FX Trade Recommendation: Short EUR/NOK Via A 3M Risk Reversal

Today’s Norwegian inflation data surprised strongly on the upside. The core measure, CPI-ATE, rose 1.8% y/y compared with 1.2% expected in the market and 1.26% expected by Norges Bank.

We believe the market reaction in EUR/NOK after the release has been too muted and believe that EUR/NOK has further downside.

If we take a closer look at the details in today’s release, it seems that domestic price pressure, in particular, is rising. The statistical office breaks down the CPI release by delivery sector. ‘Other consumer goods produced in Norway’ rose 10.6% y/y and ‘Other services with wages as dominating price factor’ rose 3.7%.

For Norges Bank, these domestic price increases should take away the easing bias currently in place and all speculation regarding a new rate cut in the autumn is now dead. Historically, the NOK has been very sensitive to surprise moves by Norges Bank, so this downside risk to the NOK should now be significantly lower. In our view, the latter is important for speculative money waiting to go long the NOK after the sell-off in June. The weekly flow data from Norges Bank indicate that ‘foreign banks’, which we see as a proxy for ‘speculative money’, have not been very active in the NOK for the last four weeks after the strong move out of the NOK in June.

Very often analysts are ‘cheated’ by special price items in Norway. However, beside higher food prices due to public administered agricultural producer prices, we see no special ‘item’ in today’s release. The higher food prices should come as no surprise to analysts or Norges Bank. Airline fares are often very volatile but they are down 15.6% y/y and are not adding to the upside surprise.

In respect of the Norges Bank rate path, higher running inflation, a weaker trade-weighted NOK, higher rates internationally and a better global growth outlook (PMIs) all tend to push the Norges Bank rate path higher. It is quite likely that in the next Inflation Report Norges Bank will remove the current ‘easing bias’.

Over the past three months, commodity currencies have in general been under strong selling pressure due to weaker data out of China and a general market theme that the ‘super cycle’ in commodities has come to an end. However, over the past two days better numbers out of China have fuelled a mini rally in commodity currencies such as the AUD and CAD. Hence, global sentiment now seems less hostile towards commodity currencies. Note also that the NOK is no longer fundamentally overvalued against the EUR. Our PPP estimate for EUR/NOK is 7.86.

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