Investment Research General Market Conditions 15 August ...€¦ · potential workers are still out of the labour market. We therefore believe the Fed will hike rates only gradually

Important disclosures and certifications are contained from page 10 of this report. www.danskeresearch.com

Investment Research — General Market Conditions

Review

The trend for lower long bond yields has continued among rising geopolitical tensions

and the view of lower terminal rates from central banks.

In the meantime, short-end rates in the US and the UK remain close to recent highs,

which reflect that policy normalisation is drawing closer.

In Europe, a temporary growth pause has reinforced downward pressure on rates and

so far the ECB’s measures have been unable to lift growth and inflation expectations.

Also, in Norway and Sweden, the yield curve flattening has continued throughout the

summer, reflecting the impact from lower long bond yields in bigger markets.

International rates

The Fed is now expected to hike in April 2015. With growth and inflation firming and

markets expecting a relatively shallow hiking cycle, there is room for higher US rates.

The UK will be the first big central bank to tighten monetary policy. A first hike is

forecast in early 2015. Rates will move higher in the coming months.

In Europe, a slow recovery and ongoing deflation risks will keep the ECB on hold for

a long period. Rates up to five years will remain fairly anchored.

The EUR swap curve is expected to steepen as policy tightening in the US and the UK

and an improving European economy will push long-tenor rates higher again.

Scandi rates

We expect the Danish central bank to stay on hold but if the ECB’s TLTROs boost

euro-liquidity sufficiently, it could put pressure on EUR/DDK and lead to a rate cut.

Following the 50bp rate cut in June, the Riksbank is expected to stay on hold for a

long time. A subdued growth outlook will limit room for higher longer-term rates.

The room for a rate cut in Norway is now relatively limited as inflation has picked up

again. We look for higher Norwegian rates in the coming months.

15 August 2014

Quick links

Eurozone forecast

US forecast

UK forecast

Denmark forecast

Sweden forecast

Norway forecast

Forecast table

Policy rate outlook

Source: Danske Bank Markets

10-year bond yield outlook


Senior Analyst Peter Possing Andersen +45 45 13 70 19 [email protected]

Senior Analyst Lars Tranberg Rasmussen +45 45 12 85 34 [email protected]

Analyst Anders Vestergård Fischer +45 45 13 66 41 [email protected]

Yield Forecast Update

Long bond yields bottoming out

Country Spot +3m +6m +12m

USD 0.25 0.25 0.25 0.75

EUR 0.15 0.15 0.15 0.15

GBP 0.50 0.50 0.75 1.25

DKK 0.20 0.20 0.20 0.20

SEK 0.25 0.25 0.25 0.25

NOK 1.50 1.50 1.50 1.50

Country Spot +3m +6m +12m

USD 2.40 2.80 3.15 3.50

GER 1.01 1.20 1.30 1.60

GBP 2.42 2.85 3.05 3.35

DKK 1.38 1.55 1.65 1.95

SEK 1.60 1.70 1.85 2.00

NOK 2.36 2.60 2.70 2.80

mailto:[email protected]



2 | 15 August 2014 www.danskeresearch.com

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Contents and contributors

Eurozone ...................................................................................................................................................................................................................................................................... 3

Macro Analyst Pernille Bomholdt Nielsen +45 45 13 20 21 [email protected]

Interest rates Senior Analyst Lars Tranberg Rasmussen +45 45 12 85 34 [email protected]


Analyst Anders V. Fischer +45 45 13 66 41 [email protected]

US ...................................................................................................................................................................................................................................................................................... 4

Macro Chief Analyst Allan Von Mehren +45 45 12 80 55 [email protected]




UK ...................................................................................................................................................................................................................................................................................... 5

Macro & Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 [email protected]

Denmark ....................................................................................................................................................................................................................................................................... 6

Macro Economist Jens Nærvig Pedersen +45 45 12 80 61 [email protected]




Sweden .......................................................................................................................................................................................................................................................................... 7

Macro & Interest rates Chief Analyst Michael Boström +46 (0)8-568 805 87 [email protected]

Senior Analyst Michael Grahn +46 (0)8-568 807 00 [email protected]

Senior Analyst Marcus Söderberg +46 (0)8-568 805 64 [email protected]

Senior Analyst Carl Milton +46 (0)8-568 805 98 [email protected]

Norway .......................................................................................................................................................................................................................................................................... 8

Macro & Interest rates Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 [email protected]

Forecast table .......................................................................................................................................................................................................................................................... 9


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Eurozone forecast

Growth and inflation

The euro recovery has lost momentum and the economy stagnated in Q2 14 after growing

