DKK: Central Bank Preview

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1 DKK: Central Bank Preview July 2012 Kasper Kirkegaard Senior Strategist Lars Tranberg Rasmussen Senior Strategist Anders Møller Lumholtz Senior Economist

2 Background The ECB meeting on 5 July is of particular interest from a Danish perspective after the Danish central bank, Danmarks Nationalbank (DN), cut its certificates of deposit (CD) rate to 0.05%, as Denmark could now be facing negative policy rates. Danmarks Nationalbank delivered two independent policy rate cuts in May to counter growing demand for the Danish krone. The rate cuts followed intervention in FX markets (DKK30bn in May), which has boosted Danish FX reserves to DKK502bn, or about 28% of GDP. The most recent policy easing left the certificates of deposit rate at just 0.05%. Furthermore, the following text appears on the DN s website: In exceptional circumstances it may be necessary for Danmarks Nationalbank to lower the rate of interest on certificates of deposit so that it becomes negative. We expect the CD rate to turn negative if either (i) FX inflows to Denmark grow too large or (ii) the ECB cuts its deposit rate. However, the DN might be prepared to accept a relatively larger increase in FX reserves this time around before introducing negative rates. In our view, the Danish krone is not likely to strengthen much further in the short term, as the market would interpret a decline in EUR/DKK below the historical low as a regime change. 2

3 ECB outlook We expect the ECB to cut its refi rate by 25bp to 0.75% at the meeting on 5 July, taking the refi rate down to a historical low. Unemployment has surged to a recordhigh rate, inflation is falling and even core economies have slid into recession. What the ECB will do to the deposit rate in this environment is highly uncertain. In our headline scenario, the ECB lowers the deposit rate by10bp to 0.15% but there is a broad range of probability outcomes, which could leave the deposit rate anywhere between unchanged and a 25bp cut. We expect the ECB to announce another ultra-long LTRO in the coming months. It might happen as early as at the July meeting but the ECB will more likely bide its time for a couple of months. Record-low interest rates in sight 2.50 % % Jan May Sep Jan May Sep Jan Refi rate Deposit rate May Sep Jan 11 May 12 Unemployment surges above 11% 12.0 % % y/y Unemployment CPI 3

4 Expected response from Danmarks Nationalbank ECB stays on hold ECB cuts refi rate by 25bp ECB cuts refi rate by 25bp and deposit rate by 10bp ECB cuts refi rate and deposit rate by 25bp ECB cuts refi rate by 50bp and deposit rate by 25bp Lending rate (currently 0.45%) 25bp 25bp 25bp 25-40bp Certificates of deposit (CD) (currently 0.05%) 0-10bp 10-25bp 10-25bp Current account (currently 0.0%) Comment We expect a Danish rate cut only if there has been substantial currency inflow. With EUR/DKK trading above , this is probably not the case. Unless there has been a strong currencly inflow, we expect the CD rate to remain at 0.05%. Whether the CD rate will be reduced is uncertain and will depend on whether there has been currency inflow. An unchanged interest rate or a 5 bp reduction to 0% is possible - but we expect a negative rate. We expect the Danish CD rate to be cut to prevent a spread widening - potentially to just slightly below zero (e.g %). Higher current account limits. We expect the Danish CD rate to be cut to prevent a spread widening - potentially to just slightly below zero (e.g %). Higher current account limits. Danske Bank s headline scenario 4

5 Spot 3M 6M 9M 12M 15M 18M 21M 24M 27M 30M 33M EUR what is the market pricing? The market is pricing a 25bp cut in the refi rate to 0.75% and a 10bp cut in the deposit rate to 0.15%. 1.00% 1.00% EONIA fixing The EONIA fixing is priced to fall 9bp to 24bp for the July reserve requirement period. This is consistent with a fall of about 10bp in the ECB deposit rate (now 0.25%). In the following months, the EONIA fixing is priced to fall another 3-4bp to around 20bp, which is broadly consistent with the ECB cutting the deposit rate to 0%. A zero deposit rate would probably leave the EONIA fixing at just under 15bp. The Euribor fixing is priced to decline another 9bp to 56bp by the maturity of the July futures contract (16 July) - i.e. 7bp below its spring 2010 low. While the 3M Euribor fixing could also fall if the ECB decides to cut only the deposit rate, the ECB would probably not cut the deposit rate without also lowering the refi rate in July. So, the market looks priced for a refi rate cut of 25bp at the July meeting, in our view. In the following two months, the Euribor fixing is priced down to 50bp. This, we believe, could be realised only if the deposit rate is lowered further towards 0% or if the ECB launches further ultra-long LTROs. 0.80% 0.60% 0.40% 0.20% 0.333% EONIA curve has negative slope over the next 3-4 months. 0.00% Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep % 1.00% 0.90% 0.80% 0.70% 0.60% 0.50% 0.40% 0.30% 0.653% ECB dates EONIA 3M Euribor Refi rate 5

6 Spot 3M 6M 9M 12M 15M 18M 21M 24M 27M 30M 33M DKK- what is the market pricing? The market is pricing the DN to track the ECB, cutting its lending rate by 15-20bp to % and the CD rate by 5-10bp, leaving Denmark with negative policy rates for the first time ever. The T/N fixing is priced to fall 8bp from its current level to -7bp in July. This is consistent with a high probability of Danmarks Nationalbank tracking the ECB, hence cutting the certificates of deposit rate by about 10bp to -0.05%. No further cuts in the Danish CD rate are priced for the following months. The Cibor fixing (3M) is priced to fall 9bp to 49bp in the coming month, which is broadly consistent with the DN lowering its lending rate by 15-20bp to %. 3M Cibor is priced to decline further in the following months to just under 0.40% by September. This should be consistent with some probability of the DN cutting its lending rate by another 10-15bp over the summer. 0.50% 0.40% 0.30% 0.20% 0.10% 0.00% 0.45% 0.017% DKK T/N fixing Cita curve has flat to slightly positive slope over the next 3-4 months % Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep % 1.10% 1.00% 0.90% 0.80% 0.70% 0.60% 0.50% 0.40% 0.30% 0.578% NB dates CITA 3M Cibor Repo rate 6

