CEEMEA Credit Strategy Update Reason for Cautiousness in CEE

Sound Core Europe debt conditions are a pre-condition for CEE-Periphery decoupling in credit spreads. The CEE region (EM) has decoupled from GIIPS (Greece, Italy, Ireland, Portugal and Spain) debt-dynamic concerns, as better and improving fundamentals have largely served to shield EM countries. In fact, the average of CDS levels have diverged in the past months, when GIIPS spreads have increased sharply (Chart 2). We notice that the pace of decoupling has slowed lately and, for example, iTraxx CEEMEA SovX has only partially recovered the previous widening (after the financial support to Greece by the financially strongest EU members – i.e., Germany and France). As shown in Chart 3, Core Europe or Core DM (Belgium, France and Germany) CDS lead the trend in EM CDS and also determine the direction. Therefore, the 175bp of spread between EM and Core DM likely will not guarantee a cont

Monitoring indicators of short-term liquidity very closely to detect any tension in (external) funding markets. Charts 4 and 5 show the relationship between the average cross-currency swap (CCS) basis in CEE (cross-currency swap basis of Poland, Hungary and Czech Republic*) and GIIPS and Core Europe CDS, respectively. We conclude that the external currency funding in CEE has not been materially affected by what is happening in peripheral European countries, but investors are likely increasingly wary about possible negative impacts of Core Europe debt deterioration (and exposure to GIIPS) on external funding markets. Wider Core European CDS spreads could cause additional concerns on global debt sustainability, implying a more negative CCS swap basis in CEE and signaling potential tightening of external funding conditions (R2 on levels between average CCS basis and Core DM CDS is 87% over the past two years).

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