New yield forecast More yield increases ahead

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1 Investment research general market conditions August 9 New yield forecast More yield increases ahead Recent market developments Yields have climbed over the summer months after falling in the latter half of June and they are now running close to their 9 highs. Economic data have continued to surprise on the upside and a number of or European economies, as well as the US, have now put the recession behind them. Meanwhile, the financial markets have continued to recover. Stock markets have surged to record highs for 9 and credit spreads in many markets have narrowed to levels seen before the crisis started accelerating last autumn. Markets have begun to look for rate hikes and are now pricing in about from the Federal Reserve and from the ECB on a M horizon. Until now, central banks have interpreted the improvement in economic data very cautiously, although both the ECB and the Fed have indicated that they will not ease monetary policy any further. Macro outlook The US economy suffered its worst downturn in many years in Q 8, but showed signs of stabilisation in Q 9. We now see clear indications of the US economy having put the recession behind it, and the US is set for a relatively strong rebound in H 9. Recently, the favourable outlook has been supported by continued improvement in manufacturing indicators (including the ISM), clear signs of housing market stabilisation and surging car sales. We believe that economic growth could be relatively strong in the coming two to three quarters. In spite of fiscal and monetary stimuli, we still see a risk of renewed weakness some time into if consumer spending fails to gather real momentum. Key news Economic data indicate that most or economies have put recession behind them. The Fed is done easing, but should stay on hold for a long time. The ECB is done cutting rates, and we expect it to start hiking rates within the next months. Look for higher long- and shortyields and rates on both sides of the Atlantic. Next yield forecast due out on September 9 The eurozone has also come out of recession. Germany and France the hubs of the eurozone even saw positive growth rates as early as in Q 9. Recent data suggest that Germany could be set for a surprisingly strong recovery in H 9 based on the positive trends in exports, manufacturing orders and investment. The German rebound should, not least, be driven by a production catch-up and a strong recovery in Asian export markets. However, we also see a risk of renewed weakness in Europe next year but this will depend mainly on developments in Asia and the US. Inflation in the eurozone is about to bottom and should move gradually upward over the next months as commodity prices increase, but the inflation rate should stay below the ECB s target over the coming years. Central banks and bond yields The Fed has announced that it will stop buying Treasuries by October and is generally signalling that it does not intend to expand quantitative easing any further, although it has left the door ajar. We expect the Fed to maintain the Fed funds rate at -.% for a relatively long time. US inflation is low and there is plenty of spare capacity in the economy, so there is no urgent need for rate hikes. We expect US yields to increase on the back of the outlook for further improvement in economic indicators, massive supply of Treasuries and the phasing-out of the Fed s Treasury purchase programme. Most of the increase in yields is expected to come over the next six months. On a six to M horizon we expect yields to move sideways. Senior Analyst Peter Possing Andersen 9 pa@danskebank.dk

2 The ECB is done with cutting rates and should start tightening up next summer. Until now, the Governing Council has interpreted the improvement in data very cautiously. However, we expect the ECB to revise its forecast substantially up at its next policy meeting, given recent positive surprises and expectations of further improvement in indicators. Thus, with inflation back up to -% y/y, the stage should be set for rate hikes in summer and hence for the ECB to abandon its exceptionally expansionary policy. We expect European yields to increase over the coming year as the economic outlook improves and the market begins to price in more rate hikes from the ECB. Higher US long yields should help pull European yields up during the next couple of quarters. Yield curves The US yield curve will likely remain unchanged short-term as the Fed continues to signal unchanged policy rates for a long time. The yield curve will probably not flatten much until the market becomes convinced that the Fed will start to consider hiking rates i.e. some time in H. In the eurozone, the yield curve should flatten as the market begins to price in more rate hikes from the ECB. Country spreads Germany and France have come out of recession earlier than the US. Although we expect the US recovery to outpace Europe s within a few quarters, the ECB will probably tighten up far more aggressively than the Fed. Against this background, we do not expect the US- European rate spread to widen any further. The spread will probably start narrowing again in H as the ECB adopts a more hawkish rhetoric and the Fed maintains a more laidback attitude. The risk is that European bonds could begin to underperform their US counterparts earlier than we have forecast. Danish rates and yields The Danish central bank, Danmarks Nationalbank (NB) is expected to continue its gradual narrowing of the rate spread to the eurozone over the coming quarters. Cibor rates should continue declining on the back of policy rate cuts and continued normalisation of the Danish money market. We expect the NB to follow suit when the ECB starts tightening up next summer. Spreads between long-term market rates in Denmark and the eurozone could narrow a little, but the general rate and yield increases will dominate and we expect Danish long yields to move higher. New forecasts EUR Refi rate m euribor -yr swap -yr swap -yr swap -yr gov -yr gov -yr gov Spot m m m..... USD Fed funds m libor -yr swap -yr swap -yr swap -yr gov -yr gov -yr gov Spot m m m DKK Repo rate m cibor -yr swap -yr swap -yr swap -yr gov -yr gov -yr gov Spot m m m Source: Danske Bank August 9

3 International interest rates USD swap rates. -year USD swap rate year USD swap rate EUR swap rates.... -year EUR swap rate -year EUR swap rate Slope of swap-rate curve, USD Slope of swap-rate curve, EUR y EUR swap - y EUR swap - y USD swap - y USD swap Country spreads Policy rates y USD swap rate - y EUR swap rate Refi Rate - - y USD swap rate - y EUR swap rate Fed Funds target rate August 9

4 Danish interest rates Y swap rate Y swap rate. %.... year swap, DKK % year swap, DKK sep sep 8 9 % Spreads to eurozone Slope of swap yield curve, DKK Spread -year swap: DKK-EUR Spread -year swap: DKK-EUR sep sep 8 9 -year DKK swap - -year DKK swap sep sep M money market rates Policy rates m cibor m euribor Danish Repo rate... Refi rate August 9

5 Disclosure This report has been prepared by Danske Research, which is part of Danske Markets, a division of Danske Bank, by Peter Possing Andersen, Senior Analyst. Danske Bank is under supervision by the Danish Financial Supervisory Authority. Danske Bank research reports are prepared in accordance with the Danish Society of Investment Professionals Ethical rules and the Recommendations of the Danish Securities Dealers Associations. 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 Danske Bank Research Policy. 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 Research Management and to the Compliance Officer. Danske Bank Research departments are organised independently from and do not report to other Danske Bank business areas. 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 dept capital transactions. Danske Bank is a market maker and may as such hold positions in the financial instruments mentioned in this report. Please go to for further disclosures and information. Disclaimer This publication has been prepared by Danske Markets for information purposes only. It has been prepared independently, solely from publicly available information and does not take into account the views of Danske Bank s internal credit department. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. 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 no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. The Equity and Corporate Bonds analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for retail customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S. Danske Bank A/S is authorized by the Danish Financial Supervisory Authority and subject to limited regulation by the Financial Services Authority (UK). Details on the extent of our regulation by the Financial Services Authority are available from us on request. Copyright (C) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission. August 9

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