Category Archives: SEK

GBPSEK selling opportunity

The Turkish crisis and Brexit muddle create an opportunity to sell GBP/SEK

 

Turkish crisis dominates the action

This month global markets are mostly concerned with Turkey, with the sharp fall in the currency the main driver of concerns about deteriorating credit quality due to large net external liabilities. The degree to which foreign currency debt of Turkish entities is currency hedged is unclear, but is key for determining their solvency. Other than the weakness of the currency, the economic situation is in any case vulnerable, but has been for some time. But from a baseline of vulnerable, conditions have deteriorated steadily in the last year or two, with inflation rising and the current account deficit widening, in part because the central bank has not been allowed to make the rate rises required to stem these trends. This political aspect of the problem makes it much more intractable, especially when you throw in the pastor and the aggressive tariff response from Trump.

It is hard to see the endgame at this stage. Funding the current account deficit will remain very difficult as long as there is no action. Even significant interest rate rises may not help much at this stage. Capital controls may come in, and there are risks of default on external debt. However, most of the risk is not government debt, as in previous crises, but corporate debt. This makes a bailout unlikely and difficult, but also probably reduces contagion risks. While there is significant exposure to Turkish debt among European banks, it is not game changing – even the most exposed banks would survive the worst case scenario as long as the problems remain isolated to Turkey.

Which leads to the main question, which is one of contagion. Most commentators argue that this is the primary risk, citing parallels with previous EM crises, notably Asia 97. And they are right, because markets are never entirely predictable, and if appetite for risk disappears what currently appears a perfectly solid investment can quickly become vulnerable. (Almost) everyone needs to raise money, and in such circumstances even perfectly solvent entities can struggle to refinance if markets suddenly become unprepared to fund. As Hamlet says “there is nothing good or bad but thinking makes it so”, and shocks like Turkey can lead to some pretty muddled thinking.

Nevertheless, we doubt that the Turkish situation will lead to a big global meltdown in EM, or a renewal of the Eurozone crisis. Even worst case scenarios should remain contained.  While we may have a period of pressure on some EM currencies and higher EM yields, in the end the global economy is starting from a position of reasonable health driven by good US growth and improving Eurozone growth, combined with a generally more solid global banking system. There are savings looking to be deployed towards higher yielding assets in a world of still very low yields. There are no certainties, but this episode looks likely to present an opportunity to buy risky assets. Of course, care is required, as especially in August things can go a lot further than we would expect before turning. Things that look cheap may yet get a lot cheaper, so technical signals that the market has completed its rout need to be awaited.

Opportunities created by Turkish crisis

The obvious opportunities are the emerging markets that have suffered in sympathy with the Turkish Lira. The ZAR, BRL, and even MXN have all weakened, and there may well be value there. But getting these right requires good timing and a clarity that the crisis is over. In these situations it is often better from a risk/reward standpoint to consider the less obvious collateral damage. In the G10 space the two currencies that have suffered the most since early August are the NZD and SEK. The NZD is understandable as it can be considered the closest thing to an emerging market in the G10 space. But the SEK? Sweden has a current account surplus, very low interest rates and inflation, the strongest growth in Europe and a very secure budget and banking system. It is no-one’s idea of an emerging market. Nevertheless, the SEK does tend to exhibit characteristics of a risk positive currency. This is in part a historic issue harking back to the days when Ericsson made up 30% of the value of the Swedish equity market and it was strongly identified with the tech boom and bubble. But nowadays, while still showing one of the strongest growth rates in the EU, there is no particular dependence on tech. Both EUR/SEK and USD/SEK have risen to levels that have to be considered excellent longer term value regardless of which way the Turkish crisis is resolved, but GBP/SEK may represent the best trade, given the risks involved in the run up to the Conservative Party conference and the October EU Summit.

With the UK parliament on holiday, there have been no significant developments in the last couple of weeks, but there has been more and more noise suggesting that the risk of a “no deal” Brexit is increasing. The main upcoming events are the UK Conservative Party conference from September 30 to October 3 and the EU Summit on October 18/19. Neither looks likely to provide any real progress on Brexit, and the prospect of “no deal” will consequently become even more probable, at least as far markets are concerned.

