EUR/SEK trading at elevated levels• Quality justifies stronger SEK
- As we have argued previously (see Quality justifies SEK strength) Sweden’s stable AAA sovereign debt rating increasingly matters, as other economies are downgraded or put on negative outlook. This is a factor providing sustained support to SEK.
- EUR/SEK is below historical average but not yet overvalued by PPP (PPP-estimate around 8.40).
- We look for the Riksbank to ease monetary policy further, but expect the negative drag on SEK to be modest. Markets have already priced in some further easing (50% probability of a 25bp cut in April priced in), and besides the link between EUR/SEK and relative rates seems to have faded.
- EUR/SEK forecasts (3-6-12M): 8.70, 8.60 and 8.50
• Implied volatility is trading at low levels
- 3M implied volatility (red line) is trading in line with realised volatility (white line). Notably, implied volatility has barely reacted to the recent spike in the spot rate, defying the usual positive correlation.
EUR/SEK Spot Rat" title=" EUR/SEK Spot Rat" width="650" height="380">
EUR/SEK 3M Implied and Realized Volatility" title="EUR/SEK 3M Implied and Realized Volatility" width="651" height="330">Positioning for a stronger SEK
• Idea
- We advise EUR-based clients looking to hedge SEK income (or, alternatively, SEK-based clients with EUR expenses) to enter a 3M participating forward.
- The structure allows its holder to participate in a move lower in EUR/SEK with 50% of the hedged amount, while retaining a worst-case exchange rate.
- Furthermore, the structure benefits from the recent decline in implied volatility.
• Strategy
- Buy a 3M 9.0560 EUR call/SEK put financed by a 3M 9.0560 EUR put/SEK call with 50% of notional.
- Zero cost structure (spot/fwd. ref. 8.9230/8.9590)
- Worst-case exchange rate of 9.0560. If spot at maturity is below the worst-case rate (9.0560), the client buys 50% EUR/SEK at 9.0560 and 50% at the prevailing spot rate. E.g. if EUR/SEK spot at maturity is 8.70 (DanskeBank 3M forecast), the resulting exchange rate would be 8.8780 (0.5*9.0560 + 0.5*8.7000).
EUR/SEK Resulting Exchange Rate at Maturity" title="EUR/SEK Resulting Exchange Rate at Maturity" width="655" height="376">
Illustration of exchange rate at maturity if a participating forward is entered. Relat ive to hedging with a forward, the client is better off if EUR/SEK at maturity is below 8.8620. Relat ive to a zero-cost risk reversal (bought 9.0560 EUR call/SEK put, sold 8.9000 EUR put/SEK call), the client is better off if spot at maturity is below 8.7440.