Yield Forecast Update Global easing move in Q1 keeps downward pressure on yields in Q2

Investment Research General Market Conditions 21 March 2016 Yield Forecast Update Global easing move in Q1 keeps downward pressure on yields in Q2 The ECB announced a large easing package at its March monetary policy meeting including additional rate cuts, higher monthly QE purchases for EUR60bn to EUR80bn, an inclusion of corporate bonds into the QE programme and a new series of TLTRO loans, which can have an interest rate as low as the deposit rate (currently -40bp). The new easing measures from the ECB mean that any significant rise in EUR yields in the short term now looks quite unlikely and further downward pressure over the next couple of months should certainly not be ruled out. Given the new ECB easing measures, there is certainly a possibility that Germany could be the next country after Switzerland and Japan to experience negative 10Y yields. However, we still see modest upward pressure on a six- to 12-month horizon, as we still expect upward pressure on the long end of US yields later in 2016. We still firmly believe that the ECB will be able to keep 2Y and 5Y yields in check with QE purchases and a deposit rate at -0.4%. Thus, we still look for a modest steepening of the EUR curve for 2Y10Y and 5Y10Y. Additionally, we expect 3M Euribor fixings to stay below zero throughout the forecast horizon. The Fed also sent a very dovish message to the markets stating that it wants to avoid tightening monetary policy too much, too quickly. In the updated projections, the important median dot for this year was lowered to signalling two hikes (down from four) as the Fed thinks that global economic and financial developments continue to pose risks. The lower dot was a fairly strong signal that the Fed is unlikely to raise the Fed funds target rate by much this year, reflecting a somewhat slower projected path for global growth and tighter credit conditions. The dovish message came as quite a surprise as US data improved in February, risk sentiment had rebounded and not least core inflation had accelerated. We expect the Fed to be on hold until September and only hike once this year, although we admit that it currently seems likely that the Fed will hike twice this year than not hike at all. We now have (1) a step-up in the ECB QE, (2) a dovish Fed and (3) possibly more Bank of Japan (BoJ) easing given the appreciation of the yen. It means that we expect a mild downward pressure on global rates and yields this spring despite the already low levels. However, looking six to twelve months ahead, the pressure from further Fed rate hikes is expected to weigh on the US treasury market and in the long end it will tend to push European yields slightly higher. The short end in Scandinavia and the Eurozone is well anchored by the local central banks. Quick links Eurozone forecast US forecast UK forecast Denmark forecast Sweden forecast Norway forecast Forecast table Policy rate outlook Country Spot +3m +6m +12m USD 0.50 0.50 0.75 1.00 EUR 0.00 0.00 0.00 0.00 GBP 0.50 0.50 0.50 0.75 DKK 0.05 0.05 0.05 0.05 SEK -0.50-0.50-0.50-0.50 NOK 0.50 0.25 0.25 0.25 10-year bond yield outlook Country Spot +3m +6m +12m USD 1.88 1.70 2.00 2.20 GER 0.19 0.10 0.30 0.50 GBP 1.44 1.40 1.60 1.90 DKK 0.49 0.35 0.55 0.75 SEK 0.54 0.75 0.85 1.00 NOK 1.26 1.00 1.30 1.50 Still more easing from Norges Bank and the Riksbank The Riksbank reacted to the low inflation at the policy meeting in February and cut the deposit rate by 15bp to -0.50%. We do not expect more rate cuts in Sweden but we do expect another expansion of the QE programme in April. In Norway, the low oil price triggered a new rate cut in March and given the soft rhetoric that followed the announcement, another rate cut in June is now expected. Finally, Denmark did not follow the ECB lower in March. Given that the ECB is now on hold, we look for an unchanged Danish deposit rate at -0.65% for the next twelve months. Editor: Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 arr@danskebank.dk Important disclosures and certifications are contained from page 10 of this report. www.danskeresearch.com

