Oct 15, 2015 - be used to build a long NOK position based on the currency's stretched valuation and an excessively short
Ready… Set… NOK!
THURSDAY 15 OCTOBER 2015
The negative implications of decreased investment and operational activity within the petroleum sector have yet to fully impact the rest of the economy. With growth in the mainland economy expected to remain subdued in the coming year, weak sentiment indicators are the main risk to our forecast. Still, in our view markets may have discounted too much negativism from lower oil prices. Our FX survey suggests that foreign speculative investors carry the short NOK bets as both domestic companies and financial institutions hold a relatively neutral position in the NOK. Survey respondents believe Norges Bank’s policy will weigh substantially on the NOK in the short term; in our opinion the market has overlooked the likelihood of a December rate cut. Coupled with persistent downside risks to oil prices, we expect EUR/NOK to trade slightly higher in the near term. However, rallies in EUR/NOK above 9.40-50 should be temporary due to the krona’s stretched valuation and already excessively short speculative NOK positioning. Norges Bank’s dovish policy will be increasingly exhausted, while both valuation and still-positive capital flows suggest the NOK will recover in the long term. We maintain a NOK profile in which the currency appreciates gradually against the euro over the long term, targeting 8.70 by end-2016. USD/NOK is expected to peak around 8.70 in H1-16 before depreciating towards 8.20 by the end of next year.
EDITOR
Trading recommendations •
• •
Long-term trade: Sell EUR/NOK on rallies towards 9.40-50. Historically, levels above 9.00 in EUR/NOK have been long-term attractive to sell. Long-term fair value is around 8.00. However, as downside risks for the NOK persist, the Norwegian currency will only recover when the full impact on the economy of lower oil prices is known. Valuation trade: Sell NZD/NOK as the NOK is undervalued and the NZD overvalued. Long-term target is below 4.50. Monetary policy trade: Sell NOK/SEK on the relative monetary policy outlook. With Swedish inflation finally moving higher the Riksbank is probably closer to ending its easing cycle than Norges Bank. Sell above parity targeting 0.95 in Q1-16.
Erica Blomgren +47 2282 7277 CONTRIBUTORS
Stein Bruun +47 2100 8534
Richard Falkenhäll +46 8 506 23133 Bjarne Schieldrop +47 2282 7253 Karl Steiner +46 8 506 23104 Dag Müller
+46 8 506 23129
NOK Views
Forecasts CENTRAL BANKS
Current target rate October November December End-15 January February March April May Mid-16 End-16 End-17
EMU
US
UK
SWEDEN
NORWAY
0.05% Unch Unch Unch 0.05% Unch Unch Unch Unch Unch 0.05% 0.05% 0.05%
0.00-0.25% Unch --+25bps 0.50% Unch --+25bps Unch --0.75% 1.25% 2.25%
0.50% Unch Unch Unch 0.50% Unch Unch Unch Unch +0.25bps 0.75% 1.00% 1.75%
-0.35% -10bps --Unch -0.45% --Unch --Unch ---0.45% -0.25% 0.75%
0.75% --Unch -25bps 0.50% ----Unch --Unch 0.50% 0.50% 0.75%
CONTENT Page 3 Page 4 Page 6 Page 7 Page 8 Page 10 Page 12 Page 14
CONTACTS Oil price outlook The growth impact The policy response NOK conclusions NOK FX survey NOK drivers and positioning The flow outlook NOK valuation and long-term outlook
Carl Hammer, Head of FX Research Erica Blomgren, Chief Strategist Norway Stein Bruun, Chief Economist Norway Richard Falkenhäll, FX Strategist Halvor Strand Nygård, Oil Sector Equity Analyst Dag Müller, Technical analyst Karl Steiner, FX Quant Strategist Bjarne Schieldrop, Chief Strategist Commodities Anders Söderberg, Chief Technical Analys
FX FORECASTS
FX EUR/USD EUR/SEK EUR/NOK EUR/CHF USD/JPY EUR/GBP
14.10.2015 1,141 9,262 9,23 1,091 119,5 0,743
14.10.2015 USD/NOK GBP/NOK NOK/SEK JPY/NOK AUD/NOK NZD/NOK CNY/NOK CHF/NOK
8,090 12,422 1,00 6,77 5,87 5,45 1,27 8,46
1m 1,15 9,25 9,40 1,09 118 0,74 1m 8,17 12,70 0,98 6,93 5,80 5,15 1,26 8,62
Q4 15 1,10 9,15 9,50 1,10 120 0,73 Q4 15 8,64 13,01 0,96 7,20 5,79 5,18 1,31 8,64
FORECASTS Q1 16 1,08 8,90 9,40 1,11 123 0,70 Q1 16 8,70 13,43 0,95 7,08 5,57 4,87 1,32 8,47
Q2 16 1,06 8,80 9,25 1,12 127 0,69 Q2 16 8,73 13,41 0,95 6,87 5,67 4,80 1,36 8,26
Q3 16 1,04 8,80 9,00 9,00 130 0,72 Q3 16 8,65 12,50 0,98 6,66 5,63 4,76 1,33 1,00
Q4 16 1,06 8,70 8,70 1,14 127 0,73 Q4 16 8,21 11,92 1,00 6,46 5,33 4,60 1,23 7,63
ACTION LEVELS Buy Sell 1,00 1,15 9,35 9,00 9,60 1,07 116 133 0,68 Buy Sell -
2
NOK Views
Oil price outlook •
The oil price ranges between $42/b and $70/b with the market continuing to run a surplus and oil inventories still rising.
•
Already bloated global oil inventories are likely to rise further in H1-16 causing a further downturn in oil prices.
