NOK: Slipping well below fundamentals – Nomura

The analysis team at Nomura have held a cautious NOK bias over the last few weeks, highlighting increased concerns about the domestic inflation outlook, however, they are now starting to believe NOK weakness is excessive and unjustified by fundamentals. 

Key Quotes

“We oppose recent NOK weakness by entering a EUR/NOK 9.25/9.10 2m put spread for the following reasons.

1) Terms of trade: NOK move excessive

The move higher in EUR/NOK from the 9.10-9.50 level seems to have been mostly driven by the 13% decline in oil prices seen since mid-April. The 3-4% depreciation of NOK is larger than historical betas would suggest. When controlling for the rates differential and risk appetite, EUR/NOK’s beta is roughly +0.1% to a 1% move in oil prices. This seems low, but typically when oil prices fall, NOK rates rally and risk appetite can decline, also pushing NOK lower. We have not seen this in the recent drop in oil prices.

Our terms-of-trade measures have remained at relatively elevated levels, and the NOK depreciation of this year seems stretched.

2) Meanwhile NOK rates have shown a lower sensitivity to oil prices

Typically, when oil prices decline the market starts to price in a policy response from Norges Bank and front-end rates tend to rally. However, in recent weeks there has been a breakdown of this relationship. We do not expect Norges Bank to cut rates further, but because roughly 30bp of hiking remains priced in the NOK OIS curve we would have expected this pricing to have been at least partly removed.

3) Oil price fundamentals – balance of risks favouring a move higher

We think the recent comments from OPEC officials on extending OPEC production cuts in H2 2017 at the 25 May meeting (notably Saudi Arabia and Russia) should help to provide a floor to oil prices. This includes discussing the possibility of extending cuts beyond December 2017. Recent oil production data show that OPEC members have now fully implemented the planned cuts. Russia has also cut production by 223k barrels p/day since October reference levels, 74% of the agreed 300k cuts. This high compliance rate from even non-OPEC members is encouraging.  

We would not expect OPEC supply cuts to improve the outlook for oil prices significantly, as any increases in oil prices may be offset soon afterwards by increased US supply. These dynamics support recent range-bound price action in oil markets.

4) NOK’s medium-term fundamentals continued to support NOK strength

We continue to believe the Norwegian economy has bottomed, and expect continued positive momentum through 2017 and beyond. This may help Norges Bank to look through lower inflation, and do not expect rate cuts.

From a valuations perspective, NOK is also undervalued on both a PPP and REER basis. As we argue above, NOK also looks cheap relative to its terms of trade. Finally, we expect a more positive flow picture to underpin NOK as the improving economy and supported oil prices attract portfolio inflows.”