• Jan

EUR/NOK macro short



From time to time, macro conditions set up just right to signal likely disconnect between two assets or currencies in the advantage of one and at the same time disadvantage of the other. One might have certain conditional exposure to weakness, and the other uses same condition exposures as its strength.


In currency markets, such dynamics typically happen between highly commodity-driven vs. non-commodity-driven currencies, usually when certain conditions are set for commodities to either rally or drop significantly. So far, such a situation has been developing between Euro and Krona and each of representative economies and is likely to remain present and elevated into upcoming years.


This post will outline some of the reasons and conclusions on why NOK (Norwegian krona) might outperform the Euro, resulting in the exchange rate of EURNOK dropping over upcoming years and how one can benefit from this. The post will also outline that this highly depends on commodity prices and conditions to remain continuing as they are present so far in mid-2021 and early 2022 into foreseeable next few years since if they were to change drastically (by the inverse of energy especially), the scenario would no longer be valid on what is outlined in article, for the sake of transparency to outline the invalidation of that macro straight away before we jump into confirmation stage so that reader always keeps both sides in perspective as that is very healthy when poking holes into the macro thesis.


It is difficult to write about macro ideas often since those can either age fast and inverse quickly or take too long to develop, but in my view, this is one of those that is likely to stick and as well unlikely to inverse, at least not within the next 1-2 years.


Interest rates (ECB / NCB)


The structural component of currency strength or weakness are interest rates, as, without strong interest rates in the relatively inflationary environment, it is unlikely for currency to perform well; however, keep in mind that there is a big difference in internal currency performance relative to equity assets, real estate or just internal inflation and the outside external Forex performance, where that currency is compared in performance against the other currency of another economy.


Typically, one should make a difference when judging the central bank's interest rates and its currency to the inflation rate / CPI of such economy versus comparing it all to the situation of some other economy and its currency performance. When it comes to interest rates, two components are crucial to factor in. One is economic strength and how high or low-interest rates are there to steer the inflation and keep it under control while attracting deposits and strengthening the currency, but also not to dampen economic activity too much so that economy remains attractive for external investments. That dynamic can be quite a mixed bag, and in total should then be compared of economy one vs. economy 2; in the case of this article, the EU and Norway are the comparable partners.


Currently, two major forces are present on both economies; one is a negative impact on growth from the pandemic and all the geopolitical issues that Europe has faced so far, which require lower rates to boost the growth and on the opposite scale, the ramping growth of inflation due to same agent provocateurs, which requires higher rates to combat the inflation. Conflicting macro forces which are both net net negative for growth.



Norway interest rate normalization path (2021-23):




Norway is currently sitting at higher interest rates relative to the EU, with 0.5%, where NCB started to hike rates last year at the end of the year, signaling that it is front-running ECB by quite nearly a year ahead (using ECBs projected estimates on where they will begin to hike slowly, in mid or late 2022).

When it comes to pricing in interest rates, two factors come into play; one is how fast versus the comparable economy one can do it (the quicker, the more strength can be priced into currency earlier, into the advantage of NOK in this case), and as well how much higher can overall rates go into the mid or later stage of hiking cycle (which based on current projections could be at minimum 1% in advantage for NOK).


Norway's central bank projects to raise rates this year around 3 to 4 times, depending on the conditions present. This is around two times more than the projected or planned hikes by ECB, signaling more hawkishness from NCB relative to ECB.


EU interest rate normalization path (2021-23):



The mixed situation for ECB. Rising energy and many commodities leads to an increase in inflation and the need for rate hikes but at the same time dampens the growth creating the need for easing rather than tightening. While that is a similar case for Norway, what matters are the ratios. ECBs rate tightening path is to be slower mostly due to reluctance to raise rates due to structural debt issues of many southern EU economies, and growth stimulation needed from lower rates to keep those economies afloat. This gives ECB already very small room on hikes and markets know it. Projected rate hikes so far are to be lesser and slower than NCB ones.


The focus here is not to discuss whether ECB should raise rates more to be aligned with inflation or to discuss how the rate policy should be adjusted to address damped growth from rising energy. The article intends to strictly focus on facts and how the policy divergence should impact currencies, regardless of whether those decisions are right or wrong.

