Sweden Strategy Leaving the soft patch; thoughts going into 2014

Transcription

1 Sweden Strategy Leaving the soft patch; thoughts going into 2014

2 Main points The strategy bias for the early part of 2014 is to embrace much stronger Swedish data than in 2013 All eyes are currently on the Riksbank December decision, but we think it s time to start looking beyond that. This document contains our Swedish strategy bias for the early parts of It contains our thoughts about macro, Riksbank, views about all types of fixed income curves and SEK. We haven t really put any hard trade ideas in, but rather see this publication as a discussion piece about what type of themes we think will work. The outlook focuses on Sweden but is of course based on a couple of key assumptions about Fed/ECB. It assumes that Fed tapers, but sticks to a low for long forward guidance. For ECB, the assumption is also a low for long guidance and that if they do anything in early 2014 it will in that case be more stimulus. The main takeaways are: 1) Swedish macro will improve markedly 2) CPIF will be low, but CPI and inflation expectations will trend up 3) The risk premiums in the government bond curve are on the low side 4) Low for long policy rates speak for bear steepening, particularly in forward space 5) Swedish bond spreads vs Germany/USA should widen, but remain in the 2013 range 6) Low Break Even Inflation offers a good risk/reward bet 7) Low for long has helped covered bond spreads, but risk/reward begins to look dicey 8) Year end optionality in EURSEK is attractive 9) Stronger Swedish data speaks for stronger SEK 10) Diverging economic trends in Norway/Sweden could push NOKSEK to parity 11) Rising interest rates could create a pause in the global expansion later in

3 Riksbank rate decision on 17 th December Looks like a coin flip. Concerns about credibility for the inflation target could lead to a rate cut, while much brighter leading indicators than earlier this year point to an on hold decision The window to cut the repo rate was wide open earlier 2013 when inflation was lower than today, the economy was weak and leading indicators gloomy. But fears that household debt could surge on rate cuts made the majority vote for on hold. Today inflation has continued to be lower than the Riksbank forecast. The economy is weak, but some of the weakness is explainedbyproductionstopsandstrongemploymentgrowth tells a totally different growth story. Leading indicators are much stronger than previously. Given that the Riksbank didn t cut the repo rate earlier 2013 it would look strange if they did it in December. However, concerns about perceived credibility for the inflation target could persuade them to deliver a rate cut. Nordea s official forecast is an on hold decision. 3 most likely scenarios: 1) A 25 bps rate cut and a repo path that has a small probability for an additional cut but also small probability for a rate hike late ) On hold, but a repo path where the first hike is pushed to Q1/Q ) On hold and same rate path as before with a short term rate cut probability and rate hike risks late in We put a much higher probability for any of the two first scenarios than the third. For markets, an on hold decision would cement the low for long scenario that Fed, ECB and now also Norges Bank is following. A rate cut will within 6 months look completely meaningless and a rate hike could thereby come into play earlier. See SEK FX & Rates: Credibility in focus for Riksbank Repo rate RIX current Scenario 3 Scenario 2 Scenario Jan 11 Jan 12 Dec 12 Dec 13 Dec 14 Dec 15 Dec NO policy rate New path Previous path Source:Riksbank, Nordea, Bloomberg Jan 10 May 11 Sep 12 Feb 14 Jun 15 Nov 16 Source:Rksbank, Norges Bank, Ecowin 3

4 Swedish Macro Outlook 4

5 Swedish macro Underlying inflation pressures remain muted to say the least. But the bottom is behind us and technical effects from rising bond yields will push up CPI in 2014 Nordea s view has for a very long time been that underlying inflation (CPIF) will continue to stay well below the inflation target and the Riksbank forecast. We see no reason to change that view. Low wage increases push down domestic inflation. And, as long as the SEK doesn t weaken too much, there is still imported deflation rather than inflation. That said, we probably already saw the y/y bottom for CPIF this spring. Rising bond yields will also mean that y/y CPI will trend up at a relatively steep angle in That should pull up longer inflation expectations, which alleviates some of the downside pressure on the Riksbank. 4 % y/y % y/y 4 CPIF 3 3 Riksbank Nordea

