In this publication we give a summary of our views across markets and asset classes.
US: The economy is likely to remain in recession for a while yet, as the effects of continued deleveraging, wealth destruction, credit tightening and negative recession dynamics (skyrocketing unemployment and business destocking) should keep growth rates negative during Q2. However, in the middle of the year we expect a range of stabilising factors to kick in. The pace of credit tightening should slow, which, combined with a significant boost to real incomes from lower commodity prices, fiscal policy easing, lower mortgage rates and slower business destocking, should help a recovery get under way. We project GDP growth at -2.7% in 2009 and 2.5% in 2010. We do not expect unemployment to stabilise before early 2010, topping out at 9.4%. Risks of deflation are rising but remain limited due to a forceful policy response. We thing the Fed is likely to keep policy rates unchanged at a close-to-zero level for a prolonged period and continue the expansion of its balance sheet as long as the credit markets remain dysfunctional.
Euroland: Euroland is almost in free-fall at the moment. Exports are falling dramatically as a result of the slump in global demand, credit tightening and falling capacity utilisation is putting a brake on investments, and a mixture of collapsing housing bubbles and decreasing job security is dampening private consumption. The speed of contraction should soon begin to taper off - partly driven by a rebound in exports and non-residential investments. However, we still expect Euroland GDP to shrink for most of 2009 and do not project positive growth before Q4 09, when we are likely to face a gradual recovery with growth reaching trend about a year later. We believe that the ECB is likely to deliver a final 50bp rate cut in April, which would bring the refi rate to 1.0%, after which it is likely that the ECB will engage in credit easing. We expect the Euroland economy to contract by 2.7% this year and grow 0.8% in 2010.
Japan: In 2009 we expect GDP to contract by an astonishing 5%. The main reasons for this extraordinary weakness is Japan's high dependence on exports of highly cyclical manufacturing goods and the comparatively weak fiscal and monetary response to the crisis. We expect the Japanese economy to bottom out at very depressed levels in Q2 09 and recover slightly in H2 2009 when the impact from fiscal easing should start to kick in and global trade should rebound slightly. A sustainable recovery in Japan in 2010 would depend on a rebound in global growth next year. With Japan entering dangerous deflationary territory and fiscal policy constrained by political uncertainty, there is likely to be increasing pressure on the Bank of Japan (BoJ) to step up quantitative easing, including increasing the purchase of government and corporate bonds. We thing the BoJ is unlikely to hike its leading interest rate before H2 2010.
Emerging Markets: Emerging market growth has slowed sharply in all regions. For emerging markets overall we expect stabilisation in Q2 09 albeit at very depressed levels. We expect a slight recovery in H2 2009 but we think we will have to wait until 2010 before the recovery gains a solid footing. We expect China to recover first; in fact it is already showing signs of improvement. We project a sharp turnaround in H2 2009. The recovery in Central & Eastern Europe is likely to be weak compared to other emerging markets. With access to external financing becoming more strained and the political status quo being increasingly questioned, there is likely to be considerable downside event risk for emerging markets in the short run. 2009 could turn out to be a very busy year for the IMF. Monetary conditions have been eased aggressively in recent months as inflation dropped rapidly amid the economic downturn; these monetary easing cycles are generally coming to an end in emerging markets, especially in CEE/CIS. In LATAM and Asia there is more room for easing going forward.
Sweden: The Swedish economy has been hit hard by the global crisis. GDP fell by almost 5% y/y during the fourth quarter last year and this year has started quite negatively as well. Exports are falling sharply, consumers are holding on tighter to their money and businesses are slashing capital expenditure massively. We expect GDP to contract by 4.6% this year and rise only 0.8% in 2010. The labour market is deteriorating at a pace not seen since the crisis in the early 1990s. We expect unemployment to breach 10% later this year and move further up through next year. Inflation should - at least for a while - show negative y/y rates this year, but base effects should help avoid a prolonged period of falling CPI inflation reaching into 2010. The big test will be the wage rounds that take place later this year. If labour market conditions have deteriorated to the extent that they result in zero or falling wages (which, after all, is a low probability outcome), Sweden would face serious problems.
