Swedish Krona Still in Play

The Swedish krona remains a market darling. Over the past 3-months it neck-to-neck with sterling as the strongest G10 currency, up about 7.75% against the dollar and about 4% against the euro.

It has strong macro-economic fundamentals. The preliminary estimate of Q2 GDP was reported in late July at 3.7% (year-over-year) after a 3% reading in Q1. With the July PMI near record levels, the positive momentum has carried into the start of Q3. The central bank expects 3.8% growth this year and 3.6% next. The government's estimates a 3.3% this year and 3.8% in 2011.

Swedish businesses have been successful in diversifying away from Europe and the US and toward Latam and Asia. About 80% of Sweden's list companies reported quarterly earnings above expectations. A similar ratio in Germany stands closer to 65%, in comparison.

The performance of the krona may challenge those who think that the trajectory of fiscal policy is the main driver of the fx market. Last year Sweden's budget deficit was about 0.5% of GDP. This year is is a little more than 2% of GDP. While this is still modest by international comparisons, it does fit into the category of a country with a larger budget deficit and stronger currency.

The Riksbank did hike key rates at the start of July from 0.25% to 0.50%. The central bank meets again in early Sept (Sept 2). Another rate hike is likely. The policy mix in Sweden is one of tighter monetary policy and looser fiscal policy. This tends to be favorable for a currency.

Swedish officials recognize the biggest risks to the country's favorable economic performance are international variables and especially a renewed financial tension. Indeed, when the market feared for the survival of EMU, the krona has been sold off. The rally of the past three months essentially recoup the losses in the first 5 months of the year.

Barring a new flare of the financial crisis, the krona is set to continue to outperform the euro. The euro is trading just below SEK9.40 and over the next several months it could be headed closer to SEK9.0. This kind of currency appreciation could augment returns for global equity fund managers, where the OMX Stockholm 30 Index is the best performer in the G10, gaining 12.4% year-to-date. The anticipated currency appreciation may also enhance the return of Swedish government bond performance as well.