Investment Research Yield Forecast Update...3 | 16 September 2016 e 5-year steepening of the EUR...

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

Investment Research — General Market Conditions

The ECB disappointed the market last week. Many market participants had expected further

policy easing in the form of new interest rate cuts or an extension/expansion of QE. The

ECB delivered none of the above and, if anything, was slightly more optimistic about the

effects of its current policy programme. The ECB did, however, acknowledge a need to

change the rules governing the instruments it can buy as part of its asset purchase

programme. The issue has now been handed over to a committee, which is unlikely to

present its recommendations until December.

The ECB’s wait-and-see stance, combined with Fed members’ rather hawkish rhetoric and

a Bank of Japan apparently also hesitant to ease policy further, prompted a rise in global

yields and a steepening of the 2-10Y and 10-30Y curves, thus hitting mainly the long end.

So, do we face an extended period of higher yields? The past three years have witnessed

two periods of rising global yields. In 2013, yields rose on the Fed announcing a tapering

of its asset purchase programme. In spring 2015, German 10Y yields increased by almost

one percentage point – ostensibly due to a combination of the market concluding that the

ECB’s QE was more than fully priced in and bad positioning in the fixed income market.

The latter should be viewed in light of the ‘risk capacity’ of banks now being much lower

than before. Hence, major market movements could be reinforced in either direction as

there is no one to take the opposite position.

We do not seem to be facing an extended period of higher yields

The future intentions of central banks remain unclear and the market may well have been

wrong-footed once again. Hence, we cannot rule out a repeat performance of the yield

increases in spring 2015, when very few market participants expected German 10Y yields

to rise almost one percentage point within six weeks. However, our overall expectation is

that global central banks will continue their expansionary monetary policies. We do not

expect the Fed to raise interest rates this year – especially in light of recent weak numbers

for the US economy. Given the still very low level of inflation, we also expect the ECB to

extend its comprehensive QE programme to run throughout 2017 and not just until March.

Furthermore, we believe global bond investors will take advantage of even minor yield

rises to increase their positions and duration. While it may sound odd to many investors, a

German 10Y yield in positive territory is a ‘good deal’.

We generally maintain our forecast of long DKK and EUR yields being range-bound over

the coming three-six months with a slight downside risk on a 3M horizon. However, we

still see yields rising slightly on a 12M horizon as the Fed, despite everything, begins to

raise rates and the market can begin to price the ECB ending its asset purchases by the end

of 2017.

16 September 2016

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


Yield Forecast Update

No bond sell-off this year

Editors:

Chief Analyst Arne Lohmann Rasmussen +45 45 12 85 32 [email protected]

Assistant Analyst Nina T. B. Andersen +45 45 12 82 87 [email protected]

Country Spot +3m +6m +12m

USD 0.50 0.50 0.50 0.75

EUR 0.00 0.00 0.00 0.00

GBP 0.25 0.10 0.10 0.10

DKK 0.05 0.05 0.05 0.05

SEK -0.50 -0.50 -0.50 -0.50

NOK 0.50 0.50 0.50 0.50

Country Spot +3m +6m +12m

USD 1.67 1.50 1.70 1.90

GER 0.01 -0.10 0.00 0.30

GBP 0.87 0.80 0.95 1.20

DKK 0.07 0.00 0.10 0.40

SEK 0.28 0.05 0.15 0.40

NOK 1.26 1.10 1.20 1.40

mailto:[email protected]


2 | 16 September 2016 www.danskeresearch.com

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Contents and contributors

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

Macro Senior Analyst Pernille B. Henneberg +45 45 13 20 21 [email protected]

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

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

Macro & Interest rates Senior Analyst Mikael Olai Milhøj +45 45 12 76 07 [email protected]


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

Macro & Interest rates Senior Analyst Morten Helt +45 45 12 85 18 [email protected]

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

Macro Chief Economist Las Olsen +45 45 12 85 36 [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 Jostein Tvedt +47 23 13 91 84 [email protected]

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





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Eurozone forecast

Euro-area GDP growth showed fairly solid GDP growth of 0.3% q/q in Q2 16, while the

unemployment rate in July remained at 10.1%. Furthermore, initial survey indicators suggest

fairly resilient economic conditions post the Brexit vote. However, we still mainly have

observations for survey data for two months and little hard data covering the period beyond

July. All in all, however, it seems that the impact on the euro area economy has been relatively

limited. Headline inflation stayed unchanged at 0.2% y/y in August.

