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Macro & FICC Research
SEK Views Thursday, April 23, 2020
Defensive qualities ”save” the SEK for now The US dollar has appreciated against all major currencies except JPY and CHF since the start of the Covid-19 crisis. SEK is one of those currencies expected by consensus to perform poorly in a global downturn and yet the trade-weighted krona is currently at the same level as when global equities entered the bear market (Feb 20th). Defensive qualities and a weak starting point (i.e. attractive valuation) with a status as a funding currency have “saved” SEK from falling out of bed. Short-term we fear SEK to be vul-nerable as financial stress increases again, current levels are attractive to buy with a medium-term perspective targeting 10.30/9.05 in EUR/SEK and USD/SEK by year-end.
Richard Falkenhäll Phone: +46 735 93 56 32 [email protected] Carl Hammer Phone: +46 70 302 6128 [email protected] Karl Steiner Phone: +46 70 332 3140 [email protected]
Temporarily weakened SEK as USD funding dried up. Sweden has long lived with a currency that has the same status as some EM currencies – highly vulnerable in times of crisis – this crisis however has shown that SEK can withstand major risk aversion and economic downturn. What did cause the currency to weaken ultimately is in our view the financial stress that was caused by malfunctioning markets and lack of USD liquidity which pressured almost all G10 currencies vs the greenback. This can be shown in the graph below where we have plotted EUR/USD basis and USD/SEK spot. By the end of march all central banks had set-up swap lines with the Federal Reserve and so the shortage of USD liquidity had its remedy and the Swedish currency has stabilized ag 11 vs the euro and 10 ag the dollar. The point we are trying to make is that SEK is vulnerable when financial stress (e.g. VIX above 50) is present but no necessarily when equity markets are falling.
Defensive SEK holding the ground. For some time we have maintained that SEK should be treated as a less pro-cyclical currency. This comes primarily from our strong national balance sheet with a large positive net investment position in Equities (+2000bn SEK) as can be seen in the table below. Relating the stock of investment abroad to actual net portfolio flows can be hazardous as the motif amongst investors buying and selling their foreign held equities can vary. In general however when looking at portfolio flows we have detected that in times of general risk aversion and falling global equity markets, the net equity portfolio flows are SEK positive as Sweden repatriates more funds abroad vs what foreigners are selling Swedish shares. In H2 2015 this pattern became very evident when equities fell and flows came back on shore appreciating the SEK. In 2016 equity markets rose and SEK weakened as net flows went to foreign markets. This relationship is by no means perfect and there are other flows and factors affecting SEK as well. See charts on the next page.
Macro & FICC Research Thursday, April 23, 2020 2
Sweden: National Balance Sheet and Net International Investment Position
Sweden: Portfolio flows 2015-2019
FX forecasts:
23 apr 1M Q2 20 Q4 20 Q4 21 LTFV*
EUR/SEK 10.88 11.20 11.00 10.30 9.85 9.85
USD/SEK 10.10 10.57 10.19 9.04 8.28 8.31
NOK/SEK 0.95 0.95 0.98 1.00 0.99 1.05
GBP/SEK 12.46 12.44 12.50 12.12 12.01 12.78
JPY/SEK 9.39 9.97 9.43 8.14 7.33 8.41
*Based on the SEB LTFV model
-105,9 50,3 -61,4 -90,2 -13,3 42,9 10,2 64,7
-95,2 104,6 124,9 -42,7 15,1 35,0 2,2 16,4
16,1 -25,7 25,0 -0,5 -5,5 17,7 -1,1 -0,2
-79,1 78,8 149,8 -43,3 9,6 52,7 1,1 16,3
-10,8 -54,4 -186,3 -47,3 -28,4 7,9 8,0 48,2
7,1 3,8 195,3 39,7 27,1 12,5 -2,3 -67,7
-3,8 -50,7 9,0 -7,8 -1,3 19,7 5,7 -19,5
Macro & FICC Research Thursday, April 23, 2020 3
Headwinds from interest rates are almost gone The extreme Swedish monetary policy regime of the past (2015-2018) including NIRP, extensive bond purchases and a currency intervention mandate resulted in extremely low Swedish interest rates compared to most other countries and regions at the time. This resulted in:
- A significant change in the carry related to the SEK based on interest rates in the short end of the yield curve that normally is used for FX-hedging.
