Invesco’s Batty: Sweden faces hard choices ahead
Invesco’s Multi Asset fund manager Richard Batty takes a closer look at the macro situation in Sweden and investment implications for the Invesco Perpetual Global Targeted Returns Fund.
We currently have two ideas in the portfolio of the Invesco Perpetual Global Targeted Returns Fund that reflect views on the Scandinavian region. One sees us buying the Swedish 10-year swap rate while selling a Euro 10-year swap rate as we believe Swedish government bonds look interesting relative to rival economies like the eurozone.
A recent trip to Stockholm and meetings with a variety of experts from central banks, national debt office, business lobbies and economic think-tanks were an opportunity to refresh the team’s views.
The policy debate in Sweden is a complex one, weighing up large disinflationary pulses and very low inflation, with an extended housing market. Poor productivity and corporate pricing power also contrasts with a strong income and credit driven consumption outlook.
I believe these dynamics cannot continue for too long. In the future, either wage inflation has to moderate, unemployment will rise (from a relatively high 8%) or corporates will regain pricing power by raising prices (the Riksbank believes the latter is the most likely outcome). Personally, I am sceptical on this latter point as competitive pressures remain high for the wider corporate sector.
The Riksbank has signalled a likely cut in interest rates in July, however, this is inflation data and ECB policy dependent. Surprisingly, there appears to be a complete lack of debate about the risks of deflation and this at a time when 90% of the inflation basket is rising at less than 1% and service sector inflation has been falling noticeably. A phenomenon that nobody (in Sweden at least) appears to be able to explain. Supply side economic reform is happening slowly, which should marginally help productivity growth longer term.
Figure 1. Swedish CPI headline inflation (YOY)
Source: Bloomberg, 8 June 2014
Seventy per cent of exports go to ‘good’ Europe plus the US, and the economy is running a current account surplus, however, this is vulnerable to a stronger Swedish krona. The industrial sector’s size remains 30% smaller than before the Global Financial Crisis, which Sweden didn’t really participate in as it had its banking crisis in the early 1990s.
Banks remain increasingly well capitalised with low impairments. Mortgage LTVs have also been reduced to 85% and macro prudential policies are starting to be enacted, though their rigour is likely to be increased after the September general election.
Sweden faces a number of hard choices in the years’ ahead – vulnerable house prices, if incomes and credit become constrained, poor productivity and the spectre of deflation. Its economic model has to change for it to compete globally.
The relaxed attitude of the authorities to imminent interest rate decisions, with cuts more likely, make government bonds look interesting relative to rival economies like the Eurozone. The SEK is vulnerable relative to some crosses, though it has cheapened up. This is supportive of our relative idea in Swedish government debt where we are buying the Swedish 10-year swap rate while selling a Euro 10-year swap rate.