Danske Bank 2018 Fixed Income Top Trades

Transcription

1 Investment Research Danske Bank 2018 Fixed Income Top Trades Arne Lohmann Rasmussen Head of Fixed Income Research Jens Peter Sørensen Chief Analyst Jostein Tvedt Chief Analyst Marcus Söderberg Senior Analyst Jan Weber Østergaard Chief Analyst Christina E. Falch Senior Analyst Carl Milton Senior Analyst Mathias Røn Mogensen Analyst 6 December Important disclosures and certifications are contained from page 25 of this report

2 2018 Fixed Income Top Trades overview 1. Sell 1Y10Y ATMS EUR straddle 2. 1Y forward 2Y-10Y flattening of the USD swap curve 3. USD money-market curve forward steepener 4. Buy the Bund spread at 48.5bp 5. Long periphery versus core-eu 6. Buy 30Y 2% callable bonds against DGBs 7. Buy 5Y non-callable bonds against DGBs (enter late December) 8. Buy Danish BEI spread 9. Buy 10Y DGB/receive 10Y DKK swaps vs EUR/EU peers 10. Buy SGB 1.5% 11/23 (SGB1057) vs Bobl 11. Receive MAR-19 SEK RIBA 12. Receive 1Y1Y USDSEK CCS 13. Receive 1Y1Y SEK vs EUR and pay 5Y5Y NOK vs EUR 14. Receive 1Y1Y USDNOK CCS Note: All prices/quotes are indicative mid-prices 2

3 Looking back on our Fixed Income Top Trades for of 19 Fixed Income Top Trades for 2017 were closed with profit Trades Opened Closed P/L #1: 10Y-30Y 5Y fwd EUR swap steepener* 30/11/ /09/ bp #2: Lower 1Y1Y real rate (rec 1Y1Y eonia vs higher 1Y1Y inflation) 30/11/ /01/ bp #3: Steeper EUR swap curve 3Y10Y 6M fwd* 30/11/ /06/2017 8bp #4: Long France versus swaps Long France versus the Netherlands 30/11/ /04/ /06/2017 #5: Long only recommendations Danish covered bonds** 30/11/ /01/ bp #6: Relative value trade DK mortgages - Buy against 10Y EUR swaps 30/11/ /12/2016 DKK 1.33 #7: Relative value trade DK mortgages - Buy against 10Y EUR swaps 30/11/ /12/2016 DKK 0.85 #8: Exploit steep money market curve and receive SEK 3Y1Y* Note: Moved into receiving SEK 1Y1Y (at 25/08/2017) 4bp 6bp 30/11/ /12/ bp #9: Receive 1Y1Y EURSEK CCS* 30/11/ /06/ bp #10: Long 6Y NGB vs. Germany with an open FX exposure (P&L on bond/currency gain in %) 30/11/ /12/ bp/-9% #11: Buy EUR 5Y30Y payer ATMF and sell EUR 5Y10Y payer ATMF+11bp (ratio of 1:2.58)*** 10/02/ /09/ bp #12: Pay 5Y5Y EUR swap and receive 5Y5Y EUR inflation swap* 10/02/ /06/ bp #13: Sell 1Y1Y SEK payer ATMF* 03/03/ /06/ bp #14: Receive 3M1Y EURUSD CCS* 02/08/ /09/2017 3bp #15: Pay SWAP 5Y USD3M* 16/08/ /08/ bp #16: Pay 2Y/5Y/10Y USD fly 1Y fwd* 19/09/ /12/ bp #17: Pay USD/JPY 3M1Y CCS* 19/09/ /11/ bp #18: Pay 5Y5Y NOK vs EUR* 18/09/ /12/ bp #19: Buy 2W10Y ATMF EUR payer swaption* 19/10/ /10/2017 2bp * The estimated P&L includes roll-down ** Based on Danske Bank s Mortgage Index relative to EFFAS 3-5Y DKK government bond index *** This is reported as bp of the notional on the long leg of the trade, i.e. the bought 5Y30Y payer and is therefore NOT bpv or delta adjusted 3

