Reading the Markets Denmark May 2017

Transcription

1 Reading the Markets Denmark Going long 5Y5Y DKK-EUR swap spread floater and non-callable bullet auctions in focus Jan Weber Østergaard Christina Emilia Falch Arne Lohman Rasmussen Chief Analyst Senior Analyst Chief Analyst, Head of Fixed Income Research Jens Peter Sørensen Mathias Røn Mogensen Chief Analyst Analyst May 2017 Investment Research Important disclosures and certifications are contained from page 12 of this report.

2 Key points New recommendation: Go long 5Y5Y DKK-EUR swap spread (slides 3-4) Low volatility has made the 5Y5Y DKK-EUR and the swap spread quite stable, for a moderately positive but stable carry/roll. Long-term pressure for a stronger DKK persists (slide 5) We do not believe that any sizeable further krone depreciation is imminent and therefore do not expect further spread widening to EONIA/EURIBOR at the short end of the curve. We take profit on sold 1Y1Y DKK ATMF Straddle (slide 6) Concurrently with the flattening Danish money market curve and declining gamma volatility in DKK, we take profit and close the strategy at a profit of 7bps. We also look into the effect of volatility changes in the callables segment (slide7). RD, Nykredit, Nordea Kredit and BRFkredit have announced auction supply data (slides 8-9) Nykredit will be selling for DKK12.3bn in 1-5Y noncallable bullets from 22 to 24 May. The floater auctions will be held on 29 and 30 May. The total auction amount for floaters is about DKK62bn. Nordea Kredit to open new callable series (slide 10) On 8 May, Nordea Kredit announced that it will open four new callable series: 0.5% 2030 (10Y), 1.5% 2040 (20Y) and 2% 2050 (30Y ord.) and 2.5% 2050 (30Y IO). Relative value View Earlier view Trade / Comment Callables Neutral We expect low issuance going forward, but solid performance and low spreads limits performance 3% 30Y Neutral Buy io series and sell non-io series due to social housing 2.5% 30Y Underweight 2.5% 30Y is still a bit expensive relative to 2% 30Y 2% 30Y Overweight Trade: Buy 2'47 (84) and 1'17 (17) vs. 1.5'37 (100) 1.5% 30Y Neutral Attractive closing effects, but low liquidity 10Y-20Y Neutral Bonds have underperformed 30Y 2% callables and looks fair Non-callables ("Flexer") Neutral We prefer 5Y non-callables 0-2Y Underweight Foreign investors buying, but low relative value in DKK space 3-5Y Neutral We prefer 5Y non-callables Floaters Neutral The pickup to Flexer has decreased - we expect better entry levels at the floater auctions at the end of May DGBs Neutral Still some value left 2Y Neutral 5Y Neutral We prefer 5Y DKK risk in DGBs 10Y Neutral We see value in DGB '27 vs. DGB '25 Linker Neutral Overweight Swaps Overweight Value against EUR. We prefer 5Y5Y segment. Stable spread but positive carry/roll 0-2Y CITA Neutral Neutral after recent spike in EUR/DKK Flexer vs. swaps Neutral Short bonds have negative carry - we prefer 5Y bonds Callables vs. swaps Neutral Risk-reward in callables have been reduced vs. Swaps Flexer vs. DGBs Neutral 5Y non-callables have performed relative to DGBs Callables vs. DGBs Neutral Swap spread DKK-EUR Overweight Neutral Callables offer a yield pickup relative to DGBs - but the spreads have decreased significantly in 2016 and 2017 New Trade: We recommend to position for a tighter 5Y5Y DKK-EUR spread. Positive carry/roll. Low risk trade. Gov spread DK-DE Neutral Overweight Neutral after recent DGB performance. EUR/DKK Underweight Neutral Fundamental downward pressure on cross. Downside potential after recent spike. 2

