Strategy Research Sweden: On the radar

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Holly Heath
6 years ago
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1 Strategy Research Sweden: On the radar This publication is a summary of interesting market related topics and observations that have been covered and discussed within the Strategy Research group, but not necessarily yet formalized in form of a specific view or trading idea Themes in this edition: USA: will a stronger USD kill the inflation forecasts for 2015? SEK rates: twisted relations, a trade for the drawer SEK covered: richness supported, but US High Yield scare can create a wobble SEK linkers: a proxy for SEK 5yr5yr fwd BEI tightener Basis swaps: opportunity to sell front end EURUSD basis FX: the danger of looking for a rebound in EURUSD Central banks: policy rate paths, we re on the road to nowhere Swedish election update: Löfven will do whatever it takes 29 September 2014

2 Chart of the week: index extension drives BEI curve decoupling Nov11 May12 Dec12 Jul13 Jan14 Aug SE BEI 5s5s generic (lhs) EUR zcpn infl 5y5y (rhs) While EUR forward break even inflation has re entered sub 2% territory, Swedish forward BEI has reached new highs. The main reason behind the richening of Swedish 10yr linkers is likely the index extension in December (see more on page 7 ) 2

3 USA: will a stronger USD kill the inflation forecasts for 2015? Indicators point to higher wage growth in 2015, companies signal price increases and rents are going up. So, accordingly, the Nordea forecast is gradually rising core inflation. But indicators are not yet at levels where core PCE inflation (the Fed favorite) surpassed 2% in the past. Yellen often points to the quit rate (the share of unemployed that is voluntarily unemployed), which still is far from the level that has prompted compensation to reach a more inflationary % y/y. And the same is true for NFIB, where the latest move actually was a big drop. These indicators need to rise. But is that enough in the new strengthening USD environment? The last 20 years, a marked WEAKENING of USD has been needed for 2%+ core PCE inflation. Keep it on the radar 3

SEK rates: twisted relations, a trade for the drawer SEK 5s/10s flattener against 5yr USD receiver and 10yr EUR payer 2 200 1 0 - - -1 SEK 5yr5yr (vs EUR) - SEK 2yr3yr (vs USD) -200 Jan 00 Sep 02 Jun

4 SEK rates: twisted relations, a trade for the drawer SEK 5s/10s flattener against 5yr USD receiver and 10yr EUR payer SEK 5yr5yr (vs EUR) - SEK 2yr3yr (vs USD) -200 Jan 00 Sep 02 Jun 05 Mar 08 Dec 10 Sep 13 Jun 16 4 Source: Nordea The market prices in a totally different future for the Fed and Riksbank, which has left SEK vs USD 5yr spreads at historical wides. At the same time, the 10yr sector in Sweden is at historically cheap levels vs EUR In the scenario where Fed (and/or BoE) begin hiking rates, there is certainly room for some risk premia on the belly of the SEK curve as well, while ECB QE may be a trigger for higher medium term EUR forward rates. Conversely, if the pricing of Fed will prove to be too hawkish and pre mature, there is notable potential for US 5yr to rally, while there is not much juice left in either SEK or EUR As such, paying SEK 2yr3yr fwd (or sell 5yr bonds) vs USD and receive SEK 5yr5yr (or buy 10yr bonds) vs EUR looks like an interesting strategic trade that also provides a substantial yield pick up (180bps, with flat roll, see chart below) Pick-up SEK vs USD 2yr3yr (rec SEK) Roll 1yr Pick-up SEK vs EUR 5yr5yr (rec SEK) Roll 1yr -75 Jan 13 Jul 13 Feb 14 Aug Source: Nordea

5 SEK covered: richness evident but near term support exists SEK covered vs swap 5y, lhs Avg SEK credit yield vs swap, rhs Earlier this year, SEK covered bonds lagged the richening in credits, but have now catched up and the richening is evident in a comparison with govies and pfandbriefe. Near term, however, the richness is supported by ECB bond buying and the prospects of further Riksbank easing Cheap Rich y covered ASW rich/cheap vs Pfand 2y covered ASW rich/cheap vs Pfand yr covered vs govie spread, rhs 3mth RIBA future

