Small and sound supersede size
For the past two years, our long-term outlook has been focused on fundamentals as being the most important driver for currencies. The intensification of the euro crisis last summer made undervalued (fundamentally weak) currencies appreciate temporarily. However, since Decem-ber the fundamentals theme has returned more quickly than anticipated. Indeed investor sentiment has improved by signs of activity bottoming out almost everywhere but Europe, and major central banks including the ECB injecting vast liquidity to the banking sector to avert possible shortages and keep bond yields low. Moreover, while we regard several currencies enjoying good fundamentals as slightly overvalued on a historical relative basis, and with the risk of correction compounded by the still unresolved European debt crisis, we expect under-lying risk sentiment to remain supportive and would still buy them on weakness. Like any other USD pair the EUR/USD has traded with a positive correlation to changes in general risk appetite. However, since December this relationship has been less clear with the EUR continu-ing to depreciate against the USD despite a general improvement in risk appetite. While this may only be a temporary development it suggests ongoing political uncertainty within the euro-zone may have a less significant impact on general market sentiment going forward. The SEK has rallied against the euro beyond most positive forecasts including our own short-term projections. Weak Swedish Q4 2011 data will limit SEK gains near-term. However after a period of consolidation, we expect further appreciation supported by a flight to fundamentals. We still see long-term fair value in EUR/SEK between 8.30-8.50. The trade-weighted Norwe-gian currency (I44) is weaker than Norges Banks own forecasts, we expect more range-trading in EUR/NOK but NOK strength will eventually prevail.
BASKET TRADE: BUY TOP 3 VS BOTTOM 3
As usual we recommend buying the top three vs. the bottom three currencies. This time AUD, SEK and CNY are bought vs HUF, GBP and EUR sold.
BUY THE FUNDAMENTALS BASKET
We expect currencies with a strong fundamental outlook to continue to appreciate based on reserve manager diversification flows. We have recommended this basket before (AUD, CAD, SEK & NOK vs EUR, USD, JPY & GBP) and see substantial long-term gains of at least 10%. Further-more, based on SEBEER, the portfolio is not considerably overvalued.
SELL NZD/NOK
NOK has been an underperformer the last two months as Norges Bank cut rates in December and as the flow picture has continued to be weaker than anticipated. The Kiwi on the other hand has been the G10 star performer despite hardly impressive economic fundamentals. We target a move back towards 4.50.
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SEB tech team