By Win Thin

Standard & Poor's said it may cut Hungary's current BBB- rating to junk after talks with the IMF collapsed this past weekend. Earlier today, Moody's put Hungary's Baa1 rating on review for a possible downgrade. S&P is closest to our own sovereign model (junk) rating of BB+/Ba1/BB+, while Moody's is most out of line.

If IMF talks drag on as we suspect, Moody's could downgrade its Baa1 rating and now S&P may cut as well. Junk status is a real possibility for Hungary, with S&P warning it will happen, as "government policies are unlikely to result in a meaningful decline in public debt." Moody's said that negotiations with the IMF over a new program is a key rating consideration, and so we think Hungary will have to come back to the table soon.

Even if it begrudgingly accepts IMF targets, markets will wonder how committed the country will be to hitting those targets. Hungary is now paying the price for all the loose talk earlier this year. Credibility, once lost, will take a long time to regain.

As we noted in our daily, the forint along with Hungarian bonds and CDSs reacted negatively to the news, and while this should serve as a wake-up call to the government, we do not expect a quick agreement with the IMF. Moody's said the review would last four months, so we note that this gives Hungary very little leeway if it tries to hold out until after October local elections to strike a deal with the IMF.

We went short HUF vs. EUR last week around 280 for a move back to the late June high of 288 and then the early June high of 290.50. Those targets were met, but we were stopped out for a gain when the forint rallied along with the rest of EM.

EUR/HUF jumped today about 1% on the Moody's news and then another 1% on the S&P news, but we still think there is scope to test the 292 high from this week and then the 300 level in the coming weeks.
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