Politics to Weigh on Poland But Fundamentals Sound

Polish assets have outperformed as economic fundamentals improved.  There are some warning signs ahead with regards to politics, and so this outperformance may be hard to sustain.  However, Poland is well-positioned for the current EM-negative environment.

INTRODUCTION

Polish assets have outperformed as economic fundamentals improved.  There are some warning signs ahead with regards to politics, and so this outperformance may be hard to sustain.  However, Poland is well-positioned for the current EM-negative environment.

POLITICAL OUTLOOK

Political uncertainty is running high after opposition Law and Justice candidate Duda won the presidency.  Now, all eyes are on the October parliamentary elections.  The party of opposition leader Kukiz has all but fizzled out after his strong third place showing in the presidential election.  As such, it’s really a two-party race but may require smaller parties to form a working coalition.

Latest polls show support for Law and Justice at 35% at the end of July vs. 23% for Civic Platform.  Law and Justice saw its popularity rise in recent weeks, mainly at the expense of third party leader Kukiz.  If Law and Justice and maintain its lead, it seems likely to win the October general elections, bringing it back into power for the first time since 2007.

Law and Justice is seen as more populist, more euro-skeptic than the ruling Civic Platform.  President-elect Duda ran on many promises to spend, and that has dragged Civic Platform into taking more populist stances too, in an effort to boost its popularity.  For instance, lawmakers just introduced a change to the foreign currency mortgage plan unexpectedly, and would effectively double the costs for banks.  If polls show further gains for Law and Justice, markets are likely to become a bit more concerned about the macro backdrop and policy mix in 2016.

ECONOMIC OUTLOOK

The economic recovery is robust.  GDP rose 3.6% y/y in Q1, up from 3.3% in Q4.  Monthly data in Q2 suggest further acceleration.  IMF sees 3.5% growth in both 2015 and 2016, but we see some upside risks here.  Poland has a large domestic market, and its external sector is much smaller than Czech Republic or Hungary.  While we thought that the country’s issue with FX-linked mortgages was no longer an important issue, it has come back to the fore.  Bank stocks have taken a big hit due to a potentially bigger burden of the plan.

Inflation is set to move higher in H2 as low base effects come into play.  CPI contracted -0.8% y/y.  The central bank signaled that the easing cycle has ended with its last 50 bp cut to 1.5% back in March.  However, it stressed that rates would remain low for quite some time.  With the economy strong and inflation likely to rise, we see tightening starting in 2016.  Bloomberg consensus is around mid-2016, but we see risks tilted towards sooner rather than later.

The external accounts continue to improve, helped by lower costs for imported oil and energy.  The current account is close to balance in 2015, but should widen out modestly in 2016 to around -2% of GDP.  The budget deficit is manageable, but more populist policies under Law and Justice would have a negative fiscal impact.

INVESTMENT OUTLOOK

Polish bonds have held up OK compared to the rest of EM, with 10-year local currency government bond yields up 52 bp YTD.  This compares to the group of worst performers that includes Turkey (+160 bp), Peru (+135 bp), Brazil (+98 bp), and Indonesia (+72 bp).  The US 10-year yield is up 10 bp YTD.  With domestic inflation set to move higher, the long end of Poland’s curve could come under some more pressure.  10-year bonds are currently yielding around 3%, which only makes sense under a deflationary environment.  If inflation returns to the 1.5-3.5% target range in 2016 as many expect, then we suspect 10-year bond yields will be closer to 4-5%.

Low oil prices and stronger growth have helped push Polish stocks higher.  It’s one of the better performers in EM (MSCI Poland at -1.1% YTD vs. MSCI EM at -7.0%).  We believe the firm growth outlook and low oil prices will keep Polish equity markets buoyant.  Our EM equity model has Poland as an outperformer over the next three months.

EUR/PLN is likely to continue rising as the EM selloff continues, but the zloty should hold up OK.  Our EM FX model rates the zloty as NEUTRAL over the next three months.  Break of 4.1835 and then 4.2350 is needed to set up a test of the December high near 4.40.