The popularity of both currencies has been driven by a combination of their offering safe-haven, alternative exposure to the European economy thanks to low levels of government debt in Sweden and Norway, along with decent yields and good economic growth.
Accordingly, EURSEK and EURNOK hit multi-year lows in August as confidence in the eurozone project wavered just ahead of the pledge from Mario Draghi, president of the European Central Bank, to do “whatever it takes” to save the euro.
The renewed confidence in the single currency – and the resulting narrowing of the spreads between the yields of German and peripheral eurozone government bonds sparked by Draghi’s commitment – suppressed haven demand for the SEK and NOK, but failed to send either currency sharply lower.
Tom Levinson, strategist at ING Financial Markets, says that is because while reduced fears over eurozone government debt are a necessary ingredient for the SEK and NOK to depreciate on a sustained basis, a further important catalyst would be expectations of renewed monetary easing from the Riksbank and Norges Bank.
That meant while confidence in the Swedish and Norwegian economies remained in place, the improving situation in the eurozone financial system did little to stem demand for the SEK or NOK.
In recent weeks, however, the Norwegian and Swedish central banks have become decisively more dovish, which could open the way for further falls in the NOK and the SEK, enabling them to more closely follow the trend of narrowing eurozone bond spreads.
| SEK and NOK versus Italian-German 10-year yield spread |
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Levinson notes that Italian and Spanish bond yields have been on a near straight-line march lower since Draghi’s statement last summer, with only Italy suffering a blip earlier this year amid uncertainty surrounding its inconclusive election.
“Although these bond markets are healing, it is understandably taking longer for FX investors in NOK and SEK to be convinced,” he says. “But there are signs that both are now in the process of shedding their star billing.”
That is because, in addition to the receding risks of a eurozone break-up, the combination of a deeper recession in the wider eurozone plus evidence of a slowdown at the region’s core – Sweden and Norway are highly export-reliant on Germany – is hurting sentiment towards the SEK and NOK.
Indeed, recent rate projections from the Riksbank and Norges Bank have taken this on board, showing greater openness to renewed monetary easing.
| Swedish and Norwegian interest rate projections cut sharply |
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Some believe rate cuts are forthcoming in Scandinavia. Sweden’s SEB, for example, believes the Riksbank will cut rates by 25 basis points to 0.75% at its July meeting, given that Swedish inflation remains stubbornly low and given the slowdown experienced in the eurozone since its last meeting in April. The Norges Bank, on the other hand, could ease policy as early as its meeting on May 9.
Uncertainty over government debt problems in the eurozone should be sufficient to prevent a collapse in the SEK and the NOK, but changing sentiment towards the two currencies, for so long favourites of investors, could leave them vulnerable to a sharp move lower.
As Levinson puts it: “It takes little for a fickle FX market to take a new idea and run with it, often resulting in a sizeable sell-off [in a currency].”
As to which currency wins the race to the bottom, it could well depend on oil prices. Further losses in crude prices would see SEK outperform, while a recovery would favour NOK.