ECB move challenges Scandinavian bet
The aftermath of the ECB’s negative-rates move has left Scandinavian currencies lacking meaningful direction. Mixed economic data in Sweden, and fears over the damage to exporters in the event of rising rates in Norway, are challenging market positions.
With Norwegian inflation figures coming in a little above expectations at 2.2%, analysts do not expect Norges Bank to have the same level of flexibility enjoyed by the European Central Bank (ECB) in cutting rates or loosening policy.
Observers, therefore, are more united in expecting appreciation of the Norwegian krone against the euro and other currencies.
From Sweden’s perspective, market views are more mixed. Sweden’s May CPI inflation figure stood at -0.2%, according to the Riksbank, underwhelming expectations for the second time in three months.
While in normal economic circumstances this dismal figure would suggest more-activist monetary policy is on the cards, the ECB decision and conflicting economic signals mean market players are hesitant to adopt aggressive SEK shorts.
“Positioning is quite light amongst both currencies, so there would not be any market barriers, especially to NOK upside, though SEK downside may be slightly harder to push given the market is quite short,” says Geoffrey Yu, G10 FX strategist at UBS.
There are also positive indicators coming out of Sweden, with the central bank indicating it expects an improving economy to lift inflation from its current level to 2% in the medium term.
“The jobless rate in the Nordic region’s largest economy fell to 8% this month, well below the level that the market was anticipating,” says Kamil Amin, currency analyst at Caxton FX. Camilla Viland, FX analyst at DNB Markets, adds: “We expect a slightly stronger SEK against the euro. Inflation is low, but likely to pick up. And activity in the Swedish economy has picked up and is expected to remain solid. Our six-month EUR/SEK forecast is 8.90.”
Amin continues: “On the back of improving data, there is now speculation that a more exact time frame has been set in which interest rates could be hiked, with the policy decision appearing more balanced than previously.
“With the ECB outlook in the near term remaining uncertain, we expect the Swedish krona to remain range bound against the euro in the near term.”
Other market players say the expectation remains for another cut.
“The Swedish fixed-income market has begun discounting a significant probability of a second and final rate cut later this year to 0.25%, in line with our own Riksbank forecast,” says SEB. “Ultimately, such a move is necessary if the krona is to continue to depreciate versus the euro, and is also the reason why ECB policy is SEK negative with pressure increasing on the Riksbank to act.”
“Normally, the SEK is traded like a high-beta euro: outperforming most currencies as the euro gains and vice versa,” states SEB.
Trading after the ECB’s monetary-policy announcement followed the expected pattern, it notes, with FX markets selling volatility and buying commodity currencies.
For the Norwegian krone, appreciation therefore looks likely.
“Oil and gas exports have risen by 50% and with export revenues accounting for more than 20% of the nation’s GDP, it is clear why the Norwegian krone has retained some strength,” says Amin. “We expect the krone to therefore continue strengthening against the euro following last week’s rate cuts and continuing outflows.”
Others feel the NOK rally has probably run its course.
“We see limited potential for further strengthening of the NOK,” says Viland. “Growth in the Norwegian economy is below par and thus it seems reasonable that the NOK should remain at levels lower than normal.”
While DNB’s expectations for Norwegian growth are in line with consensus estimates, its expectations for 2015 are below consensus, says Viland, paving the way for further disappointment.
“NOK sentiment has been poor over the last year,” she notes. “Admittedly it has improved over the last few months, but is still not back to normal. As a result, investors will keep cautious.”
Still, NOK has been the best-performing European G10 currency in 2014, after a difficult 2013. It has benefited from local rates picking up, despite Norges Bank’s firm forward rate guidance of unchanged rates until mid-2015, while geopolitical events have conspired to support gas prices, says Petr Krpata, FX strategist at ING.
“The key to NOK outperformance is inflation,” he says. “The Norges Bank’s preferred measure, the underlying CPI, is at the target of 2.5%. Clearly, such price levels are currently a rare event in Europe as it battles disinflationary pressures.”
With 0.5% inflation in the eurozone, 0.2% in Switzerland, -0.2% in Sweden and CEE figures ranging from -0.1% in Hungary to 1.2% in Romania, Norges Bank has considerably less room for manoeuvre in easing policy than its European peers. In this environment, it is difficult to see anything other than NOK appreciation.
“As we are seeing extremely low yields in developed markets and unconventional measures like negative rates and possibly QE being implemented by the ECB, it will be very difficult for Norway to hike rates without witnessing a sharp appreciation in the Norwegian krone, which would negatively affect their export industries,” says Semin Soher, senior portfolio manager at Pioneer Investments.
“In this context, we expect Norges Bank to remain on hold for the near future.”
Pioneer has taken profit on its short rates positions in Norway versus Sweden, and currently has no position in Norwegian rates, adds Soher.
“EUR/NOK still trades above levels indicated by the nominal rate spread, suggesting a potential for further correction lower,” says ING’s Krpata. “On the real-rate front, EUR/NOK looks to be trading at fair levels. The outlook for real rates suggests further EUR/NOK deprecation.”
Downside risk could be presented by US yields, he warns, though it sees key differences between the situation now compared with last year, when the krone did not fare so well. With investors anticipating a rise in US yields, and with other markets more stable than they were a year ago, the reaction is unlikely to be so aggressive.
This risk is especially pronounced if trading NOK/SEK.
“Both currencies are extremely sensitive to any movements in US rates,” says Yu at UBS. “If the US 10-year moves higher aggressively, both would be hit.”
The sell-off last year might also suggest the currency has already priced these expectations in. “Lastly, EUR/NOK correlation with UST has normalized from the elevated levels last summer, making NOK less vulnerable to spike in US yields,” says Krpata.
“With inflation close to the target, NOK is an outlier in Europe and is set to benefit,” concludes Krpata. “We see scope for EUR/NOK to correct lower, moving closer to levels suggested by the rate spread or the 10-year US yield.” This should be reinforced by high risk appetite, with the krone a major carry currency. “We expect EUR/NOK to fall below 8.00 in months to come.”
However, the risk is not confined to US policy.
“Norway’s own adjustment process is far from complete and a recent capex survey suggests that investment in the oil sector will fall significantly up ahead,” says Yu.
“While fiscal impulse could offset such declines to some extent, the experience of the AUD in the past suggests that such rebalance would likely require some pain on the currency. However, this is a longer-term story.”