Signals from the currency options market are exposing concerns about the outlook for the Swedish crown, one of the latest symbols of risk appetite, moving in lock step with the rise in global equities. The Swedish crown's implied volatility, or "vol," a measure of how much investors expect a currency to move in either direction over a specific period and seen as a barometer of risk, has stayed elevated this year even as economies world-wide have started to improve.
Analysts said Sweden's prospects remain uncertain amid its banks huge exposure to the crisis-hit Baltics region, particularly Latvia, which may face more problems from its banks in the future.
In contrast, options pricing reflects improved economic expectations for Norway, Sweden's Scandinavian peer. Historically, Swedish vols tend to trade lower than those of the Norwegian currency, also called the crown. The Norwegian crown's volatility traditionally tends to be higher because it typically moves with commodity prices due to the country's standing as the world's fifth largest oil exporter.
But Swedish vols are now outpacing Norway's, which have tracked the decline in the currency market's overall volatility. Lower volatility has emboldened investors to venture into riskier currency bets given signs of an imminent recovery around the world. "Swedish crown volatility stems from the Latvian situation," said Matthieu Zaradzki, FX options strategist, at Barclays Capital in Paris.
Latvia is reeling from Europe's harshest recession after a lending-induced real estate boom collapsed, prompting the country to seek international aid to prevent bankruptcy. The Baltic economy pegs its lat currency to the euro as part of its exchange-rate mechanism, but the financial crisis forced its government to implement austere measures to keep its economy competitive.
HIGHER IMPLIED, HISTORICAL VOLATILITY One-month implied vols on the euro/Swedish crown pair were 10.75 on Friday, Reuters data show, while similar vols for the euro/Norwegian crown were 9.65. The Swedish currency over the past year has been sensitive to swings in risk appetite, which analysts said was due to currency transactions of Swedish pensions funds related to hedging of international equity portfolios.
As Swedish funds hedge their currency exposure, a decline in the value of their portfolios would cause the funds to sell the crown, while a rise would prompt them to buy it. The Swedish crown's one-month historical volatility versus the euro, which measures the currency's deviation from its average, was also higher, at around 11.6 on Friday, compared with 10.00 for the Norway unit.
That's higher than normal. This rise in volatility EUR/SEK reflects fear the Latvian government may de-peg the lat from the euro, weakening as a result and causing a significant decline in Swedish bank assets. Three-month EUR/SEK vols, another key measure, were 10.10 on Friday, compared to an average of 5 percent up until 2007.
In the spot market, the Swedish crown has gained 7.9 percent against the euro so far this year, recovering about half of its 14 percent losses in 2008. Barclays' Zaradzki believes the risk priced into the Swedish crown has been too high and believes EUR/SEK vols could decline as Latvia stabilises. "In our view, the risk of a lat devaluation will lessen over time."
NORWAY'S BULLISH OUTLOOK In contrast, most investment banks have adopted a bullish view on the Norwegian crown. Norway is expected to contract at a slower pace this year than most G10 economies. Calyon FX strategist Stuart Bennet, for instance, expects Norway to "return swiftly to positive growth in 2010 at a rate expected to be bested only by Canada."
Morgan Stanley in a research note reckoned that the Norges Bank would be the first central bank to start tightening its monetary policy after the bank at its August meeting said it may be appropriate to raise interest rates earlier than expected. Norway's crown has surged 13 percent so far in 2009 versus the euro after plunging 18.6 percent last year. Much like the Swedish unit, the crown has become one of the proxies for risk given Norway's inks to oil as a major exporter. The crown typically benefits when the global economy expands with higher oil demand.
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