In this edition of Fixed Income Insights, SEB's experts take a closer look at recent developments in the eurozone debt issue and conclude that the political system will continue to ensure a crisis is avoided. Market implications include continued upward pressure in intra-EMU spreads up until the EU summit in June, further macroeconomic concerns, volatility and lower risk appetite. With an acute crisis averted, the experts believe the ECB will continue to raise rates gradually, delivering its next hike in July followed by another in the fall.

1. THURSDAY
The Greek chicken race 26 MAY 2011
In this edition of Fixed Income Insights, we take a closer look at recent developments in the Euro- EDITOR
zone debt crisis and conclude that the political system will continue to ensure a crisis is avoided. Jussi Hiljanen
Market implications include continued upward pressure in intra-EMU spreads up until the EU +46 8 50623167
summit in June, further macroeconomic concerns, volatility and lower risk appetite. With an acute
crisis averted, we believe the ECB will continue to raise rates gradually, delivering its next hike in CONTRIBUTORS
July followed by another in the fall. Page 4 Olle Holmgren
+46 8 7638079
Take profit on SGB3105 vs. SGB3107 flattener
Driven by a flattening of the nominal curve and a slight increase in SGB3107 (2017) relative to
Elisabet Kopelman
SGB3105 (2015) BEI, our SGB3105 vs. SGB3107 flattener recommended on Mar 17 has almost
+46 8 50623017
reached its target. Given the carry outlook, we prefer to take profits on the position. Page 2
Expect further widening in swap spreads Anders Söderberg
Following the Swedish National Debt Office’s forecast of lower borrowing than either we or the +46 8 50623021
market had expected, SEK swap spreads widened with long spreads reaching and breaching our
end-2012 targets. We continue to expect wider swap spreads, revising our forecasts upwards.
Next Fixed Income Insights due on Jun 9
Due to public holiday on next Thursday (Ascension Day), next edition of Fixed Income Insights is due
on Jun 9.
SEK FRA curve (bps)
Who owns the Greek government debt?
(pie chart approx. figures. Boxes: likely effect of a 50% haircut) 60
Total debt ~€340bn Quake
EMU/IMF IMF 55 Intra-EMU spr
emergency loans
not likely to be EMU
15 w idening
written down 38 Greek and foreign 50
pension funds and
Other
other private 45
ECB will take a 115
investors will take
loss but has ECB
the full loss
bought its bonds 40 40
below par. It will
face additional
losses if Greek 35
banks default PIGS banks have
tiny exposures. 30
Greek Banks German and
Greek banks will 60
need capital Foreign banks French banks 25 Jun12 / Dec13
72 have most
injections of about
exposure but
€25bn to handle a
losses should be 20
50% write off
Jan 1
Feb 1
Mar 1
May 1
Apr 1
manageable
34
You can also find our research materials at our website: www.mb.seb.se. This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional
investors only. Information and opinions contained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate
or complete. No liability is accepted for any direct or consequential loss resulting from reliance on this document. Changes may be made to opinions or information contained herein
without notice.

2. Fixed Income insights
Central banks
ECB Fed Bank of England Riksbank Norges Bank
Current repo 1.25% 0.00-0.25% 0.50% 1.75% 2.25%
Next rate ann. Jun 9 Jun 22 Jun 9 Jul 5 Jun 22
Action expected Unch QE2 completed Unch +25bps Unch
Trades
Directional Levels & P/L Status
Swedish government bond portfolio (Jan 27). We track the OMRX T-bond index Return YTD Hold
and may deviate +/-1 year from benchmark duration. We changed portfolio duration SEB portfolio +2.87%
from neutral to 0.5y short on Jan 27. Index +3.09%
Sell a 2.90% put, buy a 3.10% call, sell a 3.30% call and sell a 3.40% call on Cost 0.5bps Hold
Dec11 SEK FRA (original position on May 5; modified on May 10). On May 10, P/L -17.8bps
we changed our Dec11 FRA call spread to a call ladder by rolling down the long call
by 10bps and selling the 3.30% call at a cost of 0.5bps. We expect the position to
generate a profit of 20bps. We express the P/L including the cost of 0.5bps.