Norway: The Norwegian economy is also being affected by the global recession. However, there are signs of positive effects from the strong monetary and fiscal policy response feeding through to the domestic economy. In particular, the sharp drop in mortgage rates seems to have stabilised the housing market, despite rising unemployment. At the same time, lower interest rates, supported by a sharp drop in inflation, have contributed to a considerable improvement in households' real disposable income and there is encouraging evidence of private consumption reacting positively to the stimulus. Hence, as we expect fiscal policy to support the construction sector during Q2, we think the domestic economy is likely to bottom out in Q1. However, the export sector is still struggling, underlining the division in the Norwegian economy between the domestic and the export-oriented parts of the economy. We expect Norwegian GDP to be -0.3% in 2009 and 1.8% in 2010.
Our year-end 2009 target for the S&P500 is 950, or around a 25% increase from today's levels. Investors' risk aversion has obviously risen since the outbreak of the credit crisis and ex-ante ERPs are at least one percentage point higher than normal. We anticipate this unusually high risk aversion to ease off gradually, once investors start to see through the losses in the banking industry and as funding markets begin to normalise. We believe, for the stock market to show sustainable gains, more key factors need to show signs of recovery. On our five point recovery list, the only recovery sign available currently, at end of Q1 09, is the global industrial cycle. An easing in terms of negative earnings revisions for 2009/2010 could be next. US housing, the credit market as well as investor/ consumer confidence all need to heal for a market recovery to be sustainable.
Still, there is a risk that the bear market could continue for most of 2009. Our worst case could see the S&P500 at around 625, and taking into consideration recent history we cannot exclude this short-to-medium-term outcome. However, to experience a 20% correction from the already inexpensive stock market levels, the crisis would need to move to 'the next level' with clear signs of deflation and hence a prolonged 'depression-like' economic development for the US and global economies.
In the worst earnings crisis for Wall Street since the 1970s, valuations are still not expensive. US financial sector provisions and write-downs are forecast (by key US investment banks) to amount to more than USD20/share. On a 12-month forward basis, provisions and write-down inclusion gives us a 'real' P/E level of around 13.6x against an unadjusted consensus estimate of 10.3x.
When it comes to market sectors and industries, we are seeing clear signs that investors are slowly rotating into early-cycle industries. In this cycle, we expect the early cyclicals to be consumerrelated industries. In this segment we recommend quality stocks or stocks with global consumer brands, low debt and high free cash flow yields. When it comes to market segments it is important to note that Financials has lost its dominant role in S&P500 performance. The sector's likely earnings collapse (driven by provisions and write-downs) in 2009 could therefore be of minor importance for the overall stock market performance. Health Care, Energy and Technology are the dominant sectors in the US, and the trends here should dominate the earnings trends for US Financials.
Top-down views: A dire economic outlook, fluctuating risk aversion, increased supply of bonds and, not least, monetary policy responses have dominated the headlines on interest rate markets in recent months. Following the Fed's recent decision to buy treasuries, US yields have plunged and with the Feds heavy gauntlet hanging over the market we doubt yields will move higher short term. However, long term, we still expect significantly higher US yields and a flatter curve as the economy recovers and the fear of further quantitative easing subsides and supply pressure persists. When the US bond market does turn, we see a risk that it could result in quite a violent rise in yields.
We think the ECB is getting close to ending its cutting cycle with a final 50bp cut in April, and while it is currently contemplating alternative measures to ease monetary policy further, we think the likelihood of the ECB buying government bonds is very slim. German yields are likely to take their cue from US yields and risk appetite, making a sideways to slightly higher move the most likely. Longer term, German yields should rise and the yield curve steepen on the back of renewed optimism about growth and higher US yields. Euroland should remain the growth laggard throughout 2009 and the rebound in rates is likely to be much more modest here. We expect euro bond markets to outperform those in the US over the course of 2009. Supply also points towards US underperformance during 2009.
Euroland intra-government bond market: We have been overweight the core markets relative to the periphery given the significant repricing we have seen in every new deal in the government bond market during January and February. However, there is now a substantial pick-up on the periphery, and we are recommending, eg, Portugal versus Austria and Italy. Another recommendation is Spain versus Italy. However, we remain overweight core countries relative to the periphery - hence, we are long Finland, Netherlands, Germany and France versus Italy, Greece, Austria, Spain and Ireland. This is based on expected supply and, still, a general flight to quality. This was illustrated by the recent 5Y benchmark issue from Finland, which came with a new issue premium of 12bp, while recent issues from Greece, Ireland and Portugal have come with issue premiums of 30-35bp.
