Download Currency Strategy 2016-09

Renaissance of battered currencies
The combination of non-conventional monetary policy involving central bank bond buying and
persistent low/weak global nominal growth has left investors searching even more desperately
for a satisfactory yield. Global long bond interest rates have continued to fall with those in
many countries nearing the levels of Japan. The FX market has always evaluated carefully the
likely central bank policy outlook and relative interest rate differentials. With G10 rate
differentials now very limited, currency market drivers are found to be historically uncertain.
However, counterintuitively - as rates are low in most places - the FX market now regards carry
as a strong theme. Relatedly, while higher yielding EM currencies began 2016 undervalued,
their strong performances have boosted both carry and valuation strategies. Currently, there
are clearly fewer attractive valuation cases making us less inclined to search out such
prospects. Still, growing protectionism and increasing financial market regulation support
suggestions that FX markets will remain range-bound with lower implied volatilities, leaving
players in carry mode. Certainly, we regard the Swedish krona – which now suffers from
record-low interest rates - as a funding currency vulnerable to further depreciation despite its
favorable fundamentals and valuation. Within the G5 we believe concerns regarding the
economic implications of Brexit were exaggerated, meaning Sterling to perform satisfactorily
in coming months. However, we are more skeptical towards further outperformance in 2017 as
real negotiations with the EU start up. EUR/USD has range traded for 18 months with no end in
sight: most investors would clearly be surprised by a more substantial US slowdown, no Fed
hikes and EUR/USD above 1.15. Before year-end we expect the BoJ to have flirted with the
introduction of helicopter money, causing the JPY to suffer if we are correct. Finally, we remain
bullish towards the NOK: underlying appreciation pressure is strong and the economy has
troughed. Only Norges Bank stands in its way; it cannot tolerate EUR/NOK below 9.00.
WEDNESDAY
14 SEPTEMBER 2016
EDITOR
Carl Hammer
+ 46 8 506 231 28
BUY THE CS BASKET We propose the following currency
basket: long NOK (35%), GBP (35%), CAD (18%), NZD (12%)
vs short JPY (35%), EUR (24%), CHF (15%). USD (14%), SEK
(10%) and AUD (2%).
BUY USD/JPY We expect the BoJ to cut its policy rate further
and to signal it is considering monetizing state debt relatively
soon. In combination with a Fed hike in dec-16 it will serve to
weaken the JPY significantly (110 end-Q1 2017).
SELL EUR/NOK With an oil price forecast to trade around
USD 50/brl, continued NOK purchases by the central bank, an
appreciable yield and an attractive valuation, we expect a
stronger NOK. Only one factor weakens the case: Norges Bank
is unlikely to accept EUR/NOK below 9.00
BUY GBP VS EUR AND USD. Sterling has fallen by 12% in
trade-weighted terms so far this year. While Brexit will have
the gravest implications for the UK (rather than its trading
partners), this process will take time. Consequently,
expectations are very dovish and we expect a rebound shortterm.
You can also find our research materials at our website: www.mb.seb.se. This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and
opinions contained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is
accepted for any direct or consequential loss resulting from reliance on this document. Changes may be made to opinions or information contained herein without notice.
Currency Strategy
Forecasts and FX Scorecard
FX forecasts
EUR/USD
EUR/JPY
EUR/GBP
EUR/CHF
EUR/SEK
EUR/NOK
EUR/DKK
USD/RUB
SEB
Consensus*
Contents
Forecasts
13-Sep
1m
Q4 16
Q1 17
Q4 16
Q1 17
1.12
114
0.84
1.09
9.53
9.25
7.44
64.6
1.15
118
0.85
1.10
9.60
9.20
7.44
63.0
1.12
119
0.81
1.09
9.45
9.10
7.44
61.0
1.10
121
0.79
1.09
9.30
9.05
7.44
60.0
1.09
113
0.85
1.09
9.30
9.20
7.45
65.0
1.09
114
0.85
1.09
9.20
9.10
7.46
64.5
102
1.33
1.31
0.97
0.75
0.73
8.49
11.31
8.33
8.73
1.03
8.24
6.68
103
1.35
1.28
0.96
0.77
0.75
8.35
11.27
8.10
8.73
1.04
8.00
6.70
106
1.38
1.26
0.97
0.77
0.75
8.44
11.64
7.96
8.67
1.04
8.13
6.80
110
1.40
1.25
0.99
0.75
0.75
8.45
11.84
7.69
8.53
1.03
8.23
6.80
104
1.28
1.32
1.00
0.74
0.70
8.53
10.92
8.20
8.53
1.01
8.44
6.75
105
1.28
1.32
1.00
0.73
0.69
8.44
10.80
8.04
8.44
1.01
8.35
6.79
The big picture
USD
EUR
JPY
GBP
CAD
AUD
NZD
CHF
SEK
NOK
RUB
CNY
Contacts
Disclaimer
Cross rates
USD/JPY
GBP/USD
USD/CAD
USD/CHF
AUD/USD
NZD/USD
USD/SEK
GBP/SEK
JPY/SEK
CHF/SEK
NOK/SEK
USD/NOK
USD/CNY
2
5
12
14
16
18
20
22
24
26
28
30
32
34
36
38
*Bloomberg survey FX forecasts.
,
SEB FX G10 Scorecard, Medium Term
Fundamentals
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
Event risk
Risk appetite
Total weighted score
Weights
USD
EUR
JPY
GBP
CAD
AUD
NZD
CHF
SEK
NOK
15.0%
25.0%
15.0%
15.0%
12.5%
10.0%
0.0%
7.5%
0.0%
0.0%
-1
0
0
0
-1
-1
+4
-1
0
-1
-0.4
-1
-1
-1
0
+1
0
+2
-2
0
+1
-0.6
0
0
-3
+1
-1
-3
+3
-2
0
+1
-0.8
+1
0
0
-2
+3
+3
+2
-2
0
0
+0.3
+1
0
0
-1
+1
0
-1
-1
0
-2
+0.1
+1
+1
-1
0
-2
-1
-3
-2
0
-2
-0.3
+2
+1
-2
-1
-3
0
-3
+3
0
-2
-0.1
0
-2
-1
+2
-1
+1
+2
-1
0
+1
-0.4
+1
-2
-1
0
+2
0
-3
-1
0
+1
-0.4
0
0
0
+1
+3
0
-4
-2
0
-1
+0.4
G10 FX Scorecard - Contributions to total score
2
Currency Strategy
3
Currency Strategy
SEB FX EM Scorecard, Medium Term
Fundamentals
Carry
Monetary policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
Event risk
Global cycle
Total weighted score
Weights
15.0%
20.0%
7.5%
15.0%
10.0%
7.5%
0.0%
5.0%
5.0%
15.0%
RUB
-1
+4
-1
0
+3
0
0
0
-1
+1
+1.0
CNY
-1
-2
-1
-1
-3
-3
0
-1
0
+1
-1.2
4
Currency Strategy
Big Picture: From Carry and Trump to Helicopters
Since our latest Currency Strategy report in Jan 2016
several major, interesting and unexpected events have
occurred that have affected global markets generally and
the FX market in particular. The BOJ introduced negative
rates in January, while the JPY has subsequently rallied by
almost 20% in trade-weighted terms clearly indicating
the limits to which current global QE policies are subject.
In February, the G20 meeting in Shanghai concluded
(implicitly) that central banks should abstain from
influencing the FX market through the use of nonconventional monetary policies. Further, the Federal
Reserve most likely faced pressure from stressed
emerging market economies (EM) at that meeting to
proceed only very carefully with future interest rate hikes.
The oil price bottomed just a few weeks before the G20
meeting, making life somewhat easier for EM commodity
exporters and helping undervalued EM equity markets
and currencies to recover strongly ever since. Decreased
upward pressure on the dollar may also explain why
outflows from China have at least temporarily ceased.
Further, the Riksbank has finally gained FX credibility
causing investors to stop chasing the SEK higher and
leaving the outlook for the currency more uncertain with
the FX market in carry mode.
SECULAR STAGNATION AND FX
Currently, global macroeconomic policy discussions
focus on the concept of secular stagnation initiated (in
modern times) by Larry Summers. Latest developments
involving persistently weak growth and falling interest
rates “validate” this theory, which stipulates that the
world is saving too much and spending too little. The
Federal Reserve is signaling that potential growth has
fallen in recent years and that the neutral real interest
rate maybe as low as zero percent currently. Therefore,
few central banks including the Fed feel able to raise
interest rates much above their present record lows.
During 2016, bond market developments have seen most
G10 countries move down to Japanese levels. Hence, it is
becoming harder to identify FX market drivers as there
are few if any interest rate differentials left for the G10.
At the beginning of September 2016, the BIS published a
new Triennial FX Report on global FX turnover, which
hardly surprisingly showed a declining global number
compared to 2013 (table above). With global trade still
weak and with various pressures on globalization factors
set to reverse, FX turnover is being adversely affected. In
addition, we might also include tougher financial
regulations, poor hedge fund performances, proprietary
desk closures and the rise of algorithmic trading, all of
which makes for some fairly irrational market
movements. Collectively, these factors lessen risk
appetite amongst investors trading FX. Nor do we expect
the situation to improve anytime soon. But falling
turnover and lower volatilities facilitate the return of
carry strategies, despite events such as Brexit which had
only a very brief impact on overall market sentiment. Tiny
interest rate differentials make this strategy vulnerable in
times of falling risk appetite. We also think it affects the
Swedish krona given record low (negative) yields in
Sweden.
Most events have one thing in common; that today’s
global economy remains fragile and capital flows face
few boundaries with regulators still operating only at
nation state level. It is therefore perhaps not surprising to
hear calls for greater protectionism from Donald Trump,
the US Republican presidential candidate, from the UK
through its decision to abandon the European Union and
from resurgent extreme nationalist parties throughout
Europe. In this article we revisit several key events and
consider how they may affect our future expectations for
G10/G20 FX market developments.
Global FX market turnover (BIS)
Percentage shares of average daily turnover in April 2016
Currency
2001
2004
2007
2010
2013
2016
USD
89.9
88.0
85.6
84.9
87.0
87.6
Euro
37.9
37.4
37.0
39.1
33.4
31.3
JPY
23.5
20.8
17.2
19.0
23.0
21.6
GBP
13.0
16.5
14.9
12.9
11.8
12.8
AUD
4.3
6.0
6.6
7.6
8.6
6.9
CAD
4.5
4.2
4.3
5.3
4.6
5.1
CHF
6.0
6.0
6.8
6.4
5.2
4.8
CNY³
0.0
0.1
0.5
0.9
2.2
4.0
SEK
2.5
2.2
2.7
2.2
1.7
2.2
MXN³
0.8
1.1
1.3
1.3
2.5
2.2
NZD³
0.6
1.1
1.9
1.6
2.0
2.1
SGD
1.1
0.9
1.2
1.4
1.4
1.8
HKD³
2.2
1.8
2.7
2.4
1.4
1.7
NOK³
1.5
1.4
2.1
1.3
1.4
1.7
KRW
0.8
1.1
1.2
1.5
1.2
1.6
TRY³
0.0
0.1
0.2
0.7
1.3
1.4
INR³
0.2
0.3
0.7
1.0
1.0
1.1
RUB³
0.3
0.6
0.7
0.9
1.6
1.1
BRL³
0.5
0.3
0.4
0.7
1.1
1.0
Total (USD bn)
CAGR
1 239
N/A
1 934
17,2%
3 324
19,6%
3 971
5,9%
5 345
10,4%
Below we highlight in different sections some of the more
interesting themes we find on the FX market including: 1)
the outlook for Carry as a FX theme; 2) the shift in Global
5 088
-2,2%
5
FX Ringside
FX reserves and the USD flow outlook; 3) stronger USD if
Trump wins the US Presidential election; 4) weaker JPY as
BoJ approaches the use of Helicopter money; 5) the EM
rally has further to run and; 6) the new SEB FX Scorecard.
driven by carry trades rather than “safe-haven” status (like
the JPY or CHF).
