Kronen, Currency | DNB: This affects the crown more

DNB Markets currency strategist Magne Østnor was able to reveal in a webinar this week what is really important to the volatile Norwegian krone.

– The crown is the world’s currency that moves the most when the S&P 500 changes. It is a currency that fluctuates a lot, and from time to time we have seen sudden movements of the crown, Østnor said, among others.

But what should be the connection between the US stock index, the S&P 500 index, a broad stock index with the 500 largest US companies, and the price of the crown?

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Something is happening again

– The starting point was that we have an idea of ​​what is important every time the crown is moved. It is something that happens again if we paint with a slightly wide brush and see what has happened in the last three months and the last year, Østnor tells Nettavisen Økonomi.

– So we see that the biggest movements of the crown occur when the S&P 500 rises or falls. A stronger S&P 500 gives a stronger crown. There is no connection overnight, but our calculations show that if the S&P 500 changes by 1 percent, the krone changes by a third of this, Østnor says.

0.3 per cent of a euro of just over 10 NOK equals approx. 3 øre. It doesn’t sound like much, but a stock market drop or a stock market rally of 30 percent would indicate a krone against the euro exchange rate. The mood in the world’s financial markets is the key to the context.

– Give me a variable that captures the global risk mood better than the S&P 500, says Østnor a bit rhetorically.

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The trade war

Market mood is important, uncertainty is changing in the world’s capital markets. Examples of this are last year’s trade war between the United States and China. Markets feared what would happen to future economies, even the war of words had limited immediate effects.

– And there are times when the US stock markets don’t reflect the mood of the market. Other times, there are other variables that better capture the changes, such as the fear index, Østnor says.

The chart below shows how much the krone changes with a 1 percent change in S&P. As the graph shows, the Norwegian is the most affected (see far right).

– Does the connection surprise you?
– No, I feel like we’ve said this for a while and I can start the explanation from a different angle. Norway is a small and open economy, so what happens in the world around us is very important. But we have our quirks, and the krone is a small coin in the big picture, Østnor responds.

Other types of market shock include the crown crisis and disagreement in OPEC countries over production cuts. Increased uncertainty creates self-reinforcing spirals in the equity, credit and currency markets. But the price of oil remains important to the crown, even as oil and gas revenues fall.

– Yes, the price of oil is as important as it has been for the last ten years. Here there is also no connection from one day to the next or from one month to another, but for longer periods the connection lasts.

Little more than half

– During a little more than half the days, the exchange rate of the crown and the price of oil follow each other, but it is also true that many days do not. These days, the moves are minor for both the oil price and the krone exchange rate, but the connection is there over time.

– The oil sector exposes us even more to what is happening internationally. If we didn’t have a penny that was sensitive to it, it would have been very strange, Østnor says.

It reminds us that the price of oil is not just a commodity. There are also a lot of financial transactions with oil based on pure speculation, without physical delivery of the oil.

– Brent Sport, oil from the North Sea, is a typical example of this. There is no physical delivery here unless you are on the contract to expiration otherwise there is a lot of cash settlement.

Forget about interest rate spreads

Norway has at times had much higher interest rates than the countries around us. In isolation, this makes it attractive to buy crowns, but differences in interest rates have meant nothing to the crown since 2016.

– Norges Bank may surprise by adjusting interest rate expectations, so that the krona can strengthen a bit at that point. But we have a late period with a fairly high interest rate differential with many countries. The difference has been more than 2 percentage points, but it still played a small role, says the DNB currency strategist.

Østnor says it should be well done that we have a longer period with a lot of interest rate hikes in Norway. DNB Markets expects three increases through 2023 of a total of 0.75 percentage points.

Must buy crowns

Of the internal factors, public spending is the factor that matters most to the crown. Norway now has a large budget deficit in public finances. This means that Norges Bank must buy crowns through the Petroleum Fund to finance our large imports. And these are large amounts in question, Norges Bank buys NOK 2 billion a day.

– We believe that this amount will decrease in the future. Even during the financial crisis, we were nowhere near these amounts. And when the price of oil was high and we had a surplus in the state budget, we sold crowns and bought foreign exchange, Østnor says of the big changes in the finances of the central government.

A recurring theme in turbulent times, whether we’re talking about the crown crisis, trade wars, or other unrest, is that investors are fleeing to safe money ports. This port is definitely not Norwegian crowns, on the contrary, US dollars, Japanese yen, or Swiss francs.

More liquid

– The dollar is the most liquid currency and the one that is always traded. The strengthening of the yen in turbulent times has often been due to the fact that the Japanese have great foreign wealth. When the markets start to explode, they take home some of the money and buy their own currency, Østnor says.

But the Swiss franc is a bigger mystery. Since 1990, the value of the currency has more than doubled against the Norwegian krone (see graph below) and has multiplied many times since 1960. This has happened despite the fact that Switzerland has one of the lowest interest rates of the world and currently has negative interest rates.

– Why do investors want to buy such a currency?
– It is something difficult to explain, admits Østnor.

– But Switzerland has a large financial sector relative to the size of the country’s economy. They have a large surplus in the foreign economy and growth has been resistant to shocks from the world economy. Switzerland sells many luxury goods and medicines, which are less affected by recessions. But still, the reasons are not fully explained, Østnor says.

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Permanently weak

DNB Markets and Handelsbanken Capital Markets believe in a permanently weak crown in the future compared to historical values. NOK 10 to 1 euro may be the new normal, in part because oil and gas revenues are plummeting.

Norway no longer enjoys very high prices for our most important export product, as we did in the early 2000s.

– So we live the luck of the times in two ways. China’s entry into the world market meant that we could buy cheap products in a period when the price of what we sold a lot was very high, Østnor says.

The so-called terms of trade was absolutely fantastic from Norway’s point of view: the ratio of the prices of goods we sell abroad and buy abroad.

Good settlement

– The favorable relationship also raised salary growth a lot, gave us advice to give us good salary arrangements. The downside was that our competitiveness deteriorated, says the currency strategist.

And now the crown is significantly weaker than it was a year ago, not to mention five or ten years ago. The weakening of the crown has worked well for the export industry, making Norwegian products cheaper abroad.

The alternative to one’s own crown had been a common currency. In the worst case, we had to resort to big pay cuts, because Norwegian goods and wages became too expensive relative to the countries with which we compete.

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Painful

– Look at Greece that had euros. They had to restore competitiveness through lower growth in wages and prices than competitors, which was a painful process, Østnor says.

And all three Baltic countries had pegged the euro to their own currency via a fixed exchange rate when the financial crisis hit in 2008 and 2009. But these countries had a different history than Norway, which made the transition easier.

– Public sector employees accepted a 20 percent pay cut, and Estonia, Latvia and Lithuania were among the countries that recovered the fastest after the financial crisis. They had a small advantage in the fact that they became rich after the liberation of the Soviet Union, Østnor says.