Morning Commentary: Fording a Fjord

Foreign Exchange - Morning Commentary
Fording a Fjord
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Last week incoming data was broadly better than expected and solidified the narrative that an economic recovery would follow the easing of restrictions.  Should economic data continue to improve and should the USD continue to weaken, the NOK stands to be one of the biggest beneficiaries.  While the NOK is a clear underperformer within the G10 on a YTD basis, its performance over the last month has picked up.   

This recovery has been driven by multiple domestic factors related to policy support.  With regards to fiscal spending, the Norwegian government’s strong fiscal response of roughly 5.1% of GDP represents one of the largest responses in the world.  Clearly the additional government spending helps to offset the loss in demand due to COVID-19.  However, it is important to remember that this spending provides a second tailwind unique to the NOK. 

The combination of falling oil prices and large fiscal spending necessitated funding from the Government Pension Fund of Norway (GPFG).  This is relevant to the NOK because it involves the GPFG selling foreign currency in order to buy NOK.  With estimated foreign currency sales around 11% of 2020 GDP or 2.7x Norway’s 2019 current account surplus, this isn’t a trivial factor.  Beyond the current situation, Norway’s unique fiscal mechanism where it repatriates funds from abroad rather than issue debt helps cushion the currency during risk aversion and helps it outperform in a rebound. 
The NOK has also received a boost from the central bank’s stance.  The Norges Bank has proved itself to be an activist central bank.  By signaling that its next move will be for a rate hike as well as its resistance to negative rates, the central bank has prompted markets to begin pricing in a nascent hiking path.    

But as with other currencies, the virus represents key risk factor.  Recent price action illustrates the NOK’s vulnerability to negative headlines and deterioration in risk sentiment.  Should a second wave emerge or if there is a slower than expected recovery due to factors such as uncertainty and voluntary/mandated distancing that impacts oil prices, expect the NOK to be hit.  Under this scenario, the central bank can be counted on to provide additional support but the standard for such a move still a ways off.    
  • Virus headlines continue to skew negative with infection rates rising quickly as the WHO reported a one day high in virus cases.  However, deaths and hospitalizations, thus far, have been deteriorating less quickly.  From an economic point of view, countries appear to be handling outbreaks through localized shutdowns and not broad based shutdowns.  This approach, combined with continued policy support, has allowed markets to move higher as the focus remains on the recovery and not rising infection numbers.   
  • Equities around the world are following Chinese indexes higher today with the Shanghai Composite notching its biggest one day gain since 2015.   Over the past 5 days, the Shanghai 300 index has added 14%.  Some of the key drivers for Chinese equity gains have been macro hedge funds and quantitative investors unwinding bearish positions and media articles cheering the rally.  Enthusiastic articles around the rally from state media sources is seen as an official stamp of government approval.    
  • UK-China tensions are rising with PM Johnson looking into Chinese telecom giant Huawei’s activities in the UK.  This move comes after the UK announced that it would create an immigration program for Hong Kong residents following Beijing’s moves there.  While the UK isn’t the only country reacting to the developments in Hong Kong (see Australia etc.), the combination of moves from the UK does make it standout more than its peers. 
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