•
Overall, the oil market is rebalancing itself and the market is likely to be close to balance in H2-16, suggesting a gradual rebound in oil prices starting late next year.
Commodity prices have followed closely recent fluctuations in risk appetite for emerging market assets and currencies, driven largely by changing market expectations on when the US Fed will make its first rate hike. Generally, the Brent crude oil price has also followed this pattern but with some deviations. Clearly therefore, explaining and forecasting potential oil price changes this year has required an understanding of broad-based trends in market appetite for emerging market assets, currencies and commodities, and also of oil market fundamentals.
Seemingly, investment appetite for emerging market assets, currencies and commodities has become more positive since the market postponed its expectations for the first US rate hike to mid-2016. NEAR-TERM OUTLOOK. US oil production has been in decline since April, a process that appears to be accelerating. Additionally, the number of oil rigs employed in the US shale oil sector continues to fall. Lately, Middle East tensions have clearly escalated as Russia has become more fully involved in the Syrian conflict. With IS having targeted several Iraqi oil installations, Iraq has stated that it may well ask for Russian military support to combat this new threat. Obviously, there are several bullish factors at work in the oil market that may strengthen existing broader-
based bullish forces. Despite the oil market running a solid surplus all year, the oil price has continued to range between $42/b and $70/b. Consequently the oil price may easily continue moving higher in the near-term. Brent crude $/b
End-15
Q1-16
H1-16
2016
2017
SEB 50 50 50 55 60 Norges Bank* 49 51 52 53 58 *The bank’s assumption reflects future prices at time of the MPR 3/15.
However, we expect the oil market to run a surplus next year as well, although mainly during H1-16. During the same period, global oil inventories are likely to increase even further from current already elevated levels. It may therefore be very difficult for the oil price to remain at current level during this time, especially if – as we expect – the Fed actually hike rates this December. Hence, while there is scope for the oil price to increase further over the next two months, it looks set to face a new bearish challenge towards the end of the year and during H1-16.
LONG-TERM OUTLOOK. The global market is in the process of rebalancing. Currently, non-OPEC production is moving sideways and gradually declining. OPEC output is unlikely to rise by as much in 2016 as in 2015 and we do not expect any announced cut in production at the Dec 4 meeting. Massive cuts in capital expenditure on new production will at least impact non-OPEC oil supply in 2-4 years if not earlier. Additionally, oil demand appears strong due to the steep fall in oil prices. Even if the oil market becomes balanced towards H2-16, it will still need to run a deficit for quite some time to draw down swollen oil inventories. During that period the oil price must remain subdued to prevent oil production from rebounding too soon. Hence, we expect the current range of $40/b and $70/b to persist in the next year couple of years with focus on the upper-end of the range.
3
NOK Views
The growth impact
going forward. We forecast LFS unemployment to rise to 4.5% on average in 2016.
•
The negative implications of decreased investment and operational activity within the petroleum sector will substantially affect the rest of the economy. They have yet to fully impact.
•
Continued savings measures and technology developments signal that oil sector investment activity will stabilize fairly soon.
While the negative effect of decreasing activity within the petroleum sector has yet to be fully felt, we still expect the general economy to slow rather than suffer a slump. Near-term, mainland GDP should grow sequentially by a modest 0.3% in Q3 and Q4, with non-oil domestic demand and exports still positive but subdued. Full-year growth is expected to be well below trend at 1.4% this year before recovering to 2.0% in 2016.
Sharp reductions in petroleum sector investments, reflecting depressed oil prices and general cutbacks after several years of runaway cost inflation to preserve cash-flow and dividend capacity, remain the greatest drag on and risk to the Norwegian economy. We expect real capital spending in the petroleum sector to fall by 12% this year, and by a further 9% in 2016 and 5% in 2017 resulting in a cumulative decrease of 26% from its peak in 2013. Declining demand from the sector should subtract approximately 1%-point from growth in mainland GDP this year and slightly less in 2016.
WHAT COULD GO “WRONG”? In our view, markets are discounting the severe negative impact (most of it anyway) on the economy of lower oil prices, indeed more so as our projections are slightly less pessimistic than consensus. We must therefore ask: What could go “wrong” that would result in a smaller and shorter downturn in petroleum investment, which in turn might trigger a sharp turnaround in NOK sentiment. Below we consider two scenarios both of which imply that the extent of the downturn in oil investment will be smaller than is generally expected at present. Rebound in oil prices: The outlook for oil prices is uncertain with Brent oil not so long ago trading at around $60/b. While we mainly expect Brent crude oil prices to trade around $50/b for the next six months, a continued rebound is possible irrespective of the oil market surplus and bloated global oil inventories (see page 3). Should oil prices recover further and stabilise at approximately $60/b, pressure on oil companies to cut costs further would ease.
