• EM have sold off significantly. We are now in a global recession, and we see a U-shaped global recovery - also in emerging markets by late 2020 (H2).
• External factors supportive of EM even now, more later - but corona shock will leave a permanent mark and we do not see a full recovery.
• We are bullish on PLN and CZK and cautiously optimistic on RUB, mostly in H2. However, oil markets are unlikely to turn for the better before summer.

Over the past month, the key problem for many emerging economies has been the combination of a sudden stop in global economic activity, sharply declining commodity prices, and very broad-based risk aversion, driven by a combination of COVID-19 and the oil price skirmish. Most EM FX have sold off about 10-20% versus their regional reference. Near term, we are unlikely to see a marked pickup in activity, nor in commodity prices and this will weigh on industrial countries in e.g. Eastern Europe, highly indebted Latin America and not least Russia. The worst may well be over but we do not expect a quick recovery in EM FX.
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However, it is not all gloom. The global fiscal policy response is very material and especially so in the US. This has improved sentiment and adds to our belief in a cyclical uptick later in the year. Further, financial support is material from almost all major central banks and the Fed in particular is clearly in the business of containing financial stress. This has yet to lead to material USD weakness and thus EM support, but it has calmed the downward pressure on EM FX a tad.

Historically, risk aversion leads to overshooting in EM FX (that is, a weaker domestic EM currency short term than the long-term 'equilibrium' level). In our view, this currently applies to not least EUR/PLN, EUR/CZK and EUR/RUB. In TRY, MXN and BRL, one should not expect the 'strong' levels to come back and an eventual global improvement will simply allow these currencies to stabilise, at best, but hardly strengthen much.

In Poland, we see potential for a rally in the zloty once the virus concerns ebb into the summer. The sizeable domestic fiscal package amounts to 9% of GDP and will help support the economy. In turn, our 12M forecast for EUR/PLN is 4.30. The Czech economy will similarly benefit from an eventual uptick in global industry and we target 26.5 on 12M. In Hungary, the HUF has sold off quite a bit as investors had little reason to be long in the first place (interest rates at zero) and also given the expected decline in economic fundamentals. Arguably, there is some overshooting in EUR/HUF, which could unwind. But, even if global activity picks up, EM sentiment improves and corona fears fade, we would expect HUF to be the last to gain. Our 12M target is 368 but near-term overshooting of that is possible.

In Russia, the economy can weather the storm, as inflation is low, and even after the 20-30% move in the rouble we are unlikely to see double-digit CPI. We also see EUR/RUB overshooting versus fundamentals, but we have lifted our 12M EUR/RUB forecast to 75.00 (from 60). Notably, it is likely to take a while before we see an end to the ongoing oil-price war.

Shocks to EM FX do tend to have a partially permanent effect on the level of exchange rates but normalisation, as we expect, is likely to help Eastern European currencies in H2. Near term, we are seeing stabilisation due to the policy measures being taken, but it is indeed fragile.

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