Investment Research
25 August 2016
Reading the Markets
Sweden

Is the Riksbank making a mistake about what a specific policy decision means in terms
of monetary conditions?

Our case is that the government bond purchase program is extended by another half
year in October and by SEK30bn (SEK20bn in nominal bonds and SEK10bn in ILbonds).

We expect the Debt Office to lower gross borrowing in nominal bonds from SEK77bn
to SEK60bn to be announced 26 October.

Turnaround in curvature along the yield curve is likely.

We expect this to be driven by flatter 5s10s curve
Trades
New, Pay 5Y SEK swap against 2Y/10Y swap 3M forward @ -28bp. P/L:-15bp/-38bp.
New, Flatten the 5Y/10Y swap box in SEK vs EUR@ 30bp. P/L: 18bp/38bp.
Profit taken, Flatten the 5Y/10Y swap box in SEK vs EUR. Profit 12bp.
Danske Bank Markets’ market view in a nutshell
Danske Markets market view in a nutshell
Grade* Last update
Relative value
Delta
Small longs further out on the yield curve.
2
26/05-2016
Curve view
Pay 5y vs 2y/10y in swaps.
3
25/08-2016
Flatten 5s10s SEK vs. EUR. Receive SEK 2y1y vs 1y and do
Cross country sprds opposite in USD
3
25/08-2016
Short-end (<2Y)
Green FRAs trade too high relative to other markets.
2
25/08-2016
Index-linked bonds
Swedish real rates trade dear relative to german index-linked
bonds.
1
30/06-2016
Covered bonds
Buy covered bonds vs matching SGBs.
3
18/08-2016
Swap Spreads
Neutral.
1
04/08-2016
Repo rate
3m
6m
12m
-0.50%
-0.50%
-0.50%
* Grade of conviction 1-3. 3 = strongest.
* Grade of conviction 1-3, where 3 = strongest
Source: Danske Bank Markets
Chief Analyst
Michael Boström
+46 8 568 805 87
[email protected]
FI strategy
Carl Milton
+46856880598
[email protected]
FI strategy
Marcus Söderberg
+46856880564
[email protected]
Important disclosures and certifications are contained from page 11 of this report.
www.danskeresearch.com
Reading the Markets Sweden
Mixed signals
In the international central bank arena there is a lot of discussion going on about declining neutral
real rates creating new challenges for policy making. We recognise that this will be an important
theme at the upcoming Jackson Hole conference. The Riksbank (RB) however – with the
possible exception of Deputy Governor Skingsley – has been rather quiet about this particular
issue.
Another matter that we think deserves attention is how the Riksbank board members regard
decisions of policy change (or no policy change) in terms of the monetary stance, or to put it
differently if a particular policy decision actually results in the policy effect intended.
Take Cecilia Skingsley for example. In an interview of 7 April 2016, Skingsley underlined that
circumstances had changed. Resource utilization was close to normal and inflation was steadily
trending upwards towards the target. Therefore she argued, it is reasonable not to make monetary
policy even more stimulatory. We – and several others – thought that this view was probably
broadly shared among board members about why an extension of asset purchases beyond H1
2016 seemed unlikely. Swedish (10y) yield moved up by some 20bp shortly thereafter and the
SEK strengthened.
Later this conclusion turned out to be wrong. On 21 April, the RB announced an extension of
government bond purchases by SEK30bn in nominals and SEK15bn in linker running until the
end of this year.
Our point here is that Skingley’s argument implies that an extension of QE would equal
additional monetary stimulus. If so, ending QE would be a maintenance of the current monetary
stance. Another board member (Flodén) discusses monetary policy in an interview on 24 August
24. All doors were kept open:

The RB doesn’t necessarily have to do the same thing as the ECB

The current QE program ends by year end (obviously true)