4 Central bank and market overview 4

5 Fed and USD yield outlook Tighter liquidity, gradual hiking, non-negligible reinvestments and low neutral rate The Fed has begun the process of shrinking the balance sheet. In combination with rebuilding the Treasury cash balance at the Fed, this should lead to tighter USD liquidity. We recommend positioning for tighter USD liquidity in Trade 12 and Trade 14. In line with consensus, we expect the Fed to hike in December, as the core voting FOMC members put more weight on labour market data than on current inflation data. Jerome H. Powell has been nominated to succeed Janet Yellen as Fed Chair and is considered to be in the same neutral rate camp as Yellen. Hence, we believe he will vote for two rate hikes in 2018 if the economy evolves as expected. We expect a continued flattening of the USD yield 2Y-10Y curve in The short end could be pushed higher by Fed rate hikes, while, in our view, the long end could be kept low by investors buying high yielding US fixed income assets, significant Fed reinvestments in 2018 despite QT, subdued inflation expectations and a lower neutral rate (currently 2.75% according to Fed). As such, we recommend positioning for a flatter 2Y-10Y USD swap curve 1Y forward in Trade 2. Fed began quantitative tightening in October 2017 Source: Federal Reserve, Danske Bank, Macrobond Financial Fed was repriced in September and October Source: Bloomberg, Danske Bank, Macrobond Financial 5

6 ECB and EUR yield outlook: no tapering sell-off despite tapering The ECB is set to end QE purchases by end-2018 and start a very gradual hiking cycle in Q2 19. We expect it to deliver the first 10bp deposit rate hike in Q2 19, broadly in line with current market pricing. Despite lower QE from the ECB in 2018, we do not expect to see a tapering sell-off. The net before QE supply in Germany is still negative in QE redemptions should also be Bund supportive in We recommend positioning for a widening of the Bund spread in Trade 4. A slow normalisation by the ECB and macroeconomic stability favour carry and we keep a positive view on periphery bond markets for example, where we recommend buying the new 10Y bonds in Italy and Portugal in Q1 in Trade 5. We expect inflation to stay low in It underlines that the forward guidance from the ECB is credible. However, the risk is that the market will price a steeper normalisation path. The 5Y point could be exposed in such a scenario. The ECB is still keeping a tight leash on the 2Y point and we expect a modest 2Y10Y steepening of EUR swaps in Y10Y in EUR swap could flatten. Cautious tapering of QE purchases in Q4 18 Source: Federal Reserve, Danske Bank Inflation set to stay low in 2018 too Source: ECB, Danske Bank 6

7 Riksbank and SEK yield outlook: inflation and growth have peaked We expect the Riksbank to announce an exit of the QE programme at the December meeting and do only reinvestments going forward. Contrary to market expectations and consensus, we expect the Riksbank to keep the repo rate on hold until 2019, following the ECB closely. Few signs of an acceleration in wages and modest wage agreements will continue to weigh on inflation. Thus, fundamental factors speak in favour of inflation moving back towards 1.5% y/y. This is not consistent with rate hikes. The housing market is cooling off and poses a risk to the growth outlook (as well as inflation outlook). A correction of 15-20% is not unlikely and in such a scenario growth could end up being well below trend. We still like to receive the steep Swedish moneymarket curve. In Trade 11, we recommend receiving the Mar-19 SEK RIBA. In Trade 13, we recommend receiving 1Y1Y relative to EUR (against paying 5Y5Y NOK vs EUR). In Trade 10, we recommend buying the 5Y SGB versus Bobl. Market pricing close to Riksbank s view on repo rate path, which assumes higher residential prices Dec-16 Apr-18 Aug-19 Short end rate spreads move with core inflation << Spread 1Y1Y SEK vs EUR 25 Diff CPIF exe vs. EUR Core CPI >> Jan-15 Sep-15 May-16 Jan-17 Oct-17 Jun-18 Source: Mediators office Riksbank repo path Market (RIBA+FRA)