There are several reasons for the lack of progress, but the two main ones are the lack of any majority in the UK parliament for ANY Brexit plan, and the perception on both sides that the threat of “no deal” – and the brinkmanship involved in that – is necessary in order to get the “best” deal for their side. It may be that an apparent increase in the probability of “no deal” is actually a necessary condition for a deal to be done, but the process will nevertheless have continued market impact.

For what it’s worth, we believe that a free trade deal of some sort is the most likely eventual outcome in the Brexit process. Probably the best reason for this is Ireland. “No deal” would require a hard border, and that is anathema to both sides as well as effectively contravening the Good Friday agreement. But even though a free trade deal is likely eventually, that doesn’t matter right now because it isn’t the most likely next step. More stress is required to produce that outcome.

From a trading perspective, the battleground is GBP. We look to play this from the short side not only because the next events look likely to be GBP negative, but because GBP is starting from a position which we regard as barely below fair value. The current price does not adequately reflect the risks of Brexit.

GBP/SEK looks an attractive vehicle to express GBP weakness here.

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Riksbank – still crazy?

I apologise to those who aren’t interested in Sweden – I have harped on about it quite a lot and now I’m going to do so again. If you have no interest look away now.

Today sees the Riksbank monetary policy meeting with the result announced tomorrow. The median market expectation is that the Riksbank will cut rates even further into negative territory, and this is no doubt part of the reason why the SEK remains weak. Now, applying logic to the behaviour of the Riksbank may be foolhardy, as real rates of -1.25% for a country growing at near 4% real seems odd to start with, but I can see no good reason for them to cut rates. Sure, the equity market has been weak and the oil price has fallen since the last meeting, but if you are going to react to monthly moves in these markets you will be changing rates every meeting. It is not clear that these moves will either be sustained or that they will have a significant impact on inflation.

The key factors in the decision seem to me to be as follows:-

  1. Is there evidence of a weakening in the Swedish economy or a loss of confidence? No. The economic tendency survey – the best short term indicator of GDP – rose again in January and is at the highest level since 2011.  
  2. Is inflation or inflation expectations falling back to problematic levels?                    It’s too early to say. December CPIF Inflation was a little weaker than expected in the December monetary policy report at 0.9%, against the 1.1% projected, but is projected to rise sharply in January. This data isn’t out until next week. Inflation expectations remain little changed according to surveys.
  3. Is the exchange rate too strong?                                                                                         No. After strengthening sharply around the turn of the year, the SEK has weakened in the last few weeks to the lowest level since late December (based on the KIX index that the Riksbank use). It is in line with the Riksbank projected path and much weaker than they would have expected a few weeks ago.
  4.  Is there a need to cut rates for other economic reasons?                                                   No. Quite the opposite, as credit growth remains strong and the Riksbank continues to highlight the risks related to excessive household indebtedness.
  5. Will other central banks cut rates leading to SEK strength?                                        Quite possibly, and this is probably the best reason to expect a Riksbank rate cut at some point. However, with the Riksbank highlighting the possibility of intervention  to control currency strength, there is less reason to expect them to use rates if there aren’t other reasons for a rate cut. The ECB may well cut rates next month, in which case the SEK may well strengthen, but there is no need to pre-empt this, as the outcome is unknown. The Riksbank may allow some currency strength or may choose to try and control it with intervention rather than a rate cut.

All in all, I see no reason for the Riksbank to hurry into a rate cut. Of course, they have shown a recent history of extreme dovishness, but the strength of the economy, high household indebtedness, strong credit growth and their apparent willingness to use intervention to control the currency if necessary suggests to me there is no intention to move unless inflation clearly weakens significantly. Surely it is better to wait until they have the January inflation data and have seen the ECB action and the currency reaction? A cut now would be a panic measure related to market turmoil. It is of course possible (most people are forecasting it) but that makes the minority view of no change all the more attractive for SEK bulls like myself.

Supertanker turns?

