Reading the Markets Sweden - Danske Analyse - Danske Bank

Reading the Markets SwedenIncreasing pressure for Riksbank rate cutThe Riksbank’s monetary minutes contained no real news but it still feels as though theprospects of the Riksbank being able to effect its repo rate forecast is worsening. First,two members of the Executive Board (Per Jansson and Cecilia Skingsley) have suggestedthat stronger data may not automatically imply an upward adjustment of the repo rateforecast. Jansson conditions his view on the assumption that the household debt ratio doesnot deteriorate, while Skingsley argues that the precision of the macro forecast is not suchthat the relationship to the repo rate path is 1:1. Both have therefore suggested that thereis a ‘cap’ for the repo rate.Second, Governor Stefan Ingves said: ‘Estimates of the impact of macro-prudentialsupervision on inflation and resource utilisation will always be truly difficult. Even afterthe introduction of macro-prudential instruments, trade-offs for monetary policy willremain. Ingves therefore concluded that until measures are in place and are expected tohave [an] impact the repo rate will need to be higher than otherwise.’ This sounds pretty‘hawkish’ but, by extension, this means that as the FSA starts to introduce variousmeasures aimed at combating a further increase in household debt, the degree of freedomfor the Riksbank to lower the repo rate will increase. This said, the latest figures from theSKOP (October/November) suggest households have record-high expectations of houseprices, with 59% believing in rising condo prices and 51% believing in higher houseprices (which is synonymous with accelerating credit growth and rising household debt).Hence, short term, the board majority is likely to continue to worry. Despite this, it isdifficult to escape the impression that there is a lot suggesting the Riksbank will again beforced to push out the repo rate path, or pull it down a notch, i.e. risk/reward suggests thatthere is considerable downside risk to macroeconomic forecasts.In particular, this applies to the inflation outlook, which we dug into in Reading theMarkets Sweden, 31 October, where we argued that the Riksbank is overestimatinginflationary pressures in coming years . Here we concentrate on October inflation but infuture we intend to look further at the tricky (if not impossible) task of pushing upinflation to the target over coming years.The chart below shows that Macrobond expects electricity and gasoline prices to pulldown the monthly inflation rate by a total of 0.15 percentage points. This is a quite safeassessment. The uncertainty lies mainly in the ‘transportation services’ component, whichhas shown considerable volatility due to price movements in airline tickets. Theuncertainty is especially high this time, as prices have fallen sharply two months in a row,with the latter month being ‘seasonally non-normal’. Thus, we expect a rebound to addabout 0.1 percentage points this month. It may be more than this. However, there is also arisk that the price declines of recent months reflect increased competition and hence pricepressure in the airline industry. Hence, one cannot exclude the possibility that pricescould be cut again in October. Our CPI (0.14% y/y ) and CPIF (0.81% y/y ) forecasts bothend 0.2 percentage points below the Riksbank’s forecasts. Our assessment is, therefore,that the inflation outcome too will put additional pressure on the board majority’s stanceon the policy rate.2 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenContribution to October inflation (% m/m)0.100.080.060.040.020.00-0.02-0.04-0.06-0.08-0.10-0.12CPIFCPIMiscellaneousRestaurantsRecreationCommunicationTransportationCarsFuelHealthFurnitureElectricityCapital stockRatesMortgage costRentClothingAlcoholFoodCPIF-forecasts: Danske Bank vs RiksbankSource: MacrobondSource Macrobond, Danske BankFinally, the ECB’s decision to cut its key interest rate to 0.5%, with the potential foranother shot, is very likely to increase the doubt among the Riksbank’s Executive Boardmajority about how to act going forward. It is clear to us that the ECB’s Executive Boardhas concluded that economic development was considerably weaker than expected andthat deflationary pressure is growing; it will be difficult for the Riksbank to take adifferent approach.In the Monetary Policy Report in October, the Riksbank revised down its assessment ofglobal growth for this year and the years to come. However, the assessment of euro areagrowth remained unchanged. There is a risk that it will have to adjust the forecast as well asthe assessment of imported inflation. It can