At the September meeting, the ECB kept all its policy rates unchanged and maintained its

monthly QE purchases of EUR80bn and still intends to end its purchases in March 2017. The

ECB reiterated that it ‘continues to expect the key ECB interest rates to remain at present or

lower levels for an extended period of time, and well past the horizon of the net asset

purchases’. All in all, however, it was a slightly more hawkish message than expected in the

market. Despite the September decision to keep the QE purchase horizon unchanged, we

believe the ECB will extend purchases by six months at the meeting in December. We expect

this because of the lack of any upward trend in the underlying price pressure and the

persistently low market-based inflation expectations. Related to this, we do not believe a rise

in inflation later this year would be enough for the ECB to end QE purchases, as any higher

inflation would be driven mainly by the higher oil price.

Focus in the European government is now on how the ECB will handle an extension of the

QE programme without running into problems with the different rules. The issue is that there

is basically not enough German government paper to buy with the current rules. The ECB has

said that a ‘committee’ will look into how the purchase programme can be extended.

Following the ECB meeting, we have seen slight upward pressure on EUR yields. However,

given our view that the QE purchases will be extended at the December meeting, we do not

expect a prolonged rise in yields for the next three months. However, we still see modest

upward pressure on 10Y yields on a 12M horizon, as we still expect upward pressure on the

long end of US yields in 2017. Thus, on a 6M and 12M horizon, we still look for a modest

steepening of the EUR curve for 2Y10Y and 5Y10Y. Additionally, we expect 3M Euribor

fixings to stay around -30bp throughout the forecast horizon. Note, we have seen no effect on

Euribor fixings from the higher USD Libor fixings.

3M Euribor

10Y EUR swap rates

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

EUR Forecast summary


EUR swap curve


EUR Spot +3m +6m +12m

ECB 0.00 0.00 0.00 0.00

3M -0.30 -0.30 -0.30 -0.30

2-year -0.66 -0.62 -0.60 -0.55

5-year -0.51 -0.50 -0.50 -0.45

10-year -0.01 -0.10 0.00 0.30

2-year -0.23 -0.22 -0.20 -0.15

5-year -0.12 -0.10 -0.10 -0.05

10-year 0.35 0.30 0.40 0.70

Money market

German government bonds

Swaprates

-202468101214

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

0 3 6 9 12 15 18 21 24 27

Change,bp (rhs) 16-Aug-16 16-Sep-16

% bp


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US forecast

We continue to believe that the Fed will not raise the federal funds target range this year. In

Presentation US: 10 reasons why we believe the Fed will not hike this year, 14 September,

we outline why we have this non-consensus view on the Fed.

To summarise, GDP growth has slowed markedly to just around 1% q/q AR over the past

three quarters (Chart 1 in the presentation above) and ISM activity indicators are at the

weakest level since 2010, suggesting that growth in Q3 may disappoint as well (Chart 6).

Unemployment and underemployment rates have moved sideways for some time, suggesting

there is still more slack left in the labour market (Chart 2), wage growth is still subdued (Chart

3) and PCE core inflation continues to run somewhat below the 2% target (it has only been at

or above target for five months since 2008 – Chart 4). Also, we think it is an overlooked fact

that the Fed has already tightened monetary policy equivalent to 330bp due to QE tapering

and hiking expectations (Chart 8). In addition, most voting FOMC members have a dovish-

to-neutral stance on monetary policy, in our view (Chart 9).

