Reading the Markets Sweden

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1 Investment Research 22 March 2019 Both the ECB and Fed are on hold in 2019 but the Bank of Norway is hawkish. Fixings might not return to normal ASW spreads in short govvies have room to widen. SEK: Surprised but not worried. Trades New, buy SGB1047 ASW at -48.5bp. P/L: -55/-42bp. Danske Bank s market view in a nutshell Relative value Delta We expect a minor bounce upwards in longer rates in coming months. Grade Last * change 2 14-Mar-19 Curve view Room for steeper curves more limited after ECB Mar-19 Cross country spreads Neutral Jan-19 Short-end (<2Y) Neutral. 1 7-Mar-19 Index-linked bonds Covered bonds Swap spreads BEI spreads could underperform as we approach summer. Buy 3Y covered bonds vs swaps. Buy 5Y covered vs 10Y SGBs. Short end SGBs could widen further. We expect longer ASW spreads to continue underperforming the shorter maturities Mar Feb Mar-19 SEK Stay long NOKSEK Feb-19 Repo rate 3M 6M 12M -0.25% -0.25% -0.25% * Grade of conviction 1-3, where 3 = strongest Chief Analyst Michael Boström mbos@danskebank.se FI Strategy Carl Milton carmi@danskebank.se FX Strategy Stefan Mellin mell@danskebank.se Important disclosures and certifications are contained from page 8 of this report.

2 Both ECB and Fed on hold in 2019 but Bank of Norway hawkish Some weeks ago, we learned that the ECB will be on hold throughout 2019 and that it will introduce a new set of liquidity operations. Now we also have the message from the Fed saying no rate hikes in This is a quite significant change of tone from the Fed. The outlook for growth and inflation has deteriorated due to Europe and China and inflation expectations are moderate, so the appropriate policy response is to keep rates on hold. In addition, the balance sheet reduction will be scaled back to end in September. On the back of this, it is hard to see any meaningful increase in long-term yields. At the same time, the Bank of Norway struck a hawkish tone. The 25bp rate hike was expected but the Bank of Norway also raised the rate path going forward, which we did not expect. The policy announcement is part of the Riksbank s equation but the Fed and ECB are more important. Recent speeches by Riksbank board members give the impression that much has changed. Even the latest lower inflation prints do not appear to have made much of an impression. Nevertheless, we are convinced the Riksbank is thinking hard about what conclusion to draw from the new ECB/Fed policy guidance. Surely, the Riksbank has a lot of time for thinking to decide whether another rate hike in Q2 (September) is still warranted. Looking at the next policy meeting (April), we cannot find any valid reason why the Riksbank would sound more hawkish let alone hike the repo rate. However, we would not rule out that it will keep the repo rate path unchanged, something that would probably be taken as a hawkish sign. Brexit getting more chaotic by the day The Brexit process is another issue that policymakers must take into account. So far, we have regarded a disorderly Brexit as a tail-risk. Number 10 Downing Street has applied for an Article 50 extension until 30 June. The reply from EU officials is that such a short extension is conditional on the British parliament accepting the agreement it has twice rejected, otherwise an extension must be significantly longer. The latter appears to be unacceptable to the British Prime Minister. Time is running out. If we define a tail-risk as something with a very low probability, we can longer treat a disorderly Brexit as a tail-risk, simply because the Brexit issue is becoming increasingly chaotic and there is no meaningful way to assess probabilities in a chaotic process. In our view, this will also be a part of the Riksbank equation going forward. A disorderly Brexit would be a bad thing but a long extension, although probably less disruptive, would not be all that much better, because European businesses and consumers would have to live with continued uncertainty for an extended period. At last some data A new set of economic data is due to released next week and one thing worth mentioning is the NIER business and consumer survey. We have been somewhat puzzled by the mix of data in recent surveys. Manufacturing is doing pretty well, while services producers are gloomy. Considering the ongoing discussion about a global slowdown and Sweden s export dependence, we would have thought it should be the other way round. Turning back to the Riksbank, the policy strategy (slightly simplified) relies on three critical factors: the labour market, inflation expectations and inflation. As long as the labour market is (and is expected to remain) strong and inflation expectations are in line with the target, the Riksbank has a higher tolerance for a short-term deviation in inflation from the forecast March

