A Magyar martingale | FT Alphaville

A Magyar martingale

(We mean martingale, the betting strategy, not the quant model!)

Here’s the thing about Hungary, as we see it anyway. If you look at things like the current account, for example, it says “fixable by the IMF”. It’s in surplus, if deteriorating.

Everything the government does, however, says “bonkers”.

Bonkers, verging on sinister, and becoming increasingly binary: heads, an IMF loan and tails, a nasty well… tail (risk).

At any rate, it is now normal to be ultra-bearish on Hungary. On Wednesday alone:

  • Five-year Hungary CDS hit a record high (over 700bps, according to Markit).
  • Five-year Hungarian bond yields rose above 10.5 per cent.
  • Above all, the Hungarian forint continues to hug all-time lows against the euro.

The last development is especially worrying because it suggests that the central bank’s past rate hike and those anticipated in the future may no longer be offering much support to the forint, in place of using the FX reserves which Hungary’s last IMF bailout helped to restore (and which are much healthier than in 2008). Not a good prospect when the central bank is at the government’s heel, there is now constant speculation that the next step will indeed be to raid the reserves to cut government debt (which the government constantly denies), and the IMF won’t talk until the central bank is freed from its new legal dependence.

See? Bonkers, and taking it all together, nudging Hungary closer to huge tail risk (a balance of payments crisis) which would suck in the region. Thus, Hungary is fixable… just it has to go through a crisis. This is frustrating because it seems fixable already.

The government’s response on Wednesday was to simultaneously argue that the forint’s fall was due to speculation that Hungary won’t get IMF money, but that Hungary doesn’t really need IMF money that urgently anyway. That’s bonkers (well not totally — Hungary doesn’t have huge immediate bond payments to make for a while, especially in foreign currency debt). More to the point it flatters the authorities by reducing Hungary’s crisis to a demented ping-pong game of getting the IMF to blink first.

Peter Attard Montalto of Nomura put the stated the real problem particularly well (emphasis ours):

The government thinks it has enough cash to last it through any short term difficulties and take it to the other side of the Eurozone crisis. That is not the case… That is the catalyst. We are here because of bank deleveraging caused by Hungary’s own policies alienating the banks, by its anti-growth policies that have alienated FDI investors, by its unsustainable fiscal policy with a budget that hides a huge underlying deficit this year of close to -8%, policies around MNB independence etc, and above all investors scratching their heads and questioning the government’s credibility. That is why we are here.

We’d say this is the martingale — Hungary executed all these policies to drive down debt, but if the policies fail, the blowback would be heavy.

And that is why, we think, that policy conditionality (via the IMF) is a decent prospect for fixing Hungary even at this late stage. On paper anyway. In practice, it’s increasingly looking like path dependence — Hungary’s ruling party has shoved through so many laws in just the previous month that it’s created a massive switching cost for itself. The central bank law is a case in point, therefore hardening the position of official lenders like the IMF and the EU who want it repealed.

More to the point look at all the path dependence around Hungary. The deleveraging of foreign (e.g. Austrian) bank assets from Hungary isn’t going away. The government’s write-down plan for FX loans is still in place and could get bigger not smaller, bank willingness to roll over exposure in any case is gone. It’s interesting to note a modest deterioration in Austria CDS this week (chart courtesy of Gavan Nolan of Markit):

Similarly a lot of the recent moves in Hungarian debt have been exaggerated by illiquidity. But by the same token, any large foreign investor who sells a position en masse (even for technical, e.g. ratings-based) reasons is surely a bit dangerous.

Policy errors and portfolio flight. Nasty mix. It would be nice to be all contrarian and see Hungary as a fixable, tractable crisis (compared to events in the eurozone) but we just can’t any more.

Related link:
Democracy under threat in Budapest – FT
Hungary: forint fading fast – FT beyondbrics
Hungary: new year, more debt problems – FT beyondbrics