Sell a 3.40% put on Jun12 SEK FRA (Feb 10). When the position was established, Upfront premium 33bps Hold
Jun12 traded at 3.40%. Now 44.3bps
P/L -11.3bps
Sell a 3.05% 2y in 1y SEK receiver swaption (Jan 13). Swaption expiry 12.1.2012. Upfront premium 57bps Hold
Swap dates 16.1.2012-16.1.2014. We expect the Riksbank to hike much more (non-annualised)
aggressively than discounted by the market. When the position was established, 2y Now 33bps
in 1y forward traded at 3.17%. P/L +24bps
Relative value Levels & P/L Status
Buy SGB1047 (2020), sell SGB1054 (2022) nominal vs. nominal and receive Established -106bps Hold
fixed in a SGB1047/SGB1054 fwd swap (May 19). We expect SGB1047 to be a Target -60bps
natural buy-back candidate in the NDO’s exchanges vs. SGB1054 on May 30 and 31, Stop -125bps
forecasting the SGB1047/SGB1054 curve to steepen and the SGB1047/SGB1054 Now -101bps
fwd ASW spread to tighten from current extreme levels. Carry is +0.2bps over 3m. P/L +5bps
Buy C1578 (2016) vs. C1577 (2015) in nominal vs. nominal and pay fixed in Established 125bps Hold
C1578/C1577 fwd SEK IRS (May 5). We regard 1y in 4y forward CB ASW spreads as Target 80bps
too wide relative to both current 1y spot ASW spreads and stressed levels prevailing Stop 145bps
during the financial crisis (Stadshypotek: 50-60bps). Now 120bps
P/L +5bps
Buy SGB3107 (2017) vs. SGB3105 (2015) in risk neutral terms (Mar 17). The Established 23.5bps Close
position has almost reached our target and we close it with a profit of 5.6bps Target 12bps
including carry of -4.9bps. Stop 28bps
Now 13bps
P/L +5.6bps
Buy Dec11 SEK FRA vs. Mar12 RIBA in risk neutral terms (Mar 3). When the Established 60bps Hold
position was established, pricing of FX forwards implied a 3m SEK TED spread of Target 100bps
100bps by year-end. We continue to see risks of wider TED spreads especially over Stop 45bps
IMM June due to large CB redemptions at that date. Now 49bps
P/L -11bps
Buy SEB566 (2013) vs. SEB565 (2012) nominal vs. nominal, pay fixed in 1y in Established 66bps Hold
1.3y fwd SEK IRS (Feb 24). The SEB565/566 (1y in 1.3y) forward ASW spread Target 20bps
trades at a relatively high level and significantly above the 1y spot SEB ASW spread. Stop 66bps
The position could withstand 1y covered bonds in 1y revisiting levels last seen at the Now 34bps
height of the financial crisis (~55-60bps). P/L +32bps
Buy-and-hold switch from OATei2012 to SGB3106 (2012) in risk neutral terms Established 136bps Hold
(Feb 24). This is a real money switch. In addition to a real yield pick-up of 136bps, Target n/a
we expect Swedish inflation accrual pending SGB3106’s maturity to exceed that of Stop n/a
the EMU. We recommend hedging FX using a zero-cost seagull strategy. To follow Now 85bps
up the switch, we express levels as a real yield spread. Currently, the total position P/L +51bps
P/L is -1.0%, including the currency component (cash & hedge) P/L of -1.13%.
