SEK Under Pressure

NOK/SEK Supported By Relative Yields
‏On the back of today’s inflation shock (not least for the Riksbank) we have revised our call on the Riksbank and now expect a 25bp rate cut in December. The bank is likely to maintain its easing bias even after the cut and we expect it to postpone the first rate hike further out into 2015. The market is pricing in only a 50% chance of a cut (6bp for December and an additional 6bp in February). Hence, we think that EUR/SEK has more to do on the upside before this is over. We raise the EUR/SEK 1M target to 9.00 while acknowledging that the pair might get stuck above 9.00 for a period of time.

The medium-term outlook?
We must not forget that this is a relative play, where the Riksbank is obviously not the only bank lowering rates and Sweden not the only country with low/falling inflation – on the contrary. So, it is not evident that the currency with still positive rates should underperform vis-a-vis the EUR where the policy rate is nailed close to zero. In addition, our EUR/SEK interest-rate model suggests that the currency market has overpriced a more dovish Riksbank; EUR/SEK has reacted more than is implied by relative yields (). Moreover, the fact that Swedish inflation continues to undershoot Euroland means that the krona is becoming increasingly undervalued (EUR/SEK overvalued) in terms of purchasing power parity. In fact, most (all) long-term fundamental measures suggest EUR/SEK should eventually head towards and below 8.50. Thus, we keep our 12M EUR/SEK target intact at 8.40.

Short-term outlook?
For the coming months we see mostly downside risks for the krona. How to play it? We prefer long NOK/SEK over long EUR/SEK based on relative monetary policy (Norges Bank stays on hold) and relative inflation (see chart to the right). Our interest model suggests a target just below 1.10 (second chart to the right). The main risk to this trade is the poor liquidity in the Norwegian market. However, after the latest move higher in EUR/NOK we believe that the worst NOK underperformance is behind us. Importantly, we see little risk of a rate cut in Norway in December given that the trade-weighted NOK is significantly weaker than assumed by Norges Bank.

We recommend to go long NOK/SEK at 1.0725 with a target at 1.10 and stop-loss at 1.06.

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