Europe's Best Currency (Hint: It's Not the Euro)

When it comes to high-yield investments, few instruments have surpassed emerging market currencies over the past two years or so. As equities and commodities struggled, BRIC (Brazil, Russia, India and China) currencies soared. The Russian ruble (RUB) turned in an 18% return in 2009, while the Brazilian real (BRL) gained 30%.

Naturally results like those have garnered a lot of press – especially with major currencies like the euro (EUR) and British pound (GBP) offering just single-digit returns. But all the hoopla has given investors a bad case of tunnel vision. Their focus on emerging markets has led people to ignore interesting investment opportunities in more developed economies.

Perhaps the biggest victim of investors’ myopia is Sweden. With plenty of positive underlying economic fundamentals and potential for interest rate increases in the short term, the Swedish krona (SEK) is worth a closer look.

For one thing, Sweden’s economy is on its way to full recovery from the global recession. As an exporting nation, it boasts an almost $1.6 billion trade surplus. Rising demand for raw materials like timber, iron ore and copper have significantly helped boost the $130.5 billion exports sector.

A diversity of trading partners has also helped. Bigger and more developed economies tend to have a few main trading partners. For instance, China and Mexico combined represent 35% of the US export trade. But for Sweden, export trade is fairly shared among trading partners. Germany, Denmark and Norway lead the two-way trade with Sweden, with the Netherlands following not too far behind. This diversity is likely to keep the Swedish economy protected should any major trade partner fall on harsher economic times.

A strong export trade sector and rising services industry will help any economy’s growth prospects. For Sweden, it means an estimated growth rate of over 4% growth this year. And it expects continued positive pace of growth as the economy expands an average of 3.2% over the next two years, fueled by double-digit growth rates in industrial production. That’s more than double the recent assessment of US growth. And since foreign direct investors love higher rates of economic expansion, even more opportunity is likely to surface in the Nordic nation in the near future.

Another point in Sweden’s favor is its status in the European Union. It is part of it, but has not adopted the euro as its currency. That means its Riksbank, the world’s oldest central bank, has a free hand in monetary policy.

Even with that power, benchmark interest rates in Sweden are some of the lowest in the European Union. But with high growth rates, that is likely to change. In fact, the Riksbank raised interest rates by 25 basis points, or 0.25%, at its meeting last month. This brings the country’s benchmark rate to 0.75%, or 50 basis points higher than rates in the United States. Higher interest rates in the near future will only ensure higher rates of yield for investors.

On top of all that, Sweden’s inflation rate is set to rise towards 2% over the next two years. To fight it, policymakers are expected to keep raising benchmark-lending rates. An influx of investment dollars into the country looking for higher yields will help to spur the Swedish krona.

So, putting it all together, we have an economy that is supported by high export demand, which is helping a robust domestic recovery. That success will force higher interest rate considerations and boost medium-term currency appreciation.

There isn’t much more to consider when looking for an investment in an economy and its currency. The krona is already up 11% against the US dollar since its June 2010 low of 8.1400 – but more appreciation is expected. If Sweden’s economy continues to defy expectations, the krona could soar.

Richard Lee
for The Daily Reckoning