Trajectory of Policy Mix Bullish for NOK

The trajectory of the policy mix in Norway will continue to underpin the krone and may lead to some under-performance of the local bond market and underpin the equity market, which is one of the best performers in developed Europe. Although the Norwegian economy is expanding sufficiently to prompt the central bank to have considered hiking rates last month and likely will hike rates toward the end of this month, the economy is not sufficiently strong to get the politicians to withdraw their fiscal stimulus. The expanding fiscal policy while monetary policy moves in the opposite direction tends to be supportive for the currency.

As we have noted in previous comments, the Norwegian krone is terribly over-valued. In the 20-years of OCED PPP history available, the krone has been over-valued by 40% twice 1990 and 2007. Using CPI to calculate PPP, shows the krone about 18.6% over-valued. Over the last two decades, the rubber band that connects prices (nominal exchange rate) with value (PPP) has exceeded 20% on three separate occasions and each time some a relatively strong pullback.

The government intends on using a record amount of its oil fund to support the economy. Public spending will rise 2.1% next year, after a 5.6% increase this year and 3.8% increase in 2008. It will have to drawdown its oil fund by an estimated $26.4 bln (of roughly $450 bln) and represents an almost 11% increase from a year ago.

Guidelines established limit government withdrawals from the oil fund to its estimated return which is around 4%. Next year will be the second consecutive year that the guideline is violated.

Typically, Norway sells it NOK oil/gas related revenue for foreign currencies for the oil fund. Now as it dips into its oil fund, it may require less sales of NOK. Although this does not seem to be a major force driving the krone, it be a supportive factor on the margins.

Although euro-nokkie is in need of consolidation, a break of NOK8.27 may spur a quick test on NOK8.22, but further out there is potential toward NOK8.00. With disappointing Swedish data and the Baltic exposures, the Sweden story is not nearly as favorable as Norway's. The divergence in policy means that NOK will likely continue to appreciate against SEK. Consider buying a NOK pullback toward SEK1.23 for a move to SEK1.27 and possibly SEK1.30. Meanwhile, the dollar is approaching important support near NOK5.50. The market is stretched, but there is no compelling technical evidence of an extreme.