Swedish Rate Wrap. What will Mr. Draghi deliver? The market expects delivery. Central banks pushing down long swap spreads.

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1 30 November 2015 Trading Strategy Swedish Rate Wrap What will Mr. Draghi deliver? The market expects delivery Alongside next week s ECB monetary policy meeting, the ongoing bond purchase programme will be evaluated and possibly expanded. At the same time, updated forecasts will be made, where the focus will be on the inflation forecast. The market is expecting delivery, and we share this view. We review the conditions on page 3. Central banks pushing down long swap spreads The long Swedish swap spread has been at a high level since the Riksbank announced its first programme to buy government bonds early in the year. At the same time, central banks with huge currency reserves continue to sell bonds. It is likely that this sales pressure will remain for a while and, in combination with an increased need for Swedish issues resulting from the flow of refugees, we argue that it may be time for the Swedish swap curve to adapt to that of the eurozone. Figure 1: Inflation and ECB forecast Sources: Macrobond and ECB Andreas Skogelid, ansk03@handelsbanken.se Pierre Carlsson,pica01@handelsbanken.se Lars Henriksson, lahe06@handelsbanken.se Our outlook in a nutshell Kort Duration Kurva Bostäder Krediter Neutral Lång Source: Handelsbanken Capital Markets For full disclaimer and definitions, please refer to the end of this report.

2 Swedish Rate Wrap, 30 November 2015 Market in brief Duration Curve Short end Sweden vs. Germany Mortgages Swap spreads Credits Neutral. Neutral. Poor risk-reward in both directions. Widening at the short end of the curve. Long, attractive levels Down on the long side. Neutral. 2

3 Swedish Rate Wrap, 30 November 2015 Our outlook There are high expectations for Mario Draghi and the ECB ahead of next week s monetary policy meeting. Alongside the monetary policy decision, new forecasts will be presented together with an evaluation of the current quantitative measures. The market has high expectations of action from the ECB s December meeting, particularly in light of the ECB statement following the October meeting. Possible actions include an expanded QE programme and/or a reduced interest rate. There were two reasons for the ECB to start its bond purchasing. First, to significantly stimulate the European economy via lower interest rates and increased credit growth. Second, to use monetary policy to support an increase in inflation. From an inflationary perspective, the need for additional stimulus is not completely clear, at least not ex-post (Figure 2). Eurozone inflation has certainly been lower than the ECB s forecast, but the differences are marginal. Here, the new forecasts are a key factor. Like the Riksbank, the ECB is striving for the currency to be as weak as possible, thus importing inflation. The ECB s October meeting was preceded by a relatively long period of a gradually strengthening euro (Figure 3). Since then, the euro has weakened by around 5 percent in trade-weighted terms. In terms of timing, this has coincided with the increased probability of a Fed rate hike, which has contributed to a stronger dollar. The problem for the ECB is that to a certain extent, this euro weakness reflects expectations of ECB action. If these measures do not materialise, there is a risk of the euro strengthening, thereby preventing a rise in inflation. Where credit growth is concerned, it is not completely clear that the measures have had any effect. The overall growth in credit to non-financial companies has just hit zero (Figure 4), despite massive monetary policy actions. There is rising demand for credit from corporations; the question is whether the European banking sector has the capacity to meet this via higher balance sheets. It is clear that the primary target is the currency effect. Since the ECB s October meeting, the market has priced in an increasingly high probability that the ECB will also use the interest rate weapon (Figure 5). A deposit rate reduction from the current -0.2 percent would also increase the universe of available bonds for the ECB to purchase in the QE programme. The ECB is buying bonds with a yield down to the deposit rate. Figure 2: Inflation and ECB forecast Sources: Macrobond and ECB Figure 3: Trade-weighted EUR and USD Sources: The Riksbank Figure 4: Credit growth 3