8 Danish central bank and yield outlook: Still value in DKK FI Danish policy rates are set to remain below those of the eurozone given the Danish economy s strong fundamentals. We would not be surprised to see renewed FX intervention from the Danish central bank to weaken the krone in We forecast a further tightening of the spread between Cibor and Euribor fixings through a lower FRA-OIS spread in DKK relative to EUR a development we expect to tighten DKK-EUR swap spreads further. We expect a modest supply of DGBs in 2018, as funding needs remain modest and social housing will no longer be funded through government bonds. The CCS basis in DKK still makes short-dated DKK bonds attractive for foreign investors. We prefer to earn our carry in the Danish covered bond market and we expect continued strong foreign investor demand for mortgage bonds to add further support in If political uncertainty returns to the eurozone in 2018, Danish fixed income could benefit. In Trade 6 and Trade 7, we express our positive view on the DKK mortgage bond market. In Trade 8 and Trade 9, we recommend buying the Danish BEI spread and the 10Y DGB versus EU peers. Fixing spread set to tighten in 2018, which we expect to tighten the DKK-EUR swap-spreads further DKK-EUR swap-spread, bp Y swap spread 10Y swap spread 0 6m DKK-EUR fixing spread 5y5y swap spread Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Foreign demand for Danish covered bonds expected to continue growing in 2018 (foreign ownership, %) Source: Nationalbanken, Danske Bank 8

9 Norges Bank and NOK yield outlook: First one to hike We expect Norges Bank to lift the target rate by 25bp to 0.75% in December Norges Bank s Monetary Policy Report III-17 indicates that the most likely time for the first hike is mid The market is discounting an even slower normalisation of interest rates than suggested by Norges Bank s path (see chart). Norges Bank expects only a moderate increase in inflation, expecting it to stay below the 2.5% inflation target (see chart). The Ministry of Finance has signalled the release of a new Norges Bank mandate in The new mandate is likely to maintain a high degree of flexibility and will probably not change monetary policy short term. The current weak NOK will probably add some volatility to core inflation in The housing market appears to be the main risk to the recovery case for the Norwegian economy. We see a stabilisation of the housing market in the first part of 2018 supporting our call for a first hike in December In Trade 13, we recommend paying NOK 5Y5Y versus EUR (against receiving 1Y1Y SEK versus EUR). Norges Bank sees only moderately higher inflation Source: Norges Bank, Danske Bank The market and Norges Bank expect stable rates Oct-15 Apr-17 Oct-18 Apr Dec-13 Jun-15 Dec-16 Jun-18 Dec-19 Source: Norges Bank, Danske Bank 3m nibor historical Inflation Target CPI-ATE, Baseline Scenario, Central Bank of Norway, Estimate, Change Y/Y CPI, Baseline Scenario, Central Bank of Norway, Estimate, Change Y/Y Present market, 3m fwd nibor Norge's Banks 3 m nibor MPR III-17 9

10 Danske Bank Fixed Income Top Trades 2018

11 1: Sell 1Y10Y ATMS EUR straddle - Stable 10Y EUR rates in 2018 and continued low realised EUR rates volatility In October, the ECB opted for the low-for-longer QE programme extension, with asset purchases scaled down to EUR30bn per month from January 2018 to September A budget surplus in Germany points to a negative net supply of bonds. Hence, the lack of Bunds in the market is not about to go away in The Bank of Japan s 10Y yield target of around zero reduces volatility in global rates, as Japanese investors should continue to look abroad when hunting yield. In our view, equity and rates volatility are two different variables. An increase in VIX may lead to an initial knee-jerk increase in rates volatility from safe-haven fixed-income asset inflows. However, lower yields would eventually imply a smaller sample space for yields. Fundamentally, this should reduce, or at least not increase, rates volatility. Conclusion Sell 1Y10Y EUR6M ATMS straddle at (forward price) 375cts (c.40bp). P/L 225cts/500cts. 6M carry/roll 150cts. Risk factors A pickup in euro area inflation. Range trading set to continue in 2018 Steep EUR rates volatility term-structure* (in 10Y tails): solid roll-down if continued low rates volatility delivered bp 1M 2M 3M 6M 9M 1Y 18M 2Y 3Y 4Y 5Y Current curve (05-Dec-17) -3M (05-Sep-17) -6M (05-Jun-17) * Normal implied volatility reported as bp per year 11

