FX Strategy: SEK Not Out Of The Woods Yet
Danske Markets | Oct 30, 2019 08:27AM ET
- Further headwinds for the SEK despite December hike
- We stay long EUR/SEK in the FX Trading Portfolio but raise stop to entry
- We reiterate our EUR/SEK forecast, but stress that downside risks have increased
Last week we recommended buying EUR/SEK in anticipation of a dovish move from the Riksbank (see here ). Contrary to our expectations, the bank reiterated that the policy rate will most likely be raised to zero in December. The initial reaction was to send EUR/SEK lower, but at the end of the day it was back to square one, the position's entry level. Overnight, EUR/SEK has printed new post-Riksbank highs. The substantial re-pricing of the Riksbank that took place (from +9bp to +21bp for the December meeting) without follow through in EUR/SEK illustrates the poor underlying SEK sentiment: not even the strong signal of leaving negative rates seems to convince investors of an imminent reversal in EUR/SEK. Why? Lower (0%) for longer is probably one reason. A murkier cyclical outlook another. Could a Riksbank risk premium be a third?
We see further headwinds for the SEK, but the immediate argument for the trade no longer applies. Therefore, to protect the position from losses, we raise the stop/loss to 10.73 (entry), whilst keeping our soft target of 11.00.
USD/SEK still in the second quadrant.
Tighter monetary policy? Yes and no. The new rate path indicates that after having raised the repo rate to zero, the plan is to stay there for an extended period of time. While we would not rule out a positive threshold effect on the SEK at zero, we wonder if it is more than a marginal factor. Carry has been a clear headwind for the SEK, especially versus the USD. With a Riksbank hike all but priced in and with additional cuts priced in on the Fed, we think that USD/SEK will still be a preferred long in the carry/momentum space. In addition, the chance of additional hikes beyond zero looks even more remote with the new rate path. Since July the Riksbank has lowered the end-point (Q3 22) of the repo rate by 82bp, from 0.90% to 0.08% (53bp in September and an additional 29bp in October).
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This shift makes sense given the deterioration of the macro and inflation outlook and shows that the policy has actually become more expansionary. However, the December hike is still hard to grasp. Especially, as the Riksbank’s mantra has been and still is that the negative rate has served its purpose in terms of lifting inflation. From the central bank’s perspective deviating from that strategy would be like shooting itself in the foot.
Murkier growth outlook? Yes. No doubt. Both globally and in Sweden. This is typically not an environment where one would build long positions in the pro-cyclical, risk-sensitive SEK. For example, the SEK together with the NOK has been the worst performer since PMIs started to drop last year and since the trade war started in Q1 18. The USD has been the outperformer, not only offering protection in risk-off markets (a property it shares with the JPY and the CHF) but also offering positive carry and relatively healthy growth – a unique position in the FX space. Sweden has offered strong growth for many years, but not anymore. In the near term PMIs will be in focus. In Sweden, we saw a sharp drop last month, an accident waiting to happen given Germany. In October, we could see a correction higher, which in turn could lend temporary support to the SEK. The outlook for the industrial sector is still bleak though: we expect PMI to stay below 50 in coming months.
Riksbank risk premium on the SEK? Possibly. The Riksbank suddenly seems a bit uncomfortable with rates being negative and also with the risk that the depreciation of the SEK spins out of control. We agree that negative rates may have adverse effects on activity and banks, but this has not been official central bank policy until now. We also detect a new communication on the currency when it says a weaker SEK may have adverse effects on the economy. We agree to that too, but so far it has not been official policy either. If policy communication is incoherent and if policy implementation is seen as being procyclical even when the economy is slowing down and jobs are lost, investors may think twice before buying SEK. Further, should the Riksbank policy be considered as erratic and unreliable, which might be a potential fallout of the sudden shift in allegiance to negative rates, this should increase the ‘policy-risk’ of holding SEK and thus further reduce its already limited attractiveness.
Fiscal policy? We have argued that more expansionary fiscal policy is probably not only more effective in supporting growth and inflation (as monetary policy has emptied its toolbox) but also, at least in theory, something that could lend support to the SEK. However, so far authorities have been reluctant to go down that route. On the margin however, the new SNDO borrowing forecast with more bond net supply (taking into account Riksbank purchases, see here) could be seen as slightly positive for the SEK - this was the exact response to the SNDO announcement last week - but probably not a trigger for a trend reversal.
What does this mean for EUR/SEK? Our 11.00 year-end target was initially motivated by the assumption that the Riksbank would actually cut rates in February. Instead, we now look for a December hike. However, we still think that the Riksbank is too bullish on growth and too optimistic on inflation and as such we think that the pressure on the Riksbank (and the SEK) will not go away anytime soon. At the same time, we have to take into account potential threshold-effects on the SEK of leaving negative rates, about which we are uncertain as of now. This will come into play in the coming quarter and thus potentially affect our 1-3M forecasts, although it is difficult to quantify the magnitude of said effects. Hence, on balance, we keep the profile for EUR/SEK intact at 1M 10.90, 3M (NYSE:MMM) 11.00, 6M 11.20 and 12M 11.20, but would like to stress that the downside risks, especially on the 1-3M horizon, have increased on the back of the Riksbank’s surprisingly hawkish rhetoric.
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