0.2% q/q in Q1. The weaker growth reflects the slowdown in the US and China in Q1, the

strong currency and uncertainty due to geopolitical risks, which have affected business

sentiment and added to a wait-and-see approach. On the other hand, private consumption

continues to strengthen and, looking ahead, we expect the recovery to be supported by rising

real wages, less uncertainty since the euro crisis has been tamed and pent-up demand being

unleashed. Moreover, credit growth is declining at a slower pace and this will also support

activity. Inflation declined to a new cycle-low of 0.4% in June, but this was due to lower

commodity prices as core inflation remained at 0.8%. We expect inflation to stay around

current levels until Q4 14, when we forecast a pick-up to 0.8%, but there is downside risk to

our forecast.

Monetary policy and money markets

The ECB seems to be waiting for the take on the first TLTRO in September although it has

intensified preparations for an ABS purchase programme and has hired a consultant.

Moreover, the ECB continues to signal that it is ready to do broad-based QE if needed. We

still believe the bar for QE is quite high and we do not expect new stimuli for some time as

the ECB wants to see the impact of the latest measures before easing again. The EONIA

curve is currently pricing in an O/N close to zero until 2015 and below the 0.15% refi until

2016. If excess liquidity increases following the TLTROs there could be room for slightly

lower money market rates. We still expect the Euribor fixings to grind lower, but some of

this is already priced in.

Yield curve

A combination of disappointing growth data, ongoing deflation concerns and geopolitical

risks have pushed long European rates lower over the summer. Contrary to our expectations,

this has resulted in a significant curve flattening following the ECB’s easing in June. While

we see some of the flattening as a result of the failure by ECB to boost long-term growth

and inflation expectations, a fair part of the decline in long rates over the first half is also

related to the significant drop in long US rates. As geopolitical risks fade, global growth

data remains firm and global long-end rates begin to edge higher, we expect a re-steepening

of the EUR swap curve driven by higher long-end rates. Our forecast for two-year rates is

below forwards, our forecast for five-year rates is on par with forward rates, while for 10-

year and 30-year rates it is above forward rates.

3M Euribor 10Y EUR swap rates

Source: Macrobond, Danske Bank Markets Source: Macrobond, Danske Bank Markets

Forecast summary


EUR swap curve


EUR Spot +3m +6m +12m

ECB 0.15 0.15 0.15 0.15

3M 0.20 0.15 0.10 0.10

2-year 0.00 -0.05 -0.05 -0.05

5-year 0.22 0.30 0.35 0.50

10-year 1.01 1.20 1.30 1.60

2-year 0.32 0.25 0.25 0.25

5-year 0.58 0.65 0.70 0.85

10-year 1.25 1.45 1.55 1.85

Money market

German government bonds

Swaprates

-25

-20

-15

-10

-5

0

0.0

0.5

1.0

1.5

2.0

2.5

0 3 6 9 12 15 18 21 24 27

Change,bp (rhs) 14-Jul-14 14-Aug-14

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US forecast


US growth picked up to 4% in Q2 following the sharp weather-related drop in Q1. Activity

indicators have continued to be robust into Q3 with especially ISM composite roaring ahead

to the highest level in almost 10 years. Employment growth is robust at around 250,000 per

month over the past three months and unemployment continues to trend lower. Looking

ahead, we expect US growth to moderate but stay solid at 3-3.5% in H2 and 2015. Core

inflation has picked up somewhat lately to around 1.5% from 1% in the beginning of the

year. It is thus closing in on the Fed’s 2% target which we believe it will reach during in

mid-2015. Unemployment is expected to hit the Fed’s estimate of long term unemployment

at 5.4% during Q2 next year.

Monetary policy and the money market

With the Fed reaching its targets already in Q2 next year, we believe the first hike will come

in April 2015. Although the unemployment rate is reaching its long-term target, the Fed is

likely to still see more slack in the labour market as other indicators suggest that many

potential workers are still out of the labour market. We therefore believe the Fed will hike

rates only gradually to 1% by end-2015 and 2.5% by end-2016. The US money market

pricing is currently consistent with both a later and more shallow hiking cycle than we have

forecast. We therefore see room for a steeper US money market curve.