12 2: 2Y-10Y 1Y forward flattener of the USD swap curve - Gradual Fed hikes and a low neutral rate set to flatten the USD curve further in 2018 We expect a continued flattening of the USD yield 2Y10Y curve in The short end could be pushed higher by gradual Fed rate hikes. Contrary, we think the long end could be kept low, in relative terms. Investors are still buying high yielding USD fixed income assets. Besides, given the Fed s outlined cap structure on the balance sheet reduction, the Fed is still set to be a fairly active buyer of Treasuries, probably reinvesting around USD200bn in Treasuries in 2018 (versus USD216bn in 2016 and USD176bn projected this year). Both US inflation prints and expectations remain subdued and the neutral rate has edged lower (currently 2.75% according to the Fed). In isolation, this should keep a lid on longer dated USD yields. Conclusion Receive 10Y versus 2Y USD 1Y forward swaps at 24bp. P/L 10bp/40bp. 6M carry/roll -5bp. Risk factors Higher US inflation, a greater flow effect from QT than we expect, a USD fixed income sell-off. We look for a further flattening of the USD curve Source: Bloomberg, Danske Bank How many hikes needed? Low neutral rate (R*) Source: Federal Reserve, BEA, Danske Bank 12

13 3: USD money market curve forward steepener - The forward curve is too flat in 2019 relative to 2018 It remains our base case that the Fed will hike in December this year, which is close to fully priced. Currently, markets price in 45bp for next year, i.e. slightly below our expectation of two hikes. Historically, markets have been biased towards pricing in fewer hikes than expected by analysts and the Fed. Hence, the current market pricing for next year seems fairly balanced, in our view. However, looking ahead to 2019, the market is pricing in only 15bp. Although the Fed s neutral rate has edged lower in recent years (currently at 2.75%), which theoretically lowers the potential upside risk/potential for the fed funds rate, the current slope of the USD money-market curve seems too flat in Conclusion Pay 2Y3M USDOIS versus receive 1Y3M USDOIS at 15.2bp. P/L 40bp/0bp. 12M carry/roll 32bp. Risk factors End of hiking cycle post 2018 and/or an inverting USD money-market curve. Almost flat USD money market fwd curve in Dec-16 Dec-17 Dec-18 Dec-19 Fed Funds (live) Source: Federal Reserve, Danske Bank Concave USD money market forward curve implies a solid roll-down in payed 2Y3M vs 1Y3M spread % bp Y roll-down around 32bp 0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Median FOMC member 2Y3M vs 1Y3M swap (USDOIS) 1Y3M vs 3M swap (USDOIS) 13

14 bp 4: Buy the Bund spread at 48.5bp - Position for a seasonal widening in Q1 We expect the Bund spread to follow the trend we have seen over the past four years, when the Bund spread has widened in Q1. The move in the Bund spread in Q1 is typically around 10bp. It may seem odd that the Bund spread should widen in Q1, when there is plenty of issuance of SSAs, financials and corporate bonds. Issuers traditionally swap bonds back into floating rate and thus are receivers in the swap market. Investors are more mixed and thus the swap flow is skewed towards receiving. However, given large redemptions from Germany in Q1, ECB QE, a very cheap funding rate for Bunds (around -1%) and a nice roll-down on the ASWspread curve, the demand for Bunds has more than offset the flow effect from issuers receiving in the swap market. Conclusion Buy the Bund spread at 48.5bp. P/L 55bp/42bp. Risk factors A significant increase in the yields as seen in 2015 could lead to an increase in the ASW spread as investors use Bunds to hedge interest rate risk. Wider Bund spread in Q1 in past 4 years The Bund ASW-spread, bp 10 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Positive carry on long Bund spread German government ASW-spread ASW kurve curve maturity 14