- Negative interest rates on Swedish bank accounts for Swedish businesses with larger bank holdings.
- A negative impact on the return on foreign bond holdings if the FX risk was removed on foreign bond holdings
This way the combined measures addressed by the Riksbank with rate cuts and bond purchases from 2011 and onwards formed a toxic combination for the krona, where it in hindsight, was poised to weaken despite being undervalued and despite the solid fundamentals of the Swedish economy and strong global risk appetite at the time. These normally positive forces for a currency simply were not strong enough to offset the effects of the Riksbank policy. However, since the Riksbank started to raise its policy rate by the end of 2018 and the consequences of the coronavirus on interest rates outside Sweden these negative forces are now declining, creating much better conditions for the SEK going forward. Moreover, the krona has an attractive long-term valuation at current level while the relatively strong position of the Swedish economy offers capacity to handle the negative consequences of the coronavirus on the economy.
Substantial shift in short-term rates. In May 2011 the USD/SEK briefly traded below 6.00, which marked the trough of the exchange rate before the SEK started its long-term trend lower against the dollar and most other currencies. Altogether the USD/SEK has risen by almost 400 figures or around 65% since then, although not all of it is explained by a weaker krona. The trough in the USD/SEK occurred at the same time as the euro crisis emerged, which probably boosted the demand for the SEK artificially as it seemed like a safer destination for capital than the euro area at the time, which pushed the SEK into overvalued territory in 2011. But it was probably also the outcome of much more competitive Swedish interest rates. Back then the krona traded with a positive 12M carry against the USD of around 2.4% calculated from the FX forward rates, which resulted in an annual carry of around 15 figures in the USD/SEK. Since this peak relative Swedish interest rates have fallen constantly against US rates until November 2018 when the 12M carry in the USD/SEK reached -3.2% based on the FX forward rates or almost 30 figures in the USD/SEK.
Altogether this massive shift in carry by more than 5% or around 45 figures in the USD/SEK pushed the SEK from being one of the currencies where it was possible to earn carry into one of the most attractive funding currencies, which probably triggered SEK-negative speculative flows.
Huge shift for domestic exporters. The shift from being a currency offering a positive carry to instead showing up among funding currencies altered the setup for hedging foreign exchange exposures completely for Swedish exporters and financial institutions. Instead of getting paid to hedge foreign currency exposures back into the SEK hedging the FX risk was suddenly due to a cost, and this happened at the same time as the SEK spot rate trended lower against other currencies. Clearly this sudden shift must have reduced the appetite among domestic businesses and financial institutions to remove or reduce their FX exposures. To make things worse for the SEK the rate cuts by the Riksbank into negative in 2015 was also transmitted into negative rates on businesses’ bank
Macro & FICC Research Thursday, April 23, 2020 4
accounts. Suddenly did it not only cost money to hedge future export revenues but exchanging foreign currency revenues into the SEK and depositing the cash on a Swedish bank account was also associated with an interest rate cost for larger businesses. Undoubtedly this situation must have been very negative for hedging flows overall Moreover, it probably reduced deposits in SEK as other currencies offered more attractive conditions on bank accounts. Tentatively this can be observed in the growing deposits on foreign currency accounts in the Swedish banking system or as sharp increases in deposits on the government tax account, which offered zero rates while bank accounts offered negative rates for larger businesses.
Too expensive to hedge foreign bond investments. Financial institutions and bond investors faced a similar dilemma. Until the end of 2013 Swedish nominal bond yields like the 10Y bond yield traded pretty close to US bond yields, offering around 2.6% in annual nominal return at the peak in 2013. Swedish bond yields began to detach from US bond yields as the Riksbank’s easing became increasingly aggressive while the Fed changed its policy in the opposite direction, scaling back on bond purchases and eventually raised policy rates by the end of 2015. Due to the slope of the US yield curve and the positive carry related to the SEK against the USD in 2011 and 2012, it was in fact possible for a Swedish bond investor to earn a significant excess return on US treasury bond holdings.