4 Swedish Rate Wrap, 30 November 2015 An expansion of the QE programme by EUR 20bn per month would put additional downward pressure on the EUR/USD rate. However, the question is whether this is not already priced in (Figure 6). A stronger measure would be an extension beyond September 2016, with a hypothetical monthly purchase amount of SEK 50bn per month for one year (Figure 6). There is also speculation in the market that the ECB would be able to expand its purchases to other asset classes, e.g. credit bonds. There are practical problems with such purchases and we do not think the ECB is ready for such a step. However, once again the problem is that there are high expectations, and if such actions are not taken the market may well be disappointed. Our conclusion, therefore, is that next week we will see action from the ECB. The market is expecting delivery and the ECB will not be able to talk the euro down yet again. It is likely that the period will be extended and a reduction in the deposit rate by 10bp is also possible. Figure 5: 3m Euribor futures Figure 6: ECB s balance sheet and EUR/USD Our view is that this will not result in any form of monetary policy response from the Riksbank. The Riksbank s expansion of the Swedish bond purchasing programme was very much an increased insurance premium against ECB actions during December. Flatter Swedish swap curve? As we wrote in our FX Pilot on September 25 this year, the size of Chinese currency reserves has fallen since the end of last year. In conjunction with the authorities starting deregulation of the capital market and the Chinese currency market, a huge need to invest abroad has resulted in enormous currency outflows, which has put the Chinese currency, the yuan, under pressure. The central bank has been forced to sell bonds from its own currency reserve. Other countries with large currency reserves have also been forced to sell bonds from their currency reserves for various reasons, the main one being falling oil and commodity prices (Figure 7). Apparently, some Swedish bonds in the decreasing reserves were sold when the Riksbank started its bond purchase programme (Figure 8). But there are clear differences in how the Swedish swap curve has reacted compared with the US and the eurozone curves. In Sweden, the long swap spread has increased, while the short spread has been traded at about the same levels (Figure 9). In the eurozone, both curves moved upward simultaneously when repurchases started. Since then, they have traded at about the same levels. For the US, which is no longer expanding its balance sheet, sales of bonds have contributed to a slight decline in the long swap spread (Figure 10). In addition to being in different stages of the monetary policy cycle, one other difference is that Figure 7: Currency reserves in USD 4

5 Swedish Rate Wrap, 30 November 2015 the Riksbank is only buying government bonds, which of course contributes to generally higher spreads. It is clear, however, that the long Swedish end is more sensitive because it has difficulty in falling again. However, both curves have fallen markedly during the past month, despite the Riksbank s recent decision on an extended repurchase programme. This is because of lower Stibor spreads and year-end effects. It seems reasonable that China will continue to sell its foreign bonds given continued market deregulation; it is even possible that the speed of sales might increase. If China does not believe that commodity prices will increase, other countries will also continue to sell. To these factors, we should add the Swedish government s expanded borrowing requirement to finance its refugee policy. This will represent a major part of the Riksbank s bond purchases. If the Riksbank does not significantly increase its programme, or also start to buy covered bonds, there is reason to believe that the curves will adapt to the situation in the eurozone, i.e. significantly lower krona swap spreads. Figure 8: Foreign ownership of government bonds Figure 9: Long and short Swedish swap spreads Figure 10: Swap curves in SEK, USD and EUR 5

6 cc Swedish Rate Wrap, 30 November 2015 The Riksbank at a glance Inflation barometer Inflation (CPIF) and forecasts Green +2; Red -2 standard deviation from consensus forecast, yearon-year change versus historical average Sources: Macrobond, Handelsbanken Capital Markets Sources: Macrobond, Riksbank and Handelsbanken Capital Markets The Riksbank s repo rate forecast and the market Meeting Market Riksbank (Oct) Market vs Riksbank Nov Dec Feb Apr Jul Sep Oct Dec Feb Mar Apr Jul Sep Oct Dec Swedish macro data vs. consensus forecast Source: Bloomberg, Handelsbanken Capital Markets Sources: The Riksbank and Handelsbanken Capital Markets Summary The data harvest has been mixed for Swedish companies and households during the past two weeks. Both consumer and manufacture confidence levels were weaker than expected. But manufacturer confidence remains at levels clearly above the historical average. The reverse situation applies for consumer confidence. Households continue to be optimistic and retail sales increased, largely in line with expectations. The labour market continues to show strength and seasonally adjusted unemployment figures fell for yet another month. Household lending growth was a surprise compared to the October consensus view. The outcome was weaker than expected and was also revised downwards for September. Property prices for the same month continued to be strong and confirmed the largest annual increase since measurements began in

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