1. society
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3. unemployment

Trading Strategy
March 26, 2015
FX Pilot
A currency war in progress

EUR/SEK: Range trade with bias to the upside

EUR/NOK: Downside potential in the short term

EUR/USD: Sideways to higher going forward
Figure 1: Relative surprise index and a running cycle
For anyone questioning the existence of a currency war, last
week’s events provided an answer. The Riksbank’s repo rate
cut and expanded bond purchasing programme cannot be
seen as anything other than entirely linked to the recent appreciation of the SEK. The Fed’s lowering of interest rate forecasts and its generally softer line is largely a reaction to the
sharp appreciation of the USD.
There is good reason to believe that there will be further
measures taken by the Riksbank ahead as it fears the ECB
QE tide. Should the EUR/SEK close in on lows for this year
(9.05-9.10) before the next scheduled policy meeting on April
28, we believe that currency intervention is highly likely. The
prospect of this and the last rate cut will underpin the cross.
Norges Bank surprised the market by leaving the rate unchanged. In the short term, we see a stronger NOK but further ahead, we believe the NOK will weaken when Norges
Bank will likely cut interest rates in May or June by 25bp.
Pierre Carlsson – [email protected], +46 8 463 4617
Lars Henriksson – [email protected], +46 8 463 4518
Nils Kristian Knudsen – [email protected], +47 2 282 30 10
Kari Due-Andresen – [email protected], +47 2239 7007
Claes Måhlén – [email protected], +46 8 463 45 35
Table of contents
FX in brief ........................................................................... 2
FX view ............................................................................... 3
Surprises in central bank monetary policy decisions .......... 5
FX behaviour ...................................................................... 7
For full disclaimer and definitions, please refer to the end of this report.
Source: Bloomberg, Macrobond
FX Pilot, March 26, 2015
FX in brief
USD
US labour market data have continued to surprise on the upside, even against the backdrop of a weaker
global economic environment. As the timing of a possible first rate hike by the Fed approaches, this will
eventually continue to support the USD. With Fed staggering on the first rate hike as the stronger dollar
holds back inflation, we expect the strengthening of the USD to take a pause in the shorter term.
EUR
The ECB’s quantitative easing (QE) was a more powerful measure than expected. Additionally, the ECB is
already open to more QE after the current programme expires in September 2016 if inflation prospects are
not satisfactory. We expect wage growth to be stagnant, making it extremely difficult for the ECB to push
inflation toward 2%. The only lever left to pull is FX and a weaker EUR will likely be the trend longer term.
NOK
Norges Bank surprised the market by not cutting rates. They are now back to being governed by the housing market as fear of financial imbalances could build due to lower interest rates. The risk premium attached to the NOK has diminished and the volatility has been reduced significantly in recent months due to
the sideways oil price movement. However, the correlation between interest rates and the oil price is still
high and we expect lower oil prices ahead. The outlook for the Norwegian economy is quite gloomy.
SEK
The Riksbank is looking to keep the SEK weak and protect the downside. While safe-haven flows may
find their way into the SEK, the Riksbank will safeguard against a further recovery against the EUR.
GBP
The strength of the GBP will dampen the economic recovery and continue to weigh on inflation ahead.
While this has fed through to lower sterling rates, the GBP has remained supported. We see no further
strength from here.
JPY
A continued weakening of the JPY is necessary to keep the inflation outlook in line with the Bank of
Japan’s target and to counteract tax headwinds for the cooling economy. The trend towards a weaker
JPY should continue.
Handelsbanken Capital Markets’ forecasts
EUR/USD
USD/JPY
EUR/GBP
EUR/CHF
EUR/NOK
EUR/SEK
26-Mar
1.10
118
0.74
1.05
8.56
9.32
<1m
1.13
122
0.75
1.05
8.50
9.45
<3m
1.08
124
0.75
1.05
8.90
9.30
AUD/USD
NZD/USD
USD/CAD
NOK/SEK
USD/NOK
USD/SEK
Sources: Bloomberg, Handelsbanken Capital Markets
2
26-Mar
0.79
0.77
1.24
1.09
7.75
8.44
<1m
0.78
0.76
1.25
1.11
7.52
8.36
<3m
0.77
0.76
1.27
1.04
8.24
8.61
Fed
ECB
BOE
SNB
Norges Bank
Riksbank
26-Mar
0.125
0.05
0.50
-0.75
1.25
-0.25
<3m
0.25
0.05
0.50
-0.75
1.00
-0.25
<6m
0.50
0.05
0.50
-0.75
1.00
-0.25
FX Pilot, March 26, 2015
FX view
EUR/SEK to trade in a range with a bias to the
upside

