The Czech koruna has been in a narrow range of 24.60-70 EUR/CZK for the past two weeks, which we believe is still an acceptable level for the BNC to start a cutting cycle. The current level of market rates indicates slightly stronger levels below 24.60. Therefore, if global conditions allow, the corona could still strengthen by next week’s meeting. However, if the BNC delivers a rate cut, we see room to price in further cuts in the future, which would take EUR/CZK to the 24.80-25.00 range, based on the current strong relationship between the Czech Koruna and market rates. On the other hand, if the CNB does not make a rate cut, we believe the central bank has little to offer on the hawkish side, given that a cut seems inevitable. Therefore, in response, the crown may strengthen below 24.50; however, we do not expect it to remain there any longer.
The market is currently pricing in a rate cut of over 30 basis points for the November meeting, indicating a strong dovish bias in the market, and also around 25 basis points for a rate cut in December. Looking ahead, the market may be overestimating the magnitude of the rate cut in the first quarter of next year, but overall, we consider expectations for next year to be fairly priced. However, looking ahead, the CZK IRS curve, in our opinion, shows a significant underestimation of the BNC tapering cycle. Specifically at the long end of the curve, we believe the 10-year bond has the potential to trade 100 basis points lower and at this point this is probably the biggest mispricing in the CEE space. However, the condition here is the start of a cycle of CNB cuts and also a notable drop in underlying rates, which seems unlikely to be met for some time. Therefore, the most interesting segment is probably the 1-3 year segment, which can still be influenced by the CNB itself and we see room for more rate cuts to be priced in.
In the bond space, our opinion has not changed for a long time. This year’s issuance is almost covered, and the state budget has positively surprised in recent months. Therefore, CZGB supply is starting to decline and MinFin is prefinancing next year, already indicating a significant decrease in borrowing needs and CZGB supply. Along with the start of the cutting cycle, we see that CZGB is cheap in ASW and also relative to its ECO peers at this time.