The Scourge of Negative Rates And Norway's Shrinking Wealth Fund

By Mikael Holter at Bloomberg

Norway’s massive wealth fund is projected to get smaller this year for the first time since early last decade.

Budget documents on Wednesday showed the government expects the fund to shrink about 4 percent to 7.15 trillion kroner ($881 billion) at the end of 2016 after ending last year at 7.46 trillion kroner.

This historic projection comes as the fund is being bludgeoned on nearly all sides. Most pressing is probably that its returns from the 35 percent it must hold in bonds has all but evaporated amid negative yields across Europe. A rebound in the krone could also press down its value domestically as its foreign investments become worth less.

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"The fixed-income part has low returns in a situation where the bond yields are as low as they are and there’s been a lot of turbulence in the stock markets,” Finance Minister Siv Jensen said in an interview on Wednesday. “But over time, the results of the global pension fund have been very good, and we are a long-term investor and can handle short-term fluctuations."

The government is also this year making its first withdrawals from the fund as a slump in oil prices has sapped revenue and forced it to tap its piggy bank to ward off a recession. In its revised budget the government said it would withdraw 84 billion kroner from the fund as part of the 206 billion in oil money it plans to spend to support the economy.

In a budget footnote, the government said that its projections for the size of the fund assumes a gradual increase in oil money spending until it hits the 4 percent fiscal policy ceiling of the fund’s value. Spending will be 2.8 percent of the fund this year, close to a 3 percent long-term real return its managers have said they could manage.

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The fund is also facing headwinds from a possible recovery in the krone. Since the fund invests abroad, a stronger krone reduces its value in its home currency. The krone has plunged along with oil prices in recent years but now as crude has risen it has rallied about 4 percent since January, on a trade-weighted basis.

The managers of the fund are prepared and have warned repeatedly that meeting a 4 percent real return target will be difficult. Governor Oeystein Olsen has said that it has probably peaked in terms of its size relative to gross domestic product.

The question now is if he’s prepared for it to shrink?

“The fund is definitely prepared for the new scenarios,” Olsen said in an interview on Thursday. “There’s no drama in the fact that this year there may not be an inflow to the fund; it’s a contraction the other way, from the fund to the budget. But they are not taking from the fund capital, it’s part of the system that they can spend the real return.”

Source: The Scourge of Negative Rates and Norway's Shrinking Wealth Fund - Bloomberg

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