6 Swedish macro Suddenly all the planets align for a jump up in Swedish domestic demand. Being a small open economy normally means that all cylinders ignite when exports turn up The positive surprise in Q3 GDP was that domestic final demand improved. By the way, don t worry too much about the low 0.3% y/y GDP headline it was distorted by a couple of major production stops within manufacturing and a huge negative inventory contribution of 1.6 percentage points. Instead the major takeaway was that the investment cycle rapidly turned for the better. Add that leading labour market indicators signal falling unemployment, the stock market has risen, that households are massively upbeat on house prices, have an all time high savings ratio and that fiscal policy in election year 2014 will give a meaningful boost. Then you also have the ingredients for better personal consumption growth

7 Swedish macro Global growth is set to improve during the first half of Less fiscal drag is an important reason. Swedish exports will finally turn for the better Global growth will improve during the first half of Previous monetary policy stimulus is still working its way into the economy. On top of that, fiscal policy is much less restrictive in 2014 than 2012/2013. Leading indicators for the USA are pointing towards 3% GDP growth and Eurozone seems to be heading for at least 1% to start with. No stunning numbers, but a huge difference from the bleak start of In Sweden, the global improvement will finally lead to a turn around for exports and GDP should aim for 2% y/y in early We are thus leaving the period of negative data surprises behind us, which historically has been very important for interest rates and the SEK % y/y Index GDP y/y LS Sweden, Consumer Surveys, Macro index RS Source: Nordea Markets and Reuters Ecowin 7

8 Basic market thoughts on the Swedish macro scenario Positive macro surprises should lift bond curve risk premiums. And remember that interest rate risk hasn t paid off in Sweden. It s only credit risk that has delivered a return Nordea s official view is repo rate hikes in Sep and Dec As strategists, we would put the hikes later. But our belief that macro surprises will be on the upside early 2014 still means that risk premiums in Swedish fixed income should rise. We note that a Swedish government bond index has delivered a small negative return since late 2011, despite an economic slowdown, low inflation and Riksbank rate cuts. During 2014, markets should at least at some point start thinking about a future rate hike sounds like trouble! A 1 year rate in 5 years is trading around 2.5% in Sweden which we would deem to be on the low side right now. Fixed income investors have so far been saved by piling into credit/covered risk. But spreads are now compressed and risk/reward is starting to look somewhat dicey. 8

9 Positive data surprises we frame the usual suspects Sweden is a high Beta investment. The combination of better growth and positive data surprises normally translates to bond underperformance and a stronger SEK Our conviction about positive Swedish data leaves us biased early 2014 for trades such as sell bonds outright, bearish steepeners, sell Sweden vs USA/Germany and buy the SEK.The charts on this page sums that up without us needing to explain the obvious. We admit it s not rocket science, but at the same time we find beauty in simplicity. Will this be the story for all of 2014? Hardly. Butwethinkit sa good start. We probably need to adjust or even reverse these market calls at some point which we will give a glimpse of at the very end of this publication. But first we want to take you through a number of more detailed trades in Swedish Fixed Income and FX we think will work during the first parts of Hey ho, let s go 9

10 Swedish Market Outlook Fixed Income 10

11 Outright and yield curve In the environment we foresee, the SEK 5yr point could prove fragile, with curve and convexity arguably at flat levels. Not least compared with the US market, that largely dictates the trend If our scenario of a brighter economic sentiment plays out in H1 14 there is an obvious risk that we will see higher SEK yields. Given major rate setters willingness to anchor front end yields (we see no change here), its likely wiser to base positions for higher yields outside the 2yr point. In particular the notoriously sensitive 5yr sector, whichisthemid pointinmostindicesand where most supply will come. Yield curve convexity may also prove to be much too flat if the scenario of an economic recovery is unfolding. The SEK curve has also been much more driven by US rates over the past years, thanwhatnormallyisthecase.butinanenvironment with improving data, there is some catching up potential. The domestic scenario we project is a combination of, on the one hand, a central bank that will continue to signal that a rate hike remains a distant possibility (they may even cut rates), and on the other hand, improving economic data. While the former factor should keep the front endincheck,thelattershouldbe able to influence and lift the term premium. View: we foresee a domestic mix that will give an underlying steepening pressure, where the 5yr point could prove to be the most fragile part of the curve. We see potential in trades like 2s/5s or 2s/5s/10s steepeners and for those looking for a cross market position, 1yr1yr vs. 2yr3yr fwd steepeners in SEK vs. flatteners in USD looks very attractive from a roll point of view (pick up of around 18bps over 3 mths) Jan 00 Mar 02 May 04 Jul 06 Oct 08 Dec 10 Feb SGB 2s/5s/10s Repo rate, rhs, reversed Source:Nordea -6 Jan 2000 Aug 2004 Apr 2009 Dec 2013 USD 2y3y 3m roll SEK 2y3y 3m roll 11