hardly have escaped anyone’s notice that euroarea core inflation is at a record low and that deflationary risks again loom large. At the pressconference, ECB president Mario Draghi said that although he does not expect deflation inthe proper sense, the euro economy could face ‘a prolonged period of low inflation’.Reasonably, this assessment should have a bearing on the Riksbank’s view on import pricesand hence on Swedish inflation. Therefore, there is a parallel risk for Swedish inflation. TheRiksbank and, in particular, the Executive Board majority has received criticism regardingmissing the target and instead focusing on household debt and this criticism is not likely to bealleviated by the ECB recognising that the eurozone also has such a problem.Falling euro inflation puts pressure on SwedenSource: Macrobond3 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenRisk of steeper curvesDespite the uncertainty regarding the debt ceiling and the still ongoing political trenchwarfare, the US economy seems to have weathered the past few months relatively well.We have not yet received all data for this period but so far macroeconomic data has beendecent and surveys point towards continued expansion. Thus, we find it more likely thattapering could re-emerge as a market theme.While Fed’s next step may very well be a less expansive monetary policy in the shape ofsmaller bond purchases, in the eurozone the need for further stimulus is becomingincreasingly clear. The October inflation figure (+0.7% y/y) was a shock to the marketand it partly reflects the effect of the very high unemployment rate in southern Europe.Low wage pressure translates into low consumer price increases in non-core countries andinflation is generally hovering around 0%. Even in core countries, the inflation rate hasbeen below 2%. Given the significant output gap, this situation is unlikely to changeanytime soon, especially as the commodity super cycle may be over. Even though thereare few options at the ECB’s disposal, we expect some kind of response. Worth noting inthis context is that EURUSD remains at high levels despite the recent fall and couldhamper export growth. Thus, even though our base case was a December cut, today’s ratecut did not surprised us.What effect will the situation in Europe have on the Riksbank? To some extent, we mayimport the low price pressure. Also, looser monetary policy from the ECB wouldprobably set the bar lower for the Riksbank through the currency channel. Everything elsebeing equal, it should translate into more supportive monetary policy. Overall, the neteffect of a potentially softer ECB should be largest at the short end of the Swedish yieldcurve.Further out on the Swedish yield curve fears about bond tapering might get the upperhand. We have previously shown that the cross-country spread between Sweden andGermany has been highly directional (see chart below). Higher rates have meant thatSwedish rates have underperformed on a relative basis. From a macroeconomicperspective, it would make sense that Sweden is better able to capitalise on a continuedglobal recovery.Sweden vs Germany spread highly directional2.42.221.81.61.41.2>110dec-12 jan-13 mar-13 maj-13 jun-13 aug-13 okt-13 nov-13 jan-14706050403020Source: Danske Bank MarketsOverall, we therefore see a risk of a worse environment for long-dated bonds on the backof still-steady growth in the US. At the same time, a softer ECB could put further pressureon the Riksbank to keep rates low for a significant period. The net effect on the Swedishcurve could be further steepening pressure. However, the timing may be difficult asmarket movements may be volatile.4 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenIn any case, we see this as a strong reason to alter our recommendations. We havepreviously recommended receiving SEK 5Y5Y versus 1Y1Y. As the environment nowappears less supportive of longer bonds, we close this position with a minimal profit of2bp. Instead, we look for opportunities to take position for steeper curves.From floating to fixed – removing the refinancing risk in theDanish mortgage systemThe Danish Government yesterday introduced a new proposal for removing therefinancing risk in the Danish mortgage market. In our view, this is a major game changerin the Danish mortgage market, as the refinancing risk is basically moved from theborrower/mortgage bank/bank to the investor. The new proposal will be implemented by1 January 2014 if the government has a majority in the parliament. We expect theproposal to be implemented. We have not seen such a move by either regulators orlawmakers in other European covered bond markets