Fundamental Evaluation Series: USD/SEK vs. 2-year yield spread

The chart above shows, how the relationship between USD/SEK and 2-year yield spread has unfolded since 2012.

Brief background:

• The Sveriges Riksbank (SRB) began reducing interest rates (repo rates) in the aftermath of the ‘Great Recession’ of 2008/09. The interest rates declined steadily from 475 basis points in 2008 to just 25 basis points in 2009.
• The rate was increased to 200 basis points in 2011 as the impact of the ‘Great Recession’ was less severe.
• However, the interest rates were reduced again in the aftermath of the Eurozone debt crisis. Since the end of 2011, SRB reduced rates from 200 basis points to zero in 2014 and was further lowered to -50 basis points in 2016 and it remained at the level.
• In addition to that, SRB introduced asset purchase program.
• It can be seen from the chart as while SRB started reducing rates again between 2011 and 2015 and maintained dovish tone, and the US Federal reserve indicated, and began to wind up its asset purchases, the 2-year yield spread widened in favor of the dollar by more than 200 basis points and the exchange rate declined from 6.4 per dollar to 8.6 per dollar.
• Despite speculations over looming rate hikes since 2017, the central bank has not raised the rates though the economy has been strong with GDP growth at 3.3 percent first quarter, it has slowed down significantly over the last two quarters. In the third quarter, GDP growth was 1.6 percent y/y. The central bank has finally signaled that it is ready to raise rates for the first time in years by the first quarter next year.
• The central bank hasn’t raised rates despite the fact inflation rate is hovering around 2.3 percent, the highest level since 2012.

Past Reviews:

• In our review in August, we noted strong divergence as the yield spread widened by almost 9 basis points in favor of the dollar, while Swedish Krona has strengthened by almost 1000 pips against USD. We noted that such divergence is not sustainable in the medium term; hence expected the spread to narrow against the dollar and or the exchange rate to move lower in favor of the dollar. Thus we expected hawkish commentaries from SRB, in absence of which the exchange rate could decline favoring the dollar. The spread was then at 197 basis points and the exchange rate is at 8.1 per dollar.
• In our review in early October, we noted that the divergence has further widened. The yield spread has widened by 19 basis points in favor of the dollar, while the SEK has strengthened by 30 pips. And in our review on 31st October, we noted that the exchange rate has started responding to yield spread as it widened by almost 17 basis points to 233 basis points and the USD/SEK exchange rate weakened from 8.11 per dollar to 8.36 per dollar, thus reducing the divergence.
• In our review in November, We noted that the spread has further widened by 29 bps to 262 bps, while the Swedish Krona weakened by 130 pips to 8.487 per dollar.
• In our review in December, we noted that the spread has further widened by 6 basis points to 268 bps in favor of the USD and Krona has weakened from 8.277 per USD to 8.386 per USD.
• In our review in February, we noted that the spread has marginally widened by 4.5 bps to 272.5 bps in favor of the USD, however, the Swedish Krona has strengthened from 8.386 to 8.23 per USD.
• In our April 2018 review, we noted that the spread has further widened by almost 14 bps to 286 bps in favor of the dollar, and Swedish Krona has weakened from 8.23 per dollar to 8.42 per dollar.
• In May, we saw that the spread has further widened by another 16 bps to 302 bps in favor of the dollar, and Swedish Krona has weakened from 8.42 per dollar to 8.66 per dollar.
• In July, the spread has further widened by 15 bps to 317 bps as of today and the exchange rate weakened from 8.75 to 8.79 per dollar.
• In August, we noted that the sharp appreciation of the Swedish Krona that has taken place in 2017, is now reversing the course as the interest rate spread has continued to widen in favor of the USD. We forecasted the trend to continue without significant changes in central banks’ communications. The spread was little changed at 312 bps, while Krona weakened sharply to 9.1 per USD.
• In September, the divergence actually widened last month. The spread widened by 330 bps in favor of the USD in September, Krona strengthened to 8.79 per USD.
• In October, the spread is unchanged at 328 bps but Swedish Krona weakened from 8.78 per USD to 9.06 per USD.

Analysis:

In November, the spread is almost unchanged at 327 bps, while Swedish Krona weakened to 9.1 per USD.