Yield curve

Over the past couple of months, the US swap curve has seen a peculiar flattening move

driven by higher short-end rates as well as lower long-end rates. While two-year swap rates

are trading at a one-year high, 10-year swap rates are trading at a one-year low. We now

believe that the future flattening priced into the curve has become too excessive. Although

higher two-year rates will lead to further curve flattening, the market is, in our view,

underestimating the impact on the longer tenors. With growth and inflation picking up, rate

hikes drawing closer and a very flat curve relatively to the yield levels, we expect higher

rates across the curve. Moreover, once the recent geopolitical risks ease, we expect long-end

rates to see an independent lift. In summary, most of our US rate forecasts are measurably

above the forward levels currently prevailing in the market.

3M USD Libor rates 10Y USD swap rates


Forecast summary


USD swap curve


USD Spot +3m +6m +12m

FED 0.25 0.25 0.25 0.75

3M 0.23 0.25 0.48 1.06

2-year 0.42 0.75 1.25 1.90

5-year 1.57 1.90 2.40 3.00

10-year 2.40 2.80 3.15 3.50

2-year 0.63 0.95 1.45 2.10

5-year 1.72 2.05 2.55 3.15

10-year 2.54 2.95 3.25 3.60

Swap rates

Money market

Government bonds

-16-14-12-10-8-6-4-202

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UK forecasts


The UK economy expanded 0.8% q/q in Q2 led by services, the largest part of the economy,

which grew 1% in Q2. Recently, some slowdown in the manufacturing sector has been seen,

which has also been reflected in the business surveys, indicating some moderation in activity

in the coming months. However, while the recent weakness in data implies that the

downside to our growth forecasts of 3.1% y/y for 2014 has increased, the current level of

PMIs remain high, pointing to ongoing growth. Thus, we expect the UK recovery to remain

on track in H2. UK inflation came in at 1.9% in July.


In its August inflation report, the Bank of England (BoE) highlighted that the amount of

slack in the labour market remains substantial, equivalent to around 1% of GDP. The

amount of slack remains an important factor in respect of timing the first rate hike and given

the weak development in wage growth, the likelihood of a rate hike in 2014 has declined

substantially. For that reason, we now see a hike in January 2015 as the most likely scenario,

with risks tilted towards a hike already in December. All in all, however, the BoE is clearly

on a very different path for monetary policy versus the ECB. The market is pricing in the

first hike for March 2015.

Yield curve

We expect a move higher in GBP yields as we expect the market to move forward the

timing of the first rate hike to early 2015 and as we see a more aggressive hiking cycle.

Furthermore, we expect to see a spill-over effect from higher US rates especially in the 5Y

and 10Y segments. Our forecast for both 2Y and 10Y yields are higher than assumed in the

forward market and we expect GBP yields to widen versus EUR, especially on six- and 12-

month horizons.

3M GBP Libor rates 10Y UK swap rates


Forecast summary


GBP swap curve


GBP Spot +3m +6m +12m

Base rate 0.50 0.50 0.75 1.25

3M 0.56 0.65 0.81 1.34

2-year 0.70 1.10 1.30 1.80

5-year 1.81 2.20 2.40 2.80

10-year 2.42 2.85 3.05 3.35

2-year 1.22 1.60 1.80 2.30

5-year 1.99 2.35 2.55 2.90

10-year 2.56 2.95 3.15 3.45

Swap rates

Money market

Government bonds

-30

-25

-20

-15

-10

-5

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0.5

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Denmark forecast


Economic indicators have been very mixed during the summer. There was a large drop in

industrial confidence but a large increase in industrial production, with especially the latter

likely plagued by data issues. Most likely, Danish industry is suffering a bit of a setback as

we have seen in Germany. Domestic demand still seems to be increasing overall, but slowly.

The recovery remains weak, but should get more traction as the rest of Europe picks up.

Inflation was higher than expected in July as food prices are now starting to push up instead

of down, but we are still likely to see movements in both directions until annual inflation

creeps above 1% at some point next year.

Monetary policy and money markets

Despite the increase in the interest rate spread versus the euro area, the currency markets

have remained fairly stable. Hence, EUR/DKK fluctuated closely around 7.455 and there

was no significant upward pressure on DKK. This situation might change during Q3 if the

new ECB liquidity measures bring a significant increase in EUR liquidity relative to DKK

liquidity, as this could increase demand for DKK on a relative basis. The risk is that this will

result in krone appreciation, which DN may need to mitigate via FX intervention purchases

and unilateral rate cuts. While this is a risk factor to be accounted for, our base case remains

that DN will not change its stance for the foreseeable future.

Yield curve

In the swap markets, spreads versus EUR rates have remained broadly stable across the

curve. Looking forward, we expect spreads to remain broadly stable, with only moderate

risks for further widening. The DKK forecasts, therefore, track the EUR forecasts, which

implies that for 2Y and 5Y rates are slightly below the forward markets, while the forecasts

for the 10Y segment are a bit above the forwards.