where the refinancing risk is movedaway from the borrower/mortgage bank and to the investor. The main points in the newproposal are as follows.Danish covered bonds with a maturity shorter than the maturity on the loan can have amaturity extension corresponding to the underlying loan behind the non-callablebond. The proposal covers non-callables, short- and medium-term capped floaters,Cibor floaters and the new CITA floaters.The extension happens if an auction of non-callables fails or if the rate at therefinancing auction is higher than 5pp + the coupon on the bond that matures. Hence,the non-callable bond will be ‘knocked-in’ to a fixed rate callable bond if the yield atthe refinancing auction is greater than 5% +coupon of the underlying bond.Hence, investors will receive a new fixed rate callable bond with a high coupon ratherthan the principal on the non-callable bond. The cash flow on the new fixed ratecallable bond will match the cash flow on the loans that are backing the non-callablebond. Hence, the investor can possibly receive a fixed-rate callable bond with amaturity up to 30 years.Comments so far from the Ministry and mortgage banks indicate that the existing noncallablebonds will be grandfathered. Hence, the existing non-callable covered bonds willbenefit from the change in the law and we expect the upcoming refinancing auction to bevery well received by investors.The exact mechanics of the switch into a fixed-rate callable bond is uncertain: will theswitch happen if the rate is higher before, during or after the auction? The knock-inoption is attached to the existing coupon, so the investor with a 5Y bond has a risk if ratesrise by more than 5% during the 5Y period. Furthermore, rising rates over a longer periodwill affect the pricing of the knock-in option. The price of the option will increase andhence the ASW-spread of the new non-callables would rise.Assuming that the existing bonds will be grandfathered, we list some of the positivefactors regarding the new proposal.It is very supportive of the mortgage banks, as it removes the refinancing risk fromthe banks.It is positive for borrowers if rates rise dramatically, as they have a cap on theirmortgage rate going forward.There should be a positive effect on the rating and OC requirements going forward.We expect a positive statement from the rating agencies as they asked for a solutionlike the new proposal.5 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenIt could also have a positive effect on the net stable funding ratio (NSFR) if the 1Ybond with extension can be included in the NSFR. We would not expect that a 1Ybond could be included but we do not know this. This is probably up to the regulators.However, there are also a number of possible negatives.There will be more ISIN codes, as mortgage banks will open new bonds – henceliquidity will be ‘diluted’.The knock-in option has a cost for the borrower. Some market participants estimate acost of 5bp but the premium is highly uncertain, as it is dependent on the shape of theyield curve, the volatility, the credit spread/risk, and the risk of going from a 1Y bondto a 30Y.There could be a possible negative effect on the existing 30Y callables. There is anincreased risk premium given the risk of a sudden increase in the supply of 30Y fixedratecallable bonds. The effect is difficult to price given the very low risk of a rise inrates of more than 5%.Finally, who will buy the new bonds? This is a major issue, as there are a number offoreign investors in the existing 1Y bonds. It is uncertain whether they can and/or willbuy the new bonds. Similarly for funded investors, will they buy the bonds given theextension risk. It is also uncertain whether mutual funds with a maturity target around1Y will be allowed to buy the bonds.So, could this have repercussions for the Swedish covered bond market? Theuncertainties surrounding the new setup in Denmark might dent demand for flex bonds, assome investors might be less keen on having such uncertainty in their portfolios. Willthey buy a short-term bond that could possibly be extended into a 30Y fixed-rate callablebond? Hence, Swedish covered bonds might stand out as more attractive on a relativebasis, at least until the dust has settled in Denmark.In addition, with a more fragmented Danish mortgage bond market, the Swedish market,which relies on a few benchmark bonds with bigger volumes, might be easier for someinvestors to grasp. Hence, as existing Danish flex bonds mature, a few investors mightgradually move into Swedish peers instead. Thus, long term, this might be supportive ofthe Swedish covered bond market. The step taken