CPI / inflation rate in EU and Norway

As stated above, the situation on surface for interest rates is beneficial for Norway for now and NOK as currency, but let's keep in mind that the overall inflation rate also plays a role, not just interest rates themselves. Suppose Norway had much more favorable interest rates, but the inflation would have been much worse compared to the EU. In that case, the overall positive effects are negated by negatives, so the net-net is relatively even. We need to take into account the current inflation rate for both Norway and the EU and the potential future inflation rate if that were to diverge.


From latest CPI reports (February 2022) we can see that current inflation rates stand as reported:

Norway: 4% EU: 6%


But more important than actual latest CPI reports is to observe how the inflation rate has been moving over past months or years, to see which of those economies might be in near term exposed to a further rally in inflation above the other counterpart, as the images below show, it is likely that due to energy concerns the inflation rates in EU might keep rising well above Norway's rates in the near term (1-2 years). All of which is likely to create more devaluation pressures on the Euro and less on the Krona.

Norway's inflation overall has been noisier, but on average slightly higher at its rate (1% above EUs) and has been rising less consistently over the past year). Since Norway is much smaller than the EU, it is not unusual to see inflation rates of such countries more in jumpy aspects on a month to month basis, along with many other reasons that contribute to that.


European CPI rate has been steadily growing over past years, along with the global inflation rates, not all of which is to be blamed on energy. What is the most troubling about this is that inflation managed to rise few fold very quickly within just a year, in a robust large union area economy that is quite troubling as it is unlikely to decline any time soon (as this typically goes). For inflation in the large union block to rise that fast the reasons are always deeply structural and unlikely to be sorted out quickly, which means it is safe to assume that such inflation rates are to remain elevated for next one to two years, and should impact currency performance.


Since charts are often like a piece of artwork and can be interpreted in 100 different ways by 100 other individuals, it is important to draw some conclusions that are relatively well thought out and likely to stick for thesis validation.

That being:


-inflation in the EU is likely to outperform Norway's one, at least if interest rates are also considered. Current dislocation is by 1-2% (including interest rates) in favor of Norway.


-the quickness of the rise of EUs inflation could pose capital outflows from the EU's banking sector into external economies, which might benefit Norway at least from the currency X vs. X performance. Again the rising inflation is not issued per se since that is a normal phenomenon; what is troubling is if it rises fast, as is the case for the EU since its economy is more robust, the fact that rise was more persistent (even though Norway had two high CPI prints in late 2021) it shows more weakness towards EU and Euro side.

More reasons for the potential further inflationary disconnect between the two economies will be discussed lower and why it might be a more significant disadvantage of EU-Euro.

The global energy shortage and impact on energy prices



Without spending too many words on describing the energy shortage in the making globally, since this has been a complex process ongoing for the past two years (and very deceptive one where clear signs of present shortages are only going to show later on), let us focus on some facts that are in play currently and those that are likely to come into play over the next one to two years. The article's focus is specifically on the time horizon of the next two years since, in my view, there is no point in making macro plays with a more extended time horizon than that. Else the accuracy of the thesis becomes questionable as one can keep stretching the reason of "just give it time it will come into play some time".

2020 and 2021 have shown globally that supply chains can be quite a fragile concept; if they come under severe strain, even what seems to be a highly robust system can quickly come crumbling down with high costs that are mainly seen in the increase of energy commodity and overall production costs.

Typically the countries that are the most resource-consuming and high growth driven will first start to see the impact of energy shortage effects, which is why it's no surprise that the Chinese economy was first to face rather severe issues in regards to electricity blackouts and quickly rising prices in internal energy markets such as coal in the mid of 2021. The more self-sufficient and least resource-consuming the economy is, the longer it might take for those weaknesses to show, and vice versa. While this process will be ongoing for the next two years, it will be asymmetrically distributed globally, where certain countries will have more substantial difficulties while others will be more resilient and negative effects will take longer to show.




