Brexit Fallout Turns Swedish Krona Into Carry Trade’s Big Short

  • SEB, biggest Nordic FX trader, sees EURSEK at 9.6 within month
  • RBC says traders are using kronor to buy kiwi, Aussie dollars

Riksbank's Ingves: We Certainly Can Go Below -0.5%

Currency markets haven’t quite been the same since Britain voted to leave the European Union.

The fear of a sudden shock upending long-term forecasts means economic prognoses are playing less of a role in trading patterns than gains from betting on interest-rate differentials. Against that backdrop, one development that has captured the attention of traders and strategists is the Swedish krona’s new role as a funding currency for so-called carry trades.

The G-10 currency is cheap, thanks to the Riksbank’s negative interest rates. Traders have been borrowing in low-yielding kronor and using the funds to invest in higher yielding currencies, such as Australian and New Zealand dollars, according to Royal Bank of Canada. SEB AB, the Nordic region’s biggest currency trader, says its flow data show persistent krona selling during the summer.

“The market has, after Brexit, gone into quite small movements,” said Carl Hammer, chief FX strategist at SEB in Stockholm. “And in that kind of market, strategies based on interest-rate differentials often come in.”

‘Carry Theme’

The krona traded at about 9.5 against the euro on Tuesday. SEB sees the exchange rate weakening to about 9.6 in the “coming month,” Hammer said. The pressure toward further depreciation will come from the “carry theme,” which will offset other positive developments “including fundamentals, valuation and positioning,” he said. ING notes that since April 21 (when the Riksbank extended its bond purchase program) the only G-10 currency to have performed worse than the krona is the British pound.

Since Britain’s June 23 vote to leave the EU, currency markets have adapted to looser monetary policies in Europe, while central banks outside the region have been less affected. Carry trades funded in kronor are beating those using the dollar and even the euro, according to data compiled by Bloomberg.

In the past three months, selling the krona to buy the kiwi and Aussie dollars, as well as higher-yielding currencies such as South Africa’s rand and Brazil’s real, has returned 9-16 percent, beating the 6-12 percent paid by euro-funded deals and the 4-10 percent generated when using the U.S. dollar.

The real and Mexican peso are the currencies to buy in krona-funded trades through year-end, according to forecasts compiled by Bloomberg.

“Carry trades should be based on large interest-rate differentials and on a low volatility environment,” Hammer said. “We have a low volatility environment and Swedish interest rates are among the most negative of all currencies.”

The Riksbank

Sweden’s central bank left its benchmark interest rate at minus 0.5 percent on Wednesday, as predicted in a Bloomberg survey of economists. With the exception of Switzerland, that’s the lowest of the 10 major currencies tracked by Bloomberg.

The carry-trade strategy is the rough equivalent of shorting the krona. That’s something Sweden’s central bank is likely to welcome, Hammer said. A weaker currency will drive up prices on imported goods and help the Riksbank get closer to its 2 percent inflation target after missing it for almost half a decade.

Traders have yet to fully factor in Sweden’s economic health. Gross domestic product grew an annual 3.1 percent last quarter and will expand 3.4 percent this year, trouncing the 1.6 percent rate in the euro zone, the European Commission estimated in May. Even inflation is accelerating, with the underlying gauge averaging about 1.3 percent this year, compared with about 0.8 percent last year.

But ever since Brexit injected an extra dose of uncertainty into markets, such developments have done little to move the market.

“It’s this shifting way in which interest rates are driving currencies, where the dynamics have mattered less, and outright yield has mattered more,” said Adam Cole, head of global FX strategy at RBC in London. Though interest rates remain exceptionally low across the globe, Australia’s benchmark policy rate stands out as being at the high end of the scale, at 1.5 percent. In New Zealand, the rate is 2 percent, the highest in the G-10 currency universe.

“On the one hand, it’s the positive Aussie and kiwi story, and on the other hand it’s a negative Sweden story,” Cole said. But the trade may be a risky one, according to RBC.

The Risks

“If we are seeing this theme of carry driving investor positioning, then there is probably a progressively larger and larger short Swedish krona position building up in the market,” Cole said. “If we were to see something snap, if the carry trade were to go into reverse, those SEK shorts could get covered in short order and the currency could spike higher very quickly if carry trades suddenly unwound.” 

Some strategists simply attribute the krona’s weakness to disappointing data of late.

“The krona’s weakness has been mainly due to weak Swedish data over the summer,” Anders Ekloef, currency analyst at Swedbank said. “The Riksbank is probably quite satisfied as the data were mainly in line with its forecasts, and the weaker krona will keep inflation high for some time.”

At Credit Agricole, the forecast is for the krona to bounce back and trade at about 9.3 against the euro by the end of the year.

“We still expect the Swedish krona, from a broader perspective, to appreciate,” said Manuel Oliveri, an analyst at Credit Agricole. That view undermines the carry-trade argument, he said. “We don’t expect anything more from the Riksbank, we expect growth to improve again, and this should ultimately make the case for the Riksbank to reach its inflation target. It should also be reflected in a stronger currency, and that’s why we don’t think it’s a funding currency.”

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