Reading the Markets Sweden - Danske Analyse - Danske Bank

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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
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