Investment Research General Market Conditions 30 May 2018 Yield Outlook Italy pushes Scandinavian and German yields lower temporarily The focal point in the European bond market at the moment is the political situation in Italy. Since the beginning of May Italian 10-year yields have widened more than 140bp, and the spread to Germany is now above 260bp while the outright 10-year yield has been above 3% in Italy. We have to go back to 2013-14 to see similar levels for Italian yields and spreads. There is a genuine risk that a new debt crisis is on the way in Italy and the impact on the financial markets outside Italy has been sizeable. Investors have sought shelter or safe-haven in the German government bond market and 10-year German Bund yields have been more or less halved in a week to currently 0.35%. It has also dragged swap-rates lower, though the drop in swap-rates has been slightly more modest as the asset-swap spreads have widened (bond yield versus swap rate). The drop in German government bond yields has been mirrored in the Scandinavian markets given the strong underlying fundamentals of Denmark, Norway and Sweden. IT-DE spread widening and downward pressure on DE yields Quick links Eurozone forecasts US forecasts UK forecasts Denmark forecasts Sweden forecasts Norway forecasts Forecasts table Policy rate outlook Country Spot +3m +6m +12m USD 1.75 2.00 2.00 2.50 EUR -0.40-0.40-0.40-0.40 GBP 0.50 0.75 0.75 1.00 DKK -0.65-0.65-0.65-0.65 SEK -0.50-0.50-0.50-0.50 NOK 0.50 0.50 0.75 1.00 10-year government bond yield outlook Source: Macrobond Financial, Bloomberg For more on the new Italian crisis take a look at this research note: Flash Comment: The Italian market panic: drivers and near-term outlook, 30 May 2018. Country Spot +3m +6m +12m USD 2.85 3.00 3.10 3.30 GER 0.33 0.60 0.80 1.10 GBP 1.24 1.55 1.75 2.00 DKK 0.35 0.60 0.80 1.10 SEK 0.47 0.45 0.65 1.00 NOK 1.76 2.05 2.20 2.40 Note: EUR = Germany The big question is of course whether the Italian crisis is going to continue setting the agenda for the rest of 2018. There is a non-negligible risk that this is turning into a fullblown new debt crisis where the upcoming election campaign will focus on Italy leaving the euro, massive fiscal easing and debt restructuring. In that case the recent downward pressure on EUR and Scandi rates and yields will continue. The market will probably start to price out any probability of the ECB hiking rates in the next three years. In this scenario our yield and rate forecasts are far too high. Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 arr@danskebank.com Important disclosures and certifications are contained from page 11 of this report.
However, it might also be that the crisis dynamics have peaked, the Italian politicians soften the rhetoric and investors take advantage of the high yields the Italian market currently offers, and we see a stabilisation in Italian yields and spreads. We will probably not move back to the spreads seen before the political jitters started and Italy might receive one or more rating downgrades. But importantly Italy will not set the agenda every day and the safe-haven flows into German bond markets will ease and the market will slowly start to focus on the usual drivers for the fixed income market. We have in this update assumed the latter and we keep our yield forecasts more or less unchanged. We have revised lower some of the forecasts on a 3M horizon, but have made few changes to the 12M forecast. We also still forecast that the ECB will start to hike rates in the latter part of 2019. But importantly, we keep the view that Nordic/European 10Y rates and yields will not rise significantly in 2018 and that higher 10Y yields would be very much a 2019 story. Short term we could potentially see a move higher if the recent flow into German bonds reverses. The reason why we mainly see higher yields and rates is 2019 is twofold. Firstly, it