12 Outright and yield curve With the US front end anchored, the improvement o economic data has spilled over notably on US term premium. Sweden could be facing something similar 1.00 ISM Manufacturing Fed Funds Target Rate % 1 yr rate in 5 years time (government bonds) % Sweden USA Germany Source: Nordea and Ecowin Source: Nordea Markets and Reuters Ecowin yr SGB yr Treasury 10yr Germany Source: Nordea and Ecowin 12

13 Sweden vs. Germany Currently, we see more arguments in favour of wider spreads, but overall for 2014, we think spreads must be managed opportunistically within the previous years range On the one hand, Swedish rates look historically cheap on charts vs. Germany, but on the other hand, there are both fundamental and market related reasons backing it: Relative monetary policy: while the Riksbank has been reluctant to ease policy, ECB has, with good reasons, been much more active in all areas The potential relative growth rate has been re assessed Experimental global policies have created a tremendous yield grab in recent years, which has lowered the interest for safe haven investments and led to an overweighting of credit/covered bonds. On a relative basis, this has meant more for Swedish than German govies (see figs next page) In addition, Swedish 5 10yr yields also decoupled gradually from German yields, while trading more closely with US rates suggesting SGBs will be more responsive on any news around Fed Tapering (see figs next page) Jan Dec Dec Dec 13 2yr gov (swe-ge) Repo - Refi spread Source: Nordea View: since we foresee a marked improvement in Swedish macro data in H1 14, we are not expecting the Riksbank to catch up much with the aggregate loose policy run by the ECB. If anything, there may even be ground for markets to yet again end up speculating on the opposite. Currently, we see more arguments in favour of wider spreads, but overall for 2014, we think spreads must be managed opportunistically within the previous years 40 50bps range when the Swedish macro momentum improves, and/or, US yields move higher, spreads will widen, and vice versa. 13

14 Sweden vs. Germany In the wake of experimental policies, the risk appetite and yield grab has increased, while the safe haven trade has lost ground and Swedish rates followed US ones more closely "the Draghi put" "Safe haven" trade Jan Apr Aug Dec 13 5yr gov (swe-ge) 5yr Mtg-Gov (swe), rhs Source: Nordea Jan Dec Dec Dec 13 2yr gov (swe-ge) 2s/10s gov (swe-ge), rhs Source: Nordea 14

15 Linkers and break even inflation Cheap linkers offers good risk/reward in BEI wideners Break even inflation (BEI) in Sweden has historically traded much in line with short term momentum in CPI. Given that we have a longer period of time behind us with really low headline CPI, it is no surprise that BEIs are well below what consensus considers as fair value. However, we see a number of reasons why the current lowbeis(cheapnessoflinkers)offersagoodrisk reward bet for higher rates: Generic 10y break even inflation Sweden France Germany USA UK Canada Australia Asymmetric beta to nominals: The upside in BEIs at higher rates is larger than the downside at lower rates. One reason for this is that supply from the debt office has made Swedish linkers cheap also in a cross market comparison (see top chart). Macro indicators: Leading indicators point upward and negative surprises should start fading as forecaster s have become more pessimistic. These are obvious near term factors for wider BEIs, despite the medium term low inflation environment Apr 11 Oct 11 May 12 Nov 12 Jun 13 Dec Source: Bloomberg, Nordea Markets 5y BEI and expectations on the Swedish economy y generic BEI NIER macro index Source: Nordea Markets and Reuters Ecowin 15

16 Linkers and break even inflation We favour short end over long end. Go for wider BEI in Interest rate scenarios: Changes in interest rates have a huge impact on Swedish CPI, especially at the currently low level of rates. So theoretically, there should be a close relationship between the shape of the yield curve and BEIs (a steeper curve corresponds to higher BEI). Currently, the shape of the yield curve implies that BEIs in the short end are too low (see table). Also, when we test a large number of Riksbank repo rate scenarios, we find that the upside in BEI is clearly bigger than the downside. Fair valuebreak even inflation FV BEI FV BEI Bond Maturity Yield BEI Mkt rates Ndea CPI forecast SE IL SE IL SE IL SE IL SE IL Supply make us favour short end: The debt office aims at reducing the outstanding amount of SGB 3105 by up to 25 bn SEK during This will be done through bond switches where the debt office issues more long end bonds. In February, a new 10y index linked bond will be issued, and the net duration supply will be significant. We also note that in a cross market comparison, the Swedish real yield curve looks flat. All in all, we prefer being long the short end and especially SGB 3107 (see bottom chart). Real rate yield curves US Germany -1.5 France UK -2.0 Sweden Source:Nordea Markets, Reuters 16