When it comes to EU and Norway's economy and energy dependence or costs, there is a significant difference since Norway is a major energy producer and has very self-sufficient electricity production as well; meanwhile, the EU imports a large portion of energy, which makes it more exposed to potential global energy shortage developing, all of which is and could be translated into currency weakness of Euro versus the Krona.

The more energy imports that the European Union has to do at higher prices (due to shortages) and the more costly it becomes to produce industrial products or even electricity (since much of it comes from coal or gas), the lesser margins the industry has, and the more households will suffer in terms of losing the purchasing power trough the expenses whether its on heating or general costs.


This is nothing unusual and its just plain macroeconomics, but what matters is the ratio and difference at which this hurts the European economy versus the Norwegian and how it can translate into the exchange rate of the currency.


We have to take into account that this is an unusual situation in play here and not just a normal increase of energy prices that are the result of a slowly growing and expanding economy. The growth of energy prices in this case is artificially caused by constraints on supply chains, whether its through sanctions, the pandemic, dislocations, meanwhile as the global economy was actually in slight recession and not growth. This is key to understand, since most of those situations caused by artificial supply constraints cause shocks at least short term (1-3 years) and cause currencies to re-price, the exporters currencies will typically appreciate due to positive surprising situation and large importing economies will depreciate in currency values. That in itself is a different dynamic to what happens typically when energy prices globally keep rising because economic growth globally is slowly rising and the "grass is green" scenario is in play without any geopolitical disruptions in the air (2016-2020 for example).



Open the oil pipes to keep the crude price pinned down?



One question still to raise would be whether the world under the lead of the US would be willing to pressure crude oil prices downwards by increasing supply (US and Saudis plus OPEC) or forming a de-sanctioning partnership with countries like Iran to suppress the price of crude to an extent.

This could lead to limitations on how far the crude oil price might go and how that would impact the exchange rate between EURNOK (obviously only as passive factor, since no geopolitical decisions are made within the frame of concern for this exchange rate). Still, it is essential to note that the actions in play over the past two years signal from all angles that this is not in play (to limit the rise of energy prices). What is in play is actually quite the opposite (some of which is further pointed lower in the article). If there were clear directions to prevent a further rise in energy prices, those actions should or would have to be taking place (which they arent):


-the US would have to fully open the pipes of shale producers,


-bring fresh investments into new drilling projects on US side,


-decrease the green agenda omission targets across the globe but especially in US and China especially if they stand in the way of traditional oil/gas investments,


-increase relations with the majority of energy exporting countries (Iran etc),

-etc...


For now, what we are witnessing is the inverse of that, where all of those actions are pointing towards further upward pressures on price, not vice versa. This additional solidifies why the artificial supply constraints to energy are likely to remain present for a while, regardless of whether the global economy, in general, is doing okay or not.


Again this is not my personal opinion on what the US or major producers should do, i don't deal with subjective opinions on how the world should be run. I am only expressing the facts on the ground so that those are incorporated into the thesis as they are, not as they should stand.


With that said, we can establish the viewpoint that is likely that energy prices, especially the crude oil itself might be more prone to the upside rather than downside over a mid and long term (1,2,3 years), unless all of the policies above are shifted any time soon.



The bumps in energy prices (deflationary economic crunch in case of March 2020 event replication)



It is worthy of adding the road to higher commodity and energy prices in the near term might not be smooth. Suppose there was a similar event to happen as it was in 2020, March, and November, when full economic lockdowns due to pandemics caused commodity prices to crash. In such case, that would short term provide breathing room to Euro and create some sort of selloff on Krona. The question would only remain how long that event would last if it happened. It is important to keep it in the cards to be ready for potential disruption to exchange rate and trend direction. However, I should add, in my personal view, if that were to happen, the long-term forces would sooner than later correct such move to the advantage of NOK, as long as the event is within the scope of the significance of 2020s March and not significantly bigger / worse in duration or magnitude.


Two of such event examples might be 1. another strain of virus that ends with new economic lockdowns or 2. major global cyber attack with similar results as two currently most probable scenarios; each would be a short-term negative for commodities and energy.


