SEK – A mysteriously weak currency Part 1

After a multi-year slide in the Swedish krona (SEK) and large scale selling from the central bank, we noted that the new governor Erik Thedéen voiced some support for the battered currency. Is this a precursor for a shift in sentiment? In a staff memo published by Riksbanken back in April 2021 the question was raised. Is the correlation between the balance of payments and the external exchange rate broken?

Below we will highlight some flow related facts and observations

Even though the foreign exchange market is huge in terms of turnover, the facts about trading and volume is hard to come by. Bank for international settlements (BIS) tries to estimate the size of the market by way of conducting a survey every third year with major banks. The survey is focusing on the turnover in various currencies, turnover is larger than the underlying need to exchange one currency vs. another. This is just the way the currency market works. One could compare the commercial need to transact a spot trade with throwing a stone in still standing water, the turnover would then be described as the stir from that stone with risk changing hands until the market has found its new equilibrium. 

To say that the SEK is a small currency and therefore bound to be weak is incorrect. Firstly, the SEK is not a small currency, in fact it is one of the ten largest currencies in the world according to the BIS survey. Secondly, the SEK is a free-floating currency in an unregulated market, and one could then argue that supply and demand should be guiding the pricing.

During 2022 SEK were the second worst performer among the major currencies according to the site Forextraders Source.

There are several indices gauging SEK strength, some of which are published by the Swedish Central Bank. Here is another simplistic but long-term gauge of the Swedish Krona vs. the US dollar.

Historical nominal USDSEK vs. real USDSEK

Below is a graph starting in the early 1970s. There are two curves displayed in the graph.

1. The nominal market exchange rate (blue line).
2. The original starting nominal rate adjusted for differences in the US CPI and the Sweden KPI inflation indices (yellow line).

The graph is not to be seen as a forecast of the future value; it only reflects how the changes in consumer prices would have affected the rate if that were the only factor in play. The average nominal rate since 1971 is close to the current “real value”. The divergence between nominal and real rates is at all-time high levels in this 52-year perspective.

The graph also shows how severe the Swedish inflation problem were up to the point when the SEK fixed rate regime was abandoned for the inflation target. This is the yellow line creeping up from below 5,50 to over 7,50 between 1971 and 1992.

Selling by the central bank The central bank boosted the external reserves in step changes after the 2008 financial crisis by way of borrowing foreign currency from the Swedish National Debt Office (SNDO). In recent years these loans have been replaced with freshly purchased foreign currency. This program ended on new year’s eve. During 2022 the Central bank sold 500 million SEK every single day. Source: https://www.riksbank.se/sv/statistik/riksbankens-balansrakning/valutavaxlingar-for-en-egenfinansierad-valutareserv/

Selling by the swedish national debt office In the fall of 2022, the SNDO announced the discontinuation of using currency loans as a strategic instrument when managing the Swedish national debt. This will result in selling of SEK to the tune of 100 billion spread out over time in small increments to not disturb the daily market activity. Source: https://www.riksgalden.se/sv/press-och-publicerat/pressmeddelanden-och-nyheter/nyheter/2022/riksgalden-ska-avveckla-statsskuldens-valutaexponering/

When all this is done it will have resulted in several hundred of billions in SEK selling over the market. The intensity in this selling is much lower between 2023 and 2026 compared to previous years.

The external reserves are now at record nominal levels (the SEK weakness is of course partly the reason). Below is a graph from data on the Riksbanken home page.

Selling by the institutional and private investorsThis is one of the more complex questions there is when it comes to analyzing the SEK flows. We will not try to dig deeper than to say that low interest rates might have played a role in recent years. The popular term TINA (There Is No Alternative) was all about putting investments at higher risk to avoid value destruction from low or negative interest rates. The SEK rates were lower than many of its peers. TINA is for the time being not a hot topic and maybe the new landscape with higher interest rate on savings and loans will create new patterns among the public when it comes to savings and investments. If for instance the Swedish households start to prioritize amortizing loans in SEK rather than investing in equity overseas this would be a positive for SEK from a supply and demand perspective. Time will tell if the changed landscape with higher risk-free rate in fixed income will have an impact.

In this staff memo from Riksbanken, one can read more about how challenging it is to give one clear-cut answer to why the SEK has been trending weaker since the free float started back in November of 1992.

Here are a few of the many theories discussed in this staff memo:

• The reformation of the Swedish pension system (leading to more investments from Sweden into the rest of the world)
• The purchase of Swedish Government Bonds by Riksbanken, leading to a decrease in holdings from foreign investors of this particular asset.
• The low interest rates vs. USD, GBP but also EUR may have been one factor in the weakening SEK in the last 10+ years.

Below is a graph from the staff memo at Riksbanken that shows the holding by foreign investors in the fixed income market. The purchase of Gov Bonds started in 2015.

• Supply and demand issues are a potential reason for SEK weakness.
• Some excess supply is tapering after years of building up the foreign exchange reserves. The intervention in the SEK fixed income markets has stopped for now, if this had a negative effect on the supply/demand balance it is likely no longer a negative factor. The build-up of the foreign exchange reserves is now finalized. Re-payment of foreign debt will go on for years to come, relative to the buildup in reserves the annual need to sell SEK due to these loan repayments is much lower.
• The shift in inflation and consequently interest rate levels might affect the behavior of investors, the Riksbanken research point to potential link in SEK weakness when rates were low. Time will tell if this shift helps turn the tide for SEK.
• The gap between the nominal USDSEK rate and the “real” USDSEK rate is at record levels in the last 52 years.

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DISCLAIMER: THIS IS NOT A FORECAST FOR THE EXTERNAL VALUE OF SEK. THE INTENTION IS MERELY TO HIGHLIGHT SOME FACTS THAT MAY HAVE PLAYED A ROLE IN THE PRICING OF THE SEK IN RECENT YEARS. WHAT HAPPENS FROM HERE WILL BE DECIDED BY YOU THE READER AND EVERYONE ELSE WITH A VESTED INTEREST IN THE FOREIGN EXCHANGE RATE OF THE WORLD’S LEADING CURRENCIES.