CARRY PERFORMING AGAIN
For a long period the FX G10 carry strategy did not perform
well. However, that situation has changed since October
2015 with a positive post-Brexit run having brought carry
to the attention of investors once more.
Chart: Positive performance once again attracts carry flows
SHIFT IN GLOBAL FOREIGN EXCHANGE RESERVE
HOLDINGS. For the past two years, the US dollar
exchange rate and the value of Chinese foreign exchange
reserves have been closely related. Large capital inflows
to China from foreign direct investments (FDI) and trade
that cause the value of Chinese FX reserves to increase
have tended to coincide with a generally weaker dollar,
while a fall in the value of Chinese FX reserves have
usually signalled a stronger outlook for the greenback.
From mid-2014 growth in Chinese FX reserves at first
decelerated and eventually began to decline as the dollar
appreciated against most other currencies.
Also, positioning data support the suggestion that
speculative players are adopting carry positions. Our carry
investment style (mimicking carry strategies) is always
long the two G10 currencies with the highest interest rate
and short the two with the lowest. Currently the model is:
Long AUD and NZD / Short CHF and SEK. Considering
other systematic G10 carry strategies reveals a similar
picture with long AUD/short SEK positions. Using the CFTC
Commitment of Traders report on positioning it becomes
clear that the AUD has attracted an inflow over the
summer. While the CFTC does not provide positioning on
SEK, our own proxy for speculative positions clearly shows
speculative accounts adding to short SEK positions
during the summer.
As the rate spread towards EM currencies is greater
than within the G10, many carry positions have also
probably sought longs in EM currencies. This is
confirmed by the fact that EM exchange-traded funds
(ETFs) were the biggest buyers in July while European ETFs
saw the largest outflows.
In both 2015 and 2016, there have been substantial
outflows from Chinese reserves as domestic investors
have targeted alternative investments abroad. Moreover
we suspect that the change in Chinese Yuan policy in Aug
2015, which suddenly threatened possible depreciation
of the Chinese currency against the dollar, has likely
resulted in hedge-related currency flows to protect the
value of foreign investments in China against weakening
of the Yuan.
CARRY DEPENDENT ON BENIGN RISK APPETITE
Carry is well known to thrive when risk appetite is high
(and stable). Regarding carry performance and our risk
appetite index clearly illustrates this tight relationship. SEK
is hence vulnerable in an environment with rising risk
appetite. This is consistent with the behaviour of the usual
funding currencies JPY and CHF, although the krona is
6
FX Ringside
inflow of almost USD 200bn from global reserve
managers was reported, as the valued of allocated global
reserves (excluding China) generally increased.
The fall in China’s FX reserves is probably the reason why
Chinese authorities had to reduce their holdings in US
treasury securities. According to US capital flow data
Chinese officials have net sold approximately USD 130bn
in US treasury securities over the last 12 months, mostly
we suspect during the first half of this year. This would
suggest downward pressure on the USD and not the
other way around.
While clearly the euro also attracted substantial inflows
in Q1, in recent years the dollar proportion of allocated FX
reserves has increased substantially while the euro’s
share has decreased. Overall therefore, it is difficult to
argue that the dollar would suffer from large outflows
connected with foreign official holdings. More likely,
holdings seem to have shifted between global reserve
managers, with a few (oil exporters and China)
decreasing their reserves while others have been forced
to invest their growing foreign exchange reserves. The
net effect therefore seems to be dollar neutral. Although
it may be difficult to explain the fact that the dollar tend
to gain when the value of Chinese FX reserves fall the
importance of reserve manger flows from a few particular
countries clearly should not be overstated.
STRONGER DOLLAR IF TRUMP WINS. In November, the
US Presidential election will take place. Since the 1980’s,
its predecessors have shown there is little evidence to
suggest the dollar will behave in any particular way
around them. Usually pre-election USD trends tend also
to continue afterwards. Moreover there are no common
USD developments around elections – the currency has
depreciated around some and appreciated around
others.
Moreover, China is not the only country to be a net seller
of US treasury securities. Over the last 12 months foreign
official accounts have net sold treasury securities
totalling around USD 300bn. Some of these investors are
probably oil exporters that must use part of their treasury
holdings to fund a shortfall in the government budget as
a result of lower oil revenues. Most oil producing
countries have suffered severely following the sharp fall
in the oil price during 2014 and 2015.
This time it may be different, particularly if Trump against
the odds were to win. Although surveys still indicate that
a Clinton victory is the most likely outcome, the Brexit
vote has demonstrated that the outcome of elections and
referendums may be very unpredictable. We have
considered Trump’s economic policy and there are
several different issues that may have positive or
negative effects on the currency.
Most observers would probably argue that it would be
overall USD-negative if these outflows continued.
However, conversely, it appears as if the USD share of
allocated foreign exchange reserves has actually risen in
recent years. Certainly, this may be explained partly by an
increase in the value of dollar-denominated holdings due
to a stronger USD exchange rate. A more detailed
examination of changes in allocated FX reserves suggests
global reserve managers have actually been buying
dollar-denominated assets fairly aggressively. Most
recent data concerns Q1 this year when a net dollar
7
-
Substantial income tax cuts: Trump argues for
reduced taxes on both household and corporate
income. He proposes to lower the highest income tax
rate for households to 33% and to cut the corporate
tax rate to 15%. These suggested tax decreases are
far from fully funded and would increase the budget
deficit. As a result, they are likely to substantially
boost growth, making the Fed more likely to tighten
monetary policy faster than has otherwise been
expected. This would be USD-positive.
-
Homeland Investment Act II: Trump has suggested
that US multinationals that repatriate foreign
earnings retained abroad would only have to pay
10% tax on them. Although this would be less
attractive than the HIA of 2004, which entailed an
effective tax rate of only 5.25% (compared to 35%),
it would suggest increased capital inflows to the US.
In 2004-2005, US multinationals repatriated USD
312bn, all of which was eligible for the reduced tax
rate. This was actually seen in current account data
FX Ringside
In the longer term, this may cause the USD to suffer
second round effects, although their size is difficult to
estimate.
where US acquisitions of FDI were negative in Q3 and
Q4 2005. While it is difficult to isolate historical
effects on the USD, these corporate inflows probably
contributed to the appreciation of the USD which
took place in 2005 and saw EUR/USD move from 1.35
to just below 1.20. Although the tax rebate will be
substantially smaller this time and there are still not
details regarding the proposal it is still likely to be
USD-supportive.
Seemingly, we should expect a stronger dollar if Trump
were to win the presidential election in November, due to
a combination of lower global risk appetite, risks
associated with the outlook for world trade and global
growth, capital inflows connected with a new HIA and
increased US fiscal spending.
BANK OF JAPAN IS APPROACHING HELICOPTER
MONEY – BACK TO A WEAKER JPY
The Bank of Japan’s (BoJ) current policy of “Quantitative
and Qualitative Monetary Easing (QQE) with a Negative
Interest Rate (NIRP)” eases policy through three
channels: 1) Quantity - increasing the amount of asset
purchases and the monetary base; 2) Quality –
purchasing riskier assets such as ETFs vs. government
bonds; and 3) NIRP - cutting interest rates to negative. In
his Jackson Hole speech on Aug 27, Governor Kuroda
singled out NIRP as working as intended and still far from
its limit. He stated that NIRP had reduced mortgage rates
and that companies were issuing longer tenured bonds.
With his seal of approval, the next most likely action is to
reduce the policy rate to -20bps from -10bps at the Nov 1
or Dec 20 policy meetings.
At the upcoming Sep 21 policy meeting, the BoJ will also
conduct a “comprehensive assessment of the
developments… under QQE and NIRP as well as these
policy effects”. We thought this would pave the way for
use of a wider range of easing measures than “QQE with
NIRP”. However, Kuroda’s recent speeches have been full
of praise for the current framework such that new
measures seem unlikely. So why does Japan constantly
disappoint market expectations? We believe the answer
lies in changing the deflationary mindset that has
become entrenched over the past 20 years. The
government and the BoJ need to set expectations very
high. No one will listen if the bar is set low. Consequently,
dynamic policies such as “Abenomics” and “2% inflation
in 2 years, 2x monetary base” are needed to jolt the
economy out of deflation. Therefore, on a meeting-bymeeting basis, Kuroda will tend to disappoint the high
expectations set by the BoJ.
Global trade: In terms of global trade Trump favours
a stricter policy with increased protectionism. In
particular he supports a more aggressive policy with
tariffs on imports from countries that are deemed
currency manipulators or use illegal trade subsidies.
Full implementation of this policy will have several
consequences for the USD. Global trade relations will
suffer and most likely countries such as China, which
would face new sanctions, would be likely to take
counter-measures. In a worst case scenario Trump
trade policy may trigger a global trade war in which
trade-oriented countries would suffer most. As
usually the US economy would be least hurt and the
combination of lower risk appetite and the direct
impact on trade would therefore benefit the USD.
However, the US still relies on capital inflows from the
rest of the world to fund its current account and
budget deficits. Moreover, several countries including
China also own substantial quantities of US
securities, which makes the US economy vulnerable.
What difference can 10bps or 20bps make in exiting 20
years of deflation? The BoJ understands that a backup
plan to “QQE with NIRP” is needed. This view was also
supported by Kuroda’s speech at Jackson Hole, which
signaled that in Japan inflation expectations are not
anchored as they are in the US, and that adverse
temporary shocks such as Brexit and lower oil prices may
reduce inflation expectations. More needs to be done to
raise Japan’s inflation expectations permanently. Still, the
country does have one major card up its sleeve –
monetizing government debt, a form of helicopter money
(for details on debt monetization please see Nordic
8
FX Ringside
a further rally higher before the market starts to worry
about the upcoming UK political negotiations with the EU
in 2017.
Outlook August 2016, pg. 14-15). The constant rise in
government debt is the main problem with the current
strategy of increasing monetary and fiscal policy.
Households and businesses are not consuming or
increasing investments because any good news will be
matched by a future rise in taxes (remember “Ricardian
equivalence”?). Direct monetization of government debt
solves this problem either by keeping government debt
stable or by reducing it. Monetizing debt exerts direct
pressure on BoJ equity turning it negative, weakening the
currency and steepening the yield curve. Households and
businesses pay regardless but through higher inflation
rather than higher taxes. This allows Japan to exit
deflation.
DIVERGING SCANDIES?
