Chart 73: Fundamentals — CEE beats periphery Chart 74: Poland and Hungary wide relative to Chart 75: HUF vol lagging EUR and PLN Italy and Spain 190% 5% —————— SS 12 140% ©) 4% "8 11 90% © . ath 10 2% 10 40% 1% = 9 9 9 5 O"e8BeesEe oe OS al , ASE=~PNoE 0 a = 7 + @ ZO Ss - nA NWN mM tT YH YD © EER EBER BE 6 m Debt/GDP (Ihs) Ss 8 8s EAB Jan/14 Jan/15 Jan/16 = 5y change in debt/GDP (Ihs) — aly Spain —EUR/HUF ——EURIPLN ——Portugal ———= France ©2016 growth (rhs) —— Hungary Poland ——EURIUSD === Romania Czech Source: IMF Source: Bloomberg. Source: Bloomberg juncture has also weighed on public finances, and all peripheral countries are running deficits above the structural levels. The fundamental picture is not reflected in interest rate dynamics. ECB easing has pushed Eurozone interest rates lower despite worsening public finances (Chart 74). Participation in the QE program has been a strong determinant of low long-term rates, as shown by the tightening of the periphery vs CEE. Hungary, Poland and Romania have been yielding 3-3.5% in the past year, while Italy remained constantly below 2%. If stress comes back, the gap will close. Within the periphery, Italy is the most vulnerable. Fundamentals are the worst in the region, only comparable to Portugal, which trades 160bp above it. Political risks also remain high, with the referendum providing some downside risk to the prime minister. The market is apparently reaching the same conclusion: during the most recent global bonds sell-off (20 Sep-14 Nov), Italy widened 95bp, while Spain widened 70bp, in line with CEE, despite the higher beta nature of the latter and the higher FX risk. Still, there may be room for further widening: the 10y spread to Germany widened in the current move, but is still lower than it has been the three years following the latest Italian political crisis. Our European rates team argued this summer that the rally in Italy spreads was far from fundamental. Flatteners in the 30s5Qs area look the best hedge