The Swedish krona remains the best performing G10 currency year-to-date, trading 9.99% up against the US dollar at the 8.5 level. While the krona hit decade lows in the aftermath of the outbreak, its recovery benefitted from the fact that the economy experienced a relatively benign first wave.
This resulted in limited containment measures being imposed relative to its European counterparts. Coupled with this higher base of 2020 growth, a positive growth outlook for the global economy in 2021 means we remain structurally bullish on the krona, especially against the dollar.
The beginnings of the global recovery in Q2 and Q3, coupled with positive vaccine headlines, has led to a substantial improvement in risk appetite since March’s rout. This has resulted in broad USD weakness in the second half of 2020, leading to SEK being the best performing G10 currency year-to-date – the krona’s rally against EUR is much more limited at 3.4%. The procylcical nature of the krona makes it susceptible to a deterioration in the economic outlook in the short-term, however.
While any delay in the availability of a vaccine and a deterioration in the pandemic play a risk for all of our 2021 FX views, the risk it poses to our SEK views are substantial.
This is not only because Sweden is a small open economy that is unsheltered from a deterioration in the global macro outlook, but also because negative rates may come back into scope in this scenario. The downside risks to our SEK outlook are, therefore, sizeable, but given the progression of vaccination trials, we deem them somewhat of a tail risk to our broad assumption of a strong global recovery that would improve risk appetite and European growth – both of which play into the outlook for sustained krona appreciation in 2021. In the near-term, however, domestic risks to the economic outlook have increased with the rise in virus cases forcing the implementation of stricter containment measures than seen back in the first wave. This has resulted in us downgrading our short-run SEK forecasts to 10.2 and 8.57 against the euro and dollar respectively.
Monex Europe’s FX Forecasts
The Swedish krona lost ground against the euro after the Riksbank decided to expand its QE programme by more than market expectations on November 26th, while the central bank left its benchmark rate unchanged
RIKSBANK PROVIDES MORE STIMULUS BUT RAISES THE THRESHOLD FOR NEGATIVE RATES BY DOING SO
Contrary to standard economic theory, additional stimulus announced by central banks during the economic recovery has caused currency strength on the large part. The rationale was that extra stimulus sped up the pace of the economic recoveries. This dynamic was especially true throughout Q2 and Q3 when growth differentials were a main driver in FX markets. However, it didn’t hold up when the Riksbank opted to expand its quantitative easing programme from SEK500bn to SEK700bn and extend its time of purchases until December 2021 at their November meeting. While their decision to extend stimulus was also coupled with the Bank downgrading its forecasts for inflation and growth in 2020 and 2021, it reiterates our cautious view on the krona until year-end.
The Riksbank stepped up QE to hedge against the deflationary pressures of tighter lockdown measures, but its move to expand its balance sheet is not out of line with other major central banks
Source: The Riksbank’s November Monetary Policy Report
The bout of SEK weakness after the announcement was largely due to the monetary policy report that highlighted a substantial deterioration in the central bank’s near-term forecasts. The Riksbank now sees an economic contraction of 1.2% in Q4 2020, followed by a 0.6% drop in Q1 2021 before the economic recovery is believed to resume. This near-term deterioration in the economic outlook supported the idea of additional monetary support; however, we see the latest decision as a hedge against the low inflationary pressures as opposed to a signal of further monetary easing.
While the Bank did state that negative repo rates could come back into focus should the economic outlook deteriorate again, we believe the latest measures raised the bar for such a scenario to occur.