As regards Sweden and Norway, there is probably more
upside in NOK/SEK in coming months. Since late May we
have gradually lowered our forecasts for the SEK. The
Riksbank has gained credibility with the FX market while
the macro community is not chasing the currency higher
despite its favorable valuation and strong fundamentals.
In the carry market the SEK is a strong candidate for use
as a funding currency with rates at record low (negative)
levels. Only when the Riksbank starts to change its
strategy and begins deviating from ECB policy will the
krona benefit from all these positive underlying factors
apart from negative carry. The NOK does not yet suffer
from such low rates and the strong flow outlook is not
about to change as Norges Bank keeps buying its own
currency. Growth has bottomed, house prices are
recovering and inflation is well above target. With the oil
price at USD 50/brl, Norges Bank may be cautious about
cutting rates further. However, the central bank needs a
weak currency as the economy continues to rebalance
away from the petroleum sector. So EUR/NOK is unlikely
to be “tolerated” below 9.00. We favor selling EUR/NOK
with a target down to a low 9.
Towards the year end, Japan will be driven by the Fed
more than the BoJ. The combination of a Fed hike (which
SEB expects in December) and a 10bps rate cut by the
BoJ may push the Yen towards 110 by the end of this
year. The BoJ will likely disappoint at its Sep 21 meeting,
which we believe will provide good entry points for Yen
shorts. We do not think “debt monetization” policy will be
introduced in 2016, though any talk of or exploration of
this tool may move markets dramatically as this
represents a more drastic measure. It comprises an
effective threat that the BoJ can communicate even if it
decides not to carry it into effect. Furthermore, if Japan
ever does implement such a policy, it will have effects
worldwide as it opens the door for other central banks to
take similar action. A central bank writing down
government debt sounds like an alien and unrealistic
policy. However, we probably thought the same about
negative interest rates and asset purchase programs 10
years ago.
SIDEWAYS EUR/USD: LOOK AT STERLING INSTEAD
EUR/USD has been range-bound for a unusually long
time. Reviewing our FX Scorecard we conclude there is
little to suggest a rapid break out from the range. Judging
by leading indicators (ISM etc.) the Fed faces potentially
weaker growth in the US. The country’s central bank also
complains of low potential growth in the US and lack of
scope to hike rates without tightening monetary policy.
Flows are also weaker after reserve managers sold US
assets (see our sections on the USD and Trump). On the
other hand, the ECB seems content with its current
stance. Although most expect more QE for longer, it is
not entirely clear the central bank will deliver. Next year
will be very crucial for European politics with French and
German elections. Until the ECB amends its QE program
(by easing) or political risks increase substantially again,
we find it hard to see EUR/USD breach 1.05/1.15. If
anything risks lie on the upside with consensus
expectations positioned still for a stronger USD.
WHITHER THE EM RALLY?
A key market theme in 2016 has been the recovery in EM
assets. With low global inflation and loose monetary
policies in most advanced economies, and with
continued stimulus in China, conditions are in place for
global risk appetite to remain strong and for the EM rally
to continue.
THE EM RALLY HAS FURTHER TO RUN
Our EM FX index has risen by 9.1% since bottoming on
Jan 20 this year, while the MCSI EM equity index is up by
32%. EM bonds have also rallied, with spreads against US
Treasuries narrowing from more than 500bps in January
On Sterling we have a firm view: expectations are too
bearish and data are unlikely to deteriorate soon the way
sentiment stands at present. We therefore see scope for
9
FX Ringside
driven construction) to fiscal policy and its effect on
commodity prices. Nevertheless, we believe that the
bottom reached in January will last for at least another
year and that a potential correction lower from current
levels should be temporary. Beijing will not risk market
volatility by tightening monetary conditions too fast,
suggesting that the construction and real estate sectors
will continue to grow and provide a floor under
commodity prices. Additionally, while the Bank of Japan
may not add to its quantitative easing program, it is still
considering ways to loosen monetary policy. Similarly,
the ECB is a long way from tightening its monetary policy.
With the US Fed unlikely to hike before December, we
believe present conditions will ensure capital continues
to flow to EM and the rally to continue to the end of the
year. Nevertheless, the single most significant threat to
EM is a sudden jump in US inflation, prompting the FOMC
to take a considerably more hawkish stance.
to around 340bps in September. The rally mainly reflects
reduced fears of a hard landing in China, an unexpectedly
dovish US Fed, and depressed EM asset valuations. The
improvement in sentiment towards China is partly due to
reduced exchange rate volatility (following the
introduction of capital controls) and partly to stronger
growth. Although restrictions on financial account
convertibility represent a setback for China in its quest
for a more market-based economy, they have helped
restore confidence for now.
Signs of continued strong growth in China on the back of
significant monetary and fiscal stimulus have impacted
other EM economies. The Institute of International
Finance’s (IIF) coincident indicator suggests that EM
growth bottomed out in January and February reaching a
level consistent with real GDP growth of 4.7% in August.
Increasing confidence in China’s growth outlook has also
boosted commodity prices, which, in turn, has helped
stimulate demand for EM assets, especially equities and
currencies.
After hiking in December 2015, the US Fed became more
dovish in January, causing capital flows to favour EM,
almost three years after the 2013 “Taper Tantrum”. The
hunt for yield has resumed. After EM currencies
depreciated by 27% (against a basket comprising the
USD, EUR, JPY, CHF and GBP) and EM equities fell by
37%, valuation levels became very attractive.
FX SCORECARD PERFORMANCE SINCE MAY The last
update and rebalancing of the Scorecard occurred in
May, just weeks before the Brexit vote, and was based on
the following assumptions: (1) We expected relative
monetary policy to remain the key driver for the FX
market; (2) We also believed valuation, positioning and
carry would be important for the FX market; (3) We
assumed the UK would vote to remain in the EU; and (4)
We anticipated further support for risk appetite based on
accelerating growth. In this kind of environment we
forecast that the SEK, NOK and USD would outperform
other currencies, particularly the CHF, JPY and NZD.
Several indices may now be approaching resistance
levels. Technical analysis of the MSCI EM equity index
suggests it is only 2–3 percentage points away from a key
resistance level. Similarly, some EM currencies, for
example the BRL, are no longer cheap in real effective
terms. However, just as markets became oversold, a rally
above fair value should be expected.
Looking back, almost none of these assumptions were
correct following the UK’s unexpected vote to leave the
EU. Indeed, instead of focusing on valuation and relative
monetary policy expectations, the FX market has since
the end of June concentrated solely on carry. Under these
market conditions the JPY and NZD have outperformed
all other currencies appreciating against the krona by 9%
and 12% respectively since May 24. This is the main
explanation for the weak performance of the FX
CHINA AND US FED RISKS STILL LURK
Worries about a hard landing in China have not
disappeared, but simply been deferred. The country’s
credit-fuelled stimulus risks exacerbating overcapacity
and indebtedness among state-owned companies in the
medium-to-long term. Another worry is Beijing’s desired
shift away from the use of monetary policy (which has
10
FX Ringside
Traditionally fundamentals and valuation have also
received relatively high weights but not this time. There
are several examples of currencies with strong
fundamentals and attractive valuation that remain weak,
causing these factors to appear secondary for FX
investors. Instead we have an unusually high weight for
rate differentials between currencies captured by the
carry score at 25%, making it the most important driver
in our updated Scorecard. The high weight for carry is
particularly attractive for the AUD and NZD, while it
lowers total scores for the krona.
Scorecard basket, which has fallen by 6.1% since our last
update in May.
Based on individual scores for each currency and the new
set of category weights capturing the importance of
different FX drivers, the NOK and GBP receive the highest
scores with each weighted 35% in our new Scorecard
portfolio. Next, we have a fairly positive view on the CAD
(18%) and NZD (12%). Currencies with the largest short
exposures include the JPY (35%), EUR (24%), CHF (15%)
and USD (14%). Finally, the FX basket is basically neutral
in AUD and SEK.
The performance of the Scorecard approach is very much
related to long-term trends based on one or several
specific market drivers just like the dollar trend in
2014/15, which reflected expectations on relative
monetary policy divergence. In this sense present market
conditions are particularly ill-suited to this particular
methodology as it is very difficult to determine current
drivers for currencies and to observe trends in currencies
that seem long-term sustainable.
The following portfolio represents the FX
Scorecard Currency Strategy update:
THE UPDATED FX SCORECARD The FX Scorecard takes
into account the relative importance of various
categories reflected by the weight we attach to each
category. For a long time monetary policy has been the
key driver for exchange rates. One reason that monetary
policy now receives a slightly lower weight than it has for
several years is that most central banks have likely
stretched policy to its outer bound (ECB, BOJ and
Riksbank) and that further policy easing by these
institutions is unlikely to have a significant impact on
either currencies or the real economy. Instead, actual
interest rate differentials seem to have become more
importantly. Consequently, we have reduced the
weighting for monetary policy expectations to 15%, its
lowest weight since we began ranking currencies using
the Scorecard.
11
Currency Strategy
US dollar
The dollar continues to trade with monetary policy
expectations. The story has been that further tightening by
the Fed this year and next while other central banks move in
the opposite direction s should support the greenback.
However, the Sep rate decision by the ECB and weaker than
expected growth indicators in the US have reduced the case
for monetary policy divergence, which makes the outlook
for the USD less positive. Large capital outflows as foreign
investor cut back on treasury holdings could be one risk to
the USD if it continues. Historically the dollar has not
reacted on the outcome of US elections. However, an
unexpected victory by Trump would reduce global risk
appetite and be positive for the dollar, at least initially.
ECONOMIC FUNDAMENTALS T After a weak start to the
year with disappointing growth in both Q1 and Q2 there
were signs that the US economy started to pick up speed
into the second half of the year. The positive tone in US
data changed in Aug when the composite ISM was a lot
weaker than expected. In Q2 most growth was related to
private consumption. To sustain our positive growth
outlook other parts of the economy have to catch up.
Expansive financial conditions should be supportive for
investments. However, declining sentiment indicators has
increased uncertainty. Despite some temporary weakness in
Q2 the labour market has been strong over summer
although Aug was a disappointment.  -1
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY US inflation has remained muted with
the PCE core inflation (Fed’s favourite measure) still being
below the 2% target and it is not expected to pick up much
over the coming year. Moreover, market based measures for
inflation expectations remain well below the 2% inflation
target. In contrast there are signs of accelerating wage
growth as labour market conditions tightens. Although the
correlation between wage growth and inflation has been
rather poor faster wage growth should eventually lead to
rising cost pressure in the economy, which is likely to spur
further tightening by the Fed. Our assessment is one more
rate hike this year at the Dec. meeting.  0
FLOWS Despite attractive US bond yields compared to most
other developed markets foreign investors have scaled back
substantially on their holdings of US long-term securities. In
particular it seems like foreign official accounts have been
net sellers of large amounts of US treasury securities with
the net outflow over the last 12 months until June
amounting to USD 335bn. One obvious reason for this
outflow is that holdings of long-term securities have partly
been needed in public funding as a consequence of falling
commodity and energy prices. The US current account
balance has stabilized at 2-3% of GDP. It is divided between
surpluses on services and net income and a deficit in goods
trading, where non-petroleum goods nowadays account for
most of it. Historically a current account deficit of present
size has been manageable as the US economy tends to
attract sizable capital inflows. However, would capital
outflows continue a current account deficit even at today
size could be a challenge.  0
12
Currency Strategy
US dollar
VALUATION Real and nominal trade weighted indexes
for the dollar would suggest the greenback has moved
into overvalued territory. Our internal long-term fair value
model, SEBEER, indicates that long-term valuation has
moved in the same direction as the spot exchange rate,
which would suggest the USD trades roughly around its
long-term fair value in trade weighted terms. Stronger US
growth and expectations of widening rate differentials
caused a recovery for the USD since May 2014, which also
feeds into the valuation model. Although the dollar
approaches stretched territory according to some models
it is too early to argue for a weaker dollar just because of
its valuation. Based on the real effective exchange rate
the dollar is still below valuations in previous dollar peaks
in 1985 and 2002.  -1
POSITIONING Speculative accounts have mostly been
long USD since May 2014. However, after the rate hike in
December last year the net long position was unwound
and even switched to a small net short position in May.
