Czeched-out: CNB drops peg with the euro

<p>If you want to drop a currency peg, then the CNB can show you how to do it. After dropping the EUR/CZK peg earlier today […]</p>

If you want to drop a currency peg, then the CNB can show you how to do it. After dropping the EUR/CZK peg earlier today the koruna has rallied less than 1% versus the euro, and volatility has been moderate. Dismantling a long-held currency regime doesn’t need to be as volatile or panic-stricken as Swiss peg debacle back in 2015.

We mentioned last Tuesday that the CNB could drop the peg at any time after the bank failed to commit to maintaining the peg after April 1st. Doing it sooner rather than later was a good call from the CNB for a few reasons:

  • It potentially limited the amount of speculative capital flowing into the CZK on the back of expectations that the koruna would rally once the peg was dropped, this has helped to limit volatility on Thursday.
  • The CZK weakened last Thursday after the CNB failed to drop the peg at its schooled rate-setting meeting, this shook out some of the long CZK speculative interest, which also helped to keep volatility contained.
  • The bank had spent 4 months telling the market that the peg would be dropped, 10/10 for communication, taking the market by surprise a la SNB was a move wisely avoided by the CNB.

Positioning was not as extreme in EURCZK as it was in EURCHF, but there was still approx. $65bn of speculative inflows in EUR/CZK. The CNB should be praised for the smooth transition from a pegged currency to a floating one.

So where does the CZK go now?

As mentioned, the CZK has rallied only moderately on the back of today’s CNB action, and it isn’t even the best performing currency in the EMEA space. The timing of dropping the peg has been pre-emptive: the economy isn’t too hot that the CNB desperately needs a stronger currency, neither are bond yields too high, which means the CNB doesn’t have to worry about hiking interest rates. Instead, the CNB can keep a steady ship for now, although it will want to have one eye on inflation, which has risen to 2.5%, the highest level since the end of 2012. We don’t expect the CNB to hike interest rates yet, although this could be on cards for the summer months. If the CNB does hike rates then we would expect CZK appreciation against the euro.

Is the post-peg Swissie price action a blueprint for the CZK?

Although we think that the CNB masterfully avoided a SNB –style debacle today, the CZK may not be able to avoid the same fate as the CHF. The Swissie has remained stronger versus the euro since its peg was dropped in 2015, and EUR/CHF has not managed to get back to 1.20, it is currently trading at 1.07, and has lost 3.6% in the last 9 months as the ECB embarks on an extension of its QE programme. The CZK could also trade with an upward bias while the ECB maintains its ultra-lose monetary policy, and we think it will be tough for EURCZK to get back to 27.00 in the aftermath of this currency shift.

Upward pressure on the horizon:

The CZK might only be moderately higher today, but there could be upward pressure on the horizon. Right now the spread between German and Czech 10-year bond yields is at a crucial support zone that dates back to 2014. If this spread drops further and the spread widens to more than -0.65 basis points, as you can see on the chart, then we would expect further EURCZK appreciation, potentially back towards 25.00 in the next couple of weeks.

Figure 1:


Source: City Index and Bloomberg

Build your confidence risk free
Join our live webinars for the latest analysis and trading ideas. Register now

StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.