EFTA01459609.pdf

12 January 2016 FX Blueprint Forever Young Growth. We expect divergent growth trajectories for strength expected this year should lead to some ILS Poland and Hungary in the coming year. Hungarian weakness. Barring this, continued FX interventions by growth should decelerate to 2.4% in 2016, primarily on the Bol will likely prevent further shekel strength. ILS the back of a decrease in public investment driven by TWI is near 5-year highs due to substantial reduced EU funds inflows. This is because the overlap appreciation in 2015, as the Bol has not taken steps to from the old EU budgeting period has ended, and this substantially weaken the currency like other central is normally associated with a sharp drop in EU funds. banks with similar deflation concerns. But this shekel EU funds inflows in Hungary are normally back-loaded strength has weighed on exports, growth and inflation, towards the end of the budgeting envelope - for and the Bol's sensitivity to any major shekel example, just EUR 1.6bn of EU funds were absorbed in appreciation is now likely high. There are particular each of the first three years of the previous budgeting concerns about the current deflation, present since period (on average), while in the first three quarters of mid-2014 and deepening in recent months, becoming 2015 the absorption was already nearly EUR 5bn. On further entrenched. Discretionary FX interventions were the other hand, Poland has a much better record of EU ramped up somewhat in December, but we believe funds absorption that is more evenly-distributed over there is more space and likelihood of more intervention the budgeting period. This is partly the reason we acceleration, given the relatively low level of FX expect Polish growth to remain robust at 3.5% in 2016. reserves (30% of GDP) and recent leg lower in crude. Other Polish fundamentals are also sound: valuations are attractive (PLN is the most undervalued currency Shekel strength has contributed to recent deflation across our long-term metrics) and macro vulnerabilities have been sharply reduced in recent years. "'I 15 050 RoP dynamics. The sharp drop in Hungary's EU funds 8? 5 inflows this year will also lead to a contraction in the 0 capital account. This will come on top of sizable 990 0.5 portfolio outflows, as EUR 5.5bn in external debt 925 redemption is planned to be financed by the local 00 950 banking sector via domestic issuance (part of the NBH's Self-Financing Plan). Non-domestic holdings of 05 975 Hungarian government debt have come down sharply Oohsen -1 0 1000 to 26% from 35% a year ago - the increase in local Chi 3,9, Ave AA Cf I Jell — Jul Oct Jan fty demand for this debt encouraged as part of the Self- 2012 2014 9315 Financing Plan has lowered yields and squeezed out CPI % (3rnmal. ire —08 !LB Oast* 018 non-domestic investors. This process could continue into next year with the implementation of further local Sane AMMO* Sint Mscroecnd bank OE-type measures mentioned earlier, putting further pressure on the portfolio component. All in all, The Bol again sharply downgraded both growth and deteriorating BoP dynamics will weigh on HUF in 2016. inflation forecasts in December, providing forward guidance of low rates for long. For 2016, it forecasts Recent trend of portfolio outflows is likely to continue only one 15bps hike around year-end, which is even more hawkish than our forecast for the first hike in CH 5200 6 2017. Real rate spreads vs the US are already close to 5000 r "ost 0 5-year lows, and further widening of rate differentials 4800 t I 2 this year should add upward pressure on USDILS. i 4600 I r o I I. -2 Elsewhere in CEE, CZK is the most elevated net long on 4400 1 t I 8 -4 our CORAX positioning indicator across G1O and EM I 4200 -6 FX, mainly due to buying by leveraged funds. However, 4000 -8 the CNB's EURCZK 27 floor does not look in danger: FX 2012 2013 2014 2015 reserves levels are relatively low (30% of GDP); —Foreign ownership of HUF govt debt (HUF bn) potential CNB losses from eventual CZK appreciation is Net portfolio inflow (% of GDP. rhs) not a political issue (as was the case in Switzerland); on a relative scale, intervention through the life of the floor SCaen Detnen• Bent /MNAniVOCI has been small - CNB intervened for the first time since the start of the floor (Nov 2013) only in July 2015: ILS the weak one among the other EMEA low yielders inflation is expected to remain below target until well ILS remains a good funding currency, with a near-zero into next year. We believe the CNB will let go of the funding cost. The shekel's negative beta to broad dollar floor only around end-2016, in line with guidance. strength is high, and therefore the continued USD Gawarn AWani London, 4.44 20754 57066 Page 24 Deutsche Bank AG/London CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0120132 CONFIDENTIAL SDNY_GM_00266316 EFTA01459609