SEK: Still looks vulnerable – RBC CM

Adam Cole, Research Analyst at RBC Capital Markets, notes that the SEK continues to trade very poorly and was the second worst performing G10 currency in September (after GBP) and has the same status for 2016 so far.

Key Quotes

“EUR/SEK remains close to a post-crisis high. On the face of it, this is completely at odds with Sweden’s fundamentals, which are arguably better than just about any other G10 country. By a wide margin, Sweden had the strongest growth in G10 in 2015, again in 2016 and it is forecast to be amongst the strongest in 2017. Inflation has been rising steadily for two years and on core measures, is approaching the Riksbank’s 2% target, while inflation expectations are also rising. A partial explanation for SEK weakness may be inflated expectations as even strong data have, on balance, been short of consensus forecasts for much of the year. But data are now surprising to the upside and SEK is still falling, suggesting another factor is at work.

Just as AUD appears to have decoupled (to the upside) from a negative domestic rate dynamic in 2016, we think SEK weakness reflects the role outright yield is playing in driving FX returns, irrespective of the direction of expectations. In other words, carry has returned as a driver of FX market returns and our analysis shows SEK to be the optimal funding currency in G10 carry trades, a status that CAD had previously held for most of the post-crisis period. Absent a major shock to risk appetite, in the short-term, we see no strong reason why the forces driving SEK down (or AUD and NZD up) should moderate sustainably and a small upward revision leaves our end-year forecast for EUR/SEK slightly above spot (9.75).

6-12 Month Outlook – Shorts unwind

In a longer-term context, there are three key risks that could lead to an unwind of the “SEK carry trade” and a sharp re-rating of the currency. Firstly, SEK loses its recently-acquired status of funding currency, either because Swedish rates rise or because rates fall elsewhere. Secondly, SEK loses its funding currency status because it starts trading like a safe haven. Finally, carry stops working as a global FX theme due to higher yields on conventional assets or higher vol across the board. None of these seems like an imminent threat, though the third is inherently unpredictable and there is a body of thought that it may be close. On a longer-term horizon, however, it seems prudent to assume these risks rise materially and we expect SEK to rebound from deeply undervalued levels.”