We are approaching the limit for how much government bond we can purchase

We could probably buy some more government bonds after the year end if necessary

Mortgage bonds are on the list of assets that the RB potentially could purchase
Again, Flodén expressed the view that extended QE=additional monetary stimulus – is that
necessarily true?
Let’s start looking at households and primarily mortgage borrowing. Since early 2015, the repo
rate has been lowered by 50bp and the RB started to buy bonds in February. In the meantime,
3-month Stibor - the basis for mortgage loans with rates re-set every third month (such “variable
rate loans” account for 75% of new borrowing) – has declined from 0.27bp to -0.55bp. However,
3-month mortgage lending rates have been stuck at the same level as at the beginning of 2015.
5-year (generic) mortgage bond rates have, in this period gone down by some 100bp. 5-year
fixed rates on (new) mortgage loans are flat to slightly higher than in the beginning of 2015.
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Chart 1. No effect of flexible rate loans
Chart 2. or on fixed rate loans
Source: Danske Bank Markets, Macrobond Financial
Source: Danske Bank Markets, Macrobond Financial
So, it is hard to say that a sustained high rate of mortgage lending growth (8.2% in July) is the
result of added monetary stimulus: it is probably instead the result of housing shortages
combined with cheap credit in general terms.
Looking at the corporate sector instead. Bank credit to non-financial corporations is growing
more moderately (around 5%) and hasn’t accelerated at all in the last couple of years despite
lower policy rate and QE. In fact, the RB’s own business surveys clearly say that the repo rate
has little or no impact on businesses capital expenditure decisions and hence the need for new
credit. Apart from banks, the capital market is an important source of credit for businesses.
In this case, Investment Grade corporates activity in the primary SEK market has been relatively
low this year while more “average” for High Yield.
Chart 3. Low SEK primary market activity for IG
Chart 4. More "average" activity for HY
Source: Danske Bank Markets, Macrobond Financial
Source: Danske Bank Markets, Macrobond Financial
There might, of course, have been opportunities for the IG-segment to raise money in the EUR
market, but we see these trends as a sign that corporates are well funded and investment plans
are modest with no particular correlation to monetary policy as such.
Does this mean that RB policy decisions have been pointless? We don’t think so. We are quite
convinced that policy has had an impact on the krona, in effect preventing the krona from
appreciating, something that would have pushed down inflation.
Eventually the RB must make up its mind what to do when the current asset purchase program
expires. If it stops, rates would move higher and the SEK appreciate. That would equal tighter
monetary conditions. If board members agree that tighter monetary conditions are warranted
from an analytical point of view, ending QE would be logical. But if the board believes that
current monetary conditions need to be maintained to ensure that inflation gets back to 2% - and
stays there – ending QE abruptly could be a policy mistake. Our view is that the RB takes the
middle-road: extending asset purchases while scaling down volumes again.
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Reading the Markets Sweden
The timing of such an announcement of course partially depends on the ECB. Danske Bank’s
EUR analysts until just recently saw the September meeting as the likely timing of an
announcement of QE extension from them, but they have become more uncertain. They tend to
think that October or December is more probable but in any case before year-end. Both ECB
policy meetings are just before the RB board meetings. The RB December meeting is late (the
20 December) just about when the current purchase program expires. So far at least, the RB has
chosen to announce extensions well in advance so we go for October as our primary case.
Adding to this, our view on further asset purchases also reflects our inflation projection. As we
see it, CPIF inflation has probably peaked. The gap between our forecasts for the latest numbers
available at the October and December meetings, and the RB’s (current) forecast is -0.3- and
