Why Riksbank is the 'king' of currency depreciation?

The Swedish krona has been the weakest of the G10 currencies over the last year, leading a city analyst to opine that the country's central bank outlook makes it the ‘king’ of currency depreciation. 

“Growth expectations have not fallen by more than the average of those in the G10 economies, but the market has been caught out, repeatedly, by the Riksbank's policy bias,” Kit Juckes, Head of FX at Société Générale, wrote to clients. 

(Source: Société Générale CIB)

Stepping away from G10 currencies, at least krona has outperformed the Turkish lira, South African rand and Brazilian real if we cast the net a little wider. 

“Sweden’s nominal GDP growth of 4.2% in the year to 4Q18 has been met with negative rates, and there's no rush to get them back above zero. Rather, the Riksbank appears keen to keep the krona competitive against the euro as long as inflationary pressures are mild and regardless of the weakness of the euro on a broader basis.”

If the Riksbank is tracking the EUR/SEK exchange rate, regardless of relative growth and subject only to the inflation rate (if it rose, that would be a game-changer), then SocGen’s current SEK forecasts are simply wrong, Juckes added. 

“Ignore the FEER fair value, focus on the fact that PPP fair value will trend higher over time. EUR/SEK is unlikely to trade below 10 again unless Swedish inflation undershoots that of the eurozone and drags fair value rates down with it. We'll be adjusting our SEK forecasts accordingly,” the SocGen expert concluded. 

Away from the krona, the bank's analysts said the euro has broken through the bottom of its trading range because yet another spate of weak data has taken the consensus forecast for 2019 eurozone growth down again at a time when US expectations have stabilised due to the Federal Reserve's pivot. 

The euro is down at heel because of deteriorating growth expectations, and so is the Australian dollar. "In both cases, the valuation of the currency is stretched, and the recovery in Chinese growth suggests that we are close to the lows for the current move. But a bounce is predicated on economic sentiment improving."

Closer transatlantic growth expectations in 2019 could lift EUR/USD volatility, SocGen analysts added, especially if there is more optimism about the European economy. “EUR/USD volatility would be eventually supported if the market believes further in converging growth between eurozone and the US. At current multi-year low levels, we recommend rolling short-term EUR/USD forward volatility swaps until volatility picks up. See details in our recent Trade Idea,” they concluded.