The Swedish krone hit rock bottom in March, depreciating over 8% against the US dollar as Covid-19 spread across the globe, sending nations into lockdown as health services struggled to cope with its rapid transmission.
Stringent lockdown measures in Europe especially hurt the Swedish krone as its major trading partner dived head first into a recession, while the global flight to safety in dollar liquidity exacerbated the SEK outflows.
While Sweden itself didn’t embark on strict social distancing measures, its export-orientated economy will still feel the bite from the global shutdown.
Signs of reopening in Europe bodes well for the currency’s fortunes after a rough three months, with USDSEK returning to pre-virus levels on improving external conditions. However, risks to a sustained SEK rally are plentiful.
SEK returns to pre-virus levels but the recovery is based on improved risk sentiment in markets
HOW SWEDEN HAS COPED WITH THE CORONAVIRUS PANDEMIC
As a result of the pandemic, the Swedish Government has taken a number of measures amounting to more than SEK 100bn to limit both the rate of infection and the economic consequences. In addition, all municipalities received a further SEK 15bn in general state subsidies. The state is also absorbing all of the costs to businesses for two months of sick pay to ensure anyone having symptoms self isolates. To ease the pressure on companies and increase liquidity, the Government also announced a deferral in various tax payments for a year and decided on state credit guarantees to reduce credit risk for commercial banks. Furthermore, the Government has temporarily reduced employers’ social security contributions and rent support in the hardest hit industries from March to June. The Swedish Government waited longer than its Scandinavian peers to add to the crisis package but has one of the most generous stimulus packages worldwide as it corresponds to approximately 15% of GDP, which equates with the US.
The central bank had been performing under a negative interest rate policy since December 2014 and only moved back to 0% five years later in December 2019, right before the global economy was hit by the transmission of the coronavirus. In the statement of the December meeting, Riksbank Governor Stefan Ingves signalled that the central bank will not go back to negative rates unless absolutely necessary. With the barrier for cutting interest rates high, the Riksbank took less conventional measures to counteract the incoming growth shock. The central bank launched a SEK 300bn asset purchase programme in March, following the global easing cycle set by the Fed, as the Bank had no room to further cut interest rates before entering negative territory again.
The asset purchase programme is roughly thirty times its previous QE programme launched in 2015, but the Riksbank is still working actively on the next steps of a bond purchase program after hiring advisers from BlackRock Inc to provide analysis on how to expand the program into the corporate debt space.
This expansion is likely to be outlined at its July 1st meeting. In this light, the Riksbank reaction was in line with the theme seen in developed markets as central banks rushed to ease credit conditions and buffer the economic impacts of social distancing measures, but the work seems far from finished at present.
Sweden’s version of the lockdown is different from many other European countries in the sense that it kept large parts of its society open. The Swedish Public Health Agency issued recommendations to the public to work from home if possible and engage in social distancing, avoiding unnecessary travel as much as possible. Children under 16 could continue to go to school, in part to allow healthcare workers to continue working instead of having to stay home with their children. The number of Covid-19 related deaths has been significantly higher in Sweden than most of Europe, which is why the Swedish response to the pandemic has been heavily debated both within Sweden and internationally. Sweden’s Prime Minister Stefan Lofven rejected the criticism, saying it is too early to draw any definitive conclusions about the success of the strategy. The death rate in Sweden stands at 4,874 at the time of writing, compared to 596 in Denmark and 242 in Norway.
LOOSER LOCKDOWN MEASURES SUGGEST SWEDEN’S ECONOMY MAY HAVE ESCAPED A DEEPER CONTRACTION, BUT THE EUROZONE RECOVERY REMAINS PIVOTAL FOR SEK
At first glance, the Swedish economy may have been coping better than other advanced economies as the export-heavy economy even grew by 0.1% in Q1 2020 while Norway’s mainland GDP fell by 2.1% and the eurozone economy contracted by 3.8%. Sweden took a less restrictive approach to the virus outbreak compared to its European peers, mainly due to the assumption that the pandemic would last a long time and cause extensive economic damage. Gatherings of over 50 people, visits to nursing homes and sporting events were banned, while museums were closed. However, bars and restaurants were left open, along with schools for those under-16. The majority of European economies hit by the coronavirus took stricter measures to contain the humanitarian impact, at the cost of more extensive economic damage.