Since then speculators have gone long USD again but to a
far less extent compared to before the rate hike: current
positioning is 1.1 standard deviations below the three
year average position. However, the reason for the
current positioning score of -1 is the sharp trend lower
lately, representing a negative USD sentiment.  -1
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
LIQUIDITY, EVENT RISK AND GLOBAL CYCLE With its
superior liquidity the USD has traditionally been seen as a
typical safe haven currency, which is negatively
correlated with risk appetite. However, in recent years it
has actually behaved the other way around with the USD
being positively correlated with risk appetite. Instead
currencies like the EUR and the JPY, which obviously
could be seen more as funding currencies with their low
interest rates tend to gain whenever there are increased
stress on financial markets. One obvious reason could be
that the outlook for the USD is closely related to
expectations on Fed monetary policy and the timing and
pace of coming rate hikes, which makes it more closely
related to the growth outlook. We have moreover
observed that the classical relationship between the oil
price and the dollar seems to remain intact. Finally it
seems like the dollar is correlated to changes in the
Chinese currency reserves. Going forwards we expect
China FX reserves to continue to fall, albeit at a slower
rate, which should prevent the USD from weakening too
much.
13
Currency Strategy
The euro
EUR Weighted score: -0.6
The euro remains stable. With ECB monetary policy
options almost exhausted, monetary policy itself is no
longer the most important driver of the currency. Instead,
a high current account surplus, falling budget deficits and
a lower inflation rate than in most other industrialized
countries all support the euro. But the institutional
framework of the euro area remains weak and is
therefore a threat to the currency.
Fundamentals
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
ECONOMIC FUNDAMENTALS Latest readings of the
composite purchasing managers index (PMI) and the
European Commission’s Economic Sentiment Indicator
(ESI) indicate that the economy remains resilient to the
Brexit vote. The moderate recovery in the euro area
continued at the start of H2 2016. Domestic demand is
driving the expansion while exports are suffering from
weak foreign demand. We expect real GDP to grow by
1.6% in 2016 and 1.7% in 2017, allowing the budget
deficit to decline by 0.3 percentage points to 1.6% of
GDP in 2017. Negatively, growth remains uneven across
the region, while politically further progress towards
increased integration appears to have been side-lined.
National interests dominate all discussions. Moreover,
reform momentum has slowed in most vulnerable
countries, which is of major concern, preventing as it
does stronger growth momentum within the union.
Following the EU’s decision not to fine member states
that perpetually break deficit rules, the Stability and
Growth Pact is now dead in the water. Consequently, the
euro area remains vulnerable to external shocks. -1
Ec. Surprise
Event risk
Risk appetite
-0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY The ECB is in ‘wait-and–see’ mode.
The Brexit vote has created a new downside risk to
growth. As it remains wholly unclear to what extent
economic recovery in the euro area will be affected, the
ECB is awaiting more hard data to form the basis for
further policy decisions. Latest economic indicators
suggest there is no urgent need to act. Inflation rates are
slowly increasing. In recent months the annual CPI rate
has become positive once again, and is expected to move
above 1.0% by the year-end. Consequently, real ECB
policy rates will become more negative, making monetary
conditions even more favorable. ECB staff left the bank’s
GDP growth projections largely unchanged in September.
Inflation forecasts will continue to indicate a slow upward
trend in CPI rates. ECB will extend the QE-program in dec16 making monetary policy still euro-negative. -1
FLOWS In the 12 months ending in June 2016 the
cumulated current account surplus rose to EUR 347.8bn
or 3.3% of GDP, compared with a surplus of EUR 302.1bn
for the 12 months to June 2015. In coming months we
expect the current account to remain solidly positive,
thereby continuing as the most important supportive
factor for the euro. During the same period, combined
direct and portfolio investments by euro area-based
investors reached EUR 937bn, surpassing investments by
foreigners in the euro area by EUR 628bn. Going forward,
net capital outflows are expected to remain very high.
0
14
Currency Strategy
The Euro
VALUATION When the euro began to depreciate in 2014
it was clearly overvalued in trade weighted terms
according to most valuation measures including the
SEBEER long-term fair value model. The common
currency began to weaken after the ECB had announced
further policy easing including rate cuts and eventually an
extensive asset purchase program, while the oil price fell
sharply and the dollar benefited on expectations of Fed
tightening. Today, the valuation of the euro is quite close
to its estimated long-term fair value in trade weighted
terms. The SEBEER long-term fair value estimate against
the dollar fell to 1.10 after the latest update. The euro
appears slightly undervalued according to other valuation
measures as the real effective exchange rate or the
nominal trade weighted index. Altogether valuation
should be slightly positive for the euro going forward.
 +1
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
POSITIONING Speculators are net short EUR vs. USD and
has so been since May 2014. Current positioning is right
at its three year average. Judging by the less severe short
peaks April 2015, December 2015 and most recently July
2016 the long term bearish EUR sentiment is losing
ground. For now, the lack of an extreme positioning or
sharp trend in positioning renders a neutral score for
EUR.  0
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
LIQUIDITY, EVENT RISKS, GLOBAL CYCLE Although
underlying economic structural problems are still much
present, ECB QE has certainly made bond markets forget
about these issues. The economic outlook is reasonably
ok with economic growth at/just above trend. Risks are
instead building in the political area where the coming 12
months holds crucial political elections/referendums in
the euro-zone. Should Marie le Pen stage a major surprise
and be elected French president, the euro will suffer as
the market starts to fret about Frexit. From an event risk
perspective it is still reasonable to add a risk premia to
the euro outlook.
15
Currency Strategy
Japanese yen
JPY Weighted score: -0.8
The JPY strengthened over 16% from 120 to slightly
above 100 in the first eight months. The main driver for
JPY strength was the combination of BoJ under-delivering
on further easing and the Fed under-delivering on rate
hikes. Due to the strong currency, its stock market also
tumbled over 15%. Going forward, we expect JPY
weakness to 110 in 6 months as BoJ starts conversation
on helicopter money via writing off future debt issuance
or debt that BoJ has already purchased.
Fundamentals
ECONOMIC FUNDAMENTALS The economic recovery
post the VAT tax hike in April 2014 has been
disappointing. The economy has only recovered to 0.4%
y/y average growth in H1 2016. Growth has been weighed
down on all sides with exports low from weak global
demand (including China), low investment as businesses
remain cautious and consumers expecting future tax
hikes. Going forward at least consumption should
stabilize since the VAT hike has been delayed from April
2017 to October 2019. Also, fiscal stimulus of 6% of GDP
should increase leading up to the 2020 Tokyo Olympics
and counter the lackluster growth in exports. Hence,
growth should trickle higher to 0.5% for 2016.  0
Event risk
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
Risk appetite
-0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY BoJ is facing difficulties in reaching
its “2% inflation in 2 years” promise and running out of
tools. The asset purchase programs are reaching a limit
as BoJ has been dominating transactions in both the
bond and equity market. Negative interest rates are
facing major push back from the banking sector. We
think Bank of Japan will start discussing a form of
helicopter money where BoJ automatically monetizes
future debt issuances from Ministry of Finance or go one
step further and write-off parts of JGBs the BoJ owns.
Another possible direction is to add a nominal GDP target
in addition to the 2% inflation target. These discussions
alone will get the markets moving on BoJ easing
expectations and will be negative JPY.  -3
FLOWS Flows have been neutral. The capital flow is
clearly pointing outwards where corporates are investing
and buying overseas as there is plenty of liquidity
domestically and returns are higher abroad. Portfolio
managers are also going abroad in hunt for yield.
Typically, this leads to JPY weakness but this time, it’s
been offset by rising current account surplus. The current
account has grown from the trade surplus as energy
prices have reduced imports. Also, Japan has restarted
nuclear power plants and has further reduced imports.
 +1
16
Currency Strategy
Japanese yen
VALUATION Different long-term valuation measures for
the JPY give different messages concerning its valuation.
Real trade weighted indices suggest the JPY is fairly
cheap. With a long-term fair value at 114 against the
dollar the SEBEER-model, however, proposes the yen
actually is somewhat overvalued after its recovery since
the beginning of 2016. Altogether it therefore seems
appropriate to take the middle way and go with the
nominal trade weighted index which says the JPY not
trades too far from its long-term valuation.  -1
POSITIONING Speculative accounts have built a large net
long JPY position in 2016 which has been supported JPY.
Current positioning is 1.9 standard deviations above the
three year average which tends to be an unsustainably
large deviation. The positioning score is -3, reflecting the
high probability of a normalization of positioning which
would weigh on the Japanese currency.  -3
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
LIQUIDITY, EVENT RISK AND GLOBAL CYCLE There are
several risks to Japan in this category. First, JPY still
retains its safe haven status and global risk off events will
make the JPY strengthen just as we saw with Brexit.
Events such as Trump victory in the US will be seen as a
risk-off event and can strengthen JPY. Second, if BoJ
embarks on writing off JGB debt that can be a game
changer for JPY’s perception as a safe haven currency.
BoJ writing down government debt means BoJ goes into
negative equity. That is a clear sign of BoJ weakness, loss
of independence and becoming much more of a dovish
central bank. The action alone will weaken JPY but since
these adjustments are permanent (until inflation target is
reached), BoJ’s credibility will be hit and JPY can easily
lose its safe haven status. Lastly, BoJ intervention will
remain a possibility. In the past when BoJ has intervened,
even unilaterally, it has been successful and marked the
end to JPY strength.
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
17
Currency Strategy
British pound sterling
GBP Weighted score: 0.3
Since the Brexit vote was indicated in Q4 last year the
GBP has weakened substantially against almost all
currencies. At its extreme the exchange rate discounted a
virtual disaster for the UK economy. However, data so far
have been stronger than most expected and suggest
more “business as usual” than a crisis. With the
speculative market net short the GBP and absent a
significant deterioration we expect a sterling recovery in
coming months. Long-term risks related to Brexit
negotiations remain. The outcome might well harm the
economy which is why we don’t expect the GBP to
recover fully.
Fundamentals
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
Event risk
Risk appetite
ECONOMIC FUNDAMENTALS The Brexit vote was
unexpected leaving most people still struggling to
understand its political and economic consequences.