3 Manufacturers do well, service producers are gloomy Services sector is key to the labour market Source: NIER Source: NIER Manufacturers in Sweden now employ no more than 575,000 people, while 2.5 million work for services producers. Therefore, the service sector is key to how the job-market will develop. Looking at hiring plans (NIER survey), we have seen some softening but so far nothing alarming. Nonetheless, we believe this is a factor to monitor closely going forward. Fixings might not return to normal ASW spreads in short govvies have room to widen The proposal from the FSA, among other changes, to add a formal LCR requirement in SEK (minimum 75%) is likely to be one of the main contributors to the increase in the 3M Stibor fixing, coupled with relative cheapening of USD funding. Though compliance at the time of the report was good, we suspect that seasonal variations in liquidity are generally large. The market expects a gradual return to tighter fixing spreads we are less convinced about this. Moreover, we are slightly worried what this would mean in periods with large redemptions, where banks have to hoard liquidity. In particular, four covered bonds (SEB572, SWH188, NDH5530 and LFH512) mature in June 2019, with an outstanding volume of almost SEK94bn (as of 28 February 2019). It remains uncertain how fixings will behave around this time and we clearly prefer to be positioned for higher fixings. We note that Riksbank certificates have been fully subscribed for three consecutive weeks an unusual pattern not seen since 2014, although this is possibly affected by the maturity of SGB1052 (which occurred on 12 March 2019). Fixing spreads expected to tighten over time FRA-Riba spread (spot and market pricing) Spot 22.6 Jun Sep Dec Mar Jun March

4 Whatever the Riksbank decides to do with bond purchases at the April meeting (we guess no extension of purchases beyond June 2019), we believe shorter govvies are likely to remain squeezed for a long time. In particular, SGB1047 (Dec 2020, current 2Y super benchmark loan) and SGB1057 (Nov 2023, current 5Y super benchmark loan) trade dear in the repo market and are likely to remain in demand for a long time. ASW spreads have tightened somewhat since mid-2018, probably helped by the move in German ASW spreads. In our view, the room for further tightening looks limited, as the situation in the repo market should anchor the shorter loans. We note that the Riksbank has heavily bought both SGB1047 and SGB1057 and that the free float is very modest (SEK35bn and SEK29bn, see table below). Both loans trade close to 40bp dear relative to the Riksbank repo rate in the repo market. The Riksbank has bought slightly less in SGB1054, making the loan slightly less appealing. Swedish and German ASW spreads could diverge further in the short end Generic 5Y SGB ASW Generic 5Y GER ASW feb-18 apr-18 maj-18 jul-18 sep-18 okt-18 dec-18 feb-19 mar-19 maj-19 Riksbank has been aggressive in buying bonds in the short end Riksbank Amount Riksbank holdings Bond Purchases Outstanding share of stock "Free float" Maturity SGB % SGB % SGB % SGB % SGB % SGB % SGB % SGB % SGB % SGB % EX % To some extent, ASW wideners in shorter govvies could act as a hedge against holdings in shorter covered bond versus swaps (we hold SHYP1585 ASW, Dec 2021). In our view, if short rates remain under pressure, shorter covered bonds could ultimately come under some pressure, despite the ongoing hunt for yield. Very short-dated covered bonds, such as SWH189 (matching SGB1047) trade somewhat dear on an outright basis in our view, as by the running spread in the repo market (spread 42bp compared with around 40bp difference in the repo market) completely explains the spreads. A correction in short-end covered bonds would possibly have some spillover effect on slightly longer covered bonds, if fixing spreads remain under upward pressure March

