SEB FX Ringside 13 January 2016

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Eunice Gibson
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1 SEB FX Ringside 13 January 2016 Swedish FX intervention is now a policy tool Author: Carl Hammer The theme of diverging fortunes for Scandinavian currencies continues this year based on underlying fundamentals. We still target EUR/SEK to grind lower but the threat of interventions makes the short-term outlook less SEK constructive. The currency remains the best bet to position for a fast growing Swedish economy. At some point in 2016 we will look to switch from lower EUR/SEK and NOK/SEK into a recommending outright short EUR/NOK position. The timing for NOK depends on the oil price stabilising and an end to the Norges Bank easing cycle. On the last trading day of 2015 NOK/SEK traded at our 3-6 month target at The Swedish krona s appreciation reflects a very strong macroeconomic performance and outlook (rather than other flows driving the currency stronger as in Switzerland or Denmark, more below). Despite this logical and expected appreciation, the Riksbank responded on 30 Dec by issuing a press release indicating that the central bank will not tolerate a too strong exchange rate. Further, on 4 Jan, the Riksbank also gave Governor Ingves and First Deputy Governor af Jochnick joint (sole) power to take the decision to intervene should it prove necessary. stronger than forecast, the Riksbank has verbally intervened/added more policy stimulous. Now that the bank has increased its rhetoric, should the currency deviate from forecast by more than 2-3%, FX interventions are highly likely to take place (more below). What complicates the outlook is the fact that the Riksbank is probably moving towards adopting a slightly more flexible approach to achieving its inflation target. On 19 Jan, Mervyn King and Marvin Goodfriend will publish their 5-year evaluation of Riksbank monetary policy. We expect the report to indicate a need to broaden and relax the approach being taken to reach the central bank s 2% inflation target (perhaps moving back to the 1-3% CPIF interval) while also paying slightly greater attention to financial stability and house prices. Although the report contains only recommendations, they will likely influence monetary policy over the medium- to long-term. This means the Riksbank may see a higher hurdle to be overcome to add more stimulus if inflation continues to surprise on the downside. Higher inflation over time and the fact that the Riksbank KIX forecast (graph below) also expects the SEK to cautiously appreciate mean that the EUR/SEK floor where FX interventions will be conducted (currently ) will fall over time (i.e. the Riksbank will eventually allow a slightly stronger SEK). In recent weeks the collapse in commodity prices has probably made the Riksbank even more sensitive to SEK appreciation as inflation remains well below its 2% target and looks set to stay there. Yet we continue to expect that the currency will ultimately be the (necessary) factor in tightening overall financial conditions relative to euro-land. However, the short-term Riksbank reaction function concerning the SEK is fairly straightforward, i.e. during the past 3-6 months whenever KIX (and implicitly EUR/SEK) has traded more than 2% SEK FLOW OUTLOOK: NO SWITZERLAND OR DENMARK Unlike Switzerland and Denmark, Sweden does not face structural and currency positive inflows currently (apart from the current account surplus (of which we expect 50% to remain in foreign currency i.e only SEK 100bn is translated back to SEK). On the contrary, when considering portfolio flows foreign investors are currently selling Swedish government bonds rapidly resulting in a declining ownership rate (see graph below). Some but certainly not the full amount has already been FX hedged tough. And so far, these outflows have more or less been You can also find our research materials at our website: 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.

