A Run Thorough On Norges Bank’s Surprising Cuts - Correlation Of Norwegian Krone Conducive For Asymmetric Shorts

Norges Bank surprised general expectations yesterday and lowered interest rates by 25bp to now zero. At the same time it made it clear that this was the end of the line and that negative interest rates were not on the agenda. It intends to keep its key rate at this level for the foreseeable future. The current rate path does not show any key rate changes whatsoever for the entire forecasting horizon until year-end 2023. The 25bp cut seems like a symbolic final gesture intended to underline the finality of the decision. That is how the market seems to have interpreted it too and krone is showing its appreciation of Norges Bank’s clear statement with slightly higher levels both against EUR and USD.

NOK vols are well off the March explosion, which at the peak surpassed 2008. Currently at around 15vol handle, they are still a solid 8vols from the pre-COVID-19 period.

What’s more, the recent oil hiatus helped push the NOK correlations to unprecedented levels but those historically high NOK correlations may be vulnerable without NOK-specific drivers with the impact from the oil uncertainty starting to dull and with Norges Bank on hold.

USDNOK- EURNOK 1Y implied correlation in mid-80s makes short lean very favorably asymmetric.

The capped nature of correlations has a special appeal for prospective NOK vol sellers, especially with the view about softer NOK correlation being possible to directly express via USDNOK- EURNOK correlation swaps. Our preference is for longer expiries in order to mitigate risk from spot realizing.

Trade tips: Stay short in EURNOK - USDNOK 1y corr swap @77/85corr pts. Courtesy: JPM