EUR/USD is a supertanker. It takes a lot to turn it, and yesterday’s break higher was long overdue, as the European data had been steady and the US data deteriorating for some time with little impact on the currency. Whether this is a proper long term turn depends on how much trust we can place in the evidence of weak US and more solid Eurozone data and whether we believe that Draghi has more ammunition to halt the EUR recovery. I suspect we aren’t quite ready to believe that the US recovery is burned out so long term EUR/USD gains will have to wait. But even if the supertanker hasn’t made a longer term turn, it doesn’t reverse these sort of moves quickly. While rapid moves of this sort are often corrected for a period before extending, I would still be looking to buy a big enough dip. Technically, we have now achieved the 61.8% retrace of the 1.1495 to 1.0525 October to December decline, so I wouldn’t be chasing it as we may well see some retrace, but I think it will take real news, and not just a decent employment report tomorrow, to get us back below 1.10 with major supports now at 1.0980 and 1.0940. People may start to remember that employment data often lags the cycle.

For what it’s worth, I doubt that he US economy is really weakening dramatically. The data is unreliable in the short run and the short term impact of a weaker oil price may have been negative, but longer term effects are more likely to be positive. I wouldn’t rule out a rate hike this year, despite the latest market moves, though again, we need to see some numbers to get the market thinking that way again, and they aren’t going to turn up immediately.

Of course, Draghi won’t be happy to see EUR/USD spiking higher, and its rise will give him some ammunition to persuade the ECB Council that more easing is required. If he gets the desired further ease, EUR/USD will settle into a range again. I’m not sure he will but the market is probably going to bet on it ahead of the March meeting, so I think other currencies where easing is less likely are more attractive USD alternatives. The JPY is one possibility, and the easing has already been done so another move near term is unlikely, but you have to back weak equities to favour major yen strength. It’s quite possible, but I’m not quite ready to do that as even though the US data has been disappointing, equities get the comfort of lower yields, and European data has been less of a concern. I’m keener on the AUD, which looks ripe for a recovery if commodities stabilise, and the SEK, where the Riksbank’s threats look empty with EUR/SEK pushing 9.40 and growth remains the strongest in the developed world.

 

Hard to like the USD right now

Sure, big picture the idea that the Fed is going to continue to raise rates while rates stay unchanged in Europe underpins the consensus expectation of a stronger dollar in the fullness of time. But right now it’s hard to see immediate USD strength, especially against the EUR (and SEK).

1) The US data has been weak, especially on the manufacturing side. Industrial production and the Empire index on Friday underlined this. This is in part a global story, but the European numbers have been more stable, and the Swedish numbers positively strong.

2) True, the US employment data remains strong, but the lack of wage growth and the weak oil price suggest this isn’t going to be enough to translate into another near term rate hike, and there is a concern that employment is a lagging indicator.  Retail sales were also weak in December, and the Atlanta Fed GDP nowcast currently suggests 0.6% annualised for Q4 (i.e. 0.15% q/q) after Friday’s weak data.

3) Spreads have edged against the USD because of the weak data, with the T-note/bund spread at 155bp the lowest since late October, when EUR/USD was above 1.11. This has been a close correlation in the last 9 months or so.

4) Risk appetite is low, and few see real value in US equities even if we see a risk recovery. The safer havens have done well in the last few days, but the EUR is still in the middle of its recent range while risks and spreads suggests it should be pressing the top.

5)  The SEK has suffered from the general risk off tone, but it is not at all clear that it should now it is one of the lowest yielders and biggest surplus currencies. At this level of the currency, it is also clear that any rate cut or intervention threat has disappeared.

6) Positioning remains long USD despite the poor news, and to some extent the USD may be enjoying some safe haven characteristics while markets are jumpy, but it’s hard to see the fundamental value at this level against the EUR and SEK if US rates aren’t rising.

ECB? BoE? No – Swedish CPI

There will be a lot of focus on the ECB and Bank of England monetary policy meetings and press conferences and minutes on Thursday, but frankly I can’t see much of interest coming out of either. The ECB has only just announced its latest easing, so can’t really be expected to do anything or say a great deal. Inflation is a touch lower with the oil price, but not so much that it changes the long term view, and the economy continues to perform OK.