3 Trade overview DKK Fixed Income market Open trades Name Nom Entry Level Return (bp of investment) Current Target Stop loss DK '47 RD DK '17 Jul NYK DK '37 RD '47 vs. 1.5'47 og 1Y flex (Opened 01/03/2017) 20bp 40bp -30bp Closed trades 2017 Name Nom Entry Level Return (bp of investment) Closed Target Stop loss DK '22 Apr RD DK DGB 3' Y Flex vs. DGB 3'21 (Opened 15/02/2017) 74bp 21/04/ bp -40bp Receiver 5Y DKK6M-EUR6M (Opened 03/01/2017) 24.6bp 3.9bp 03/05/ bp 30bp DGB Nov '18 vs BKO Dec '18 (Opened on 19/04/2017) 22bp 8bp 24/04/ bp 29bp Sælg 1Y1Y Straddle ATMF (Opened on 15/03/2017) 29bp 7bp 17/05/2017 We close our recommendation to sell a 1Y1Y DKK Straddle ATMF at a profit of 7bps following the latest drop in gamma volatility. 3

4 DGBs and Danish swaps relative to EUR the world s most boring trade Danish yield spreads to euro swaps and German Bunds are remarkably stable. Since mid-2016, volatility has been more or less eliminated from both the DGB spread and the swap spread to Germany/euro swaps as shown in the chart to the right and the charts on slide 4. The Danish/German government spread in the 8Y segment has been about 20-30bps. On the other hand, spreads between DGBs and semi-core papers have witnessed decent activity. However, this merely expresses the volatility between German and semi-cores rather than independent Danish movements. The stable country spreads at the long end of the government bond curve are due to a combination of moderate issuance given a low borrowing requirement, buy-backs from Danmarks Nationalbank (DN) and switch auctions across the DGB curve. At the same time, short-term DGB, ARM and swap rates are very stable (see chart on slide 4). Last but not least, the continued narrowing of OAS on long-term DMBs and ASW spread for noncallable bullets have capped the Danish/German yield spread. Danish/German yield spread very stable 50 Spread between DGB 1.75%'25 and EU peers, bp vs. Finland vs. Holland vs. Østrig vs. Tyskland 4

5 New recommendation: go long 5Y5Y DKK-EUR swap spread Danish short-term rates (DGBs, non-callable bullets and swaps) have been quite stable as shown in the chart below. DGB 0.25% 2018 has been trading at around - 60bp despite strong Schatz fluctuations since mid NYK 1 D 01OCT2018 DBR 1 12OCT DGB NOV2018 RD 1 T 01APR Low volatility has triggered highly stable 5Y5Y DKK-EUR and 2Y5Y DKK-EUR swap spreads, providing a moderately positive, and not least stable, carry/roll. 5Y5Y DKK-EUR swap spread has a positive roll of about 2bp a year. We capitalise on the stability by going long 5Y5Y DKK-EUR swap or, alternatively, 2Y5Y DKK-EUR swap spread DKK-EUR swap spread, bp 5Y spread 2y5y swap spread 5y5y swap spread 5

6 Long-term pressure for a stronger DKK persists EUR/DKK has been trending higher since the French presidential election and is no longer trading in the intervention zone. The weaker krone is now anchored at the short end of the curve, and CITA/EONIA and CIBOR/EURIBOR spreads have widened marginally. However, we do not think a sizeable further krone depreciation is imminent and do not expect further spread widening at the short end. As highlighted in FX Strategy: DKK EMPI signals prevailing downward pressure on EUR/DKK, 10 May 2017, Danish fundamentals are simply too strong. We expect a Danish current account surplus of over 9% this year. Also, there is a constant need for Denmark to adapt to the mounting excess liquidity in the euro area spurred by ECB QE. Such adaptation could be in the form of a further DKK appreciation (currency is already strong) or through a lower certificates of deposit rate (close to absolute low). So, in practice, adaptation can only be effected through an increase of the surplus liquidity. The only way is through currency intervention or, alternatively, by drawing on the central government s account and buying back government bonds. The chart to the right shows the difference in percentage points in surplus liquidity in Denmark versys the eurozone relative to nominal GDP. As there has been no major currency intervention in 2017 to date and DGB buy-backs remain moderate, a need for a larger Danish surplus liquidity is being accumulated. A higher net position generally contributes to low and stable CITA T/N fixings in upcoming quarters, which would point to stable-to-tighter spreads also further out the curve. See recommendation on slide 4 to receive 5Y5Y DKK-EUR spread. Marginal weakening of DKK is temporary Source: Macrobond Financial, Danske Bank Markets Relative liquidity between DK and EU* Source: Macrobond Financial, Danske Bank Markets Net position vs ECB s excess liquidity relative to nominal GDP (ppt difference) 6

