Fixed Income and FX Weekly

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1 Fixed Income and FX Weekly Rate hikes postponed, not called off 15 August, 2011 Bjørn Roger Wilhelmsen Chief Strategist, FX & Fixed Income

2 Good morning, In the Norwegian newspaper Dagens Næringsliv, Governor Olsen writes this morning that interest rates will be increased if the Norwegian economy remains robust. The decision to leave rates on hold last week was a response to the financial market turbulence and increased uncertainty about global growth prospects, which could have an impact on the Norwegian economy as well. But if incoming surveys and data do not indicate a significant change to growth prospects in Norway, the Norges Bank will continue to raise rates towards a more normal level. However, the pace of tightening will be slower and we have revised our interest rate forecast accordingly. We now expect Norges Bank to remain on hold until March 2012 and we expect three hikes next year to 3% by year-end At the moment, the uncertainty surrounding this forecast looks biased towards the upside; it is more likely that the Bank hikes before March-2012 than after. However, expectations in the market, as suggested by FRA-rates, suggests stable rates until late In fact, the market was pricing in a 25 bp cut last week, but this cut is being removed this morning. EURNOK has been trading recently. Our short-term fair value model for I-44 (trade weighted NOK) suggests downside for the NOK due to a higher VIX, a lower oil price and lower interest rate differentials. This week is all quiet in terms of data releases for Norway. Market participants will look carefully at housing and industrial data from the US as well as developments in euro area debt problems. 2

3 Key event of the week: Industrial data in the US Fixed Income Strategy: Norges Bank will hike, but at a slower pace FX Strategy: NOK resilience despite Norges Bank and risk aversion 3

4 Key event of the week: Industrial data from the US Production growth has levelled our, consistent with surveys. Will it get better or worse? US business surveys USA Manufacturing production 40 NY Empire State Index Phil. Fed FIRST FIRST m/m %

5 The week in Review: Federal Reserve commits to ZIRP through mid-2013 At least we know where the 2y US treasury should trade for a while US 2y treasury yield capped below 0.25% Jan Apr Jul Oct Jan 09 Apr Jul Oct Jan 10 Apr 11 Jul 0.1 ZIRP through 2013 is consistent with Taylor rule based on forecast for unemployment and inflation 5

6 The week in Review: Norges Bank follows low rate scenario Norges Bank base case and low rate scenario Press release after leaving rates on hold: Norges Bank base case Low interest rate scenario (assuming weaker growth abroad) The (June Monetary Policy) Report also presented an alternative scenario with lower growth in the world economy, persistent turbulence in financial markets and where the interest rate increase in Norway was moved further ahead. This alternative scenario suggests stable rates in September as well. Then the Bank will hike by 25 bp in October Market expectations now* *Based on our estimates of credit spreads In a letter to the newspaper Dagens Næringsliv today, Governor Olsen says interest rates will eventually rise if the Norwegian economy remains robust. 6

7 The week in Review: Focus on euro zone crisis turns to France Spread between French and German government bonds first rose, then fell back again Yields on 10y gov. bonds, spread to Germany Yields on 10y gov. bonds, spread to Germany 1.0 France Jan Mar May Jul Sep Nov Jan 10 Mar May Jul Sep

8 Key event of the week: Industrial data in the US Fixed Income Strategy: Norges Bank will hike, but at a slower pace FX Strategy: NOK resilience despite Norges Bank and risk aversion 8

9 Swap market: NOK 10y swap rate trading too high vs. peers The slope of the NOK yield curve steepened last week, also relative to trading partners Changes in rates (swaps) last week, bp 10y interest rate swaps 0-5 Norway Sweden Euro area US 2y 5y 10y

10 Time to lock in a historical low 5yr NOK rate NOK 5y interest rate swap at all time low Interest rate yield curves, swaps - 5yr segment is the most expensive part on the swap yield curve in Norway - The slope of the NOK yield curve in 5-10 is too steep relative to others 10

11 butterfly model: 5yr NOK segment in Norway is too expensive 5 yr segment has outperformed 2yr and 10 yr fly vs. model estimate deviation from model Butterfly model y-0.5x(10y-2y) Our fly model is a regression on: a) Short-term NOK rates (1y) b) The slope of the 2-10 yield curve should trade at bp when short-term rates are low and when Norges Bank has embarked on an hiking cycle. The fly is currently detached from this model, suggesting that the 5yr segment is expensive 11

12 Money market: NIBOR fixings up, expected future market rates down Change in 3m rate and FRAs last week, bp 3m FRA rate in December