in Denmark is probably positive but, inour view, it is likely to give rise to some uncertainty for investors.6 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenOpen strategiesType Trade Idea Target & P/L StatusCovered/BEIBuy SGBi3107 vs. SGB1051, After the recent flattening of the mm curve Opened 24 okt 2013 Holdand sell SHYP1576 buythe long end trades too steep and too high Start 15900.00SHYP1580Target/Stop 13500/17500Now 15800.66P/L 1.0Money market Recieve FRAJUN14Low for longer, low voaltility, risk tilted for Opened 22 okt 2013 Profitlower rates tell us to buy covered bonds Start 1.31 takenTarget/Stop 1.2/1.38Now 1.2P/L 12.0Fwd spread Rec. 5y5y and Pay 1y1y RB on hold for longer and more bond friendly Opened 21 okt 2013 Holdglobal environment.Start 176Target/Stop 155/190Now 173.5P/L 2.5Fwd ASWBuy NDH5529 vs. NDH5527 vs Short end BEIs trade cheap - hedge by rec. 4y Opened 17 okt 2013 Holdfwd swapEUR swapStart 73.5Target/Stop 55/88.5Now 64.2P/L 9.3ASW spread Buy 2DEC13 vs. matching swap We see signs of lack of short-end supply. This Opened 04 sep 2013 Holdmight mount as SEK 40bn of T-bills mature Start -39.5in mid September.Target/Stop -50/-32Now -38.3P/L -1.2Money market Sell RibaDec13 As a cheap hedge we like selling RibaDec13. Opened 02 aug 2013 HoldStart 0.97Target/Stop 0.9/1.05Now 1P/L -3.0Source: Danske Bank Markets7 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenCalendar week beginning 11 November 2013Monday, 11 November, 2013Period Danske Bank Konsensus Previous00:00 JAP Eco Watchers Survey Outlook (Current) Index Oct 54.2(52.8)00:50 JAP Bank lending y/y Oct 2.0%09:00 DEN CPI m/m|y/y Oct 0.0%|0.6% 0.3%|0.5%10:00 weco3 Industrial production m/m|y/y Sep -0.3%|-4.6%10:00 NOR Consumer prices m/m|y/y Oct 0.5%|2.8%10:00 NOR Core inflation (CPI-ATE) m/m|y/y Oct 0.4%|1.7%Tuesday, 12 November, 2013 Period Danske Bank Konsensus Previous00:50 JAP Tertiary industry index m/m Sep 0.2% 0.7%06:00 JAP Consumer confidence Oct 45.408:00 GER HICP, final m/m|y/y Oct -0.2%|1.3%09:30 SWE CPI m/m|y/y Oct 0.0%|0.1% 0.4%|0.1%09:30 SWE Underlying inflation CPIF m/m|y/y Oct 0.0%|0.8% 0.4%|0.9%10:00 ITA HICP, final y/y Oct 0.7%10:30 UK PPI - Output m/m|y/y Oct -0.1%|1.2%10:30 UK CPI/HICP Inflation m/m|y/y Oct 0.4%|2.7%13:30 US NFIB small business optimism Index Oct 93.9Wednesday, 13 November, 2013Period Danske Bank Konsensus Previous00:50 JAP Machine orders m/m|y/y Sep -2.3%|14.2% 5.4%|10.3%00:50 JAP Domestic CGPI m/m|y/y Oct -0.2%|2.6% 0.3%|2.3%10:30 UK Average Earnings 3Ms/YoY Sep 0.7%10:30 UK ILO Unemployment rate % Sep 7.711:00 EMU Industrial production m/m|y/y Sep 0.0%|0.4% 1.0%|-2.1%11:30 UK BoE Inflation report20:00 US Budget statement USD bn Oct22:45 NZ Retail sales q/q Q3 1.7%Thursday, 14 November, 2013Period Danske Bank Konsensus Previous00:50 JAP GDP, preliminary q/q|ann. Q3 0.4%|1.6% 0.9%|3.8%05:30 JAP Industrial production, final m/m|y/y Sep 1.5%|5.4%07:30 FRA GDP, preliminary q/q|y/y Q3 0.5%|0.4%08:00 GER GDP, preliminary q/q|y/y Q3 0.3%|0.6% 0.7%|0.5%08:45 FRA HICP m/m|y/y Oct -0.2%|1.0%09:30 SWE Unemployment % Oct 7.4 7.5%09:30 SWE Unemployment s.a. % Oct 8 8.0%10:00 EMU ECB monthly report Nov10:00 ITA GDP, preliminary q/q|y/y Q3 -0.3%|-2.1%10:30 UK Retail Sales m/m|y/y Oct 0.6%|2.2%11:00 EMU GDP, preliminary q/q|y/y Q3 0.1%|-0.3% 0.3%|-0.5%14:30 US Unit labour cost, preliminary q/q Q3 1.5% 0.0%14:30 US Trade balance USD bn Sep -39.0 -38.815:00 EMU Eurogroup meetingFriday, 15 November, 2013Period Danske Bank Konsensus Previous09:00 EMU ECOFIN meeting09:30 SWE Capacity utilization, industry % Q3 86.2%10:00 NOR Trade balance NOK bn Oct -21.711:00 EMU HICP m/m|y/y Oct -0.1%|0.7% 0.5%|1.1%11:00 EMU HICP core, final y/y Oct 0.8%14:30 US Import prices m/m|y/y Oct -0.6%| 0.2%|-1.0%14:30 US Empire manufacturing PMI m/m Nov 4.00 1.5215:15 US Industrial production m/m Oct 0.2% 0.6%15:15 US Capacity utilization % Oct 78.3% 78.3%15:30 EMU EU-US brief press on trade talksSource: Compiled from various sources by Danske Bank Markets8 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenDisclosuresThis research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘DanskeBank’). The authors of this research report are Michael Grahn, Macro/Strategy Analyst, and Marcus Söderberg,Quant/Strategy Analyst.Analyst certificationEach research analyst responsible for the content of this research report certifies that the views expressed in theresearch report accurately reflect the research analyst’s personal view about the financial instruments and issuerscovered by the research report. Each responsible research analyst further certifies that no part of the compensationof