FxWirePro: Why payer position in CZK interest rate swap? Tepid CPI keeps CNB to stay pat but other key fundamentals indicate rate hikes underway

The Czech National Bank held its benchmark two-week repo rate at 0.25 pct on September 27, 2017, after a 20bps hike in the previous meeting, as policymakers await for new economic forecasts and more clarity on European Central Bank policy in November. Wages are rising at their fastest pace in a decade and inflation is above the central bank's 2 pct target. The lombard rate and the discount rate were also left unchanged at 0.5 pct and 0.05 pct, respectively. 

At least two senior board members have indicated earlier that they might vote for a hike. But this decision enables the central bank to buy more time to see if the current growth momentum and the inflation reduction are sustainable. Of the seven members, only one voted for a reduction in interest rates.

In the months to come, a minority expect a 25bps rate hike - we lean towards this camp. Board members as well as the central bank's chief economist have signaled that at least one hike before the end of the year is quite likely.

We ourselves have penciled for two hikes, in fact – one in this month which didn’t happen majorly due to somewhat after the CPI print for August turned out to be softer than expected and again in November on the back of the economy grew by an ultra-strong 2.5% QoQ in Q2; in Q3, the euro zone manufacturing cycle retained a strong footing; Czech wage growth is accelerating too.

Since fundamental developments have continued, it is more straightforward to assume that CNB raises rates going forward, following the unanimous rate hike decision of August, rather than to assume that it will skip one meeting and then raise next time. We didn’t get an idea of whether we are on a regular hiking cycle or just a couple of "technical adjustments". On the consensus of atleast one rate hike this year, it is expected that EURCZK to drop to 25.90 levels by the year-end; in a scenario of no hike, there would be obvious upside risk to our forecast.

The 2y is fairly valued according to macro fundamentals while the 10y is around 35bp above the model’s predicted level. Building inflation pressures over the past year leads us to maintain paid position in CZK 10yr IRS.

Hence, payer position in 10-year CZK IRS is advocated, which is currently trading at 1.22%. The target is at 40bp move higher to 1.62%, and place a stop-loss at 1.02%. The trade horizon is 6-9 months and the position likely to cost about 1bp per month in carry and roll.