Sweden Riksbank preview

There is almost no disagreement about expectations for today’s Riksbank policy decision. The central bank last lowered the repo rate in December and is unlikely to alter policy settings again so soon, with the policy rate likely to be maintained at 0.75%

The SEK is unlikely to be impacted by today’s rate decision, with the currency benefitting from the recent improvement in risk appetite. However, a relatively dovish statement from the Riksbank may undermine the SEK especially as it approaches EUR/SEK support around 8.75.

Further out, we expect SEK to continue to appreciate gradually but its worth noting that gains in the currency are not comfortable for the Swedish authorities, who have called for stricter capital rules on its banks to help weaken the currency (via keeping policy rates low).

GBP resilience, SEK vulnerable

Signs of some further flexibility on both sides reveal that negotiations over the US fiscal cliff are progressing, albeit very slowly. Discussions between President Obama and House speaker Boehner yesterday appeared to go relatively well but the chances of a deal by year end remain slim. Against this background US equities posted gains while risk measures improved ignoring the weaker than expected reading for the December Empire manufacturing survey.

There is little else in terms of directional influence today, with highlights including RBA December board minutes, a vote on the Italian 2013 budget, UK inflation data and an interest rate decision in Sweden. The overall tone is likely to continue to be constructive for risk assets.

While I expect GBP to show some resilience over the coming year especially against the EUR, I look for the currency to eventually end the year weaker against the USD. The principal risk to GBP revolves around the UK economy. It seems very likely that the UK economy has contracted in the final quarter of the year. Worryingly, a weaker external environment taken together with the relative resilience of GBP has resulted in a deteriorating trade deficit, which could ultimately inflict pressure on GBP to weaken.

The fact that the UK basic balance (direct investment + portfolio flows + current account) position remains in negative territory also suggests that the underlying support for GBP is weak. Given these soft economic fundamentals it is difficult to see GBP breaking significantly higher over the coming months. Although the relationship is not perfect, my expectation that EUR/USD will drift lower over the course of 2013 will act to drag EUR/GBP lower too, with my forecast at 0.79 by end year.

EUR/SEK has probed higher over recent weeks and look to register further upside. Today’s Riksbank policy meeting will be the next focal point for SEK but with a rate cut largely priced in following recent deterioration in employment data and other signs of slowing growth, the SEK is unlikely to find any support in the near term. Sweden’s industry body and the OECD have highlighted the policy room to lower interest rates, with the OECD also noted the fiscal leeway that Sweden has should economic conditions worsen.

Officials are also targeting the exchange rate given recent comments by Sweden’s finance minister Borg about increasing foreign exchange reserves over the longer term. The implication is that the SEK will suffer as other currencies are bought against it. The weakness in the SEK is consistent with my quantitative models and a break of EUR/SEK 8.80 is looming over the short term.

SEK weaker, Asian FX still following CNY

Despite a series of better than expected data releases in the US including October durable goods orders, Case Shiller house prices and consumer confidence the lack of progress towards resolving the fiscal cliff is weighing on risk appetite. Comments by Senate Majority leader Reid of little progress in budget talks hit equity markets and will cast a shadow over risk appetite today.

News that the US did not label China a currency manipulator did little to help as such an outcome was expected in the US Treasury’s semi-annual currency report, especially given the recent appreciation of the CNY. Any positive boost from the Greek aid deal also proved short lived. The lack of major data releases or events today will likely most asset classes within recent ranges.

The EUR has failed to hold onto Greek debt deal inspired gains but looks well supported above 1.2900. The realisation that any aid to Greece will still be subject to several parliamentary approvals, ongoing reforms and a successful debt buy back may have dampened sentiment or more likely the deal was already priced in.

Looking ahead there is little on the economic front to provide any directional impetus for EUR/USD aside from M3 money supply data where a modest increase is expected in October. In contrast the run of better US economic data is set to continue, with October new home sales and the Beige Book likely to provide encouraging reading. The difficulty in reaching agreement on the fiscal cliff may perversely play negatively for the EUR as risk aversion pushes higher.