3M Cibor Rates 10Y DKK swap rates


Forecast summary


DKK swap curve


DKK Spot +3m +6m +12m

REPO 0.20 0.20 0.20 0.20

3M 0.37 0.33 0.28 0.28

2-year 0.08 0.05 0.05 0.05

5-year 0.38 0.50 0.55 0.70

10-year 1.38 1.55 1.65 1.95

2-year 0.59 0.49 0.50 0.50

5-year 0.88 0.90 0.95 1.1010-year 1.58 1.75 1.85 2.15

Swap rates

Money market

Government bonds

-25

-20

-15

-10

-5

0

0.0

0.5

1.0

1.5

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Sweden forecast


Q2 GDP (1.9% y/y, adjusted for working days) was something of a disappointment. Again,

activity related to manufacturing (exports, capex etc) was weak and indeed monthly

industrial production data – if anything – shows a negative trend. Domestically-oriented

activities are performing better (residential construction for instance is booming) and

consumer spending is relatively well behaved but on balance we fear that our 2014 growth

forecast (2.5%) is in danger. Inflation remains low (CPIF 0.6% y/y in July) and apart from

gyration related to factors such as package holidays and energy, we see no clear trend right

now. The krona has traded weaker this year but the SEK response to the Riksbank’s

unexpected 50bp repo rate cut (announced on 3 July) has been moderate, so we do not

expect much exchange rate effect on imported inflation going forward.


The Riksbank made a sort of analytical stop-loss at the July meeting by lowering the repo

rate by 50bp to 0.25% and scaling down the forecast rate path by up to some 120bp (until

Q4 15) compared with the April projection. Inflation has been too low for too long and the

minutes released a couple of weeks later clearly revealed that a majority of board members

are worried that the Riksbank’s credibility in fulfilling its main objective (2% inflation) has

been damaged. The Riksbank now expects to keep rates unchanged until Q4 15 (we think it

may be even longer). The next policy announcement is on 4 September and we do not

expect any market-moving news then.

Yield curve

During the summer (after the July Riksbank announcement), the Swedish yield curve in the

2/5Y and 2/10Y flattened while the 5/10 year curve at least initially steeped (but then

reversed again). On the back of the Riksbank joining the ‘lower-for longer camp’, we

suspect that the front end will be more or less stuck for a considerable period of time.

Therefore, we expect curve movement to basically reflect the direction of longer maturities.

Rates are undoubtedly very low but with inflation low, the central bank on hold and growth

risk on the downside, we do not see much reason to expect rates to move much higher in the

medium term. Consequently, we suspect that curve-gyrations will be quite moderate too.

3M Stibor rates 10Y SEK swap rates


Forecast summary


SEK swap curve


SEK Spot +3m +6m +12m

Repo 0.25 0.25 0.25 0.25

3M 0.52 0.50 0.50 0.50

2-year 0.24 0.25 0.25 0.35

5-year 0.70 0.75 0.80 1.00

10-year 1.60 1.70 1.85 2.00

2-year 0.64 0.65 0.65 0.70

5-year 1.14 1.15 1.20 1.35

10-year 1.82 2.05 2.20 2.30

Swap rates

Money market

Government bonds

-20

-15

-10

-5

0

5

0.5

1.0

1.5

2.0

2.5

3.0

0 3 6 9 12 15 18 21 24 27

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Norway forecast


The Norwegian growth outlook improved broadly over the summer. Retail sales rose an

impressive 1.2% m/m in June and we estimate private consumption showed 1.3% q/q

growth in Q2. Together with growth in employment and manufacturing production over the

quarter, this points to growth in mainland GDP of 0.8% q/q in Q2, well above the Norges

Bank forecast of 0.45% q/q. The housing market has also continued to improve and prices

rose for a seventh consecutive month in July. Finally, core inflation surprised on the upside

in July, rising 2.6% y/y, which was well above the Norges Bank’s forecast of 2.2%. In

particular, higher-than-expected food prices pushed the rate of inflation higher.


Norges Bank struck a surprisingly dovish tone at the June monetary policy meeting,

lowering the rate path and saying that the policy rate could be lowered if a ‘further

weakening of the outlook for the Norwegian economy’ was seen. However, given the

improvement in Norwegian numbers seen over the summer, we are confident that Norges

Bank will not lower its policy rate over the next 12 months. Indeed, we look for a small

upward revision of the rate path at the September monetary policy meeting. The first rate

hike is still pencilled in for late 2015. We estimate that further rate hikes will be seen in

2016 and 2017 and that the hikes will be somewhat faster than priced in the forward market.