Although lower investments and operational activity within the petroleum sector will significantly impact the rest of the economy, so far their adverse effects have been confined to the manufacturing and petroleum-related service sectors. The contraction within manufacturing should hurt growth in Q3, while momentum is expected to remain negative. However, the recovering PMI suggests that such weakness is not feeding on itself, while the most recent Norges Bank regional network report showed manufacturers outside the petroleum sector performing rather well. In particular, exporters of non-oil goods are benefiting from increasing foreign demand and a substantially weaker NOK. Indeed, outside of the weather-related electricity industry, such exports surged by 7% y/y in Q2. Moreover, private consumption has been surprisingly firm although softer labor markets are expected to undermine private spending
Improved project economics: Here markets tend to focus on only one side of the equation. However, while lower oil prices depress activity within the sector, forced internal cost cutting and subsequent efficiency gains also improve project economics. For example, the North Sea Maria field saw a more than 30% cost reduction between the original PDO date (2014) and the final sanction date (2015) as service prices decreased. Also, the massive Johan Sverdrup development is benefiting from a lower service price environment. Phase 1 capex was estimated at NOK 123bn (nominal) when the PDO was submitted in February this year. Now, as a result of the “positive market response in contracts and purchase orders” Phase 1 capex is estimated at NOK 114bn – some 7% less than the initial budget. However, we believe there is much more to come because: (i) only NOK 50-55bn (~45%) of contracts have so far been awarded; (ii) the estimate probably still includes a “market allowance” inflator on individual contracts (4-8%) from the days when rates were increasing; and (iii) the estimate
4
NOK Views
includes contingencies/buffers, also on fixed price contracts. The absolute level of these has not yet been adjusted in accordance with the new estimate of NOK 114bn. There are currently no indications of the scale of such an adjustment but it may be between 15-20%. Hence, we would not be surprised if eventual Phase 1 capex for Johan Sverdrup was below NOK 100bn. Moreover, the initial concept development of the Johan Castberg discovery in the Barents Sea had a breakeven oil price in the high 80-ies. However, if now the concept is revised from semi-sub installation with a transport pipe connected to shore to instead, for example, an FPSO solution combined with lower service prices, the breakeven price could be improved to potentially below $50-60/b.
WHAT COULD GO EVEN WORSE? Private consumption has been surprisingly firm, actually increasing by a solid 2.9% in the year to Q2. This is particularly important for growth as private consumption accounts for roughly half of mainland GDP. In other words, so far, household spending has defied sharply decreasing confidence and weaker labor markets. Prima facie, consumer confidence stands at a six-year low consistent with declining consumption compared to a year ago. Consequently, the main risk to the current outlook is if consumers begin to act as they feel. For this to happen, Norwegians must start assessing their own finances more pessimistically. So far, their view has remained more positive than the historic norm due to low mortgage rate costs, rising existing home prices, still solid real disposable income and the fact that the increase in unemployment has been centred geographically on petroleum-related counties. However, this situation may change: latest data show that the relationship between housing demand and supply is about to turn negative. If this trend continues, house prices are likely to weaken, which may have negative knock-on effects on consumption. Lower pay rises and slower overall employment increases resulting in weaker income growth could also pressure consumption. Our forecast growth of 2.3% in overall private consumption in 2016 may prove too optimistic.
While improved cost metrics in existing fields pressure nominal investment over the coming year, sector demands on the rest of the economy will be unaffected as reduced capex results from lower prices to suppliers. Therefore, continued savings measures and technology developments suggest that investment in the sector in terms of volume will stabilize fairly soon. In two to three years, the situation might therefore differ as new fields are more likely to be developed. Remember that on the two previous occasions when oil investment fell sharply, everyone was surprised by the strong rebound that followed. To conclude, growth in the mainland economy is expected to remain subdued in the coming year and weak sentiment indicators are the main risk to our forecast. Still, we think markets may have discounted too much negativism from lower oil prices. As has been proven, people tend to underestimate the turnaround in petroleum investment which might well be the case this time around as well.
5
NOK Views
The policy response •
The proposed 2016 budget suggests continued pressure on monetary policy to support economic growth. A December rate cut is likely, but is not yet fully discounted by markets.
When the economic policy mix was re-formulated in 2001, fiscal policy became mainly responsible for stabilising economic developments. Since then, however, policy rates have in reality become the “first line of defence” as the government seeks to promote long-term structural changes that imply fiscal orthodoxy. FISCAL POLICY. Admittedly, the 2016 budget proposal forecasts higher spending and lower business and personal income taxes against a background of plunging oil prices. However, the expansionary effect of the budget is only slightly higher at 0.7%-point of mainland GDP from 0.5%point in the current year. While the estimated expansionary effect is twice as much as the average for the past 10 years, it pales beside the 1.8%-points of stimulus in 2009 when extraordinary measures were introduced. The government is therefore using only a small part of its fiscal leeway as the higher cyclically-adjusted nonoil budget deficit in 2016 is expected to correspond to 2.8% of the Government Pension Fund Global. The budget proposal means that the pressure on monetary policy to support economic growth will persist and will therefore not prevent Norges Bank from cutting the key rate further if it thinks it justified. However, the government has plenty of room to manoeuvre: the 4% limit stipulated by the fiscal policy rule would actually allow for the structural non-oil budget deficit to increase by NOK 87bn to NOK 281bn in 2016. For the government to raise spending sufficiently to alleviate some of the pressure on Norges Bank, economic momentum must be substantially weaker with GDP declining and unemployment rising beyond 5%. Note that the next general election takes place in 2017 and opinion polls currently favor the opposition. MONETARY POLICY. Persistent currency weakness continues to fuel stronger imported inflation. Currently, core inflation is running at 3.1% annually. Norges Bank does not expect CPI-ATE to return to its 2.5% medium-term target until early 2017. In our view, the bank has temporarily suspended the inflation target in favor of mitigating downside risks to the economy resulting from sharply lower petroleum investment. Consequently, the bank is fixated on oil
prices and aims to keep the NOK exchange rate weak to help exports take up part of the slack from negative demand impulses attributable to the petroleum sector. The rate cut in September to a record-low 0.75% was coupled with yet another downward revision to the rate path that now signals a ~60% chance of another cut. We regard the current policy as too aggressive when considering the expansionary effect of sharp NOK depreciation (-15% y/y) and believe real rates are already lower than those of peers. Still, the bank takes a very pro-active approach that promotes early and decisive action to alleviate downside risks to growth. We therefore expect Norges Bank to take further action if economic momentum slows further. Given our expectations that growth momentum will remain sluggish this year and that downside pressure on oil prices will increase going into H1-16, we think it likely that the bank will cut its key rate again in December. We thereafter expect rates to be kept on hold until mid-2017 when a very gradual normalization of rates should commence. The bank’s current dovish bias suggests it could move further towards 0%. However, the governor has said that unconventional measures are not under consideration and that there is little likelihood of a negative key rate.
