- Sentiment has remained very nervous over the past month. The EU summit package agreed in late October has so far failed to stabilise the markets. Periphery bond yields have risen further, while German and Danish bond yields have reached new lows.
- The ECB cut its key rates by 25bp in November. Mario Draghi highlighted significant downside risks to economic growth and abating inflation pressures. The ECB com-munication softened further over the past week.
- Meanwhile, US economic data has surprised on the upside and there are signs of stabilisation in China. This has supported a further widening of the yield spread across the atlantic during the past month.
International rates
- The ECB will deliver more cuts in December and January taking the refi rate to 0.75%. With economic data remaining weak and the debt crisis continuing, Euribor fixings and EUR swap rates are set to decline over the coming three to six months.
- The Fed is on hold for a long time but will retain its bias toward more easing. Even so USD fixings are likely to continue higher until the debt crisis settles down. We expect swap rates to range trade in the short term, but to increase over the forecast horizon.
- The Bank of England will announce another £50bn increase in the asset purchase target in January 2012, but will not cut the base rate further. The GBP curve seems relatively fair priced given the current outlook for monetary policy and growth.
Scandi rates
The Danish Central Bank will follow the ECB and cut the lending rate by another 25bp in both December and January taking it to 0.70%. Risks remain tilted for addi-tional Danish rate cuts. Swap rates and fixings will decline further in Denmark. The Riksbank will cut the repo rate by 25bp in December and make two more cuts in February and April, before it goes on hold on 1.25%. The risk is of more cuts. There is significant room for lower SEK rates and fixings. We have lowered our NOK policy rate forecasts – postponing the first expected 25bp hike until October 2012 followed by further tightening in 2013. We expect rates on hold over the next few months, although there is a possibility of rate cuts.
Eurozone forecast:
Growth and inflation
Eurozone GDP increased 0.2% q/q in Q3. The growth was in particularly driven by de-cent numbers from Germany and France. Recently economic indicators, such as PMIs and Ifo have deteriorated further and also retail sales and industrial production have given in. We forecast that the euro area is heading for a mild recession with GDP dropping 0.3% q/q in Q4. Fiscal policy is being tightened, implying that the peripherals are set for very modest, or even negative, GDP growth. Due to the headwinds from fiscal tightening and turmoil in the financial markets, we expect the eurozone economies to grow 1.6% in 2011E and only 0.3% in 2012E. Inflation should remain above the ECB‟s 2% target throughout 2011 before edging below 2% in 2012.
Monetary policy and money markets
The ECB cut its key policy rate by 25bp in November and highlighted significant down-side risks to economic growth, abating inflation pressures and the expectation for a mild European recession. While Draghi did not pre-commit to further policy easing, we believe the ECB will cut by another 25bp in both December and January, taking the refi rate to 0.75%. We expect the ECB to narrow the rate corridor by 25bp to +/- 50bp at the January meeting, implying that the deposit rate will not be lowered to more than 0.25%. The Euribor fixings have started moving lower and we expect this to continue over the next 12 months. Our projections for the fixings are below forward markets.
Yield curve
Swap rates are expected to decline over the coming three to six months, as economic data will remain weak, the ECB will cut rates further, and the risks regarding the European debt crisis are set to dominate. There is most downside to short rates, as our expectation of several more ECB cuts is not yet fully priced. Further, an improved macro picture in the US and China is set to counter some of the downward pressure on rates for long ma-turities. This implies that there is a decent potential for curve steepening over the coming 6-12 months. Our forecasts are generally below the forward market for the coming six months. However, we look for a bottom in long rates by mid-2012, reflecting a stabilisa-tion in the euro area by that time and an improved global growth picture.
US forecast
Growth and inflation
US growth has surprised on the upside recently, recovering to 2.5% in Q3 following less than 1% growth in H1. Employment has also risen more than expected and business sur-veys support a picture of stabilisation. The recovery has been driven by domestic demand with consumption and investment gaining some traction in H2 as headwinds from rising commodity prices and the Japanese earthquake have turned into mild tailwinds. We look for continued growth around 2.5% over the coming year. Inflation is heading lower as base effects from commodity prices kick in. Core inflation pressures are also ebbing and we expect it to decline to 1.5% by mid-2012 from the current level of 2.0%.