At the time of writing, markets have priced in just a 10% probability of a hike in September

and a 60% probability of a hike in December. Although a December hike cannot be ruled out

if we see a rebound in data, it is not our base case and we think US yields will move lower

over the next 3M as markets price out the probability of a Fed hike this year. We anticipate

2Y and 10Y US yields declining to 0.70% and 1.60%, respectively, by year-end.

As we still expect a Fed hike in H1 17, we expect US yields to climb up again in 3-12M as

markets begin to price in a continuation of the Fed’s hiking cycle. We expect 2Y and 10Y US

yields to trade at 1.20% and 1.90% in 12M, respectively.

Note that we continue to see USD Libor fixings moving higher due to the effects of the US

Money market reform. See also The US Money Market Reform: The Scandi angle, 9 August

2016. We assume that the regulatory changes to the US Money Market will have a lasting

effect on USD Libor fixings. Hence, we expect 3M USD Libor to stay relatively elevated for

the next six months, despite our view that the Fed will not hike the Fed funds target range this

year.

3M USD Libor rates 10Y USD swap rates


USD Forecast summary


USD swap curve


USD Spot +3m +6m +12m

FED 0.50 0.50 0.50 0.75

3M 0.85 0.80 0.95 1.05

2-year 0.73 0.70 0.80 1.20

5-year 1.17 1.10 1.30 1.60

10-year 1.67 1.50 1.70 1.90

2-year 0.99 0.95 1.05 1.45

5-year 1.19 1.10 1.30 1.65

10-year 1.50 1.40 1.60 1.85

Swap rates

Money market

Government bonds

0

2

4

6

8

10

12

14

0.0

0.5

1.0

1.5

2.0

0 3 6 9 12 15 18 21 24 27


% bp

http://danskeresearch.danskebank.com/link/PresentationUSNoFedHike140916/$file/PresentationUS_NoFedHike_140916.pdf

http://danskeanalyse.danskebank.dk/abo/USMMReform090816/$file/US_MM_Reform_090816.pdf


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UK forecasts

Soft economic indicators suggest that the UK rebounded in August after the initial

deceleration in July, suggesting that the UK economy may avoid a Brexit recession. PMIs

have rebounded sharply across sectors: the NIESR GDP estimate has been positive and

consumer confidence is still at a relatively high level. As the economic data has been better

than expected, we now expect quarterly GDP growth to stay positive during H2 16, i.e. we no

longer expect a Brexit recession although the probability of a recession is still relatively high.

Also, it is worth noting that the economy is still expected to slow markedly compared with

pre-referendum growth rates due to Brexit uncertainty. However, we stress that uncertainty

surrounding our forecasts is higher than usual as the Brexit withdrawal negotiations are set to

begin early next year when the UK triggers Article 50 and we still await the release of hard

economic data. For more details, see our presentation Post-Brexit Status – UK may avoid a

Brexit-recession as data have surprised positively, 13 September 2016.

As expected, the Bank of England (BoE) made no policy changes at the September meeting

meaning that the Bank Rate was kept at 0.25%, the target for the stock of government bond

and corporate bond purchases was unchanged at GBP435bn and GBP10bn, respectively, and

there were no changes to the new Term Funding Scheme (TFS). Despite better economic data,

the Bank of England left the door open for additional easing later this year. We still expect a

15bp rate cut from 0.25% to 0.10% in November but it is a close call and will depend largely

on how data comes out. There is only about a 5bp BoE rate cut priced in for November;

therefore, we think markets are too complacent about the probability of further easing.

After yields on Gilts fell sharply on the back of the restart of BoE’s asset purchase programme

and expectations of further BoE easing, 10Y Gilts yields have increased from the 0.52% low

in the middle of August to 0.90% currently. We expect UK yields to drop slightly in the

autumn as markets begin to price in more BoE easing, the ECB extends QE and Fed hikes are

priced out.

