Investment Research General Market Conditions 3 May 6 Fed hikes, higher oil prices and ultra-long bond issuance are upside risks to European yields Any significant rise in global rates and yields over the next three months still looks unlikely, in our view, given the latest easing measures from the ECB (more bond purchases, TLTRO II and purchase of corporate bonds), a BoJ expected to ease further to avoid a further appreciation of the yen, a Fed not likely to hike at the June meeting, together with still low inflation and inflation expectations. In fact a new downward pressure on global rates and yields should not be ruled out. Given the new ECB easing measures and uncertainty ahead of the UK EU referendum, there is certainly a possibility that Germany could be the next country after Switzerland and Japan to experience negative Y bond yields. Also factors pointing to higher yields in the long end (Y) But there are also factors pointing in the other direction, especially if we look six to twelve months ahead. The resumption of Fed rate hikes in September is expected to weigh on the US treasury market and it will also tend to push Y European yields higher. Remember, very few rate hikes are priced in the US for the next two years. Furthermore, if the higher oil price feeds into higher inflation expectations European Y yields could also move higher than we forecast. It is also worth mentioning that over the past month we have seen a lot of ultra-long government bond issuance. France, Belgium, Spain and Ireland have all issued 5Y bonds and Italy may be next in line. On top of that, Belgium and Ireland have issued Y bonds. So far investor demand for these long bonds has been high but if we see a change of sentiment or more countries decide to issue in this part of the curve, sentiment could change. Ultra-long bonds also add a lot of interest rate risk to the market and we have already seen 3Y yields in the periphery moving higher partly due to these long bonds. Hence, an upward pressure on Y EUR rates in particular from the very long end of the curve (3Y) should certainly not be ruled out. Apparently, many European debt offices regard the 3Y-5Y yield level as very attractive, as they have taken the opportunity to lock-in some of their interest rate exposure for up to years. If we see market inflation expectations moving higher, e.g. due to higher oil prices or a better European economy, the Y to 3Y segment of the curve could also be vulnerable. Currency pivotal for Scandi markets The Riksbank reacted to the low inflation at the policy meeting in February and cut the deposit rate by 5bp to -.5% and in April the QE programme was extended. A feature of the extension was that it implies a tapering of purchases in H 6. But given the modest inflationary pressure in Sweden and the risk of a stronger SEK, the outlook is still tilted towards more easing. In Norway, higher oil prices take away some of the pressure for lower rates, but given the stronger NOK we continue to expect a final rate cut at the September meeting. We still look for an unchanged Danish deposit rate of -.65% for the next twelve months. However, a Brexit or a significant step-up in ECB QE could fuel new currency inflow into Denmark and in general we see some potential for a narrowing spread between DKK and EUR rates. Quick links Eurozone forecast US forecast UK forecast Denmark forecast Sweden forecast Norway forecast Forecast table Policy rate outlook Country Spot +3m +6m +m USD.5.5.75. EUR.... GBP.5.5.5.75 DKK.5.5.5.5 SEK -.5 -.5 -.5 -.5 NOK.5.5.5.5 -year bond yield outlook Country Spot +3m +6m +m USD.74.7.. GER.5..3.5 GBP.4.5.65.9 DKK.4.35.5.7 SEK.49.75.85. NOK.37..4.55 Editor: Chief Analyst Arne Lohmann Rasmussen +45 45 85 3 arr@danskebank.dk Important disclosures and certifications are contained from page of this report. www.danskeresearch.com
Contents and contributors Eurozone... 3 Macro Senior Analyst Pernille B. Henneberg +45 45 3 perni@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 85 3 arr@danskebank.dk US... 4 Macro & Interest rates Senior Analyst Mikael Olai Milhøj +45 45 76 7 milh@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 85 3 arr@danskebank.dk UK... 5 Macro & Interest rates Senior Analyst Morten Helt +45 45 85 8 mohel@danskebank.dk Denmark... 6 Macro Chief Economist Las Olsen +45 45 85 36 laso@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 85 3 arr@danskebank.dk Sweden... 7 Macro & Interest rates Chief Analyst Michael Boström +46 ()8-568 85 87 mbos@danskebank.com Senior Analyst Michael Grahn +46 ()8-568 87 mika@danskebank.com Senior Analyst Marcus Söderberg +46 ()8-568 85 64 marsd@danskebank.com Senior Analyst Carl Milton +46 ()8-568 85 98 carmi@danskebank.com Norway... 8 Macro & Interest rates Chief Analyst Jostein Tvedt +47 3 3 9 84 jtv@danskebank.dk Forecast table... 9 3 May 6 www.danskeresearch.com
