USDNOK: Is it time to buy Norwegian krone?

Summary:

• Norwegian economy runs a decent current account surplus

• Norway has a tiny exposure to China and the US when it comes to where it directs its exports

• Inflation hovers close to the target, Norges Bank aims to continue rising rates next year

• Interest rates market doubts rates in Norway could be increased

• A deterioration in European PMIs have had a limited impact on the Norway’s indicator

• Oil prices could see a turnaround in the nearest time, the OPEC meeting could bring further relief

• Heavy indebtedness of consumers poses a downside risk to the Norges Bank’s policy

Scandinavian currencies have not performed well so far this year and the stronger US dollar has been the prime reason behind this. However, over the course of the year a significant change has taken place in Norway where the central bank hiked rates after a long period of historically low borrowing costs. In Sweden the backdrop looks more complicated and as a result market participants are still uncertain when the Riksbank could pull the trigger for the first time. Therefore, in this analysis we would like to focus on the Norwegian economy and its currency - the krone.

A limited impact of trade tensions

The Norway’s economy still runs a decent current account surplus and it has its exports directed mainly to the European Union. Source: Macrobond, XTB Research

While the ongoing trade dispute between the US and China could be seen as a factor constraining global trade, the direct effect on the Norwegian economy should be limited. First of all, Norway directs the lion’s share of its exports to the European Union having tiny trade links with the US and China. Secondly, the US has so far refrained from imposing tariffs on European cars which is also a positive fact for the Norwegian economy. Of course, the risks for Norway is the slowing rate of growth across European countries which is expected to continue in the following quarters. Nonetheless, this effect could be in part offset by relatively stable oil prices that we see going forward.  On the one hand, higher prices will be quickly tempered as more US producers will become profitable. On the other one, lower prices could hurt US producers and encourage OPEC to keep its output in check. Thus, the range between $50 and $70 per Brent barrel could prevail in the future. Looking at the chart above one needs to also notice that Norway runs a firm current account surplus being produced largely by oil and gas exports. In the long-term, the higher CA surplus, the higher upward pressure on the currency (the demand for the exporting country’s currency rises). Since the crisis the Norwegian CA surplus has shrunk to 8% from almost 16%, at the same time the USDNOK has risen more than 65%. Furthermore, the relatively higher current account balance in Norway compared to Germany present during the crisis could have helped Norway to go through the crisis being less afflicted - real GDP in Germany fell in 2009 by 3% while Norway’s GDP contracted 1.6%. In the third quarter of this year the Norway’s CA surplus outpaced the German CA surplus for the first time since the end of 2015. If this trend unfolds, it could help the krone regain its lost appeal.

Firm inflation and fading belief in higher rates

Price growth in Norway remains solid but the likelihood of the subsequent rate hike has declined of late. Source: Macrobond, XTB Research

The Norges Bank lifted interest rates (the main rate was increased to 0.75% from 0.5%) in September and announced more hikes to come. Then, in October the central bank largely reiterated its previous communique adding that “economic growth has been a little lower and inflation somewhat higher than projected”. Let us remind that the Norway’s central bank decided to lower the inflation objective from 2.5% to 2% earlier this year which means that headline price growth is currently clearly above the desired price level. Of course, a lot could be ascribed to temporary factors such as energy prices but underlying price growth is also close to the target and the central bank expects it should stay there until 2021. Simultaneously, annual wage growth is projected to rise gradually from 2.8% seen this year to 3.9% in 2021. Note that the Norges Bank expects that the economy will operate at the positive output gap in the three following years, this is another factor acting in favour of higher inflation. Having said that, the likelihood of the second rate hike in this cycle until March has plunged lately based on FRA rates. This move seemed to be a by-product of the sharply sliding oil prices and led to the NOK depreciation. From this standpoint the NOK has been offered more space to appreciate on the back of rebuilding odds for the rate hike at the meeting in March.

Norwegian resilience to European slowdown

Norway’s PMI has been quite stable in recent months despite the sharp drop in Germany. Source: Macrobond, XTB Research

Another point to focus on is PMI. While the manufacturing index in Germany has seen a deep slide in recent months, the Norwegian gauge has been remarkably resilient to this move. One needs to note that historically the Norway’s indicator tended to show lower volatility and it often began falling with a little lag compared to the German PMI. Nevertheless, this time the lag is really long as the German indicator has started gradually falling basically since the start of this year. The Norwegian PMI has seen some ‘spikes’ in the meantime but the trend (6MMA) has been relatively stable. In our eyes it could, at least in part, reflect a lower exposure of Norway’s trade to either China and the US unlike Germany.

Oil prices could shore up the krone

The relationship between the USDNOK and Brent prices has been strong in recent weeks, thus the higher crude prices may be supportive of the NOK in the nearest future. Source: Bloomberg

Over the several past years the relationship between Brent prices and the USDNOK was really strong. Although the krone seems to be still dependent on oil prices, the power of this link has weakened of late. Nevertheless, both figures moved in line with economic sense when oil prices saw sharp moves either up or down. Therefore, we may conclude that if oil prices keep improving in the coming weeks, it could benefit the NOK which appears to be below its ‘fair value’ based on the REER approach. As we have mentioned earlier, the OPEC is widely expected to prolong its output cuts beyond this year (the cartel meets on December 6), a move which could bring relief to oil bulls and thereby help buttress the NOK.

High indebtedness poses a risk to further rate rises

Norwegian entities almost doubled its debt burden (measured as % of GDP) over the past twenty years. Source: Norges Bank

Among many positives one may also identify some downside risks to our recommendation. Theoretically oil prices could continue falling well below the current levels, the OPEC could refrain from lowering output or the Norges Bank could halt its rate rises due to difficulties faced by households in servicing of debt. Over the course of the past twenty years the debt burden held by various entities in Norway almost doubled and households were responsible in the largest extent behind this build. While the level of foreign debt rose meaningfully its share in total debt remains fairly low limiting sensitiveness of the Norwegian economy to higher rates abroad. By and large, while some downside risks exist we do not assign a high probability to materialization of them, sticking to the view that the NOK ought to appreciate gradually along with the fading US dollar strength.

Technical outlook

Finally let’s take a look at the weekly chart suggesting that the price could see a larger pullback in the nearest future. Any rises seem to be contained to the upper limit of the bullish channel placed nearby 8.70. Our call is to sell the pair at a market price with the target at 8.00 and the stop loss at 8.80. Source: xStation5