5 Therefore, we suggest buying either SGB1047 or SGB1057 in an ASW, with a slight preference for the former as fixing spreads should have a more pronounced effect on shorter maturities. We set the P/L levels at -55 and -42bp, respectively. Potential left in shorter ASW spreads -40 SGB1057 ASW SGB1047 ASW dec-17 apr-18 jul-18 okt-18 feb-19 maj-19 We note that longer end ASW spreads in SGBs have underperformed relative to the short end. If we are correct that the Riksbank is not likely to extend purchases beyond June, there is, in our view, room for further underperformance in long-dated ASW spreads. Short-dated ASW spreads could continue to outperform longer maturities especially if the Riksbank ends bond purchases Generic 10Y SGB ASW Generic 3Y SGB ASW -70 dec-17 apr-18 jul-18 okt-18 feb-19 maj-19 SEK: surprised but not worried There has been a lot of media attention recently on this year s depreciation of the SEK. Following this, several Riksbank board members have said they are surprised. In defence of the Riksbank, we note that the YTD development has taken many observers and experts by surprise (us included). This said, a key explanation is that the SEK has been used as a funding currency, which has to do with the Riksbank s actions. While the SEK may have responded positively to these comments, we do not consider them as verbal interventions against SEK weakness: surprised yes, worried no. In addition, we believe it woul be ironic if the Riksbank started to manage the exchange rate from the weak side just weeks after it formally removed the intervention mandate that should hinder any premature SEK appreciation. We think the board is talking to the public ( don t blame us, we are surprised too ) rather than market participants. In addition, the comments merely reflect what the KIX forecast implies: the SEK has been 3% weaker than the February forecast and 6% weaker than the December forecast March

6 Surprisingly weak Source: Macrobond Financial, Danske Bank If the SEK were to collapse because the market loses confidence (interest) in the currency, it would be likely to fuel a broader discussion in society about what is going on and the Riksbank s responsibility. However, then it is the overall monetary policy framework, which is set by politicians that should be addressed. We are not in that situation yet, though. Cecilia Skingsley s repeat of higher tolerance toward inflation misses also supported the SEK. We should read this in the light of the latest two prints, which were as much percentage points below forecast. This suggests that if the March numbers are not much worse she will at least support keeping the H2 rate hike guidance intact in April. The same goes for Henry Ohlsson. An interview in Dagens Industri shows that he is not shaken by the inflation prints or (according to him) talk of a slowdown in the Swedish economy. For the April meeting, our base case is that the Riksbank will lower its inflation path but keep the repo rate path intact. Such a manoeuvre would effectively raise the threshold for inflation disappointments ahead. Hence, given the information and market pricing that we have now, such a move could push up RIBA and pull down EUR/SEK. This said, we stick to our call that the Riksbank will not hike this year, so we see a risk the SEK will eventually come under pressure again. Open strategies Type Trade Idea Target & P/L Status Covered bonds Buy SGB1047 ASW. SGB1047 likely to be increasingly squeezed, Opened 21 mar 2019 New while short dated swaps could be pushed Start higher by fixings. Target/Stop -55/-42 Now P/L 0.0 Covered bonds Buy SHYP1588 (Mar 2024) vs An alternative to 3Y-10Y swap steepener, Opened 28 feb 2019 Hold SGB1061 (Nov 2029) buying longer covered vs 10Y SGBs may be Start 14 less exposed to the risk of continued hunt for Target/Stop 4/21 yield. Now P/L 0.5 Covered bonds Buy SHYP1585 (Dec 2021) Attractive carry and roll and stability in Opened 31 jan 2019 Hold ASW short end ASW spreads are supportive. Start 7 Target/Stop -3/15 Now 1.39 P/L March