Eurozone forecast Euro area GDP growth surprised on the upside by increasing.6% q/q in Q 6. The solid growth was likely driven by private consumption, in turn supported by the low oil price and progress in the labour market (notably, the unemployment rate has declined to.%, its lowest level since ). Looking ahead, uncertainty about a potential Brexit is likely to be a headwind particularly for business sentiment and hence investments. Inflation declined to -.% y/y in April with core inflation declining.3pp to.7% y/y. Some of the decline in core inflation was likely due to the early timing of Easter this year, but other factors should also have had a negative impact. This is a concern for the ECB, which looks for average core inflation of.% y/y this year. In the coming months, we expect headline inflation to remain negative as energy price inflation remains a drag. Later this year, base effects related to the oil price should result in a rebound in inflation. The ECB is currently in implementation mode after announcing a large package of easing measures in March. During the summer months we expect it to remain on hold, with the focus being on the details and impact of the easing measures. At the latest ECB meeting in April, Draghi said the ECB s policies are working but must be given time. He also concluded that broad financing conditions have improved, which supports our view that the ECB will remain side-lined in the coming months. From a longer-term perspective, we expect the ECB to extend the QE purchases beyond March 7, as inflation should not have picked up sufficiently. As mentioned above, the ECB is too optimistic on its outlook for core inflation in our view and we expect continued downward revision of its core inflation projection alongside an extension of QE. The new easing measures from the ECB mean that any significant rise in EUR yields now looks quite unlikely and further downward pressure in the next couple of months should certainly not be ruled out. Given the March ECB easing measures, there is certainly a possibility that Germany could be the next country after Switzerland and Japan to experience negative Y yields. However, we still see modest upward pressure on a six to -month horizon, as we still expect upward pressure on the long-end of US yields later in 6. We still firmly believe that the ECB will be able to keep Y and 5Y yields in check with QE purchases and a deposit rate at -.4%. Thus, we still look for a modest steepening of the EUR curve for YY and 5YY. Additionally, we expect 3M Euribor fixings to stay below zero throughout the forecast horizon. EUR Forecast summary EUR Spot +3m +6m +m ECB.... 3M -.6 -.8 -.8 -.8 -year -.5 -.5 -.45 -.45 5-year -.38 -.35 -.3 -.3 -year.5..3.5 -year -.6 -.5 -. -. 5-year...5.5 -year.55.5.7.9 EUR swap curve German government bonds Swaprates. % bp 6. 5.8 4.6 3.4.. -. 3 6 9 5 8 4 7 - -.4 - Change,bp (rhs) -Apr-6 -May-6 3M Euribor Y EUR swap rates 3 3 May 6 www.danskeresearch.com
US forecast Despite some of the more hawkish FOMC members still saying that a June hike is a possibility, we think the April jobs report closed the door. Employment rose by 6, in April, which was the lowest increase in seven months and now we have a combination of a significant slowdown in terms of GDP growth in Q and slower employment growth. In our view, the Fed will wait with hiking until the FOMC meeting in September. For some time we have argued that we believe the Fed is unlikely to risk tightening too much, too quickly and it is important to recognise that most voting FOMC members are skewed towards a dovish stance on monetary policy. Also, Fed chair Janet Yellen emphasised the downside risks to the economy in her latest speech. By waiting until September, the Fed can see that growth is rebounding after a weak Q, that the labour market continues to tighten, we are past the UK referendum and the Fed can better prepare markets about its hiking intentions in connection with the July meeting. That being said, this is based on our main scenario that the UK remains in the EU. If the UK votes to leave, we think the Fed will most likely postpone the second hike further in order to analyse the short-term impact on the economy. We continue to expect three hikes next year. In recent weeks we have seen US yields moving down and currently