seems that the global business cycle is losing momentum. In our view there are clear signs that the global business cycle peaked in early 2018.. Declining PMI levels across regions tend to cause some anxiety about the strength of the recovery and would normally put a cap on bond yields. We rarely see yields moving significantly higher at the same time as business cycle indicators such as the PMIs move lower. Secondly, we continue to hold the view that the ECB will not hike before December 2019, when Mario Draghi and other dovish members have left the ECB. Wider spread between USD and EUR rates We continue to see a further widening of the two-year spread between USD and EUR rates. We expect the Fed to hike three times this year and next. Importantly, we still expect the Fed to raise the Fed funds rate above the longer run dot of 2.75% (the Fed s estimate of the natural rate of interest when the economy is normalised) in coming years. Our fixed income view higher yields mainly a 2019 story We have kept our 12M forecast for German 10Y yields unchanged at 1.1%. We also continue to expect a steeper 2Y10Y German yield curve. The ECB still maintains a relatively tight grip on the short end of the curve, especially with the first ECB rate hike expected late in 2019. However, this is not the case for the 10Y segment of the curve, which we still expect to be pushed by higher US yields in 2019. We continue to see 10Y US Treasury yields at 3.30%. Contrary to the European markets, the US curve 2y10y is expected to flatten further over the next twelve months. We plan to publish the next issue of Yield Outlook end of June. 2 30 May 2018
Contents and contributors Eurozone...4 Macro Senior Analyst Aila Mihr +45 45 12 85 35 amih@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 arr@danskebank.dk US...5 Macro & interest rates Senior Analyst Mikael Olai Milhøj +45 45 12 76 07 milh@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 arr@danskebank.dk UK...6 Macro & interest rates Senior Analyst Morten Helt +45 45 12 85 18 mohel@danskebank.dk Denmark...7 Macro Chief Economist Las Olsen +45 45 12 85 36 laso@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 arr@danskebank.dk Sweden...8 Macro & interest rates Chief Analyst Michael Boström +46 8 568 80587 mbos@danskebank.com Senior Analyst Michael Grahn +46 8 568 80700 mika@danskebank.com Senior Analyst Marcus Söderberg +46 8 568 80564 marsd@danskebank.com Senior Analyst Carl Milton +46 8 568 80598 carmi@danskebank.com Norway...9 Macro & interest rates Chief Analyst Jostein Tvedt +47 23 13 91 84 jtv@danskebank.dk Forecasts table... 10 3 30 May 2018
Eurozone forecasts Sentiment indicators, including PMI, ifo and ZEW have pointed towards abating growth momentum in the eurozone. Although we expect the euro area business cycle to move one gear lower, we still look for robust growth of 2.1% in 2018 and 1.9% in 2019. We expect the first ECB hike of 20bp only in December 2019, due to increased downside risks to the growth and inflation outlook. Although we expect a rebound to 1% in core inflation, we still think core inflation will remain subdued throughout 2018. Consequently, we do not expect the ECB to shift towards more optimistic language with regard to the inflation outlook anytime soon. This also means we do not expect the next change in the ECB s forward guidance to come before the July meeting. Political risks have risen recently and are likely to stay elevated amid the Italian turmoil but, so far, we do not expect this to affect the ECB s monetary policy stance. We continue to expect a steeper EUR yield curve on a 12M horizon. The ECB still maintains a relatively tight grip on the short end of the curve. However, this is not the case for the 10Y segment of the curve, which we expect to be pushed by higher US yields, the end of ECB QE from the ECB and the pricing of rate hikes in 2020. An expected higher term premium works