Contents and contributors Eurozone... 3 Macro Senior Analyst Pernille B. Henneberg +45 45 13 20 21 perni@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 arr@danskebank.dk US... 4 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... 5 Macro & Interest rates Senior Analyst Morten Helt +45 45 12 85 18 mohel@danskebank.dk Denmark... 6 Macro Chief Economist Las Olsen +45 45 12 85 46 laso@danskebank.dk Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 arr@danskebank.dk Sweden... 7 Macro & Interest rates Chief Analyst Michael Boström +46 (0)8-568 805 87 mbos@danskebank.com Senior Analyst Michael Grahn +46 (0)8-568 807 00 mika@danskebank.com Senior Analyst Marcus Söderberg +46 (0)8-568 805 64 marsd@danskebank.com Senior Analyst Carl Milton +46 (0)8-568 805 98 carmi@danskebank.com Norway... 8 Macro & Interest rates Chief Analyst Jostein Tvedt +47 23 13 91 84 jtv@danskebank.dk Forecast table... 9 2 21 March 2016 www.danskeresearch.com

Eurozone forecast We have revised our growth forecast for 2016 down from 1.8% to 1.5% mainly due to external factors causing uncertainty and hence headwinds to business investments and exports. We still expect private consumption to remain solid due to progress in the labour market and the low oil price, see Weaker euro growth due to external factors, 2 March. Inflation dipped back into negative territory in February, being -0.2% y/y as the low oil price is a drag to inflation. Despite the recent increase in the oil price, the drag from energy prices will continue over the coming months, hence we expect negative inflation over the coming months until Q4 when it should rebound. The ECB announced a large package of easing last week including additional rate cuts, higher monthly QE purchases, an inclusion of corporate bonds in the QE programme and a new series of TLTRO loans which can have an interest rate as low as the deposit rate (currently -40bp), see ECB s easing package and markets zig-zag, 11 March. We believe the comprehensive easing package has bought the ECB some time before additional easing will be required. Over the coming three-six months the focus will be on the details and impact of the easing measures and, in our view, the ECB will remain on hold during that period. From a longer-term perspective, it is still likely that the ECB will extend the QE purchases beyond March 2017, as inflation has not picked-up sufficiently. In the ECB s updated inflation projection, it expects inflation to increase to only 1.1% in Q1 17, while it is still too optimistic on its outlook for core inflation in our view. 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 new ECB easing measures, there is certainly a possibility that Germany could be the next country after Switzerland and Japan to experience negative 10Y yields. However, we still see a modest upward pressure on a six to twelve-month horizon, as we still expect upward pressure on the long-end of US yields later in 2016. We still firmly believe that the ECB will be able to keep 2Y and 5Y yields in check with QE purchases and a deposit rate at -0.4%. Thus, we still look for a modest steepening of the EUR curve for 2Y10Y and 5Y10Y. Additionally, we expect 3M Euribor fixings to stay below zero throughout the forecast horizon. EUR Forecast summary EUR Spot +3m +6m +12m ECB 0.00 0.00 0.00 0.00 3M -0.24-0.28-0.28-0.28 2-year -0.48-0.50-0.45-0.45 5-year -0.31-0.35-0.30-0.30 10-year 0.20 0.10 0.30 0.50 2-year -0.15-0.15-0.10-0.10 5-year 0.03 0.00 0.05 0.05 10-year 0.55 0.45 0.65 0.85 EUR swap curve German government bonds Swaprates 1.2 % bp 3 1.0 2 0.8 0.6 1 0.4 0 0.2-1 0.0-0.2 0 3 6 9 12 15 18 21 24 27-2 -0.4-3 Change,bp (rhs) 22-Feb-16 21-Mar-16 3M Euribor 10Y EUR swap rates 3 21 March 2016 www.danskeresearch.com