Conceptually if there was an event and let's say that it lasts for 2-4 weeks, the likely exchange rate would eventually correct that move, based on my hypothesis:



In such a case, the market would correct such event back down because long-term (more extensive macro) forces typically tend to correct the mid-term macro forces because they are larger. Not always, but typically that is the case. Once economy would reopen (if such event was to happen), the crunch of supply chains would cause the draw on inventories (just as 2020 lockdowns did), which, later on, lead to a rise in inflation and not deflation since the supply has to catch up with the demand. That is what happened from 2020/21 situation and would pretty much happen if any of the two likely scenarios above was to happen as well. Deflationary response first followed by heavy reclaim into inflation.



Ukraine / Russia geopolitical escalation




The first two years of the pandemic provided the global economy with significant supply chain issues and rise of inflation across the board; however, one event that only kicked everything into overdrive is the Russia-Ukraine military escalation in early 2022. The negative macro forces were amplified with this event, all of which present before only made more worse by this event and likely much longer-lasting. While pandemic might have left a mark on supply chains for the entire 2022 and lightly into 2023 as well (semiconductors, commodities, industrial trade products etc..), the Ukraine situation extended that duration by a minimum of several years, especially across the commodity and global inflation price hikes and it opened further pressure on two major components, that being the food (wheat) and the energy (crude oil and gas).


Not to go too deep into dragging out the reasons why this military campaign happened, as that is hindsight already. It is however safe to outline why the Russian military is unlikely to pull out of Ukraine until the government is fully replaced as the main objective of the campaign. The only question remains how further into the west of Ukraine the forces are commanded to push as that would dictate conflict extension in terms of months/years (which is unknown).

But overall, from a market perspective, this does not play that significant role because the sanctions on Russia are already done. The blockade on exports is already in function regardless of what happens next within this conflict, which means that further escalation or prolonged conflict between Ukraine and Russian forces (if NATO supplies them) does not change the energy situation or the wheat situation by much. It would keep equity markets within fear territory likely since the heavy headlines would keep hitting the media for a while (if whole Ukraine takeover is the goal), especially for EU equities and to the extent all global equities, but outside of that, the situation as it is has been already priced as -Russian exports being either largely or entirely cut from European markets. This taken into account that at no point shortly does NATO fully engage in this conflict as that would be another situation in itself of course.


It is safe to say that Russia has taken substantial damage for triggering the campaign, and it is unlikely there would be a military retreat at this point until the goal is reached as strategically that would not make any sense, hence it is also the low probability to expect that any of imposed sanctions would be inverted any time soon, or any time all, which is essential to conclude as it will impact the thesis formation as outlined (towards the strength of NOK and weakness for EUR).

Onwards from here the exports of Russia and to the extent Ukraine will become a gap needed to fill, which obviously is easier said than done, and it is unlikely to happen at least in mid term (2 years), therefore the prices will have to jump considerably higher for the next few years to price the supply and demand imbalance, on commodities that is.


Since this conflict is unlikely to end any time soon, even if the military campaign is quickly finished with Kiev takeover, and it is nearly zero chance that any sanctions would be reversed even if the peace is met between Ukraine and Russia (in my opinion), the upward pressures on commodity prices, are likely to remain present for the foreseeable future. This is a very crucial point, as this helps to build a firmer thesis in regards to all that is being mentioned for the EUR/NOK exchange rate situation.


My firm belief is that regardless of what happens in Ukraine next (the side that wins the conflict or how far the Russian forces decide to push or capture/split the country), the sanctions imposed on exports of Russian commodities are unlikely to be inversed. This long lasting sanctions exposure and export ban is a key reason why shortages and pressures on upward prices are likely to remain for many commodities, lets list which those are and how they might affect exchange rate implications for Euro and Norwegian krona:



Commodities on impact:


-Wheat:

Since wheat has rallied a lot, it creates a burden in terms of inflationary pressures; since Norway is not that large wheat consumer and EU markets consume or import a lot more, the EU is more exposed negatively to rise in wheat prices. Additionally due to fertilizer bans from Russia and potash disruption from Ukraine the EU farm producers will face likely higher production costs and weakening margins for the agricultural industry. Wheat has rallied approx 40% since the conflict began. EURNOK negative (slightly)

-Crude oil:

Norway is a large exporter and benefits from rising crude oil due to blocked Russian exports, while the EU is at its disadvantage as a major consumer of energy. EURNOK negative (strongly).