in the same direction. We have a 12-month 1.1% forecast for 10Y Germany. Higher 10Y yields is mainly a 2019 story. EUR forecasts summary 30/05/2018 --- Forecast --- --- Fcst vs Fwd in bp --- EUR Spot +3m +6m +12m +3m +6m +12m Money market Refi 0.00 0.00 0.00 0.00 - - - Deposit -0.40-0.40-0.40-0.40 - - - 3M -0.32-0.33-0.33-0.33-7 -9-12 Government bonds 2-year -0.69-0.55-0.50-0.30 - - - 5-year -0.30 0.00 0.20 0.40 - - - 10-year 0.33 0.60 0.80 1.10 - - - Swap rates 2-year -0.14-0.15-0.10 0.10-6 -6 +1 5-year 0.29 0.45 0.65 0.85 +8 +22 +27 10-year 0.92 1.05 1.25 1.55 +7 +22 +41 EUR swap curve one-month change 2.0 % bp 6 4 1.5 2 0 1.0-2 0.5-4 -6 0.0-8 0 3 6 9 12 15 18 21 24 27-10 -0.5-12 Change,bp (rhs) 30-Apr-18 30-May-18 3M Euribor 10Y EUR swap rates 4 30 May 2018
US forecasts We expect the Fed to hike twice more this year with risk skewed towards a third hike. This was also the message the Fed sent at its March meeting, when the median dot was unchanged at three this year but underlying details showed the committee was divided between a total of three and four hikes this year. As the economic expansion continues, it is still the subdued inflation and wage growth that will be key determinant for the hiking pace. Note the Fed put more focus on the modest inflation at its latest policy meeting. In line with our expectation, the Fed also signalled it is ready to start hitting the brakes soon, as the committee now signals it is ready to raise the Fed funds rate above the longer run dot of 2.875% (which is the Fed s estimate of the natural rate of interest where monetary policy is neither expansionary nor contractionary). We expect three additional hikes next year and believe that it is possibly the hiking cycle will continue into 2020. We still see a case for a Fed repricing in 2019/20, pushing 2Y yields higher. We continue to expect a flattening of the curve for the 2Y10Y on a 12M horizon. However, we still see the 10Y US treasury yield at 3.30% in 12M, as we see a further repricing of the US term premium given the risk of higher interest rate volatility and as we expect an effect from the more expansive US fiscal policy going forward, which would boost US bond supply. USD forecasts summary 30/05/2018 --- Forecast --- --- Fcst vs Fwd in bp --- USD Spot +3m +6m +12m +3m +6m +12m Money market Fed Funds 1.75 2.00 2.00 2.50 - - - 3M 2.32 2.42 2.62 2.95 - +10 +21 Government bonds 2-year 2.40 2.50 2.70 3.00 - - - 5-year 2.68 2.80 2.90 3.10 - - - 10-year 2.85 3.00 3.10 3.30 - - - Swap rates 2-year 2.65 2.80 3.00 3.30 +8 +22 +45 5-year 2.80 2.95 3.05 3.25 +12 +20 +36 10-year 2.89 3.05 3.15 3.35 +14 +22 +40 USD swap curve one-month change 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 % bp 0 3 6 9 12 15 18 21 24 27 Change,bp (rhs) 30-Apr-18 30-May-18 0-2 -4-6 -8-10 -12-14 3M USD Libor rates 10Y USD swap rates 5 30 May 2018
UK forecasts The Bank of England (BoE) did not increase its Bank Rate in May, as economic indicators surprised on the downside. However, we still believe the hiking cycle has been postponed, not cancelled. However, we think there will probably be fewer rate hikes than previously thought. We expect one hike in the second half of 2018 and one in 2019. The next hike may come as soon as August if economic data hold up but the probability has declined since the meeting, as the BoE will get only a few months more data, which may not be enough for the majority of the its members to feel comfortable about a hike. The next possibility would be the November meeting. Consensus among analysts is that the BoE will hike in August, with the following hike in February 2019. Markets are priced more softly, with the probability of a rate hike in August at 35% (70% for a hike in November). However, markets have nearly priced in two full hikes by year-end 2019, which is fair. We generally forecast higher yields across the curve and with the BoE expected to lift the front