The market’s expectations for Norges Bank are well correlated with developments in oil prices. Following the small rebound in early October, the market only discounts a 10% chance of a rate cut before the yearend while seeing a total 80% probability of a 25bps reduction by mid-2016. Our expectation of a December cut coupled with a continued dovish bias suggests monetary policy will continue to weigh on the NOK in the short-term. However, our growth projections are less bearish than Norges Bank’s, indicating that eventually the central bank will need to adjust its forecast slightly upwards resulting in a more neutral policy. This will prove positive for the NOK in H2-16. 6
NOK Views
NOK conclusions
on the NOK, pushing EUR/NOK higher in the near term.
•
Domestic investors are neutrally positioned in the NOK, while foreign speculative investors carry large short NOK bets.
•
Upside in EUR/NOK remains vulnerable in the near-term as we expect Norges Bank to cut rates again in December and because downside pressure on oil prices persists.
•
Rallies in EUR/NOK towards 9.40-50 should be used to build a long NOK position based on the currency’s stretched valuation and an excessively short speculative NOK position.
We expect EUR/NOK to trade around 9.50 by the end of this year. However, risks of spikes towards last December highs just below 10.00 cannot be excluded on the back of downside risks to oil prices going into H1-16. However, such rallies should be temporary due to the NOK’s stretched valuation and already excessively short speculative NOK positioning. All valuation measures indicate that the NOK is markedly undervalued. Historically currencies have only tended to trade at such stretched valuation levels for a temporary period, suggesting rallies in EUR/NOK towards 9.40-50 are attractive for building a long NOK position over the medium term.
The NOK’s performance over the past year has been closely tied to developments in oil prices and expectations concerning Norges Bank. Based on current correlations with EUR/NOK, the corresponding rate spread and oil prices are likely to continue driving the NOK in the short-term. Therefore, near-term risks of NOK weakness include a further sell-off in oil and signs that the economic environment is deteriorating, which would trigger further easing by Norges Bank. Perhaps somewhat surprisingly, our FX survey reveals that both domestic companies and financial institutions hold a relatively neutral position in the NOK. Moreover, speculative trading in the currency has either remained unchanged or been scaled back over the past six months. However, the market is perceived to hold the shortest NOK position since the survey began in 2011. This likely reflects the NOK’s poor performance over the past year and suggests that foreign speculative accounts carry short NOK bets. Domestic companies have to some extent taken advantage of the weak NOK, but these flows have likely been undermined by foreign speculative flows. Since domestic investors expect Norwegian growth prospects and monetary policy to weigh on the NOK going forward, we expect them to remain sidelined. In the short term therefore, the krone exchange rate will remain driven by foreigners. Even if excessive positioning should make speculators sensitive whenever the NOK strengthens, there probably needs to be a greater change in view on oil prices, the Norwegian economy and possibility of an unexpectedly weak NOK due to Norges Bank before the short position is more substantially downscaled. An increased concern for being long NOK in an environment characterised by low liquidity and an unpredictable central bank will likely prevent a marked recovery in the NOK in the near term. The NOK is seasonally weak in Q4 and since a December rate cut is not discounted by the market it will weigh
Our own model, SEBEER, sees long-term fair value in EUR/NOK at just below 8.00, suggesting large upside potential for the NOK once the oil price stabilizes at a reasonable level. Moreover, as Norges Bank is moving closer to the zero-boundary for interest rates and since the bank seems unwilling to introduce unconventional measures monetary policy is becoming increasingly exhausted. We believe this is mainly a story for H2-16. Absent large net NOK selling from speculative accounts, Norges Bank’s daily purchases of NOK will likely greater impact the EUR/NOK exchange rate. The fact that capital from the oil fund is being used directly in the budget from next year means that capital flows will turn more NOK positive going forward. In 2016 we forecast that total purchases will decline slightly to NOK 160bn, equal to a daily average of NOK 630mn. We maintain a NOK profile in which the currency appreciates gradually against the euro over the long term based on the krone’s attractive valuation, stable oil prices, still-positive capital flows, and a dovish monetary policy that will become increasingly exhausted. We expect EUR/NOK to trade at 9.25 and 8.70 by mid- and end-2016, respectively. Our bearish EUR/USD forecast implies that the NOK will weaken further against the dollar to 8.73 by mid2016 before recovering to 8.21 by end-2016. We do not expect the government or Norges Bank to raise concerns regarding the substantial depreciation and increased volatility in the NOK. The official objective of restructuring the domestic economy implies that authorities welcome a weaker NOK to boost non-oil exports and improve competitiveness. Despite NOK depreciation in recent years, it is still too strong to compensate for the rapid increase in wage costs in Norway over the last two decades. However, we do not believe the central bank will deliberately weaken the NOK further.
7
NOK Views
monetary policy is the most negative seen since we began our survey in 2011.
NOK FX survey •
•
Both domestic companies and financial institutions hold a neutral to slightly long position in the NOK. Respondents believe domestic growth and monetary policy will weigh substantially on the NOK going forward.
•
Still, survey participants expect relatively tight EUR/NOK and USD/NOK ranges for the remainder of the year.
•
Domestic investors believe the NOK is undervalued against the EUR and some companies have decreased their FX exposure.
