Why is the Norwegian Krone so weak despite the stronger oil price?
Many investors are surprised by the weakness of the Norwegian Krone (NOK) to the Euro (EUR). The oil price is up, the economy is gaining momentum and interest rates are much higher than in the Euro zone.
Series rebased to 100 at the start of 2017, Source: Bloomberg
How can we explain this, or rather, is there anything to explain? After soon 25 years in the markets, I do notice the general urge to explain the smallest market move on the sell side. The bigger the move and the less obvious reasons we find, the more nonsense explanations we see.
Anyhow, what explanations do we see out there?
Liquidity – The NOK is less liquid than the major currencies and it is not that difficult to make it move. It has also been mentioned that the Norwegian Central bank is soon stopping their NOK purchases for the year. We agree that liquidity in the NOK can make it react quickly to change of flows. This is true both ways, both for weakening and strengthening!
Weakening Inflation – Leads some investors to expect the Central Bank to a more dovish path. Inflation has come down, we see this as a similar situation as seen in the EU, but the Inflation was stronger in Norway as long as the effect from the weakening NOK brought it up through imported inflation. This effect is now abating and the real inflation at lower levels is showing. Investors knowing well this economy realise that the Norwegian central bank saw through this and hence there is no new market pricing or expectation stemming from this. This should be no surprise.
Reduced Oil Dependency – The Norwegian economy is through political will trying to turn less oil activity dependent. This will take time and is still not the case. As we see it, a higher oil price is definitively better for the Norwegian economy and an expected net positive contributor to the 2018 GDP growth. Too early to be a good explanation.
Commodity producing countries – Some have pointed to the similar moves for currencies in commodity producing countries with high residential real estate prices and a highly leveraged population. Is there a theme being played in the market impacting the NOK? Hard to say.
The Norwegian Residential Real Estate Market – There is an international fear of a crash that could hit consumer confidence/spending, bank earnings, and slowing down growth, this again leading to a more dovish Central Bank. The main local brokers do not expect a residential real estate market crash; this is not our working hypothesis either. Note also that Mortgage Covered Bond issuers finance themselves cheaper in the EUR market than in the local market, should the consensus view among international investors be a residential price crash, this is hard to reconciliate. We consider there are a lot of exaggerated headline reactions by international investors on this topic.
The Swedish Residential Real Estate Market – There is fear that if the Swedish market crashes, so will the Norwegian. There is little evidence there is a direct link between these two markets for fundamental reasons. We do not believe in this.
Relative to Europe – Since a currency rate by definition allude to a pair of currencies, it of course matters how the Euro zone economy develops. The strength of the growth indicators has been a surprise and may have attracted capital to the region, hence strengthening the EUR. The Bloomberg Composite consensus, a lagging indicator, for Eurozone GDP growth is 1,9% in 2018 and 1,6% in 2019.
A soft landing in the Norwegian residential real estate market. A continued low unemployment level, at 4.2% end September. All in all a confident consumer continuing to consume.
A strengthening Norwegian economy where energy related investments grow again, while real estate investments slow. The current NOK weakness is further stimulating the exporting parts of the economy. The SSB, the Norwegian statistical bureau, released their updated growth expectations for Norway mainland this week at 2.5% for 2018 and 2.4% for 2019. The Bloomberg Composite consensus, a lagging indicator, for Norwegian GDP growth is 2.0% in 2018 and 2.0% in 2019.
We expect inflation to stay around current levels for some time and that it will likely increase again if current weakness in NOK continues, due to imported inflation. The inflation level is 1.2% end October (SSB).
We see the next move from the central bank to be on the upside but not before 2019. Current Central bank rate is 0.5% (yes, positive) and 3 month Nibor is around 0.8% (Bloomberg). In general, we expect a low interest level environment in many years to come.
Our best guess for the current weak NOK?
Exaggerated fear for a crash in the Norwegian residential real estate market and misunderstood link to the Swedish residential real estate market. This coupled with the relatively low liquidity makes the NOK move. We would not be surprised if we learned that the flows bringing the NOK down are of international origin and not from local investors that knows well the Norwegian economy.
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Dag A.D. Messelt
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