- Central banks getting nervous?
- Expect December inflation sub-Riksbank, with a downside risk
- Profit taken in short EUR/SEK - neutral ahead of CPI week
Trades
New; Receive FRA-SEP19 @ 1.5bp (P/L: -10/-10 bp)
Loss taken; Receive SEK FRA-Sep19 vs FRA-Sep21 and do the opposite in EUR close at a loss of 5bp
Central banks getting nervous?
The FOMC-minutes published last Wednesday along with a series of dovish comments from FOMC-members including Chair Powel are important in our view. The Federal Reserve has been pretty much on auto-pilot for quite a while, but no more it seems. The so called dot-plots still show a median forecast saying two more rate hikes this year but one gets the impression that board members are uncertain about the appropriate next step and for now the Fed seems to be on hold. The Fed has noticed the Q4 equity market turmoil but we sense that the fundamental issue is a higher degree of uncertainty about the global economic outlook.
In the meantime, Eurozone (EZ) data have not been very upbeat, rather the opposite. Business and consumer confidence declined again in December. The numbers are still a bit above the 2015-16 levels but there is nothing that suggests a growth rebound in Q4. Hard data are disappointing as well. Industrial production (November) was poor in France (- 2.1% y/y) and lousy in Germany (-4.7%). Retail sales (also November) were modest at best (1.1% y/y).
Swedish macro data have been mixed but tilted to the soft side. Our GDP-proxy suggests that GDP continued to lose momentum into the fourth quarter, even though the latest observation (December) must be taken with a grain of salt considering that several data have not been published yet.
In short, the story that gripped markets late last year – that of a cyclical slowdown - seems to be corroborated by recent data.
All this is reflected in market pricing. The table below shows annually implied central bank rate changes derived from 1m forward OIS.
What really stands out is the US, where the market is now pricing in rate cuts rather than hikes. In our view that might be somewhat stretched. Another interesting observation is that it is only this year that pricing of the Riksbank and the ECB deviates to any meaningful degree. In Sweden the market is not fully pricing in another 25bp rate hike, whereas for the ECB the market foresees only a marginal probability of a hike.
However, from 2020 and the following four years implied rate hikes are almost identical. For now, we do not see a reason to expect that the Riksbank would move at a slower pace than the ECB over the next 4-5 years. To us this suggests that implied Riksbank rate hikes in 2020-24 are at or close to the lower bound – unless the ECB adjusts its rate guidance lower.
This year is another matter, though. The December Riksbank minutes released this week suggest that, even though all members but one agreed to raise the repo rate, the Riksbank is not on a pre-set course. There was a lot of talk about global downside risks and again no mention of signs of higher wage growth.
With the Fed announcing a more cautious approach the question is what can be expected from the ECB. At the December board meeting, the central bank for the first time openly said that data had not lived up to expectations but it did not adjust forward guidance on rates. If data do not start to look better pretty soon, it would not be a big surprise if the ECB would signal more caution as well.
The Riksbank at its latest meeting pushed the next forecasted hike from summer to autumn. Our guess is that the Riksbank sticks to the current rate path at the upcoming meeting in February (announcement 13 February). At the time of the April meeting Q4 GDP will have been published. The Riksbank forecast is 1.4% y/y, which based on current information looks too high. We think that would provide the Riksbank with a strong argument to shift the hike further out by another quarter at the April meeting. We are sceptical about the reasons to deliver another hike in 2019.
For the whole of 2019, we estimate that around 20bp is expected from the Riksbank (see table below). Even though the probability of a rate hike is far from zero, we see current pricing as being clearly on the high side. If the market postponed what is currently discounted in Q3 19 to Q4, it would justify FRA SEP19 moving lower by around 10bp.
Moreover, as we wrote earlier, we do not expect the current rise in the 3M (NYSE:MMM) Stibor versus the average repo rate spread (FRA MAR19 versus Riba JUN19 currently at +14.5bp) to be sustainable in an environment that continues to reach new record levels each week (if we disregard the volatile weekly demand for Riksbank certificates). We expect fixing spreads to gradually move lower, which should provide some tailwind for receiving FRA SEP19.