3M GBP Libor rates

10Y UK swap rates


GBP Forecast summary


GBP swap curve


GBP Spot +3m +6m +12m

Base rate 0.25 0.10 0.10 0.10

3M 0.38 0.19 0.19 0.20

2-year 0.14 0.10 0.10 0.15

5-year 0.29 0.25 0.35 0.50

10-year 0.87 0.80 0.95 1.20

2-year 0.44 0.40 0.40 0.45

5-year 0.55 0.50 0.60 0.75

10-year 0.87 0.80 0.95 1.20

Swap rates

Money market

Government bonds

0

5

10

15

20

25

0.0

0.2

0.4

0.6

0.8

1.0

1.2

0 3 6 9 12 15 18 21 24 27


% bp

http://danskeresearch.danskebank.com/link/UKPostBrexit130916/$file/UK_PostBrexit_130916.pdf

http://danskeresearch.danskebank.com/link/UKPostBrexit130916/$file/UK_PostBrexit_130916.pdf


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Denmark forecasts

Growth in Q2 was only slightly weaker than in the previous quarter and employment growth

has accelerated; therefore, the overall economic picture has brightened somewhat. However,

productivity growth remains low and consumer spending seems to have slowed somewhat. A

large drop in the price of cell phone services has pulled inflation down further but the

government no longer plans to scrap the PSO tax on electricity in 2017. Therefore, the overall

outlook is unchanged.

The Danish Central Bank did not need to intervene in the FX market in August. EUR/DKK

has settled in the range of 7.44-7.4450 since early August – at this level we do not expect DN

to be active in the FX market. We expect DN to keep the rate of interest on certificates of

deposits unchanged at -0.65% on a 12M horizon. However, if the need to sell DKK in FX

intervention accelerates, or if the ECB decides to cut its deposit rate further (not our main

scenario), DN may opt to cut to -0.75% – a level we still view as the lower bound for the key

policy rate in Denmark. Tight excess liquidity in the DKK money market has eased on the

back of DN selling DKK in FX intervention and buybacks of government bonds. With further

buybacks in the pipeline, the liquidity situation is expected to ease further in the coming

months. This should maintain moderate downward pressure on Danish money market fixings.

The Danish CITA money market rates and Cibor fixings have recently edged marginally

higher along with EONIA rates, as the market now prices in a lower probability of further rate

cuts from the ECB. The money market does not expect CITA rates to move above EONIA

rates before spring 2018. Our forecasts for the deposit rate and money-market rates are more

or less in line with market pricing. However, 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

near future and in 2018 and beyond. We expect the general ‘hunt for yield’ in the wake of the

stepped-up ECB QE programme to attract investors to the marginally higher yields in

Denmark. We forecast that 6M CIBOR fixings will stay marginally below zero, while we

expect 3M fixings to stay negative by some 20bp. We expect 10Y swap rates to rise lightly

on a 12M horizon in line with EUR rates.

3M Cibor rate 10Y DKK swap rates


Forecasts summary


DKK swap curve


DKK Spot +3m +6m +12m

CD -0.65 -0.65 -0.65 -0.65

REPO 0.05 0.05 0.05 0.05

3M -0.19 -0.20 -0.20 -0.20

6M -0.04 -0.05 -0.05 -0.02

2-year -0.53 -0.52 -0.50 -0.45

5-year -0.35 -0.25 -0.25 -0.20

10-year 0.05 0.00 0.10 0.40

2-year -0.03 -0.02 0.00 0.055-year 0.14 0.12 0.12 0.2010-year 0.63 0.55 0.70 1.00

Swap rates

Money market

Government bonds

0

2

4

6

8

10

12

14

-0.20.00.20.40.60.81.01.21.4

0 3 6 9 12 15 18 21 24 27


% bp


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Sweden forecast

There are several signs that Swedish growth has shifted to a lower gear. Exporters face more

headwind, which is less of a surprise considering sluggish global demand for investment

goods. Perhaps a bit more puzzling is the fact that consumers have started to hold back too

and retailers have become more worried about business going forward. Mandatory

amortisation on new mortgage loans was introduced this summer and it appears that price

pressures have abated both for owner-occupied flats and single-family houses. Inflation

showed a steady upward trend in 2014-15 but so far this year, CPIF inflation has been stuck

at around 1.5% – indeed, excluding the effects of higher energy prices, the inflation trend

appears to have turned down again.