Emerging Markets: With monetary easing cycles coming to an end, the downside to short-term yields is becoming more limited - especially in CEE/CIS. We expect longer-term yields to move up, especially in the most imbalanced countries. Fears over rising public budget deficits and crowding out from the enormous rise in the public bond supply in mature markets could push up long-term yields in CEE/CIS. However, if the IMF increases its presence in CEE/CIS, it is likely to call for reduced public spending, and this could bring some stabilisation to long-term yields in the region.
Scandi Fixed Income:
Danish Government bonds: We are underweight Danish Government bonds versus Euro bonds, especially at the long end of the curve. Here the DGBs are trading lower than for all EU countries apart from Germany, even though Denmark has not adopted the Euro.
Danish mortgage bonds: Since early January, we have been overweight 2Y-5Y non-callable mortgage bonds versus government bonds, which so far have yielded a solid excess return of 0.5-1.8%. Going forward, the risk of spread widening between non-callables and government bonds has increased in tandem with the rising risk aversion and the knock-on effect on the Scandinavian banking sector, which has initially hit Swedish banks. Escalation of the crisis in Eastern Europe and the Baltics should put renewed pressure on Swedish mortgage bonds and European covered bonds and we could see a spill-over to Denmark. Here we often see the spread curve between covered bonds and government bonds steepen in Sweden and Euroland, while Danish non-callables and callables are lagging behind. We therefore choose to reduce the time to maturity of our long non-callable position vs government bonds, focusing on the 1Y-2Y segment. We favour underweighting mortgage bonds versus government bonds, given the significant risk aversion prevailing in the markets, which has not spilled over into Danish mortgage bonds. We therefore recommend that investors invest future coupon payments and prepayments (about DKK26.5bn) in government bonds rather than mortgage bonds. Given our view that DGBs are expensive, we recommend buying other government bonds than DGBs (see section on EUR government bonds).
Sweden: We think the Riksbank is now just a month away from reaching what in practice would amount to ZIRP. What comes after that can only be a subject for speculation, but we expect quantitative easing (QE) to be on the table. If indeed QE is implemented, we expect the Riksbank to prioritise corporate credit as a way to alleviate distressed bank balance sheets and reduce the funding strains for large Swedish corporations. Obviously, the fact that QE could be used at all is likely to have positive contagion effects on mortgage and government bond markets. We therefore believe there is reason to remain in favour of a flatter yield curve in the near term. A flatter yield curve in government bonds could also be supported by the issuance of a new 30yr benchmark, should it be in great demand, and the looming risk of a Baltic devaluation, which could put the Swedish banking sector under considerable stress. In terms of spreads vs the German curve, we expect potential QE in Sweden to favour the long end of the Swedish curve. Since the Riksbank is likely to have hit rock bottom at the very short end of the curve soon, there is no potential left for outperformance at the short end. A relatively flatter curve in Sweden vs Germany is therefore on the cards. On the money markets, we also see potential for a flatter FRA curve, both due to the risk of higher fixing spreads at the front end and lower rates at the longer end due to bleak Swedish growth and inflation prospects.
Norway: We think the market is pricing in a rate path from Norges Bank that is slightly too low. The market expects policy rates to fall to 1.5%, whereas we think rates will bottom out at 1.75%, or perhaps even higher. The Norwegian economy is showing clear signs of stabilization thanks to aggressive fiscal policy and a very interest rate sensitive housing market. However, we still think that long-dated NGBs offer value both outright and relative to bunds. Despite a very aggressive fiscal policy response from the government, this is unlikely to result in any extra supply of long bonds. Relative to other countries Norway can fund deficits by using oil money; hence, we expect the chronic lack of duration to continue. Therefore we recommend buying long-dated NGBs rather than bunds or asset swaps. We also see some value in the NOK at the current level and recommend that foreign accounts buy NGBs unhedged - albeit the risk to the NOK has become more two-sided.
Banks have been under renewed pressure in 2009 and more bad news is probably in the pipeline. We have a selective overweight on Financials, favouring senior paper from strong names from strong countries. We have an underweight on Industrials and a strong underweight on Pulp & Paper. On Telecoms we like the shorter end of the curve but are negative on longer-dated exposure on Nordic names. Finally, we have an overweight on Utilities.
JPY strength seems to have run its course and we see little support from domestic factors going forward.