7 Expected market reaction Eurozone If the ECB cuts its refi rate by 25bp and the deposit rate by 10-15bp as expected, the market will probably price a further decline in the deposit rate. The Eonia curve will probably trade lower potentially at just under 15bp (i.e. down 4-5bp) If the ECB cuts its deposit rate to 0% as early as at the July meeting, we would see a larger initial decline in market interest rates, as this scenario is not fully priced. Denmark We expect EUR/DKK to trade at around 7.43, as a move towards 7.42 would cause uncertainty about the sustainability of the narrow de facto trading range. The market response in Denmark should depend largely on whether Danmarks Nationalbank decides to introduce a negative CD rate already at this stage. Negative rates Money market curve remains flat, leaving potential for a larger fall in Danish than in eurozone rates of potentially 7-8bp. Zero rates DN does not fully track ECB deposit rate cut => speculation about whether Denmark is prepared to introduce negative rates => smaller rate fall than in eurozone. 7

8 Money market recommendation On 16 May, we recommended receiving the 6M6M (DKK-EUR) OIS spread at +3bp with forward start as of 22 November Due to the two independent Danish interest rate cuts, the 6M spread with forward start as of 22 November 2012 has narrowed to -22bp, leaving a running p/l of +25bp. The forward market is currently pricing a widening of the Cita-Eonia 6M spread of around 1bp per month, giving the position a slightly positive roll. We see value in keeping the position open into the forthcoming ECB meeting, as the spread could narrow. We see particular potential for pricing lower Cita forward rates if Danmarks Nationalbank cuts its certificates of deposit rate below zero, as this would indicate the DN not shying away from pursuing a negative interest rate policy. After the ECB meeting, we will consider whether to take profit. Bp Bp Cita-Eonia 6M spread Spot +1M +2M +3M +4M Løbende Running p/l p/l May 23 May 30 May 06 Jun 13 Jun 20 Jun 27 Jun 8

9 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 FX market recommendation The 12M Cibor Euribor spread turned positive at the beginning of 2012 after the eurozone LTRO had pushed European interest rates lower. Recently this spread has turned negative again, which together with increased EMU risks have widened EUR/DKK forwards. EUR/DKK now trades with a 12M forward discount of about 340 pips. It is now possible to buy EUR/DKK 12M forward at around 7.40 or more than 2 figures below the historical low of We consider buying EUR/DKK forward attractive from a hold-to-maturity perspective. However, note the high forward market volatility and hence considerable mark-to-market risk. The timing of a potential future euro zone LTRO relative to the 28 Sept. Danish 3Y LTRO will be important for the forward market. Three ECB meetings are due by then and we see a high probability of an ECB announcement at one of these meetings. Hence, the forward discount could narrow before the launch of the Danish LTRO. We expect the DN to keep EUR/DKK at around 7.43, as a breach of the 2003 low would be interpreted by the market as a regime change and thus could trigger increased speculation. We do not consider a significant weakening of DKK likely in the current environment EUR/DKK forward discount 12M 3M 12M Cibor Euribor spread Cibor Euribor Cibor - Euribor 9

10 Disclosure This presentaitonhas been prepared by Danske Research, a division of Danske Bank A/S ("Danske Bank"). 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 authorized 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 Services Authority (UK). Details on the extent of the regulation by the Financial Services Authority are available from Danske Bank upon 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 high quality research based on research objectivity and independence. These procedures are documented in the research policies of Danske Bank. Employees within the Danske Bank Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to the Research Management and the Compliance Department. Danske Bank 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 over-all 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 upon request. Risk warning Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis of relevant assumptions, are stated throughout the text. First date of publication Please see the front page of this research report for the first date of publication. Price-related data is calculated using the closing price from the day before publication. 10

11 General disclaimer This presentation has been prepared by Danske Markets (a division of Danske Bank A/S). It is provided for informational purposes only and should be viewed solely in conjunction with the oral presentation provided by Danske Markets and/or Danske Markets Inc. 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 presentation has been prepared independently and solely on the basis of publicly available information which Danske Bank considers to be reliable. Whilst 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 presentation. The opinions expressed herein are the opinions of the research analysts responsible for the presentation and reflect their judgment as of the date hereof. These opinions are subject to change, and Danske Bank does not undertake to notify any recipient of this presentation of any such change nor of any other changes related to the information provided in the presentation. Danske Bank, its affiliates, subsidiaries and staff may perform services for or solicit business from any issuer mentioned herein and may hold long or short positions in, or otherwise be interested in, the financial instruments mentioned herein. The Equity and Corporate Bonds analysts of Danske Bank and undertakings with which the Equity and Corporate Bonds analysts have close links are, however, not permitted to invest in financial instruments which are covered by the relevant Equity or Corporate Bonds analyst or the research sector to which the analyst is linked. Danske Bank is authorized 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 Services Authority (UK). Details on the extent of the regulation by the Financial Services Authority are available from Danske Bank upon request. This presentation is not intended for retail customers in the United Kingdom or the United States. This presentation 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. 11

12 Disclaimer related to presentations to U.S. customers In the United States this presentation is presented by Danske Bank and/or Danske Markets Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank. In the United States the presentation is intended solely to "U.S. institutional investors" as defined in SEC Rule 15a-6. 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 presentation 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 presentation 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. 12

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