Europe | Fiscal Policy | FX | Monetary Policy & Inflation
USD/NOK has finally broken below 9.00 in recent weeks after enormous turbulence in March. Although the usual drivers could explain this move – oil has consolidated above $40, the DXY is back to 93.00, the VIX has collapsed below 25, and Europeans PMIs have rebounded – the real action has taken place in the monetary and fiscal space.
The actions started during the extreme turbulence in March – which reminded everyone that Scandie currencies can display much higher volatility than other G10 currencies. The Norges Bank announced actions to break the ‘extraordinary’ krone slide on 19 March. Since then, USD/NOK has only gone down.
How Norges Monetary Policy Differs From Others
Norges Bank cut its policy rate to a record low of 0% to support the economy. However, they excluded negative rates, while a number of peers have been more open to that option. They ruled out QE as a policy measure and eased liquidity via loans for banks, while G10 central banks have implemented QE.
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USD/NOK has finally broken below 9.00 in recent weeks after enormous turbulence in March. Although the usual drivers could explain this move – oil has consolidated above $40, the DXY is back to 93.00, the VIX has collapsed below 25, and Europeans PMIs have rebounded – the real action has taken place in the monetary and fiscal space.
The actions started during the extreme turbulence in March – which reminded everyone that Scandie currencies can display much higher volatility than other G10 currencies. The Norges Bank announced actions to break the ‘extraordinary’ krone slide on 19 March. Since then, USD/NOK has only gone down.
How Norges Monetary Policy Differs From Others
Norges Bank cut its policy rate to a record low of 0% to support the economy. However, they excluded negative rates, while a number of peers have been more open to that option. They ruled out QE as a policy measure and eased liquidity via loans for banks, while G10 central banks have implemented QE. They stepped into the market to buy NOK for the first time in decades, purchasing NOK 400mn/day, five times larger than the average level in Q1. And last but not least, although the Governor Olsen said the policy rate will remain at 0% for ‘some time ahead’, he talked about a ‘gradual rise’. It is quite hawkish compared with other G10 central banks who are ‘not even thinking about thinking about raising rates’. Overall, Norges Bank seems to be one of the less dovish G10 central banks.
Norway’s Secret Weapon
However, Norway’s peculiarity lies not in its monetary policy, but its unique fiscal infrastructure. To finance a rising fiscal deficit, a country has to borrow money and increase its public debt. The weaker fiscal position of a country may lead to a higher sovereign risk premium. In Norway, the mechanism is different.
The discovery of oil in the North Sea transformed Norway in 1969. Direct government participation and a tax rate for oil companies at 78% ensure that most of the oil revenues flow into government coffers. Norway established its sovereign wealth fund, the Government Pension Fund Global, in 1990 to shield the economy from ups and downs in oil revenues. It was decided that the fund should only be invested abroad. The current portfolio includes holdings in 9,200 companies across 74 countries.
Since 2001, Norway has established two fiscal rules which imply a cautious spending path to avoid side effects such as the ‘Dutch disease’ or ‘the resource curse’ and manage intergenerational concerns. The following rules have guided funds transfers from the GPFG to the government:
- Transfers from the fund to the central government budget shall, over time, follow the expected real return on the fund (currently estimated at 3%);
- Significant emphasis is placed on evening out economic fluctuations to contribute to sound capacity utilisation and low unemployment.
When the state’s non-oil fiscal deficit is below the oil revenue received in NOK, the government transfers the surplus in NOK to Norges Bank, who converts it into foreign currency to be put into the GPFG (they only invest abroad). However, if the non-oil fiscal deficit rises above the oil revenue received in NOK, the GPFG will repatriate foreign assets and Norges Bank will convert them into NOK and transfer the amount to the government. For this reason, Norway’s public debt is only 40% of GDP compared with more than 100% for G7 countries. These FX transactions that Norges Bank realise have nothing to do with ordinary conduct of monetary policy.
The Fully Funded Fiscal Boost
The government announced a stimulus plan of up to NOK 480bn in response to the pandemic. The fiscal impulse, the cyclically adjusted change in the budget balance, is estimated to be as large as 4.5% of GDP in 2020, one of the highest among DMs. As the non-oil fiscal deficit rose above the plummeting oil revenue, the government revealed a plan to withdraw NOK 400bn in 2020 from the GPFG. According to the GPFG H1 report, the fund already transferred NOK 167bn to the government and so NOK 230bn has to be repatriated in H2, creating a structural NOK 2bn inflows per day for the rest of the year.
NOK to Stay Strong
The recent months’ price action seems to confirm that the unique monetary/fiscal combination has supported the currency. From 18 March to 30 April, NOK strengthened 15% against the EUR and the USD despite the oil price fall from $30 to $15. The usual correlations broke, and the realized volatility collapsed. Everyone was stopped out during the first two weeks of March, and therefore, Norges Bank became the only game in town.
Going forward, the central bank’s reaction function and the unique fiscal mechanism should support the currency. While Sweden’s response to COVID-19 dominated headlines, the recent GDP releases showed the Norwegian economy outperformed its neighbour in Q2. The economy contracted by 5.1% QoQ compared to 8.6% in Sweden and 12.1% in the Euro area. In a low rates environment, the growth and the fiscal dynamic will likely be two important drivers of FX. In this regard, Norway could outperform.
But we may still be a few months off from starting to compare countries due to the abnormally high volatility in the economic data. Indeed, the EUR/NOK price action has been rather muted recently. The pair traded in a 3.00% range over the last two months, while oil rallied 12%, DAX rose 7% and the BTP/Bund spread eased by 30bps. USD/NOK may be a better short right now because USD remains vulnerable, while the EUR may continue to be supported more than the NOK by non-cyclical drivers not reflecting yet a true rebound in the global economy.
Reuven is a macro strategist. He currently works for a private bank in Geneva on the strategy & advisory side. He has previously worked 4 years at Harness Investment, a $1bn global macro hedge-fund. His areas of interest are G10 & EM currencies. He holds a master of finance from Bocconi University.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)