- The Norwegian krone has been steadily falling against the euro and the Swiss franc.
- Chances of a rate cut by the Norges Bank are overblown by the markets.
- Recent inflation data indicates that inflation is the greater threat than a significant slowdown in the economy.
- Norway is western Europe's biggest oil producer and should benefit from increased tensions in Russia and the Middle East.
Norway could make an argument for having the strongest economy in Europe since the Great Recession of 2008.
The Norwegian economy generates a huge current account surplus, consistently averaging over double digits due to its export of petroleum and petroleum products. The surplus generated by Norwegian petroleum income is deposited into the Government Pension Fund. The Government Pension Fund is the world's largest pension fund and has assets of over 5 trillion NOK. This massive war chest allows a high standard of living for the Norwegian citizen.
Largely due to its management of its petroleum exports, Norway's economic fundamentals are robust and one would expect a strong krone as a result. Norway boasts the lowest unemployment rate in Europe at below 3.5%, has a government surplus of over 10%, and has a debt to GDP ratio of around 30%. Its interest rate at 1.50% is also high compared to other developed nations.
However, because the Pension Fund invests heavily in foreign assets, the Norwegian krone is prevented from appreciating too much.
Recently, the Norwegian krone has lost ground to both the euro and the Swiss Franc in recent years. Compared to the euro, the krone topped out in the middle of 2012 at approximately 7.25 krones per euro and in July 2014 hit a bottom of close to 8.60 krones per euro, as shown on the chart below.
The krone has fared no better against the Swiss franc, hitting a high of around 4.6 krone per franc in late 2007 to a low of close to 7.9 krone per franc at the height of the financial crisis. While the krone rebounded to 6.0 krones per franc by January 2013, it has resumed its decline relative to the franc and hit a low of 7.00 krones per franc in July 2014, as shown on the chart below.
Following a multi-month decline, the krone seemed to find good support at 7.00 krone per franc earlier in 2014. The franc was unable to appreciate above 7.00 krone per franc in both December of 2013 and January of 2014, forming a double top. The krone strengthened until June of 2014 when Norges Bank Governor said that a reduction in the key policy rate may be needed if the economic outlook deteriorates. This lead to a rapid depreciation of the krone. However, even this dovish comment wasn't enough to strengthen the franc past 7 krones per franc. The krone finally got some respite with stronger than expected inflation data sending the krone sharply higher, as shown on the chart below.
It is our belief that the market over-reacted to comments by the Norges Bank. We posit that the possibility of a rate cut is slim to none in the forseeable future. With inflation rising to close to the 2.5% mandate of the Norges Bank, we expect a lengthy pause in interest rates before an interest rate hike, setting a floor to the recent decline in the krone.
An additional reason to go long the krone is the current geopolitical turmoil engulfing oil exporting regions: Russia and the Middle East. We believe that the recent Ukraine crisis will only benefit Norway as Europe looks to lessen its dependence on Russian energy exports. Furthermore, any flare ups in the Middle East should only boost the price of oil, which is positive for Norway.
We recommend a long krone position against the Swiss franc with CHFNOK 7.00 providing a good resistance level.
Additional disclosure: I am short CHFNOK in my personal account as well as my clients' accounts.