markets have priced in only a /3 probability of a hike this year and below.5 hikes in total before year-end 7. Although we could see slightly higher yields if the US data are good, we think the markets are less focused on the second Fed hike as we are now very close to the UK s EU referendum. After the referendum there could be a re-pricing of Fed expectations if no Brexit is seen. The dovish message from the Fed together with a step-up in QE from the ECB, the BoJ expected to ease further and low global inflation mean that we still have a positive environment for global fixed income markets. US treasuries are the only major market that offer a Y yield close to %. Hence, we expect the next three to six months to see a further flattening of the curve YY as more Fed hikes are priced in and as investors hunt the higher US yields. Hence, there will be little scope for higher Y yields. Eventually the Fed will, however, resume its hiking cycle, causing US yields to trend higher. The move higher in US yields is mainly expected on a 6- and -month horizon. Our forecasts for US rates on a M horizon are above the forward market. USD Forecast summary USD Spot +3m +6m +m FED.5.5.75. 3M.63.78.97.4 -year.74.9.5.5 5-year...5.9 -year.74.7.. -year.87.5.4.65 5-year.8..55. -year.6.6.95.5 USD swap curve Government bonds Swap rates.5 % bp 3..5. -.5 - -. - 3 6 9 5 8 4 7 Change,bp (rhs) -Apr-6 -May-6 3M USD Libor rates Y USD swap rates 4 3 May 6 www.danskeresearch.com
UK forecasts First estimate of Q GDP growth showed that growth slowed to.4% q/q in Q 6 from.6% q/q in Q4 5. This was the slowest growth pace since Q4. Moreover, the labour market report for February showed the first fall in employment since May 5 and in our view slower growth and falling employment indicate Brexit uncertainties have hit the economy. This is also reflected in the composite PMI that fell sharply in April. The upcoming EU referendum on 3 June represents a significant medium- to long-term risk factor for the UK economy and, for this reason, economic data releases will fade in the background in coming months. In our view, the Bank of England s hands are more or less tied ahead of the EU referendum and we expect UK money market rates to remain fairly stable near term. We see little evidence of a Brexit risk premium priced in the Gilt market and, in our view, Brexit concerns are primarily a theme for the FX market. Indeed, the UK is on negative watch by Standard & Poor s and we believe a Brexit would be likely to trigger a downgrade of its sovereign rating. However, this might not necessarily change foreign investors appetite for Gilts drastically and any rise in the risk premium on GBP assets is likely to be offset by a lowering of the Bank Rate from.5% to.% and a possible resumption of the QE programme. Hence, the direction for GBP yields is not a clear case in the event of a Brexit. We expect the first BoE hike in Q 7 (probably in February) based on the assumption that the UK remains in the EU but risks are skewed towards a later hike especially if the economy slows further post the EU referendum. The market is pricing the first rate increase in Q 9. In the event of a yes vote on 3 June, we see potential for a moderate rise in GBP yields across the curve and a steepening of the YY curve in the magnitude of 5- bp as uncertainty and severe downside risks to the economy are removed. Longer term, we still forecast higher UK interest rates on a medium-term horizon driven by Bank of England rate increases and higher US interest rates. We forecast the five-year UK swap rate at.65% in M (revised down from.7%) and our 6M and M yield forecasts are above the forward market across the curve. GBP Forecast summary GBP Spot +3m +6m +m Base rate.5.5.5.75 3M.59.59.6.4 -year.39.45.75. 5-year.8.9..45 -year.4.5.65.9 -year.78.85.5.5 5-year...3.65 -year.43.55.7.95 GBP swap curve Government bonds Swap rates.9 % bp 4.7 3.5.3..9 -.7 -.5-3 3 6 9 5 8 4 7 Change,bp (rhs) -Apr-6 -May-6 3M GBP Libor rates Y UK swap rates 5 3 May 6 www.danskeresearch.com
