURPLN spot, which is trading at 4.3060. The position generates carry of about +15bp per month. We target a 1.89% move lower to 4.2260 and place a strict stop-loss at 4.3432, thereby, one could achieve attractive risk/reward.

Risk profiling: Positioning in the currency is a source of risk, with investors generally already bullish on PLN. Further controversial actions from the current Law and Justice government may create negative headline noise, which would be detrimental to the currency. Additionally, deterioration in the external environment or sharp increases in core rates would likely weigh on PLN and cause the trade to under-perform.