12 May 2019

FX weekly: A Stairway toHeaven for Krona shorts

Martin Enlund | Andreas Steno Larsen

The EUR seems buoyant despite trade risks, which may be reflectingan unwind of EM longs and low-intensive de-risking of FX portfolios. InScandinavia, we prefer to pay NOK rates and sell NOK, while the Riksbank isbuilding a Stairway to Heaven.

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Table 1: Our current convictions

The equity bull story has suddenly been on the ropes. There is no trade truce between China and the US,green shoots have been wilting in Asia while geopolitical risks have been on the rise.

While picking up, FX market volatility has been fairly subdued in our view. The JPY has predictablybeen strengthening and EMs have been weakening, but not yet in any alarming way. Perhaps this is a signof complacency, or a sign that central bank puts are keeping risk appetite robust. But truth be told, it’s not asif neither FX nor bonds have been reacting to earlier green shoots, the green shoots story has primarily beenplaying out in credit and equity space.

Chart 1: So far limited spill-overs from weaker equities onto FX or US Treasuries

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

The recent buoyancy of the EUR may be reflecting an unwind of EM longs and reflect low-intensivede-risking of FX portfolios. However, it is also the case that USD liquidity is on the rise following adrawdown in the US Treasury’s GCA, and this can be dollar-negative.

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 2: EFFR dropping on the back of rising bank reserves

The market will indeed have to adapt to a substantial rise in US excess liquidity in coming months. Thesurprise fall in the Eective Fed Funds Rate to 2.39% in the past week is evidence of this, as is the recentLibor-OIS compression. As bank reserves rise, strains in the funding market ease.

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 3: First Libor-OIS compresses, then a weaker USD tends to follow

First there’s the Libor-OIS compression, and then the dollar starts to (suddenly) weaken. When theUS Treasury’s General Cash Account dwindles in early 2017, it did the dollar after some delay. On this line ofthinking, the DXY index is ripe for a correction lower.

SEK: Is Ingves building a stairway to heaven?

• The Riksbank tells us that the SEK will appreciate (MPR forecasts), but thatit must not be allowed to appreciate (press releases, speeches, interventionmandate). The Riksbank also launched QE to try and prevent the SEK fromappreciating.

• It then uses the lack of SEK strength as a reason to cut its estimate of the SEK’sfair value. As a consequence, it now has to worry even more about “undue” SEKstrength (April minutes).

• The Riksbank also launched QE to depress bond yields, but it then usesdepressed market pricing to argue that neutral rates are lower than in the past(Ingves: Structural trend shifts need to be included in monetary policy analysis).

• And with a lower real neutral rate (maybe lowered from ~2% to -1%), theRiksbank cannot dare to hike as aggressively or as high, which in turn depressesmarket pricing.

• Aside from some wise remarks by Deputy Governor Flodén, the Riksbank showsno doubt that its ammunition may simply be defective - despite an abysmaltrack-record (see here for arguments why its policies may have become self-defeating).

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 4: The Riksbank’s SEK cycle?

In 2013, the Riksbank judged that the implicit fair value of EUR/SEK was around 8.00 (translating its realKIX estimates to EUR/SEK levels). The trend weakening of the SEK since then brought the Riksbank tohike this estimate to around 9.00 in 2018. Minutes showed that both Ingves and Jansson were interestedin reassessing the fair value of the SEK. A similar revision as in 2018 this year, would put the new implicitfair value of EUR/SEK around 10.00. And what’s to say the process won’t be repeated in 2020, whenthe Riksbank’s krona-killing machine has undermined the SEK further without creating much, if any,inflation?

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Chart 5: The real trade weighted SEK vs Riksbank’s guesstimates – a stairway to heaven?

The Riksbank launched a massive QE program in part to depress SGB yields, and now it argues thatdepressed market pricing means that the neutral rate is much lower than before. Taken the Riksbank at facevalue, it could mean that the appropriate rate path is now some 250-300 basis points lower than in thepast (very good news for indebted households, if true).