Buy SGB1041 (2014) vs. SGB1046 (2012) nominal vs. nominal and pay fixed in Established -5bps Hold
an SGB1046/SGB1046 fwd SEK IRS (Jan 27). Although the position has reached Target -70bps
our initial target, as SGB1041 remains only slightly squeezed in the repo market we Stop -40bps
prefer to retain an open position with a revised target at -70bps. From Jan 27, 3m Now -59bps
carry is +5.6bps. P/L +54bps
Note: Until the position is closed, P/L is expressed without taking carry into account and using mid-prices.
2

3. Fixed Income insights
that the decline in long yields has gone hand in hand
Markets this week with downwardly revised central bank expectations
LOST HIGHWAY. Recent price action in European bond indicates that instead of being driven only by safe haven
and FX markets has been dominated by escalating Euro- buying, the decrease in long yields has been motivated
zone debt concerns, increasing uncertainty and a lack of by increasing uncertainty regarding real macroeconomic
political consensus. No one knows what a solution to the developments. In Sweden, current market pricing for
debt crisis will look like or how long it will take to devise. end-2011 is in line with the Riksbank’s own repo rate
This is especially so given adverse political conditions in path for end-2012 and ~40bps below it for end-2013. In
several EMU countries, the widening gap between the past two months, we have recommended positioning
politicians and voters and, to some extent, between for higher short rates via options (see “Trades”) in order
politicians and the ECB. While we maintain our main to obtain some downside protection relative to our
scenario involving restructuring Greek, Irish and forecast. Considering the current uncertainty we
Portuguese debt with Spain possibly also seeking a bail- certainly continue to prefer options positions.
out from the EFSF/ESM as outlined in Nordic Outlook,
Riksbank repo rate
May 17 (see “The path to European debt restructuring”
Market SEB Riksbank Market vs.
on pages 14-15), very recent market developments have
Effective pricing forecast Apr 2011
accelerated more dramatically than we had expected. As date Repo chg Repo chg Repo chg SEB RB
a result, our short duration Swedish government bond 2011-05-26 1.75 1.75 0 1.75
portfolio has not performed since mid-April when the 2011-07-06 1.99 24 2.00 25 1.94 19 -1 5
ongoing collapse of both short- and long rates began. 2011-09-14 2.19 20 2.25 25 2.10 16 -6 9
2011-11-02 2.30 11 2.50 25 2.28 18 -20 2
While uncertainty is high concerning near term bond
2011-12-21 2.43 13 2.75 25 2.45 17 -32 -2
market developments, we maintain our short duration 2012-02-15 2.50 7 3.00 25 2.55 10 -50 -5
for the time being, not least given the extent to which 2012-04-18 2.62 12 3.25 25 2.79 24 -63 -17
Swedish rates are stretched on the downside. 2012-07-04 2.68 6 3.50 25 2.89 10 -82 -21
2012-09-05 2.74 6 3.75 25 3.00 11 -101 -26
TECHNICAL OUTLOOK: SGB1050 (2016). Having 2012-10-24 2.79 5 3.75 0 3.05 5 -96 -26
passed our primary downside correction target of 2012-12-19 2.83 4 3.75 0 3.20 15 -92 -37
2.96%, the secondary target 2.76%, was activated. With 2013-02-13 2.86 3 3.22 2 -36
2013-04-17 2.89 3 3.35 13 -46
the market now having arrived and halted at the
2013-07-03 2.91 2 3.43 8 -52
resistance we stand ready looking for an upside print to 2013-09-04 2.93 2 3.50 7 -57
add confidence of a completed downside correction. A 2013-10-23 2.95 2 3.56 6 -61
return to above 2.99% will be the ultimate such a move 2013-12-18 2.97 2 3.60 4 -63
and more or less confirm that we will be back on track for 2014-02-13 2.98 1 3.65 5 -67
2014-04-17 2.99 1
new cycle highs. Breaking (and especially if closing)
below the 233d ma, 2.66%, we will take a more neutral STRETCHED ON THE DOWNSIDE. While recent Euro-
stance awaiting new directional guidance. zone developments make our repo rate forecast more
uncertain, we still regard SEK FRAs as stretched on the
Yield
downside. Interestingly, the market discounts rate hikes
totalling almost 100bps over the next 12 months, but
3 only 25bps between mid-2012 and early-2014 (see the
38.2% 2.761 front page chart). We reiterate our view that the Euro-
2.7 zone debt crisis alone should not justify this flat FRA
50.0% 2.588
curve tail given the low absolute level of green FRAs.