15 bp 5: Long periphery vs core EU - Buy at expected syndications in Q1 18 We expect both Portugal and Ireland to launch new 10Y benchmarks early in 2018 through syndicated deals, given the attractive funding levels. Ireland has traditionally been one of the first issuers at the start of the year and a new 10Y benchmark seems obvious to us, as there was no new 10Y in The syndicated deals typically offer a little new issue premium for investors. The rating story is positive for both countries and the economic outlook continues to be supportive for public finances. We expect Ireland to return to an AA rating and Portugal might get a new investment grade rating from Fitch and/or Moody s on top of the one from S&P. The Portuguese curve is still very steep relative to the core and semi-core curves as shown by the 5Y5Y forward rate. Conclusion We recommend buying the new 10Y PGB and the new 10Y IRISH government bond at the expected syndication early next year. Risk factors Uncertainty surrounding the budget for 2018 and political uncertainty in Ireland. Very steep Portuguese curve between 5Y and 10Y 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 5y5y forward for Portugal relative to Germany and France 0.00% Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Jul Portugal Germany France Ireland is cheap relative to France in the 10Y segment Ireland versus France Ireland versus Belgium 0 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 15

16 6: Buy 30Y 2% callable bonds against DGBs Callable mortgage bonds have performed significantly in 2017 due to large interest from foreign investors and Danish investors. We still expect foreign investors to be a dominant buyer in 2018 as long as excess liquidity is high and interest rates are low. This should support current low OAS levels. Danish investors have not notably sold callable bonds in 2017 and we expect Danish investors to hold on to their portfolio of callable bonds. We expect remortgaging of subsidised housing loans of callable bonds to start in This could increase demand for low-coupon callable bonds if buybacks of 1.5% 2047 begin in We expect callables to continue to trade at current OAS levels in We prefer 2 50 (ord+io) and 2 47 (ord+io) among callable bonds. The new is an alternative if issuance rises. Greatest risk factors Foreign investors stop buying callable bonds. Significant increase in volatility and credit premiums. OAS levels have fallen to a low level Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Aug-16 Feb-17 Aug-17 but excess carry in callables vs DGBs is still high 90 12M carry 80 Break even OAS

17 7: Buy 5Y non-callable bonds against DGBs (enter late December) Five-year non-callable bonds offer the same excess carry to DGBs as 30Y low coupon callables but with lower overall risk if the current carry sentiment turns. Non-callable bonds have also performed against DGBs but not as much as callable bonds. In particular, 5Y non-callable bonds are a good alternative to 10-15Y callable bonds. We expect supply of 5Y non-callable bonds in 2018 to be less than in 2017; in particular, the supply at refinancing auctions is lower. We expect remortgaging of subsidised housing loans of 5Y non-callable loans to start in 2018 and this could reduce supply by c.dkk10-15bn. We expect non-callables to continue trading at current OAS levels in Late December is set to give a large supply of 5Y non-callable bonds. Regarding the timing of this trade, late December could be a good opportunity. Greatest risk factors Foreign investors stop buying short non-callable bonds. We have recently seen low interest from these investors and the market is trading soft. We expect supply to be lower in but excess carry in callables vs DGBs still high Bond Gov Spread HPR HPR Relative to Govt name YCS roll w/roll Excess BPV adj. NYK 1'19 (Jan) NYK 1'20 (Jan) NYK 1'21 (Jan) NYK 1'22 (Jan) NYK 1'23 (Jan) Supply 5Y non-callables (DKKbn) (Est.) Tap sale Auctions 17

