Over the last six months, we’ve documented Sweden’s descent into the Keynesian Twilight Zone in great detail.
Once upon a time, the Riksbank actually tried to raise rates, only to be lambasted by a furious Paul Krugman who accused the central bank of unnecessarily transforming Sweden from “recovery rockstar” to deflationary deathtrap. Tragically, the Riksbank listened to Krugman and reversed course in 2011. Before you knew it, rates had plunged 35 basis points into NIRP-dom. Unemployment subsequently fell, but the promised lift in inflation didn’t quite pan out. Sweden did, however, get a massive housing bubble [13] for their trouble:
h/t @auaurelija [14]
Obviously, those charts beg the question of why in the world Sweden (or Denmark [15], or Norway [16] for that matter... or hell, even the US) are trying to contend that there's no inflationary impulse, but let's leave that for another day.
As for the Riksbank’s QE program, things began to go awry [17] during the summer when the central bank managed to buy such a large percentage of the stock of government bonds that market depth was affected, causing investors to reconsider the trade off between liquidity and the benefits of frontrunning central bank asset purchases. In short, government bond yields began to rise in what perhaps marked the first instance of QE actually breaking.
But that didn’t stop the Riksbank from doubling down [18] and increasing their asset purchases just a week later.
Since then, it’s been touch and go, with Stefan Ingves looking warily [19] south towards Frankfurt hoping Mario Draghi doesn’t do something that sends the krona soaring on the way to ushering in a deflationary impulse.
Well, that’s exactly what Draghi did last week when the ECB telegraphed either a further depo rate cut, an expansion of PSPP, or both in December. That pretty much sealed the deal for the Riksbank - either cut, expand QE, or concede defeat in the global currency wars.
Not ready to throw in the towel just yet, the Riksbank has just expanded QE by SEK65 billion while keeping the repo rate on hold (for now anyway). Here’s some color from the statement:
“There is still considerable uncertainty regarding the strength of the global economy and central banks abroad are expected to pursue an expansionary monetary policy for a longer time. An initial raise in the rate will be deferred by approximately six months compared with the previous assessment. The trend of rising inflation is expected to continue. But compared with the assessment at the previous monetary policy meeting, the inflation forecast has been revised down slightly. This depends on poorer inflation prospects abroad as well as on a new assessment that demand needs to be stronger in Sweden in order to stabilize inflation.”
And the knee jerk reaction in Swedish 10s (which are apparently risk-free [20] even though other sovereign debt is not):
Here’s some color from various analysts via Bloomberg whose summary can be found here [21]:
- Riksbank probably needs to buy other types of assets than government bonds if it wants to expand QE further next year, Anna Breman, economist at Swedbank, says by phone.
- Expects Riksbank to continue to expand QE in 2016
- Even if borrowing needs are raised next year, Riksbank will probably need to expand bond purchases into assets such as municipality or covered bonds; hard to see that borrowing needs would rise to extent that it could buy more govt bonds
- Riksbank’s govt bond purchases will now be “very high” at about 34% of total stock
- Development of krona will be very important for Riksbank
- Handelsbanken sees “no more changes in monetary policy in this cycle” after Riksbank expanded bond purchases while keeping repo rate unchanged.
- Given unchanged probability of additional rate cuts and repo rate closer to lower bound, “we should see low probability of additional rate cuts priced by the market”
- Still, after ECB “left the door wide open for additional stimulus at the December meeting, the Riksbank may experience trouble toward year-end”
- Says Riksbank is close to bottom regarding repo rate given concerns about Sweden’s housing market; extension of bond purchase program in 3Q to pare ECB’s purchases would therefore “be preferable if the Riksbank deems this necessary to reach the inflation rate target”
- Handelsbanken suggests buying SEK against EUR
- The Riksbank was softer and the QE expansion larger than Nordea had expected, Torbjoern Isaksson, economist at Nordea, says by phone.
- Nordea had expected additional bond buying of SEK35b while Riksbank expanded government bond purchases by SEK65b
- Riksbank is haunted by krona, soft ECB; krona important part of strategy to lift inflation.
- Nordea still believes in further repo rate cut in Dec.; doesn’t expect Riksbank to expand bond purchases further
Got all of that? Here's the short version: Sweden has to figure out a way to keep the krona from soaring now that further ECB easing looks like a virtual certainty, otherwise, inflation will flatline (the housing bubble notwithstanding). Cutting the repo rate further risks exacerbating the housing bubble but at 34% of outstanding issuance, QE is almost exhausted lest the Riksbank should break the government bond market entirely and risk another episode like that which unfolded during the summer when bond yields started to move in the wrong direction. Further, there's no way government borrowing needs in 2016 are going to translate into enough new supply to satisfy the Riksbank's appetite. So, caught between a rock and a hard place, no one knows what Ingves will do next.
While this fourth expansion of QE may have a short-term effect on yields, we doubt whether it will be sufficient to bring about sustained krona weakness given the size of Draghi's bazooka (so to speak), which means that despite the various Catch-22s outlined above, the Riksbank will likely persist in the monetary madness for the foreseeable future, and on that note we close with the following from Stefan Ingves:
"If krona was to appreciate too quickly, it would be harder to get inflation to rise to target of 2%. Riksbank has more space on repo rate, can cut rate further. Riksbank not worried about running out of assets to buy.”