This was the case both compared to the nominal yield on a Swedish bond with the same maturity or on a US bond, by simply removing the FX risk on holdings of US treasuries by hedges with a duration like 3 or 6 months. This certainly was an attractive feature which must have generated significant hedging flows supporting the SEK at the time. However, these conditions changed drastically from 2014 as the Riksbank sliced rates and in the beginning of 2016 a currency hedged investment in US treasuries had instead turned into the worst of these three alternatives, a condition that has lasted until very recently. This dramatic shift must presumably have triggered quite hefty changes in the behavior of Swedish bond investors and either reduced their exposures in US treasuries or reduced their FX hedges on these exposures, which surely must have contributed to SEK-negative flows in the FX-market since then.
Conditions are being more favorable today. However, as these charts clearly illustrate conditions have shifted in the opposite direction since the end of 2019. In fact, this begun already by the end of 2018 due to higher Swedish short-term interest rates following the first rate hike by the Riksbank, and accelerated when the Fed started to slash US interest rates last summer. As we highlighted earlier the rate differential between Swedish and US 12M interest rates have already been falling dramatically since the beginning of the year. The changes in the long end of the yield curve have shifted almost in the same remarkable way reducing the gap between Swedish and US 10Y nominal interest rates from more than 300bps by the end of 2018 to around 60bps today. The result is that the annual yield for a Swedish investor on a US 10Y bond with the FX risk removed is today 0.23% compared to -0.03% on a Swedish 10Y government bond. This dramatic change in market conditions suggests a couple of different things for the future.
1) The negative carry based on 3-6M interest rates against other currencies and particularly the USD is now more or less gone, and the SEK is unlikely to be used as a funding currency in the same way the future. This suggests that negative SEK-flows related to speculative accounts are likely to decline, disappear or eventually even turn positive.
2) The cost of hedging the SEK against other currencies and particularly the important USD is significantly lower than before the great lockdown and given that the SEK continues to
Macro & FICC Research Thursday, April 23, 2020 5
trade at a long-term undervalued level this should render increased hedging activities from Swedish exporters and domestic financial institutions.
3) As the negative interest rates no longer exist on Swedish bank accounts, while also having declined in other currencies, it seems reasonable to expect a growing repatriation of revenues and profits into the SEK from Swedish exporters going forward.
4) The return on unhedged exposures in longer dated treasury bonds are not as attractive for Swedish bond investors today, on a relative basis, as it used to be. Still, arguably US government bonds have some downside potential (in terms of yield) from today’s levels, considering where interest rates are on similar bonds outside the US trade today. This may be a reason to hold on to these bonds. However, as the return on currency hedged holdings of 10Y US treasuries have turned positive and currently is around 24bps higher than the Swedish 10Y government bond yield, hedging activity is likely to increase going forward and that should create a significant SEK-positive flow from domestic institutional investors.
The SEK will break its long-term trend when global growth recovers. The SEK weakened in March just like a whole bunch of less liquid currencies amid the panic and turbulence created by the corona outbreak. This is the normal behavior as uncertainty increases sharply and has been observed numerous times in the past. This time, the reaction in the SEK was much more contained than what it has been traditionally. However, the shift in global interest rates have reduced previous headwinds for the SEK from negative interest rates and negative carry. This shift had already started after the first rate hike by the Riksbank in December 2018, but the corona outbreak caused it to accelerate significantly. The SEK currently trades at long-term undervalued levels against most currencies (with a few exceptions), but finally conditions may be in place for a more sustained recovery of the SEK against currencies like the EUR and the USD once the market turbulence and the uncertainty created by the coronavirus fade away and risk appetite returns.