18 % 8: Buy Danish BEI spread - Buy DGBi 0.1% 2023 vs DGB 1.5% 2023 Recent inflation data has surprised on the upside recently. In 2018, our economists forecast Danish inflation will be 1.3% y/y. In H1 18, we expect monthly fixings to be above 1.3% y/y. Currently, the implied BEI spread (and the simple BEI spread) for Denmark is trading around 1.1% y/y. In the implied BEI spread, we take account of the seasonality in Danish inflation but the simple BEI spread is currently 1.1%. We see the Danish linker as an alternative to the German linker there is a close correlation between the BEI spreads and, with the large German redemption in April and modest supply from Germany, the Danish linker could be an alternative to German linkers. Furthermore, our economists have a below-market view on EUR inflation in Conclusion We recommend buying the Danish linker DGBi 0.1% 2023 relative to the DGB 1.5% 2023 at 1.1%. P/L target at 1.35%/0.95%. Risk factors Inflation surprising on the downside. The implied BEI rate is currently 1.1% Implied BEI-spreads for Denmark and Germany 0.00 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Denmark (Implied BEI-rate) Germany (Implied BEI-rate) We expect monthly fixings to be above 1.1% in H % 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% Danish inflation EU inflation ex. Tobacco DK and EU inflation in 2018 Danske Bank's forecast for Danish inflation Danske Bank's forecast for EU inflation 18

19 Return on a 12mth horizon, % 9: Buy 10Y DGB/receive 10Y DKK swaps vs EUR/EU peers - More value in Danish fixed income The sweet spot on the Danish curve is the 10Y segment, as it offers the best risk/return on the Danish curve and is in line with the carry/roll-down to EU peers. There are several supporting factors for the Danish government bond market in 2018 even though the spread between Denmark and EU peers has performed well in Denmark s public finances are in excellent shape and we expect the funding requirement for 2018 to be DKK55bn. Hence, the auctions are likely to continue to be of the order of DKK bn. In order to support liquidity, we expect the Danish Debt Management Office to be very active with buybacks and switches. There is a lack of duration from the decline in OA duration on Danish mortgage bonds. Conclusion Buy DGB 0.5% 11/27 relative to EU peers such as Bund 08/27 at 6bp or Nether 0.75% 07/27 at -2bp or receive 10Y DKK swap and pay 10Y EUR swap at 17bp. Risk factors Issuance flow dominates the pricing of DGBs. Foreign investors taking profit on DGBs and switching into local bonds. 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 12mth carry and roll-down, unchanged curves and spreads -0.50% Denmark Netherlands -1.00% Germany Austria Maturity Source. Danske Bank DGB 0.5% 11/27 relative to EU peers, bp DGB 0.5% 11/27 - DBR 02/27 DGB 0.5% 11/27 - Nether 07/27 DGB 0.5% 11/27 - RAGB 0.5% 04/27-15 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Source. Danske Bank 19

20 10: Buy SGB 1.5% 11/23 (SGB1057) vs Bobl - The sweet spot on the Swedish curve In our view, the scarcity of short-end government securities will be a major market theme in The stock of T-bills is set to be cut to the lowest level since On top of this, the Riksbank holds 50% of bonds <5Y and the Debt Office intends to concentrate issuance in the 10Y segment. The SGB curve is steep out to the five- to six-year segment. In March, we estimate the T-bond index duration extension will be the largest since This will be supportive of SGBs in general. Hence, we like to buy SGBs in the 5Y segment versus Bobls. A twist to the trade would be to buy 5Y SEK covered bonds versus Bobls. The 12M carry/roll in such a trade is some 35bp (85bp yield spread). Another option is to pay EUR swap versus the bond. Conclusion Buy SGB1057 versus Bobl at 38. P/L : 15/50bp. 12M carry/roll +10bp. Risk factors Riksbank turning more hawkish in 2018 if the inflation rate moves higher. Available stock of government securities (T-bill and SGBs) up to 2Y and up to 5Y including forecast for 2018 (last point) (SEKbn) Dec-08 Aug-11 May-14 Feb-17 Nov-19 SGBs vs Germany steep out to 5-6Ysegment Gov. securities <2y Gov. securities <5y -20 Sep-17 Jun-20 Mar-23 Dec-25 Sep-28 Jun-31 20