Swedish pension funds and life insurers have been
actively building up large positions of unhedged currencies over the last couple of years (mainly USD). It
seems likely that pressure on the SEK will not continue
this year. Strong performance in bond and equity markets should result in a pent-up demand to buy SEK.
Outside of Sweden, there is obviously a search going
on for an alternative to the EUR and this search intensified after the last ECB meeting. The flow picture in
Denmark has reportedly cooled off (even slightly reversed) lately but there is an obvious threat to the
Riksbank that the same money is looking for new and
similar destinations. It has been close to two months
(Feb 5) in Denmark with -0.75% for excess liquidity, so
speculators are not easy to expel once they start to
settle in. The main difference is that there is a built in
stop loss in Denmark (the ERM2-band), which does
not exist in Sweden. On the other hand, Swedish fundamentals are more favourable than Danish fundamentals in general.

It seems that the Jansson interview on March 6 in New
York, as well as the rate decision last week, has kept
the EUR/SEK from testing 9.00. There is reason to believe that there will be further measures ahead as the
Riksbank fears the ECB QE tide. Should the EUR/SEK
close in on year lows (9.05-9.10) before the next
scheduled policy meeting on April 28, we believe that
currency intervention is highly likely. The prospect of
this and the last rate cut will underpin the cross.

There is a clear difference in the price action after the
last central bank action and the three previous ones.
We are now trading much closer to the post-cut-high
after one week than last time, and lows are coming in
higher. In our opinion, this indicates that the central
bank is controlling the game so far.
Figure 2: EUR/SEK and swap spread gap to tighten
Source: Bloomberg
Figure 3: EUR/NOK and rate spread
Source: Bloomberg
Figure 4: Surprise index and EUR/USD
EUR/NOK: Downside in the NOK short term

The unchanged rate decision from Norges Bank has
led to an increased risk of further short-term NOK
strength as market participants have placed Norges
Bank back on the more hawkish shelf.

The volatility in the oil price will be a major determinant
of the NOK exchange rate as the correlation between
oil and the NOK should stay high.

In the more medium term, we find an asymmetric risk
towards NOK rates as both a slowdown in the real
economy and a higher oil price could increase pressure for additional rate cuts beyond current pricing.
Source: Bloomberg
3
FX Pilot, March 26, 2015
EUR/USD: Sideways to higher going forward

The Fed dropped its promise of being “patient” about
raising short-term interest rates from its statement last
week. However, it staggers on a rate hike as the
stronger USD primarily suppresses inflation and economic activity going forward. This was probably the
nail in the coffin for a pause in the strengthening of the
USD and a multi-month correction in EUR/USD. A
break of 1.0463 would alter this view. Watch out for
the 1.1080-1.1120 range where there will be a good
amount of stop losses.

