IMF now have to make the decision; letting Latvia devalue or not? The Latvian politicians will of course make the formal decision, but, in practise, it is the IMF who now decides. As Ive mentioned before, I believe the Latvians will get their IMF loan.
However, there will/should be strings attached. One string that would suit the Latvian politicians policies would be to tie the LVL to the ERMII system. IE, letting the LVL move +-15% around the existing midrate. A way to save face for the Latvian politicians. The road to the Euro,,,,,right. It will be in vain though. Most likely scenario post such an announcement would be for the LVL to immediately weaken to the 15% limit. Stay there for a brief time and then the Lvl would be forced to float freely. Sending the Lvl weakening to a total of 40%-50%. If not more,(read, The new leading indicator for Latvia; Latvian prostitution prices ).
* The SEK and the Baltics
In my view, the Swedish Riksbanks stresstest of the Swedish banks, although harsher than the analyst consensus, was too soft. Not that surprising. Not that surprising that stockmarket analysts are off either. (They are bottom up analysts, not top down. Bottom up analysts historically have underestimated future losses, writedowns and overestimated profits during downturns.) The Swedish Riksbank are cautious not to stir things up too much at this very sensitive time for the Baltics.
Going forward, in my view, the Swedish Riksbanks estimates of creditlosses are likely to be revised upwards going forward. Anyway, the SEK is likely to come under pressure again, pushing Eur/Sek towards the 11.15/11.25 area for starters. The summer months of June and July are seasonally weak SEK months during normal circumstances. Should Latvia start the Baltic devaluation chain reaction the implications for the SEK should be heavy. A test of the alltime highs for Eur/Sek at 11.7860 should not be ruled out.
This scenario should take place within the next one to two months. If not, some other solution has been found involving the IMF, injecting an even bigger package into Latvia.
* The Baltics and the CEE area
Although the CEE area in general has floating currencies generating a significant advantage compared to the Baltics in the current environment, the CEE area has similar problems when it comes to foreign hard currency debt. Main lenders; Western European banks. Full circle.
One risk would be for a refocus on the lack of deleveraging in the European area, European bad debts and the vulnerability of European banks. This in turn risks turning more attention towards the Euro area and sovereign debt.
On the other hand, chunky realmoney flows are expected to start flowing into assetmarkets as implied volatilites have shrunk significantly. Now, realmoney flows are often a counterindicator, but, those flows are also very chunky. So, short term could see continued support for financial markets. Although I doubt the CEE area will benefit very much from the realmoney flows.
Add to this the assymetric risks present and it makes sense to start planning for a "hot" end of summer.
Disclosure; I am long Eur/Lvl Fx Forwards
* New positions and position changes
- Taken profit on long Eur Call /Usd put option
- Taken profit on long Gbp Call/ Usd put option
- Long Eur/Sek
As usual, good luck
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