A barrier to more CHF strength comes from the SNB's interventions and the CHF is likely to lose slightly against EUR over our forecast horizon.
GBP has significant potential, but negative domestic factors weigh on the pound in the near term. Risk appetite is likely to remain subdued in the short run, so smaller, pro-cyclical currencies can continue to trade at low levels while safe-haven currencies enjoy support. We expect, however, that some normalisation should occur, leading to lower highs and lower lows in pairs that have spiked over the past year, and vice versa.
With regards to Scandi, we continue to favour both the NOK and the SEK on a medium-to-long-term horizon. Both currencies are fundamentally undervalued and if we see a normalisation of risk appetite both currencies should perform strongly.
However, short term the outlook is quite divergent. The SEK could continue to suffer from an exceptionally weak Swedish economy, uncertainties regarding the Baltics and the impact on the Swedish banking sector, and not least how the Riksbank acts going forward. We think the Riksbank is likely to be the next central bank to go for zero rate interest policy and discuss quantitative easing as the way forward. The April monetary policy meeting should be pivotal. Hence, even though the SEK has benefitted lately from improved risk appetite, the near-term outlook is very uncertain and we recommend high caution regarding the SEK.
The NOK has performed strongly lately. It has become obvious to the market that the Norwegian economy is relatively strong and that Norwegian balances are in a class of their own. We expect the NOK to get further support from Norges Bank going forward: we think the Norwegian central bank to repeat that rates will bottom out marginally below 2.0%. We think it quite unlikely that Norges Bank will cut rates to zero or use quantitative easing.
We expect DKK to benefit from a positive policy spread and money market spread vs the EUR. Hence, we see EUR/DKK marginally below the central parity for the next six months. The size of the Danish currency reserves should pave the way for a further tightening of the monetary policy spread to 40bp against the ECB policy rate on a 12-month horizon.
OPEC has slashed production aggressively in the past couple of months. The cartel has a relatively high compliance rate of above 80%. The supply response has stabilized oil market and oil prices are likely to end the year well above USD60/barrel. In general, we still expect commodities to move higher in H2 2009 as the global economy slowly recovers. We forecast the ISM indicator to rise in the coming quarters, which also bodes well for commodities sensitive to the business cycle, such as base metals. All in all we still find it attractive to lock in commodity exposure at the current level, even though commodity markets in general are trading in contango (forward prices are above spot prices). However, if the global economy becomes even weaker than we forecast, or risk appetite nose-dives, we could see new lows in commodity markets, not least in Q2. However, we still argue that a very weak growth trajectory is priced into commodities.
Danske Bank
Disclaimer
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Macro and central bank outlook
Global: The global economy is in its worse crisis since the 1930s and GDP is falling rapidly. However, we expect massive stimulus packages to lead to a gradual improvement, starting in the US and Asia in H2 2009 and spreading to Europe during 2010 (see Global Scenarios, March 2009). We expect global leading indicators to rise during the spring and summer.US: The economy is likely to remain in recession for a while yet, as the effects of continued deleveraging, wealth destruction, credit tightening and negative recession dynamics (skyrocketing unemployment and business destocking) should keep growth rates negative during Q2. However, in the middle of the year we expect a range of stabilising factors to kick in. The pace of credit tightening should slow, which, combined with a significant boost to real incomes from lower commodity prices, fiscal policy easing, lower mortgage rates and slower business destocking, should help a recovery get under way. We project GDP growth at -2.7% in 2009 and 2.5% in 2010. We do not expect unemployment to stabilise before early 2010, topping out at 9.4%. Risks of deflation are rising but remain limited due to a forceful policy response. We thing the Fed is likely to keep policy rates unchanged at a close-to-zero level for a prolonged period and continue the expansion of its balance sheet as long as the credit markets remain dysfunctional.
Euroland: Euroland is almost in free-fall at the moment. Exports are falling dramatically as a result of the slump in global demand, credit tightening and falling capacity utilisation is putting a brake on investments, and a mixture of collapsing housing bubbles and decreasing job security is dampening private consumption. The speed of contraction should soon begin to taper off - partly driven by a rebound in exports and non-residential investments. However, we still expect Euroland GDP to shrink for most of 2009 and do not project positive growth before Q4 09, when we are likely to face a gradual recovery with growth reaching trend about a year later. We believe that the ECB is likely to deliver a final 50bp rate cut in April, which would bring the refi rate to 1.0%, after which it is likely that the ECB will engage in credit easing. We expect the Euroland economy to contract by 2.7% this year and grow 0.8% in 2010.
