EVENTS in the Eurozone periphery have unsurprisingly continued to grab traders’ attention over the past couple of months. But while foreign exchange investors are concentrating on the southern and eastern fringes of the single currency area, opportunities are opening up on the northern edge.
The balance sheets of the eastern European and Club Med states have come under scrutiny, but the non-Eurozone Scandinavian countries have been putting their finances in order. Consequently, they have benefited from the wave of risk aversion that has swept across the continent.
“The search for euro alternatives, with North European quality, continues unabated,” says RBS’s head of FX strategy Alan Ruskin. He adds: “The Norwegian krone, the Swedish krona and the Swiss franc will all overshoot against the euro, and money will stake out every nook in search of safety, even the innocuous Danish krone.”
But it isn’t just pure risk aversion that is making the Swedish krona look attractive. The currency has strengthened some 17.5 per cent against the euro over the past year, but there are three reasons why buying the krona should still prove profitable.
First, the rally has taken place from a position of extreme undervaluation, says Darren Williams, senior European economist at AllianceBernstein, an asset management firm. “The exchange rate is still outside of its pre-crisis trading range...there is ample room for the krona to strengthen further,” he explains.
Ruskin forecasts that euro-krona should fall from its current level of SKr9.63 to SKr9.30 by the end of this year and then stabilising at SKr8.90 from December 2011.
Second, krona strength is not reliant on euro weakness – the domestic case is solid. Although it was badly hit during the recession – exports account for 50 per cent of GDP – the economy is recovering strongly.
First quarter GDP data showed growth of 1.4 per cent, taking the annual rate to 2.9 per cent. This is stronger than anything in the Eurozone and is close to Sweden’s pre-crisis trend. A strong start for the public finances has allowed looser fiscal policy and the structure of the mortgage market means that the rate cuts have been passed on quickly to consumers – this should boost spending and GDP. Concerns about the banking system’s exposure to the Baltic states have now largely disappeared.
And finally, the economic recovery, combined with high household debt – which rose 8 per cent to 86 per cent of GDP last year – and rising house prices, will encourage the Swedish central bank to start tightening monetary policy as early as this summer, says AllianceBernstein’s Williams.
“Under these circumstances, some withdrawal of monetary accommodation is essential and, barring a big deterioration in the global credit markets, we expect the first 25 basis point rate hike at the beginning of July.” He expects rates to rise to 1.25 per cent by the end of this year from their current level of 0.25 per cent, and to at least 3 per cent by the end of 2011.
With the European Central Bank (ECB) expected to keep policy extremely loose for at least the rest of this year, the interest rate differential favours the Swedish krona as FX traders seek higher yields.
But there are some risks to this rosy economic outlook. Societe Generale’s David Deddouche notes that 75 per cent of Sweden’s exports head elsewhere in Europe, making the country vulnerable to a slowdown in demand. The Riksbank could delay rate hikes, mitigating the impact from interest rate differentials.
But these risks are unlikely to tarnish the overall picture, which is one of increasing krona strength. With plenty of upside forecast, FX traders bearish on the euro should look north, not south.