Strategy The end game

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1 Investment Research General Market Conditions 19 June 2015 Strategy The end game Crunch time in Greek crisis is getting near. An emergency euro leader summit will be held on Monday and we are reaching the end game for the crisis. Either a solution is found next week or Greece is likely to have no other option than defaulting and leaving the euro. We are still optimistic that an agreement will be reached but it s not likely to be until the last minute, see Research: Grexit what if? Summer crunch time is near but no solution this week, 17 June Too much is at stake for each side to not reach an agreement. And the gap between the two sides is not really that big even though you could easily get the opposite impression from their comments and media reports. However, too much is at stake for each side not to fight till the very end. The Greek government has made clear (unrealistic) promises ahead of the election which it has to show it s doing everything it can to fight for. Similarly, the euro leaders need to make the price of keeping Greece in the euro as small as possible. Too big concessions would set a dangerous precedent for other countries who have stuck to the austerity programmes. In this game between the euro area and Greece, each side will try to put as much pressure as possible on the other in order to try to force them to blink. This is what makes it so nerve wracking because there is the risk of an accident. Namely that no one blinks and it ends in a crash. Key points It s crunch time we still expect a deal between EU and Greece We should see a decent rally in stock markets and tighter peripheral spreads following a deal US growth is rebounding - we still look for a September hike Euro area data still mixed but exports should take over the baton from consumers soon However, on the euro side, German chancellor Angela Merkel has extensive experience with this type of game by now. It s definitely not the first time we have been biting our nails over the possibility of a failure to reach a deal. However, Merkel also needs to wait till the last minute because of the strong opposition to Greece within Germany. So why should Greece be kept in the euro area at all? The popular view is often that it s time they get kicked out. However, this involves a lot of risks both in the short term and longer term that tend to be underestimated. Markets are nervous Source: Danske Bank Chief Analyst Allan von Mehren Important disclosures and certifications are contained from page 6 of this report.

2 First, there is the risk that the short-term financial and economic impact is bigger than expected. Bond markets have become very illiquid and going into the summer market does not help on that front. Credit markets have so far not taken a big hit but if investors start to pull out just in case the selling could feed on itself. Liquidity in this market is very poor. The euro recovery could also take a hit due to heightened uncertainty. We saw last year that the Ukraine crisis made companies step hard on the brakes. This could happen again. The euro area finally has a recovery that seems to be more sustainable and a Grexit would risk derailing it at a point where the economic tools left are getting more experimental. However, even if the euro area manages in the short term there are also longer-term risks. Greece would clearly suffer a lot in the short term as Argentina did in But if it manages to recover in the following years as did Argentina from 2003 to 2007 when growth was above 8% - this could set a dangerous precedent. Next time the euro area hits recession, which will come eventually, sentiment in Portugal and Spain could turn in favour of leaving the euro. Or investors might quickly flee those countries out of fear they would leave. It would no longer be credible to say that the euro is irreversible and the whole thing could unravel. If Greece does not recover then the political situation could be very destabilising and who knows what could happen. In the face of a Grexit, Greece could also turn to Russia and China for help and they would most likely be happy to reach out to Greece. All this would be very destabilising for the EU project which is already seeing many cracks in the core. The UK is going to have a referendum on EU membership over the next one to two years and in Spain the anti-austerity party Podemos formed in 2014 currently has 20% support in opinion polls. Stocks take hit in Greece and Portugal Also contagion to bond markets US leading indicator point to strong rebound in Q2 To sum up, in our view the gap between the positions of the euro area and Greece is not big enough for a deal not to be reached given the risks for both parties. But we do expect it to be at the last minute for the reasons described above. US to bounce back strongly we still look for September hike The past week showed more evidence of a US recovery in Q2. In fact the data suggests that it could be quite a strong rebound. It is not unusual that when the pendulum swings too much in one direction it swings back fast once it moves in the other direction. The cold weather and port strikes led to a Q1 that was too weak and we could see a swing back to a Q2 and/or Q3 that are too strong. This was the pattern we saw in 2014 when very cold weather led to a big slowdown in Q1. Same picture from US jobless claims Leading indicators for June rose 0.7% m/m for the second month in a row. This is the strongest increase over two months since summer last year when growth swung back to a 4-5% pace. Our baseline projection is that the economy recovers to a 2.5-3% pace in the coming quarters but the risk seems to be increasingly on the upside. Jobless claims also continue to paint a robust picture, and also indicate a strong lift to growth in Q2. While the Fed was more cautious than we expected at the meeting this week, we continue to look for a September hike based on more positive expectations for unemployment than the Fed has (see FOMC meeting: Inner circle of FOMC tilts towards one hike this year, 18 June 2015). We also believe that the increased confidence the Fed clearly seeks before it hikes will be gained from the rebound we expect in the time up to the September meeting June