7 Calendar Monday, 25 March, 2019 Period Danske Bank Konsensus Previous 10:00 GER Ifo Index Mar 98,7 98,5 10:00 GER Ifo expectations Index Mar 94,5 93,8 15:30 US Dallas Fed manuf. Activity Index Mar 9,6 13,1 Tuesday, 26 March, 2019 Period Danske Bank Konsensus Previous 08:00 DEN Retail sales m/m y/y Feb -0.3% 0.1% 08:45 FRA Business confidence Index Mar :45 FRA GDP, final q/q y/y Q4 0.3% 0.9% 09:30 SWE PPI m/m y/y Feb 0.8% 5.6% 13:30 US Building permits 1000 (m/m) Feb (-0.7%) 13:30 US Housing starts 1000 (m/m) Feb (18.6%) 14:00 US FHFA house price index m/m Jan 0.4% 0.3% 15:00 US Conference Board consumer confidence Index Mar Wednesday, 27 March, 2019 Period Danske Bank Konsensus Previous 08:00 NOR Unemployment (LFS) % Jan 3.7% 08:45 FRA Consumer confidence Index Mar :00 EZ ECB's Draghi speaks in Frankfurt 09:00 SWE Consumer confidence Index Mar :00 SWE Economic Tendency Survey Index Mar :00 SWE Manufacturing confidence Index Mar :15 SWE NIER economic forecasts 09:30 SWE Household lending y/y Feb 5.4% 09:30 SWE Trade balance SEK bn Feb 1, :45 EZ ECB's Praet speaks in Frankfurt 10:00 ITA Consumer confidence Index Mar 112,0 112,4 10:00 ITA Manufacturing confidence Index Mar 101,3 101,7 13:30 US Trade balance USD bn Jan :00 US Current account USD bn Q :30 US DOE U.S. crude oil inventories K Thursday, 28 March, 2019 Period Danske Bank Konsensus Previous 08:00 NOR Credit indicator (C2) y/y Feb 5.7% 09:30 SWE Retail sales s.a. m/m y/y Feb 0,0% 2,5% 0.8% 2.2% 10:00 EZ Money supply (M3) y/y Feb 3.8% 11:00 EZ Service confidence Net bal. Mar :00 EZ Business climate indicator Net bal. Mar 0,69 11:00 EZ Industrial confidence Net bal. Mar :00 EZ Economic confidence Index Mar :00 EZ Consumer confidence, final Net bal. Mar 13:30 US GDP, 3rd release q/q AR Q4 2,4% 2,6% 14:00 GER EU-harmonized CPI m/m y/y Mar 0,6% 1,7% 0,5% 1,7% 15:00 US Pending home sales m/m y/y Feb 0.5% % -3.2% Friday, 29 March, 2019 Period Danske Bank Konsensus Previous 00:30 JAP Unemployment rate % Feb 2.4% 2.5% 00:50 JAP Retail trade, preliminary m/m y/y Feb % -1.8% 0.6% 00:50 JAP Industrial production, preliminary m/m y/y Feb 1.0% -0.6% -3.4% 0.3% 08:00 DEN GDP, final q/q y/y Q4 0.7%... 08:00 NOR Retail sales, s.a. m/m Feb 1.6% 08:45 FRA Household consumption m/m y/y Feb 1.2% 1.0% 08:45 FRA HICP, preliminary m/m y/y Mar 0.1% 1.6% 10:00 NOR Unemployment % Mar 2.5% 10:30 UK GDP, final q/q y/y 4th quarter 0.2% 1.3% 11:00 EZ HICP - core inflation, preliminary y/y Mar 1,0% 1.0% 11:00 EZ HICP inflation, preliminary y/y Mar 1,5% 1.5% 13:30 US Personal spending m/m Feb 0.3% -0.5% 13:30 US PCE headline m/m y/y Jan 0.0% % 1.7% 13:30 US PCE core m/m y/y Jan 0.2% % 1.9% 14:45 US Chicago PMI Index Mar :00 US University of Michigan consumer confidence, final Index Mar :00 US New home sales 1000 (m/m) Feb (-6.9%) Source: Various sources, Danske Bank 7 22 March

8 Disclosures This research report has been prepared by Danske Bank A/S ( Danske Bank ). The authors of this research report are Michael Boström (Chief Analyst), Carl Milton (Analyst) and Stefan Mellin (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. 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. 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 security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis of relevant assumptions, are stated throughout the text. Expected updates Weekly. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research report has been prepared by Danske Bank A/S. It is provided for informational purposes only and should not be considered investment advice. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided herein. This research report is not intended for, and may not be redistributed to, retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent March

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