US forecast At its March meeting, the FOMC sent a very dovish message to the markets stating that it wants to avoid tightening monetary policy too much, too quickly. In the updated projections, the median dot for this year was lowered down to signalling two hikes (from four) as the Fed thinks that global economic and financial developments continue to pose risks. As we assess that most voting FOMC members are dovish-to-neutral, the lower dot was a pretty strong signal that the Fed is unlikely to raise the Fed funds target rate by much this year, reflecting a somewhat slower projected path for global growth and tighter credit conditions. The dovish message was a relatively big surprise as the US data have improved, risk sentiment has rebounded and core inflation has accelerated. These three factors explain why we thought that the Fed would be relatively hawkish and why we saw a repricing of the Fed in the markets in the days up to the March meeting. While the door is not yet closed for a hike in June, we (and so do the markets) think the probability has declined significantly after the meeting. Thus we still expect that the Fed will keep on hold until September and only hike once this year, although we admit that it still seems more likely that the Fed will hike twice this year than not hike at all at the moment. Next year we expect three hikes as the growth concerns fade. For more details see also FOMC review: Concerned Fed sends very dovish message to the markets, 16 March 2016. The dovish message from the Fed together with a step-up in QE from the ECB and the BoJ on alert to avoid a further appreciation on the yen mean that we have a very positive environment for global fixed income markets. US treasuries are the only major market that offer a 10Y yield close to 2%. Hence, we expect the next three months to see a flattening of the curve 2Y10Y as investors hunt the higher US yields and there will be little scope for higher yields. Eventually the Fed will, however, resume its hiking cycle, causing US yields to trend higher, although long-term yields are pushed down by easier monetary policies by the ECB and the BoJ. This could be the case on a 6- and 12-month horizon. Our forecasts for US rates on a12m horizon are above the forward market. USD Forecast summary USD Spot +3m +6m +12m FED 0.50 0.50 0.75 1.00 3M 0.62 0.68 0.84 1.14 Government bonds 2-year 0.83 0.70 1.25 1.50 5-year 1.33 1.20 1.50 1.90 10-year 1.87 1.70 2.00 2.20 Swap rates 2-year 0.92 0.85 1.40 1.65 5-year 1.27 1.20 1.55 2.00 10-year 1.71 1.65 2.00 2.25 USD swap curve 2.5 % bp 1 2.0 0 1.5-1 -2 1.0-3 0.5-4 0.0-5 0 3 6 9 12 15 18 21 24 27 Change,bp (rhs) 22-Feb-16 21-Mar-16 3M USD Libor rates 10Y USD swap rates 4 21 March 2016 www.danskeresearch.com

UK forecasts The UK economy grew 0.5% q/q in Q4, driven mainly by consumer and government spending, while both investments and exports contracted. It is likely that both GDP growth and employment growth will slow in H1 16 due to increased uncertainties ahead of the referendum, which could hamper investments and private consumption. This is also reflected in the business survey, with both manufacturing and service sector PMIs declining in February. UK CPI inflation increased from 0.2% y/y in December to 0.3% y/y in January. We expect CPI inflation and CPI core inflation to remain subdued in 2016. The upcoming EU referendum on 23 June represents a significant medium- to long-term risk factor for the UK economy and, for this reason, economic data releases will stand in the background in coming months. We see little evidence of 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. 