(Bloomberg) -- It may be time to acknowledge that going short on the Swedish krona has a poor risk-reward ratio.
The market seems to have already priced in a dovish tilt by Riksbank at its Sept. 6 policy announcement and a muddy national election outcome three days later. Positioning suggests there is ample room for an extended short squeeze as momentum funds are long the euro versus the krona at a time when hedging though options is almost the most costly this year.
The krona hit a nine-year low versus the common currency on Aug. 29 at 10.7291, as trend-following accounts chased the market higher. Nordea Bank AB analysts including Martin Enlund highlighted that the euro-krona pair reached 11 trading days of higher highs, the longest run ever. Such overstretched positioning in the cross could result in a deep corrective pullback toward the 61.8 percent Fibonacci retracement of its latest rally, now near 10.4200.
The krona may remain defensive before the elections, yet to fall to new cycle lows fresh dynamics would need to emerge. While analysts expect policy makers to push back the chances of tighter monetary policy, there is a risk that officials don’t deviate from earlier forward guidance and keep the probability of a hike this year intact.
“This is the last chance they have of pushing back the first rate increase or they have to raise the repo rate later this year. Right now the market is pricing in a deferral of the first hike well into next year,” said Fredrik Lockne, an options specialist at SEB AB in Stockholm. “This suggests that we could get a substantial rise in volatility if the Riksbank sticks to its current path.”
Recent Swedish data has something for bulls and bears alike. The country’s economic tendency indicator rose in August, while Swedish retail sales unexpectedly fell in July, casting doubts over the economic momentum.
If Riksbank sounds less dovish than expected, a knee-jerk reaction higher for the Swedish currency would follow on positioning, yet substantial gains may not be sustained as national elections loom. The Nordic country is girding for a vote that has the potential to dramatically change its political landscape, yet its effect on the currency market may not be prolonged.
“Our view of a relatively contained financial market reaction to the Swedish electoral outcome is in line with empirical observation over the past 30 years,” said Lasse Holboell Nielsen, an economist at Goldman Sachs Group Inc. in London, in a note. “Any potential spikes in market prices are unlikely to be persistent.”
Investors who look to hedge themselves against any Riksbank and election scenarios need to pay a relatively hefty premium. The spread between two-week implied and realized volatilities that captures the risk events has steepened the most since early January. On the other hand, betting on a stronger krona isn’t such a costly exercise. The euro-krona volatility skew shows traders remain in favor of upside potential with two-week risk reversals, a barometer of market positioning and sentiment, at the most bullish sentiment on the euro since May.
What to Watch:
- Liquidity issues may arise on Monday as U.S. and Canada markets are closed
- U.S. awaits the Sept. 6 end of a public comment period before it potentially proceeds with the next round of tariffs on China, which is expected to retaliate
- Bank of England Governor Mark Carney testifies before U.K. lawmakers on the August inflation report and monetary policy decision on Sept. 4
- RBA monetary policy decision the same day; Australia’s central bank is forecast to keep its benchmark interest rate at a record low; Governor Philip Lowe speaks after the decision
- Bank of Canada rate decision the following day; the BOC is expected to keep rates steady
- Policy makers’ speeches include European Central Bank Executive Board member Yves Mersch, Swiss National Bank Vice-Chairman Fritz Zurbruegg, Chicago Fed President Charles Evans, Minneapolis Fed President Neel Kashkari, New York Fed President John Williams, Boston Fed President Eric Rosengren, Cleveland Fed President Loretta Mester
- Economic releases include euro area GDP, U.S. payrolls report, U.K. services PMI; see data calendar
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