Fixed Income and FX Weekly Rate hikes postponed, not called off 15 August, 2011 Bjørn Roger Wilhelmsen Chief Strategist, FX & Fixed Income +47 23 11 62 63 brw@first.no
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 2012. 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 2013. 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 7.82.7.90 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
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
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 30 20 10 40 30 20 10 102.5 100.0 97.5 95.0 Index 8 7 6 5 4 0-10 -20-30 -40-50 -60 Phil. Fed FIRST 00 01 02 03 04 05 06 07 08 09 10 11 0-10 -20-30 -40-50 -60 92.5 90.00 87.5 85.0 82.5 80.0 FIRST m/m % 05 06 07 08 09 10 11 3 2 1 0-1 -2-3 -4 4
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% 1.5 1.5 1.4 1.4 1.3 1.3 1.2 1.2 1.1 1.1 1.0 1.0 0.9 0.9 0.8 0.8 0.7 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.2 0.2 0.1 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
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: 5.0 4.5 4.0 3.5 3.0 Norges Bank base case Low interest rate scenario (assuming weaker growth abroad) 5.0 4.5 4.0 3.5 3.0 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. 2.5 2.0 1.5 Market expectations now* *Based on our estimates of credit spreads 10 11 12 13 14 15 2.5 2.0 1.5 In a letter to the newspaper Dagens Næringsliv today, Governor Olsen says interest rates will eventually rise if the Norwegian economy remains robust. 6
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 0.9 1.0 0.9 0.8 0.8 0.7 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.2 0.2 0.1 Jan Mar May Jul Sep Nov Jan 10 Mar May Jul Sep 11 0.1 7
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
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 -10-15 -20-25 -30-35 -40 9
Time to lock in a historical low 5yr NOK rate NOK 5y interest rate swap at all time low 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 96 98 00 02 04 06 08 10 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 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
2-5-10 butterfly model: 5yr NOK segment in Norway is too expensive 5 yr segment has outperformed 2yr and 10 yr 2-5-10 fly vs. model estimate 0.75 2-5-10 deviation from model 0.5 0.5 0.4 0.4 0.50 Butterfly model 0.3 0.3 0.25 0.2 0.2 0.1 0.1 0.00 0.0 0.0-0.1-0.1-0.25 5y-0.5x(10y-2y) -0.2-0.2-0.50-0.3-0.3-0.4-0.4-0.75 99 00 01 02 03 04 05 06 07 08 09 10 11 12-0.5 99 00 01 02 03 04 05 06 07 08 09 10 11-0.5 Our 2-5-10 fly model is a regression on: a) Short-term NOK rates (1y) b) The slope of the 2-10 yield curve should trade at 25-30 bp when short-term rates are low and when Norges Bank has embarked on an hiking cycle. The 2-5-10 fly is currently detached from this model, suggesting that the 5yr segment is expensive 11
Money market: NIBOR fixings up, expected future market rates down Change in 3m rate and FRAs last week, bp 3m FRA rate in December 2012 12
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
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 4.0 3.5 NOK 3.0 2.5 2.0 4.0 3.5 3.0 2.5 2.0 1.5 1.0 17 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 Jul Sep Nov Jan 10 Trading partners Spread Mar May Jul Sep 11 1.5 1.0 17 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 14
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 5 4.5 4.5 4 4 3.88 3.5 3 3.05 3.06 3.05 3.08 3.25 3.41 351 3.51 3.65 3.5 3 2.5 2.5 2 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 2013 15
Asset swap spread remains elevated on demand for NOK bonds 10 yr Norway asset swap spread and crisis 10 yr Norway asset swap spread 150 125 Mexico crisis Russian crisis Global Fianancial Crisis US and EMU debt crisis 150 125 100 100 75 75 50 50 25 25 0 94 96 98 00 02 04 06 08 10 12 14 0 16
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
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
The extent of Swiss franc overvaluation against NOK Assuming a stable real exchange rate, a fair long-run CHFNOK value is 5.5-6.0 NOKCHF fair value constant real exchange rate CHFNOK & EURNOK 8.0 8.0 11.50 8.0 7.5 7.0 7.5 7.0 11.25 11.00 10.75 7.5 6.5 6.0 5.5 5.0 4.5 4.0 Valutakurs NOK/CHF Fair value estimat, PPP 6.5 6.0 5.5 5.0 4.5 4.0 10.50 10.25 10.00 9.75 9.50 9.25 9.00 8.75 8.50 CHFNOK 7.0 6.5 6.0 5.5 3.5 3.0 3.5 3.0 8.25 8.00 7.75 EURNOK 5.0 2.5 2.5 7.50 4.5 80 85 90 95 00 05 10 06 07 08 09 10 11 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
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 7.860 0.6% 0.0% 0.9% 7.90 0.5% 7.70-2.0% 0.39 SEKNOK 0.850 0.5% -0.7% -2.0% 0.86 1.0% 0.85 0.1% 0.21 GBPNOK 8.942-0.3% -0.2% -4.9% 9.4 5.4% 9.1 1.7% 0.09 DKKNOK 1.055 0.5% 0.1% -5.3% 1.06 0.5% 1.03-2.0% 0.08 USDNOK 5.494 0.4% -1.1% -5.6% 5.64 2.7% 5.58 1.6% 0.06 JPYNOK 7.147 2.3% 2.0% 0.7% 7.05-1.3% 6.20-13.3% 0.03 CHFNOK 6.900-3.3% 1.5% 10.6% 7.52 9.0% 6.42-7.0% 0.01 TWI 93.6 0.4% -0.3% -1.5% 94.9 1.3% 92.8-0.9% 20
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