News & analysis

After being hit by the double whammy of a strengthening dollar and a collapse in oil markets, the Norwegian krone became the worst performing G10 currency in the year to date. 

The currency sold off dramatically in March and reached all-time lows against the dollar and the euro. As global conditions started to recover, NOK gradually regained its composure. Norway’s government announced large wage subsidies for furloughing and grants for start-ups, while also expanding sickness, child care and unemployment benefits. VAT rates were lowered from 12% to 8%, and several deferrals of tax payments were announced. Additionally, the government offered billions in loans and guarantees to local companies. On the monetary side, the Norges Bank has not been idle either. The Bank cut interest rates by a total of 125 bps in March, and surprised markets with yet another 25 bp rate cut in May, which brought interest rates to the effective lower bound at 0%. The central bank also sent a warning to markets in March saying it could intervene in FX markets for the first time in over two decades if the panic sell-off continued.

NORWAY’S $1 TRN SECRET WEAPON WILL BE THE NATION’S HELPING HAND IN THIS CRISIS

The economic reasons for cutting rates during this period were a given considering the significant contraction Norway’s economy was going through. The implications of the cutting cycle on the currency were lessened to some extent by the Federal Reserve, who carried out a similar plan regarding interest rates and took it a step further by announcing unlimited Quantitative Easing.

The Norwegian krone still sold off significantly as global conditions created upward pressure on the dollar following liquidity issues and investors were craving the safe haven US dollar.

NB Governor Øystein Olsen hinted that the current policy rate is as far as the central bank is likely to go, which follows the same lines as Olsen’s speech last year in which he stated that neither negative rates nor quantitative easing were feasible options for the Norges Bank.

The largely exhausted monetary firepower shifts the emphasis to fiscal policy to further facilitate economic recovery going forward. In this front, Norway’s enormous wealth fund of US$1 trn in assets determines a large part of the policy room. For perspective, Norway’s nominal GDP in Q1 2020 stood at roughly $96 bn, slightly below one-tenth of the oil fund. The government drew more assets from the fund in March than ever before, and in May, the vast wealth fund had to be partly liquidated to cover withdrawals by the government for the first time on record.

In addition, the fund is particularly relevant for the Norges Bank since it is the main channel to conduct alternative market stability tools like currency interventions. Norway has two ways of conducting FX purchases, either via NB´s own FX reserves or via FX sales from the sovereign wealth fund. The Norges Bank announced to sell FX on behalf of the government equivalent to NOK 2.3 bn per day in June this year, 200 million more than the sales in May. Up until March, the central bank had never sold more than NOK 1 bn from the sovereign wealth fund. As Europe’s main oil exporter, further developments in crude oil markets and its effects on the Norwegian krone’s price action, largely determines the fund valuation. The market value of 12 energy companies excluded from the fund in May after an assessment of several environmental, social and governance (ESG) criteria, dropped by $438 million on the back of the sharp NOK sell-off only. The holdings of the excluded companies amounted to $3.13bn before NOK plummeted to record lows earlier in March. Although this may slightly weaken the central bank’s position as it erodes its ammunition to purchase its local currency from selling FX from the fund, the great initial size of the fund leaves enough elbow room for the Norges Bank to manoeuver.

 

Norges Bank FX portfolio reflects sharp intervention in currency markets

 

The Norges Bank sees the decline in the Norwegian economy coming to a halt in spring this year, and expects activity to gradually pick up as containment measures are scaled back. The central bank foresees a decline in GDP of 5% between 2019 and 2020, and acknowledges that the sharp economic contraction among the nation’s trading partners will certainly amplify Norway’s economic decline, -although the wealth fund built from the oil reserves will serve as the nation’s chief support.

Activity is expected to move back to pre-virus levels in a couple of years, but the projection published in May worsened compared to the Monetary Policy Report published in March.

Registered unemployment sharply rose in the past months – at the end of April, 9.6% of the labour force were fully unemployed while 5.0% were registered as partially unemployed. The Norwegian Labour and Welfare Administration (NAV) estimates that around 60% of the fully unemployed are furloughed. The central bank expects that unemployment will recede ahead, while also acknowledging it will take time before it returns to pre-virus levels.

CRUDE OIL MARKETS ARE TENTATIVELY IMPROVING

Crude oil prices, a key determinant of the Norwegian economy and currency, continue to recover from all-time lows reached in April. The rise in oil benchmarks follow output cuts and signals a gradual recovery in global oil demand. As the world’s second-largest oil consumer, the reopening of factories and returning commuters in China highlighted a resurgence in demand conditions, at a time when other European economies were also attempting to restart economic activity. Chinese officials announced Mid-May that oil demand had almost returned to pre-virus levels -consumption was reported to stand at about 13 million barrels a day, compared to 13.4 million a year earlier. This caused a marked turnaround in crude markets – WTI prices surged above $30 bpd at the end of May, while Brent rose to over $35 bpd. Both occurred only three weeks after prices for June delivery of the West Texas Intermediate contract fell into negatives. American shale production has fallen to its lowest level in more than a decade, with an estimated 1.5m bpd shaved from production levels. OPEC+ oil shipments have fallen by 6.4 million b/d so far this month, according to oil market intelligence experts. Russia, OPEC’s largest ally, is also showing signs of full compliance with the OPEC+ production cuts, with Energy Minister Alexander Novak saying in a phone interview in May that Russia will move ahead fully in line with the deal.

Based on the narrative of a rebound in crude oil markets and ongoing daily NOK purchases by the Norges Bank via the large wealth fund, we see a growing case for the NOK to advance, especially with an eye to the easing of more containment measures down the road.

During previous oil market collapses in 2015-2016 or during the global financial crisis, NOK volatility increased. A similar development was seen in March this year, when crude oil plunged and took the Norwegian krone down with it. However, both EURNOK and USDNOK have stayed relatively stable ever since, while volatility in crude oil markets certainly has not decreased likewise, signalling that the Norges Bank FX intervention may have helped in keeping NOK from getting utterly demolished in the past two months, and in fact trade in the green against almost the entire G10 currency board.

 

NOK price action is less sensitive to oil volatility on the back of strong FX intervention

 

Given our assumptions and the likelihood of the economy gradually recovering, and our base scenario of the economy going, we expect the Norwegian krone to take on a bullish path.

As current conditions are more likely to improve than not, we expect the rebound in oil prices to support the currency and potentially lead to less FX interventions by the Norges Bank in the longer run from rebalancing their reserves. However, there are certain risks to our view. As oil prices recover, the question will be whether OPEC+ members will continue to comply with the agreed production cuts or if they will move to the initial production levels too soon, leading to oil prices bouncing back to earlier lows.  Additionally, there is a risk of eurozone growth remaining low when the Norwegian economy is ready to pick up again. Scandinavian lockdown measures came nowhere near the restrictions imposed by its southern neighbours in the eurozone. Norway roughly followed Sweden in its mild approach to the virus outbreak and started lifting restrictions a month after lockdown. If eurozone growth or global growth remains low, that would lead to recovered but lower oil prices for a longer time. On the upside, the global economy could recover at a higher pace than currently anticipated. In such a scenario, the uncertainties around compliance of OPEC+ members with the agreed production cuts will be less of an issue as the pick-up in demand would at least partly compensate for the failed compliance with the output cuts.

 

 

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