-0.5 percentage points (i.e we are lower).
Our case is that the government bond purchase program is extended by another half year
in October and by SEK30bn (SEK20bn in nominal bonds and SEK10bn in IL-bonds)
There is another player that has a role here however – the Debt Office. The current Debt Office
state budget forecast differs significantly from others for next year. The Debt Office projects a
SEK42bn deficit (from a SEK41bn surplus this year). That compares with the latest NIER
forecast of a SEK1.5bn 2017 surplus and the current ESV forecast of a SEK3bn deficit (ESV is
the Swedish budget agency – Swedish Financial Management Authority). Yesterday the
government released a new forecast showing a surplus of about SEK8bn. Among other things,
migration costs for coming year(s) have been revised down significantly. We think that there is
a strong case for the Debt Office lowering borrowing projections for 2017.
We expect the Debt Office to lower gross borrowing in nominal bonds from SEK77bn to
SEK60bn to be announced on 26 October.
In fact, this is a relatively cautious estimate, Should the Debt Office fully align with other
forecasts mentioned above it could have to scale down supply further. That in turn could
potentially make it difficult for the RB to continue buying government bonds after year end, in
which event there is a case that the RB turns to mortgage bonds as an alternative. Such a
combination would no doubt open up for outperformance of covered bonds versus govvies.
Yield curve convexity likely to bottom out – pay SEK 5Y vs
2Y/10Y (spot or 3M forward)
As rates have moved steadily lower, unsurprisingly, yield curve convexity has steadily decreased
as the 5Y point on the swap curve has outperformed the 2Y/10Y wings. But we argue that this
outperformance is nearing an end, independent of the direction of interest rates. Indeed, we see
clear signs that the yield curve dynamics in the 5Y point are about to change. We think that
regardless of whether rates move lower or higher from here, yield curve convexity (5y vs 2y/10y)
is likely to increase.
Indeed, looking at butterflies further in on the yield curve, we note that convexity has increased
significantly despite rates moving lower. Looking at the 4Y vs 2Y/8Y butterfly for instance,
convexity has moved up by 15 bps. The correlation with the rate direction seems to have shifted
signs around March this year: see chart below.
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Reading the Markets Sweden
Barbells further in on the yield curve have changed direction
<< 2*SWAP 5Y-SWAP 2Y-SWAP 10Y
<< 2*SWAP 4Y-SWAP 2Y-SWAP 8Y
SWAP 10Y>>
0.00%
1.90%
1.70%
-0.10%
1.50%
-0.20%
1.30%
-0.30%
1.10%
-0.40%
0.90%
-0.50%
0.70%
-0.60%
06-apr-15
15-jul-15
0.50%
23-okt-15 31-jan-16 10-maj-16 18-aug-16 26-nov-16
Source: Danske Bank Markets
We think that the 5Y segment ought to be next. The 5Y vs 2Y/10Y is still trading very close to
lows, but there are signs that the 5Y point is running out of steam compared to longer maturities.
The beta coefficient (see chart below) between the 5Y SEK swap and 10Y SGBs has recently
dropped markedly, while it remains high in 10Y swaps. Also, plotting the butterfly (scatter chart
below) against the yield level in the 10Y SGB, the regression line seems to have shifted over the
summer.
20d rolling beta against 10Y govvies has fallen drastically in the 5Y swap
2.50
SWAP 3M 10Y SEK3M
SWAP 3M 5Y SEK3M
SWAP 3M 2Y SEK3M
10Y Gov Yld (RHS)
2.00
2.50%
2.00%
1.50
1.50%
1.00
1.00%
0.50
0.50%
0.00
-0.50
Sep-14
Dec-14
Apr-15
Jul-15
Oct-15
Jan-16
May-16
Aug-16
0.00%
Nov-16
Source: Danske Bank Markets
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Relationship between 10Y SGBs and the 5y vs 2y/10y barbell: the regression line
has shifted over summer
2*SWAP 5Y - SWAP 2Y - SWAP10Y
Since July 2016
Latest
0.0%
-0.1%
-0.2%
-0.2%
-0.3%
Level in butterfly
-0.1%
-0.3%
-0.4%
-0.25%
Level 10Y govt
0.75%
1.25%
0.25%
1.75%
2.25%
Source: Danske Bank Markets
As this probably sounds too good to be true, we should highlight some risks. First, if rate cuts
were to come back on the agenda, it could spark renewed performance in the mid-segment of
the curve. However, we see the likelihood of another rate cut as quite small as the pass through
to the real economy should be very limited and would likely to increase financial distortions