6 SEK covered: watch US High Yields, that can create a wobble! S&P 0 Index ishares iboxx $ High Yield Index, rhs SHB Covered Bond Index Total Return (rebase 08/13) iboxx $ High Yield Index (rebase 08/13) The development in US High Yield has yet again proved wobbly, highlighting the poor underlying liquidity in the asset class In turn, it has increased the tension also in equities, due to the suspicion that investors may have to look at other asset classes when reducing risky asset exposure (such as small cap equities) because it is too expensive to unwind the preferred amount of corporate bonds From both a valuation and a Fed perspective (i.e. tapering and prospective rate hikes), it s reasonable to expect this wobbliness to continue and eventually, it may even seek its way into Swedish spread over, as the bottom two charts suggest yr SGB ASW spread, rhs ishares iboxx $ High Yield Index

7 SEK linkers: a proxy for Swedish 5yr5yr forward BEI tightener While EUR forward break even inflation has re entered sub 2% territory, Swedish forward BEI has reached new highs. The main reason behind the richening of Swedish 10yr linkers is likely the index extension in December There is no pure way of expressing a view on Swedish 5yr5yr break even inflation in the index linked market. However, one can implement a proxy; for example, a trade on lower SEK 5yr5yr inflation can be constructed by: sell SGBi 3109 BEI (SGB 1058 as nominal comparator) buy SGBi 3102 BEI (SGB 1047 as nominal comparator) sell 123 % the DV01 in 3109, compared to % DV01 in 3102 The P/L in that spread will mimic the P/L in a 5y5y fwd BEI very closely, which is illustrated in the chart to the right: Nov11 May12 Dec12 Jul13 Jan14 Aug14 SE BEI 5s5s generic (lhs) EUR zcpn infl 5y5y (rhs) Nov11 May12 Dec12 Jul13 Jan14 Aug14 SE BEI 5s5s generic (lhs) 3109/1058 vs 3102/1047 (123% risk i 3109 vs % risk 3102) (rhs)

Basis swaps: opportunity to sell front end EURUSD basis The 3m EURUSD basis has

This should partly be driven by the disappointing TLTRO uptake, resulting in

reach its balance sheet target should argue for a higher probability that the

Timing wise, selling front end EURUSD basis swaps ahead of quarter end

8 Basis swaps: opportunity to sell front end EURUSD basis The 3m EURUSD basis has continued its tightening trend and decoupled further from the currency. This should partly be driven by the disappointing TLTRO uptake, resulting in liquidity conditions being somewhat tighter than expected, but also by quarter end coming up. Going forward, we think that front end basis swaps are an interesting way to play increased QE speculation. All else equal, lower market inflation expectations and pressure on the ECB to reach its balance sheet target should argue for a higher probability that the central bank delivers in large scale. Timing wise, selling front end EURUSD basis swaps ahead of quarter end (Wednesday) is an interesting bet ahead of Thursday s ECB meeting EURUSD 3m basis EURUSD, rhs ECB Sep meeting Jan 2013 Sep 2013 May 2014 Jan 2015 Source:Nordea & Bloomberg Liquidity typically eases in EZ after month-end 8

9 FX: the danger of looking for a rebound in EURUSD There are many viable reasons for a short term rebound in EURUSD; positioning is turning extreme, technicals, QE potentially resulting in EUR inflows etc While we don t disagree, it s also worthwhile to acknowledge that the ECB would likely gladly see the currency move extended and we would prefer to be positioned along the interest of the central bank rather than against it. The 3m EURUSD forecast was revised lower last week from 1.32 to 1.24 (see Martin Enlund s comment in Markets in a QE mood ) and the option market still makes it relatively cheap to go for the downside. The coming 3m period covers AQR/stress test results, the 2 nd TLTRO, 3 important ECB meetings and Fed ending tapering. Being long vol (and positioned for the downside) may not be a bad idea even if it has rebounded from the lows this summer 9

