NOK/USD – Just a Commodity Currency, or Does the Krone have Horns?

The NOK/USD exchange rate has had a bumpy year, with the dollar buying nearly 9 Krone during a January high, with lows in May and September of around 8. That this last rise occurred at the same time as OPEC countries reached a preliminary agreement to cut oil production is of course no coincidence, and nor are this month's drops in value for the currency of the world's 15^th largest oil producer. This article will consider the ways in which current events may impact the NOK/USD exchange rates, at the same time as considering the longer term picture for this currency pair based on a brief consideration of the fundamentals of the Norwegian economy.

As a commodity currency, the Krone is of course influenced by rises and falls in the prices of certain commodities, in particular oil, and this coming weekend promises to make Monday quite an interesting day for the Scandinavian currency. Should OPEC negotiations collapse, expect the Krone to follow suit by dropping against the dollar.

In September, OPEC signed an agreement to curb oil production, however scepticism about the strength of the deal was evident even as it was announced. As October comes to a close it seems more and more probable that such scepticism was reasonable.

It is getting complicated, an OPEC delegate said before the meeting began on Friday. Every day there is a new issue coming up

Recently, as a result of such scepticism, oil prices returned to a level of below $50 a barrel for the first time in three weeks, following what may be a prelude to the collapse of September's OPEC agreement, or at least its watering down to a point whereby it is essentially meaningless. Iraq, Libya and Nigeria have been making their case for opt-outs, even before the preliminary meeting on the 28th of October, with the formal meeting still one month away on November the 30th in Vienna. Despite this, owing to recent and escalating unrest in Venezuela, the price of Brent Crude has recovered to just above the $50 mark. Yet, stabilising above the $50 mark might prove somewhat tough, given the market's reasonable scepticism about the ability of OPEC first of all to hold together an agreement, and second of all to actually follow through with it by observing any mandated quotas. Ole Hansen, senior manager at Saxo Bank sees a medium target of $48.40 as a safe bet. If this is the case, the NOKUSD will certainly drop, although not as heavily as a more pessimistic oil price prediction of the mid to low 40s might have implied. 

This current OPEC meeting, while not tasked with deciding policy, will provide an indication of the strength of any deal which might be announced in November. What is being discussed over the last weekend of October is however a potentially troublesome issue: production limits per country, the precise type of detail around which talks often collapse. Should the meeting surpass expectations and remain drama free, expect commodity currencies and the price of oil to trepidatiously rise, as scepticism over the current integrity of OPEC will not be cleared by one meeting. Contrastingly, should more than cracks appear, the markets are likely to assume the deal is essentially off, and that November's meeting may become little more than a face-saving exercise, in which case betting against currencies such as the Krone, or indeed the Canadian Dollar, might be a prudent action.

Interestingly, with the meeting scheduled to continue for a second day, during which non OPEC nations will be invited into meetings, it might ALSO be possible to get a picture of the global sentiment of oil producers. With little faith held in internal OPEC politics, the Saturday meeting might prove quite interesting for Monday's markets, in light of statements such as Putin's that he saw no obstacles to a global oil price freeze. So while less likely, there is the potential for several scenarios to emerge from the weekend's talks. What can be expected however is a clear picture of what to expect in the run up to the end of the year. Pessimism or optimism? The short or the long option on commodity currencies? On Monday the answer will be much clearer. 

Despite the general lack of belief in OPEC, it is worth noting that some analysts, such as those at RBC Capital Markets, do in fact believe OPEC will follow through, suggesting that the cartel's reputation is on the line, which makes it likely that it will make sure production reduction targets are met. They do however note that a “failure to launch [the deal properly] will undoubtedly send the market reeling back into the low $40/bbl price environment, or lower.”

Outside of the influence of oil however, the Norwegian economy appears to be recovering from the difficulties it faced from the -56% drop in oil prices since 2014. Countercyclical spending, along with rate cuts ,and a lower currency value, has helped Norway back on its feet, and the fact that rates are on hold for the fourth consecutive quarter suggests that Norges Bank is confident the economy is on a steady course and an even keel. The economy grew by 1.6% in the fourth quarter, and whist manufacturing levels have continued to fall, for the most part this can be attributed, yet again to oil, sentiment amongst non-oil manufacturers is contrastingly increasingly positive. The actions of the central bank were also viewed positively by markets, with the Krone hitting a two-day high of 8.97 against the Euro. Erica Blomgren, chief strategist as SEB Norway, suggested that markets were worried the Norwegian Central Bank might send negative signals to weaken the Krone, and that the fact that this did not occur relieved the nerves of currency traders holding a position in the Norwegian currency.

In the short term, with oil prices likely to fluctuate in line with events as the year comes to a close, outside of a small potential post U.S. Election bump, the USDNOK exchange rate is likely to see small but steady gains for the dollar, with commodity related swings in the other direction, however the longer term picture may not be quite as clear. What the above report analysis of the Norwegian economy in a more general sense is intended to portray is a generally strong economy which seems to be on the up, and may indeed be somewhat undervalued. Sentiment for instance, amongst producers of more traditional Norwegian goods, such wood products, paper and paper products, chemicals and metals reported some increases in production in Q3, and they remain optimistic in the fourth quarter according to Handelsbank and Statistics Norway. Additionally some analysts, most particularly those of Bank of America Merill Lynch, suggest going long on the Krone in the event of any pullback. Oil prices have been climbing which is good news for Norway, however having to deal with the fallout of a sharp reduction in oil income may also have made the Norwegian economy leaner, fitter and more diverse, which is no bad thing for the country's long term prospects. Thus, if you're interested in a long-term bet, with the macro-view in the medium term for Norway being positive, an FX position in the Krone taken during any upcoming dips, with an eye kept on central bank sentiment to a stronger NOK, might prove a clever investment. Indeed, as per Bank of America, should the Norwegian Central Bank continue to steer clear of rate rises, there is potential for a bullish increase for the Kroner in 2017.

Rate differentials still suggest some upside potential and indeed, even positioning shows real money investors have room to add to longs