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In order to find value in being long NOKSEK, the execution of seagull strategy is advised. The trading stance is motivated not just by cheap NOK valuations, but predominantly driven by the relative central bank reaction functions.
The Swedish central bank held its benchmark interest rate at -0.5 pct on July 3rd, as widely expected, saying monetary policy needs to continue to be expansionary for inflation to remain close to target despite strong economic activity. Still, the central bank reiterated that slow repo rate rises will be initiated towards the end of the year. In addition, SEK is more vulnerable to a more dovish ECB stance as well as an escalation of global trade risks relative to NOK.
Admittedly, SEK valuations are cheaply given rate differentials (EURSEK should be closer to 9.60, if they had moved in line with EU-SWE 5-year yield differentials) and Swedish rates are low relative to Riksbank’s forecast. But in our view, the macro catalyst for mean reversion would be a more hawkish stance from the Riksbank, but this seems unlikely to be delivered in the near term.
Our expectation is for the rate profile to be largely left unchanged with perhaps a reflecting a modestly lower probability for a December hike. We think that the central bank will likely refrain from sending a hawkish signal and could even be modestly dovish.
While domestic developments by themselves have been mostly in line with RB expectations — growth slightly better than forecast, CPI-F ex energy a tenth below their forecast, firming wage growth, a currency 2% weaker than their forecast (but unchanged from the level at the April meeting) — an offset comes from international developments, namely trade conflict and a delayed ECB pivot, which is likely to keep them cautious.
Long a 2m NOKSEK 1.0975-1.1150 call spread, short a 2m 1.0725 NOKSEK put, RKI 1.06. Courtesy: JPM