10 Central banks: policy rate paths, we re on the road to nowhere In the words of David Byrne & Talking Heads: We re on the road to nowhere, come on inside. Takin that road to nowhere, we ll take that ride Forward guidance in a world where no one can predict the future, come on Markets have since long drawn this conclusion; seen in the divergence between guidance and money market curves in for example Sweden (1 bps below Riksbank 2017) and USA (125 bps below Fed 2017). What is worse; not even the central banks seem to believe their own rate paths anymore! Yellen repeatedly tells the market not to listen to the median Fed projections. What s new is that even the Riksbank (incl. governor Ingves), that has been a very strong advocate of publishing a rate path, admits that it is pointless to look at it further out than 6 12 months Repo rate Market implied repo rate Riksbank rate path Jan 11 Jan 12 Dec 12 Dec 13 Dec 14 Dec 15 Dec Now Source:Riksbank, Nordea, Bloomberg % Market pricing and the Fed Implied fed funds futures rates % And Norges Bank s rate path is so volatile it should make markets ignore it. NOK moves a tad, commercial banks adjust their lending margins marginally, and Norges Bank surprise the market yet again with a shift in its rate path. So, follow the rate paths and you ll get to nowhere faster than you can say fan chart. Common sense vs Monetary policy academics Aug-17 Jul-17 Jun-17 May-17 Apr-17 Mar-17 Feb-17 Jan-17 Dec-16 Nov-16 Oct-16 Sep-16 Aug-16 Jul-16 Jun-16 May-16 Apr-16 Mar-16 Feb-16 Jan-16 Dec-15 Nov-15 Oct-15 Sep-15 Aug-15 Jul-15 Jun-15 May-15 Apr-15 Mar-15 Feb-15 Jan-15 Dec-14 Nov-14 Oct-14 Sep-14 Median FOMC forecast

11 Swedish election update: Löfven will do whatever it takes ItisclearthatStefanLöfvenandtheSocialDemocrats will be forming government together with the Green Party, that was Löfven s message to the speaker last week. Tha Löfven will do whatever it takes to govern seems to be his vision, as he has made an implicit guarantee that he can get the S + G(reen) Budget Bill through Parliament with the assistance from the Left party. Theopposition,theAlliance+SD,willnotobjectto Löfven being elected Prime minister this week despite that he is somewhat fraudulent and only have indicated that he is willing to manifest a soft coalition with the Left. At this point, we see no reason to question Löfven s negotiation ability since the speaker has given him a go ahead. Although we still emphasize the difficulty in striking a deal with the Left Party that is sufficient for the Left party not to create mutiny within their electorate and at the same time, the struck bargain can t be too controversial in order to leave the door open for support from the Alliance in the future. 11 We expect a Red and Green budget to be presented on the 24th of October. Their bill will compete with the bill put forward by the Alliance and the one from the Swedish Democrats (SD). The most likely outcome is that SD and the Alliance will unsuccessfully vote for their respective bill. S+MP + V will vote for their Red/Green alternative as the Left party will not present a budget bill of their own. A cross party support for the Alliance from the kingmaker SD is not likely since the alliance budget is very generous in terms of funds for immigration and integration issues. The parliamentary situation communicates a future with consensus politics and watered down negotiations in order to pass legislation. The risk of re election further down the road can not be ruled out since there is a situation of a majority of right wing parties (the Alliance + SD) in Parliament. The abracadabra of minority government will result in very few rabbits being pulled out of the hat. We still argue for a combo of risk premiums in the Swedish krona where political uncertainty is one but also the continued soft bias from the Riksbank.

12 Thank You! Nordea Markets is the name of the Markets departments of Nordea Bank Norge ASA, Nordea Bank AB (publ), Nordea Bank Finland Plc and Nordea Bank Danmark A/S. The information provided herein is intended for background information only and for the sole use of the intended recipient. The views and other information provided herein are the current views of Nordea Markets as of the date of this document and are subject to change without notice. This notice is not an exhaustive description of the described product or the risks related to it, and it should not be relied on as such, nor is it a substitute for the judgement of the recipient. The information provided herein is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase or sale of any financial instrument. The information contained herein has no regard to the specific investment objectives, the financial situation or particular needs of any particular recipient. Relevant and specific professional advice should always be obtained before making any investment or credit decision. It is important to note that past performance is not indicative of future results. Kristoffer Eriksson kristoffer.eriksson@nordea.com Fredrik Floric fredrik.floric@nordea.com Mats Hydén mats.hyden@nordea.com Mikael Sarwe mikael.sarwe@nordea.com Henrik Unell henrik.unell@nordea.com Nordea Markets is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction. Alexander Wojt alexander.wojt@nordea.com This document may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Markets. 12

Themes in this edition:

Themes in this edition: Strategy Research Sweden: On the radar This publication is a summary of interesting market related topics and observations that have been covered and discussed within the Strategy Research group, but not