So far, the Riksbank has expressed satisfaction with the development of inflation but if it fails

to tack another step upwards again (as we suspect), it is likely to become more concerned.

The question is how the Riksbank will move forward when the current QE programme

(purchases of government bonds) expires in December. Should inflation fail to rise further in

coming months, with the ECB likely to announce an extension of its QE programme, the

Riksbank is likely to consider an extension too. The problem is that the Riksbank is probably

approaching the limit for how large a share of bonds it can buy without damaging market

liquidity. To avoid distressed market conditions, it may have to consider other assets too. We

see another repo rate cut below -0.5% as rather improbable but at the same time, we see little

reason to expect it to hike rates before end-2017.

Despite very low yields, we still see powerful forces pushing down rates. Growth has peaked,

the pick-up in inflation is likely to be over and central banks, via QE, have taken command

over market pricing. We have for a long time held the view that the Swedish yield curve is

too steep out to five years, reflecting expectations of more rapid rate hikes than we regard as

warranted. More recently though the 2Y/5Y curve has indeed flattened rather significantly

and now looks more ‘fair’. The five-year swap rate close to zero probably has a rather limited

downside, which is why we think that continued downward pressure on rates will result in a

5Y/10y flattening.

3M Stibor rates

10Y SEK swap rates


Forecast summary


SEK swap curve


SEK Spot +3m +6m +12m

Repo -0.50 -0.50 -0.50 -0.50

3M -0.47 -0.55 -0.50 -0.50

2-year -0.65 -0.65 -0.65 -0.65

5-year -0.26 -0.30 -0.20 -0.10

10-year 0.27 0.05 0.15 0.40

2-year -0.43 -0.50 -0.50 -0.50

5-year 0.00 0.00 0.05 0.15

10-year 0.73 0.60 0.65 0.85

Swap rates

Money market

Government bonds

0

5

10

15

20

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

0 3 6 9 12 15 18 21 24 27

Change,bp (rhs) 16/08/2016 16/09/2016

% bp


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Norway forecast

We expect Norges Bank to be on hold at the upcoming board meeting on 22 September.

Norges Bank’s June Monetary Policy Report guided towards a cut at the September meeting

unless a major surprise on the upside should occur. Inflation has recently been significantly

higher than expected by Norges Bank. Key economic data has been fairly strong. The market

no longer expects a target rate cut in September.

However, the market may have underestimated the probability of a target rate cut going

forward. An unusually high spread between the 3M Nibor and the target rate may be a concern

to Norges Bank. To keep the currency weak is a top priority for Norges Bank’s board. Both

factors suggest that Norges Bank should stick to the original plan and cut the target rate at the

upcoming meeting.

Norwegian inflation during the summer has been above target and significantly higher than

expected by Norges Bank. Core inflation in August was 3.3% y/y – down from an elevated

3.7% y/y in July. The high inflation seems mainly to be a delayed effect of the weakening of

the NOK. Inflation will probably drop significantly going forward as the inflationary effect

of the past weakening of the NOK fades. Wage-generated inflation is still very muted. That

is, Norges Bank, being forward looking, could rightly defend a cut to the target rate at the

upcoming board meeting, regardless of the recent high inflation numbers.

The recent Regional Network report was significantly stronger than expected. The six- month

forward looking index increased from 0.28 to 0.75, i.e. the highest level since September

2014. The report confirms the recent strong PMI and production indexes. That is, the business

cycle trough seems to be behind us and activity seems to be picking up slightly. The drag on

total activity from the oil investment slowdown is reduced.

