The Swedish krona and Australian dollar look set to lead foreign exchange markets through the recovery phase following the coronavirus crisis, according to ING analysts.
With coronavirus curves beginning to flatten and countries slowly starting to ease lockdown restrictions which have ravaged the global economy, strategists are looking to identify which economies could recover first and which may be saddled with a hangover from the crisis.
Strategists at Dutch bank ING are backing "pro-cyclical" currencies which do not have exposure to oil to outperform in what they believe will be a "U-shaped" recovery. They also believe the dollar is looking vulnerable.
Pro-cyclical currencies are those which tend to correlate with economic fluctuations. Meanwhile, oil prices have plunged at an unprecedented rate as the coronavirus pandemic continues to hammer demand, leaving currencies in major exporting countries — such as Russia and Nigeria — floundering.
"The SEK and AUD are both under-valued on our medium-term valuation model, are positively correlated with a steeper yield curve in a recovery phase and aren't saddled with exposure to oil," ING Global Head of Markets Chris Turner said in a note Thursday.
Broadly, ING analysts favor G-10 (group of 10) currencies over emerging markets in the early stages of recovery, when sovereign balance sheets — or the strength of a country's finances — will be more important.
Central banks worldwide have embarked upon aggressive easing of monetary policy in a bid to shore up their economies against the fallout from the pandemic.
However, Turner highlighted that the Swedish Riksbank had lagged its G-10 peers by extending quantitative easing but resisting cuts to interest rates, thereby reducing the negative rate differential versus its peers. A host of countries have cut rates into negative territory, while the Riksbank has held its repo rate firm at zero.
When combined with its lack of exposure to commodity prices, this renders the krona well positioned for a "cautious recovery in sentiment towards G-10 currencies in coming months" and makes it the most attractive in this group of 10 major economies, according to ING's models.
ING analysts compiled a foreign exchange scorecard based on five primary factors: current valuation, real rates, correlation with the U.S. yield curve, exposure to oil markets and sovereign credit ratings.
As of Friday morning, the krona was trading at around 9.78 to the dollar. Since the start of the year the greenback is higher by 4.6% against the Swedish currency, but the dollar has fallen more than 2.6% against the krona this week.
The Australian dollar was ranked second by ING when compared to the other G-10 currencies. Having already pared most of its first-quarter losses and with relatively strong fundamentals, ING's models anticipate that it will likely continue to lead any additional risk recovery in the group.
ING identified several key factors in favor of the Aussie, the first being the massive 320 billion Australian dollar ($209.7 billion) relief package deployed by the federal government, amounting to around 16% of GDP (gross domestic product). Meanwhile, the central bank has already begun tapering its asset purchases and indicated that economic conditions are improving.
"Australia's biggest export, iron ore, is proving particularly resilient thanks to relatively stable demand from China and lingering supply shortage from Brazil," Turner outlined in the note, adding that the country's success so far in flattening its coronavirus contagion curve may further bolster its recovery prospects.
As of Friday morning, the Aussie was trading at around 0.645 against the U.S. dollar. Since the start of the year it has fallen by more than 8%, but has gained around 0.8% this week.
The world's most liquid currency, the U.S. dollar, has been boosted by a mass flight to safety for investors during the coronavirus pandemic, however, it scored poorly in ING's models.
"Consistent with our views that the dollar will underperform during a recovery phase, our scorecard shows the dollar performing poorly in valuation, real rates and yield curve steepening episodes," Turner wrote.
Although up by around 2.7% since the start of the year, the U.S. dollar currency index has fallen by around 1.4% in the last week.
The flattening of coronavirus curves, plans to reopen economies and aggressive action from monetary and fiscal policy makers have combined to bring gauges of market risk down from their peaks in mid-to-late March.
"Volatility levels are declining across the board and the USD Libor-OIS spread, a metric of inter-bank funding stress, is now at levels not seen since early March," Turner highlighted in the note. "These developments will mean that in the FX space investors will be starting to re-assess their positioning."