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Fundamental Evaluation Series: USD/NOK vs. 2-year yield spread

The chart above shows, how the relationship between USD/NOK and 2-year yield spread has unfolded since 2012.

  • It can be seen that the pair and the yield spread between 2-year treasury and 2-year Danish government bond have enjoyed a very close relationship.
  • The Norges Bank (NB) began reducing interest rates in the aftermath of the ‘Great Recession’ of 2008/09. The interest rates declined steadily from 575 basis points in 2008 to just 125 basis points in 2009.
  • The lending rates were gradually increased to 200 basis points in 2010 as the impact of the ‘Great Recession’ was less severe and the price of oil recovered. It rose further to 225 basis points in 2011.
  • However, the interest rates were reduced again in the aftermath of Eurozone debt crisis. Since the end 2011, DNB reduced rates from 225 basis points to just 152 basis points in 2012 and was further lowered in the aftermath of oil price crash in 2014 to just 50 basis points and it remained at the level.
  • It can be seen from the chart as while DNB started reducing rates in 2011 and in 2015 and maintained dovish tone, and the US Federal reserve indicated and began to wind up its asset purchases, the 2-year yield spread widened in favor of the dollar by more than 200 basis points and the exchange rate declined from 5.5 per dollar to 8.9 per dollar.
  • However, since the beginning of this year, there have been speculations in the market that the Norges Bank (DNB) would soon follow other central banks in the region, namely the Czech National Bank (CNB) that increased interest rates by 20 basis points. However, the speculation remains capped by falling inflation rate that declined to 1.5 percent in August and a lower oil price.
  • In our review in August, we noted that despite lower oil price and falling inflation, a strong divergence is visible as the yield spread has widened this year by almost 18 basis points in favor of the dollar, while Danish Krone has strengthened by more than 600 pips. So, the exchange rate moved much faster than the spread, which is not an unnatural phenomenon. However, we noted that such divergence will not be sustainable in the medium term. Hence, we expect hawkish commentaries from DNB and warned that in absence of which the exchange rate could decline favoring the dollar. The spread was then at 71 basis points and the exchange rate at 7.9 per dollar.
  • In our review in early October, we noted that the yield spread has widened by 22 basis points in favor of the dollar, while the NOK has weakened by 60 pips. And in our last review in late October, we noted that the yield spread narrowed by 10 basis points in favor of the dollar and the Norwegian Krone weakened by around 180 pips, thus reducing the divergence.
  • In our last review in November, we noted, that the spread has further widened by 17 bps to 125 bps in favor of the USD and the Norwegian Krone has weakened by more than 120 pips to 8.29 per dollar.
  • In our last review in December, we noted that the spread has further widened from 125 bps to 149 bps in favor of the USD and Norwegian Krone has weakened from 8.13 per dollar to 8.37 per USD.

Since that review, the spread has further widened by 17 bps to 166 bps, while the Norwegian Krone weakened from 8.37 per dollar to 7.88 per dollar; thus widening the divergence.

Such divergence is not sustainable in the medium to long-term; hence we expect the reduction of divergence either through depreciation of Krone or by an increase in the Danish interest rates.

With central banks changing their monetary policy outlooks, we highly recommend regular following of the yield spread.

 

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