Monetary policy and the money market
The Fed has stepped to the sideline following new stimulus measures this autumn. We now expect the Fed to be on hold for a long time but more stimulus could be put on the table in 2012 if growth falters again. In our view, it is likely to take the form of buying of mortgage bonds. The money market is pricing no Fed cuts for the future. However, USD fixings have been moving higher in response to the squeeze in the USD funding market. This could continue gradually until the debt crisis settles down.
Yield curve
The US yield curve is caught between improving US macroeconomic indicators and a continued worsening of the European debt crisis. Going forward, much depends on the debt crisis in Europe. With uncertainty remaining high and the Fed retaining its easing bias, US bond yields are likely to remain caught in the recent range for the next couple of months, despite our expectation of some further improvement in the US economic indica-tors. We emphasise that volatility is likely to remain high and that the market will be very sensitive to both positive and negative news regarding the debt crisis. Even though the US cyclical picture is improving, our forecast for a gradual rise in long rates is only likely to be proven right if financial stress eases off. We have made very few adjustments to our forecasts. Our forecast for 5-year maturities and longer is above the forward market, with the biggest difference in a 12-month horizon.
UK forecast
Growth and inflation
Economic growth in Q3 was a decent 0.5% but we expect Q4 to be flat at best and it could be negative. Unemployment stands at its highest in 15 years and is likely to rise further. Consumer and business sentiment is worsening and household disposable income is falling. Access to credit is diminishing as banks are struggling. The UK economy is in slightly better condition than the average eurozone country though but the difference is not large. We estimate 2012 growth will be a modest 1.0%. The UK risks being down-graded next year.
Monetary policy and the money market
The Bank of England has increased the ceiling for asset purchases by £75bn to £275bn in an attempt to boost the economy. The programme will run for four months and the central bank will just buy Gilts. We reckon that gains from QE are somewhat questionable and there might be adverse effects that are hard to grasp.
It is in our view unlikely that the economic outlook will improve substantially over the coming months and we expect the Bank of England to announce another £50bn increase in the asset purchase target in January 2012. We do not think the Bank of England will cut the base rate but the SLS, which ended in mid-2010, can be revived if the central bank decides to address some of the issues in financial markets and improve the poor liquidity in the interbank market.
Yield curve
The UK yield curve is extremely flat, effectively pricing in „seven lean years‟ as the Governor said it in one of his speeches. We agree overall with the current pricing and our forecasts reflect our bleak macroeconomic projection. We recommend corporate clients pay fixed and receive floating, especially at longer maturities. If the Bank of England revives the SLS, Libor forwards could decline.
Denmark forecast
Growth and inflation
The growth outlook for the Danish economy has weakened significantly in the recent month. Monthly indicators for foreign trade and private consumption indicate a rather sharp drop in GDP in Q3 (we get the official numbers at the end of the November). Look-ing ahead the expected mild recession in the euro area in Q4 11 and Q1 12 is expected to further limit Danish growth prospects going forward. We therefore see an increasing possibility that the Danish economy will fall into recession in Q4. We have therefore revised down our growth forecast for this year to 0.7% y/y from 1.1% y/y and to 1.0% y/y next year from 1.6% y/y. Inflation climbed up a notch in October to 2.8% y/y from 2.5% y/y in September. The higher inflation was primarily due to the new tax on fat and the increase in inflation can thus be characterised as exogenous and temporary.
Monetary policy and money markets
Following another period of upward pressure on the Danish currency, the Danish central bank cut all its leading rates by 35bp, leaving the CD rate at 0.65% and the lending rate at 1.20% (5bp below the ECB refi). This is the first time there has been a negative spread in the leading rate between Denmark and the eurozone. We believe that the Danish central bank will follow the ECB and cut the lending rate by another 25bp in both December and January, taking it to 0.70%. The risks remain tilted for additional Danish rate cuts. The CD rate is forecast to be cut to 0.40% in December and then remain on hold, as we do not expect EONIA rates to move persistently below 0.40% with an ECB deposit rate at 0.25%. The Danish money market is only factoring in limited declines in rates, so we see decent potential for lower Cita rates and Cibor fixings in the months ahead.