3 The somewhat softer stance from the Fed coupled with strong data was good news for the US stock market. Following the recent correction lower, we saw a robust increase towards the end of the week. We are generally moderately positive on stocks in the medium term but expect a decent relief rally on a deal between EU and Greece. German ZEW points to softness in the short term Stronger US data and a September hike from the Fed is also expected to eventually fuel renewed USD strength. We look for EUR/USD to move to 1.04 in 3M. However, we believe this will be the bottom for EUR/USD and that higher euro area inflation and an eventual increased focus on ECB exit will drive a move higher in EUR/USD to 1.06 in 6M and 1.10 in 12M. See also FX Forecast Update - Final stage of USD rocket, 15 June ZEW points to deceleration in the euro area Apart from the Greek drama it has been a fairly quiet week in the euro area. The German ZEW indicator fell a bit more than expected in June giving more indication that the euro recovery is losing a bit of pace in the short term. Strong oil tailwind for euro consumers has turned to mild headwind Despite a bit of softness in the short term, we continue to look for a robust euro area recovery. As US and Chinese growth picks up and the effect of the weaker euro increasingly kicks in, we believe exports will take the baton from consumers and drive the recovery onwards. Global market views Asset class Equities Moderately positive on 3m horizon, positive on 12m horizon Main factors Rebound in US and Chinese growth, euro recovery continues. Monetary easing from ECB, BoJ and PBoC supports equities. Equities are still attractive vs. bonds Bond market Core yields: Bund yields moderately higher. US yields higher US-Euro spread: Wider Peripheral spreads to tighten gradually from here Credit spread to remain stable, but with bouts of volatility Fed hike approaching and inflation rising. German bonds supported from ECB QE, but liquidity is an unknown. Policy divergence and a closing of the surprise gap to drive spreads wider QE continue to support the periphery. Greece remains a risk factor Added liquidity from ECB, stable fundamentals and search for yield FX EUR/USD - lower ahead of first Fed hike, but rebound further out Divergence in growth and monetary-policy outlook still warrant downside in 3-6M USD/JPY - Higher as Fed is re-priced Relative monetary policy and Japanese outflows will remain supported by pension reform EUR/SEK - Stuck between near-term, lower medium-term Battle between Riksbank and ECB for now, further out EUR/SEK to fall on Swedish growth outperformance EUR/NOK - Lower June cut from Norges Bank but NOK stronger on decent fundamentals Commodities Oil prices - range bound near-term, recovery in H2 M etal prices trending higher Gold prices to correct lower still Agricultural risks remain on the upside Higher global growth, supply consolidation to support recovery this year. Chinese growth concerns a near-term negative factor, supply side risks. Trending down as first Fed hike draws closer. Geopolitical concerns a supportive factor. Trending up again, El Niño weather this year is key upside risk. Source: Danske Bank Markets 3 19 June

4 Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The author of the research report is Allan von Mehren, Chief 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. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank 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 Regulation Authority 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 interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. 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 This publication is updated on a weekly basis. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered 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/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report June

5 The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. This research report is not intended for retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. Disclaimer related to distribution in the United States This research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer and 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 solely to U.S. institutional investors as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this research 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 independence of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a non-u.s. jurisdiction. Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument 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 be registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S. Securities and Exchange Commission June

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