end much faster than the market s pricing, we look for a gradual flattening of the 2y-10y and 5y-10y yield curves. We forecast yields on 2Y gilt at 1.40% in 12M and target yields on 10Y gilts at 2.00%. UK forecasts summary 30/05/2018 --- Forecast --- --- Fcst vs Fwd in bp --- GBP Spot +3m +6m +12m +3m +6m +12m Money market Repo 0.50 0.75 0.75 1.00 - - - 3M 0.61 0.82 0.82 1.07 +12 +4 +17 Government bonds 2-year 0.64 0.90 1.20 1.40 +27 +53 +57 5-year 0.97 1.30 1.50 1.70 +34 +51 +63 10-year 1.24 1.55 1.75 2.00 +19 +35 +51 Swap rates 2-year 0.93 1.15 1.45 1.70 +15 +39 +52 5-year 1.23 1.55 1.75 2.00 +27 +43 +60 10-year 1.47 1.70 1.90 2.15 +20 +37 +57 UK swap curve one-month change 2.0 % bp 0-2 1.5-4 1.0-6 -8 0.5-10 -12 0.0-14 0 3 6 9 12 15 18 21 24 27 Change,bp (rhs) 30-Apr-18 30-May-18 3M GBP Libor rates 10Y UK swap rates 6 30 May 2018
Denmark forecasts We do not expect any rate changes from the Danish central bank over the next 12 months. If anything, we could see the central bank intervening in the market to weaken the DKK, as fundamentals such as the significant current account surplus still tend to strengthen the DKK. We expect DKK fixings to remain at the current low level for the time being. In January and February, we saw underperformance for Danish mortgage bonds as global yields moved higher, which spilled over to both the Danish swap and government bond market and we saw a spread widening versus German government bonds and EUR swaps. This spread widening has now reversed and we continue to expect a further spread tightening in 2018. We expect the 10Y spread versus Germany to reach zero. Foreign demand for Danish fixed income is pushing spreads tighter. For government bonds, the buybacks by the debt office funded by the government s own cash buffer are also supporting the Danish fixed income market in 2018. DKK forecasts summary 29/05/2018 --- Forecast --- --- Fcst vs Fwd in bp --- DKK Spot +3m +6m +12m +3m +6m +12m Money market CD -0.65-0.65-0.65-0.65 - - - Repo 0.05 0.05 0.05 0.05 - - - 3M -0.29-0.30-0.30-0.30-3 -6-11 6M -0.14-0.15-0.15-0.11-5 -9-11 Government bonds 2-year -0.60-0.45-0.40-0.20 - - - 5-year -0.15 0.10 0.30 0.50 - - - 10-year 0.36 0.60 0.80 1.10 - - - Swap rates 2-year -0.02 0.00 0.05 0.25-3 -4 +5 5-year 0.42 0.60 0.80 1.00 +12 +24 +30 10-year 1.06 1.20 1.40 1.70 +9 +23 +42 DKK swap curve one-month change 2.0 % bp 4 2 1.5 0-2 1.0-4 0.5-6 -8 0.0-10 0 3 6 9 12 15 18 21 24 27-12 -0.5-14 Change,bp (rhs) 30-Apr-18 30-May-18 3M Cibor rate 10Y DKK swap rates 7 30 May 2018
Sweden forecasts We think that Swedish rates will enter a period of curve flattening when short rates will be rather sticky on the downside while longer rates move a bit lower. A combination of a weaker krona and surging gasoline prices is likely to give at least a temporary boost to inflation. In our view, CPIF inflation will be around 2% throughout this year. The Riksbank is currently thinking of starting to raise the repo rate late this year (October or December policy meeting). We are far from convinced that it will but on the back of high inflation, short rates will probably have a hard time trading lower. However, longer rates are guided more by macro data and, in our view, current consensus growth forecasts are too optimistic. The housing market is an ongoing issue, consumer spending is relatively soft and uncertainties prevail regarding both Brexit (less than a year from now) and US-EU trade relations. This should give support to longer rates. In the bond space, Swedish investors are significantly underweight government bonds, which almost automatically means they are short duration relative to benchmark indices. Next month there is a significant index extension and we think investors need to add some longer risk in order not to get even shorter. Lower longer term bond yields would probably also have a spillover effect on swaps. SEK forecasts summary 30/05/2018 --- Forecast --- --- Fcst vs Fwd in bp --- SEK Spot +3m +6m +12m +3m +6m +12m Money market Repo -0.50-0.50-0.50-0.50 - - - 3M -0.41-0.45-0.40-0.40-5 +0-25 Government bonds 2-year -0.59-0.50-0.50-0.40 - - - 5-year -0.12-0.05 0.00 0.20 - - - 10-year 0.47 0.45 0.65 1.00 - - - Swap rates 2-year -0.19-0.15-0.15-0.05-5 -14-26 5-year 0.40 0.35 0.45 0.65-14 -13-11 10-year 1.12 0.95 1.15 1.40-23 -10 +2 SEK swap curve one-month change 2.0 % bp 0 1.5-2 1.0-4 0.5-6 0.0-8 -0.5-10 -1.0 0 3 6 9 12 15 18 21 24 27-12 Change,bp (rhs) 30-Apr-18 30-May-18 3M Stibor rate 10Y SEK swap rates 8 30 May 2018