Studies prior to the referendum warned there would be
serious negative effects on the economy and that was
also what most people feared in July when all sentiment
indicators slumped to recession levels. However, this
initial reaction was excessive. Instead, the impact on the
economy is unlikely to be as bad as many had feared, not
least because the UK will remain an EU member until new
conditions have been negotiated. Moreover, financial
conditions have eased substantially since the
referendum was announced with falling interest rates, a
weak sterling, bond purchases and liquidity provision by
the central bank all bolstering the economy. Indeed,
while post-Brexit data are still incomplete and
uncertainty remains high, we are quite confident the
gloomiest forecasts are unlikely to materialize. Longterm the objective is to make the UK a “supercompetitive economy”.  +1
-0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY The Brexit vote forced an
immediate response from the BOE, which moved quickly
to prevent any liquidity shortages and maintain the
credibility of the financial system. After assessing the
situation it proceeded to cut its policy rate by 0.25pp to
0.25% in August and restart its bond purchase
programme including Gilts and Corporate bonds. Going
forward the bank stands ready to support the economy if
necessary. Currently we expect a further bank rate cut at
the November meeting to the lower bound of 0.05%.
However, this reduction is far from certain. Indeed, if
economic indicators show that the economy has
shrugged off the Brexit vote the bank would not hesitate
to leave its present policy rate unchanged.  0
FLOWS The UK current account deficit has widened to
around 7% of GDP in the last two quarters. Much of this
is attributable to a shift in the income balance as a
previous surplus has turned into a widening deficit.
However, the trade-related deficit has also increased in
recent quarters. The trade related deficit is likely to
improve though, given present pound weakness. A
deficit of the current size is unsustainable, as it requires
massive capital inflows to finance the shortage in
domestic savings, which makes the GBP vulnerable given
present political uncertainty.  -2
18
Currency Strategy
British pound sterling
VALUATION The GBP has depreciated substantially since
the referendum on the EU-membership was initiated in
November last year. The sell-off in the GBP accelerated
after it was clear the UK had voted to leave. Prior to this
Brexit-related depreciation the sterling was slightly
overvalued in trade weighted terms, although the
updated SEBEER long-term valuation model indicated it
was roughly around fair value. However, following the
depreciation there is no doubt – the GBP is substantially
undervalued today, which makes it an interesting longterm valuation case. Clearly current valuation is
unsustainable unless the economy suffers badly from the
vote. So far indicators, however, show only a limited
impact on the economy. Current valuation reflects a more
negative development. +3
POSITIONING Speculators are sitting on a close to record
net short GBP position which was quickly established
after the Brexit vote. Deviation from the three year
average is a whopping -2.5 standard deviations which is
stretched and the positive positioning score of +3 reflects
the fact that a downscaling of this unusually large net
short position will support GBP. +3
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
EVENT RISK, LIQUIDITY AND GLOBAL CYCLE
Traditionally the outlook for the GBP has been closely
related to the outlook for UK growth and BOE monetary
policy. After the Brexit vote in June this is indeed still the
case. The GBP is long-term undervalued against most
other currencies after the EU-vote due to political
uncertainties and potential consequences on the
economy. The obvious topic for discussion is whether the
expected negative impact on the British economy has
been exaggerated. Currently it seems to be the case.
Would the UK economy continue to improve in line with
sentiment indicators, which are back well above the 50level, the GBP looks like an attractive buy at current
levels. The GBP was also punished after the August rate
cut from BOE and the restart of bond purchases. These
decisions have clearly lowered UK bond yields in a GBPnegative way. Would the tight correlation between the
GBP and relative bond yields persist this could limit the
upside potential for the GBP.
a
19
Currency Strategy
Canadian dollar
CAD Weighted score: 0.1
The CAD was appreciating fast against the USD in the
first quarter, but has basically trended sideways since
April thus moving more or less in lockstep with oil prices.
After the huge depreciation in 2015-2016, the bigger
picture is that the loonie is still supercharged thus helping
the Canadian economy growing above its potential
growth rate. If anything, we expect CAD to outperform its
peers due to its current valuation, gradually increasing oil
prices and extensive connections to the US economy
which is returning to more robust growth.
Fundamentals
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
Event risk
ECONOMIC FUNDAMENTALS In the second quarter, the
economy took a hit from the Alberta wildfires and real
GDP growth contracted 1.6% at an annual rate. In all
likelihood the plunge is temporary and we are expecting a
growth rebound to well above the potential growth rate in
H2 and beyond. A pickup in the US economy and federal
infrastructure spending are important drivers while easy
financial conditions, in part reflecting the past
depreciation of the Canadian dollar, are supporting
growth too. The cheap CAD is boosting competiveness
and is helping the economy adjust to lower commodity
prices; a reallocation of investment and employment
from the resource sector to the non-resource sector is
underway. Despite the generally slow growth backdrop in
recent quarters, the unemployment rate has been drifting
down and is currently sitting below the NAIRU. While this
is suggesting less slack in the economy, wage growth is
decreasing and the output gap is not expected to close
until the end of 2017.  +1
Risk appetite
-0.8 -0.6 -0.4 -0.2 0.0
0.2
0.4
0.6
0.8
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY After keeping its policy rate at 1%
for over four years, BOC cut rates twice last year to 0.50%
where the target for the overnight rate is sitting today.
Sluggish growth in recent quarters, the difficult
adjustments in the resource sector and the output gap all
suggest that a rate hike is off the table for at least a year
in our view. According to market pricing, the probability
of a cut is actually higher than the probability of a hike for
as long as the eye can see. So why not cut rates again in
order to provide an extra boost to the economy? In our
view, the infrastructure spending projects mean less
pressure on the Bank to do the heavy-lifting. Moreover,
against the backdrop of rapidly increasing house prices
and the real estate market close to overheating, a rate cut
may not be the best medicine.  0
FLOWS Recent data on goods exports have been on the
weak side, in part reflecting the temporary slowdown in
US investment earlier this year. As such, the current
account deficit has increased but we expect a turnaround
as export growth picks up again. Meanwhile the trends in
the basic balance and the broad basic balance are
showing signs of turning around.  -1
20
Currency Strategy
Canadian dollar
VALUATION The Canadian dollar traded at rich levels for
a long time after the financial crisis, which indisputably
has been negative for Canadian competitiveness. The
sharp decline in commodity prices, and in particular lower
prices on oil, have weakened the currency significantly in
trade weighted terms since 2014. In nominal terms the
CAD seems undervalued compared to its long-term
average. Our model gives a slightly different message as
the its long-term fair value estimate has been falling in
recent years. Valuation probably is a fairly neutral factor
for the CAD. However, would Canadian terms-of-trade
deteriorate further on the back of a lower oil price there is
probably more downside risk for the CAD from current
levels.  +1
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
POSITIONING Speculative accounts are net short CAD as
has been the norm since 2014. Currently the net short is
far larger than normal; to be exact it is 1.2 standard
deviations below the three year average, which is the
second most extreme position in this report. However,
the net short is not large enough to render positive CAD
score that would indicate high probability of a correction.
The trend with speculators adding to their net short
position, which began in November 2015, has corrected
slightly but is not strong enough yet to render a negative
slope score. All in all the positioning score for CAD is
neutral/cautiously negative in this report.  0
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
EVENT RISK, LIQUIDITY AND GLOBAL CYCLE
Historically the Canadian dollar has correlated positively
with general risk appetite and the performance of the US
equity market. Lately however it is foremost the oil price
that dictates the development of CAD. RBA’s favoured
fair value model seems to work well for the CAD and is
based on terms of trade and the real interest rate spread
versus US, Europe and Japan. Terms of trade have been
under pressure since 2011 but the decline increased
greatly from mid-2014 when oil prices tumbled. From
March to May 2016 oil prices corrected higher and the
USD generally weakened giving a bounce in the model
again. CAD also responded positively to this
development. Our near-term forecast for oil and relative
interest rates (sideways) also produce a range bound
environment for the loonie.
The Bank of Canada’s inflation-control target must be
renewed every five year and the current period ends 31
December 2016. While not our base scenario, there are
speculations that its current target could change. We
think that the details of the renewal will be presented in
November.
21
Currency Strategy
Australian dollar
USD Weighted score: -0.4
The economy is hampered by a large decline in business
investment, although other sources of domestic demand
are growing at or above trend. Evidence suggests the
country’s transformation from a resource-based economy
to a service economy is gaining speed. Both the recovery
in commodity prices and the stabilisation of Chinese
economic activity have provided support for the
Australian dollar, although terms of trade remain much
lower than they have been in recent years. The RBA cut
the cash rate in February and August. Inflation is below
target and provides an argument - along with the central
bank’s wish to avoid an appreciating exchange rate - for
further monetary easing.
Fundamentals
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
Event risk
Risk appetite
-0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8
ECONOMIC FUNDAMENTALS The economy continues to
suffer from falls in mining-related investments while
spending on non-mining activities, except for housing,
has so far failed to pick up. However, low interest rates
support domestic demand while the weaker exchange
rate helps the export sector, which we expect will
contribute positively to growth. Although labour market
indicators are mixed, employment is forecast to continue
growing. Prospects for households have improved, as
shown by rising consumer confidence, which is likely to
result in higher household spending going forward.
Significantly, indicators suggest that economic activity is
switching more rapidly to the non-resources sector.
Overall, GDP growth remains healthy, having accelerated
for four consecutive quarters so far to 3.3% y/y in Q2.
Further more rapid increases are expected towards 3.5%
y/y in 2017-2018, above potential growth.  +1
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY Headline inflation decelerated
further in Q2 to 1.0% y/y; well below the target range of
2-3%. Core inflation is also below the lower part of the
target range, while wage growth remains slow. Recent
appreciation by the AUD has renewed the downward
pressure from import prices in recent years and may drive
inflation even lower in the near-term, although we
forecast inflation will accelerate to 1.5-2.5% by the end of
2018. This is because we expect an improving labour
market to result in gradually rising labour costs. The RBA
reduced the cash rate by 25 basis points in May and
August but left it unchanged in September. Currently the
cash rate is 1.50%. A more stable situation in China and a
recovery in commodities prices have made further RBA
easing less likely in the short term. However, low inflation
provides an argument for looser monetary policy while
the RBA is also keen to avoid an appreciating exchange
rate. Future Fed policy is important.  -1
FLOWS The current account deficit has deteriorated
dramatically in recent quarters to currently almost 5% of
GDP. The trade deficit is partly offset by net portfolio
inflows involving equity securities and direct investments.
Compared to other developed economies, Australian
yields are relatively high, providing scope for carry trade
inflows.  0
22
Currency Strategy
Australian dollar
VALUATION Falling commodity prices have resulted in a
significant deterioration in terms of trade from highs back
in 2014, supporting a lower valuation. They were also the
reason for the RBA’s statements that it regarded the
Australian currency as overvalued. In trade weighted
terms, both real and nominal, the AUD trades very close
to its long-term average after being overvalued since
2010. According to our model, however, the currency’s
long-term valuation continues to fall making it look
expensive despite the depreciation in recent years.
Altogether the AUD appears overvalued, but remains far
from previous extremes. Although the currency’s
valuation may not be a driver in itself, its present value is
unlikely to slow down further depreciation going forward.
