1. Rates forecast update
While waiting for Santa Claus, Draghi will deliver
Nordea Research, 5 December 2011
We don’t expect EU leaders to agree on a grand bargain to contain the debt crisis – at
least not on this side of Christmas
Instead ECB president Drahgi on 8 December will cut rates and offer 2-3 year LTRO’s,
signalling leading rates will be lower for longer – i.e. first rate hike postponed till Q1 2014
Short term we see somewhat lower market rates but volatility will stay high – we see no
prolonged period of low market rates
ECB to ease even further follow, but the sequencing matters”. By some
We expect the ECB to cut rates by 25bp this market commentators this was interpreted as a
Thursday’s ECB meeting. That will bring the signal that the ECB is willing to contemplate
refi-rate to 1.00%, which we now believe will large scale bond purchases – and that this could
be unchanged until Q1 2014. Previously our be announced shortly. We do not share this line
forecast was that the ECB would resume hiking of thinking. Instead we believe that Draghi will
rates mid-2013. The 9-month postponement is continue to emphasize that ECB bond purchas-
based on a further deterioration in the Euro ar- es are limited and temporary.
ea economy: We now expect a mild winter re-
cession with GDP forecasted to contract -0.2% Draghi’s hard stance on the “sequencing” puts
in 2012 (compared to our 0.6% growth forecast the EU leaders in the spotlight. On 9 December
in August), and a 2013 GDP growth of just European leaders will meet, with the debt crisis
1.0% (compared to our 1.8% growth forecast in dominating the agenda. Judging from the latest
August). rhetoric from Merkel and Sarkozy, we are like-
ly to see leaders agreeing on a strengthening of
On Thursday we also expect that ECB presi- surveillance of fiscal policy within the euro ar-
dent Draghi will offer 2-3 year LTRO’s, signal- ea, possibly enshrining this in the EU treaties
ling that leading rates will be lower for longer. as well. This will in itself not do anything to
The ultra-long market operations are intro- bolster confidence in the short term, but it
duced to ease some of the tensions in the mon- might be the necessary steps for the EFSF to
ey markets. begin its support of bond markets in January
2012. In addition European leaders are likely to
3M Euribor/Eonia spread at alarming levels reinforce the conclusions regarding the EFSF
% %-points
6 2,00
from the October 26 summit. Specifically,
1,75
5
1,50
there still seems to be support in favor of EFSF
4
1,25 bond insurance schemes and SPV’s.
3 1,00
0,75
2
0,50
In short: The market may once again be disap-
1
0,25 pointed on EU leaders, whereas Draghi will
0 0,00
jan-08 jul-08 jan-09 jul-09 jan-10 jul-10 jan-11 jul-11 jan-12
deliver a bit more, “passing the ball” to EU
EURIBOR 3M (L) EONIA SWAP 3M (L) EURIBOR 3M Vs. EONIA SWAP 3M (R) leaders once again. That may trigger a new
Source: Nordea Markets
round of risk off as Christmas approaches.
Last week Draghi said that if Euro area leaders
could agree on a substantial strengthening of
fiscal surveillance, then ”other elements might

2. No US recession, but slower growth Lower rates ahead – but window temporary
Since our previous financial forecast we have In the past few sessions intra-Euro area spreads
revised up our growth forecast on the US econ- have tightened from historical highs – partly as
omy – no recession, but slow growth: US GDP the ECB has scaled up the SMP bond purchas-
growth of 1.7% in both 2011 and 2012; 2.6% es, partly as expectations of a grand bargain
in 2013 (August forecasts of 1.3%, 1.6% and have developed ahead of this week’s EUR
2.7% in 2011-2013). Biggest risk to our rela- summit. As we expect a disappointment from
tively optimistic view on the US economy is a the EU leaders later this week, we could easily
more severe financial crisis in the Euro area. see a renewed risk off environment. Add the
risk of further sovereign downgrades, changes
We have made no changes on Fed: The Fed is to collateral rules and implementation of aus-
on the side-line for now, and has pledged to terity measures, the outlook is not favourable
keep the fed funds target unchanged at least for peripherals, and even the AAA-space still
until mid-2013. We expect the Fed’s next poli- looks shaky. We therefore expect continued
cy move to be in the form of strengthening its high market volatility, wider spreads, and po-
pledge to keep rates low for long; either by in- tential for further bull-flattening of the EUR
cluding forecasts of the fed funds rate in the swap and German government yield curves
FOMC’s projections and/or by specifying the through the winter.
economic conditions that would warrant an exit
from the Fed’s current policy. However, QE3 The ECB is priced to cut rates in December or
is not expected unless the US economy shows in January 2012 at the latest. The introduction
clear signs of a new recession or if European of ultra-long LTRO’s might push EONIA rates
banks were to collapse. to 30-35 bps, as was the case between July
2009 and July 2010. This leaves some down-
On 30 November the Fed – in coordination ward potential on money market rates (Eonia
with other major central banks – lowered the priced around 40-50 bps in 2012 and 3M Euri-
rate on USD swap lines from OIS + 100bp to bor priced just above 1% for 2012).
OIS + 50bp. The rate cut came to address the
rising tensions in the global money markets, However with central banks appearing deter-
where USD liquidity is becoming scarce. Ten- mined to fight the risk of a recession on both
sions have eased somewhat, but this week’s sides of the Atlantic, and with policy makers
USD liquidity operation at the ECB will be a likely to be forced to take more determined
litmus test, as the cut invites European banks to (and more convincing) steps to solve the sover-
use the ECB’s USD facility, as was the case eign debt crisis, we do see a potential for some
back in 2008/09. We believe, that the central of the safe-haven flow being unwound during
banks will be willing to move boldly again, spring/early summer 2012. That should help
should the money market tensions increase fur- market rates higher again – both in EUR and
ther. That should prevent USD Libor fixings USD swaps as well as in Treasuries and Bunds.
from soaring significantly.
