Norwegian Macros Provides Breathing Space To Norges - Delta Loop Vanilla Triangle Package For NOK

Inflation was not much of an issue in Norway anyway over the past few years, so that Norges Bank was able to hike its key rate quite strongly over the past two years until it lowered it back to 0% again as a result of the Covid-19 crisis. However, the combination of a collapsing oil price and the effects of the pandemic are having a particularly strong effect on the Norwegian economy as yesterday’s GDP data for Q1 illustrated (overall -1.5%, mainland -2.1% qoq). The fact that the krone nonetheless recorded a decent performance yesterday was mainly due to market sentiment. And that is going to remain the case: oil price and risk aversion will drive the development in the krone short term.

After Norges Bank considered intervening on the FX market in March to cushion the collapse of the krone it is likely to have shelved these considerations for now. Unless there is a renewed wave of NOK selling, there is no need for interventions with EURNOK slowly drifting further downwards.

NOK vols are well off the March explosion, which at the peak surpassed 2008. Currently at around 15vol handle, they are still a solid 8vols from the pre-COVID-19 period. What’s more, the recent oil hiatus helped push the NOK correlations to unprecedented levels but those historically high NOK correlations may be vulnerable without NOK- specific drivers with the impact from the oil uncertainty starting to dull and with Norges Bank on hold. USDNOK- EURNOK 1Y implied correlation in mid-80s makes short lean very favorably asymmetric. The capped nature of correlations has a special appeal for prospective NOK vol sellers, especially with the view about softer NOK correlation being possible to directly express via USDNOK- EURNOK correlation swaps. Our preference is for longer expiries in order to mitigate risk from spot realizing.

Consider: Sell EURNOK - USDNOK 1y corr swap @77/85corr pts.

An alternative expression to the above short corr swap is to utilize the so-called “closed delta loop” triangles, an approach of monetizing correlations without the need for continuous delta-hedging and/or strike management.

The closed delta loop vanilla triangle package is composed of short EURNOK calls, short USDNOK puts and long EURNOK calls with equal NOK notionals on the two NOK-legs, and the EUR notional and strike of the EURUSD leg appropriately chosen based on those of the NOK-legs. The resulting long/short vol stance on the three legs is the right way for expressing a short corr. view, and the suitable choice of calls/puts for the trades ensures no net currency transactions at expiry. The structure sells both of the rich NOK options. Courtesy: JPM & Commerzbank