NEUTRAL POSITION. Our Norwegian FX survey shows participants hold a small long position in the NOK, compared to a minor short one in our last survey in April. However, respondents believe the market is very short NOK. Historical overweight positioning in NOK 40 % 20 %
8%
0% -15 %
0%
20
Positive
Market ranking of NOK drivers
10 0 -10 -20 Negative
-30
Somewhat surprisingly, oil prices are deemed a positive factor for the NOK. This may reflect expectations that oil prices have bottomed or that low oil prices are already discounted in the NOK exchange rate. That risk appetite is regarded as neutral reflects our respondents’ belief that the market’s willingness to assume risk over the next three months will remain unchanged. Moreover, not surprisingly, liquidity and volatility are expected to adversely affect the krone. Most respondents claim they have either reduced or left their speculative trading in the NOK unchanged over the past six months. Speculative trading in NOK now vs 6mths ago
-20 % -40 %
-36 %
-26 %
38 % 31 %
-55 %
-60 %
23 %
Oct-11 Mar-12 Oct-12 Oct-13 Mar-14 Oct-14 Apr-15 Oct-15 Own positioning Perceived market positioning 8%
However, most respondents claim to be neutrally positioned in the NOK with both corporate and financial institutions holding such a position. Participants' own positioning 93 %
22 %
13 %
7%
0% Neutral Companies
0%
Considerably Somewhat Unchanged Somewhat Considerably Don't take lower higher speculative lower or higher ceased positions in NOK
Neutral positioning is also consistent with the median respondent expecting relatively tight EUR/NOK and USD/NOK ranges until the end of the year.
65 %
Overweight in NOK
0%
Underweight in NOK Financials
NORGES BANK TO WEIGH ON NOK. The neutral to slightly long position in the NOK held by respondents reflects their belief that domestic growth and monetary policy will weigh substantially on the NOK during the next six months. In fact, the score for
Respondents’ NOK expectations EUR/NOK EUR/NOK USD/NOK USD/NOK Dec-15 Jun-16 Dec-15 Jun-16 Med 9.25 9.00 8.23 8.04 High 9.75 10.00 9.30 9.30 Low 8.40 7.30 7.80 7.15 SEB 9.50 9.25 8.64 8.73 Average during survey period: EUR/NOK 9.20, USD/NOK 8.11.
While we agree with most of our survey respondents’ assessments of drivers for the NOK, we believe there is still a risk that oil price developments will weigh on the NOK in the short term. Consequently, we see
8
NOK Views
further upside in EUR/NOK and USD/NOK for the rest of this year compared to the expectations of our median survey respondents. However, we agree with our survey participants that the NOK is undervalued vs. the EUR. Median respondents believe long-term fair value (LTFV) in EUR/NOK is 8.50. Long-term fair value in EUR/NOK 10,00 9,50 9,00 8,50 8,00 7,50 7,00 6,50 6,00
the current weak NOK exchange rate. A clear majority (71%) claim the NOK is now weaker than their company’s currency estimate, while the remainder say it is largely in line with their projections. Most domestic companies report an unchanged hedging strategy over the past two years, although one third have decreased their FX exposure as shown by an higher hedge ratio and longer duration. Domestic corporates FX hedges Current
Duration
Ratio
Average Median
12 months 12 months
66% 70%
Changed behaviour over the past 2 years Mar- Oct- Jun- Oct- Mar- Oct- Oct- Mar- Oct- Oct10 10 11 11 12 12 13 14 14 15 Average High/Low
DOMESTIC GROWTH DECISIVE FOR NORGES BANK. In line with expectations that domestic growth and monetary policy will be the most negative factors for the NOK going forward, respondents believe the Norwegian economic outlook will be decisive for Norges Bank in determining rates in the short-term. It will also take into account oil prices and NOK exchange rates. We fully agree with this view. This also suggests that absent better growth momentum the market will continue to expect further rate cuts.
% of respondents
Higher
Unch
Lower
Duration Ratio
31% 33%
63% 53%
6% 13%
The majority of domestic exporters are most dependent on the dollar and the euro. Given the continued depreciation of the NOK vs. both the EUR and USD, we are hardly surprised that some companies are increasing their FX hedging activity and taking advantage of the currently weak NOK by extending the duration of their hedges.
Which factor is decisive for Norges Bank's rate setting in the near-term 50 %
21 % 14 % 7%
7%
0% Oil prices
NOK
Housing market
Domestic Domestic inflation growth
Global growth
Despite it not being fully discounted by the market, the median respondent, like us, expects Norges Bank to deliver one more rate cut this year and afterwards to remain on hold. However, only 15% of participants expect Norges Bank to introduce unconventional measures. We also regard the use of unconventional measures in Norway as farfetched. That monetary policy is still regarded as extremely negative for the NOK during the next 3-6 months could well reflect the fact that Norges Bank is expected to maintain a very dovish bias without necessarily acting on it. DECLINING FX EXPOSURE. According to our survey, most exporter respondents have been surprised by
9
NOK Views
NOK drivers and positioning •
Speculative investors hold an excessively short NOK position, reflecting increased concern about being long NOK in an environment characterised by low liquidity and an unpredictable central bank.
•
Since the market does not discount a December rate cut, monetary policy is likely to weigh on the NOK in the short-term.
•
Despite EUR/NOK trading at historically high levels neither the technical outlook nor our STFV model suggest the currency pair is presently stretched.
•
We expect EUR/NOK to trade around 9.40/50 over the next 3-6 months before gradually grinding lower.