Long-term SEK-valuations are stretched Over the past few years we have written several articles on how we think the long-term fair value of SEK has steadily been undermined. There are several sources behind this trend higher in the fair-value in for instance the EUR/SEK. One reason is the fact that Swedish real interest rates, just like nominal rates, have persistently trended lower vs the euro area. In addition, relative terms of trade were unfavourable in the past while Swedish inflation and ULC have increased faster in recent years. Over the last 10 years Sweden has seen steeper wage increases than the euro area with the same (poor) level of productivity growth. Since the end of 2010 the Swedish ULC increased by almost 10% compared with ULC in the euro area, which is undermining Swedish competitiveness. Considering that 9.25 in EUR/SEK was seen as a reasonable exchange rate a decade ago, it would be 10.10 today to fully compensate for higher relative ULC.
However, at today’s levels of around 10.90 in the EUR/SEK and just above 10.00 in the USD/SEK the krona is significantly undervalued against these major currencies. According to our updated long-term fair value estimates the EUR/SEK fair value is 9.82 while the fair value in the USD/SEK is 8.30. These fair value estimates therefore indicate that the SEK would have an upside potential of around 10% against the EUR and between 15 and 20% against the USD.
SEK Flows: Stated versus revealed preference We have as usually in SEK Views studied our own flows with different client categories in order to check if we can detect a revealed preference in line with the stated preference in the FX survey. In
Macro & FICC Research Thursday, April 23, 2020 6
short, we think there is clear support for the Corporate SEK underweight and the Financials SEK overweight.
Perceived market position: For the perceived market position, we use our aggregated net flow with foreign financial institutions as a proxy. The perceived market position showed record low net balance of -55% in the survey and we find a slight confirmation of this looking into our flows as they indeed as well show a larger long EUR/SEK position compared with in Oct-19 when the previous survey was conducted. However, this indicator shows a gradual build-up which has only recently reached levels seen early Sep-19 when the indicator headed lower for a while (indicating net SEK buying). Judging by the index EUR/SEK is at an equilibrium level now, after having headed too low in Nov and Dec 2019 and too high during the USD liquidity squeeze 9-20 March.
Positioning vs EUR/SEK long-term Positioning vs EUR/SEK medium-term (2016-2020) (2019-2020)
Domestic companies and financial institutions: Concerning companies and financials positioning it is difficult to make a comparison as the they are referring to the deviation (under- or over weighted) versus a benchmark. Thus, only looking at weekly net flows doesn’t correspond with the answers in the survey. To get a better measure for comparison we have looked at how the weekly flows in the period since the last SEK Views survey deviates from longer-term averages.
For companies there tends to be a very constant SEK buying pattern with a long-term average weekly net flow to volume of 18%. During the period since the previous report the weekly average has been significantly lower (0%) which seems to provide support for the stated preference by the companies that they are underweighted the SEK.
For financial institutions, we have studied flows versus both the EUR and the USD. Beginning with the EUR a similar approach as for companies i.e. using a long-term average of the weekly net flows does not reveal a stabile pattern as there have been large changes. Instead comparing the flows before and after the previous report provides an interesting take. Until October 2019 there is a clear SEK selling pattern for Swedish financial institutions with an average weekly net flow to volume of -5% which in the period after up to last week instead rise to -0.1%.