Denmark forecast Indicators suggest growth remained subdued in Denmark in Q but employment in the private sector is still growing strongly, pointing to a sustained cyclical recovery. Inflation was zero in both March and April as clothes prices dragged it down but wage growth and service prices indicate that underlying inflation pressure is substantially higher in the domestic economy. Danmarks Nationalbank (DN) did not sell any kroner in FX intervention during April despite the drop in EUR/DKK to 7.44. Now EUR/DKK has dropped below 7.44 and DN will likely need to step in to support EUR/DKK with FX intervention in the coming months as we look for DKK to stay supported by a tighter policy rate spread to ECB, a low net position and hedging of potential EUR risk due to UK EU referendum in June. Selling DKK in FX intervention will likely suffice for DN as it will increase banks net position and push short-term money market rates down and EUR/DKK FX forwards further into negative. All in all, we expect DN to keep the rate of interest on certificates of deposit unchanged at minus.65% on M. However, if DN needs to sell DKK in FX intervention of around DKK-bn over a shorter period, it may trigger a bp rate cut to minus.75%. Likewise if the ECB decides to cut its deposit rate further, DN will most likely mirror this down to minus.75% - a level we still view as the lower bound for the key policy rate in Denmark. The Danish money market is priced for a gradual rise in Danish money market rates from 7 and that the spread towards EONIA will turn positive in 7. Hence, our forecasts for the deposit rate and money market rates are still slightly below market pricing. We still believe that the significant Danish current account surplus will ensure that the Danish policy rate can stay below that of the ECB for the foreseeable future. The general hunt for yield in the wake of the stepped-up ECB QE programme is also expected to attract investors to the marginally higher yields in Denmark. Therefore, we also forecast that Danish yield spreads versus Germany will tighten slightly throughout 6. A Brexit could create a currency inflow into Denmark and tighten the yield spread versus Germany further. In respect of the Y rates we expect a slight upward pressure from higher USD rates and we look for a steeper curve YY and 5YY in 6. We forecast that 6M CIBOR fixings will stay marginally above zero, whereas 3M fixings are expected to stay around -bp. Forecasts summary DKK Spot +3m +6m +m CD -.65 -.65 -.65 -.65 REPO.5.5.5.5 3M -.8 -. -. -. 6M.7.5.5.7 Government bonds -year -.4 -.35 -.3 -.35 5-year -. -.5.. -year.4.35.5.7 Swap rates -year.9.5.. 5-year.3.5.3.3 -year.86.8.. DKK swap curve.6 % bp 8.4 7. 6. 5.8 4.6 3.4.. 3 6 9 5 8 4 7 Change,bp (rhs) -Apr-6 -May-6 3M Cibor Rates Y DKK swap rates 6 3 May 6 www.danskeresearch.com
Sweden forecast Tentative indications from monthly data suggest Swedish GDP growth may be in for an abrupt slowdown in Q after levitating at more than 4 % y/y in H 5. This appears to be mostly related to retail spending and services, but to some extent it is also visible in foreign trade (goods). As yet we have no strong stance as to whether this is temporary or more longlasting. That said, even with a slowdown Sweden compares favourably with most countries. Inflation has been a bit higher than we had forecast over the previous months, as retailers were still adjusting prices upwards after the weaker SEK seen in 5. Looking forward, however, we expect basically all measures of inflation (CPI, CPIF and CPIF ex. Energy) to gradually flatten out and move lower, mainly as a result of still too low wage growth (new deals set at.% for next year) and the SEK appreciation grinding import prices lower. Hence, inflation is set to undershoot the Riksbank s forecast again. Contrary to our expectations, the Riksbank extended the QE programme at the April meeting by a total of SEK45bn in government bonds of which SEK5bn will be linkers. The total programme now stands at SEK45bn and is set to run until the end of 6. A feature of the extension was that it implies a tapering of the purchases in H. Clearly, the Riksbank is aware that its purchases as a percentage of GDP are quite small compared with the ECB s equivalent and that this suggests that EURSEK will gradually move lower (i.e. the SEK will appreciate). Although we do not expect any more action from the Riksbank, our inflation forecast still suggests it will continue to find it difficult to reach the % inflation target for the reasons mentioned in the section above. Hence, the risk is still tilted in the easing direction rather than the opposite. On the back of lower international rates, SEK yield curves have flattened somewhat. It is noteworthy that the -5Y swap curve is now trading below the 6-85bp range that has been in place since mid-5. In our view, that segment should continue to flatten due to the subdued outlook for inflation and hence future policy rate hikes. The 5-Y segment has also flattened somewhat but it remains significantly steeper than the -5Y segment. For a long time we have been arguing that much of the yield curve steepness should be located in that segment and we see no reason to alter that stance. Forecast summary SEK Spot +3m +6m +m Repo -.5 -.5 -.5 -.5 3M -.44 -.45 -.45 -.45 -year -.6 -.45 -.45 -.45 5-year -.9 -.5 -. -. -year.49.75.85. -year -.3 -.35 -.3 -.3 5-year.6.5.5.3 -year..5.5.4 SEK swap curve Government bonds Swap rates.5 % bp 5. 4.5 3..5. -.5 -. 3 6 9 5 8 4 7 - Change,bp (rhs) /4/6 /5/6 3M Stibor rates Y SEK swap rates 7 3 May 6 www.danskeresearch.com