7 Taking profit on DKK 1Y1Y Straddle ATMF DKK 1Y1Y volatility down since ECB March meeting In Reading the Markets Denmark: Hedged 3% bonds exposed to yield increases and value in Danish volatility curve, 16 March 2017, we recommended selling a 1Y1Y DKK Straddle ATMF as the ECB meeting in March had triggered a surge in both EUR and DKK gamma volatility. In the meantime, however, the ECB has quenched any speculation that it is (1) planning to raise interest rates before tapering; and (2) that it will start tapering its QE programme sooner than expected. In other words, the QE programme is scheduled to run for at least the remainder of the year. This has caused both EUR and DKK volatility to drop, benefiting our strategy. Based on developments in gamma volatility, we therefore close our strategy at a 7bp profit. However, despite recent volatility movements, investors may consider holding on to the carry strategy for the following reasons. We still expect ECB QE to continue well into 2018 and to hold off on the first rate hike until well after tapering concludes. We also expect that the Danish Central Bank will primarily employ currency intervention to defend the DKK/EUR rate. In our view, the key policy rate in Denmark is very close to the lower bound bp 0 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 DKK3M 1Y1Y Implied Volatility Note: normal implied volatility shown as bp/year. Realised volatility calculated as 20-day average of squared changes in the underlying swap, shown as bp/year. DKK MM curve has flattened slightly since ECB March meeting SNB induced strong preassure on DKK Brexit DKK3M 1Y1Y 20d Realized Volatility bp Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 SWAP 1Y 1Y DKK3M SWAP 1Y DKK3M 7

8 Volatility impact on callable mortgage bonds As mentioned on the preceding slide, the lower EUR and DKK volatility has made our recommendation to sell a 1Y1Y DKK Straddle ATMF perform since we opened the trade in mid March, and we are now taking profit on the strategy. The drop in normalised volatility was particularly noticeable in the gamma volatilities, i.e. swaption volatilities with option maturities of 12 months or less, but long option volatilities (vega) are also down, although not to the same extent as for gamma volatilities. The lower left table illustrates the changes in normalised volatilities since mid-march. In most cases, volatility sensitivity in callable mortgage bonds centres on vega volatilities, and there is virtually no sensitivity to changes in gamma volatilities. For example, in a vega split of (see lower right table), volatility sensitivity is clearly concentrated around 5Y15Y, 10Y10Y and 10Y15Y. Locking in the volatility grid at mid March in order to calculate OAS at a constant price and the price at a constant OAS, we are able to calculate the effect of the volatility change for the various callable mortgage bonds. As shown in the upper right chart, 3 47, and have had notable volatility effects. This applies especially to the 30Y bonds, for which the market has seemingly priced in the full volatility effects. OAS has widened for 10Y and 20Y bonds during the period, which may be because the volatility effect is not fully priced in. Change in ATMF normal implied volatility Expiry/Tenor 1Y 2Y 5Y 10Y 15y 30Y 6m y y y y y y Vega split - RD 2.5'47 Expiry/Tenor 6M 1Y 2Y 5Y 10Y 15Y 30Y Total 6M Y Y Y Y Y Y Total