Nibor fixings have fallen over the summer, as the liquidity situation has improved. We

expect 3M and 6M fixings to stay around the current level for the next nine months.

Yield curve

The Norwegian swap curve 2s10s has continued to flatten this year from around 145bp at

the beginning of the year to close to 90bp currently. The dovish rhetoric from Norges Bank

and the ECB rate cut in June pushed down the short end but the rally in global long yields

pushed the long end down even more. We continue to expect a further – albeit modest –

flattening of the curve given our bearish view on Norges Bank and our view that the long

end of the Norwegian curve will not underperform dramatically against the EUR curve. At

an outright level, in particular, our two-year swap forecast is above the market but we also

expect long rates to rise more than currently priced into the forward market. It is primarily

higher USD and GBP rates that we expect to push up the long end.

3M Nibor rates 10Y NOK swap rates


Forecast summary


NOK swap curve


NOK Spot +3m +6m +12m

ON DEP 1.50 1.50 1.50 1.50

3M 1.72 1.75 1.75 2.10

2-year 1.44 1.65 1.85 2.05

5-year 1.75 1.90 2.10 2.50

10-year 2.36 2.60 2.70 2.80

2-year 1.84 2.10 2.35 2.55

5-year 2.14 2.55 2.70 3.05

10-year 2.69 3.00 3.05 3.35

Swap rates

Money market

Government bonds

-10

-5

0

5

10

15

1.0

1.5

2.0

2.5

3.0

3.5

0 3 6 9 12 15 18 21 24 27

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Forecast table

Forecast table


Horizon Policy rate 3m xIbor 2-yr swap 5-yr swap 10-yr swap 2-yr gov 5-yr gov 10-yr gov

Spot 0.25 0.23 0.63 1.72 2.54 0.42 1.57 2.40

+3m 0.25 0.25 0.95 2.05 2.95 0.75 1.90 2.80

+6m 0.25 0.48 1.45 2.55 3.25 1.25 2.40 3.15

+12m 0.75 1.06 2.10 3.15 3.60 1.90 3.00 3.50

Spot 0.15 0.20 0.32 0.58 1.25 0.00 0.22 1.01

+3m 0.15 0.15 0.25 0.65 1.45 -0.05 0.30 1.20

+6m 0.15 0.10 0.25 0.70 1.55 -0.05 0.35 1.30

+12m 0.15 0.10 0.25 0.85 1.85 -0.05 0.50 1.60

Spot 0.50 0.56 1.22 1.99 2.56 0.70 1.81 2.42

+3m 0.50 0.65 1.60 2.35 2.95 1.10 2.20 2.85

+6m 0.75 0.81 1.80 2.55 3.15 1.30 2.40 3.05

+12m 1.25 1.34 2.30 2.90 3.45 1.80 2.80 3.35

Spot 0.20 0.37 0.59 0.88 1.58 0.08 0.38 1.38

+3m 0.20 0.33 0.49 0.90 1.75 0.05 0.50 1.55

+6m 0.20 0.28 0.50 0.95 1.85 0.05 0.55 1.65

+12m 0.20 0.28 0.50 1.10 2.15 0.05 0.70 1.95

Spot 0.25 0.52 0.64 1.14 1.82 0.24 0.70 1.60

+3m 0.25 0.50 0.65 1.15 2.05 0.25 0.75 1.70

+6m 0.25 0.50 0.65 1.20 2.20 0.25 0.80 1.85

+12m 0.25 0.50 0.70 1.35 2.30 0.35 1.00 2.00

Spot 1.50 1.72 1.84 2.14 2.69 1.44 1.75 2.36

+3m 1.50 1.75 2.10 2.55 3.00 1.65 1.90 2.60

+6m 1.50 1.75 2.35 2.70 3.05 1.85 2.10 2.70

+12m 1.50 2.10 2.55 3.05 3.35 2.05 2.50 2.80

Note: * German government bonds are used, EUR swap rates are used

US

DE

UR

*G

BP

NO

KD

KK

SE

K


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Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’).

The authors of the research report are Peter Possing Andersen (Senior Analyst), Lars Tranberg Rasmussen (Senior

Analyst) and Anders Vestergård Fischer (Analyst).

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Documents

Investment Research General Market Conditions 15 August ...€¦ · potential workers are still out of the labour market. We therefore believe the Fed will hike rates only gradually