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MONEY MARKETS

Crown, interest rates and bond yields set new records. Tumultuous week on money market follows NBS moves

The Slovak central bank (NBS) ended months of speculations and floated the crown on Thursday October 1, abolishing its fluctuation band against the mark/dollar basket and leaving the currency's fate to the forces of supply and demand.
The central bank since the beginning of August has used a big portion of its foreign exchange reserves to defend the stability of the crown exchange rate, but devaluation expectations created a healthy appetite for hard currencies and the NBS could not allow a further drop in its reserves.

The Slovak central bank (NBS) ended months of speculations and floated the crown on Thursday October 1, abolishing its fluctuation band against the mark/dollar basket and leaving the currency's fate to the forces of supply and demand.

The central bank since the beginning of August has used a big portion of its foreign exchange reserves to defend the stability of the crown exchange rate, but devaluation expectations created a healthy appetite for hard currencies and the NBS could not allow a further drop in its reserves.

Rates hit 200%

The cumulative local currency funds in the sector fell to 70-80% of funds required to meet the central bank minimum requirements. Interest rates thus shot up to reach levels above 100% for the short end of the yield curve. One day deposits hit 200% a day after the central bank announcement. The long end of the yield curve disappeared, with two months funds traded between 50-150%.

The Slovak currency shed around 7% after the announcement and hit 13% below the former midpoint during the last few minutes of trading on October 1. On the next day, the crown fell another 6% and reached 19% below the former parity. During the next days the crown fluctuated between 14-19% on the weak side of the former band. According to central bank officials, these levels were acceptable for the central bank.

The forex market, however, remained very nervous and oversensitive to any new signals and facts regarding the current situation. The spreads on the market were around 1%, and even minute amounts were sufficient to move the market very quickly.

Interest rates came down quickly a few days after the currency devaluation, with the central bank adding liquidity to the market through short-term repo-tenders in order to avoid any market collapses as some banks did not have liquidity even for domestic currency payments.

Interest rates fell very quickly on October 7, when one of the big local banks resigned in an attempt to meet minimum reserve requirements for this period and most other banks were overliquid. Thus, rates came down and fluctuated between 20-35% for all periods up to 3 months.

Bond yields over 30%

The central bank also organised the auction of a one-year state bond on October 6, where bids worth around 3 billion crowns were accepted at record yields of up to 32%.

Future developments depend fully on central bank steps to refinance the market shortage of Slovak crown funds. On the foreign exchange market, players are waiting for any news from the central bank or any new government. The central bank will monitor the exchange rate of domestic currency against the German mark in the future (as the basket was abolished), so the crown will be traded against the German mark only, without any dollar/mark hedging, very soon.

The central bank will intervene on the market very actively in order to protect the crown and prevent any big, exaggerated moves. Developments in the near future could be affected by profit-taking, which could move the crown to stronger levels, but the market expectation is that we will see the crown at weaker levels during the weeks to come as its fundamentals remain weak. But the central bank is likely to intervene strongly if the crown approaches 24.0-25.0 SKK/ 1 DEM.

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