Divergent inflation picture in Scandinavia suggests further NOK/SEK upside

In the Scandi FX markets attention now turns to inflation data. The data out of Sweden and Norway are expected once again to underline the big difference between Norwegian inflation at target (2.5% for CPIATE) and Swedish underlying inflation, CPIF, at 0.3% y/y. The divergent inflation picture together with the higher probability of a new rate cut in Sweden at the July meeting is expected to support NOK/SEK further the coming weeks and a test of the 1.10 level looks likely. Note that strong resistance is seen at 1.0970 and at 1.0985 in NOK/SEK and note also that the cross, according to our short-term financial model, looks significantly overbought trading more than 1.8 standard deviations above the models fair value estimate of 1.08100 (see page 2 for details).

In respect of EUR/SEK we continue to see upside over the next couple of months after the softer Riksbank message yesterday. We still expect inflation to gradually turn out below the Riksbank’s new CPIF forecast and for that reason, pressure on the Riksbank to deliver a rate cut in July will remain. Riksbank itself give a 40 % probability for a cut in H2 and market currently price in accumulated 10bps cut in the Swedish money market curve. Hence further down side in Swedish money market rates and upside in EUR/SEK is likely to unfold in the coming months. For more on the SEK outlook see the Strategy Sweden: our Riksbank view gains support published yesterday.

The minutes to the March FOMC meeting stroke a fairly dovish tone. The increase in the forecasted path for the Fed Funds rate was downplayed and a number of participants were concerned that the change in the ‘dots’ could be interpreted as a move by the Committee to a less accommodative reaction function. The minutes included no record of a discussion as to how long it would take between the end of QE and the beginning of rate hikes. There was a significant market reaction where rates were lower across the US curve and EUR/USD traded higher. The combination of more soft Fed guidance, still soft data, and a feeling of the market being caught a bit short here indicates that the recent sell-off in the US will take a breather in the near term. This implies further EUR/USD range trading in the near-term. However, looking at the current market pricing relative to the FOMC’s forecast for the Fed Funds rate, there is indeed room for higher US money market rates (see page 3), and eventually we still expect a steepening of the US money market curve to support the case for a lower EUR/USD.