Japan: In 2009 we expect GDP to contract by an astonishing 5%. The main reasons for this extraordinary weakness is Japan's high dependence on exports of highly cyclical manufacturing goods and the comparatively weak fiscal and monetary response to the crisis. We expect the Japanese economy to bottom out at very depressed levels in Q2 09 and recover slightly in H2 2009 when the impact from fiscal easing should start to kick in and global trade should rebound slightly. A sustainable recovery in Japan in 2010 would depend on a rebound in global growth next year. With Japan entering dangerous deflationary territory and fiscal policy constrained by political uncertainty, there is likely to be increasing pressure on the Bank of Japan (BoJ) to step up quantitative easing, including increasing the purchase of government and corporate bonds. We thing the BoJ is unlikely to hike its leading interest rate before H2 2010.
Emerging Markets: Emerging market growth has slowed sharply in all regions. For emerging markets overall we expect stabilisation in Q2 09 albeit at very depressed levels. We expect a slight recovery in H2 2009 but we think we will have to wait until 2010 before the recovery gains a solid footing. We expect China to recover first; in fact it is already showing signs of improvement. We project a sharp turnaround in H2 2009. The recovery in Central & Eastern Europe is likely to be weak compared to other emerging markets. With access to external financing becoming more strained and the political status quo being increasingly questioned, there is likely to be considerable downside event risk for emerging markets in the short run. 2009 could turn out to be a very busy year for the IMF. Monetary conditions have been eased aggressively in recent months as inflation dropped rapidly amid the economic downturn; these monetary easing cycles are generally coming to an end in emerging markets, especially in CEE/CIS. In LATAM and Asia there is more room for easing going forward.
Scandi macro
Denmark: Denmark is in a deep recession having seen a decline in GDP of 2.0% q/q in Q4 08. The downturn is a result of a slump in consumption and investment. Private consumption fell 2.8% and car sales fell a dramatic 24% in Q4 as households increased precautionary saving. Both residential and non-residential investments are falling sharply. The prospects for 2009 look bleak - we expect a decline in GDP of 2.5-3.0% - but 2010 looks brighter with substantial income tax reductions and the possibility of a stabilisation in the housing market. Nevertheless, we expect unemployment to double from the current 2.3% before the end of 2010. We expect Danmarks Nationalbank to follow the ECB's rate cut, and in addition narrow the interest rate spread by 25bp in April, which would narrow the spread down to 50bp. The policy rate would then be 2.0%. We then expect Danmarks Nationalbank to narrow the spread slowly and in small steps.Sweden: The Swedish economy has been hit hard by the global crisis. GDP fell by almost 5% y/y during the fourth quarter last year and this year has started quite negatively as well. Exports are falling sharply, consumers are holding on tighter to their money and businesses are slashing capital expenditure massively. We expect GDP to contract by 4.6% this year and rise only 0.8% in 2010. The labour market is deteriorating at a pace not seen since the crisis in the early 1990s. We expect unemployment to breach 10% later this year and move further up through next year. Inflation should - at least for a while - show negative y/y rates this year, but base effects should help avoid a prolonged period of falling CPI inflation reaching into 2010. The big test will be the wage rounds that take place later this year. If labour market conditions have deteriorated to the extent that they result in zero or falling wages (which, after all, is a low probability outcome), Sweden would face serious problems.
Norway: The Norwegian economy is also being affected by the global recession. However, there are signs of positive effects from the strong monetary and fiscal policy response feeding through to the domestic economy. In particular, the sharp drop in mortgage rates seems to have stabilised the housing market, despite rising unemployment. At the same time, lower interest rates, supported by a sharp drop in inflation, have contributed to a considerable improvement in households' real disposable income and there is encouraging evidence of private consumption reacting positively to the stimulus. Hence, as we expect fiscal policy to support the construction sector during Q2, we think the domestic economy is likely to bottom out in Q1. However, the export sector is still struggling, underlining the division in the Norwegian economy between the domestic and the export-oriented parts of the economy. We expect Norwegian GDP to be -0.3% in 2009 and 1.8% in 2010.
