NOK
OK Strategy
Date 02.12.2010
02
NOK Strategy
Fundam
amentals have turned NOK suppo
portive
In trade
e weighted terms, the NOK exchange has depr
preciated somewhat over the
summer,
r, mainly reflecting markets’ downgrading of expec
ected future interest rate hikes
by the No
Norges Bank. In addition, substantial FX purchas
ases by the Norges Bank may
have cont
ntributed as well.
Looking ahead,
a
fundamentals look a lot more NOK suppor
ortive in our view:
Research
Bjørn-Roger Wilhelmsen
+47 2311 62 63
[email protected]
FX and Fixed Income Sales
Knut Kobberstad
+47 2311 62 81
[email protected]
Ludvig Uddeholt
+47 2311 62 64
[email protected]
Growth: Economic
E
growth has gained momentum in 2H a
after a relatively soft 1H. GDP
expanded
ed at an above-trend pace in 3Q and various indicators
i
point to even firm
growth in 4Q and 2011 as well.
Monetary
ry policy outlook: Despite low inflation, we expect
ct the Norges Bank to resume
monetary
ry policy tightening in 1H, forecasting three hikess in 2011. The reason for this is
strongerr growth
g
momentum as well as a sharp rise in home
me prices.
Norges B
Bank FX purchases: As usual, the Norges Bank
nk will not purchase FX to the
pension fund
f
(oil fund) in December. Moreover, Norges
es Bank is likely to purchase
considera
rably less FX in the beginning of 2011 than it did in September, October and
Novembe
ber 2010.
Risk app
ppetite: Stronger global macro data should support
sup
risky assets including
commodit
dity prices, barring any significant escalation off the
th euro area sovereign debt
crisis.
On balan
ance, we expect the NOK TWI to perform rea
easonably well going forward,
forecastin
ting a stronger NOK against all major currencies
ies over the next three month
horizon.
EURNOK
SEKNOK
GBPNOK
DKKNOK
USDNOK
JPYNOK
CHFNOK
TWI
1/12/10 Change Change Change
last week last month in 2010
8.078
-1.0%
-1.4%
-2.8%
0.881
0.7%
0.1%
8.7%
9.601
-0.3%
2.6%
2.4%
1.084
-0.9%
-1.3%
-2.6%
6.159
0.9%
5.6%
6.2%
7.306
-0.4%
0.9%
17.2%
6.141
0.3%
2.9%
9.6%
98.2
-0.3%
-0.1%
1.3%
3m forecast
Spot
Change
ge
forecast
in %
7.90
-2.2%
0.86
-2.0%
9.1
-5.5%
1.06
-2.2%
5.85
-5.0%
6.98
-4.4%
5.94
-3.3%
95.5
-2.7%
12m forecast
Spot
Change
forecast
in %
7.70
-4.7%
0.86
-2.9%
9.7
0.6%
1.03
-4.7%
5.92
-3.8%
6.48
-11.2%
5.70
-7.1%
94.6
-3.6%
Trade
Weights
0.39
0.21
0.09
0.08
0.06
0.03
0.01
NOK Strategy
NOK Strategy – 02.12.2010
NOK TWI slightly weaker in November too
The NOK exchange rate depreciated marginally in November on a trade weighted basis, following a slightly
bigger sell-off in the previous month (2.3%). This development has been in line with our modestly bearish shortterm view on the NOK as expressed in the previous two editions of our FX monthly product (see “NOK weakness
st
likely to persist in November”, published on November 1 , and “No interest rate hikes before X-mas”, published
st
on October 1 ).
Although the trade weighted TWI depreciated only slightly in November, there were significant changes to some
FX crosses. The NOK sold off against the USD and GBP (5.5% and 2.6% respectively), but gained a little
against the EUR (1.4%).
The main factor behind the weak NOK development this fall has been lower expectations of future interest rate
hikes by the Norges Bank and lower interest rate spreads against trading partners (see charts below), associated
with relatively weak growth in the first half of 2010 and falling inflation
NOK vs TP 3m FRA Jun-12
NOK vs. 2y swap spread vs. trading partners
2.25
2 y spread
2.00
1.75
92.5
95.0
NOK TWI
97.5
1.50
100.0
1.25
102.5
1.00
105.0
08
Jan
May
Sep
09
Jan
2.75
Trad. partners avg.
2.00
3.50
2.00
1.25
1.25
1.7
1.7
Spread
1.5
110.0
1.3
112.5
May Sep
10 Source: EcoWin, First Securities
1.1
0.50
Sep
2.75
1.3
107.5
May
NOK
3.50
1.5
0.75
0.25
Jan
TP = Weighted average of trading partners
90.0
1.1
Jul
Aug
Sep
10
Oct
Nov
Source: EcoWin, First Securities
Stronger growth momentum likely to support the NOK going forward…
The relatively weak growth momentum in 1H 2010, which contributed to lower interest rate prospects, appears to
have come to an end. In particular, the Mainland-Norway economy expanded at an above-trend pace in Q3,
supported by strong growth in private consumption and net exports. This was the first quarter with growth above
trend since early 2008, marking the beginning of a cyclical upswing after a relatively mild downturn by
international comparisons.