the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressedin the research report.RegulationDanske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subjectto the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. DanskeBank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority(UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential RegulationAuthority are available from Danske Bank on request.The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts’rules of ethics and the recommendations of the Danish Securities Dealers Association.Conflicts of interestDanske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highqualityresearch based on research objectivity and independence. These procedures are documented in DanskeBank’s research policies. Employees within Danske Bank’s Research Departments have been instructed that anyrequest that might impair the objectivity and independence of research shall be referred to Research Managementand the Compliance Department. Danske Bank’s Research Departments are organised independently from and donot report to other business areas within Danske Bank.Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includesinvestment banking revenues, but do not receive bonuses or other remuneration linked to specific corporatefinance or debt capital transactions.Financial models and/or methodology used in this research reportCalculations and presentations in this research report are based on standard econometric tools and methodologyas well as publicly available statistics for each individual security, issuer and/or country. Documentation can beobtained from the authors upon request.Risk warningMajor risks connected with recommendations or opinions in this research report, including a sensitivity analysisof relevant assumptions, are stated throughout the text.Date of first publicationSee the front page of this research report for the date of first publication.General disclaimerThis research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided forinformational purposes only. It does not constitute or form part of, and shall under no circumstances beconsidered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments(i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/oroptions, warrants, rights or other interests with respect to any such financial instruments) (‘Relevant FinancialInstruments’).The research report has been prepared independently and solely on the basis of publicly available information thatDanske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are notuntrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliatesand subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitationany loss of profits, arising from reliance on this research report.The opinions expressed herein are the opinions of the research analysts responsible for the research report andreflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does notundertake to notify any recipient of this research report of any such change nor of any other changes related to theinformation provided in this research report.This research report is not intended for retail customers in the United Kingdom or the United States.9 | 7 November 2013www.danskeresearch.com

Reading the Markets SwedenThis research report is protected by copyright and is intended solely for the designated addressee. It may not bereproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank’s priorwritten consent.Disclaimer related to distribution in the United StatesThis research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealerand subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S.Securities and Exchange Commission. The research report is intended for distribution in the United States solelyto ‘U.S. institutional investors’ as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for thisresearch report in connection with distribution in the United States solely to ‘U.S. institutional investors’.Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independenceof research analysts. In addition, the research analysts of Danske Bank who have prepared this research report arenot registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirementsof a non-U.S. jurisdiction.Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant FinancialInstrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non-U.S. financial instruments may entail certain risks. Financial instruments of non-U.S. issuers may not beregistered with the U.S. Securities and Exchange Commission and may not be subject to the reporting andauditing standards of the U.S. Securities and Exchange Commission.10 | 7 November 2013www.danskeresearch.com