17 Linkers and break even inflation Break even inflation and the shape of the linker yield curve Both break even inflation and monetary policy tend to follow trends in CPI. An environment where inflation is on the rise is generally one where policy rates are increasing and break even inflation trades higher. In particular, there is a visible relationship between the slope of the yield curve and CPI (see bottom chart). Intuition squares well with this, since it is for example hard to imagine the nominal yield curve being inverted if not inflation exceeds 3percent. Holding forward curve steepeners against break even wideners is a combination that seems attractive based on the observations made above. If the yield curve fails to flatten in line with forwards (central banks continue to hold policy rates down even in a recovery), then inflation is most likely contained and break even inflation stays at current low levels while you roll into a steeper curve. If the yield curve actually flattens in line with forwards, then surely this should coincide with at least a moderate pickup in inflation, and thus higher break even inflation than today. For those already positioned for a steeper forward curve, adding break even wideners make sense. For those long break even inflation, adding forward curve steepeners or selling optionality on forward curves below or close to zero should be of interest Monetary policy cycle Sweden, CPI y/y, rhs Sweden, Policy Rates, Repo Rate (Effective Dates), SEK Source: Nordea Markets and Reuters Ecowin Inflation & yield curve 250 Mar 99 Aug 04 Feb 10 Aug 15 SEK 2s/10s + fwd strip, reversed CPI y/y Source:Nordea 17

18 Covered bonds In a low for long/low volatility environment, demand will be met by supply and spreads stay low. If market challenges the central bank commitment, covered bonds will likely get hurt If rates stay low and stable (low for long, forward guidance, QE programs kept running) lending to Swedish household should hold up well. No doubt, end investors will search for yield pickup and pump up demand for covereds, even though carry looks exhausted at some curve segments (about equal carry in 2s as in govies). But at the same time huge redemptions in 2014 and regulators disapproval of foreign currency funding will create supply to meet increases in demand. On the other hand, if the business cycle turns for the better, lending might continue while demand for bonds lessen(rate hike expectations). This is in our view the main beararguments against covereds, especially in the 5y segment. Our bias is to believe in wider 5y covered bond spreads in the first half of The proposed increase in risk weights for mortgage loans from 15 to 25 % corresponds to about 0.3% higher lending rates. This should have a dampening effect on lending and in this aspect be favourable for covereds. But this is a really foggy subject, where the fact that banks that will be more capitalized might lead to emigration of collateral from the mother banks (unsecured lending) to the mortgage institutions where funding is cheaper (covered bond programs). Conclusions are not clear cut yr covered vs government spread 5yr covered bond asw Jan 87 Jun 92 Dec 97 Jun 03 Nov 08 May 14 bn SEK SEK covered bond stock Stock less redemptions Stock assuming 5% lending growth Source:Nordea Source:SCB, Nordea Markets 18

19 Covered bonds There are some risks brewing in the background when it comes to covered bond spreads. We definitely think the triple A rating is highly motivated, but risk/reward looks dicey at these spreads InvestorsinbothSwedenandelsewherehaveinthiscycle been particularly keen on buying various corporate/covered bonds. Credit risk has been the place to be and still is the place to be. But no one knows what will happen if people at one point want to get out of these less liquid products. Covered bond spreads look tight to us, even though we know that there over time will be domestic demand for the bonds. On top of domestic supply, there are also other factors which could drive covered bond spreads wider in 2014: 1) Domestic fixed income risk is concentrated in covereds and rising bond yields could force investors to sell Aug05 May08 Feb11 Nov13 Mtg-Gv 5y (lhs) Repo rate and mkt expectation (rhs) Rix FC 2) Spreads normally start to widen at the time markets sniff out that there will be no more rate cuts from the Riksbank. Being long covered/credit spreads is a rate cut trade. 3) Our Norwegian colleagues believe house prices will drop 15 20% in Norway. This could create market worries also about Swedish prices and thus covered bonds. 4) Credit spreads are linked to stock market movements and, in our minds, there is a larger risk for stock market turbulence sometime in 2014 than there was in Maybe the sweetness of 2013 could turn in to some bitterness