-Gas:

EU is a large gas consumer not just for heating but also electricity production, at a much bigger scale than Norway is. Since gas prices are very sensitive and can respond with sharp increases if supply is dislocated as it has been since the conflict in terms of exports (Nord stream 2 and potential sabotages on Ukrainian pipelines), it has an immediate inflationary impact overall, especially since it's not easy to source gas quickly from external suppliers, other than LNG tankers from abroad. EURNOK negative (medium).

-Metals:

EU industry is at a scale much bigger and makes more trade with Russia and Ukraine than Norway does; exports ban or difficulty made in importing due to Russia being banned from the SWIFT system is EURNOK negative (slightly).


This is a very rough overview of major imports and exports and its impact they might have on currencies if we compare the two economies. As you can see, the result is pretty much across the board, more negative for Euro than it is for Norwegian krona, at least from my angle.




Tripple combo on upward energy pressure





Lately, we have seen several developments that are all step by step, adding towards producing upward pressure on energy prices globally. Since all energy assets are somewhat connected, if there is pressure across the board of all the niches of the energy industry, there is no escape room for countries to quickly find a solution to hedge the costs.



Three key factors in play currently pushing energy prices higher:



1. Aggressive green energy agenda:


Lead by the US, but most countries especially larger ones have agreed to reduce the CO2 output by large amounts within the next two decades, all of which diverts the investments from high capacity energy projects (older non-renewable sources) into weaker capacity energy projects (renewables) limiting the supply.

Green energy markets, due to extensive agenda by the US administration, are receiving bids across many assets, whether lithium, battery production, EVs, existing projects, and the prices they can sell the energy. All of which is making substantial bids on green energy across the globe, making it more expensive for countries to hedge quickly through this route if they try to.

2. Lack or prevention to invest in new drilling projects within the US for oil and gas industry:


This could be part of the green energy agenda or its agenda in itself, the result is the same as for the point above in terms of limiting the supply.

Canceling new investments into new oil and gas drilling projects by US administration (Gulf area especially) causes the lack of fresh supply to hit the markets, all of which makes the demand forces stronger on price within the US and hence the globe itself, since energy prices are all priced more or less globally. Whether that is or is not intentional is another article in itself; let's say that this is highly likely to remain present for two additional years, which goes hand in hand with the projections for EURNOK in the first place.

3. Geopolitical pressures on Russia, China, and Iran:


Especially Russia and Iran as significant suppliers, if they are restricted on output or exports, has significant implications on prices as it constricts supply, China is much more mixed story depending on the supply chain issues or the growth factor as consumer, however escalation of tensions with China near Taiwan would produce the bid on energy to the same extent as Russian, or Iran sanctions do, which ballparks all of those three nations into inflationary energy pressures either already in play or potentially to be soon.


Or to use likely proxy hotspots for each:

Russia-Ukraine

Iran-Afghanistan or Persian gulf

China-Taiwan

4. Supply chains clogged from pandemic:


Clogged supply chains from pandemic lockdowns initially caused a deflationary crash in commodities and energy, but once the economy reopened, the shock of excessive demand relative to the inability for supply to catch up to it caused prices to recover and is now leaning strongly to the supply lack or shortage. However, much of these effects are not very straightforward visible. Examples are high shipping rates for tankers, clogged ports, weather events in Canada, etc...



Energy weakness in terms of costs (EU-EUR) versus strength in revenues (Norway-NOK) and impact on each currency



It should go without saying that the rally in energy prices and its primary commodities, if it continues or is sustained over the next two years, poses weakness for the EU not just industry but households as well. Meanwhile, it presents an opportunity for Norwegian exports to cushion the budget expenses of households and state to extent if a portion of those revenues is reflected in higher wages or opportunities.


Generally, energy prices are a significant component of currency negative performance over the longer term, especially if the country is a sizeable net importer. One of such current examples might be Turkey, which imports large amounts of energy, much of it denominated in external currency (EUR or USD). If inflation is already ramping inside the internal economy, it can cause quite a significant increase in cost and lead to further devaluation of the currency.

