During my recent trip to Hungary and Poland, I was able to gain firsthand impressions of those countries’ economic prospects and investment opportunities. For starters, their respective economic stories bear many similarities.
A Shared Economic Trajectory
Both countries have enjoyed stable, decent growth rates after the Eurozone debt crisis in 2011, and then faced a mild slowdown last year, followed by a reacceleration in growth this year (Exhibit 1). Their similar growth patterns are, I think, no coincidence: The uptick they’ve experienced this year is partially due to the acceleration of economic growth in the Eurozone, their main trading partner.
There’s another factor that may explain their economic slowdown in 2016 and subsequent recovery this year. As members of the European Union (EU), Poland and Hungary are entitled to receive financial support once every several years as part of the EU’s effort to reduce regional disparities in income, wealth and opportunities among European nations. This support is delivered in the form of so-called Structural and Cohesion Funds, which are significant contributors to public investment—and hence to growth—in central and eastern Europe. In 2016, the delivery of those funds was stalled in the bureaucratic corridors of the European Commission, and Poland’s and Hungary’s governments; it takes time to approve various government projects that would put those funds to work toward economic expansion. Many of those funds were finally deployed this year and are adding to growth.
Poland and Hungary have enjoyed economic growth in other respects, including consumption (which has been strong thanks to job creation and improving confidence); and years of decreasing unemployment, which was down to levels not seen since the early 2000s and has boosted disposable incomes. Poland’s and Hungary’s current-account surpluses—and their receipt of Structural and Cohesion funds—indicate a very favorable position in their balance of payments.
Divergent Inflation Trends
While recent economic growth in Poland and Hungary has been strong, inflation was “missing in action” for some time, much like in other countries throughout the world. But now those two countries appear to be diverging in that respect. In Poland, underlying (core) inflation was in negative territory in 2016. It turned positive this year and is trending upward but is still at low levels. There is still some slack in the Polish economy. Additionally, an influx of Ukrainian immigrants has increased the labor supply, kept wage pressures under control, and eased pressures in Poland’s labor market.
In Hungary, however, core inflation has been steadily trending upward and converging to the central bank’s target. Moreover, pressures on the country’s economic capacity are greater: Hungary’s economy is close to—if not at—full employment. Companies are adjusting to the tight labor market by increasing work hours. Further, the government raised the minimum wage rate by 8% this year which led to a rapid growth in earnings of about 13% annually, as of May 2017. All of these factors have ratcheted up inflationary pressures (Exhibit 2).
Divergent Monetary Policy
Monetary policy is another key difference between those two countries. The National Bank of Poland (NBP) has adopted a somewhat conservative approach and didn’t lower its policy rate below 1.5%, despite negative inflation. I believe this was a prudent approach, and, given low inflation, I think the NBP can credibly maintain low rates for a while. I also expect the NBP to keep the policy rate unchanged for at least until the summer of 2018—and then start hiking rates.
The National Bank of Hungary (NBH), however, adopted a very loose and unconventional monetary policy. In conventional policymaking, the central bank’s policy rate practically dictates the short end of the money market rate. That doesn’t seem to be the case in Hungary, where the NBH’s policy rate of 0.9% doesn’t reflect the money market rate. The NBH injected liquidity into the system using various tools that steered the short end of the yield curve to effectively zero. Further out along the yield curve, the two-year swap rates are about 0.4%. These rates appear unsustainably low for an economy that is near full employment, and where nominal growth in gross domestic product (GDP) year-over-year was more than 7% as of the first quarter of 2017. I expect the NBH to pursue policy normalization by absorbing some of the liquidity in the money market in order to bring short-term interest rates closer to the policy rate. That would mean higher rates at the short end of the yield curve.
What Does This Mean for Investment Portfolios?
- Currencies: From a medium-term perspective, the currencies of both countries look attractive, in my view. I believe they will be bolstered by strong economic growth and a strong balance-of-payments position. In both countries, central bank policy rates are much lower than longer-term neutral levels, meaning that short-term rates are expected to rise in the coming year or two and give further support to local currency. It’s true that both the Polish zloty (PLN) and Hungarian forint (HUF) appreciated noticeably this year, but in my estimation, they still look undervalued on a historical basis.
- Rates: I believe Poland offers relatively more value in rates (i.e., government bonds and related securities). In addition to low inflation and prudent monetary policy, Poland’s fiscal budget has surprised on the upside thanks to greater tax revenue because of tax reforms and improved tax collection. The debt office argued that some planned bond auctions in the fall may be canceled. Lower bond supply could translate to higher bond prices and lower yields later this year.
In Hungary, however, I believe that interest rates on the short end of the curve are too low. There is also risk of an overheated economy, which the central bank will need to avert by raising short-term rates. Yet the impression I had while traveling to Budapest was that the central bank is still very dovish: I believe it will keep monetary conditions easy as long as it can, and also try to prevent the HUF from strengthening too much as long as it can. As a result, I suspect short-term rates will remain low for the time being. But as inflationary pressures continue to mount, I think the NBH will need to change course. Our observation is that the yield curve in Hungary is quite steep by historical norms. Accordingly, we are positioning our portfolios through “curve-flattener” trades, which are consistent with our anticipation of higher short-term rates.
Poland, Hungary and Emerging Markets: Will the Rising Tide Lift All Boats?
Looking more broadly, we in the Global Debt Team see the economic outlook for Poland and Hungary as similar to that of other emerging markets, where fundamentals in most countries are in better shape, and where 2017 has seen a reversal in the capital outflows that had been occurring for more than three years. We believe this trend will continue and may spur a broad-based increase in allocations to emerging markets among investors—especially given the benign global economic environment, which is also showing broad growth with no signs of accelerating inflation.
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