Close Short EUR/NOK Positions Ahead of Annual Address

In our FX Top Trades 2012 from  14 December 2011 we recommended selling a 12M EUR/NOK and a 12M USD/NOK forward. The recommendation is currently 3.2% in the money. To lock in some of the profit we recommend buying back the EUR/NOK 12 FWD at 7.6442 for a profit of 2.87%. Hence, we keep or short 12M USD/NOK forward that we entered at 6.01. It can currently be bought back at 5.7324 with a profit of 3.54%. We also keep our short GBP/NOK recommendation that was entered at 9.17 on 19 January. This recommendation is currently 2.1% in the money.

The reason why we have decided to close our short EUR/NOK position is the growing risk that the Norwegian central bank governor tomorrow night in his annual address will try to verbally intervene in the FX market. EUR/NOK is now at the same level as after the SNB announcement  on 6  September 2011, when the 1.20 minimum target was introduced. The EUR/CHF-minimum target resulted in many investors turning their focus to Norway and EUR/NOK fell in a few days to 7.52 from 7.70 in the beginning of September.

The strong NOK appreciation resulted in a strong verbal response from Norges Bank two days after. On  8  September Norwegian central bank governor Olsen said, “The Norwegian krone appreciated sharply after the announcement. A krone that is too strong can over time result in inflation that is too low and growth that is too weak. In that case, monetary policy measures will be taken. In Norway, the key policy rate is the relevant instrument”.

He further added, “The Norwegian krone market is small by international standards. This means that the krone exchange rate can fluctuate considerably in times of international turbulence. This will also be the case the day foreign exchange market participants decide to shift out of their krone positions. The exit may  prove narrow if too many investors decide to withdraw at the same time”.

If the governor repeats his warning tomorrow night, we  believe it could trigger some short-term profit-taking, but we doubt it will have any lasting effect on NOK. The Norwegian economy is still very strong and the housing market certainly does not need lower interest rates. We can in fact much easier explain the move lower in EUR/NOK this time  than in  September last year. Risk appetite, relative rates and the oil price  are all factors that support a strong NOK. Furthermore, the weekly flow data from Norges Bank indicate that the market is less stretched positioning-wise this time. In September huge long speculative positions had been built in the market. This does not seem to be the case this time.

Hence, we would use a possible spike in EUR/NOK tomorrow night to position for a new move lower in the cross. Our short-term financial model could not justify the strong move lower in EUR/NOK in September last year. The move was more than 3 standard deviations away from the model estimate. This time it is approximately one standard deviation away. Especially the move in relative rates can justify the latest NOK appreciation.

He further added, “The Norwegian krone market is small by international standards. This means that the krone exchange rate can fluctuate considerably in times of international turbulence. This will also be the case the day foreign exchange market participants decide to shift out of their krone positions. The exit may  prove narrow if too many investors decide to withdraw at the same time”.

If the governor repeats his warning tomorrow night, we  believe it could trigger some short-term profit-taking, but we doubt it will have any lasting effect on NOK. The Norwegian economy is still very strong and the housing market certainly does not need lower interest rates. We can in fact much easier explain the move lower in EUR/NOK this time  than in  September last year. Risk appetite, relative rates and the oil price  are all factors that support a strong NOK. Furthermore, the weekly flow data from Norges Bank indicate that the market is less stretched positioning-wise this time. In September huge long speculative positions had been built in the market. This does not seem to be the case this time.

Hence, we would use a possible spike in EUR/NOK tomorrow night to position for a new move lower in the cross.

Our short-term financial model could not justify the strong move lower in EUR/NOK in September last year. The move was more than 3 standard deviations away from the model estimate. This time it is approximately one standard deviation away. Especially the move in relative rates can justify the latest NOK appreciation.

Furthermore, we note that the market this time is less stretched positioning-wise. The weekly flow data from Norges Bank show that foreign banks (proxy for speculative money) have not built excessive long NOK positions ahead of the latest NOK appreciation. In September last year the market was record long NOK. Hence, the verbal intervention from Norges Bank caught the market on the wrong foot. We doubt we will see the same strong effect this time should Norges Bank repeat its warning tomorrow night.