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. As such, we think there are many reasons for the Bank of England to stay on hold for an extended period: (i) subdued inflation and wage growth, (ii) other central banks have adopted a more dovish stance and (iii) not least, Brexit uncertainties, to name a few. We still expect the Bank of England to increase interest rates in Q1 17 but, with the great uncertainty surrounding the EU referendum, things could change rapidly after it. The market is pricing the first rate increase in Q2 19. We hold the view that the recent more dovish stance from central banks globally is likely to remain very supportive for global fixed income markets. We have thus lowered our 1-12M UK interest-rate swap forecasts some 15-25bp on the 5-10Y tenors, projecting lower rates at the long end of the curve, driven by lower global rates in the coming months. We expect a flat development in the 0-2Y segment in the coming one to three months. Longer term, we still forecast higher UK interest rates over the medium-term horizon driven by Bank of England rate increases and higher US interest rates. We now forecast the five-year UK swap rate at 1.70% in 12M (revised down from 1.75%) and our 6M and 12M yield forecasts are above the forward market across the curve. GBP Forecast summary GBP Spot +3m +6m +12m Base rate 0.50 0.50 0.50 0.75 3M 0.59 0.59 0.59 0.89 2-year 0.46 0.45 0.60 1.10 5-year 0.85 0.85 1.05 1.50 10-year 1.44 1.40 1.60 1.90 2-year 0.81 0.85 1.00 1.50 5-year 1.02 1.05 1.25 1.70 10-year 1.44 1.45 1.65 1.95 GBP swap curve Government bonds Swap rates 1.9 % bp 5 1.7 4 1.5 3 2 1.3 1 1.1 0 0.9-1 0.7-2 0.5-3 0 3 6 9 12 15 18 21 24 27 Change,bp (rhs) 22-Feb-16 21-Mar-16 3M GBP Libor rates 10Y UK swap rates 5 21 March 2016 www.danskeresearch.com

Denmark forecast GDP growth has recovered somewhat after the very weak Q3 last year but it now looks like it will be below 1% for 2016 as a whole. Nevertheless, job growth remains strong, with the private sector adding 3,200 employees in January. As expected, inflation declined from January but looks likely to remain positive before picking up again in the second half of 2016. Danmarks Nationalbank (DN) opted not to track the 10bp ECB cut in March after it had to intervene to support the DKK in February. DN thereby narrowed the DKK-EUR interest rate spread. The key policy rate in Denmark thereby remains at minus 0.65%. We expect it to stay at this level on a 12-month horizon. In our view though, the risk is clearly that the accumulated 30bp of tightening relative to ECB since December has been too aggressive and that downward pressure on EUR/DKK will emerge. In particular if capital starts flowing into DKK as a hedge against the uncertainty regarding the impact on the EUR of the UK EU referendum. In this case we expect DN to follow its normal reaction function, which means DKK10-20bn in inflow will trigger a 10bp cut to minus 0.75%. We still regard this level as the lower bound for the key policy rate. The Danish money market is priced for a gradual rise in Danish money market rates from 2017 and that the spread towards EONIA will turn positive in 2017. Hence, our forecast for the deposit rate is 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 2016. In respect of the 10Y rates we expect a slight upward pressure from higher USD rates and we look for a steeper curve 2Y10Y and 5Y10Y in 2016. We forecast that 6M CIBOR fixings will stay close to zero, whereas 3M fixings will edge further into negative territory in 2016. Forecasts summary DKK Spot +3m +6m +12m CD -0.65-0.65-0.65-0.65 REPO 0.05 0.05 0.05 0.05 3M -0.10-0.06-0.06-0.06 6M 0.07 0.09 0.09 0.09 Government bonds 2-year -0.31-0.30-0.30-0.35 5-year -0.03-0.05 0.00 0.00 10-year 0.48 0.35 0.55 0.75 Swap rates 2-year 0.11 0.10 0.15 0.10 5-year 0.34 0.30 0.35 0.35 10-year 0.90 0.80 1.00 1.15 DKK swap curve 1.6 % bp 3 1.4 2 1.2 1 1.0 0 0.8-1 0.6-2 0.4-3 0.2-4 0.0-5 0 3 6 9 12 15 18 21 24 27 Change,bp (rhs) 22-Feb-16 21-Mar-16 3M Cibor Rates 10Y DKK swap rates 6 21 March 2016 www.danskeresearch.com

