The krone has strengthened almost 3% against the euro this week, fuelling a belief that investors now consider it a substitute safe-haven currency, following moves by the Swiss National Bank on Tuesday to cap further appreciation of the Swiss franc.
Although Norway has attractive characteristics such as a good current account surplus and strong fiscal position, analysts say it fails in other key areas. For instance, it’s a small open economy highly correlated to the global trade cycle, with a relatively illiquid currency, which limits the ability to enter and exit trades efficiently. These features make it unsuitable as a safe-haven currency, according to analysts at RBC and SEB.
“With daily turnover in NOK at around a third of that in CHF as well as liquidity being particularly challenged outside local hours, the NOK is not the most suitable candidate for a safe haven,” Elisa Lignos, an FX strategist at RBC, tells EuromoneyFXNews.
The NOK is also a currency whose liquidity is strongly influenced by the hedging activity of local corporates, which could be undermined by an economic slowdown in Europe, argues Carl Hammer, an FX strategist at SEB in Stockholm. In a slowing economic environment, Norwegian export orders would be expected to fall and consequently hedging activity would also decline.
With fewer active corporates in the market willing to buy Norwegian krone, liquidity would be stretched even further. Thin liquidity would increase the risk of crowded-trade syndrome, putting traders in an uncomfortable position when a shift in risk sentiment occurs. Hammer cites such a situation in May 2010 when EUR/NOK jumped almost 10% in three trading days, in a scramble to exit long NOK trades.
According to Hammer, this week’s strong moves in NOK and to some extent SEK are a knee-jerk reaction to the closing off of other safe-haven avenues following the SNB move and market concerns about similar Japanese intervention. “What we’ve seen is a flight to quality fundamentals at a time when there is so much uncertainty in markets,” says Hammer.
RBC’s Lignos is doubtful that the NOK’s historical status as a risk-correlated asset is likely to be reversed in such a short time. “Historically NOK has traded strongly in line with risk appetite in the market,” she says. “Whilst correlations are backward-looking, and you can imagine that this trend may change over time, the idea that overnight a switch will be flicked in markets seems a bit stretched.”
Yesterday, the Norwegian central bank governor, Oeystein Olsen, indicated that he might impose measures if the krone strengthened too much.
“A krone that is too strong can over time result in inflation that is too low and growth that is too weak,” he said in a speech at the University of Oslo. “In that case, monetary policy measures will be taken. In Norway, the key policy rate is the relevant instrument.”
According to analysts at Citigroup, if the krone continues to strengthen at its recent pace, the central bank will probably cut the policy rate at the September 21 meeting. In the same speech Olsen warned of the potential for severe moves in the currency, should risk-market sentiment change.
That’s something at the forefront of the minds of traders who spoke to EuromoneyFXNews. “If we have a risk-off move in markets generally, we will get a nasty squeeze in EUR/NOK,” says one trader. A break above 7.60 could precipitate a larger correction given the size of long positions built up this week.
| EURNOK Spot (01/09/11 - 09/09/11) |
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| Source: Bloomberg |