For a long time, we have regarded monetary policy as a key driver for currencies. Recently however, FX markets have paid more attention to growth prospects. Valuation has also become an increasingly important driver and the correlation between exchange rates and risk appetite has resumed. The NOK’s performance over the past year has been closely connected with developments in oil prices and expectations for Norges Bank. NOK CORRELATIONS. Largely EUR/NOK moves can usually be explained by reference to developments in the rate spread between the two currencies. Lately however, the oil price has been an unusually obvious driver of the currency pair. The correlation between EUR/NOK and the oil price has increased considerably since 2010 and despite a small correction when oil prices rebounded at the start of this year their correlation remains high.
Moreover, while risk is currently not the main NOK driver and survey participants expect it to remain neutral, it should not be ignored. Although in 2010-11
the risk correlation was very high (EUR/NOK rising when VIX rose), since 2012 it has been significantly lower. However, in 2015 it has once again increased and is now close to three-year highs. Therefore, we recommend caution in shorting EUR/NOK if larger negative changes in risk appetite are expected.
NOK SEASONALLY WEAK IN Q4. Seasonal performance by EUR/NOK indicates EUR/NOK should appreciate in October and November before correcting slightly lower in December. However, monthly patterns are not particularly strong: for October and November the five-year average is positive (+0.7% and +1.2%) but in only three of the past five years has there been a positive change. Except in 2014 when (and for other reasons also) Norges Bank cut its policy rate causing the pair to rise sharply by 2.9%, December exhibits a more robust pattern with EUR/NOK having fallen four out of five times with an average change of -1.3%. Although not entirely convincing it still suggests a seasonally weak NOK during the final months of 2015. EUR/NOK Seasonality October 2010 2011 2012 2013 2014 5y average
1.8 -2.0 0.4 -0.8 4.1 +0.7
November
December
-1.2 0.8 -0.3 3.1 3.5 +1.2
-3.4 -0.2 -0.3 0.2 2.9 -0.2
NOK POSITIONING. Currently, our speculative positioning index for the NOK vs. EUR is excessively short. The index declined following a net long indication in May 2014, providing instead a series of net short indications approximately a year later in May 2015. Subsequently, it has continued to accelerate becoming increasingly short, while retaining a close relationship with the rise in EUR/NOK. Last week we saw a sharp fall in EUR/NOK and also speculators downscaling their excessively short positions. Even if an unduly large position should make speculators sensitive to NOK appreciation, there probably needs to be an even greater change of views regarding oil 10
NOK Views
prices, the Norwegian economy and the possibility of an unexpectedly weak NOK due to Norges Bank before a larger downscaling of the short position occurs. Anecdotal evidence from speculative accounts indicates an increased concern about being long NOK in an environment characterised by low liquidity and an unpredictable central bank.
towards the end of the year. Moreover, downside risks to oil prices persist going into H1-16. By the end of this year, we expect EUR/NOK to trade slightly higher at 9.50 and USD/NOK to reach 8.64. EUR/NOK NOT STRETCHED. The technical picture also confirms that the NOK depends on oil price developments. Prospects of oil still being short of its cycle low should disfavour the NOK. If true, the import-weighted NOK index high of 109.37 from last year is exposed. However, neither the short-term EUR/NOK technical outlook nor our own STFV model indicates that the currency pair is currently stretched. Significant gains in the oil price during October have brought the September low of 9.1350 into focus. However, the most recent setback in oil may again floor the pair preventing it from exploring the downside towards 9.02.
NORGES BANK EXACERBATES NOK WEAKNESS. Several surprises from Norges Bank have resulted in high volatility in EUR/NOK surrounding Norges Bank’s rate announcements. The intraday move in the currency pair was on average 17 figs in 2014 and has been 23 figs so far this year. Moreover, the reaction in EUR/NOK on the day of the rate announcement has been larger on the upside than the downside.
Avg dovish
Change in EUR/NOK (figures)
30 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30
10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00
Change in EUR/NOK (figures)
EUR/NOK intraday on rate decision days
30 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30
EUR/NOK STFV has corrected the previous minor NOK undervaluation. The explanatory power of the model remains at a historically high level (91%) with all three factors (oil price, equity ratio and rate spread) being statistically significant at >99%. However, combining this model with our EUR/USD STFV shows that USD/NOK is stretched on the downside. A correction to the STFV target at 8.27 is increasingly likely. However, further corrections lower in oil prices would likely move this target higher.
Avg hawkish
Since a December rate cut is not fully discounted by the market, another dovish surprise is likely by yearend. Alternatively, the market will start to price in such an outcome based on upcoming key data despite the already excessively short position. For example, we expect the next oil investment survey (Nov 24) to show a further decline in investment as companies have finalized their budgets for next year. Moreover, the Regional Network Report (Dec 4) is likely to indicate still sluggish growth momentum with risk of more severe spillover effects to non-petroleum sectors. Overall this suggests that growth prospects and monetary policy will exacerbate NOK weakness
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NOK Views
Flows remain NOK supportive •
•
The non-oil budget deficit will exceed the government’s oil revenues in 2016 forcing it to withdraw capital from the oil fund.
government petroleum revenues and consequently that capital from the fund must be used to cover the budget deficit. There are two reasons for the sharp decrease in the annual net transfer to the oil-fund since 2012: 1.
We expect NOK purchases by Norges Bank to continue in 2016 at an average daily rate of NOK 630mn.