Financial outlook
Equity markets
For stock investors, the current focus should be the trend in the US stock market. Nothing means more for absolute returns in 2009 than the trend in the world's largest stock market, and here a new bear market rally has started, which is likely to lead to a rise in US stocks by another 7-10%, up into the 825-850 range, for the S&P500 in the short term.Our year-end 2009 target for the S&P500 is 950, or around a 25% increase from today's levels. Investors' risk aversion has obviously risen since the outbreak of the credit crisis and ex-ante ERPs are at least one percentage point higher than normal. We anticipate this unusually high risk aversion to ease off gradually, once investors start to see through the losses in the banking industry and as funding markets begin to normalise. We believe, for the stock market to show sustainable gains, more key factors need to show signs of recovery. On our five point recovery list, the only recovery sign available currently, at end of Q1 09, is the global industrial cycle. An easing in terms of negative earnings revisions for 2009/2010 could be next. US housing, the credit market as well as investor/ consumer confidence all need to heal for a market recovery to be sustainable.
Still, there is a risk that the bear market could continue for most of 2009. Our worst case could see the S&P500 at around 625, and taking into consideration recent history we cannot exclude this short-to-medium-term outcome. However, to experience a 20% correction from the already inexpensive stock market levels, the crisis would need to move to 'the next level' with clear signs of deflation and hence a prolonged 'depression-like' economic development for the US and global economies.
In the worst earnings crisis for Wall Street since the 1970s, valuations are still not expensive. US financial sector provisions and write-downs are forecast (by key US investment banks) to amount to more than USD20/share. On a 12-month forward basis, provisions and write-down inclusion gives us a 'real' P/E level of around 13.6x against an unadjusted consensus estimate of 10.3x.
When it comes to market sectors and industries, we are seeing clear signs that investors are slowly rotating into early-cycle industries. In this cycle, we expect the early cyclicals to be consumerrelated industries. In this segment we recommend quality stocks or stocks with global consumer brands, low debt and high free cash flow yields. When it comes to market segments it is important to note that Financials has lost its dominant role in S&P500 performance. The sector's likely earnings collapse (driven by provisions and write-downs) in 2009 could therefore be of minor importance for the overall stock market performance. Health Care, Energy and Technology are the dominant sectors in the US, and the trends here should dominate the earnings trends for US Financials.
Fixed income markets
Global Fixed IncomeTop-down views: A dire economic outlook, fluctuating risk aversion, increased supply of bonds and, not least, monetary policy responses have dominated the headlines on interest rate markets in recent months. Following the Fed's recent decision to buy treasuries, US yields have plunged and with the Feds heavy gauntlet hanging over the market we doubt yields will move higher short term. However, long term, we still expect significantly higher US yields and a flatter curve as the economy recovers and the fear of further quantitative easing subsides and supply pressure persists. When the US bond market does turn, we see a risk that it could result in quite a violent rise in yields.
We think the ECB is getting close to ending its cutting cycle with a final 50bp cut in April, and while it is currently contemplating alternative measures to ease monetary policy further, we think the likelihood of the ECB buying government bonds is very slim. German yields are likely to take their cue from US yields and risk appetite, making a sideways to slightly higher move the most likely. Longer term, German yields should rise and the yield curve steepen on the back of renewed optimism about growth and higher US yields. Euroland should remain the growth laggard throughout 2009 and the rebound in rates is likely to be much more modest here. We expect euro bond markets to outperform those in the US over the course of 2009. Supply also points towards US underperformance during 2009.
Euroland intra-government bond market: We have been overweight the core markets relative to the periphery given the significant repricing we have seen in every new deal in the government bond market during January and February. However, there is now a substantial pick-up on the periphery, and we are recommending, eg, Portugal versus Austria and Italy. Another recommendation is Spain versus Italy. However, we remain overweight core countries relative to the periphery - hence, we are long Finland, Netherlands, Germany and France versus Italy, Greece, Austria, Spain and Ireland. This is based on expected supply and, still, a general flight to quality. This was illustrated by the recent 5Y benchmark issue from Finland, which came with a new issue premium of 12bp, while recent issues from Greece, Ireland and Portugal have come with issue premiums of 30-35bp.
Emerging Markets: With monetary easing cycles coming to an end, the downside to short-term yields is becoming more limited - especially in CEE/CIS. We expect longer-term yields to move up, especially in the most imbalanced countries. Fears over rising public budget deficits and crowding out from the enormous rise in the public bond supply in mature markets could push up long-term yields in CEE/CIS. However, if the IMF increases its presence in CEE/CIS, it is likely to call for reduced public spending, and this could bring some stabilisation to long-term yields in the region.