My quantitative models have continued to point to EUR/SEK upside. Economic data yesterday provided more negative news for the currency, with business and consumer confidence for November recording bigger than expected declines. Q3 GDP data tomorrow will confirm the slowing in the economy, while retail sales are set to record a decline.

However, while the SEK remains vulnerable it is already pricing in some bad news. I suspect that the 26 October high around EUR/SEK 8.7194 will be difficult to break through. I prefer to play SEK weakness versus NOK at current levels.

Asian currencies remain relatively well supported and continue to track movements in the CNY rather than the USD although slightly higher risk aversion will weigh limit the ability of Asian FX to strengthen. USD/KRW looks likely to continue to struggle to break below the 1080 level as markets remain wary of official action to weaken the currency. A likely unchanged rate decision from the Bank of Thailand ought to leave the THB to trade within its tight range.

JPY, SEK and GBP view

USD/JPY remains stuck within a tight range having reversed its recent break higher towards the 80.00 level, once again settling back below 79.00. Once again the main determinant of the exchange rate appears to be yield differentials and notably the JPY has had a very low sensitivity to gyrations in risk over recent months.

For JPY bears it it’s worth noting that US 2-year bond yields have began to edge higher this week, suggesting some upward pressure on USD/JPY. The speculative market remains net long JPY suggesting scope for a drop in JPY speculative appetite too, but any upside is set to be gradual, with a technical hurdle at around 79.37 likely to be tough level to break above.

EUR/SEK has edged higher over recent days following its dramatic multi month drop. Why has the currency pair turned now? One of the key factors appears to be an increased sensitivity to risk which is playing negatively now that risk aversion is rising again. Indeed my risk barometer has been moving higher since around the middle of the month, in turn dragging SEK lower.

My quantitative model estimate based on interest rate differentials, relative equity performance and risk aversion, suggests that the SEK has further to weaken especially against the EUR. Based on the results of the model I suggest playing for such a move, targeting 8.7252, with a stop loss at 8.1616.

Another currency for which I am bearish on versus EUR is GBP. Although the move higher in EUR/GBP has been a slow grind, I continue to see value in this trade. Indeed, my models show that there is still much upside potential left for EUR/GBP based on the current levels of yield differentials and risk aversion.

As for cable (GBP/USD) it appears to be stuck to the coattails of EUR/USD but I expect it to lag any move higher in EUR/USD going forward. Moreover, if as I expect EUR/USD loses momentum into next week, this will leave GBP/USD rather exposed to downside risks.

Plenty of event risk

In the wake of the EU Summit at the end of last week sentiment has stabilised, with risk indicators such as the VIX ‘fear gauge’ reflecting a firmer tone to risk appetite. Although a few stumbling blocks have arisen such as the objections by both Finland and Holland to bond purchases by the ESM bailout fund they may not be sufficient to derail the project. The euphoria is likely to fade in the days ahead but the US Independence day holiday tomorrow may keep trading somewhat subdued.

There are plenty of events this week including central bank decisions by the RBA (Australia), Riksbank (Sweden), ECB (Eurozone) and BoE (UK), to provoke some excitement. A likely rate cut from the ECB and an extension of asset purchases by the BoE will give markets plenty to chew on. Finally, at the end of the week the US June jobs report will also be closely watched. We forecast a 100k increase in payrolls but will look for clues from tomorrow’s ADP jobs report.

The disappointing US June ISM manufacturing survey released yesterday highlighted that growth risks will remain a key weight on the market dampening any improvement in risk appetite over coming weeks. Moreover, weaker growth in Europe will make it more difficult to achieve budget targets, while adding to pressure to ease bailout terms. Undoubtedly the European summit was a step in the right direction but with plenty of details still needing to be thrashed out and growth concerns intensifying it would be highly optimistic to expect a fully fledged ‘risk on’ to ensue.

Notably the EUR has given back some of its gains after failing to break above 1.2700 against the USD. Further downside is likely but the EU Summit outcome has meant that the risk of a sharp drop lower has receded. Although there is likely to have been some short covering following the summit outcome EUR short positions remain significant, a factor that may also limit downside in the currency. EUR/USD will find some short term support around 1.2553 but will likely edge down to around 1.2500 over coming sessions.