Including revisions of past quarters, Mainland-Norway GDP growth was actually stronger than we predicted in
Q3 compared with the same quarter last year as growth in the beginning of the year was somewhat stronger
than previously thought. The year-on-year growth rate came in at 2.5% in Q3, somewhat better than our forecast
of 2.1% and Norges Bank’s at 2.0%.
Data released this week suggests that the positive growth momentum continued in Q4, as manufacturing PMI
rose to 56.0 in November (from 54.4) and goods consumption continued up in October after a strong September.
Moreover, the housing market boom in recent months indicates rising consumer confidence and highlights the
need for a more dynamic housing supply going forward. Furthermore, today’s oil and gas investments survey
suggest there will be considerable growth in investments in 2011.
…via higher interest rate differentials next year
Needless to say, stronger than expected economic growth in isolation is an argument for Norges Bank to revise
its interest rate forecast up. The sharp rise in home prices in recent few months adds to this view. At the same
time, we stress our below-consensus view on inflation for 2011, which should balance the strong growth effect on
interest rates. Taken together, we expect the Norges Bank to leave rates on hold for another few months (until
March or May 2011) and thereafter bring rates gradually higher more or less in line with the projection in the
October Monetary Policy Report. This implies, however, a more hawkish interest rate profile compared with
expectations currently prevailing in the market, see chart below.
NOK Strategy
NOK Strategy – 02.12.2010
Interest rate projections
Norges Bank rate path vs market
4.5
4.5
First Securities
4.0
4.0
Norges Bank
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
Market expectations*
1.5
1.5
* Based on our estimates of credit premia
1.0
09
10
11
12
13
1.0
14
Source: EcoWin, First Securities
Norges Bank slows FX purchases
As usual, the Norges Bank, which assists the State Pension Fund managers (NBIM), will not buy FX in
December. Our estimate for 2011 is that the Norges Bank will have to purchase FX equivalent to NOK 35 bn in
the year as a whole to cover the difference between capital transfers to the Pension Fund and FX revenues from
the State’s Direct Financial Interest (SDFI). This is broadly in line with the amount of FX which the Norges Bank
purchased in 2010 (having revised their FX purchases significantly up after the Government published its revised
National Budget for 2010 in May 2010).
If you split this amount on each of the twelve months, the Norges Bank will on average purchase FX equivalent
to NOK 3 bn every month, or NOK 150 million every day. For comparison, the Norges Bank purchased NOK 800
million every day in November.
Even if our estimate is associated with a significant amount of uncertainty, it is very likely that the Norges Bank
will purchase considerably less FX in the beginning of 2011 than it has done in September, October and
November 2010. This should in isolation support the NOK in coming months.
Correlation between the NOK and risky assets turning positive again
The NOK exchange rate tends to be positively correlated with risky assets, such as equities and commodity
prices. But this correlation broke apart in September and October, as risky assets performed reasonably well,
whereas the trade weighted NOK depreciated.
The reason why the correlation broke apart is, as discussed above, that market participants downgraded their
expectations of future interest rate hikes by the Norges Bank. But this is set to change going forward as the
Norges Bank is likely to gradually tighten monetary policy on stronger economic growth and an unwelcome
housing market boom.
NOK Strategy
NOK Strategy – 02.12.2010
NOK vs. the oil price
90.0
87.5
85.0
82.5
80.0
77.5
75.0
72.5
70.0
67.5
65.0 FIRST
Mar
Brent spot USD/b
93
94
95
96
97
98
NOK TWI index
May
Jul
Sep
10
99
Nov
Source: EcoWin, First Securities
Medium-term NOK model: NOK should appreciate going forward
Our medium-term NOK model, which is an econometric model that seeks to explain the quarterly change in the
trade weighted NOK exchange rate, supports our positive NOK view for 2011. The forecasts, which are
presented in the chart below, are based on the assumption that interest rate spreads between Norway and
trading partners will widen next year, having narrowed substantially recently. Moreover, it is also based on the
assumption that the oil price will increase gradually by a dollar per barrel each quarter.
Medium-term NOK TWI Model
Appreciation
De = a + b(Doil) + c(D(i-i*)) + d(CPI/CPI*) + e(long run)
90
95
90
NOK TWI
Model
95
100
100
105
105
110
110
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Long-term NOK valuation: Roughly fair on current commodity prices
The real trade weighted NOK exchange rate (calculated by the OECD on the basis of relative CPIs between
Norway and trading partners) is around 3% stronger than the long-term average, having depreciated around 5%
since the peak in April this year. But as we have been highlighting for a while, when considering the strong
terms-of-trade improvement for Norway over the past decade, which has created a massive current account
surplus, the average real trade weighted NOK over the past 40 years may not be an appropriate gauge for the
longer-term fair value of the NOK.
Consequently, we also assess the valuation of the trade weighted NOK exchange rate using an econometric “fair
value” model which uses both relative CPI (the CPI in Norway as a ratio of trading partners CPI) and the oil price
as important input variables. The oil price captures the terms-of-trade effect. According to this model (see chart
to the right below), the nominal trade weighted NOK is broadly neutral at current levels, perhaps slightly
undervalued. The model is estimated on monthly data from January 1975 to December 2005. Data from 2006
and onwards are used for making a projection.
NOK Strategy
NOK Strategy – 02.12.2010
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