Danish Government bonds: We are underweight Danish Government bonds versus Euro bonds, especially at the long end of the curve. Here the DGBs are trading lower than for all EU countries apart from Germany, even though Denmark has not adopted the Euro.
Danish mortgage bonds: Since early January, we have been overweight 2Y-5Y non-callable mortgage bonds versus government bonds, which so far have yielded a solid excess return of 0.5-1.8%. Going forward, the risk of spread widening between non-callables and government bonds has increased in tandem with the rising risk aversion and the knock-on effect on the Scandinavian banking sector, which has initially hit Swedish banks. Escalation of the crisis in Eastern Europe and the Baltics should put renewed pressure on Swedish mortgage bonds and European covered bonds and we could see a spill-over to Denmark. Here we often see the spread curve between covered bonds and government bonds steepen in Sweden and Euroland, while Danish non-callables and callables are lagging behind. We therefore choose to reduce the time to maturity of our long non-callable position vs government bonds, focusing on the 1Y-2Y segment. We favour underweighting mortgage bonds versus government bonds, given the significant risk aversion prevailing in the markets, which has not spilled over into Danish mortgage bonds. We therefore recommend that investors invest future coupon payments and prepayments (about DKK26.5bn) in government bonds rather than mortgage bonds. Given our view that DGBs are expensive, we recommend buying other government bonds than DGBs (see section on EUR government bonds).
Sweden: We think the Riksbank is now just a month away from reaching what in practice would amount to ZIRP. What comes after that can only be a subject for speculation, but we expect quantitative easing (QE) to be on the table. If indeed QE is implemented, we expect the Riksbank to prioritise corporate credit as a way to alleviate distressed bank balance sheets and reduce the funding strains for large Swedish corporations. Obviously, the fact that QE could be used at all is likely to have positive contagion effects on mortgage and government bond markets. We therefore believe there is reason to remain in favour of a flatter yield curve in the near term. A flatter yield curve in government bonds could also be supported by the issuance of a new 30yr benchmark, should it be in great demand, and the looming risk of a Baltic devaluation, which could put the Swedish banking sector under considerable stress. In terms of spreads vs the German curve, we expect potential QE in Sweden to favour the long end of the Swedish curve. Since the Riksbank is likely to have hit rock bottom at the very short end of the curve soon, there is no potential left for outperformance at the short end. A relatively flatter curve in Sweden vs Germany is therefore on the cards. On the money markets, we also see potential for a flatter FRA curve, both due to the risk of higher fixing spreads at the front end and lower rates at the longer end due to bleak Swedish growth and inflation prospects.
Norway: We think the market is pricing in a rate path from Norges Bank that is slightly too low. The market expects policy rates to fall to 1.5%, whereas we think rates will bottom out at 1.75%, or perhaps even higher. The Norwegian economy is showing clear signs of stabilization thanks to aggressive fiscal policy and a very interest rate sensitive housing market. However, we still think that long-dated NGBs offer value both outright and relative to bunds. Despite a very aggressive fiscal policy response from the government, this is unlikely to result in any extra supply of long bonds. Relative to other countries Norway can fund deficits by using oil money; hence, we expect the chronic lack of duration to continue. Therefore we recommend buying long-dated NGBs rather than bunds or asset swaps. We also see some value in the NOK at the current level and recommend that foreign accounts buy NGBs unhedged - albeit the risk to the NOK has become more two-sided.
Credit Markets
Despite the poor outlook for the global economy we remain constructive on credit as an asset class as we believe that the market in general is pricing in a default scenario so severe we think it is unlikely to materialise. That said, the fundamental outlook is grim and the ride is likely to be rough as uncertainty over the timing of an economic recovery persists. We advocate overweighting the asset class and, in our view, the most prudent way to build up an overweight position is via the primary market, thereby taking advantage of the new issuance premium and at the same time reducing the risk that secondary market positions will re-price due to new issuance (as it usually takes a while before an issuer returns to the market). On CDS, we are neutral to positive following the latest widening, but CDS movements are violent at times as it is the only liquid hedging instrument.Banks have been under renewed pressure in 2009 and more bad news is probably in the pipeline. We have a selective overweight on Financials, favouring senior paper from strong names from strong countries. We have an underweight on Industrials and a strong underweight on Pulp & Paper. On Telecoms we like the shorter end of the curve but are negative on longer-dated exposure on Nordic names. Finally, we have an overweight on Utilities.