21 11: Receive MAR-19 SEK RIBA - The Swedish money-market curve is still too steep We expect Swedish core inflation to underperform the Riksbank s forecast significantly in Hence, we see no room for Riksbank rate hikes in 2018 or even beyond this. In addition, the ECB s forward guidance makes it difficult for both the ECB and the Riksbank to hike rates before 2019, as the ECB expects key interest rates to remain at their present levels for an extended period of time and well past the horizon of the net asset purchases. In particular, we expect the ECB to deliver the first 10bp deposit rate hike only in Q2 19. There is still a solid roll-down on the steep moneymarket curve, despite some performance recently. Conclusion Receive Mar-19 SEK RIBA at -16.5bp. P/L -45bp/-0bp. 12M carry/roll +33bp. Risk factors A pickup in Swedish inflation, a recovering Swedish housing market and a Riksbank hike in The steep Swedish money-market curve implies a solid roll-down the curve compared with peers Source: Bloomberg, Danske Bank, Macrobond Financial Riksbank pricing implies relatively aggressive hikes Yearly rate hikes priced (OIS pricing) 2018 Riksbank 31.0 ECB 1.5 FED 45.2 BOE 26.6 Norges Bank

22 12: Receive 1Y1Y USDSEK CCS - Divergence in relative USD/SEK excess liquidity The Fed s balance sheet reduction, in isolation, is set to tighten USD liquidity by around USD350bn by the end of In addition, assuming that a longer term solution to the US debt limit is found, USD liquidity is likely to tighten by around USD200bn in Contrary, SEK excess liquidity is set to remain ample in 2018 and we expect an eventual decrease to be very gradual. Besides, year-end effects are likely also in play next year, with the Resolution Fund and continued rich SEK cash with few issued Swedish T-bills. As such, we take advantage of the structural supply/demand imbalance that still keeps the USDSEK CCS forward curve relatively steep. Conclusion Receive 1Y1Y USDSEK CCS at -21.1bp. P/L -35bp/-15bp. 12M carry/roll-down 5.8bp. Risk factors Post year-end USD relief, i.e. tighter CCS against USD in general. Further postponed rebuilt US treasury cash balance at the Fed. Less severity in richness of SEK cash ahead of year-end Divergence in relative USD/SEK excess liquidity Source: Federal Reserve, Danske Bank (own calculations), Macrobond Financial 3M forward USDSEK CCS ( breaks ) remains elevated further out on the curve, Macrobond Financial 3M USDSEK fwd curve 22

23 13: Receive 1Y1Y SEK vs EUR and pay 5Y5Y NOK vs EUR - The Scandinavian roll-trade divergent 2018 outlook for Norway and Sweden The steep Swedish money-market curve and the inverted NOK swap curve relative to EUR swaps implies a solid roll-down on both legs in this Scandinavian roll-trade. Our stronger-than-expected-growth expectations for the Norwegian economy should put upward pressure on the 5Y-10Y segment of the NOK swap curve relative to EUR rates. In Sweden, we expect core inflation to underperform the Riksbank s forecast for 2018 significantly. Hence, we see no room for Riksbank rate hikes in 2018 or even in coming years. Receiving the 1Y1Y segment of the SEK curve relative to EUR in this trade constitutes a hedge against a potential negative spillover from the Swedish housing market or economy to Norway. Conclusion Receive 1Y1Y SEK3M versus EUR3M and pay 5Y5Y NOK6M versus EUR6M at -73.7bp. P/L -105bp/- 45bp. 12M carry/roll 34bp. Risk factors Deterioration in the Norwegian economic outlook. A pickup in Swedish inflation. A Riksbank hike in Tailwind from roll-down and fundamentals, Macrobond Financial 1Y roll-down: 34bp Inverted NOK vs EUR 1Y forward curve and steep SEK curve imply a positive roll on both legs bp Spot 1y 2y 3y 4y 5y 6y 7y 8y 9y 10y NOK vs EUR 1Y fwd curve SEK vs EUR 1Y fwd curve 23

