European Debt Woes Expand As Hungary Downgraded

by Win Thin

Moody’s downgraded Hungary two notches to Baa3, matching the BBB- ratings by both S&P and Fitch. Our model has long put Hungary at junk status, and we note that its implied rating deteriorated further in our latest round to BB/Ba2/BB from BB+/Ba1/BB+ previously, and so we believe further downgrades are likely. Indeed, we note that S&P affirmed Hungary’s BBB- rating last month but kept the negative outlook in place, signaling that all is not yet clear for the country. We believe that markets have gotten too bulled up on Hungary lately and are overlooking fiscal and downgrade risks that remain in place. Without the IMF program (which expired in October), we simply do not think Hungary has the stomach to stick with aggressive fiscal tightening in the midst of a tough economic backdrop. Moody’s move comes after the government unveiled its 2011 budget, and so the agency clearly has some doubts about the fiscal trajectory. Note that Hungary (actual ratings of BBB-/Baa3/BBB) CDS price of 351 bp is higher than Romania (actual ratings of BB+/Baa3/BB+) at 318 bp.

EUR/HUF fell last week as EM came back strongly, but appears to have put in a near-term base around 276 for now, which is the 200-day moving average. We think current levels offer value to go long EUR for a move back to 285 (late November high) and then 290 (September high). We still favor going short HUF vs. TRY and PLN. In the former, we think a near-term low was put in place just below 140 and we look for a move back to 145 (late November high) and then 150 (September high). In the latter, a good base was established just above 69 and so we look for a move back to 71 (mid-November high) and then eventually 73.30 (September high). In our view, the surprise rate hike in Hungary is not going lend the forint much support in the current environment.