further. Other measures (primarily extended/increased QE) seem much more likely, at least in
the near term. Also, we could see FRA-OIS spreads widen, which should impact short-dated
swaps the most. However, given the extent of the SEK excess liquidity we think that the market
movement should be limited.
A payer position in 5Y vs 2Y/10Y 3M forward currently yields a roll around 0. Overall, we do
find risk/reward very attractive. We set the P/L levels to -15 bps/-38 bps (current level -29
bps).
Take profit in the 2s5s swap box – go further out on the curve
We have seen a nice performance in Swedish rates over the summer relative to European peers.
The 2y2y spread has tightened by almost 50bp in the year, which is close to lowest since 2011.
In fact, the curvature in the Swedish yield curve has declined markedly and is now trading very
close to the EUR curvature. Hence, the 5y segment along the Swedish curve has outperformed.
The 2Y2Y spread has tightened to 14bp from 60bp at the very start of the year
1.2
1
0.8
0.6
0.4
0.2
0
-0.2
-0.4
Aug-11
SWAP 2Y 2Y SEK3M-(SWAP 2Y 2Y EUR6M)
May-12
Feb-13
Nov-13
Aug-14
May-15
Feb-16
Source: Danske Bank Markets
In the section above we showed that the movement in the 5y segment has slowed amid low
volatility in general but also given the low level of yield (5y bonds -0.40% and 5y swap rate
close to 0%). The beta to the 10y government bond yield has plummeted recently as the 5y swap
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25 August 2016
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Reading the Markets Sweden
rate hit negative territory. The rate could of course continue its course downwards but we sense
that movements have a harder time feeding into the 5y segment. Moreover, as the mid segment
offers less and less yield compared to a 50/50 weighted barbell (the wings) investors start to
shift away from the mid segment. In the bond curve the curvature is -15bp, i.e. doing an equally
weighted barbell in 2y and 10y bonds will offer a 15bp yield pick-up. Interestingly, the German
bond curve has also had difficulties in trading with a negative curvature significantly below 15bp, over a protracted period of time. At the end of last year it dropped to -24bp at one occasion
but quickly moved back again. Currently the German bond curve trades with a 2s5s10s curvature
of -16bp (zero coupon rates). Another pattern in the German curve is that the 5s10s curve started
to flatten at the same time as the curvature hit its trough (and the Swedish curve relative
steepened significantly).
The curvature in SEK swap curve trading close to the EUR curve
0
-0.05
-0.1
-0.15
-0.2
-0.25
-0.3
-0.35
-0.4
-0.45
Oct-14
SEK 2s5s10s fly
Jan-15
Apr-15
EUR 2s5s10s fly
Jul-15
Oct-15
Jan-16
Apr-16
Jul-16
Source: Danske Bank Markets
The 5s10s curve on the other hand is still trading relatively steeply compared to the EUR swap
curve. In bonds the Swedish curve has relatively flattened a lot over the summer. The next stage,
in our view, would be the swap curve to follow suit. We expect curvature to increase if rates
move lower, on the back of a flatter 5s10s yield curve (flattening more than the 2s5s curve).
Hefty relative flattening in 5s10s vs. Germany in bonds – we expect swaps to follow
0.4
Box 5s10s SWE/GER
5s10s box EUR/SEK swaps
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
Aug-15
Nov-15
Feb-16
May-16
Aug-16
Source: Danske Bank Markets
In line with this development we take profit (we collect a 12bp profit) in the 2s5s swap box even
though the box has not moved as has the 2y2y spread (we took profit in 2y1y and the 5y bond
spread over the summer). We see more potential in the 5s10s box SEK/EUR and probably also
more protection should Swedish data surprisingly improve again. The biggest risk in such a trade
is probably the market starting to price in additional rate cuts from the Riksbank, which would
result in a steeper curve and more potential for the 5y swap rate to drop further.
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Reading the Markets Sweden
Receive 10Y, pay 5y in SEK and do the opposite in EUR swaps @ 30bp. P/L: 18bp/38bp. We
prefer doing the 5s10s box to the 5y5y spread trade, which however might be an option, as the
box has barely moved lower whereas the 5y5y forward spread has dropped by 35bp from 2016
peaks.
The 5s10s box look attractive (relative the 5y5y spread) as the box has barely
