Back in May, we picked long Aussie, short Swedish Krona as our favourite trade. Eight weeks later, the trade was up 13% year-to-date. The rationale was based on an inevitable Riksbank easing and Aussie rebound as the Royal Bank of Australia (RBA) gave up on talking down the currency. Both of those events materialised as the Riksbank delivered its shock rate cut while the RBA kept its hands off the rebounding Aussie.
So what’s next for these Nordic currencies?
July’s 50-basis-point cut from the Riksbank was a surprise in its magnitude as most market observers had been expecting a 25-basis-point move. But the central bank, long criticized for falling behind on its 2% inflation target, was forced to prioritize price stability, causing the governor to be outvoted by four members opting for the 50-basis-point cut.
From the Riksbank to the Norges
As Norway’s Norges contends with record low rates in Sweden and the Eurozone, it raises the question about whether the central bank will be forced to ease in response. Recent manufacturing figures may suggest second quarter GDP to slow near 0.5% from 1.1% in the first quarter, but this may not be sufficient to prompt a rate move as the currency is currently weaker than the Norges had anticipated.
However, looking ahead we may have seen the top in NOK/SEK around 1.13, which would later be followed by a gradual retreat towards 1.07 as the Norges eases its policy bias. Norway’s federal finances and current account situation are among the strongest in the world, but with higher inflation, interest rates are among the lowest. This suggests rates may have to be forced lower from their current 1.50% in the event that the robust currency starts importing lower prices.
So far, there is no risk of inflation undershooting the Norges’ forecast or for the central bank to pull the interest rate trigger in its September meeting. Headline inflation edged up to 1.9% in the year ending in June, pushing the main underlying rate to 2.4% year-over-year and closer towards the central bank’s 2.5% target.
Most of Norway’s competitors and trading partners are suffering from the risk of disinflation. The Nokkie has certainly reflected this reality. But if the global economic slowdown amplifies the July plunge in oil prices, then the oil and gas-dependent NOK could see its fortunes change quickly, and inflation slows sharply.
Danish or Swissy?
In the case of Denmark, the central bank’s discount rate target stood at 0% since July 2012 in response to an average inflation rate of 0.50% over the last 12 months. This kept bond yields below 2.0% on a combination of low inflation and low growth drifting below 1.5% over the past three years. Denmark’s currency has outperformed both the SEK and NOK despite its ultra-low rates as the situation prevailed for well over two years. The novelty of the shock rate cut from Sweden and the potential for an easing down the road from Norway may well be behind the recent resilience in DKK.
Switzerland’s consumer price index has dipped back to zero and the harmonized CPI adopted by the Eurostat is at -0.1%. Meanwhile, retail sales fell 0.6% in the fiscal year ending in May. Yet the currency remains resilient due to safe haven flows from lingering uncertainty in the Ukraine.
Currencies have repeatedly proven that profit optimisation is best derived from the forward-looking interest rate horizon, rather than the picture prevailing at the present time. With this logic, SEK shorts may remain attractive against USD and AUD into the middle of the third quarter until the focus leans towards a more bearish stance in Norway as the Norges is forced to embrace a more dovish directive. We thus anticipate USD/NOK to strengthen towards 6.75 and CAD/NOK to reach 6.00 by fall as the changing inflation picture in Norway forces more dovishness from the Norges.
Ashraf Laidi is Chief Global Strategist at FX Solutions/City Index, founder of AshrafLaidi.com and author of “Currency Trading & Intermarket Analysis”.