Each year, the Norwegian government receives substantial revenues from the country’s exports of oil and gas. Generally, such income results from taxes on oil and gas extraction, dividends from the government’s ownership of Statoil and proceeds from direct involvement in the oil and gas industry (SDFI) through Petoro. Over the last decade a substantial share of such oilrelated revenues has been transferred into what has become one of the world’s largest sovereign wealth funds – the Government Pension Fund Global (GPFG or simply the oil-fund). These payments have reduced the direct and indirect effects of large petroleum revenues on the Norwegian economy and the currency. In addition, the fund acts as a long-term savings vehicle to help cope with future pension obligations, and also to smooth the spending of volatile oil revenues over time. Based on the fiscal spending rule part of the country’s annual petroleum revenues has been utilized in the government budget, while the remainder has been transferred to the GPFP. According to the spending rule, the government determines how much oil revenue will be used to balance the budget, up to a maximum limit of 4% of the value of the GPFG. NEGATIVE TRANSFER TO GPFG IN 2016. In 2012, the net transfer to the GPFG peaked at almost NOK 300bn. In 2015 the net transfer decreased to NOK 38bn as more money was used in the budget, while government oil revenues declined because of lower oil prices.
Under the 2016 budget, the net transfer to the oil fund is projected to be negative (NOK -3.7bn), the first time this has ever occurred. Effectively, a negative transfer means that the structural budget deficit exceeds projected
2.
Drop in government net revenues from the petroleum sector. Total government revenues from the petroleum sector are simply the product of oil- and gas prices and the volume sold. Norwegian petroleum production has declined slowly year-byyear. With the slump in oil prices since summer 2014 the value of the production has decline sharply. According to the government’s 2016 budget, oil gross revenues are forecast to fall to NOK 233bn compared to NOK 420bn in 2012. Government net revenues (including petroleum-related expenditures) are projected at NOK 204bn in 2016. Non-oil budget deficit indicated by spending rule grows. Following large transfers to the GPFG and the fund’s strong performance (and also the NOK’s depreciation), the value of the oil-fund has grown rapidly both in absolute terms and relative to the Norwegian economy. Currently it is valued at around NOK 6,900bn. Consequently, the fiscal spending rule permits the government to generate larger non-oil budget deficits as these are related to the size of the oil-fund. Although the government has kept deficits well below the level dictated by the 4% rule, they have still increased in nominal terms year-by-year since 2012. The 2016 budget forecasts the non-oil deficit will grow by almost NOK 28bn to nearly NOK 208bn next year. This is more than twice the size of the 2012 budget deficit. Also, it exceeds government petroleum revenues by just under NOK 4bn, a deficit which will be met by withdrawing the same sum from the oil fund.
The government beginning next year to withdraw money from the oil fund to finance the non-oil budget deficit was expected, although the fall in oil prices has caused it to happen earlier than had been anticipated. As the oil fund will continue to generate positive returns that will exceed the amount being used in the budget, it will still grow in coming years. However, the fact that capital from the oil fund is being used directly in the budget means
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NOK Views
that one of the objectives of the system, to neutralize NOK positive flows from petroleum exports, is no more. Consequently, capital flows will continue to turn more NOK positive going forward.
NOK PURCHASES WILL DECLINE MARGINALLY IN 2016. Since the beginning of October 2014, Norges Bank
were temporarily boosted as the amount of foreign currency on Norges Bank’s balance sheet (the petrobuffer) totaled almost NOK 50bn at the end of last year. Norges Bank then decided to lower it to NOK 510bn before the end of 2015, a decision which has generated more than NOK 40bn in temporary NOK purchases in 2015.
has been active in the FX market buying NOK against foreign currencies. Since February this year daily NOK purchases have amounted to NOK 700mn. These occur as the non-oil budget deficit currently exceeds tax revenues and dividends denominated in NOK. Seen from a different perspective, NOK purchases reflect the fact that Norges Bank receives more foreign currency from the SDFI than is being transferred to the GPFG. In its budget for 2016, the government proposes that NOK 208bn of petroleum revenues be used to cover the non-oil budget deficit. As this exceeds projected government net revenues from the petroleum sector in 2016 (estimated at NOK 204bn) there will be no transfer to the oil fund. Consequently Norges Bank will need to exchange total gross revenues in SDFI to NOK next year to prevent the petrobuffer on the central bank’s balance sheet from expanding. If Norges Bank continues to buy NOK 700mn per day in November and December this year NOK purchases will total NOK 169bn in 2015. In 2016 we forecast that total purchases will decline slightly to NOK 160bn.
It is reasonable to expect that Norges Bank will seek to maintain stable NOK purchases in 2016. Assuming steady buying of NOK 160bn next year, this would indicate average daily purchases of NOK 633mn or NOK 700mn until August, when they will be reduced to NOK 500mn for the rest of the year. Consequently, this one-way flow will remain supportive for NOK.
EQUITY FLOWS NOT NEGATIVE. In 2008, foreign net selling of Norwegian energy shares was the main reason behind the rapid depreciation of the NOK. This time around, data shows that equity flows have not added to last year’s krone weakness. Since oil prices started to decline last autumn, the foreign ownership rate on Oslo Stock Exchange has increased by 1%-point to 37.0%.
But how come NOK purchases will decline at the same time as the non-oil budget deficit is expected to increase by NOK 28bn? As previously explained the amount of purchases is determined by the combination of the amount being transferred to the oil fund (in accordance with the budget), gross revenues in SDFI and changes to the petrobuffer held by Norges Bank. In 2016 the transfer to the oil-fund will be negative (NOK -3.7bn vs. NOK 38bn in 2015). At the same time gross revenues in SDFI will probably decrease slightly in 2016 compared to this year. A fairly simple model that assumes an average oil price of NOK 440/b in 2016 suggests that gross revenues in SDFI will amount to NOK 156bn in 2016 compared to NOK 160bn this year. However, NOK purchases in 2015
Admittedly, foreigners have scaled down on their holdings of energy shares markedly. At the same time, however, they have increased their ownership rate in other sectors. Consequently, equity-related flows have remained neutral to slightly positive. Going forward, we expect the foreign ownership rate to remain relatively stable, suggesting a neutral impact on the NOK.