Norway forecasts In the Monetary Policy Report 1/18 15 March, Norges Bank moved the most likely time for the first hike in the sight deposit rate to September. Despite somewhat mixed economic data recently, we do not expect Norges Bank to back down on its plan to hike over the summer. Interest rates in the short end of the curve have, however, dropped on weaker data and a spillover from the declining US FRA-OIS spread. The forward curve is now significantly below Norges Bank s projection. Recent Norwegian data have been mixed. Core inflation was 1.3% y/y in April, below Norges Bank s forecast of 1.66%. Adjusted for volatile airfares and food prices, corecore inflation still seems to be increasing. Retail sales lately have been somewhat disappointing. However, the labour market is continuing to tighten. Recent wage talks point to wage growth of around 3.0% for 2018. It appears the Norwegian Philips curve is alive and kicking. We expect Norges Bank to hike the sight deposit rate by 25bp to 0.75% at the 20 September monetary policy meeting. In 2019, we expect two hikes of 25bp each in March and September. We expect 5Y and 10Y yields to widen slightly versus peers in 2018, as the Norwegian economy is improving slowly, higher wage growth versus international peers has become apparent and Norges Bank will hike according to its own projections whereas the ECB will stay on hold. NOK forecasts summary 30/05/2018 --- Forecast --- --- Fcst vs Fwd in bp --- NOK Spot +3m +6m +12m +3m +6m +12m Money market Deposit 0.50 0.50 0.75 1.00 - - - 3M 1.03 1.15 1.30 1.50 +5 +11 +20 Government bonds 2-year 0.80 0.85 0.95 1.30 - - - 5-year 1.44 1.70 1.95 2.10 - - - 10-year 1.77 2.05 2.20 2.40 - - - Swap rates 2-year 1.37 1.55 1.65 2.00 +12 +15 +36 5-year 1.77 2.00 2.25 2.40 +17 +36 +39 10-year 2.16 2.40 2.55 2.75 +20 +31 +44 NOK swap curve one-month change 2.7 % bp 0 2.2-5 1.7-10 1.2-15 0.7-20 0 3 6 9 12 15 18 21 24 27 Change,bp (rhs) 30-Apr-18 30-May-18 3M Nibor rate 10Y NOK swap rates 9 30 May 2018
Forecasts Forecasts USD EUR * GBP NOK SEK DKK Horizon Policy rate 3m xibor 2-yr swap 5-yr swap 10-yr swap 2-yr gov 5-yr gov 10-yr gov Spot 1.75 2.32 2.65 2.80 2.89 2.40 2.68 2.85 +3m 2.00 2.42 2.80 2.95 3.05 2.50 2.80 3.00 +6m 2.00 2.62 3.00 3.05 3.15 2.70 2.90 3.10 +12m 2.50 2.95 3.30 3.25 3.35 3.00 3.10 3.30 Spot -0.40-0.32-0.14 0.29 0.92-0.69-0.30 0.33 +3m -0.40-0.33-0.15 0.45 1.05-0.55 0.00 0.60 +6m -0.40-0.33-0.10 0.65 1.25-0.50 0.20 0.80 +12m -0.40-0.33 0.10 0.85 1.55-0.30 0.40 1.10 Spot 0.50 0.61 0.93 1.23 1.47 0.64 0.97 1.24 +3m 0.75 0.82 1.15 1.55 1.70 0.90 1.30 1.55 +6m 0.75 0.82 1.45 1.75 1.90 1.20 1.50 1.75 +12m 1.00 1.07 1.70 2.00 2.15 1.40 1.70 2.00 Spot -0.65-0.29-0.02 0.40 1.04-0.61-0.17 0.35 +3m -0.65-0.30 0.00 0.60 1.20-0.45 0.10 0.60 +6m -0.65-0.30 0.05 0.80 1.40-0.40 0.30 0.80 +12m -0.65-0.30 0.25 1.00 1.70-0.20 0.50 1.10 Spot -0.50-0.41-0.19 0.40 1.12-0.59-0.12 0.47 +3m -0.50-0.45-0.15 0.35 0.95-0.50-0.05 0.45 +6m -0.50-0.40-0.15 0.45 1.15-0.50 0.00 0.65 +12m -0.50-0.40-0.05 0.65 1.40-0.40 0.20 1.00 Spot 0.50 1.03 1.37 1.77 2.16 0.80 1.43 1.76 +3m 0.50 1.15 1.55 2.00 2.40 0.85 1.70 2.05 +6m 0.75 1.30 1.65 2.25 2.55 0.95 1.95 2.20 +12m 1.00 1.50 2.00 2.40 2.75 1.30 2.10 2.40 * German government bonds are used, EUR swap rates are used 10 30 May 2018
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