Currency Markets
Volatility is still high compared to historical levels and most movements are associated with changes in risk appetite and stock market performance and less with country-specific macro news. The USD still enjoys support from the global dollar funding shortage, its safe-haven status, the contraction of global trade, financial flows, the impact of US fiscal policy on capital preservation, the rate outlook and the fact that the US is ahead of most countries in the business cycle, among others Euroland. However, the decision by the Federal Reserve to engage in quantitative easing has certainly put pressure on the greenback in the short term. The Fed is actively monetizing its government deficit. It is to add further dollar liquidity to the market, and eventually this could lead to higher US inflation. Hence, the short-term outlook is very uncertain for USD. But medium to long term we still expect the dollar to perform against the overvalued EUR, which is burdened by internal debt issues, deteriorating export prospects to the CEE and the fact that Western European banks face what is not a negligible risk of large losses, due to their involvement in CEE.JPY strength seems to have run its course and we see little support from domestic factors going forward.
A barrier to more CHF strength comes from the SNB's interventions and the CHF is likely to lose slightly against EUR over our forecast horizon.
GBP has significant potential, but negative domestic factors weigh on the pound in the near term. Risk appetite is likely to remain subdued in the short run, so smaller, pro-cyclical currencies can continue to trade at low levels while safe-haven currencies enjoy support. We expect, however, that some normalisation should occur, leading to lower highs and lower lows in pairs that have spiked over the past year, and vice versa.
With regards to Scandi, we continue to favour both the NOK and the SEK on a medium-to-long-term horizon. Both currencies are fundamentally undervalued and if we see a normalisation of risk appetite both currencies should perform strongly.
However, short term the outlook is quite divergent. The SEK could continue to suffer from an exceptionally weak Swedish economy, uncertainties regarding the Baltics and the impact on the Swedish banking sector, and not least how the Riksbank acts going forward. We think the Riksbank is likely to be the next central bank to go for zero rate interest policy and discuss quantitative easing as the way forward. The April monetary policy meeting should be pivotal. Hence, even though the SEK has benefitted lately from improved risk appetite, the near-term outlook is very uncertain and we recommend high caution regarding the SEK.
The NOK has performed strongly lately. It has become obvious to the market that the Norwegian economy is relatively strong and that Norwegian balances are in a class of their own. We expect the NOK to get further support from Norges Bank going forward: we think the Norwegian central bank to repeat that rates will bottom out marginally below 2.0%. We think it quite unlikely that Norges Bank will cut rates to zero or use quantitative easing.
We expect DKK to benefit from a positive policy spread and money market spread vs the EUR. Hence, we see EUR/DKK marginally below the central parity for the next six months. The size of the Danish currency reserves should pave the way for a further tightening of the monetary policy spread to 40bp against the ECB policy rate on a 12-month horizon.
Commodity markets
Commodity markets have stabilized in Q1 after the price and demand collapse we saw in the past quarter. In fact, prices of lead, copper and oil, for example, are now well above the level seen in January. We are still seeing several commodities, including aluminium, nickel and zinc, trading well below marginal costs. The lower prices have already resulted in supply being cut for several commodities, but these cuts have not kept up with the severe drop in demand experienced in Q4 and at the beginning of this year. Hence, global commodity stocks are, in general, at elevated levels. This should keep a lid on prices, even if demand recovers. Stocks are very high for aluminium.OPEC has slashed production aggressively in the past couple of months. The cartel has a relatively high compliance rate of above 80%. The supply response has stabilized oil market and oil prices are likely to end the year well above USD60/barrel. In general, we still expect commodities to move higher in H2 2009 as the global economy slowly recovers. We forecast the ISM indicator to rise in the coming quarters, which also bodes well for commodities sensitive to the business cycle, such as base metals. All in all we still find it attractive to lock in commodity exposure at the current level, even though commodity markets in general are trading in contango (forward prices are above spot prices). However, if the global economy becomes even weaker than we forecast, or risk appetite nose-dives, we could see new lows in commodity markets, not least in Q2. However, we still argue that a very weak growth trajectory is priced into commodities.
Disclaimer
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