For the BoE, there isn’t much reason for anyone to change their view, though McCafferty could decide to fold short term on his rate hike call, but even if he does it doesn’t make a lot of difference. Clearly the manufacturing data has softened, and growth in general may be slowing a touch, so policy is on hold. I doubt they will say anything that significantly changes market pricing for the first UK rate hike. If they had any sense, they would try to talk GBP down a bit in the minutes. Although in reality the recent weakness of manufacturing probably has very little to do with the overvalued pound, a weaker pound wouldn’t hurt, and in bringing inflation up would allow a rate hike at some point which would be good for the balance of the economy. I’m not holding my breath expecting a GBP collapse on the minutes, but it seems to me that’s the risk if there is one.

But all this is really just hot air. Swedish CPI for December looks more interesting to me. The Riksbank have been resolutely talking down the SEK and threatening all manner of measures to stop it going up too fast, essentially because they have an inflation target and worry that a stronger SEK will kill progress towards it.Frankly, I think their stance is bonkers, as recent experience of inflation targeting has shown that trying to target it too closely is likely to be unsuccessful in the short run and counterproductive in the long run. The Swedish economy grew at about 4% in 2015 and is expected to do the same in 2016. Inflation being 1% below target (and rising) is not a big problem. The SEK will have to go up sooner or later. Best to let it go up when the economy is in shape to deal with it.

Still, rightly or wrongly the Riksbank has it’s inflation blinkers on, so a weak number on Thursday will get everyone thinking they might cut rates again. I doubt it myself, but it would probably be enough to send EUR/SEK to 9.30 or so. Conversely, a strong number would allay some of the low inflation concerns, and send it to 9.20. I doubt the Riksbank would get involved with their threatened intervention this side of 9.20, and probably not before 9.10 if inflation is stronger. Risks are probably towards a weaker than expected number rather than a stronger one, but I’m a buyer of SEK on the dip, as it’s only as low as it is because people are worried about Riksbank action, and they won’t do anything if the currency dips.

 

Risk off – why EUR/JPY?

Yes, the Chinese data has been a bit soft, and the US manufacturing numbers haven’t been too special either. Plus we had the North Korean “earthquake” to jangle some nerves. But the European PMI data has been solid enough, and the US employment data continues to impress. The oil price is hitting new lows, but that’s double edged for growth and equities. It’s not all great, but it doesn’t all look terrible either. In my book it’s not bad enough to create a major sell off in equities. Yet we are at the lowest level since October. In the US, this may make some sense. Rates are higher and the recent data has been on the disappointing side. But for some European markets, the price action is harder to justify. Sweden in particular is testing the October lows which were also the 2015 lows, but rates are negative in Sweden, the currency is still very low against the USD, and growth is running close to 4% and expected to hold there for 2016. It’s hard for European markets to buck the trend of the US, but it’s hard to understand them underperforming.

This is also reflected in a bit of an FX puzzle. EUR/JPY has been hammered in the last few sessions, but the EUR doesn’t look the obvious currency to suffer from risk aversion. The European numbers have been reasonable, but  in any case, the EUR has tended to benefit from risk aversion in recent months, which makes sense given that it has been the favoured funding currency. AUD, CAD, GBP, USD and NOK all look more obviously vulnerable to risk negative news.

On a fundamental basis, it is also hard to justify EUR/JPY weakness on risk aversion, as the Eurozone is now the biggest current account surplus region, and positioning remains more heavily short EUR. It may be that the ECB does eventually ease more, but at this stage the BoJ is still implementing QE even more aggressively. Valuation wise, I would argue that the EUR is also slightly cheaper than the JPY, and though some will disagree with this assessment, valuation isn’t a major issue. All in all, I can see no real case for major EUR/JPY weakness with the obvious equity correlation looking harder to justify. Yet we are approaching the 2015 low at 126.10. It’s hard to oppose current momentum, but seems to me this should hold until there is clearer evidence of risk aversion extending. So even though the chart looks pretty compelling in favour of the longer term JPY bulls, I’d look for a near term bounce.