61.8% 2.416 2.4 While we regard it as attractive positioning for a
steepening of red vs. green FRAs, we prefer to await for
2.1 better timing to enter the trade due to currently
excessive volatility.
Sep Oct Nov Dec Jan Feb Mar Apr May Jun EXPECT FURTHER WIDENING IN SWAP SPREADS.
Q3 10 Q4 2010 Q1 2011 Q2 2011
Following the Swedish National Debt Office’s forecast of
lower borrowing than either we or the market had
LONG RATES DRIVEN BY LOWER RATE HIKE expected, SEK swap spreads widened with long spreads
EXPECTATIONS. The decline in long rates (around reaching and breaching our end-2012 targets. We
45bps both Germany and Sweden since mid-April) has continue to expect wider swap spreads and will publish
been accompanied by substantially lower rate hike revised swap spread forecasts early next week.
expectations concerning both the ECB and Riksbank
(around -50bps in EMU and -40bps in Sweden Jussi Hiljanen & Anders Söderberg
concerning end-2013 pricing of the repo rate). The fact
3

4. Fixed Income insights
Government deficit, % of GDP
Euro-zone debt crisis 2.5 2.5
INCREASING CONTAGION FEARS. The euro-zone
0.0 0.0
debt crisis continues to run its course while spread
widening between peripherals has intensified in recent -2.5 -2.5
weeks. So far 10y Spanish and Italian spreads have been -5.0 -5.0
relatively stable, having avoided following countries
-7.5 -7.5
receiving EU/IMF support higher.
-10.0 -10.0
10-year yield spreads to Germany
4.0 -12.5 -12.5
10 00 01 02 03 04 05 06 07 08 09 10 11 12
3.5
3.0 Forecast EU-commisson Spain
8
Italy
2.5 Forecast EU-commission
6
2.0
4 1.5 With the exception of Greece and Ireland budget and
Irel 1.0 debt forecasts for Euro-zone countries remain largely
2
0.5 unchanged according to the EU Commission. The
Italy
0 0.0 following chart summarizes budget and debt forecasts
08 09 10 11 for selected countries with budget deficits shown on the
Average Greece, Portugal, Ireland left hand scale and debt as a percentage of GDP on the
Italy bottom. Dots show the development in both debt and
Spain
deficit between 2009 and 2012. For example, the
Since Standard & Poors (S&P) put Italy on negative Spanish deficit is expected to decline to just over 5% in
outlook last week, spreads have begun to widen both 2012 from 9% in 2010, while Italian debt will stabilise at
there and in Spain. S&P justifies its negative outlook on around 120% of GDP. The chart also shows that Spanish
Italy more in terms of political uncertainty than either the debt remains below the Euro-zone average, with the
weaker than expected budget or growth outlook. same true for the Italian budget deficit. This suggests
Political gridlock is jeopardising much needed structural that confidence problems concern not only public
reforms and the commitment to reduce budget deficits. finances but also the general economic situation in these
While the economic outlook for both Italy and Spain countries. An illustration of possible threats to this
remains weak, it has not deteriorated further so far this situation is the increase in the Irish budget deficit to 30%
year. We forecast Italian GDP growth of around 1.5% in of GDP when the country’s banks required
both 2011 and 2012, with Spanish growth slightly lower. recapitalisation in 2010.