13 The slope of the money market yield curve is inverted Markets price in interest rate cuts in Norway. That is unlikely to happen NIBOR and NOK FRA curve LIBOR-OIS spreads 13

14 Cross country: Interest rate differentials should go up The spread to EUR turned at 185 bp, as usual, but should go higher again 3m FRA-rate in Mar-2012, NOK vs. EUR 3m FRA-rate in Jun-2012 vs. trading partners NOK Jul Sep Nov Jan 10 Trading partners Spread Mar May Jul Sep

15 We revise our interest rate forecast further down Weaker international climate will lead to lower NOK rates as well 3m NIBOR and FRA curve vs. forecasts Key policy rate forecasts 5 FRA-curve Norges Bank FRA forecast First Sec Source: Bloomberg, Norges Bank, First Securities 2 New forecast: Norges Bank leaves rates on hold at 2.25% until March 2012, then gradually higher to 3% by year-end 2012 and 4% year-end

16 Asset swap spread remains elevated on demand for NOK bonds 10 yr Norway asset swap spread and crisis 10 yr Norway asset swap spread Mexico crisis Russian crisis Global Fianancial Crisis US and EMU debt crisis

17 Key event of the week: Industrial data in the US Fixed Income Strategy: Norges Bank will hike, but at a slower pace FX Strategy: NOK resilience despite Norges Bank and risk aversion 17

18 NOK model signals a weaker NOK going forward The trade weighted NOK is now below (stronger than) our estimated valuation band NOK I-44 vs. model estimate The time-varying bands in the chart indicates valuation thresholds for the trade weighted NOK exchange rate. Low numbers = strong NOK. The bands are estimated using an econometric model that combines the effect of changes in the oil price, interest rate differentials and risk appetite (VIX) on the NOK. 18

19 The extent of Swiss franc overvaluation against NOK Assuming a stable real exchange rate, a fair long-run CHFNOK value is NOKCHF fair value constant real exchange rate CHFNOK & EURNOK Valutakurs NOK/CHF Fair value estimat, PPP CHFNOK EURNOK The fair value estimate is based on the assumption that the changes in the nominal exchange rate shall over time reflect differences in inflation Wage and price inflation has been persistently lower in Switzerland than in Norway for decades, but clearly not enough to justify current CHFNOK levels 19

20 FX forecast table 3m forecast 12m forecast 15/8/11 Change Change Change Spot Change Spot Change Trade last week last month in 2011 forecast in % forecast in % Weights EURNOK % 0.0% 0.9% % % 0.39 SEKNOK % -0.7% -2.0% % % 0.21 GBPNOK % -0.2% -4.9% % % 0.09 DKKNOK % 0.1% -5.3% % % 0.08 USDNOK % -1.1% -5.6% % % 0.06 JPYNOK % 2.0% 0.7% % % 0.03 CHFNOK % 1.5% 10.6% % % 0.01 TWI % -0.3% -1.5% % % 20

21 This document was prepared exclusively for the benefit and internal use of selected parties in order to evaluate the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure to any other party. This document is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by First Securities AS. This presentation may not be used for any other purposes without the prior written consent of First Securities AS. This presentation is not prepared in accordance with the requirements applying to investment researches. This document does not constitute or form part of an offer or invitation or recommendation to subscribe for or purchase any securities. The distribution of this document may be restricted by law in certain jurisdictions and person into whose possession this document comes should inform themselves about, and observe, any such restriction. Any failure to comply with these restrictions may constitute a violation of the laws of any such jurisdiction. First Securities AS shall not have any responsibility for any such violations. Any decision to purchase or subscribe for securities in any offering must be made solely on the basis of the information contained in the prospectus or other offering circular issued in connection with such offering. In preparing this document we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us or otherwise reviewed by us. The information contained in this document has been taken from sources deemed to be reliable. We do not represent that such information is accurate or complete and it should not be relied on as such. Any opinions expressed herein reflect our judgement at this date, all of which are accordingly subject to change. First Securities AS accept no liability whatsoever for any direct, indirect or consequential loss rising from the use of this document or its contents First Securities AS and/or their employees may hold shares, options or other securities of any issuer referred to in this document and may, as principal or agent, buy or sell such securities. First Securities AS may have other financial interests in transactions involving these securities. 21

Date 02.12.2010. Fundamentals have turned NOK supportive. growth in 4Q and 2011 as well. policy outlook: Despite low inflation, we expect

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