 -2
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
POSITIONING Speculative accounts have built a large net
long AUD position during the summer. This coincides
with the increasing popularity of carry trades with
standard G10 strategies generally using the AUD as the
major long currency. Current positioning is 1.7 standard
deviations above the three-year average, which is
generally unsustainable and likely to be followed by a
correction that would weigh on the AUD. Positioning
therefore scores -1. With carry trades at least partly
responsible for long positioning in AUD, we would remain
wary on risk appetite, as an especially sharp deterioration
may cause a short squeeze when carry positions are
unwound.  -1
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
EVENT RISK, LIQUIDITY AND GLOBAL CYCLE
Previously, considerable support for the AUD was
attributable to high commodity prices, which attracted
foreign capital inflows to the mining sector.
Consequently, falling commodity prices have proved
particularly disadvantageous for the AUD. However, in
the current low yield environment Australian interest
rates contribute to preventing capital outflows. The
recovery in commodity prices and yields - both of which
are relatively high compared to other developed
economies - has helped the AUD to appreciate during
2016. However, a sustained rise in commodity prices is
unlikely, limiting AUD upside from current levels. The RBA
has already cut the rate twice in 2016, while a more stable
situation in China and higher commodity prices have
made further easing in the short-term less likely. But the
Chinese growth slowdown is expected to resume in 2017
and may exert downward pressure on the AUD. Inflation
well below target provides another argument for
monetary easing.
23
Currency Strategy
New Zealand dollar
NZD Weighted score: -0.1
The New Zealand economy continues to perform well
compared to most other developed countries. While GDP
growth is hampered by weak dairy prices and exports,
robust domestic demand has ensured it remains above
2%. Low inflation has forced the RBNZ to cut the OCR
twice so far this year to currently 2.0%. More easing is
expected. The NZD has appreciated recently contributing
to negative inflation in the tradables sector. As a result,
the inflation objective has become more difficult to meet,
which exerts pressure on the RBNZ to try to weaken the
exchange rate.
Fundamentals
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
ECONOMIC FUNDAMENTALS The divergence between
New Zealand’s external and domestic environments
continues. Low prices for export goods are a drag on
growth. Although activity in the Chinese economy has
stabilised recently, its slowdown is expected to continue
in 2017. Australian growth is being maintained at a
modest rate. However, New Zealand’s domestic economy
is performing well, with GDP growth accelerating to 2.8%
y/y in Q1. Migration, construction activity, strong tourist
spending and looser monetary policy will continue to
support growth. The labour market is solid with
unemployment edging downward in Q1 and associated
forecasts revised lower. Employment is increasing while
net immigration will continue to add to labour supply.
Low interest rates will continue to support household
spending; retail sales accelerated in Q2. +2
Event risk
Risk appetite
125
E U R /U S D
1 .35 0
100
1 .30 0
75
50
1 .25 0
25
1 .20 0
1 .15 0
0
S p ecu lative po sitions
04
05
06
-2 5
Contracts (thousands)
-0.8 E-0.6
-0.2tive
0.0position
0.2 0.4
U R -0.4
specula
s 0.6 0.8
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced
MONETARY POLICY The RBNZ cut its OCR in March and
in August to currently 2.00%. Since the present monetary
policy cycle began in June 2015, rates have been eased by
150 basis points. Inflation remained at 0.4% in Q2, well
below the 1-3% target. CPI inflation is being squeezed by
negative tradable inflation, and is expected to weaken
further in Q3 according to the RBNZ, due to the recent fall
in fuel prices. The NZD has appreciated in recent months
and is substantially stronger than assumed in the central
bank’s June statement, weighing further on tradables
inflation. The RBNZ has stated that more monetary policy
easing is required and argues that 35 bps of additional
OCR cuts are necessary to move inflation back within the
target band.  -2
FLOWS The terms of trade have declined significantly in
recent years. Weak global demand and strong supply in
some markets will continue to weigh on New Zealand’s
commodity exports. The RBNZ forecasts that the terms of
trade will improve slowly from 2017. The current account
deficit is expected to remain around 3% of GDP. A
positive balance on external goods and services is
outweighed by an investment income deficit. Compared
to other developed economies yields are relatively high,
providing some scope for carry trade inflows.  -1
24
Currency Strategy
New Zealand dollar
VALUATION Lower commodity prices and inflation well
below the target finally changed the monetary policy
stance of RBNZ previously being one of few central banks
tightening policy. This was the trigger for a normalization
of the NZD-valuation from stretched levels. At most the
NZD weakened by roughly 17% in trade weighted terms.
However, this year the NZD has recovered around half of
it, which once again makes it look a bit expensive. At the
same time as the currency has depreciated its long-term
fair value according to our SEBEER long-term fair value
model has moved in the opposite direction making the
valuation stretch according to this model smaller.
Altogether a high valuation is still a risk to the NZD in the
longer terms, although we doubt it will weigh on the
currency as long as it benefits from higher bond yields
attracting inflows.  -3
125
E U R /U S D
1 .35 0
POSITIONING: Speculators are almost squarely
positioned in NZD and as there has not been any specific
trend lately the positioning score is neutral. Interestingly
NZD/USD has headed higher in 2016 but speculators
seem to have had little interest in the currency as
positioning has been light and shifted between net long
and net short many times.  0
100
1 .30 0
75
50
1 .25 0
25
1 .20 0
1 .15 0
0
S p ecu lative po sitions
04
05
06
-2 5
Contracts (thousands)
E U R specula tive position s
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced
LIQUIDITY, EVENT RISK AND GLOBAL CYCLE Global
growth remains below trend. Moreover, while in China it
has stabilised recently, the economy is expected to
decelerate further in 2017 as the effects of previous
monetary easing diminish. A larger Chinese slowdown
would not only have direct negative effects on the NZ
economy but also indirect consequences including
potentially weaker Australian growth. The housing market
boom is still a major risk to the NZ economy. Macroprudential measures introduced in November 2015
(tighter loan-to-value restrictions) initially reduced house
price inflation. However, since March this year, Auckland
price pressures have re-emerged, spreading to nearby
regions, to produce a more generalised resurgence in
housing prices nationwide. With banks heavily exposed to
the sector, the RBNZ is clearly concerned about financial
stability risks. A house price correction could push a NZ
risk premium higher or even tighten liquidity due to the
country’s high dependence on overseas refinancing.
Currently, the RBNZ is considering additional macroprudential policy options that may be introduced before
the end of this year.
25
Currency Strategy
CHF Weighted score: -0.4
Swiss franc
Fundamentals
The Swiss franc probably remains cautiously overvalued.
On a trade weighted basis the currency is still around
9.0% higher than it was before the EUR/CHF floor at 1.20
was abandoned. So far the Swiss National Bank (SNB) has
successfully stabilized the CHF but has failed to weaken
it. We believe the central bank will continue to resist any
upward pressure on the currency. With CPI inflation
becoming positive in coming months, we expect the franc
to weaken slightly.
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
ECONOMIC FUNDAMENTALS GDP growth slowed to
0.1% in Q1 2016, from 0.4% during Q4 2015.
Subsequently, the KOF economic leading indicator has
signalled some acceleration in growth. In the six months
to August 2016 it averaged 102.2 points, up from 99.6
points during the preceding six months. Therefore, the
Swiss economy appears set to post real GDP growth of
between 1.0% and 1.5%, in line with the SNB’s
expectations. Regarding inflation, Switzerland reported a
negative annual CPI rate of only 0.2% in July 2016, a
significantly higher reading than back in December 2015
when it declined by -1.3%. The rate is expected to
become positive once again before the year-end.  0
Event risk
Risk appetite
-0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY The SNB has kept a steady hand in
recent months and we expect it to continue to do so
going forward. FX reserves are increasing meaning the
SNB will not tolerate EUR/CHF to decline below 1.07-1.08
anytime soon. With the dampening effects of low energy
prices further abating in coming months, the annual CPI
rate will soon become positive for the first time since
August 2014, i.e. consistent with the central bank’s
definition of price stability of “below two percent but
positive”. Price trends suggest there is no need for
additional rate cuts at present. Therefore, the SNB will
keep its policy rates stable and concentrate on fighting
any upward pressure on the franc. Its GDP growth
projection for 2016 will remain stable at “between 1 and
1.5 percent” in September. In its conditional inflation
forecast the bank will continue to expect the annual
inflation rate to turn positive in Q4 2016.  -1
FLOWS Sight deposits by Swiss commercial banks with
the central bank are a reliable indicator of SNB
interventions in currency markets. Since the end of 2015,
these have grown by CHF 46.2bn. In the two weeks
following the Brexit vote a larger increase of around CHF
10bn indicated rising capital inflows, which the SNB was
compelled to absorb. Since then, the flow situation shows
there has been no permanent increase in demand for
safe-haven currencies. +2
26
Currency Strategy
Swiss Franc
VALUATION Strong trends in valuation measures like
nominal and real trade weighted currency indexes for the
CHF make it difficult to judge what its appropriate longterm valuation is. The historical averages against the euro
and the dollar suggest it would be substantially
overvalued after its appreciation since 2008. In contrast
the CHF trades spot on the SEBEER long-term fair values
against the euro and the dollar suggesting it would rather
be fairly close to a more sustainable valuation. The
combined approaches therefore indicate the CHF
probably is somewhat overvalued although its valuation
is too close to its long-term sustainable level for valuation
to be a driver for the CHF.  -1
POSITIONING Speculators are currently net long CHF vs
USD. After the peg broke early 2015 positioning has been
gyrating between small short and long positions. Lately
speculators added quite largely to their net long position
which renders a small positive positioning score as the
trend is expected to continue and support CHF.  +1
LIQUIDITY, EVENT RISKS AND GLOBAL CYCLE The SNB
continues to intervene in the FX market in order to
prevent EUR/CHF moving down towards parity again.
Although market reactions to Brexit have been fairly
muted it is a reminder of the uncertain European political
landscape. In the coming 12 months there are several
European events potentially increasing political risk
premia including the Italian constitutional referendum
(Oct 2016), French Presidential- (May 2017) and German
elections (Sept 2017). All these will be a recap to nervous
investors of the fragile state the euro zone is in making a
case for more capital flows seeking shelter in the Swiss
franc.
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
27
Currency Strategy
Swedish
krona
E one
SEK Weighted score: -0.4
Riksbank monetary policy - which indirectly aims to keep
the SEK artificially weak - has won credibility with market
participants. As such, despite strong fundamentals and
an attractive valuation, the market lacks a credible trigger
to realise the currency’s potential. This catalyst remains
connected with relative monetary policy differences
between Sweden and Euro-land. SEK risks include weaker
than anticipated global growth and the use of the krona
as a funding currency. The outlook is neutral now, but
positive going into 2017.