The relative surprise index between US and EMU
economic data suggests that we could see the
EUR/USD at 1.15 and higher over the next couple of
months (Figure 4). Such an outcome is transient. The
momentum for the US economy is strong and the labour market is expected to continue to improve. Moreover, given the running cycle, the tide is gradually
changing in favour of positive surprises in economic
data for the US rather than the eurozone (Figure 5).
4
Figure 5: Relative surprise index and a running cycle
Source: Bloomberg, Macrobond
FX Pilot, March 26, 2015
Surprises in central bank monetary policy decisions
Riksbank surprised by cutting the rate
Figure 6: Wage pressure in Sweden is still too low
The Riksbank seems to have realised that global inflationary
pressure will remain low for the foreseeable future. At the
same time, there are few signs of Swedish salaries increasing, which could create domestic inflationary pressure (Figure 5). Salary expectations continue to be low and there is a
risk that decreasing inflation expectations will make the low
inflation environment permanent, via the collective agreement negotiations which must be completed by the first quarter of 2016. Thus, in the short term, the only way for the
Riksbank to influence inflation is through the SEK. The SEK
has depreciated sharply in the past year, which is already
trickling into imported inflation, likely with more to come (Figure 6). So, shouldn’t the Riksbank be satisfied?
We believe the Riksbank looks at figure 8 and fears the
EUR/SEK will be under constant, intense, downward pressure
in the next year due to the ECB’s growing balance sheet.
Given that the EUR accounts for almost 50% of the KIX
(trade-weighted SEK index), this could mean that the entire
inflation rate increase will be reversed by the time salary discussions enter their final phase. Therefore, as far as the Riksbank is concerned, risk-reward is definitely in favour of a proactive approach.
The Riksbank’s approach can be interpreted as a shift from
the reactive way it has functioned over the past few years,
when lower-than-expected inflation outcomes have triggered
a monetary policy responses. In the future, the inflation outcome and expectations may be of less importance than the
EUR/SEK trend. We expect that further measures will be
needed to counteract the strength of the SEK (relative to the
EUR). The Riksbank is prepared to consider continued rate
cuts and expanded bond purchases. However, an increasingly negative interest rate means that the pressure on the
financial system is increasing and more bond purchases
lead to liquidity in the bond market being under further pressure as the “free float” decreases.
Outright currency interventions seem to be an increasingly
attractive option. Since alternative measures started to be
discussed, currency interventions have been ranked as the
least likely alternative. Several members of the Executive
Board have viewed interventions as inadequate tools because
they would irritate other countries, particularly those in the
eurozone. After all, Sweden has chosen to be outside the eurozone without actually having negotiated it, so this is potentially a sensitive issue. “Currency interventions could probably
entail a clear and fairly rapid upturn in inflation. However,
when monetary policy abroad is also limited by the policy
rate’s lower bound, the positive effects of currency interventions on inflation in Sweden would probably fully come from
negative effects on inflation abroad,” said Martin Flodén at the
Monetary Policy Meeting on December 15.
Source: Macrobond
Figure 7: KIX Index and imported goods & services
Source: Macrobond
Figure 8: EUR/SEK and ECB balance sheet
Source: Macrobond and Handelsbanken Capital Markets
5
FX Pilot, March 26, 2015
Interventions seemed to be far down the list of potential
actions at the February meeting, but since then, the Riksbank seems to have changed its stance. Per Jansson
pointed out the advantages of this action on a couple of
occasions over the past few weeks and Stefan Ingves indicated the possibility in a speech earlier this week. We interpret the latest signals as a significant increase in the
probability of currency interventions.
Figure 9: SEK vs. USD and relative core inflation
Norges Bank surprised by not cutting the rate
Norges Bank kept the key policy rate unchanged at the
March meeting. The reason given was the fear that financial imbalances would start to build due to rapidly rising
housing prices.
According to Norges Bank, the outlook for demand is weaker
than at the December report, as oil prices have continued to
fall and it now appears that activity in the petroleum industry
will be lower than previously anticipated. Despite those
negative factors affecting production and employment
ahead, Norges Bank still draws up an output gap that is less
negative than it expected in December. In our view, the output gap revision seems overly optimistic and has obvious
downside risks.
Given that Norges Bank did not have time to take into account actions by the Riksbank, the Fed, or a softer than expected Bank of England, the new path for the key policy rate
was too high when it was released. Technically, the probability of an interest rate cut in May is therefore higher than the
50 percent that the new path for the key policy rate implies.
However, one can never be sure how Norges Bank will feel
about financial stability in May and whether it will want to
wait a little longer. Given the current outlook, our best guess
is that Norges Bank will cut the key policy rate in May and
cut the interest rate once more later in the year.
Source: Bloomberg, Macrobond
Figure 10: Norges Bank policy rate forecast
Source: Handelsbanken, Norges Bank
Figure 11: Krone Index
Source: Macrobond
6
FX Pilot, March 26, 2015
FX behaviour
G10 policy rates
G10 two-year swap rates
4.0
4.0
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.0
0.5
-0.5
0.0
-1.0
-0.5
NZD
AUD
NOK
CAD
GBP
USD
EUR
JPY
SEK
CHF
NZD
AUD
NOK
Source: Macrobond
Source: Macrobond
G10 REER valuation
G10 budget balance
20.0
12.0
15.0
10.0
10.0
8.0
5.0
6.0
0.0
4.0
-5.0
2.0
-10.0
0.0
-15.0
-2.0
-20.0
-4.0
-25.0
-6.0
-30.0
CAD
GBP
USD
JPY
EUR
SEK
CHF
SEK
AUD
CAD
EUR
GBP
USD
JPY
-8.0
GBP
NZD
Source: Macrobond
CHF
USD
AUD
SEK
NOK
EUR
CAD
JPY
NOK
CHF
NZD
Source: Macrobond
7
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