The fiscal policy is expansionary. The fiscal budget for 2017 is due to be released on 6

October. The recent economic slowdown is the perfect excuse for the government for

releasing an expansionary fiscal budget ahead of the general election on 11 September 2017.

A current target rate of 0.50% seems to be the trough of this interest rate cycle as fiscal

stimulus gradually kicks in and the drag on total demand from the oil investment downturn

fades. However, Norges Bank will probably indicate that a cut in December cannot be ruled

out at the upcoming board meeting. The dovish stance is motivated by the ambition to

maintain a weak NOK. This weak NOK policy will probably prevail for some time, which

suggests fairly stable interest rates spreads versus European peers going forward.

3M Nibor rates 10Y NOK swap rates


Forecast summary


NOK swap curve


NOK Spot +3m +6m +12m

ON DEP 0.50 0.50 0.50 0.50

3M 1.08 1.00 1.00 0.85

2-year 0.61 0.60 0.60 0.70

5-year 0.88 0.85 0.85 0.90

10-year 1.25 1.10 1.20 1.40

2-year 1.18 1.20 1.20 1.30

5-year 1.22 1.25 1.25 1.30

10-year 1.49 1.40 1.50 1.70

Swap rates

Money market

Government bonds

-10

-5

0

5

10

15

20

0.7

0.9

1.1

1.3

1.5

1.7

1.9

0 3 6 9 12 15 18 21 24 27

Change,bp (rhs) 16/08/2016 16/09/2016

% bp


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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 0.50 0.85 0.99 1.19 1.50 0.73 1.17 1.67

+3m 0.50 0.80 0.95 1.10 1.40 0.70 1.10 1.50

+6m 0.50 0.95 1.05 1.30 1.60 0.80 1.30 1.70

+12m 0.75 1.05 1.45 1.65 1.85 1.20 1.60 1.90

Spot 0.00 -0.30 -0.22 -0.11 0.36 -0.65 -0.50 0.01

+3m 0.00 -0.30 -0.22 -0.10 0.30 -0.62 -0.50 -0.10

+6m 0.00 -0.30 -0.20 -0.10 0.40 -0.60 -0.50 0.00

+12m 0.00 -0.30 -0.15 -0.05 0.70 -0.55 -0.45 0.30

Spot 0.25 0.38 0.44 0.55 0.87 0.14 0.29 0.87

+3m 0.10 0.19 0.40 0.50 0.80 0.10 0.25 0.80

+6m 0.10 0.19 0.40 0.60 0.95 0.10 0.35 0.95

+12m 0.10 0.20 0.45 0.75 1.20 0.15 0.50 1.20

Spot 0.05 -0.19 -0.02 0.14 0.65 -0.53 -0.34 0.07

+3m 0.05 -0.20 -0.02 0.12 0.55 -0.52 -0.25 0.00

+6m 0.05 -0.20 0.00 0.12 0.70 -0.50 -0.25 0.10

+12m 0.05 -0.20 0.05 0.20 1.00 -0.45 -0.20 0.40

Spot -0.50 -0.46 -0.42 0.01 0.74 -0.64 -0.26 0.28

+3m -0.50 -0.55 -0.50 0.00 0.60 -0.65 -0.30 0.05

+6m -0.50 -0.50 -0.50 0.05 0.65 -0.65 -0.20 0.15

+12m -0.50 -0.50 -0.50 0.15 0.85 -0.65 -0.10 0.40

Spot 0.50 1.08 1.18 1.23 1.49 0.61 0.88 1.26

+3m 0.50 1.00 1.20 1.25 1.40 0.60 0.85 1.10

+6m 0.50 1.00 1.20 1.25 1.50 0.60 0.85 1.20

+12m 0.50 0.85 1.30 1.30 1.70 0.70 0.90 1.40

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 author of the research report is Arne Lohmann Rasmussen, Chief Analyst.

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