Fundamentals
ECONOMIC FUNDAMENTALS Sweden has outperformed
most peers: the economy grew by 5-6% q/q AR by late
2015/early 2016. As the result of record-fast population
growth, housing starts and residential investments are
contributing strongly to GDP, as are public consumption
and investments. Recently, economic growth appears to
have slowed partly due to surprisingly weak exports, we
expect GDP to rise by around 2.5% next year. While
employment growth is very strong, unemployment is
falling only very slowly as more immigrants enter the
labour market. There are no signs of underlying wage
pressure despite several indicators showing neutral to
firm resource utilisation. In relative terms, the Swedish
economy remains strong although several policy areas
(e.g. housing, immigration/integration etc.) raise longer
term concerns.  +1
Event risk
Carry
Mon. policy
Flows
Valuation
Positioning
Liquidity
Ec. Surprise
Risk appetite
-0.8 -0.6 -0.4 -0.2 0.0
0.2
0.4
0.6 0.8
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY Having prolonged the QE program
yet again in April, the Riksbank appears finally to have
won credibility for its hard stance on the exchange rate.
Inflation remains stubbornly low and the effect on CPIF
from previous krona depreciation is fading. Despite few
near-term triggers for a much stronger SEK, the Riksbank
can hardly lower its guard short-term. We therefore
expect a fresh round of QE (albeit modest) in December.
Currently, the FX market is trading on a carry theme, so
monetary policy is contributing to a very weak SEK
outlook. This will change in due course with the nearest
potential trigger being a potential change in the Riksbank
mandate (the possible adoption of an inflation interval
could be seen as hawkish).  -1
FLOWS The current account surplus remains relatively
high (5%/GDP) despite growth being driven by strong
domestic demand. Foreign real money investors have
lowered their ownership rate for Swedish government
bonds fairly drastically (from 50% to 31%). Also,
speculative investors have finally heeded repeated
warnings from the Riksbank not to chase the currency
any higher. Consequently, positioning is currently
neutral/short SEK for the first time in a long while. As
Swedish FX hedge ratios remain low, further SEK positive
flows from domestic accounts are possible also including
financial institutions. To unlock the potential for a
stronger flow outlook Riksbank is the ultimate trigger
when policy diverges from ECB.  0
28
Currency Strategy
Swedish krona
70%
POSITIONING Our speculative proxy position for SEK
versus USD indicates that speculators just switched into a
small short SEK position. Meanwhile our positioning
analysis of speculators positioning in SEK versus EUR
which is based on client flows has shown a negative SEK
sentiment during summer with mostly net SEK selling.
However, lately the interest has been waning and last
week the sentiment was basically neutral indicating a
possible shift in sentiment. However, the positioning
score in this report is zero as the overall position is not
excessive compared to historical levels and the recent
less SEK negative trend is not large enough.  0
xe 50%
d
in
t 30%
n
e 10%
m
ti
n
se ‐10%
yl
ke‐30%
e
W‐50%
‐70%
SEK flows versus EUR/SEK
Main risks for the krona are: 1) Inflation to remain well
below target meaning Riksbank has to extend QE. 2)
Adverse developments on the Swedish housing market
which could trigger a foreign exodus of portfolio
investments. However, we still attach a low probability to
this event happening; 3) Squeeze on money market
especially shortage of USD liquidity making SEK even
more of a funding currency.
29
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
07
9.0
9.1
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9.3
9.4
9.5
9.6
The lack of significant upside progress in
9.7
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8 5 3 0 8 5 net
7 4 1 9 substantial
2 2 0 7 5 2makes
2 9 current
5EUR/USD
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. 1
. 1
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. 1
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. . . . . . . . . . . . . . . . . . . . . .
6
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1 5
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2 2reduced.
2 2 2to2 be
2 2 have
2 2 2 2 2 2 2 2 2 2
2 2 2 will
2longs
Buy high volume
Sell high volume
EUR/SEK reversed
LIQUIDITY, EVENT RISK AND GLOBAL CYCLE Liquidity
remains poor at times and Riksbank government bond
purchases (SEK 215 bn) have worsened this liquidity
premia. SEK correlations to risk appetite has changed
during 2016, we think SEK should have relatively low
correlation to risk appetite longer-term.
8.9
E U R speculative positions
Contracts (thousands)
VALUATION The trade weighted krona remains undervalued compared to our long-term fair value model
(SEBEER). It appears to be roughly 5-6% undervalued in
trade weighted terms based on the SEBEER-estimate.
Hence valuation is not severely stretched. As SEK has
continued to slide a weaker exchange rate now
contributes to a pick-up in imported prices. This is
important for Riksbank as it fights to reach for the 2%
inflation target. Nevertheless maintaining a weak SEK is
desired by the central bank as it will support
competitiveness and support higher inflation. In real
trade weighted terms the krona seems still cheap, which
makes it complicated to argue Sweden would need an
even weaker krona.  +2
Buy avg volume
Sell avg volume
Buy low volume
Sell low volume
)
d
ser
ev
er
( K
ES
/
R
U
E
Currency Strategy
Norwegian krone
The krone has been hurt by plunging oil prices, which has
spurred fears of a Norwegian recession and unconventional
monetary policy. Such risks have now been significantly
reduced, but the krone still trades cheap relative to its longterm fair value. With the NOK still closely tied to oil prices,
our $55/b average forecast for next year is supportive.
Moreover, as growth momentum picks up further, Norges
Bank will switch to a more neutral policy stance and relaxed
attitude against the krone. In the near-term, however,
Norges Bank is likely to watch the 9-handle in EUR/NOK
carefully. We favour to sell EUR/NOK on rallies towards
9.40.
ECONOMIC FUNDAMENTALS Extensive cutbacks in the oil
sector has slowed growth over the past years. Fears of even
more severe negative secondary effects have lingered but
various sentiment indicators and economic data have
recently confirmed that the low point was passed last
winter. To wit, sequential growth in mainland GDP firmed in
spring by rising 0.4%. The composition of growth was
favourable with stronger non-oil domestic demand on back
of resilient private consumption and rebounding mainland
investment. However, the recovery will be modest due to
still sharply falling petroleum investment and high inflation
squeezing households’ spending power. We expect belowtrend growth in mainland GDP of 0.9% in 2016 and 1.8% in
2017.  0
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY Norges Bank has noted that downside
risks to growth have eased although it expects the economy
to remain weak in the coming period. The “certain”
September cut in the bank’s June path was thus a bit
surprising and signals the bank remains on guard against a
too rapid and speculation-driven appreciation of the NOK.
Monetary policy going forward will be a trade-off between
positive economic data and stronger krone. EUR/NOK
above 9.10 would give the bank room to adopt a wait-andsee approach. Hence, we expect Norges Bank to remain on
hold while keeping a clear dovish bias in its rate path. A
further pick-up in growth next year will render a more
neutral policy and allow for EUR/NOK to trade below the 9handle. A repricing of market’s expectations has already
occurred, but long-term rate prospects remain very
subdued.  0
FLOWS Expansionary fiscal policy generates positive NOK
flows as the government is using an increasing share of its
oil revenues to cover the non-oil budget deficit. Norges
Bank will carry on purchasing 900-1000m NOK per day
against FX in 2016, upholding the positive NOK flow.
Despite OBX being heavily energy-related, foreigners’
ownership ratio has been surprisingly stable over the past
years and is expected to remain around 36-37% in coming
months. As investors’ search for yield continues, Norwegian
bonds should become increasingly attractive on a relative
basis. Such flows have not been sufficient to have a material
impact on the krone so far and we expect fast money to
continue dominating flows.  +1
30
Currency Strategy
Norwegian krone
VALUATION Lower oil price and a recoupling of NB
monetary policy with other central banks have been
extremely harmful to the NOK. The krone reached
extreme levels of more than two standard deviations
from long-term averages against both the EUR and the
USD at the beginning of this year, which rarely is
sustainable. Our long-term fair value model (SEBEER) also
suggests that the NOK is undervalued in trade weighted
terms with fair value in EUR/NOK at 8.25. However, when
considering the rapid growth in labour compensation for
more than two decades, the NOK depreciation has so far
only neutralized part of the sharp increase in Norwegian
labour costs. Basically all valuation measures indicate the
NOK has reached undervalued levels. With a more stable
oil price, signs that the economy starts to recover and a
long-term NOK-positive flow outlook current stretch in
valuation is unlikely to persist.  +3
POSITIONING Our proxy for speculative positioning in
NOK versus USD indicates that speculative accounts are
somewhat long NOK. Current positioning is 1.0 standard
deviation above the three year average as the strong USD
trend is still in the calculation. The past two weeks the
long NOK position has been scaled back marginally but
both the level of the position and the recent change are
too small to generate anything but a neutral positioning
score.  0
LIQUIDITY, EVENT RISK AND GLOBAL CYCLE
Performance of the krone remains closely tied to
developments in oil prices. The correlation between NOK
and oil increased substantially when oil prices plunged in
late 2014 and remains high. We expect the correlation to
be maintained as long as oil prices impact the outlook for
growth outlook and Norges Bank. We believe that the oil
market is rebalancing with crude stocks sliding as
demand is healthy and supply side is contracting in 2016.
We thus expect the oil price to recover estimating Brent
crude to average $55/b in 2017. Given the correlation the
outlook supports our positive view on the krone.
However, one cannot exclude a renewed downturn in oil
prices. There are signs of increased activity in the US with
the number of active oil rigs having jumped by ~30%
since late May. Should this trend continue the oil market
will remain in surplus next year, depressing the outlook
for the oil price. Such a scenario risks fuel NOK-negative
speculative flows as 1) market would re-focus on rate
cuts, and 2) Norges Bank would maintain a
currency/growth-oriented policy.
eric
31
Currency Strategy
Russian rouble
The correlation between the RUB and the price of oil has
weakened, due to rising global risk appetite driving
capital to high-yield Emerging Markets. Nevertheless, the
RUB’s fortunes remain highly dependent on energy
prices. With Brent set to average $50/b in H2 16 and the
Russian central banks (CBR) rebuilding reserves, we see
USD/RUB hovering around 64.00 for the remainder of
the year. We see the risk as being evenly distributed
between an unexpected strengthening and a weakening.
ECONOMIC FUNDAMENTALS The price of oil in RUB
terms is now close to the 2016 budget assumption of
RUB 3,150/b. The price recovery has eased fears of a
further slowdown in economic activity and reduced the
pressure on the RUB exchange rate. Nevertheless, due to
high inflation undermining the purchasing power of the
RUB, the government will still have to cut expenditure
sharply. It will delay some budget cuts by tapping into
the reserve fund, but it cannot avoid the inevitable. As a
result, economic recovery will be slow. Real GDP looks
set to fall by 0.4% in 2016 and grow by only 1.0% in
2017. At the same time, inflation will remain elevated at
7.3% this year and 6.0% in 2017, above the 4.0% target.
While the recession appears to be bottoming out,
consumption has been hit hard by a fall in household real
income, which will remain a drag on overall growth.