Sweden forecast Sweden seems to have defied gravity, with Q4 growth at 4.5% y/y (4.1% in Q3). SCB estimates that about half a percentage point comes from migration (increased public spending) but basically everything, from private consumption to investments (mainly construction) to net exports, performed well. Employment is developing accordingly. Inflation popped in January as a result of higher indirect taxes (added half a percentage point) and higher energy prices but came down somewhat again in February. The Riksbank s policy variable (CPIF) stood at 1.1% y/y in February. Worth noticing is that the main contributor to the somewhat higher inflation since early 2014 higher prices on imported goods and services now appear to have started moving in the opposite direction. This is not too surprising considering that the krona now is stronger in y/y terms. After a repo rate cut of 10bp to -0.5% in February, recent signals from the Riksbank suggest further rate cuts, though not excluded, would require larger deviations of inflation and growth from forecast than has hitherto been the case. This is quite similar to the signals given by other central banks, for instance the ECB. In our minds, this does not imply that rate hikes could come faster or at a steeper pace. On the contrary, the Riksbank (governor Stefan Ingves) has recently, again, underlined that the Riksbank cannot deviate much from the ECB (without risking a toostrong krona). Considering that the ECB signals that rate hikes are very distant indeed rates will be low or lower well beyond the conclusion of the QE programme (March 2017 at the earliest), that the Swedish money market curve starts to price in rate hikes from early next year. We think this is far too early. We expect the Riksbank to announce (in April) another extension of QE by a quarter (though September), with purchases of nominal bonds with an average maturity of some five years. Against this background, we stubbornly stick to the view that the Swedish yield curve is too steep from one year out and up to four to five years out. We expect it to correct gradually, meaning more of the steepness should be pushed out to the five- to 10-year segment. Before the February policy meeting, there was speculation the Riksbank was preparing a two-tier deposit rate system, something that could potentially have opened the way for considerable pressure on Stibor fixings. This we think is one though not the entire reason swaps have outperformed government bonds for some time. However, such a two-tier system does not seem very likely to us, so we expect some reversal of swap spreads (versus government bonds). Forecast summary SEK Spot +3m +6m +12m Repo -0.50-0.50-0.50-0.50 3M -0.47-0.47-0.45-0.45 2-year -0.63-0.45-0.45-0.45 5-year -0.12-0.25-0.20-0.10 10-year 0.54 0.75 0.85 1.00 2-year -0.38-0.35-0.30-0.30 5-year 0.24 0.25 0.25 0.30 10-year 1.13 1.15 1.25 1.40 SEK swap curve Government bonds Swap rates 2.5 % bp 4 2.0 3 2 1.5 1 1.0 0 0.5-1 0.0-2 -3-0.5-4 -1.0 0 3 6 9 12 15 18 21 24 27-5 Change,bp (rhs) 22/02/2016 21/03/2016 3M Stibor rates 10Y SEK swap rates 7 21 March 2016 www.danskeresearch.com