We therefore recommend receiving FRA SEP19 outright @ +1.5bp. We set the P/L levels to -10/+10bp.
Loss taken. On the back of the above our trade recommendation ‘receive FRA SEP19 versus FRA SEP21 and the opposite in EUR’ no longer makes sense, which is why we close the position at a small cost (5bp).
New trade. We see a good case for the Riksbank to delay another hike. Therefore we see value in receiving FRA SEP19 @ 1.5bp (P/L @ -10/+10bp).
Expect December inflation sub-Riksbank, with a downside risk
We expect CPIF and CPIF excluding Energy to print 2.1% y/y and 1.4% y/y respectively, both figures being 0.1 percentage points below Riksbank’s forecasts. Higher prices for international airline tickets and charter packages are the main contributors to Swedish inflation this month, but we also expect a certain increase in food and clothing. Looking at Danish and Norwegian December data, however, suggests there is a downside risk to our forecast: food and clothing prices actually fell in both countries. The data on airline tickets and charter packages were mixed. In the background, however, Travelmarket’s Flight Price Index for December showed a smaller than normal increase, suggesting a slight downside risk.
Profit taken in short EUR/SEK – neutral ahead of CPI week
As we expected the Riksbank raised the repo rate in December and as expected it lent support to the SEK, while EUR/SEK has trended slightly lower since then. That said, the dovish tilt and poor risk sentiment have capped the downside in EUR/SEK. The market doubts whether the Riksbank is set to deliver a second hike this year as do we (see table). For many years the Swedish money market curve was too steep relative to peers, which suggested that re-pricing of the curve would push EUR/SEK higher. This is not the case anymore as market pricing of the Riksbank is now closely aligned with the ECB (2020 and beyond). The scope for re-pricing in relative terms is, in our view, perhaps more in favour of the SEK. Meanwhile, we continue to look for a cyclical slowdown in 2019, a potential headwind for the SEK, although it is more of a consensus call now. In all, we see only limited downside potential in EUR/SEK, which is reflected in our 3M target at 10.10.
In December, we entered a short position in EUR/SEK in anticipation of the first hike in seven years. We noted that it was close to a 50/50 call in terms of pricing, a 55%/45% event among currency investors according to our own survey, the FX Thermometer, while, finally, bank analysts favoured on hold (February hike). Hence, we saw good risk reward to be long SEK. This week we closed the trade at 10.1850 with a 1.3% profit. We prefer to be square ahead of next week’s inflation data, where our forecast is slightly below the Riksbank (see above), the vote on the new PM and government in Sweden and the Brexit vote in the House of Commons.
We note that EUR/SEK is trading close to fair value (10.20) as implied by short-term rates and a proxy for risk sentiment.
The government end-game has arrived. Four months have now passed since Election Day. The only concrete result is that the conservative (Moderate + Christian Democrats) budget gained approval in the parliament. Regarding the new PM, however, the positions appears to be as locked as ever. The two main candidates, Stefan Löfven and Ulf Kristersson, have both been voted down and now only two attempts remain until a snap election is triggered.
The speaker has announced that the next candidate is to be presented on Monday 14 January, with a subsequent vote on Wednesday 16 January. This weekend the Centre Party and the Liberals will decide their stance. If the candidate is rejected by the parliament, the fourth (and final) vote will take place on 23 January. A snap election should take place no later than 21 April. If a government is formed within the next two weeks, we expect limited impact on the markets (if anything, slightly SEK positive). Should a snap election be triggered, we could see a small and probably temporary selloff in the SEK.
As part of our Top Trades for 2019, we are long NOK/SEK. The trade had a bad start as the NOK was hard hit in December and NOK/SEK plunged to 1.02, before we saw a sharp rebound at the turn of the year (see seasonality chart). The trade is fundamentally motivated with a constructive view on oil, relative growth and relative monetary policy. In particular, we expect a hike in March and a second 25bp hike in H2, which is in line with Norges Bank’s own communication but in stark contrast with market pricing.