Norway forecast Norwegian inflation stays at elevated levels. April core inflation was unchanged from March at 3.3% y/y, whereas headline inflation dropped slightly from 3.3% y/y to 3.% y/y. Current inflation levels are basically in line with Norges Bank s projections and are mainly a reflection of a weak NOK. As the year-on-year effect of the weak NOK fades, inflation is expected to gradually decline and is expected to fall below the inflation target of.5%. Norges Bank expects inflation to drop as low as.6% y/y by end 9. So far the oil investment downturn has not spread to the mainland economy to any large degree. Since the March Norges Bank monetary policy meeting economic data have been mixed. While retail sales have been weak, unemployment seems to have stabilised and the housing market, outside the oil exposed regions, is strong. Industry indicators suggest a further decline in production, but the rate of decline is slowing. Recent production numbers have been unexpectedly strong but may be affected by Easter effects. The oil market has strengthen to some extent since March, but this will hardly have any large impact on the excess capacity in the Norwegian oil related industries going forward. On May the government released a revised fiscal budget for 6. The structural non-oil deficit will be at a record high NOK6bn, which is about NOKbn higher than the original budget. The budget indicator is at a high.% up from.7% in the original budget (an indication that public spending is growing.%-points faster than the rest of the economy). The expansionary fiscal policy reduces the risk of zero interest rates going forward. At the press conference after the Monetary Policy meeting on May, Norges Bank reiterated the message from the 7 March Monetary Policy Report. Interest rates may be cut later this year. That is, a June target rate cut to.5% cannot be ruled out, but the most likely case seems to be a September cut. The Monetary Policy Report 6-I suggests a target rate trough of.% in 7. Norges Bank cannot rule out negative rates in the case of major negative shocks. However, in the formal communication Norges Bank has not yet taken into account the revised fiscal budget. That is, their actual view on the forward interest rate path may be slightly less dovish than communicated. This may support no change until a final cut in the target rate in September. Market interest rates at the short end of the curve are significantly higher at present than Norges Bank s March projection. The market only seems to discount one cut of 5bp to.5% late summer. The spread between the target rates and the 3m nibor is unusually high, and the market seems to expect this to continue this spring partly due to low interbank liquidity. The long end of the yield curve is still affected by low liquidity and bond market related demand for receiving fixed rates. Consequently, the Norwegian yield curve is unusually flat relative to international peers. Forecast summary NOK Spot +3m +6m +m ON DEP.5.5.5.5 3M...7.65 -year.6.5.6.6 5-year.88.8.8.8 -year.37..4.55 -year.98.85.95.95 5-year.7.5..5 -year.6.5.75.95 NOK swap curve Government bonds Swap rates. % bp.9.7 5.5.3. 5.9.7 3 6 9 5 8 4 7 Change,bp (rhs) /4/6 /5/6 3M Nibor rates Y NOK swap rates 8 3 May 6 www.danskeresearch.com
Forecast table Forecast table USD EUR * GBP NOK SEK DKK Horizon Policy rate 3m xibor -yr swap 5-yr swap -yr swap -yr gov 5-yr gov -yr gov Spot.5.63.87.8.6.74..74 +3m.5.78.5..6.9..7 +6m.75.97.4.55.95.5.5. +m..4.65..5.5.9. Spot. -.6 -.6..55 -.5 -.38.5 +3m. -.8 -.5..5 -.5 -.35. +6m. -.8 -..5.7 -.45 -.3.3 +m. -.8 -..5.9 -.45 -.3.5 Spot.5.59.78..43.39.8.4 +3m.5.59.85..55.45.9.5 +6m.5.6.5.3.7.75..65 +m.75.4.5.65.95..45.9 Spot.5 -.8.9.3.86 -.4 -..4 +3m.5 -..5.5.8 -.35 -.5.35 +6m.5 -...3. -.3..5 +m.5 -...3. -.35..7 Spot -.5 -.44 -.3.7. -.6 -.9.49 +3m -.5 -.45 -.35.5.5 -.45 -.5.75 +6m -.5 -.45 -.3.5.5 -.45 -..85 +m -.5 -.45 -.3.3.4 -.45 -.. Spot.5..98.7.6.6.88.37 +3m.5..85.5.5.5.8. +6m.5.7.95..75.6.8.4 +m.5.65.95.5.95.6.8.55 Note: * German government bonds are used, EUR swap rates are used 9 3 May 6 www.danskeresearch.com
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