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Positions in Europe: Long British Pound (FXB); Short Spain (EWP)
Conclusion: Swedish economic fundamentals remain strong as the Riksbank sends a clear message of interest rate tightening to head off inflation. Yet the threat of higher capital requirements on Swedish banks looms as a competitive drag. We’re bullish on Sweden’s growth profile and sober fiscal policy, yet are not currently invested in the country. We’ve previously used the etf EWD as an investment vehicle in the Hedgeye Virtual Portfolio.
If you’ve followed our work over the last years you’d know how critical we’ve been on the policy of global central bankers. In particular, we’ve positively noted the proactive monetary moves (interest rate hikes) from the central banks of Australia, China, and Sweden to control inflation and entice investors through a higher cost of capital, while Bernanke at the Fed refuses to see The Inflation, and has kept benchmark rates artificially low around 0% for the last 29 months.
Sweden’s government, under the leadership of Prime Minister Fredrik Reinfeldt’s, who won another four years in office in September, said this week that his government plans to reduce taxes for a sixth consecutive year in 2012, and outlined an economic game-plan for the next 2-3 years, including steps to further hike interest rates, which we applaud. We contend that rate hikes from Sweden’s central bank (Riksbank) are consistent with the country’s proactive policy action and will be bullish for Scandinavia’s largest economy and boost the Swedish krona against major currencies.
Below are the government’s updated forecasts:
- GDP will expand 4.6% in 2011 versus a forecast of 4.8% last month [GDP grew 5.5% in 2010]
- Unemployment will fall to an average of 7.3% in 2011; 6.6% in 2012; and 5.8% in 2013
- Consumer Prices (Index) will rise 2.5% in 2011; and 2.0% in 2012
- Swedish krona will rise to 8.70 per euro at the end of 2011 and weaken to 8.80 per euro at end of 2012, according to Finance Minister Anders Borg, who also said gains will be tempered by rising interest rates outside the country
- Central bank’s benchmark rate would reach 2.25% this year (currently at 1.50%); 3.25% in 2012; and level out at 3.75% percent in 2013
To the last point, Sweden’s Riksbank has raised its key rate five times since July, from a low of 0.25% to 1.5% in February 2011, largely in response to home price inflation. We think their guidance to continue to tighten will help head off headline inflation (CPI at 2.9% in March Y/Y), and quell housing inflation that is being driven by a lack of supply. The interest rate moves should also strengthen the krona against major currencies, which is up a monster 30% versus the EUR since a low in early May ’09!
Sweden has enjoyed the safe haven trade (along with Switzerland) given sovereign debt contagion across the Eurozone for the last 18 months. For an economy that is heavily levered to exports for growth (~50% of GDP), a strong krona is certainly a headwind worth considering. While we’ve not seen significant evidence of such to date, and finance minister Borg makes a fair point that investors will increasingly chase yield outside of Sweden as global central banks further tighten, the impact of a strong krona is worth investment evaluation.
Banking Rebound vs Regulatory Drag:
The position of Riksbank Governor Stefan Ingves remains that Swedish lenders should imposing tighter standards than those set out by the Basel Committee and enforce the rules faster than Basel’s 2019 start date. Additionally, finance minister Borg said in March that banks should prepare for a 1% increase in capital requirements every year over the next few years. The obvious implication here is the competitive drag on Swedish lenders if they’re required to carry higher capital ratios versus their peer banks.
For reference, most Swedish lenders already have lofty Tier 1 capital ratios, largely in response to their weak positions in 2008-2010 as a result of their leverage to bad loans to the Baltic states. Of the major lenders (Nordea Bank, Svenska Handelsbanken, SEB, and Swedbank), the Swedish Financial Supervisory Authority has measured most lenders to have Tier 1 ratios in the range of 8.9% to 10.3%, with Swedbank at 13.4%.
In short, Swedish lenders look to be well capitalized and cognizant that banks can’t take on the risks they did pre-Lehman, emphasizing the importance of raising tier 1 capital ratios. That said, should Swedish lenders be mandated to have capital ratios above their European peers, we’d expect underperformance from these banks and a commensurate drag on the broader equity indices.
This morning's CPI numbers make it increasingly tough for Bernanke to ignore inflation with CPI +2.7%. But they'll be quick to latch on to the 1.2% excluding food and energy, Well... guess what Ben, we need to eat, and most of us need to heat our homes and use energy to get to work each day. We can't exclude it from our wallets.
Nonetheless, we look at the relative spread in consumer prices vs. import costs (reported by OTEXA) net of the % of apparel that is produced domestically. In the end you get the chart below. We refer to it often, because it matters.
At the start of this year, we came out of a 2.5 year period of having a 3-Standard Deviation positive spread between costs and consumer prices. Yes, this helped margins -- by about $3bn per year. For a $280bn industry with high-single-digit margins this is big. Even if I'm generous and give 'em a 10% margin, that's $28bn in normalized operating profit. $3bn on top of that PER YEAR for 2.5 years running.
Now we're 2-Standard Deviations in the other direction. Logically, not many people will debate that. But There are too many people I talk to who are already looking to 2H12 for an earnings rebound. They're a year too early.
Q2 KEY MACRO THEMES: FINDING STABILITY AMID HEIGHTENED VOLATILITY
DIAL IN & MATERIALS
Today, April 15, 2011, 11am EDT
5-10 minutes prior to the 11 AM EDT start time please dial:
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Materials: "Q2 KEY MACRO THEMES"
If the hyperlink does not open, please copy/paste the following link into the URL of your browser: http://docs.hedgeye.com/2Q11%20Key%20Macro%20Themes2.pdf
We invite you to join our Q2 Key Macro Themes call to help prepare for what's in store this spring. The call will be hosted by our CEO, Keith McCullough and Managing Director, Daryl Jones and will cover the following topics:
- Year of the Chinese Bull (Bullish on Chinese equities and the Chinese yuan)
- Deflating the Inflation (Inflation Scenario Analysis)
- Indefinitely Dovish (U.S. Interest Rate Scenario Analysis)
See you there,
The Hedgeye Risk Management Macro Team
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