Norway forecast February CPI was at a high 3.1% and core inflation, CPI-ATE, at 3.4%. The main reason for the high inflation at present is the weak NOK during 2015. However, the current level is still above most observers, including Norges Bank s, expectations. The high inflation is expected to be temporary, as wage growth for 2016 seems to become muted and real wage growth may easily become negative for the first time in decades. Still the slowdown in the oil industry has only to a moderate degree affected traditional household demand. Retail sales is basically trending sideways. According to the recent labour force survey unemployment is trending slightly upwards but still at a moderate 4.5%. However, regional differences are becoming more apparent reflected by a weak housing market in the oil-exposed south west region and a booming housing market in the Oslo area. Norges Bank cut the target rate by 25bp to 0.50% at the monetary policy meeting on 17 March. Norges Bank indicated a gradually increasing probability of another cut of 25bp during 2016, which suggests another cut at the monetary policy meetings in June or September. The Monetary Policy Report suggests an interest rate trough of 0.20% in 2017. Norges Bank cannot rule out negative target interest rates in the case of major negative shocks. The central bank governor refrained from commenting, in any detail, at the press conference, on whether a stronger NOK could represent a major shock or not. We now look for a June rate cut from Norges Bank bringing the policy rate down to a record low of 0.25% Norges Bank lowered the trough of the forward 3M Nibor projection to 0.50% by Q3 17, from the December projection of a trough of 0.65%. The end point of the new projection is a forward 3M Nibor of a low 0.90% late 2019. The strong downward revision of the long end of Norges Bank s projection has so far not entirely been followed by the market. That is, the market at present sees up to 10bp higher interest rates in 2019 than projected by Norges Bank. Historically, in a cutting cycle, it is unusual that the market discounts a higher interest rate than Norges Bank. Given the short-term risk of negative rates, in a strong NOK scenario, the FRA curve 2017 to 2019 should be steeper than projected by Norges Bank. That is, the current market seems to be fairly priced. Forecast summary NOK Spot +3m +6m +12m ON DEP 0.50 0.25 0.25 0.25 3M 1.02 0.55 0.55 0.55 2-year 0.61 0.50 0.60 0.60 5-year 0.76 0.65 0.70 0.75 10-year 1.26 1.00 1.30 1.50 2-year 0.79 0.75 0.90 0.90 5-year 0.96 0.90 1.00 1.10 10-year 1.45 1.30 1.60 1.85 NOK swap curve Government bonds Swap rates 2.1 % bp 0 1.9 1.7-5 1.5 1.3-10 1.1-15 0.9 0.7-20 0 3 6 9 12 15 18 21 24 27 Change,bp (rhs) 22/02/2016 21/03/2016 3M Nibor rates 10Y NOK swap rates 8 21 March 2016 www.danskeresearch.com

Forecast table Forecast table 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 0.50 0.62 0.92 1.27 1.71 0.83 1.34 1.88 +3m 0.50 0.68 0.85 1.20 1.65 0.70 1.20 1.70 +6m 0.75 0.84 1.40 1.55 2.00 1.25 1.50 2.00 +12m 1.00 1.14 1.65 2.00 2.25 1.50 1.90 2.20 Spot 0.00-0.24-0.15 0.03 0.56-0.49-0.32 0.19 +3m 0.00-0.28-0.15 0.00 0.45-0.50-0.35 0.10 +6m 0.00-0.28-0.10 0.05 0.65-0.45-0.30 0.30 +12m 0.00-0.28-0.10 0.05 0.85-0.45-0.30 0.50 Spot 0.50 0.59 0.81 1.02 1.44 0.46 0.85 1.44 +3m 0.50 0.59 0.85 1.05 1.45 0.45 0.85 1.40 +6m 0.50 0.59 1.00 1.25 1.65 0.60 1.05 1.60 +12m 0.75 0.89 1.50 1.70 1.95 1.10 1.50 1.90 Spot 0.05-0.09 0.11 0.35 0.92-0.32-0.02 0.49 +3m 0.05-0.06 0.10 0.30 0.80-0.30-0.05 0.35 +6m 0.05-0.06 0.15 0.35 1.00-0.30 0.00 0.55 +12m 0.05-0.06 0.10 0.35 1.15-0.35 0.00 0.75 Spot -0.50-0.47-0.38 0.24 1.13-0.63-0.12 0.54 +3m -0.50-0.47-0.35 0.25 1.15-0.45-0.25 0.75 +6m -0.50-0.45-0.30 0.25 1.25-0.45-0.20 0.85 +12m -0.50-0.45-0.30 0.30 1.40-0.45-0.10 1.00 Spot 0.50 1.02 0.79 0.96 1.45 0.61 0.76 1.26 +3m 0.25 0.55 0.75 0.90 1.30 0.50 0.65 1.00 +6m 0.25 0.55 0.90 1.00 1.60 0.60 0.70 1.30 +12m 0.25 0.55 0.90 1.10 1.85 0.60 0.75 1.50 Note: * German government bonds are used, EUR swap rates are used 9 21 March 2016 www.danskeresearch.com

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