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 6: The Riksbank - flogging a dead horse since 2015

The Riksbank started NIRP and QE in February 2015. Since then it has amassed roughly ~350bn worthof SGBs. As a result of its policies and an ever-weaker SEK, the Riksbank has managed to push coreinflation 0.1 percentage point above its long-term average. If we simplistically assume the Riksbank’s greatsuccess stems from asset purchases, we can calculate what will be required to push core inflation to 2%.(2%-1.47%)/0.12*350 = ~SEK1550bn. Now THAT’s a QE program!

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 7: Riksbank’s krona-killing monster won’t show up until August

In short, the beatings will continue until morale improves. The Riksbank’s krona-killing monster won’thowever start causing SEK-negative flows in earnest until August, so perhaps the SEK won’t weakenfurther in the near term. The monster suggests that any SEK strength in coming months should be used tobet against the SEK. We stay short NOK/SEK over early summer but would use a dip in NOK/SEK (towards1.0750) to buy fundamentally back into the case bull-case.

NOK: Pay rates, sell NOK?

A weaker NOK (except for Friday) and higher NOK front-end rates. That is the name of the game inNorwegian rates and FX markets currently. EUR/NOK seems to be closer connected to the steepness of theNIBOR-path than to actual spreads versus the Euro zone (otherwise EUR/NOK would have been below 9.00already).

Hence, the current trend from Norges Bank with a more aggressive front paired with a more defensive backof the rate path might not be enough to help NOK in a broader setting. The front of the rate path is drivenmostly, if not solely, by domestic variables such as growth, employment and inflation. On those parametersNorges Bank receives an all-in green light to hike further currently. The June meeting hike is now almostpriced in, but a hike in December-19 is not. We still like to pay the DEC+3M FRA. (Don’t fight Norges Bank:Pay the front)

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 8: The steepness of the NIBOR-path may matter for NOK than actual spreadstowards EUR

On the other hand, another downwards revision of the end-point of the Norwegian rate path could beon the cards in June, as e.g. import-weighted 1y1y rates abroad continue to add a downwards pressure onthe end-point in our model. The model currently suggests another 10bps revision lower in the long-end ofthe rate path. This would make the rate path look very flat, which wouldn’t necessarily be a good sign forNOK short-term.

We stay short NOK/SEK (despite a sluggish start to that view), as i) Positioning is loaded long, ii) Excessliquidity will increase in the NOK banking system and iii) The Riksbank SEK-killing machine is on pause until1st of August.

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 9: The end-point could be taken down further in June by Norges Bank

Rest of G10: Australian data better surprise now, while Poloz will look throughthe crazy job-report

We were right that RBNZ was more likely to cut than RBA, which should have been helpful for our AUD/NZD longs. Trump or China (depending on which side you ask) though killed that positive impulse with there-escalation of trade tensions.

Overall, our slightly positive AUD view versus NZD is looking a little shaky, as RBNZ has now more thancaught up to the dovishness of RBA. Australian data simply needs to surprise massively, if rate cuts areto be avoided. The new forecasts from RBA are based on the two cuts that are priced in Australia until theend of the forecast horizon (RBA always use forward pricing), and even with the more dovish pricing, RBAtook down both inflation and growth forecasts.

The CPI forecast now stands at 2% through 2020 with two rate cuts implied, which by the end of the daymeans that markets are free to price in even more cuts, if inflation doesn’t show signs of converging totarget. We though hold decent hopes of a rebound in Australian inflation in Q2.

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 10: The Melbourne gauge suggests that Q1 CPI was “too low”

The big dierence between the RBNZ and the RBA case is that RBNZ struggles with an even morebroad-based CPI weakness than RBA. The issues in Australia are more narrowly isolated to the housingcomponent of the CPI, and the weekly auction clearance data points have shown some early signs of bettertimes ahead – also for the housing CPI (see chart 11). We stay long AUD/NZD, but we are mulling an earlytake/profit on our position.

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 11: Auction clearance data is starting to improve. Will it lead the housing CPI higheras well?

Should the trade tensions escalate even further, then we would rank CAD, AUD and NZD as 1,2 and 3 in terms of risks. USD/CAD is currently closer correlated to USD/CNY than USD/AUD and USD/NZD are, while BoC is not (yet) that dovishly priced in a relative G10 setting.That cocktails sets up for a weak CAD, should the trade tensions increase more.