Yield curve
We expect the Danish yield curve to continue to move in tandem with German yields. We expect the 10Y swap rate spread to the euro to remain broadly unchanged at about 0-10bp over the entire forecast horizon. Our forecasts for Danish swap rates are below forwards on three- and six-month horizons.
Sweden forecast
Growth and inflation
Although Q3 GDP growth is likely to be OK, around 0.5% q/q and 3.5% y/y, forward-looking data such as NIER‟s business confidence survey suggests that growth has contin-ued to slow in Q4. PMI and order data suggest that manufacturing is losing momentum, with a possible negative impact on investment spending. However, domestic sectors may be even harder hit on the back of cautious consumers as evidenced by lower-than-average confidence in retail trade and private services. A significant risk for the Swedish economy is a simultaneous deterioration in both labour and property markets. Actually, we fear that Sweden, in 2012, may encounter a situation looking much like that in 2008, when the world was hit by the financial crisis. Inflation surprised on the downside in October, with core CPIF printing at a mere 1.1% y/y. This may signal that increasing deflationary pres-sure is evolving now.
Monetary policy and the money market
The Riksbank lowered its growth projection at the October meeting, but both the Fed and the European Commision have cut their economic projections since then. This and the ECB‟s somewhat surprising cut in its policy rate recently are likely to have implications for the Riksbank‟s repo rate decision going forward. Other factors also point in the same direction. The Riksbank assumes that the PIIGS debt crisis will gradually be resolved but in reality it appears to be accelerating. Moreover, October inflation was 0.5 percentage points below the Riksbank‟s forecast. Hence, both growth and inflation suggest that the Riksbank should cut rates to get closer to the target at the same time as the debt crisis raises the risk both in terms of growth and for the financial system. Hence, the Riksbank is likely to start cutting rates in December, followed by more in February and April. We keep an open mind to the possibility of a more aggressive easing scenario.
Yield curve
We expect a steepening of the government yield curve on the back of Riksbank rate cuts and the government‟s guidelines suggesting more supply at the super-long end. Short-dated mortgages are trading at close to multi-year spread highs versus government bonds, looking very attractive in a rate-cutting environment. The Swedish swap curve is still very flat from about 5 years and onwards compared with the EUR curve, suggesting duration extensions are cheap.
Norway forecast
Growth and inflation
We expect the recovery to continue in the coming year – although lower growth abroad will curb the Norwegian upturn through lower exports. We expect annual growth in the mainland economy of around 2.7% in 2011 and 3.2% in 2012 helped by high residential and oil investments. Very high terms of trade and low real rates are important drivers behind the Norwegian recovery. Strong growth in real wages and moderate growth in employment should lead to high growth in demand from households. Fiscal policy will be marginally expansionary next year but there should be room for more expansionary fiscal policy, should the expected upswing abate. Core inflation in Norway is still low. Different measures (CPI-ATE and CPIXE) indicated a core inflation of 1.2% in October – broadly in line with Norges Bank‟s projections. We expect inflation to bottom out at around cur-rent levels.
Monetary policy and the money market
Following the ECB‟s rate cut in November and our lowered projections for the ECB policy rates, we have also lowered our NOK policy rate forecasts – postponing the first expected 25bp hike until October 2012 followed by further tightening in 2013. Although there is a possibility that Norges Bank will cut rates in December 2011 or March 2012, our assessment is that rates will probably be maintained at current levels in the next few months. Developments in Europe and ECB rate setting going forward will be key. If we are correct, the key policy rate will be 2.50% in 12 months. The risk is tilted downwards. Current market pricing indicates almost three rate cuts (each 25bp) by next summer. The next Norges Bank rate decision is due on 14 December and the next Monetary Policy Report is due on 14 March.
Yield curve
We expect the 2-10 curve to remain broadly unchanged in the short term. Furthermore, asset swap spreads are likely to remain high and volatile amid high and shifting risk appetite – but further ahead (six months) we expect swap spreads to normalise at lower levels amid less financial turbulence. Moreover, the spread between NOK and EUR rates is expected to increase somewhat when market participants realise that Norges Bank – in contrast to the ECB – will probably keep rates on hold in the next few months. However, uncertainty remains very high.