This has been highlighted in the latest round of Purchasing Managers’ Indices. While the PMIs released in May confirm that although there was a decline in service sector activity in the past month, the contraction was much less apparent than seen in the eurozone. The manufacturing sector in Sweden was hit hard, however, which is understandable given the drop in external demand along with sluggish domestic economic activity. Taken together, the composite PMI for May came in at 40.5, while the euro-area composite sat substantially lower at 31.9. The devil may be in the detail however. The eurozone PMI rebounded from a historic low of 13.9 in April, whereas the rebound in the Swedish reading was far more muted.
Despite looser lockdown measures meaning a deeper recession was avoided, falling external demand due to deep recessions in the EU and UK are likely to hamper a sharp recovery in Sweden’s economy.
The EU accounts for roughly 70% of Sweden’s exports and extensive scarring in major EU economies such as Germany and France are likely to weigh on Sweden’s GDP outlook for the year. The IMF previously forecasted that the fall in Sweden’s GDP this year will be significantly greater than the 14.4% contraction during the financial crisis. The Riksbank holds a more optimistic view, with the two likeliest scenarios seeing GDP fall by 7% or 9% in 2020 while unemployment rises to 10% or 11% respectively. With this in mind, not only will the economy struggle to experience a sharp V-shaped recovery, but the krone’s recovery to pre-virus levels may find increasing resistance.
Goldman Sachs’ Current Activity Indicator (CAI) models real-time economic releases to paint a picture of the current state of growth conditions. Although Sweden’s CAI shows a deeper contraction than during the global financial crisis, similar to that expected by the IMF, its contraction is dwarfed by that of the eurozone. While on the surface this highlights how Sweden’s lockdown measures sheltered its economy from the impact of coronavirus better than its peers, it also highlights the incoming challenges the domestic economy will face as its largest trading partner struggles to recover.
Sweden CAI vs. Eurozone CAI between the global financial crisis and now
WE REMAIN BULLISH ON SEK GIVEN THE TREND TOWARDS A GLOBAL ECONOMIC RECOVERY, HOWEVER, RISKS REMAIN ELEVATED TO THE DOWNSIDE
While the Swedish economy didn’t contract as much as its European neighbours due to the government avoiding strict social distancing measures, its outlook going forward will still be subject to importing weak economic conditions from its main trading partners. For now, with lockdown measures being scaled back and global demand conditions improving, the outlook for a continued SEK rally looks promising. However, the risks of a second wave remains seismic to both the Swedish economy and global risk appetite. It is widely considered that a secondary outbreak will be met with a more targeted response by authorities than back in March. This would ultimately shelter the economy somewhat from wide ranging lockdown measures that hampered consumer demand. With Sweden’s initial measures proving lax compared to its European neighbours, a domestic second wave is unlikely to disrupt the local economy too much should the response follow expectations. In this light, the greater risk lies with a larger second wave in one of the major economies, such as the eurozone, US or China. Not only will this weigh substantially on external demand and disrupt supply chains, but it will also hamper global risk sentiment. This would hit the krone’s rally with a double blow.
A second wave in neighbouring economies would likely lead to a substantial sell-off in the krone, with the magnitude of the outbreak determining the depth of the sell-off. Markets still remain hungry for dollar liquidity in times of heightened risk, and a shift in demand back to the greenback for safety is still likely. This will weigh on the SEK rally, albeit to a lesser extent now the Fed has intervened in global markets, but will still prove a significant price driver in the short-run. The structural damage this poses for the Swedish economy is even greater, however. A more prolonged global economic recovery will increase the structural scarring each economy faces, even for the success stories such as South Korea and Australia. Open economies such as Sweden are likely to feel the brunt of this, especially with the Riksbank arguably out of room to loosen policy substantially before entering back into negative territory.
With this in mind, we expect the krone to act as a major countercyclical instrument in the interim before a policy response is announced. Over the one-month horizon, we have EURSEK trading towards the 10.19 level, with USDSEK trading to 9.18.
Author: Ima Sammani, FX Market Analyst
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