One advantage that the Eurozone has, in general, is that currency due to the linkage into the German economy and to some extent, France creates a deflationary cushion, which is a significant long-term benefit to stabilize the currency even if energy prices do increase. Many emerging market economies and their currencies will lack such features in the near future and are more likely to be inflationary exposed and therefore will be forcefully dolarized (as we see in Turkey presently). However, since we are strictly comparing the EU to Norway and not emerging economies, Norway is not at such a disadvantage as much even without having the deflationary currency such as Euro.




The graph above shows a 50% dependency on imports on average for the EU. If energy prices are low, this doesn't play too much of a role; if they start to get elevated, it starts to play in disadvantage of EU's economy much more than it does to Norway.



Electricity production, robustness and coal/oil price exposure from its production



One of Norway's significant advantages is its ability to produce much of its electricity through a renewable (and relatively reliable) source such as water. This might not be a significant factor in normal circumstances, but if energy shortages were to get much worse, it could be a crucial factor playing into the strength of NOKs performance. Again this all depends on ratios. This factor would only come into play if shortages and energy prices get so high that they disrupt the electricity production as we have seen in China and Turkey in 2021 for example, causing severe blackouts and industrial productivity fallout.


Let's not forget that electricity prices so far in the EU have skyrocketed for a portion of the industry, and projections are pretty high; if something doesn't change, the above situation of Norway will play a role potentially long term in the advantage of NOK, if EUs industry comes under pressure or electricity grid as a whole.



EU electricity prices for industry:



The industry can handle price hikes in electricity, but everything has its breaking point, since if household prices electricity increase too much, it is possible that governments start to ration electricity by cutting the distribution to industry forcefully as we have seen so far previous year in China and this year in Turkey, all of which could be a possibility in EU as well if prices were to rise much more.

The overall situation on the electricity side is much more favorable to Norway than it is to the EU, especially under the current very unusual macro situation that the globe is already and will face in upcoming years; it is not to underestimate how much of a role this can play in overall exchange rate long term for EURNOK.




The electricity grid of EU, (its all connected)




Having a fully connected electricity grid within developed economies has its advantages for most situations. However, if the economic bloc was to come under energy shortage, those advantages of connected electricity grid could become a shared weakness. A weak spot within such a grid (country unable to meet demand needs at large scale) could start to destabilize the grid as a whole (as we saw to an extent in 2021 from Romania), all of which could cause blackouts similar to those in China, where a portion of the grid is, or countries could be forcefully disconnected. Since entire greed is connected it could cause chain-effect on supply chains.


If energy prices keep rising and if the supply from Russia for coal and gas was to shrink to nearly non-existing levels due to sanctions, it could become a possibility that the electricity grid as while could come under significant pressures, mainly because so much energy is produced from those two sources. Nuclear plants have been in the process of shutdowns over past years to certain ratio where it could be a tipping point in case if severe energy shortage of primary raw sources was present.

A scenario like this might seem unthinkable on the surface. Still, if the energy shortage crisis was to progress much deeper, this could become a reality, with blackouts becoming a somewhat repeatable event across the EU grid. This would very much depend on how much and how quickly the EU would be able to source the needed energy resources from external producers and fill the supply gaps, and what the potential breaking point of producing the electricity in weaker European economies would be (such as Kosovo for example).


In such a case European position would be far more problematic than Norway is because Norway produces much of its energy from water which is unlikely to be disrupted quickly, therefore opening a potentially heavily bearish scenario for Euro and not the Krona. Again this is not to say it must happen or that it is a very high probability, let's say that considering the ongoing shortage and prices, it is a potential scenario. If it were to come into play, the EURNOK exchange rate would for sure take a steep dive.

The potential for such blackouts is not just energy shortage or inability to supply electricity-producing resources such as coal at adequate supply. Still, it could also be triggered by cyber attack, which lately has come in front of media headlines frequently.


In either case whether there is significant pressure or not on the electricity grid one thing is clear, the costs of producing the electricity for EU in upcoming years are likely to be much more unstable and potentially higher than those for Norway.