24 14: Receive 1Y1Y USDNOK CCS - Tighter USD liquidity in 2018 The Fed s balance sheet reduction is set to tighten USD liquidity by around USD350bn in In addition, assuming that a longer term solution to the US debt limit is found, USD liquidity is likely to tighten by around USD200bn in In , Norges Bank has introduced some changes to the open-market operation facilities, aimed at easing NOK liquidity in periods of declining structural NOK liquidity. Most recently, Norges Bank announced the offering of F-loans from 29 December to 2 January with full allotment and at an interest rate given by the target rate plus 15bp. As such, we take advantage of the structural supply/demand imbalance that still keeps the USDNOK CCS forward curve relatively steep. Conclusion Receive 1Y1Y USDNOK CCS at -18.6bp. P/L -30bp/-10bp. 12M carry/roll-down 7.4bp. Risk factors Post year-end USD relief, i.e. tighter CCS against USD in general. Further postponed rebuilt US treasury cash balance at the Fed. Tighter NOK structural liquidity in USD liquidity set to tighten in 2018 Source: Federal Reserve, Danske Bank (own calculations), Macrobond Financial 3M forward USDNOK CCS ( breaks ) remains elevated further out on the curve, Macrobond Financial 3m USDNOK fwd curve 24

25 Disclosures This research report has been prepared by Danske Bank A/S ( Danske Bank ). The authors of this research report are Arne Lohmann Rasmussen (Chief Analyst), Jens Peter Sørensen (Chief Analyst), Jostein Tvedt (Chief Analyst), Jan Weber Østergaard (Chief Analyst), Christina E. Falch (Senior Analyst), Marcus Söderberg (Senior Analyst), Carl Milton (Senior Analyst) and Mathias Røn Mogensen (Analyst). Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. Danske Bank s research reports are prepared in accordance with the recommendations of the Danish Securities Dealers Association. Danske Bank is not registered as a Credit Rating Agency pursuant to the CRA Regulation (Regulation (EC) no. 1060/2009); hence, Danske Bank does not comply with nor seek to comply with the requirements applicable to Credit Rating Agencies. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Danske Bank is a market maker and liquidity provider and may hold positions in the financial instruments mentioned in this research report. Danske Bank, its affiliates and subsidiaries are engaged in commercial banking, securities underwriting, dealing, trading, brokerage, investment management, investment banking, custody and other financial services activities, may be a lender to the companies mentioned in this publication and have whatever rights are available to a creditor under applicable law and the applicable loan and credit agreements. At any time, Danske Bank, its affiliates and subsidiaries may have credit or other information regarding the companies mentioned in this publication that is not available to or may not be used by the personnel responsible for the preparation of this report, which might affect the analysis and opinions expressed in this research report. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual fixed income asset. We base our conclusion on an estimation of the financial risk profile of the financial asset. By combining these risk profiles with market technical and financial assetspecific issues such as rating, supply and demand factors, macro factors, regulation, curve structure, etc., we arrive at an overall view and risk profile for the specific financial asset. We compare the financial asset to those of peers with similar risk profiles and on this background, we estimate whether the specific financial asset is attractively priced in the specific market. We express these views through buy and sell recommendations. These signal our opinion about the financial asset s performance potential in the coming three to six months. 25

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