Firstly, the Riksbank’s choice to meet the latest economic shock with QE as opposed to rate adjustments highlights their aversion to negative rates. Secondly, by coupling the decision to expand QE with an inflation and growth downgrade, the Riksbank allows more scope for an upwards surprise in next year’s data. By doing so, it raises the bar further for a negative shock to force their hand to re-enter negative territory. In addition to this, in the MPR the Bank listed a substantial number of factors that will determine whether negative rates are appropriate, which in our view adds further hurdles to the prospect of negative rates becoming an eventuality. These include; the development of the exchange rate, how fast the supply side of the economy recovers in relation to the demand side, and how a lower policy rate is assessed to affect interest rates in general and ultimately consumption and investment. Overall, we believe that a delay in the availability of an effective vaccine beyond 21H1 is unlikely, with the balance of risks to the Riksbank’s latest economic projections tilted towards the upside. While of limited probability, the downside risks are substantial and will likely spur haven flows into the dollar, SEK weakness and the Riksbank to discuss negative rates more vocally. The implementation of negative rates, on the other hand, pose an even more limited risk to our 2021 outlook, but the mere discussion of them in the Bank’s latest MPR means the scenario shouldn’t be ignored.
Latest central bank projections (September’s projections shown in brackets)
NEAR-TERM RISKS MOUNT AS LOCKDOWN MEASURES IMPLEMENTED
Covid-wise, Sweden is in the midst of a second wave, with daily cases spiking to almost 4,700 a day and the total case count exceeding 225,500 at the time of writing. Authorities have responded to the resurgence in new daily cases by implementing the toughest restrictions yet. Public gatherings of more than eight people are banned, while alcohol can no longer be sold in restaurants after 22:00 CET. During the first wave, Sweden relied mostly on voluntary measures as authorities only recommended the population to abide by social distancing rules. With a death rate notably higher than elsewhere in developed markets, Sweden’s approach was somewhat frowned upon by other nations.
The results of this more laissez-faire stance during the first wave may be the reason why Sweden has returned to more conventional and economically damaging containment measures.
Sweden’s Prime Minister Stefan Lofven recently addressed the nation to warn of the growing threat of the virus and stated that “too many people have been careless about following the recommendations”.
On the macro front, the labour market has yet to react to the latest restrictions. With the containment measures not implemented until October, and the stricter measures not effective until November 24th, the effects are yet to be visible in most hard data points. For example, the labour market has yet to react to the latest restrictions. Unemployment in October fell to 7.8%, down from 8.3% in September, but economists have warned that the data for the coming months will be less positive, especially in labour intensive service sectors.
In the third quarter, Sweden’s economy grew by more than expected after the virus numbers receded throughout the summer. GDP grew 4.9% QoQ compared to the consensus of 4.3% in a Bloomberg survey of economists. The Q4 GDP data is likely to be grim, however, as the virus tightens its grip and the effects of the recent containment measures make the scene. Hope for Q4 GDP data lies at the mercy of the manufacturing sector, which is less impacted relative to Q2, while the service industry was already depressed before the latest lockdown measures. The Manufacturing Confidence Index even rose from 106.8 in October to 110.6 in November, ignoring the recent tightening of measures.
DESPITE THE NEAR-TERM RISKS, THE 2021 OUTLOOK FOR THE KRONA LOOKS POSITIVE
Looking ahead, the krona’s outlook is positive, despite the recent uptick in virus numbers. The second wave will weigh on near-term activity with lockdown measures being in place for at least the next two weeks but hopes that improving vaccine developments would make for an accelerating global economic recovery in 2021 should be beneficial to the Swedish krona. This is especially the case given the currency historically benefits during periods of global economic expansions. While the central bank has downgraded its expectations of growth and inflation for 2020 and 2021, we believe their view on next year’s recovery is pessimistic. This is partly done on purpose to raise the bar for speculation over negative interest rates. Therefore, we expect the recovery to exceed the central bank’s expectations in 2021 given our base case for the global recovery and vaccine availability.
Central banks across the globe maintaining accommodative policies should also help SEK see positive returns over the next year as interest rate differentials remain subdued, offsetting any negative carry from the 0% repo rate expected until 2023. Additionally, Joe Biden’s presidency could usher in a more stable geopolitical backdrop and friendlier trade policies, which would boost risk appetite at a minimum. With Sweden’s heavy reliance on exports, especially to the eurozone, SEK will likely find support in this as it provides more stimulus for a fast recovery in mainland Europe.
Ima Sammani, FX Market Analyst
Simon Harvey, FX Market Analyst