EUR/NOK: Overvalued, but Not Overdone (Yet)

Summary

• EUR/NOK is 20.1% overvalued and trading around year highs.
• NOK has failed to benefit from elevated commodity prices as investors have refused to commit substantial investment to the exporting sectors (oil and gas). It has also been hurt by the market’s concentration on dwindling global growth expectations while Norges Bank proved surprisingly dovish at their last meeting.
• Recently, EUR/NOK has dipped 2.5% from highs as OPEC+ pushed crude oil prices higher, and markets believe a Federal Reserve (Fed) pivot is forthcoming. We think the Fed is unlikely to pivot and markets will reaffirm their downward trajectory.

Market Implications

• Short-term EUR/NOK pullback will provide opportunities to be long EUR/NOK. Further afield, when Europe realises it will not make the winter unscathed, an elevated EUR/NOK will likely be an attractive short.

Introduction

We have been bearish NOK; we claimed that one should have patience shorting EUR/NOK while we benefitted from being short NOK/SEK. Now, OPEC+ has cut production by two million barrels per day (Appendix: Table 1)! Brent crude prices have surged, and, in theory, this should be good for Norway. After all, a quarter of their exports are oil. So, should you short EUR/NOK?

Overvalued, but Not Overdone

Sitting around 10.5, EUR/NOK is up 8.5% since mid-August. That could make any reasonable person scratch their head. The irony is real; Europe is feeling the heat of an energy crisis, while Norway is left out in the cold of not benefiting from elevated commodity prices. It leaves EUR/NOK 20.1% overvalued; an initial glance would lead you to believe a sharp reversal is in order (Chart 1). However, we can easily argue the move is far from overdone. Two years prior EUR/NOK was trading at 11.1/11.2, 6.5% higher than current levels (Chart 2).

Commodity Prices Are Not Helping NOK

Crude oil prices topped near $130/bbl in March as the world began to travel more, while central banks had only just begun to raise interest rates. NOK felt the benefit at that time (Chart 3). However, this relationship has faded.

Then came the panic around natural gas and Europe’s ability to obtain enough of it. Prices skyrocketed and, again, NOK benefitted (Chart 4). However, prices have begun to tumble, and while our medium-term view is that Europe has insufficient gas resources to last the winter, prices may fall further still. As a result, NOK may continue to weaken.

Global Growth Expectations are Hurting NOK

Markets are favouring a poor global growth outlook rather than focusing on a tight demand-supply narrative to drive commodity prices. Indeed, when the market believes the Fed will turn more hawkish, risk appetite is hurt. And, as a result, equity prices suffer, as does NOK (Chart 5).

Adding insult to injury, Norway is suffering from record capacity constraints meaning there is less investment seeping through to Norway’s oil and natural gas sector (Charts 6, 7, and 8). So, even if Norway wishes to export more oil and gas, it may struggle (Chart 9).

Norges Bank Unable to Help NOK

Norges Bank hiked its policy rate to 2.25% (+50bp) at their last meeting, but added a dovish twist. They now expect the economy (mainland) to contract 0.3% through 2023 (previously +1.1%) and for unemployment to raise faster than before. It left the forecast for the terminal rate practically unchanged. And while this is largely reflected in the German – Norway two-year interest rate differential, it does not fully encapsulate Henry’s view for a 75bp hike from the European Central Bank (ECB) on 27 October alongside his 3% terminal rate (Chart 10).

Bottom Line and Market Implications

Many factors suggest EUR/NOK has reached a medium-term top: it appears overvalued, it has reached year-highs; oil has returned above $90/bbl for the first time in three weeks; dwindling risk appetite is seeing a reprieve; the interest-rate differential has stopped widening. However, we believe this may be just a short-term narrative. As risk markets resume their life under pressure, so should NOK. And, assuming natural gas prices do not surge higher, it could mean EUR/NOK heads toward its 2020 highs.

In short, we believe a short-term equity bounce may help drive EUR/NOK lower. These lows are likely to be attractive levels to go long. Further afield, when Europe realises it will not make it through the winter unscathed, it is likely to be a good time to be short EUR/NOK.

Appendix

Ben Ford is a Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

(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.)