moved lower whereas the 5y5y forward spread has dropped by 35bp
0.4
Box: 5s10s SEK/EUR
Spread 5Y5Y SEK/EUR
0.35
1.1
1
0.3
0.9
0.25
0.8
0.2
0.7
0.15
0.6
0.1
0.5
0.05
Oct-14
0.4
Apr-15
Oct-15
Apr-16
Source: Danske Bank Markets
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Reading the Markets Sweden
Open strategies
Source: Danske Bank Markets
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25 August 2016
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Reading the Markets Sweden
Data calendar
Monday, 29 August, 2016
09:30
SWE Trade Balance
09:30
SWE Retail Sales
14:30
USA Personal income/spending
14:30
USA PCE deflator
14:30
USA Core PCE deflator
16:30
USA Dallas Fed
Tuesday, 30 August, 2016
GER German Länder Inflation
11:00
EZ
Consumer Confidence
14:00
GER CPI, prel
14:00
GER HICP, prel
16:00
USA Consumer Confidence
Wednesday, 31 August, 2016
08:45
FRA CPI
08:45
FRA HICP
09:15
SWE NIER publishes new forecast
09:55
GER Unemployment change
09:55
GER Unemployment Rate
11:00
EZ
CPI estimate
11:00
EZ
Core CPI estimate
14:15
USA ADP employment
16:00
USA Chicago PMI
Thursday, 1 September, 2016
08:30
SWE PMI Manufacturing
09:50
FRA Manufacturing PMI
09:55
GER Manufacturing PMI
10:00
EZ
Manufacturing PMI
10:30
UK
Manufacturing PMI
14:30
USA ULC
15:45
USA Markit PMI Manufacturing
16:00
USA ISM Manufacturing
Friday, 2 September, 2016
14:30
USA Trade balance
14:30
USA Non-farm Payrolls
14:30
USA Unemployment rate
14:30
USA Average hourly earnings
14:30
USA Weekly Hours
15:45
USA ISM NY
14:30
USA Factory orders|ex. transportation
Period
Jul
Jul
Jul
Jul
Juk
Aug
Danske Bank
Period
Aug
Aug
Aug
Aug
Aug
Danske Bank
Period
Aug
Aug
Danske Bank
m/m|y/y
m/m|y/y
000's
%
yoy
yoy
000's
Index
Aug
Aug
Aug
Aug
Aug
Aug
Period
Aug
Aug
Aug
Aug
Aug
Q2
Aug
Aug
Danske Bank
Index
Index
Index
Index
Index
saar%
Index
Index
Period
Jul
Aug
Aug
Aug
Aug
Aug
Jul
Danske Bank
SEK bn
mom|yoy
mom
mom|yoy
mom|yoy
mom|yoy
USD bn
000's
%
mom|yoy
Index
mom|mom
0.4%|0.3%
0.0%|0.8%
0.1%|1.5%
-3.0
Previous
1.8
-0.6%|3.2%
0.2%|0.4%
0.1%|0.9%
0.1%|1.6%
-1.3
Konsensus
Previous
96.6
-8.5
0.3%|0.4%
0.4%|0.4%
97.3
Konsensus
Konsensus
Previous
-0.4%|0.2%
-0.4%|0.4%
170
54
-7
6.1
0.2%
0.9%
179
55.8
Konsensus
Previous
55.4
48.5
53.6
51.8
48.2
2
52.1
52.6
2.1
52.0
Konsensus
-43.0
170
4.8
0.2|2.5
34.5
1.6%|n.a.
Previous
-44.5
255
4.9
0.3|2.6
34.5
60.7
-1.5%|0.4%
Source: Various sources, Danske Bank Markets
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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
authors of the research report are Michael Grahn, Senior Analyst and Carl Milton, Analyst.
Analyst certification
Each research analyst responsible for the content of this research report certifies that the views expressed in the research
report accurately reflect the research analyst’s personal view about the financial instruments and issuers covered by the
research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst
was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report.
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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 Regulation Authority are available from
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The research reports of Danske Bank are prepared in accordance with the Danish Finance Society’s rules
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based on research objectivity and independence. These procedures are documented in Danske Bank’s research policies.
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Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment
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Financial models and/or methodology used in this research report
Calculations and presentations in this research report are based on standard econometric tools and methodology as well as
publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the
authors on request.
Risk warning
Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant
assumptions, are stated throughout the text.
Expected updates
None.
Date of first publication
See the front page of this research report for the date of first publication.
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This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational
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a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein
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