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 12: USD/CAD holds the highest correlation with USD/CNY

We remain overall negative on the CAD, as Bank of Canada lags Fed. Even with the almost crazy strongemployment report from Canada last Friday, the unemployment momentum doesn’t really support higherinterest rates and Poloz re-iterated the need for an accommodative policy in front of the Senate again lastweek. BoC will look through the strong labour market (as the Fed does), why we consider the employment-based rally on Friday a good chance to re-sell CAD. We remain structurally short CAD/NOK as the way toexpress this view.

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

Chart 13: BoC will look through strong labour markets

Previous FX weeklies:

 

·FX weekly: Mnuchin to bail-out Fed (05 May)

·FX weekly: 3 reasons why the USD has been resurgent (28 Apr)

·FX weekly: No doomsday (yet) (21 Apr)

·FX weekly: In EUR we trust (14 Apr)

·FX weekly: Crouching Tiger, Hidden Inflation Dragon (07 Apr)

·FX weekly: There is a smell of 2016 in the air  (31 Mar)

·FX weekly: Dear Mr. Powell (24 Mar)

·FX weekly: The devils advocate (17 Mar)

·FX weekly: Mario Bla-blaghi (10 Mar)

·FX weekly: Chinese reflation (3 Mar) 

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

·FX weekly: QT cannot run forever (24 Feb)

·FX weekly: The USD is now in Trumps hands (17 Feb)

·FX weekly: Time to care about Euro area politics again (10 Feb)

·FX weekly: Is Powell turning into a MAGA-man?  (03 Feb)

·FX weekly: On climate angst and fake news (27 Jan)

·FX weekly: The Mnuchin bailout (20 Jan)

·FX weekly: FX weekly: Cause I'm a flip-flopper, yes I am (13 Jan)

·FX weekly: FX weekly: Treasury vs. Fed (06 Jan)

·FX weekly: Top 4 FX/MM trades for Q1-2019 (01 Jan)

·FX weekly: On liquidity, witches and warlocks (23 Dec)

·FX weekly: Qui N'avance pas, recule (16 Dec)

·FX weekly: Burnin down the house (9 Dec)

·FX weekly: In Gut we Trust (2 Dec)

·FX weekly: Pikachu ain't no hobbit (25 Nov)

·FX weekly: Powell pondering pausing (18 Nov)

·FX weekly: Another SOMA-test of 1.13 (11 Nov)

·FX weekly: 1.13 will hold unless the Republicans keep both chambers (04 Nov)

·FX weekly: HIA, SOMA and REBA-days (28 Oct)

·FX weekly: The debt ceiling is a USD ceiling (21 Oct)

·FX weekly: Volatility makes odd bedfellows (14 Oct)

·FX weekly: No Di-Maio'nnaise for your EURs (yet) (7 Oct)

·FX weekly: Along came year-end (30 Sep)

·FX weekly: Twin deficit scare #2 (23 Sep)

·FX weekly: The Pope of Nope has spoken! (16 Sep)

·FX weekly: Who wants to impeach a +60 ISM president? (09 Sep)

·FX weekly: It is time to go long Scandis again (02 Sep)

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

·FX weekly: The Conte-Trump alliance (26 Aug)

·FX weekly: Fat-burning shorts (19 Aug)

·FX weekly: Time to call in Steven Seagal(12 Aug)

·FX weekly: Is the cyclical momentum over-priced? (05 Aug)

·FX weekly: How to trade a cease-fire? (29 Jul)

·FX weekly: What's that curve? (22 Jul)

·FX weekly: The China Factor (15 Jul)

·FX weekly: Take a short trade war breather (08 Jul)

·FX weekly: Trump will never #238 (01 Jul)

·FX weekly: The USD is the best carry currency in the world (24 Jun)

·FX weekly: Dollar to provide headwinds for earning estimates (17 Jun)

·FX weekly: Fire and fury risks for the USD (10 Jun)

·FX weekly: It's not only Italy.. (03 Jun)

·FX weekly: The Sumo SOMA days (27 May)

·FX weekly: EM won't be sprinting, if the Fed is unprinting (20 May)

