BNY Mellon: Carry on with the Krona

April 23, 2019

By Neil Mellor, Senior Currency Strategist

• The eurozone is a source of pessimism in Sweden
• Belief in Riksbank's caution is justified
• SEK's role in the carry trade not so straightforward

The Swedish economy is by no means an under-performer - as we have noted - but  the currency has been under some pressure since Thursday’s unexpected spike in the unemployment rate.

Although employment has continued to rise, a full 0.6% point spike in the unadjusted jobless rate caught the market by surprise, and it came just days after a confidence-sapping 2.8% monthly drop in industrial orders.

Despite the increase, the unemployment rate remains around a 10-year low, but the market was not in the mood for reassurances given that the order figures were a hint of what lies ahead for the export-orientated Swedish economy.

While domestic orders dropped 1.6% m/m, export orders fell by 2.3% in a stern reminder of the growing gloom surrounding the economic outlook of Sweden's principal trading partner: the eurozone.

No sooner had the ECB slashed its 2019 GDP growth forecast by a hefty 0.6% points last month, than the OECD downgraded its own assessment of the Swedish economy; and although Riksbank is no longer fighting deflation, the time and effort it has spent doing just that is reason enough to expect a suitably cautious approach to policy.

Indeed, amid the latest run of weak European data (culminating in Wednesday’s weak PMIs), Riksbank has reiterated Governor Stefan Ingves’ observation last month that the “repo rate path is a forecast, not a promise”. And just possibly, Riksbank’s policy stance is now slowly aligning with the IMF's views on Swedish monetary policy.

Either way, with confidence growing that Riksbank is not about to promote currency strength (directly or indirectly) with any allusions to a hike in the (-0.25%) repo rate, talk of the SEK’s resumed role as a funding currency is understandable. However, timing might be key to its success because SEK volatility has slumped to some interesting levels.

Although EUR/SEK experienced a prolonged period of low volatility from 2004 to 2008, on a one-month (historical, close-on-close) basis, it has only been lower than its present level on 59 days since the start of 2010, and half of this can be accounted for in two years: 2014 and 2017.

Notably, the highest average monthly volatility through any one year since 2010 came in 2015 (i.e. the year after a slump), although no appreciable rebound from low volatility came in 2018.

Things are a little more interesting for USD/SEK, however.

In USD/SEK, one-month historical volatility has only been lower than present on 280 days in the 10,703 days that have elapsed since 1990; and nearly 80% of those days can be accounted for in just three years: 1990, 1996 and 2014. Hence the fact that vol is now at its lowest levels in five years is not without significance.

But as a final point, it may interest readers to know that each subsequent year (i.e. 1991, 1997 and 2015) occupy three of the top four spots when we look at the largest year-on-year increases in (12 month average) historical volatility since 1990 (the other, unsurprisingly, being 2008). And for these three years, the bounce back has averaged 55%.

The month-long reprieve for the SEK may be over, but those warming to the idea of the currency’s renewed role as a vehicle in the carry trade would be well advised to take note of historic trends that may or may not have relevance to the present.