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
Due to a strong dependence of public finances on oil
(roughly 50% of federal government revenue come from
the hydrocarbon industry), the central bank will not let
the RUB appreciate unless oil also rallies. Another reason
for resisting an appreciation of the RUB is that it would
hurt fledgling non-oil exports.  -1
MONETARY POLICY The CBR resumed its rate-cutting
cycle in June after having been on hold since August
2015. With confidence returning and inflation edging
down, the CBR will cut interest rates by 50bps to 10.00%
on September 16 and by another 100 bps before the end
of 2016. CBR governor Elvira Nabiullina enjoys a good
relationship with President Putin, who has avoided
criticising the bank. The CBR has been quite hawkish,
staying committed to bringing down inflation to 4% by
2017, despite pressure from lower-level politicians to
loosen policy. We do not expect the CBR fully to succeed
to bring down inflation to the target, which will limit the
downside potential to rates. If high interest rates attract
capital inflows, the CBR will respond by accumulating
reserves rather than cutting rates.  -1
FLOWS The current account surplus has narrowed in H1
2016 compared to the same period in 2015 due to lower
exports. Yet, it will continue to generate a surplus. The
pace of capital outflows has slowed, even turning into a
surplus in Q2. Reserves have risen by almost 8% since
January. With a strong global risk appetite, reduced
political uncertainty, including talks of easing sanctions,
and high yields in Russia, capital flows will be supportive
for the RUB.  0
32
Currency Strategy
Russian rouble
VALUATION The RUB remains severely undervalued in
real, standing more than 20% below its detrended
average. However, the appreciation impetus from the
undervaluation of the REER is currently offset by the low
value of oil in RUB terms. Assuming that oil remains close
to the current level around $48/barrel (±$3.0), in order to
bring the price of oil in RUB to the inflation-adjusted
mean since July 1994, the RUB would need to depreciate
by some 10% against the USD. However, fearing an
inflationary impact, we expect the CBR to keep interest
rates attractive enough to avoid a selloff in the RUB.
While the REER is not a reliable guide in terms of the
valuation of the RUB, it suggests that the RUB is unlikely
to depreciate much further, leaving the currency as an
interesting carry target.  +3
1 25
E U R /U S D
1 .3 50
POSITIONING Speculators in the RUB have become
increasingly bullish and have added to their net long RUB
positions since the begging of 2016 very much in line with
the recovery in oil prices. Net longs reached a 5-year high
on August 30, but the jump was not large to generate a
positive positioning score.  0
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
04
EVENT RISK, LIQUIDITY AND GLOBAL CYCLE The rouble
is facing two key risks: 1) a renewed fall in the price of oil;
and 2) increasing tensions in relations with the EU and
US.
0
S peculative positions
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
The relative stability in the oil market in 2016 suggests
that it has found, if not an equilibrium point, at least an
equilibrium range close to $45–$50 per barrel. If Brent
goes below that range US production starts to shut down,
sapping supply, and vice versa if prices rise above the
range.
Regarding relations with the “West”, they have
deteriorated to the point of a new cold war. However, the
current cold war is not as tense as the one during the
Soviet era. Russia is highly unlikely to increase tensions
much further permanently. Intervening militarily in a Nato
country, for example the Baltics, would risk much more
severe sanctions than did the annexation of Crimea and
involvement in eastern Ukraine. It could even include a
military confrontation with Nato. The long-term cost
would be too high and the benefits would be dubious.
Event risk is nevertheless high, but should be followed by
periods of fence building. We are currently in a calmer
period in relations with the West, but an easing of
sanctions is unlikely before 2H 2017.
33
Currency Strategy
Chinese yuan
We expect USD/CNY to end this year at 6.80. China will
continue to slowdown and more strict tightening
measures will be implemented in late 2016 and into 2017
to control the rising debt and property market. The
slowdown will weigh on the currency. We don’t expect
large depreciation on the currency because we are
entering a sensitive political season heading into Q4 2017
when the top members of the communist party change
every 5 years. President Xi would want to keep economic
and politics as stable as possible going into this meeting
to make sure he can appoint his people. That would pave
the way for potential more reforms in the following 5
years. Also, President Xi won’t become a target of
investigation once he leaves office in 2022.
ECONOMIC FUNDAMENTALS China had a healthy
growth of 6.7% in the first half led by monetary and fiscal
support. However, the outlook is to decelerate to 6.6% by
year end further to 6.3% in 2017. The slowdown should
come from the construction and housing sector that has
performed too well. Property prices in major cities like
Shanghai and Beijing are rising over 30% y/y and that has
reignited construction activity and commodity demand.
However, now the government has started to implement
austerity measures to cool down the housing market. In
addition, capex from businesses should slow as Chinese
companies look abroad to acquire new technologies and
export excess capacity.  -1
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
0
S peculative positions
04
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
MONETARY POLICY Monetary policy stance has shifted
to neutral from an easing bias. Interest rates and reserve
requirement ratios (last cut in March) have been stable
but other forms of lending using local government bond
issuances have added as monetary stimulus in late 2015
and early 2016. We expect this to slow, policy to shift to
neutral and dampen economic growth into 2017.
Government officials are commenting that growing by
debt is the same economic model as the past that has
gotten them into trouble and will slowly move away from
debt driven growth. Inflation may rise temporarily in Q4
due to floods increasing food prices but that should come
down in 2017 and hence, inflation risks remain low.  +1
FLOWS The mass outflows have abated with a more
stable currency and some capital controls. However,
going forward the pressure is for outflows to restart.
Generally, households want to diversify from holding
100% of their assets denominated in RMB and demand
for buying foreign assets will only increase. Corporates
also want to invest abroad as China’s economy slows.
Corporates also want to buy foreign companies to acquire
technology and move up the value chain. We think the
combination of outward flows and keeping the currency
stable into 2017 political shift will lead to more depletion
in FX reserves. China’s central bank will continue to sell
foreign assets.  -1
E one
34
Currency Strategy
Chinese Yuan
VALUATION China’s government and IMF both stated in
2015 that CNY has reached fair value. Since then, CNY
has become undervalued by almost 10%. The RMB index
published by the government continues to weaken and
many investors are worried that government policy is to
weaken CNY on a trade weighted basis. We don’t think
the government wants to weaken CNY on a long term
basis and this is one step in creating two-way volatility.
The CNY will again strengthen on NEER and REER basis in
the next 6 months to prevent one-way bets.  +1
POSITIONING This is difficult to gauge but we estimate
based on long term and short term. Long term, we still
think most domestics are long CNY. These positions were
accumulated over 10 years post the depeg and domestic
corporates still have not learned to hedge FX exposure
and still need to liquidate long CNY positions. Short term,
we look at how spot is trading relative to daily fixing and
the band of +/- 2%. Spot is now swinging around the
fixing, meaning markets are neither long nor short CNY.
0
1 25
E U R /U S D
1 .3 50
1 00
1 .3 00
75
50
1 .2 50
25
1 .2 00
1 .1 50
04
LIQUIDITY, EVENT RISK AND GLOBAL CYCLE Even
CNY has succumbed to the mighty USD and the global
cycle. CNY and CNH will weaken mildly on one or two Fed
hikes. The risk is if US enters a regular tightening cycle.
You can see the risk when the CNY and CNH spread
widens. The CNY market is still controlled by a closed
capital account but the “more open” CNH market shows
stress on the currency and the CNY and CNH spread
starts to widen in times of stress. Another risk we see is
on FX policy. The central bank is not letting the currency
weaken according to fundamentals for political reasons.
That means pressures are rising for CNY to weaken. We
think there is a risk of another one-off devaluation post
the next transition in the communist party in 4Q 2017.
 -1
0
S peculative positions
05
06
-25
Contracts (thousands)
E U R speculative positions
07
The lack of significant upside progress in
EUR/USD makes the current substantial net
long speculative position a burden. Should
the sub-1.29-area be revisited, speculative
longs will have to be reduced.
35
Currency Strategy
Contacts
STOCKHOLM
Carl Hammer (editor)
+46 8 506 231 28
[email protected]
Richard Falkenhäll
+46 8 506 231 33
[email protected]
Mattias Bruer
+46 8 506 232 94
[email protected]
Per Hammarlund
+46 8 506 231 77
[email protected]
FRANKFURT
Thomas Köbel
+49 69 97 27 12 45
[email protected]
OSLO
Erica Blomgren
+47 22 82 72 77
[email protected]
SINGAPORE
Sean Yokota
+65 6505 0500
[email protected]
Andreas Johnson
+46 8 506 232 95
[email protected]
Karl Steiner
+46 8 506 231 04
[email protected]
36
Currency Strategy
Notes
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37
Currency Strategy
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38
Currency Strategy
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Methodology
SEB Research & Strategy determines the global economic backdrop and outlook for fixed income, FX and commodity markets using; 1) own analysis and
aggregation tools, including proprietary models and indicators and amended by publicly available data providers (free and fee-based) such as
Macrobond, Bloomberg and others; 2) input from other research units within SEB; 3) Various research reports (free and fee-based). The various sources
being integrated must fulfil the principles of consistency, plausibility and must be backed by fact. Final consideration as to any valuations, projections
and forecasts contained in this report are based on a number of assumptions and estimates and are subject to contingencies and uncertainties, and
their inclusion in this report should not be regarded as a representation or warranty by or on behalf of the Group or any person or entity within the Group
that they or their underlying assumptions and estimates will be met or realized. Different assumptions could result in materially different results. Past
performance is not a reliable indicator of future performance. Foreign currency rates of exchange may adversely affect the value, price or income of any
security or related investment mentioned in this report. In addition, investors in securities, such as ADRs, whose values are influenced by the currency of
the underlying security, effectively assume currency risk
THIS REPORT IS NOT INTENDED TO BE PUBLISHED OR DISTRIBUTED IN THE UNITED STATES.
The Bank is incorporated in Stockholm Sweden with limited liability and is a member of the Stockholm Stock Exchange, The London Stock
Exchange, the IPE, and the OM, EDX, Euronext Liffe, Euronext Paris, Eurex and Pulpex exchanges. The Bank is regulated by
Finansinspektionen (the Swedish Financial Supervisory Authority), and, for the conduct of designated investment business in the UK, by the
FSA.
Confidentiality Notice This report is confidential and may not be reproduced or redistributed to any person. Skandinaviska Enskilda Banken
AB (publ). All rights reserved This page has been left blank on purpose
Innehållet i denna rapport är baserat på uppgifter från källor som av Banken bedöms vara pålitliga. Banken lämnar dock ingen garanti för
fullständigheten eller riktigheten i dessa uppgifter. De som tar del av rapporten uppmanas att basera sina investeringsbeslut på undersökningar de
själva bedömer vara nödvändiga.
SEB svarar inte för förlust eller skada – direkt eller indirekt, eller av vad slag det vara må – som kan uppkomma till följd av användandet av denna
rapport eller dess innehåll.
Materialet är avsett för mottagaren, all spridning, distribuering, mångfaldigande eller annan användning av denna rapport får inte ske utan SEB:s
medgivande. Distributionen av detta dokument kan vidare vara begränsad enligt lag. Denna rapport får inte spridas till fysiska eller juridiska personer
som är medborgare eller har hemvist i ett land där sådan spridning är otillåten enligt tillämplig lag eller annan bestämmelse.
39
With an eye for trading opportunities
Did you know that you can do all your trading business via the Internet?
By using Trading Station, you are always in contact with the global trading market.
You get access to the latest exchange rates, and you can buy and sell at the blink of an
eye – spots, swaps or forwards.
To find out how you can develop your electronic trading, visit us at www.seb.se/mb.
Or call one of our traders to activate our e-service:
Gothenburg +46 31 774 90 60
Stockholm +46 8 506 231 40