In short, Norway has disconnected electricity grid which can make it more self-reliant and stable and within its internal control; additionally, if it indeed came down to electricity blackouts due to energy imbalance Norway has a much higher chance to resume operations and ensure stability within the system that the EU has, due to what source the electricity is produced in the first place and the structure of the grid. Again this would only play a role if there is a scenario where the grid came under pressure due to energy shortage in the next 2 years. This would potentially play major dislocation and downwards pressure on EURNOK if it was to come about. Typically electricity costs don't play that much of a role to determining the path for currencies but this situation is likely to be different and it just might matter a lot more.


Norways capital inflows and investments from abroad amidst rising energy prices and unattractevness of EU industry under increasing costs and lowering margins



When energy prices rise, and crude oil specifically increases in price the investments into countries such as Norway as well increase somewhat, the industry within the EU might suffer a lack of investments in such cases to extent. However, this is very roughly speaking, since Norway has not been at least over the past few years very keen on starting too many new energy projects, and it is hard to compare the size of Norway's and EU's economy in terms of capital inflows or outflows unless it is spoken specifically within % relatives. This would only play a role if there were a clear precedent of large outflows from the EU and inflows into Norway, let's say, within the next six months. Facts would have to confirm this before it comes into play for further thesis validation.

However, it is common to see that when energy commodities rise, the country that extracts them will typically see an influx of investments in such cases, although that might be more true for the emerging economy than it is for developed ones.

This can help currency appreciate in such a case a bit, hence somewhat positive for NOK against the EUR.




Strength of (NOK) currency response during 2020 March commodity price collapse (recovery pace)



One of the highly useful measurements of the strength of financial assets is how quickly they recover from harsh conditions. It is one of typically very much overlooked aspects of investing or trading. It is almost like a biological reflection of strength confirmation if an asset can recover very fast it reflects health. Just as a strong animal (in its prime or in good health for example) will recover fast from sprinting, fight, or similar negative exposure, so will a strong financial asset, which gives it more validation that it might continue displaying strength after that.


NOK was able to recover relatively fast, well before the crude oil did after 2020 crash, as displayed on the chart below. It has recovered also quicker against many other global currencies for that matter.



Another point highlighted by the chart above is how EUR managed to outperform the NOK in the short term. As commodities crashed, this served as a relief to the European economy, consumption, and industry, hence the overperformance of EUR in the short term. It goes and highlights all the points made in the article above.



EURNOK projected moves and targets based on the reasons outlined



There are a few targets I have specifically in mind regarding the exchange rate for EURNOK. First, I do not believe that we would see a sharp devaluation of EUR against the NOK. If anything, it is likely to see a steady and slowly progressing downtrend over subsequent months.

Historically NOK does not have many indications that it had strengthened by a high % against EUR even when crude oil was at the rally; most of those conditions (2003-2005, for example) led to the slower and choppier decline of EUR vs. NOK. We most likely should see something along with that, although it would depend on how quickly or slowly the energy prices respond (scenarios outlined below).


My target is 9,000 for EURNOK over 1-2 years. It is likely to see the choppier trend, and much of the rallies are to be sold off. Since the target is not very deep the point of trading this is obviously to use leveraged positions of FX markets. But what matters more is not the final target itself but the expected trend progression as that gives more potential trading opportunities along the way, as long as trend remains respected somewhat.






Crude oil price impact on long term exchange targets for EURNOK and few different scenarios



Three main scenarios should be considered when weighing the long-term costs of energy into the currency performance of each of those two countries/zones.

1. Fast rise of energy with sustained prices for next two years (crude oil 150-200 per barrel):


The quicker price moves in energy would likely push EUR lower quickly and NOK to the upside. How much it depends on really how large the % move in energy prices is, but the lag effect can take and last in ratio of 1:5. For example, if energy prices spike quickly, it could take five times longer for Euro to price this spike into overtime, so the effect of the spike can have a lasting impact, as long as the spike is not quickly retraced. The quicker and the bigger in % the energy price rallies within next months (if that was to happen) and for example, we see per-barrel prices 130s to 150s the EURNOK exchange rate would be likely falling very fast and price that with at least one month of lag effect still being dragged down, even if energy was to retrace substantially meanwhile. By fast spike of energy it isn't meant to happen within a day or week but a short time horizon for such "spike" would be few months for example as very aggressive one.