2 Fixed Income Insights fully matched by Riksbank government bond purchases. Foreign investors also owns a historically high share of the Swedish equity market (37-40%). Should they decide to lower that exposure, it will obviously contribute to a weaker SEK as most positions come with full SEK exposure. Regarding the Swiss experience, the euro-crisis made investors rush to buy the prime safe haven currency CHF (as a result Swiss FX reserves rose from 10% to 80-90% of GDP). In Denmark local pension funds grew uneasy over the prospect of a stronger DKK and weaker EUR and began to hedge their EUR exposure. These events were temporary in nature and occurred as the respective currencies (CHF in particular) were already overvalued -> FX interventions made clear sense (Denmark obviously also had to defend the DKK given the currency peg vs. the euro). As regards Sweden, we have long stated that the SEK is undervalued and that domestic institutions and corporates may start to lower their overall (high) FX exposure which increased in the aftermath of the Great Recession in 2008/09. Sweden might therefore begin to resemble Denmark, i.e. its possession of a strong economic outlook combined with a still attractive currency valuation may trigger more positive SEK flows (from lower Swedish FX exposure) meaning the central bank may ultimately be found on the other side of that trade (selling SEK and buying FX). But if the threat of FX interventions is credible these flows (lowering Swedish FX exposure through SEK purchases) may be on hold for the time being. This leaves the more speculative investors who have purchased the SEK on the back of the strong Swedish macroeconomic outlook. Should the Riksbank wish to squeeze long SEK bets, we therefore believe relatively small sums would be required to weaken the SEK (in the absence of larger structural flows). This also means that verbal FX interventions including threats may be enough for now. HOW TO INTERVENE SHOULD IT PROVE NECESSARY? Compared to other countries, Sweden s FX reserves are still small at SEK 494bn or 13% of GDP. Currently, these reserves mainly comprise US Treasuries and Euro Government bonds. Bringing the size of Sweden s FX reserves into line with Denmark or the Czech Republic would require approximately SEK 1000bn or 25% of GDP. These amounts will certainly be adequate to prevent the SEK from appreciating through 9.00 vs. the euro in the next 12months. When the Riksbank last conducted FX interventions in 2001, it chose to buy SEK vs. EUR (800m) and USD (400m). We would be very surprised to see currencies other than the EUR and the USD featuring on the right hand side of any Riksbank FX interventions. We would not expect the Swedish central bank to then (having purchased EUR/SEK and USD/SEK) sell EUR vs. other G10 currencies such as the GBP, NOK, AUD and CAD (other currencies in its FX reserves) as the Swiss National Bank did (they bought EUR/CHF and then recycled 50% into other currencies by selling EUR vs. the USD, GBP, AUD, CAD etc. FX INTERVENTIONS BEFORE 9.00 IS TRADED EUR/SEK REMAINS RANGEBOUND We expect the next policy easing in Sweden (should that be necessary) to take the form of FX interventions. Recent Riksbank press releases must be followed by actual interventions should EUR/SEK trade towards the low 9. This means that EUR/SEK will remain rangebound at 9.00/ /50 in Q Ultimately we expect EUR/SEK to be driven lower and down towards critical levels as: 1) the strong growth outlook; 2) attractive valuation; 3) Riksbank perhaps moving towards a more flexible inflation targeting regime and; 4) Continued progress towards lower FX exposure by domestic institutions and corporates all speak for a stronger SEK. Weremain with a short EUR/SEK recommendation (entry 9.40, target below 9.00).

6 FX Ringside FX recommendations B/S 13-Jan Price obj. Stop P/L Start val / Start date EUR/SEK Sell % Oct GBP/SEK Closed % Oct FX Forecasts SEB Forecasts Action levels 13-Jan 1m Q1 16 Q2 16 Q3 16 Q4 16 Buy Sell EUR/USD EUR/SEK USD/SEK EUR/NOK USD/NOK NOK/SEK GBP/USD EUR/GBP GBP/SEK EUR/CHF USD/JPY EUR/JPY AUD/USD USD/CAD EUR/PLN EUR/HUF USD/TRY USD/RUB USD/CNY USD/KRW USD/SGD Central Bank forecasts Sweden Norway USA EMU Japan UK Canada Switzerland Base rate -0.35% 0.75% % 0.05% 0.10% 0.50% 0.50% -0.75% Next meeting 11-Feb 17-Dec 16-Dec 21-Jan 29-Jan 14-Jan 20-Jan 17-Mar Action expected unch -0.25% 0.25% unch unch unch unch unch Next change Q4-16 Dec-15 Jun Apr-16 Aug Direction hike bps --- increase +25 bps

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