A decline in the Swedish unemployment rate has been confirmed this week. This was in line with expectations and whilst we don’t expect major improvements in this area, we are confident that the labour market is stabilising after the weakness that has been such a feature of the past six months or so. In addition, data has evidenced a strong upward trend in consumer confidence, which is at its highest level since August 2012. This has translated into better domestic consumption, as shown by an impressive 1.6% rise in retail sales in Q1.
However on the industrial side, conditions remain highly uncertain. Confidence in the Swedish manufacturing sector is not quite so buoyant and figures have been mixed. We have seen an excellent 0.8% industrial production figure for March, backed up by an extremely impressive new orders figure of 10.5%. However, April’s manufacturing PMI, which pointed to contraction, remains a source of concern. The underlying trend in manufacturing is tilted slightly upwards but with eurozone growth failing, clearly conditions are highly vulnerable. In addition, a seemingly soft start to Q2 contributed to a disappointing budget deficit of 0.8bn in April.
In terms of Swedish monetary policy, the inflation outlook will be the key driver and the SEK will be highly sensitive to developments in this area. The news has been SEK-negative on this front; Sweden’s CPI figure for April saw a much larger decline than expected, with the annual rate falling from 0.9% to 0.5%. This figure undershot not only market expectations but the Riksbank’s own projections, which could well convince the bank to cut interest rates to 0.75% at its next meeting in July. There will be major focus on May’s inflation data next month, but in light of the strong SEK, soft-ish Swedish growth and high unemployment, the case for a rate cut is compelling and the Riksbank will probably bow to pressure in July. This poses a significant risk to the SEK’s performance this summer.
On the issue of the strength of the SEK, comments from Swedish officials have weighed somewhat on the currency as well. Riskbank Deputy Wickman-Parak confirmed that the central bank is monitoring developments closely but importantly, she did note that alarm bells are not ringing at current exchange rate levels. Finance Minister Borg also chimed in, “We are not in a situation today where the SEK is a serious problem, but potentially it’s a problem.” Market concerns in this regard will likely limit SEK upside.
As far as the euro is concerned, it’s been relatively quiet on the debt crisis front. The way in which the Cyprus crisis was contained has strengthened market confidence in the future of the euro and represents another indicator that the worst of the crisis could be behind us. A look at Spanish and Italian 10-years bond yields, which at 4.0% are at their lowest levels since the end of 2010, tells you how calm market nerves are with respect the debt crisis. While Italy may have established a much-needed government, political instability certainly represents a key concern. Public discontent with eurozone austerity is building constantly and this looks set to be the central threat to the euro moving forward.
Growth data from the eurozone has remained reliably poor in recent months. The Q1 GDP figures revealed a double-dip French recession, extremely weak German growth (0.1%) and yet another quarter of negative growth for the eurozone as a whole (-0.2%). The gravity of this depression hasn’t been lost on the ECB, which at last cut interest rates to 0.50% at its last meeting. More worryingly for those long of the euro is the declared openness of the ECB to the policy of negative deposit rates. If this option is utilised, the euro really will suffer.
This week’s May PMI figures from the eurozone are expected to show a degree of stabilisation but we wouldn’t be at all surprised to see them disappoint once again. On the bright side, Germany stands a decent chance of gaining some momentum in Q2, based on some impressive industrial order and output figures in March. However, broadly speaking we remain very bearish on eurozone growth and expect further ECB monetary easing, or speculation in that regard, to weigh on the euro in the months ahead.
Middle and Far Eastern reserve managers continue to rotate out of dollars and into euros but this theme is waning somewhat. We hold a very firm outlook for the USD in 2013 and if we are correct, as we have been so far this year, there is a high probability that this will result in a weaker euro in H2 2013. The 8.50-8.65 range has held for the past month but we prefer the lower end of this range, with potential upside considered quite limited. Range-trading around the 8.50 level looks a decent bet for the next 2-3 months before paying another visit to the 8.30-8.35 trough that was established at the end of Q1. Neither currencies look attractive in the current environment but we believe the euro’s downside risks are greater.
Richard Driver
Foreign Exchange Analyst
Caxton FX
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