9.0
9.5
10.0
10.5
11.0
-5,400,000,000
-4,900,000,000
-4,400,000,000
-3,900,000,000
-3,400,000,000
-2,900,000,000
-2,400,000,000
-1,900,000,000
-1,400,000,000
Jan-
16
Jul-1
6
Jan-
17
Jul-1
7
Jan-
18
Jul-1
8
Jan-
19
Jul-1
9
Jan-
20
EUR
/SEK
Offshore financial positioning vs EUR/SEK
Off-shore financials positioning (lhs)
EUR/SEK (rhs)Agg
rega
ted
SEK
pos
ition
High
er =
> se
lling
SEK
Low
er =
> bu
ying
SEK
10.1
10.3
10.5
10.7
10.9
11.1
11.3-5,100,000,000
-4,900,000,000
-4,700,000,000
-4,500,000,000
-4,300,000,000
-4,100,000,000
-3,900,000,000
Jan-
19
Feb-
19M
ar-1
9
Apr
-19
May
-19
Jun-
19
Jul-1
9
Aug
-19
Sep-
19
Oct
-19
Nov
-19
Dec
-19
Jan-
20
Feb-
20
Mar
-20
Apr
-20
May
-20
Offshore financials positioning vs EUR/SEK
Offshore Financials PositioningEUR/SEK
High
er =
> re
duci
ng S
EKLo
wer
=>
addi
ng S
EK
-60%
-10%
40%
90%
-60%
-10%
40%
90%
201
9.0
1
201
9.0
3
201
9.0
4
201
9.0
6
201
9.0
8
201
9.1
0
201
9.1
2
202
0.0
2
202
0.0
3
Domestic corporatesNet selling/buying of SEK versus EUR
Buy high volume Buy high volume Buy avg volumeBuy small volume Sell avg volume Sell low volume
-70%
-50%
-30%
-10%
10%
30%
50%
70%
-70%
-50%
-30%
-10%
10%
30%
50%
70%
201
9.0
1
201
9.0
3
201
9.0
5
201
9.0
7
201
9.0
8
201
9.1
0
201
9.1
2
202
0.0
2
202
0.0
4
Domestic institutionsNet selling/buying of SEK versus EUR
Buy high volume Buy avg volume Buy small volumeSell high volume Sell avg volume Sell low volume
-100%
-50%
0%
50%
100%
201
6-0
320
16-
05
201
6-0
720
16-
08
201
6-1
020
16-
12
201
7-0
220
17-
04
201
7-0
620
17-
07
201
7-0
920
17-
11
201
8-0
120
18-
03
201
8-0
520
18-
07
201
8-0
820
18-
10
201
8-1
220
19-
02
201
9-0
420
19-
06
201
9-0
720
19-
09
201
9-1
120
20-
01
202
0-0
3
Domestic institutionsNet selling/buying SEK versus USD
Buy high volume Buy avg volume Buy small volumeSell high volume Sell avg volume Sell low volume
Macro & FICC Research Thursday, April 23, 2020 7
Thus, compared to the norm at least it seems that, even if financial have net sold SEK, they have done so to a lesser extent than before which in term could be seen as a mild support for the notion that they are slightly over weighted the SEK versus their benchmarks. However, when instead looking at the weekly net flows versus the USD there is a clearer support for large SEK buying which should have led to a net SEK overweight. This is clear in the chart below showing plenty of green staples (SEK buying) which also are dark green indicating above average volumes.
SEB's view of the krona is summarized as follows:
The krona has not weakened (at all) as in similar times and periods when the global economy is in recession. During the financial crisis, growth barometers plummeted and the krona fell by 20-30%. This time the economic outlook is more serious, while KIX has so far weakened by just under one percent, that is a huge difference. Negative interest rates caused many investors to borrow in kronor to buy other higher yielding currencies, ie when we entered this crisis and the krona was "saved" by the fact that the market was already short the SEK and long-term valuations were already stretched. We also believe that the companies hold large reserves in dollars, but as US interest rates are now moving closer to Swedish interest rates, these incentives decrease. When the global economy starts to recover in H2 2020, we think some of this money should be converted to the SEK. Swedish investors probably also have a relatively open exposure in the the USD, which is now much cheaper to hedge, and the long-term valuation of the krona is attractive today. All in all, should financial stress become significant again the SEK may revisit the lows and therefore it is too early to rule out a somewhat weaker SEK short term. However, in H2 2020 we have a fairly positive scenario for the krona as the global economy recovers. Our forecasts for the EUR / SEK and the USD / SEK by Dec-20 are 10.30 and 9.04 respectively and long-term we are even more optimistic.
You can also find our research materials at our website: www.mb.seb.se. This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for any direct or consequential loss resulting from reliance on this document. Changes may be made to opinions or information contained herein without notice.
Macro & FICC Research Thursday, April 23, 2020 8