Eurozone public finances outlook (ECFIN)
0 Germany 0
Belgium Italy
2012
PMI, Composite
Gen.Government budget balance (% of GDP)
2012
-5 -5
65 65 2012
2012
-10 Spain -10
60 60 Portugal
2009
2009
Greece
-15 -15
55 55 2009
2009
-20 -20
50 50
-25 -25
45 45 Ireland
-30 -30
40 40
-35 -35
35 35 50 60 70 80 90 100 110 120 130 140 150 160
Government debt (% of GDP)
30 30
00 01 02 03 04 05 06 07 08 09 10 11 CURRENT ACCOUNTS REMAIN IN DEFICIT. Also of
Spain Euro Zone Italy concern, current account deficits remain large while the
improvement which occurred in Spain during 2008 has
BUDGETS IN LINE WITH FORECASTS. Both Italian and ceased. In our view this indicates that the adjustment
Spanish budget deficits are developing in line with process has further to run. Further, many questions
official forecasts with the EU Commission even making remain regarding the banking sector. We still think it
small downward revisions to its deficit forecasts in April. highly likely that Spain will eventually require an EU/IMF
rescue package.
4

5. Fixed Income insights
Current account balance, % of GDP ORDERLY RESTRUCTURING BUT NOT NOW. What to
make of it? Our view, as presented in our recent Nordic
0 0
Outlook, is that Greece will be unable to successfully
-2 -2 manage current government debt of around EUR 350bn,
equivalent to 150% of GDP. Some kind of “hard” (albeit
-4 -4
orderly) restructuring involving haircuts (amounting we
-6 -6 believe to around 50% of private debts) will be
necessary. For several reasons – not least the risk of
-8 -8
contagion to other PIIGS economies – we do not think
-10 -10 this will happen before 2012, at the earliest. Irrespective
of restructuring, new funds from the EMU/IMF will be
-12 -12
00 01 02 03 04 05 06 07 08 09 10 needed to, among other things, cover recapitalisation of
the banking sector. Well before the end of 2011, EU
Italy Spain
governments and the IMF will need to agree to extend
GREECE ON THE EDGE. Fears that Greece may default present support and/or ease its terms.
and worries about serious contagion effects on other
Euro-zone countries have increased recently, partly Who owns the Greek government debt?
(pie chart approx. figures. Boxes: likely effect of a 50% haircut)
triggered by conflicting official statements and clear
Total debt ~€340bn
signs of divisions between Euro-zone governments, the EMU/IMF
emergency loans
IMF
15
Greek authorities and the ECB. We regard this as part of not likely to be
written down
EMU
38 Greek and foreign
the political process and therefore not necessarily a sign ECB will take a
Other
pension funds and
other private
115
investors will take
that the will of European states to reach a solution has loss but has
bought its bonds
ECB
40
the full loss
been exhausted. In the following analysis we highlight below par. It will
face additional
several current key issues. We still believe the political losses if Greek
banks default PIGS banks have
system will once again do whatever it takes to avoid a Greek Banks
tiny exposures.
German and
Greek banks will
crisis while deferring more difficult questions till later. need capital
60
Foreign banks
72
French banks
have most
injections of about
Nevertheless, markets are likely to have a bumpy ride €25bn to handle a
exposure but
losses should be
50% write off
ahead of the EU summit in June. manageable
34
The Greek position and both how and when it is
addressed are now critical. The IMF’s fourth mission to REPROFILING CANNOT BE EXCLUDED. We do not
Greece is scheduled to result in a report in mid-June. believe soft restructuring or “reprofiling” involving
Unless further measures are taken the country will in all voluntary extension of the private sector’s holding of
likelihood not qualify for a further EUR 12bn instalment Greek sovereign debt will resolve the country’s
of its EUR 110bn loan facility due in June. If that happens, underlying problems. The main objective would be to
Greece says it will be unable to continue to repay lenders buy time, similar to the original but now failed rescue
i.e. effectively threatening a messy default. At the same package. Still, such a course carries a number of
time, the Euro-zone and the IMF have still not devised a attractive features.
solution on how to handle Greece next year when, Firstly, a voluntary extension would remove the almost
according to the original plan, it is meant to begin re- EUR 50bn of maturing principal that falls due between
accessing bond markets, something it will clearly be now and end-2012, representing almost all the nearly
unable to do. EUR 60bn left of the EMU/IMF loan (including EUR 20bn
So far the official stance has been that these problems in June). Consequently, the need to demand taxpayers
should be resolved by: throughout the rest of the EU to provide more funds for
Greece would diminish proportionately.