2. Slow rise of energy over two years with price staying around 100-150 per barrel zone:


This scenario would create more steady downwards pressure on EURNOK with a slower and ongoing trend since the market would not be quickly pricing in revenue increases for Norway nor the destabilization of European energy markets since slow and steady moves are more controllable as the economy can adjust a bit better. Therefore Euro is likely to face a slower selloff in such case.



3. Fast rise of energy and commodities followed by deflationary shocks and sharp reversals, but overall uptrending prices for next two years, price staying around 120 to 160 USD per barrel:


This would be overall more bullish for Norway as spikes in crude prices or energy, in general, are much more unwanted for highly consuming or importing economies. However, Euro in the short term would recover its losses against the krona if such shocks were to happen as the negative high energy price pressures would decrease at least in the short term and provide a relief rally. It would most likely create spikes to the upside on EURNOK that would eventually quickly be corrected back down, although the question of how quick is very much debatable depending on what event would cause it.

4. Reversal of energy prices onwards from here under 100 USD per barrel and decline under 70 for next two years:


In such a scenario, much of the above said in the article would be invalidated. Not all of it, since inflationary pressures and interest rate differentials, would remain present, but the certain core of the thesis would be decreased by strong factors. As mentioned, I do not believe this scenario is likely, but its always necessary to remain humble when it comes to macro thesis formulation because you always want to have an invalidation scenario ready ahead; otherwise, its too easy to get caught with pants down, especially when you form a firm opinion on the financial asset.

This under 100 USD price scenario per barrel is not meant for crude to drop under that as a qualifier. Instead, if the price was to drop under that price and never return higher over next year, and stayed substantially under there closer towards 70 prices. For that majority of present macro forces mentioned above on article would have to be completely flipped upside down and inversed. What is the chance for that happening? Very low. Possible, but low.


Trading approach


Using Forex brokers to short EURNOK or USDNOK. Swing position or intraday trades along with the trend?


This article doesn't discuss what trading approach one should use, as many different approaches can be applied to this macro overview.

One could trade short along the trend using a swing approach with wider stops, aiming for 10-20 trades over the next 15 months.

Or one could be a lot more active trying to short along the micro downtrends each pops if the FX pair remains downtrend and avoiding shorting those micro-trends if the more significant trend is a bit more noisy and inconclusive.

Or another way would be to seek distribution plays with tight risk and strong RR (look distribution article on that) as another complementary method.

Or a bit more exotic way might be to convert EURO denominated deposits at the bank into NOK and hold that for two years if one believes that thesis above holds water.

There are many ways to apply this thesis/idea to trading or investing, and it is up to the individual to deploy what makes the most sense or goes along risk appetite.

My approach is the use of the first three methods except for the last one, which won't be deployed.


Conceptually:





Conclusion



The primary intent of this article is not to convince anyone to short EURNOK with high conviction by just running with the thesis outlined here, but rather to use this article as to how to structure the FX currency pair thesis in general and perhaps then apply a similar framework to some other opportunity if it presents itself. Balancing the weaknesses and strengths of the economy and the exposure of currency on those is the key to building a macro outlook for FX currency pairs and which currency within any such pair might outperform the other, creating a trade opportunity.


Since commodities go now and then (typically every 10ish years) in strong bull or bear cycles, they often create opportunities, especially in FX pairs where one currency is positively exposed to rising commodity prices and the other currency is in an inverse position having negative exposure as consuming and non energy exporting economy.

Regarding FX macro trading, one should have conditions present that make two currencies polar opposites in terms of exposure, rather than being too balanced and close to similar performance (as it's often an issue for EURUSD currency traders). When energy prices are at the rally and there are structural reasons for that to remain present for a while, it is best idea to trade the currency pair that consists one currency/economy of major exporter or producer and the other being net importer and consumer. That, additional to other reasons which should also be as on opposite scale for each as much as possible.

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