20 Swedish Market Outlook FX 20

21 EURSEK Year end optionality attractive Movements in EURUSD will be important for EURSEK, but the conclusion for EURSEK will depend on the underlying reason for the EURUSD move EZ Sweden Stronger USD If EURUSD falls because of tapering from the Fed, SEK is likely to suffer and EURSEK will go up. Weaker EUR If EURUSD falls on some type of ECB easing, EURSEK will likely weaken as well. Approaching year end, a number of data and central bank events could send SEK in any direction. A traditionally thin year end market could very well make the market overshoot, so trades where you are long optionality appears interesting Macro surprise index still at lows with a Q3 GDP negatively affected by temporary factors and inventory drag all speak for a better risk reward betting for stronger SEK early 2014 rather than weaker around current levels. Risk reward to bet for an unchanged repo rate in December 2013 also seems to be better in FX space than in rate space. In addition, cheap vol suggests owning FX optionality to be attractive Surprise Index Europe Surprise Index Sweden Source: Nordea, Bloomberg Source: EUR vs SEK 2Y IRS EURSEK Jan 08 May 09 Sep 10 Feb 12 Jun 13 Nov EUR vs SEK 2Y IRS EURSEK, rhs Source:Nordea, Bloomberg 21

22 USDSEK To taper or not to taper Our official call is that tapering will occur in the beginning of next year, and yes, that will likely help the dollar S&P 500 Fed total assets However, a tapering with 15bn/month is more or less priced in and Fed s balance sheet will continue to grow in relation to ECB. As for ECB, if at all, any new measures of easing is likely to come after the stress tests. All in all, we expect EURUSD to gain ground over the coming months. In addition, better than expected Swedish macro makes us biased for short positions in USDSEK in the beginning of the year Indeed, a larger/earlier tapering than expected is likely to harm illiquid high yielding assets such as NOK and SEK, hence the outlook later in 2014 is for a higher USDSEK Jan 09 May 10 Sep 11 Feb 13 Jun 14 S&P 500, lhs Fed total assets Source:Nordea, Bloomberg 1.80 Relative balance sheet EURUSD Jun 10 Dec 10 Jul 11 Jan 12 Aug 12 Feb 13 Sep 13 Apr 14 Fed vs ECB balance sheet EURUSD, rhs Source:Nordea Bloomberg 22

23 NOKSEK To trade better than expected Swedish macro we see short NOKSEK as the most attractive position As we have a positive view on Swedish macro for the first part of next year, we believe SEK is likely to benefit on the back of this With several uncertainties surrounding Fed/ECB we see the best way to play a domestic macro bet to be in NOKSEK. Parity should not be impossible! Whereas Swedish growth is likely to surprise on the upside in the first half of next year the outlook for Norway should be the opposite. Domestic demand as well as house prices continue to paint a gloomy picture and our macro economist s call is for Norges Bank to lower rates next year. This as opposed to the Riksbank, where our economists project rate hikes Jun 03 Feb 06 Nov 08 Aug 11 May 14 NOK I44 Source:Nordea, Bloomberg 23

24 Famous Last Words 24

25 Nothing lasts forever what is worrying us We see early signs of a global slowdown late That spells risk off at some stage. So most of the trade thoughts in this publication have a best before date We are FX and fixed income people. We are born with a deeprooted conviction that things are uglier than they look. Sowe can t believe that the cyclical improvement will be a straight road to economic nirvana. There will be stumbling blocks. A favourite one is that interest rate increases might be too large for the economies to carry. Our interest rate based leading indicators warns for slower global growth the second half of Currently, we don t see a recession but rather a slowdown that currently isn t in most economists forecasts. For markets that means that risk on could turn to risk off. It will probably not be a severe, falling off a cliff, market reaction but a period of falling stock markets, some pressure on credit spreads and reasons for traditional government bonds to actually shine a bit again. But we ll get back to that later in

26 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. Nordea Markets is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction. Fredrik Floric, fredrik.floric@nordea.com Mats Hydén, mats.hyden@nordea.com Nils Rosendahl, nils.rosendahl@nordea.com Mikael Sarwe, mikael.sarwe@nordea.com Henrik Unell, henrik.unell@nordea.com This document may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Markets. Alexander Wojt, alexander.wojt@nordea.com 26