1. further Greek reform efforts and
Secondly, damage to Euro-zone banks holding Greek
2. Greek privatizations totalling around EUR 50bn. debt would probably be limited compared to a haircut.
Whether such measures would work is highly doubtful, According to an OECD study in Aug 2010 only 17% of
even if the Greek political system had faithfully bank exposure to Greek sovereign debt was held in
implemented all agreed measures. How, for example, will trading portfolios and therefore exposed to a
Greece find foreign buyers (a prerequisite for improving revaluation. The vast majority of strategic holdings
its external debt situation) for a fire sale of assets would probably not be affected in a way likely to trigger
belonging to a country teetering on the brink of default? any immediate large negative effects on either results or
Meanwhile the ECB is threatening to pull the plug on the capital.
Greek banking system in the event of restructuring – be
it soft or hard.
5

6. Fixed Income insights
Thirdly, the longer it takes before the private sector IMPORTANT EVENTS AHEAD. We see several key
becomes involved, the less debt will be held by it if and events going forward which will be crucial for the
when hard restructuring is in fact implemented. continued debt crisis negotiation process:
At the same time there are several issues to resolve  June 9. ECB meeting. If our forecast of a July hike is
concerning even soft restructuring. How should such an correct, we would expect the ECB to signal it in its
offer be constructed in order to attract sufficient lenders statement by regular wording. We see no major
without exerting too much upside pressure on the price changes to the ECB’s liquidity facilities.
of existing Greek bonds? Are private lenders willing to
voluntarily worsen their situation without any form of  Mid-June. IMF fourth mission report on Greece.
official guarantee from, for example, the EFSF/future We expect Greece to present measures sufficient to
ESM, one which would in fact only increase the risk justify payment of the next instalment.
borne by taxpayers? Could indeed such guarantees be
 Mid-June. European Stress tests published. The
extended without changing the situation for other bond
tests will not include scenarios involving sovereign
holders in a way that would be characterised as a credit
default or losses on the banking sector’s strategic
event and trigger, for example, CDS contracts? The
sovereign bond holdings. However, its individual
consequences for CDS contracts are ambiguous (for
sovereign debt exposure will become more widely
more, read the assessment of our credit strategist Jonas
known, increasing market discipline over respective
Ranneby here). Most importantly, it is difficult to assess
banks to raise capital. The stress test will be
the contagion effects on other PIIGS and whether such
followed by a procedure to strengthen capital
actions would only raise expectations of eventual hard
wherever necessary with the objective at least to
restructuring in Greece, and perhaps Ireland and
increase resistance to future debt restructuring.
Portugal too.
 June 5. Elections in Portugal.
As regards the ECB, its harsh statements are a part of the
negotiation game. We have a hard time believing the  June 20. Euro Group meeting. The group will need
bank would in fact act in a way likely to bring only to reach an agreement on the ESM, the rescue
disaster to the Greek economy and probably to the Euro- mechanism to replace the EFSF, and issues left
zone financial system as a whole. However, the ECB is unresolved at the March EU summit, including, for
likely to demand the recapitalisation of Greek banks, as example, private sector involvement. This will also
has been done in Ireland, as the price for continuing to make a future rescue package for Spain easier to
finance the Greek banking system in the event of a soft deal with, whenever it may become necessary.
restructuring. Markets will also expect a decision on how to
finance Greece beyond 2011.
 June 24. EU summit. Decision on the ESM.
Olle Holmgren & Elisabet Kopelman
6