9 Auction details from Nykredit - non-callable bullets Nykredit will be the only issuer to refinance Jul 2017 non-callable bullets. According to its announcement, Nykredit expects to sell DKK12.3bn worth of non-callable bullets from 22 to 24 May, for an average refinancing rate of 72%. Nykredit will be auctioning non-callable bullets for DKK6.2bn (1Y papers), DKK5.0bn (3Y) and DKK700m (5Y) and selling DKK200m in 2Y and 4Y non-callable bullets in tap sales. All of these non-callable bullets are classified as Level 1B under the LCR rules. The total DKK12.3bn supply is DKK4bn short of the expected supply of DKK16.3bn estimated on the basis of an assumed refinancing rate of 95%. Presumably, the difference is due to some borrowers deciding to remortgage in connection with the refinancing auctions. The average refinancing rate at the May auctions is about 72%, which is higher than the rates of 59% to 66% seen over the past year s Nykredit non-callable bullet refinancing auctions. Non-callable interest reset bonds from Nykredit ISIN Type Maturity Currency Triggers Expected LCR Auction Preliminary auction classification dates amount (mio.) DK SDO (H) 01/07/2018 DKK IT + RF Level 1B May 6,200 DK SDO (H) 01/07/2020 DKK RF Level 1B May 5,000 DK SDO (H) 01/07/2022 DKK RF Level 1B 24. May 700 NYK 1Y 2Y 3Y 4Y 5Y > 5Y Total DKK Bonds Maturing bonds % refinancing rate Amounts Difference Tap sale Auction schedule RD NYK NDA BRF 22 May 23 May 24 May 29 May 30 May : Non-callables fixed rate bonds : Floaters Source: Nykredit, Danske Bank Markets 9

10 Auction details from mortgage banks floater bonds RD, Nykredit, Nordea Kredit and BRFkredit have all announced the details of their upcoming floater refinancing auctions. Nykredit has not yet released refinancing information for the 3M CITA bond maturing on 1 July The table below provides details of floater bonds to be sold at the upcoming auctions. Nykredit will hold a floater auction on 29 May, while RD, Nordea Kredit and BRFkredit will hold their floater auctions on 30 May. The total auction amount for floaters is about DKK62bn. Most of the bonds, perhaps DKK61bn worth, will be DKK denominated. RD is the only issuer selling EUR denominated bonds. RD will be selling EUR70bn in an existing 3M EURIBOR floater (ISIN DK ), which was opened in connection with the May 2016 refinancing auctions. With the interest premium already fixed at 65bp, investors will be bidding for the bond price. If the auction price is lower than , RD reserves the right to cancel this auction and change the auction method. After the auction, the bond will be applied for new loans. RD 3M EURIBOR (ISIN DK ) has a coupon floor, whereas the other bonds do not. It should also be noted that Nykredit will be issuing a callable 3M CIBOR floater bond (ISIN DK ). DKK denominated floater bonds to be issued by RD, Nykredit, Nordea Kredit and BRFkredit will be offered at a price of , and investors will be bidding for the interest premium. The initial coupon is 0%. The RD 3M EURIBOR has a 2Y maturity, whereas the DKK denominated floaters have maturities of from 2.5 to 5 years. All floater bonds with the exception of the RD 6M CITA floater (ISIN DK ) are expected to be classified as Level 1B under LCR. The RD 6M CITA floater is not expected to be LCR eligible at the date of the auction, but it should be classified as Level 2A after three months. All floater bonds will be issued with a refinancing trigger. The bonds will have an annuity cash flow profile with an io option for up to 10 years. All bonds to be sold at the upcoming refinancing auction will be covered bonds or mortgage covered bonds. ISIN Type Maturity Currency Reference Coupon Callable? Initial /current Interest spread/ Auction Auction Expected LCR Source: RD, Nykredit, Danske Bank Markets rate floor? coupon Issue price dates amount (mio.) classification DK RD SDRO (T) 01-Jul-19 EUR 3M EURIBOR Yes No 0.32% 0.65% 30-May Level 1B DK RD SDRO (T) 01-Jul-21 DKK 6M CITA No No 0% May-17 1,600 Not LCR* DK NYK SDO (H) 01-Apr-21 DKK 3M CIBOR No No 0% May-17 16,300 Level 1B DK NYK SDO (H) 01-Jul-20 DKK 3M CIBOR No Yes 0% May-17 7,500 Level 1B DK NYK SDO (H) 01-Jan-20 DKK 6M CITA No No 0% May-17 9,800 Level 1B DK NDA SDRO (2) 01-Jul-21 DKK 6M CIBOR No No 0% May-17 14,800 Level 1B DK BRF SDO (E) 01-Jul-22 DKK 3M CIBOR No No 0% May-17 11,400 Level 1B *: at the auction. The bond is expected to be classified as "Level 2A" after 3 months. 10

