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SEK: Relative rates come back as key driver

Wed, Sep 24 2008, 13:51 GMT
by Stefan Mellin

Danske Bank A/S

For several months EUR/SEK has been mainly driven by risk aversion and stock markets performance. This continues to be the case and we also continue to believe that any meaningful rebound in the SEK will not materialize until the overall market sentiment improves. Now the situation appears to get worse by the day; VIX is edging higher again and stock markets fail to get a firm footing amid uncertainty whether the Paulson/Bernanke rescue plan will be passed through the congress without delay. If it does it might be a positive trigger but that surely remains to be seen. If it does not it will weigh heavily on the market and likely send EUR/SEK to new highs. Meanwhile the SEK gets hammered by difficult market conditions such as sharp rise in USD libor rates, 3-month fixed 27 basis points higher than yesterday. Swedish ditto were close to flat. From a strict carry perspective this is not SEK supportive.

That being said it is interesting to note that the 2-year swap spread, which was firmly placed in the back seat over the summer months, has made a come back as a key driver for EUR/SEK. The chart below shows that the main drivers right now are VIX (risk appetite/aversion), stock market developments in absolute terms and rela-tive yields whereas relative stock markets (EuroStoxx vs OMXS) have lost power. Another anomaly over the summer was the positive correlation with EUR/USD. This is now changing as well.

Even though risk sentiment will be No 1, if fundamentals are back on the agenda, what do we see? Well, in short, the growth outlook remains in the doldrums. The inflation picture is improving as exempliefied by the fact that households 1-year expectations have fallen from 3.7% in July to 2.4% in September according to NIER. We ex-pect to see a longer term inflation expectations to come down as well amid actual inflation is heading lower. The Prospera inflation expectations survey are released on 8 October and will be very important. Elevated price plans among food retailers have been used by the Riksbank hawks (Mr Öberg) for raising rates. Today's NIER survey showed these plans have moderated sharply. Hence, it is not difficult to make a case for more front-loaded repo rate cuts. The Riksbank main scenario is a first cut in Q3’09r. We see the first cut in Q1 but with an increasing chance for December. Barbro Wickman-Parak (dove) said last week: "One can, on the other hand, if it becomes apparent that economic activity is declining, reduce the interest rate more rapidly than was originally intended." Stefan Ingves' (hawk) speech at 15.00 today will be closely watched for any signs of a change in stance. We do not rule out a marginally softer tone although we basically expect him to differentiate between monetary policy and actions undertaken to facilitate market functionality. Due to credit market turmoil it is hard to say exactly how much the market is discounting in terms of rate cuts, but we estimate some 100bp through 2009, i.e., close to our forecast.

In conclusion, while humbleness should be a virtue not least in these troubling times, we expect the SEK to continue to trade on a weak note in the coming months. EUR/SEK fair value is within the 9.50-60 range. But still we see a non-negligible risk that EUR/SEK takes another leg higher on further troubles in the markets or a softer Riksbank. Trading-wise however we prefer to look for opportunities to re-enter a long position in USD/SEK.

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Published on  Wed, Sep 24 2008, 13:55 GMT