At the same time, while the scenario may ap-
ECB’s USD facility massively used in 2008/09 pear remote right now, inflation concerns on
USD bn
350
the back of the massive liquidity pumped into
300
the economies could at some point return, also
250
putting some upside pressure on market rates.
200
150
100
Specifically we expect the Fed to resume rate
50
hikes in June 2013, leaving the fed funds target
0
at 1.75% end-2013 horizon. That leaves espe-
dec07 jun08 dec08 jun09 dec09 jun10 dec10 jun11
cially USD rates much higher than currently
ECB weekly allotment on USD auction
Source: Bloomberg priced on the longest horizon term.

3. Nordea swap and government yield forecasts at a glance
Note: Change from previous forecast in italic
Swaps Govies
Euroland Spot 05-03-2012 30-06-2012 31-12-2012 31-12-2013 Germany Spot 05-03-2012 30-06-2012 31-12-2012 31-12-2013
Leading rate 1,25 1,00 0,00 1,00 0,00 1,00 0,00 1,00 -0,50 Leading rate 1,25 1,00 0,00 1,00 0,00 1,00 0,00 1,00 -0,50
3M 1,47 1,05 -0,10 0,90 -0,15 0,90 -0,30 1,20 -0,55 3M 1,47 1,05 -0,10 0,90 -0,15 0,90 -0,30 1,20 -0,55
2Y 1,42 1,25 -0,05 1,50 0,00 1,70 0,00 2,60 -0,40 2Y 0,32 0,20 -0,10 0,65 0,00 1,10 0,00 2,00 -0,40
5Y 1,99 1,75 0,05 2,10 0,10 2,30 0,00 3,10 -0,30 5Y 1,07 0,85 0,05 1,40 0,10 1,80 0,00 2,70 -0,30
10Y 2,68 2,35 0,15 2,75 0,15 2,85 0,05 3,50 -0,15 10Y 2,17 1,85 0,30 2,35 0,30 2,50 0,05 3,15 -0,15
30Y 2,77 2,45 0,00 2,90 0,10 3,10 0,10 3,80 0,00 30Y 2,75 2,40 0,05 2,85 0,10 3,05 0,05 3,75 -0,05
5Y-2Y 0,58 0,50 0,10 0,60 0,10 0,60 0,00 0,50 0,10 5Y-2Y 0,75 0,65 0,15 0,75 0,10 0,70 0,00 0,70 0,10
10Y-2Y 1,26 1,10 0,20 1,25 0,15 1,15 0,05 0,90 0,25 10Y-2Y 1,85 1,65 0,40 1,70 0,30 1,40 0,05 1,15 0,25
30Y-10Y 0,10 0,10 -0,15 0,15 -0,05 0,25 0,05 0,30 0,15 30Y-10Y 0,58 0,55 -0,25 0,50 -0,20 0,55 0,00 0,60 0,10
United States Spot 05-03-2012 30-06-2012 31-12-2012 31-12-2013 United States Spot 05-03-2012 30-06-2012 31-12-2012 31-12-2013
Leading rate 0,25 0,25 0,00 0,25 0,00 0,25 0,00 1,75 0,00 Leading rate 0,25 0,25 0,00 0,25 0,00 0,25 0,00 1,75 0,00
3M 0,53 0,60 0,00 0,55 0,00 0,50 0,00 2,10 0,00 3M 0,53 0,60 0,00 0,55 0,00 0,50 0,00 2,10 0,00
2Y 0,69 0,70 0,00 0,80 0,00 1,35 0,00 3,50 0,00 2Y 0,26 0,20 0,00 0,40 0,00 1,05 0,00 3,10 0,00
5Y 1,34 1,25 0,00 1,40 0,00 2,10 0,00 4,00 0,00 5Y 0,94 0,80 0,00 1,00 0,00 1,75 0,00 3,65 0,00
10Y 2,22 1,90 0,00 2,15 0,00 2,85 0,00 4,25 0,00 10Y 2,06 1,70 0,00 1,95 0,00 2,65 0,00 4,00 0,00
30Y 2,76 2,50 0,00 2,80 0,10 3,85 0,00 4,65 0,00 30Y 3,06 2,80 0,00 3,10 0,10 4,00 0,00 4,75 0,00
5Y-2Y 0,65 0,55 0,00 0,60 0,00 0,75 0,00 0,50 0,00 5Y-2Y 0,69 0,60 0,00 0,60 0,00 0,70 0,00 0,55 0,00
10Y-2Y 1,53 1,20 0,00 1,35 0,00 1,50 0,00 0,75 0,00 10Y-2Y 1,81 1,50 0,00 1,55 0,00 1,60 0,00 0,90 0,00
30Y-10Y 0,54 0,60 0,00 0,65 0,10 1,00 0,00 0,40 0,00 30Y-10Y 1,00 1,10 0,00 1,15 0,10 1,35 0,00 0,75 0,00
Niels From, Global Rates Strategist Morten Hassing Povlsen, Rates Strategist
niels.from@nordea.com +45 3333 1435 morten.povlsen@nordea.com +45 3333 1726
Anders Matzen, Chief Euro-zone Analyst Johnny Bo Jakobsen, Chief US Analyst
anders.matzen@nordea.com +45 3333 3318 johnny.bo.jakobsen@nordea.com +45 3333 6178
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