Expect Riksbank Cut In December

Receive RIBA March 14 and/or 6 Month STINA
Steepen 5s10s
Do carry trades in covered bonds, hedge with BEI spread
Receive SEK 5Y versus EUR

In our latest weekly (Reading The Markets – Sweden), we suggested that the Swedish bond curve might face steepening pressure. A tug of war between forward guidance (battling low growth and low inflation) and tapering will probably spook fixed income markets for some time yet. At the short end of the Swedish yield curve, the Riksbank is facing increased demand for rate cuts on the back of lower inflation and disappointing growth figures. The inflation data today was 0.4pp below the Riksbank’s forecast (just a few weeks old) and the Riksbank may not be able to resist a rate cut. All in all, we now expect a December rate cut. In any case, Sweden needs to adopt a ‘low for long’ position just like the US and the euro area, and we do not think it is fully reflected in current pricing. We suggest three different trades that we think will benefit as the market adjusts pricing: steepen the yield curve, combine carry trades in covered bonds with BEI spreads and receive SEK 5Y versus EUR.

We now expect the Riksbank to cut in December
Since December 2012 when the Riksbank lowered the repo rate from 1.25% to 1.00%, it has revised the inflation forecast quite massively (the biggest adjustment came in April). To illustrate: in December 2012 the Riksbank projected CPIF inflation to reach 2% in April/May 2014. According to the forecast published in October this year, the 2% level is expected to be (almost) reached by the end of 2016. These rather remarkable forecast revisions have however not resulted in any policy response other than a gradual delay of the point in time when policy is assumed to first be tightened. The reason behind this is well known and does not need to be repeated in any detail: concern about household debt. This factor alone has undoubtedly made the board majority reluctant to lower rates further.

However, we sense that recent information will probably prove to be too much to resist. Swedish ‘hard data’ – especially related to manufacturing – has continued to perform poorly and suggests a quite weak Q3. The ECB’s decision to cut the refi rate last week was, as far as we understand, not foreseen by the Riksbank and the ECB expressed clear concern about a prolonged period of very low inflation. Finally, Swedish inflation data in October came in 0.4pp below the Riksbank’s forecast in terms of CPI, CPIF and CPIF excluding energy. The lower-than-expected inflation was broad based with 10 out of 15 main CPI components showing a decline. So probabilities are flipping over. We simply think the current mix of data and other information will make it too hard for the Riksbank to resist – hence a 25bp rate cut appears probable in December. We have previously pushed our forecast for the first hike out to Q1 15. At the current juncture, we do not see enough reasons to change that, but of course what will happen in more than a year is pretty uncertain.

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