Head of FX Strategy, Saxo Bank Group
Summary: NOK and SEK have shown rather dynamic moves in a mostly moribund market and long-term positioning through options looks compelling given widespread complacency.
The NOK is essentially flat since the bounce-back at the beginning of this year, while SEK has dropped to record lows versus the euro. Both currencies have shown a degree of price fluctuation dynamism that has largely been absent from the broader currency market – especially the US dollar - as we all await the outcome of the fraught US-China trade talks and whether the floor under the Chinese renminbi will be maintained.
First, as the chief focus of this article, let’s have a look at what drives NOK:
Risk appetite and economic cycle – as an oil exporter, NOK is generally positively correlated with the outlook for global growth and the risk sentiment linked to the economic cycle outlook, which should be (but isn’t always) the chief long term driver of oil prices.
Importantly, and especially at times of market stress – NOK can move up and down with the ups and downs of risk sentiment – generally weak when risk appetite is weak as traders prefer to stay away from thinly traded currencies like NOK. Recent bouts of weak risk appetite have not been kind to NOK and remain a distinct risk for the near term, especially if the US-China relationship deteriorates badly. Watching the late June G20 meeting for important next steps in the US-China relationship.
Oil prices – Historically, NOK has moved in varying degrees of correlation with oil prices as Norway is Europe’s largest oil exporter – even if much of that revenue is kept in foreign currencies. Oil prices have presented a confusing picture at times this year. Late last year, the over-riding fear was that the world was slipping into a global growth slowdown. This year, prices have risen sharply again, but some portion of that rise is due to supply disruption, meaning that the shorter-term price for oil has risen far more than the longer term price (price for oil to be delivered in 12 months or later). So the oil price rise this year has offered less support for NOK than one would normally expect.
Real interest rates – this is one of the key factors keeping the NOK under pressure, as it is really the most fundamentally important aspect of a currency: the interest rate on a NOK deposit (currently 1.0% and likely set to rise to 1.25% in June) versus the inflation rate (over 2.5%), meaning that holding NOK deposits will see a decline in purchasing power over time via negative real interest rates.
Combine this with a small investable base of NOK assets: fixed income yields are weak in real terms, there is no deep government bond market and its yields offer weak returns and equity investments are chiefly oil and gas and shipping based in large part. As well, Norway appears on a trajectory of reducing investment in oil and gas on climate policy concerns. All of this means that there is little reason for capital to flow into NOK assets and many reasons for Norwegians to send savings elsewhere. It does help that the Norges Bank is the only developed economy central bank besides the Riksbank in an active hiking cycle – this tempers the risk of significant further downside, barring a crisis or a collapse in energy prices.
Longer-term idea: Long USDNOK puts: Example: 1-year 8.00 USDNOK put – cost just below 0.1000 (with spot trading 8.73 on May 14, so breakeven just above 8.00. This is an idea for establishing over the coming couple of months rather than positioning all at once.
Though NOK is weak, there are still many short-term risks in holding long NOK positions if we are headed toward the growth slowdown we suggest is the overriding risk late this year and into early next year. History shows that if the market lurches into a bear market in risk assets and ugly economic growth outcomes, safe haven seeking could drive USD strength and weakness in less liquid currencies.
Those could impact NOK negatively, with the added risk of at least a brief collapse in the oil price on demand concerns. Still, positioning in options for a longer term trade allows a brief USD spike to unfold in such a scenario. Regardless, we suspect that the US economy could be set to weaken sharply in coming months, given the severe tightening of Fed monetary policy from 2017 through 2018, and the hangover for US equities and the US economy itself after artificial pumping from the Trump tax cuts wear off, could drive a very significant and politicized Fed response that will finally see the USD rolling over and aggressively so – again, possibly after a brief spike higher.
This may be a story for Q3 and Q4 more than now – but at present long-term volatility is rather historically cheap. In short, the difficulty here is the timing and we may be a bit premature, but looking out over the next year as opposed to the next few months, we suspect the risk is for a much weaker USD. Traders can put on half a position now and half a position with once the USD is in a clear weakening trend and after the Fed has launched a major easing in response to recession concerns.
Chart: USDNOK 1-year implied volatility and USDNOK
Longer-term opportunities for getting long NOK via options compelling for a couple of reasons: rather extreme valuations and rather low implied volatility (market assumes the amount that NOK will move over the next year is rather small – see chart below). Currently, the 1-year implied volatility in USDNOK options (the blue line using the left axis in chart below) is below 9%, at the lower end of the range of the last 20 years. Historically, many of these episodes of low volatility have preceded dramatic expansion in volatility. Long USDNOK volatility via USDNOK puts well out of the money (for example 1-year, strike at 8.10) are one way to position for a shift to a weaker USD, stronger NOK regime.
NOKSEK is an interesting relative value trade as the SEK valuation is extraordinarily stretched to the weak side. Sweden is generally thought very prone to exposure to the global and especially EU economic outlook, as the Swedish economy is very leveraged to external demand via its very export oriented economy and traditionally large current account surpluses.
Negative real rates are even more punitive as the policy rate is a -0.25% and may not be raised to zero for some time while inflation is 2.0%. But the market has taken SEK valuation to remarkable extremes on the lack of interest for Swedish assets – especially fixed income.
Yes, the market could take this valuation a bit further in EURSEK terms (the pair trading already at all time highs), but as a relative value trade, NOKSEK sticks out, given that the risks to a global growth downturn are far greater for NOK relative to where it is priced (especially thinking about oil) relative to where SEK is priced. Importantly, Norway already runs massive budget deficits (ex-petroleum) while Sweden runs a large budget surplus.
Any whiff that Sweden’s attitude toward fiscal policy is changing would be very SEK positive and attract investment to Sweden. (There have been calls from various corners – especially from Swedish pension funds and even from unions – for the government to change its attitude). Sell half a position here in the 1.1000 area – stop above 1.1100, looking to add and lower the stop if NOKSEK trades and sees a daily below 1.0875 for a try toward 1.0600
This one is both technical and fundamental – note that recent turnaround in the price action near the multi-year highs in AUDSEK as a sign of mean reversion back into the range. But importantly, while the Riksbank is slowly normalising its policy, the Reserve Bank of Australia is setting up to cut rates and could cut 100 basis points or more from its 1.50% policy rate over the coming four to six quarters.
The risks for Australia from the US-China trade showdown are also a bit more direct and immediate for Australia than almost any other economy. This week, a NAB business conditions survey in Australia saw its employment component drop into negative territory for the first time since early 2016 and the RBA has explicitly linked its inclination to cut rates with the jobs market. Trade view: sell AUDSEK here in the 6.65-67 area with a stop above 6.72 for a fall back to 6.50 and even lower long term.
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