·FX weekly: The two final nails in the dovish FOMC-con (13 May)

·FX weekly: Is there anything left in the USD bull-run? (06 May)

·FX weekly: Dragon Energy (29 Apr)

·FX weekly: Relative curvature is the new king of FX (22 Apr)

·FX weekly: Why is EUR/USD not trading lower? (15 Apr)

·FX weekly: Like watching paint dry, they said (08 Apr)

·FX weekly: The list of potential USD-positives is getting longer (01 Apr)

·FX weekly: 2 reasons why EUR/USD has decoupled from rates spreads (25 Mar)

·FX weekly: Time to buy a USD lottery ticket? (18 Mar)

·FX weekly: Taxation mirror on the wall, who is the fairest of them all? (11 Mar)

·FX weekly: Trump's game of chicken (04 Mar)

·FX weekly: Will the market neglect the clutch of canaries? (25 Feb)

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

·FX weekly: Is the correlation break-down driven by FX hedges? (18 Feb)

·FX weekly: The liquidity tide is ebbing (11 Feb)

·FX weekly: Hawkish spectacles (04 Feb)

·FX weekly: Who will stop EUR/USD from moving higher? (28 Jan)

·FX weekly: Did the Democrats dent the Dollar? (21 Jan)

·FX weekly: Is 1.25 the new 1.20? (14 Jan)

·FX weekly: The euphoria rises (07 Jan)

·FX weekly: Paging Dr. Pangloss (01 Jan)

·FX weekly: The R-star of Bethlehem (24 Dec)

·FX weekly: A numbers game (17 Dec)

·FX weekly: The year-end liquidty shrink (10 Dec)

·FX weekly: Three reasons why EUR/USD isn't trading lower (03 Dec)

·FX weekly: Which currencies to sell if the housing downturn continues? (26 Nov)

·FX weekly: The global industrial cycle is set to weaken (19 Nov)

·FX weekly: Is high-yield a canary in the global coal mine? (12 Nov)

·FX weekly: Is this the end of the inflation convergence trade in EUR/USD? (5 Nov)

·FX weekly: Was that it for the EUR bulls? (29 Oct)

·FX weekly: Hawks in opposition, doves in charge (22 Oct)

· FX weekly:Continued convergence or re-divergence?(15 Oct)

·FX weekly: Thingsdon't matter until they do(08 Oct)

·FX weekly: "October seasonality is strong" (01 Oct)

·FX weekly: “Is 1.20 the new 1.15?”(24 Sep)

· FX weekly: Honey, I shrunk the balance sheet(17 Sep)

· FX weekly: “USD liquidity will turn scarcer, but when?” (10 Sep)

· FX weekly: “Strong currencies and inflation”(3 Sep)

· FX weekly: “USD in the (Jackson) hole” (27 Aug)

· FX weekly: “Q4 is the USD quarter”(20 Aug)

e-markets.nordea.com/article/48872/fx-weekly-a-stairway-to-heaven-for-krona-shorts

· FX weekly: “In the year 2525”(13 Aug)

· FX weekly: “EUR/USD ceiling or debt ceiling?”(6 Aug)

· FX weekly:“Elevator up, stairs down “(30 Jul)

· FX weekly:Trump “spices” up EUR/USD(23 Jul)

· FX weekly:Flip-flop?(16 Jul)

· FX weekly:Consolidation time?(9 Jul)

· FX weekly:Hawks R Us(2 Jul)

· FX weekly:Another lowflation week?(25 Jun)

· FX weekly:No Fed put?(18 Jun)

· FX weekly:A bouncy dollar?(11 Jun)

· FX weekly:Heating up(4 Jun)

· FX weekly:Summertime sadness(28 May)

· FX weekly:Special counsel lessens Trumpbulence, while OPEC looms(21 May)

· FX weekly:Are China worries old hat?(14 May)

· FX weekly:Inflation week…(7 May)

Martin EnlundGlobal Chief FX StrategistMartin.Enlund@nordea.com

Andreas Steno LarsenGlobal FX/FI Strategistandreas.steno.larsen@nordea.com+45 55 46 72 29

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