FxWirePro: Does growth divergence lead to policy divergence in Scandis? – Stay short in DKK/SEK to mitigate currency divergence risks

The Swedish economy advanced a seasonally adjusted 1.3% on quarter in the three months to December of 2015, following an upwardly revised 1% growth in the previous period and beating market expectations of 0.7%. It was the fastest growth rate since the fourth quarter of 2010, as both domestic and external demand contributed to growth.

While, the Danish economy advanced 0.1% on quarter in the last three months of 2015, rebounding from an upwardly revised 0.6% contraction in the previous period but lower than initial estimates of a 0.2% expansion

The growth divergence will be reflected in a fall to 1.10 over time. The Swedish economy is expected to see 3.5% GDP growth this year, marginally down from last year’s 3.8% but still on a different level from the rest of Europe.

On the contrary, in Denmark, where a consensus forecast of 1.6% growth may be optimistic, at least judging by the finance ministry’s revision to 1.1%.

As rising oil prices push headline inflation slowly back up in Sweden, how long can the Riksbank policy of negative rates last against this kind of growth backdrop?

While EUR/SEK’s further gradual fall is projected as the stress on the Riskbank is developed.

Meanwhile, the EUR/DKK link, remains in place and is not under pressure, but growth divergence could put it under some pressure.

Risk profile: Risks Risk aversion, housing market slows sharply in Sweden Global risk aversion tends to cause SEK to weaken relative to EUR, so this trade will work badly in a major sell-off.

The longer the Riksbank keeps policy too easy, the greater the risk that eventually, the housing boom becomes unsustainable.

Trading Tips:

Look for drift to DKK/SEK 1.20 near term, 1.10 over 18 months.

At spot ref: 1.2337, stay short in DKK/SEK futures contracts of far month expiries.

3-month target 1.20, 18-month target 1.10, stop 1.2550.