Spain moves to the epicentre

Risk appetite has continued to firm but caution prevails. Rumours overnight of a Eurozone bank rescue fund (later denied) helped sentiment, but the ECB’s rejection of plans to recapitalise Bankia in Spain via an injection of EUR 19 billion of sovereign bonds and a downgrade of Spain’s credit ratings, once again brought a dose of reality back to markets. Additionally a Xinhau news agency report that China has no plans to introduce a major stimulus package will also dampen sentiment. Against this background it is difficult to see any rally in risk being sustained.

Admittedly equity valuations look more compelling, with the price / earnings ratio on the S&P 500 below its long term average, but that does not mean that now is the time to buy stocks or risk assets in general. The USD remains the winner on the FX front and will continue to edge higher over coming days and weeks, with the currency interestingly verging on a close above its 100 month moving average.

Once again the EUR has failed to hold onto gains, with the currency making lower highs and lows, dropping below 1.2500 overnight. Even a firmer tone to equity markets and slightly better risk appetite has failed to provide any support to EUR as Greece passes the baton to Spain as the new epicentre of market attention. A new poll showing increased support for pro bailout parties in Greece has helped to alleviate Greece concerns slightly there.

Today’s data slate in Europe will come as little relief to the EUR. A further deterioration in economic confidence surveys in May will only serve to highlight the growing growth disparity between the Eurozone and US although the surprisingly large drop in May US consumer confidence was hardly encouraging. The data will leave the EUR vulnerable to further slippage and follow through below 1.2500, with a test of technical support around 1.2300 on the cards.

Like most other currencies the sensitivity of USD/SEK to risk aversion has increased over recent weeks. According to my calculations it has been one of the most highly correlated currency pairs with Risk Aversion over the past 3-months. This has been reflected in the drop in SEK against the USD which accelerated during May. However, USD/SEK has stabilised lately while EUR/SEK has dropped sharply.

A further drop to around 8.95 (trend line from beginning April) is on the cards in the near term but further SEK gains are unlikely unless risk aversion improves. On the positive side, Swedish economic data is at least perking up as reflected in the bigger than expected jump in May consumer confidence yesterday. GDP data today ought to confirm that the drop in growth in Q4 will not be sustained, which will to provide short term relief to the SEK.

SNB shakes up FX markets – Pressure now on Japan?

The action by the Swiss National Bank yesterday rippled through FX markets fuelling sharp moves across major currencies. In case you missed it the SNB introduced a currency floor in EUR/CHF at 1.20 and committed itself to buy FX in unlimited amounts. The last time the SNB did something similar was in 1978 when a ceiling was set against the Deutsche Mark. The sharp initial reaction to the news saw EUR/CHF jump by around 8.5% largely as a result of the shock from the announcement.

The SNB will not need to worry about the inflationary implications of pumping CHF into the market while it is clear that the currency is highly overvalued, supporting their cause. However, the real test will be evident over coming days and weeks in the commitment to hold the 1.20 level at a time when the situation in the eurozone periphery continues to deteriorate and demand for CHF remains strong. The risk is that the SNB may have simply set up a target for markets to attack. One other implication of the SNB’s move is that it could be a trigger for an intensification of ‘currency wars’.

The onus is now on the Japanese authorities to act more aggressively especially if safe haven flows focus increasingly on the JPY and less on the CHF given the new EUR/CHF floor. So far FX interventions have clearly not worked as was the case in Switzerland and Japan’s new Prime Minister is likely to want to prove his credentials. Japan has had a tendency to underwhelm with regard to JPY measures in the past and unless there is a major announcement today USD/JPY is likely to move lower again below 77.00.

Scandinavian currencies are also set to be beneficiaries of the SNB’s decision. EUR/SEK has come under increasing downside pressure over recent weeks even as risk aversion has intensified and it appears that safe haven flows out of Europe are now targeting Scandinavian currencies. As the CHF is now less attractive in this respect, the SEK as well as NOK will find themselves under further upside pressure over coming days and weeks. Both NOK and SEK versus EUR and USD have had insignificant correlations with risk over recent months, highlighting their appeal as anti-EUR currencies.

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