CAD tumbles, and we need to talk about SEK

Adding further pressure on all risky assets yesterday was the turnaround in US equities and negative noise on the status of the US-China trade negotiations from Larry Kudlow (still “pretty sizable difference” in the positions, apparently) and Trump’s statement that he will not meet with Xi Jinping before the March 1 trade talk deadline.

We need to talk about SEK. As I discussed on the morning call this morning, the Swedish krona weakness is becoming profound and deserves considerable attention here as new lows trade versus the US dollar since late 2016 (another 2% higher from current 9.26 level at 9.44 and in turn the highest level since 2002) and only a couple of percent from its multi-year lows versus the EUR as well.

While we have focused on SEK in its excessively weak relative value terms and admired the Riksbank’s efforts to start down the normalisation path ahead of the ECB (which now appears more in need of tilting back toward accommodation), the economic setup for Sweden for Riksbank policy normalisation is all wrong: traditionally Sweden and SEK are considered particularly leveraged to the Eurozone economy, and now a sick EU economy risks an even sicker Swedish economy.

Compounding Sweden’s problems, its housing market is now clearly in steep retreat before the Riksbank even manages to take the interest rate above the zero bound and the credit cycle will inevitably tighten as bank’s reign in credit on signs of housing market strain. Consumer borrowing is already decelerating rapidly (5.5% year-on-year growth, down from 2016 peak near 8%, and Sweden managed to fall into a technical recession back in 2012 after lending growth fell to a still positive 4.5%). And borrowing demand will fall further as confidence in the economic outlook and real estate asset values decline.

In short, the Riksbank is in a very bad place as Sweden is the only country in the world that has generated a massive housing bubble with a backdrop of negative rates and only recently concluded QE. It only has itself to blame as its current policy mix represents an over-correction from an attempt to aggressively exit near-ZIRP conditions back in 2010-11, when it viciously tightened the policy rate from 0.25% to 2.0% in a twelve-month time frame.

The Riksbank simply can’t talk up normalisation next week on the foundation of an improving outlook for growth or inflation, and the only reason it can continue to advocate rate hikes is by focusing on the risks of a weaker currency and implications for prices. This will sacrifice economic growth. No mercy for the Swedish real estate market would deal an ugly blow to the Swedish economy. So what will it be, Riksbank: a stable currency and vicious recession or easy policy that risks unleashing a further SEK devaluation and eases recession severity? I suspect the Riksbank will elect the currency goal before it wrecks the economy. Regardless, signaling from the Riksbank next week will prove pivotal – any observation on the krona will be seized on by the market.

Chart: USDSEK weekly

USDSEK is exploring some pretty remarkable territory above the prior local intraday highs and far above the highest weekly close for the cycle. Note that clearing these highs also clears the post-global financial highs (marked by the red line) and the highest level since 2002. Given the dilemma the Riksbank faces as we discuss above, there is no immediate prospect for a ceiling if the Riksbank sends the signal that it is happy to let the currency go to shore up risks to the Swedish economy from a weakening external outlook.

The G-10 rundown

USD – staying strong on the weak risk appetite – need to see a bigger impulse move in EURUSD below support to talk about something more profound, however. Last night’s 30-year treasury auction went off well relative to the 10-year the prior day.

EUR – the difficult progress lower in EURUSD continues but we are all in suspense if we need a catalyst to take the rate below 1.1300.

JPY – paint is drying in USDJPY at the moment, but the strong US T-bond auction and risk off generally supportive of the JPY across the board.

GBP – sterling all over the map yesterday, first lower on the BoE’s “fog of Brexit” warnings and then higher on a story raising hopes that May might be making progress on the Irish backstop Gordian knot. Now we are essentially back to unchanged. Positioning in options seems the only option, with expiries post March 29. 

CHF – risk off feeding further CHF strength versus the euro and the EU existential worry angle is creeping back into the picture as Italian BTP’s are under pressure from the EU’s downgrade of Italy’s growth outlook, which can only bring forward the next confrontation between Italy and EU over spending limits.

AUD – we remain negative on the outlook, but goodness if iron ore prices don’t come down soon we may need to reassess.

CAD – the USDCAD chart is turned and disappointed with AUDCAD and NZDCAD so far for relative outperformance, if not yet ready to give up. Canada’s latest jobs report and housing starts data up later today. 

NZD – AUDNZD just can’t get anything going it seems – suspect yesterday’s immediate setback after the prior bounce down to the quicker reflex to sell the AUD.

SEK – Riksbank not in an enviable place next week. Only rout to hawkishness is in defense of the currency, not the economy – is the central bank in a bad enough place yet?

NOK – nothing to like here with the weak risk appetite and oil backdrops. Watching the 9.80-9.90 zone for possible resistance.

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