The zloty exchange rate is trying to stabilize. Are the biggest shocks already behind us?

This week, the dollar rate shot up in a way not observed since July 2022 (6 days of increases in a row) to PLN 4,12, which was the highest level since November 2023. The euro rate, in turn, increased with the greatest dynamics since the memorable reduction. interest rates by RPP in September 2023 to PLN 4,37. Currently, however, the situation seems to be stabilizing due to several interconnected factors.

What could be behind such a dynamic sale of PLN?

Primarily strategies called carry trade, which are popular in the markets of emerging economies with good prospects for economic growth, internal stability and high interest rates. These include, for example, Poland, but also Meksyk, where interest rates are at 11%. Carry trade involves borrowing a currency with a lower interest rate and investing it in a currency with a higher interest rate. In this way, you can earn money on the interest rate difference, but also count on a positive change in the exchange rate.

In this way, for example, Poland and Mexico were included in one basket of foreign investors, where since the bottom in October 2022, both PLN and MXN have strengthened against USD by about 20%, and the path of exchange rate changes over time is very similar.

However, the carry trade strategy has this feature: if we count on profit from the interest rate difference on the volatile currency market, if the expected change in rates in the near future increases (so-called implied volatility), it is less profitable to hold such positions. As a result, both MXN and PLN lost at a very similar pace at the beginning of the week due to the sudden closing of carry trade positions due to the increase in expected volatility caused by the geopolitical situation.

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Euro and dollar exchange rates - is the worst behind us?

It follows from the above that in order for the Polish zloty, peso or other similar currencies to strengthen again, a decrease in the expected volatility on the currency market is needed for the carry trade to become profitable again. However, EM currencies may also be helped by the decline in US bond yields, whose increase at the beginning of the week to 4,7% may have also scared some investors and discouraged carry trades.

However, the situation here is changing dynamically and we are already observing a rapid decline in bond yields in the US following the dynamic decline in oil prices. Yields also rose earlier due to fear of higher inflation caused by, among others, a sharp increase in prices of raw materials, including oil. In turn, oil is cheaper after announcements about the possible release of reserves by the US and information about higher inventories than expected.

This is positive information that may give the zloty room to catch its breath. Currently, a potentially important level for the dollar may be around 4,04, and only a sustained drop below this level can restore the trend of strengthening the zloty. In relation to the euro, this level may be around 4,32 and only if it is broken down, the trend may resume. At the moment, however, a more likely scenario is that of consolidation and a sideways trend, but without a sudden sale of the zloty provided that the geopolitical and market situation is stable.