11 Nordea Kredit has opened new callable series Nordea Kredit announced on 8 May that it would open four new callable series: 0.5% 2030 (10Y), 1.5% 2040 (20Y) and 2% 2050 (30Y ord.) and 2.5% 2050 (30Y IO). Nykredit and BRFkredit announced in late March and early April the opening of new 1.5% 2040 (20Y), 2% 2050 (30Y ord) and 2.5% 2050 IO. We have previously (on 22 March) released a paper in which we calculated estimated prices for the new callable mortgage bonds, see Danish Mortgage Bonds: Pricing of new callable series and update on calculations of closing effects on open series, 23 March. We have recalculated the estimated prices of the new 0.5% 2030, 1.5% 2040, 2% 2050 and 2.5% 2050 IO bond series, as shown in the table below. Interest rates have generally risen since 19 April when we last updated our estimates (see Reading the Markets Denmark: Buy DGB 18 against Schatz pros and cons of 30Y 3% mortgage bonds, 20 April) and our estimates therefore indicate the price spread between 1.5% 2040 and 1.5% 2037 has widened by some points. The 0.5% % 2027 price spread is also expected to be some points. The new series will not generally qualify as Level 1B assets under the LCR rules unless the mortgage banks pre-issue in these series. However, we believe that the markets will expect especially the 30Y series to qualify as Level 1B assets within a relatively short period, and, therefore, we do not expect the markets to price in a premium for lack of Level 1B classification in these series. The table below shows the expected LCR classification after 3 and 6 months. We assume the same average daily issuance levels as in the preceding three months. Other things being equal, we expect lower interest rates to lead to an increase in issuance. We do not expect any significant price differences between Nykredit, Nordea Kredit and BRFkredit because of the different LCR classifications. As can be seen from the table, Nykredit s series are expected to become LCR eligible within three-six months, whereas the Nordea Kredit (aside from the 2% 2050) and BRF series are not expected to be LCR eligible after six months. Pricing of new 2050 callable bond series ISIN code Short Name Type Expected pricing Spreads relative to 2027/2037/2047 Expected LCR classification OAS Price OAS Price After 3 months After 6 months DK NYK 1.5% 2040 SDO (CC E) bp Level 1B Level 1B DK NYK 2% 2050 SDO (CC E) bp Level 1B Level 1B DK NYK 2.5% 2050 IO SDO (CC E) bp Level 2A Level 1B DK BRF 1.5% 2040 SDO (CC E) bp Not LCR eligible Not LCR eligible DK BRF 2% 2050 SDO (CC E) bp Not LCR eligible Not LCR eligible DK BRF 2.5% 2050 IO SDO (CC E) bp Not LCR eligible Not LCR eligible DK NDA 0.5% 2030 SDRO (CC 2) bp Not LCR eligible Not LCR eligible DK NDA 1.5% 2040 SDRO (CC 2) bp Not LCR eligible Not LCR eligible DK NDA 2% 2050 SDRO (CC 2) bp Level 2A Level 2A DK NDA 2.5% 2050 IO SDRO (CC 2) bp Not LCR eligible Not LCR eligible Source: Nordea Kredit, Nykredit, BRFkredit, Danske Bank Markets 11

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