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NOK Views
NOK valuation – it’s a bargain, or is it? LONG-TERM VALUATION – FROM ONE EXTREME TO ANOTHER. With the Norwegian economy suffering from such low oil prices that Norges Bank has been forced to ease its monetary policy even further, the NOK has weakened substantially over the past year. Indeed, in only two and a half years, the currency has switched from being substantially overvalued in trade weighted terms to being ridiculously cheap. Based on the commonly used I44-trade weighted index employed by Norges Bank, the Norwegian krone has depreciated by almost 30% in nominal terms against the currencies of the country’s most important trading partners. This represents a huge repricing of the NOK during which it has changed from being overvalued by around two standard deviations compared to its historical average to instead being undervalued to approximately the same extent.
REAL VALUATION – PPP OR COMPETITIVENESS? Sometimes changes in the nominal value of a currency may simply be driven by higher inflation in one country compared to others. If domestically a country’s prices rise more rapidly over time this should simply be offset by the depreciation of its currency, to maintain approximately the same prices on goods and services between states based on the purchasing power parity theory. In other words, taking into account just the nominal exchange rate or a nominal effective exchange rate could sometimes create an unfair impression of its valuation. This may be compensated for by simply deflating exchange rates or a trade weighted index by relative inflation over time. In real terms, its historical average is therefore probably a fairer and more accurate means of reflecting a currency’s long-term valuation. The chart below shows the real effective exchange rate for the NOK since 1970. It is very rare that the real trade weighted exchange rate differs by more than two standard deviations from its historical average; indeed usually one standard deviation is sufficient to capture most fluctuations. Currently the NOK’s real effective exchange rate is well outside two standard deviations from its historical average. Its trade weighted index is even far beyond levels seen at the height of the financial crisis in 2008. This kind of extreme valuation stretch in real terms usually appears when market participants react to new information and must make large adjustments to their exposures towards either the country itself or its currency. It is however very rare that it lasts for more than a few months. Indeed, using a real effective exchange rate for the NOK produces approximately the same outcome as for a nominal trade weighted index, although the current stretch in valuation appears to be even more extreme.
Considering various exchange rates with important trading partners such as the Euro area or Sweden further underlines the current weakness of the NOK. Historically, levels above 9.00 in EUR/NOK (and USD/NOK) have been regarded as long-term attractive to buy the NOK, as these currency pairs rarely trade much higher and only for a limited period. The long-term average EUR/NOK exchange rate since 1987 is 8.12. Similarly the long-term NOK/SEK average rate since 1993 (when the SEK was freely floated) is near 1.12. Since historically the exchange rate has fluctuated between parity and 1.25, this indicates that it currently trades below its lower bound and more than two standard deviations off its historical average. Deflating by using relative CPI-inflation is simply one approach. However, to reflect the competitiveness of the Norwegian economy and in particular its non-petroleum sector it is perhaps more relevant to focus on unit labour costs (ULC) rather than CPI-inflation. This is illustrated in the next chart, which tells a slightly different story. Despite the weakening of the NOK in recent years, which
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NOK Views
has lowered its valuation substantially from previous highs, it remains insufficient to compensate for the rapid increase in wage costs in Norway over the last two decades. This suggests that businesses outside the petroleum sector still face difficulties in competing with foreign companies. However, since the NOK’s recent depreciation, following the decisions by Norges Bank to cut the policy rate at its meetings in June and September, the situation has improved substantially. Indeed, signs of rising unemployment and weaker demand for labour from the large petroleum sector are likely to reduce wage growth further in coming years which will benefit competitiveness.
SEBEER LONG-TERM FAIR VALUE. In 2011 we first published our SEBEER-model to estimate long-term equilibrium exchange rates for various currency pairs based on several fundamental factors and relative longterm interest rates. The SEB long-term fair value (LTFV) model shows that the NOK is one of the most undervalued G10 currencies, which is consistent with our previous findings. According to our model, the LTFV for EUR/NOK is just below 8.00, while the estimated LTFV for NOK/SEK is 1.07.
revenues. In estimating the NOK’s fair value we have tried to account for this situation by making various adjustments. LONG-TERM ATTRACTIVE LEVELS TO BUY NOK. No matter what kind of approach is used, the NOK appears to be substantially undervalued from a long-term perspective after having depreciated considerably since 2013. This mainly reflects the oil price slump (which still creates uncertainty regarding the Norwegian growth outlook), and additional rate cuts by Norges Bank. The table below summarizes all the different valuation approaches that have been applied. Altogether these provide a broad indication of the upside potential of the krone once the oil price stabilizes at a reasonable level of around $60-70/b, its negative impact on the Norwegian economy becomes clearer, and Norges Bank finally stops easing monetary policy. NOK Valuation - Substantially undervalued Measure Hist. avg. Current NEER (I44-index) 96.7 107.9 EUR/NOK (since 1987) 8.12 9.46 NOK/SEK (since 1993) 1.12 0.99 REER (CPI) 104.3 117.1 REER (ULC) 82.5 93.1 SEBEER EUR/NOK 7.96 9.5 SEBEER NOK/SEK 1.07 0.99 *Negative value indicates NOK undervaluation.
Diff.* -11% -15% -13% -12% 12% -17% -8%
However, the empirical LTFV for the Norwegian krona using this kind of general, empirical model is undoubtedly more uncertain than for other currencies, due to the special situation affecting the country’s currency flows. Transfers to the national petroleum fund are intended partly to neutralize the currency impact of revenues from the petroleum sector, which otherwise would strengthen the NOK substantially. As intended, this arrangement has probably kept the NOK a lot weaker than it otherwise would have been considering its strong fundamentals and the country’s large export
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