The global economic climate continues to be strong. We see evidence of this in the US where most macro data is exceeding market expectations. The recent harvest of data from China confirms a strong start to the year. The trend in global inflation is also positive. Previous monetary policy stimulus measures are feeding into the economy and contributing to the improvement that we are now seeing. This forms the basis of increasing long yields.
Inflation is partly driven by earlier energy price rises. The price of oil falling to USD 40/barrel by year-end represents a risk to our view of inflation and long yields. Despite this, we still believe that interest rates will continue to rise. We address this on page 3.
Populist winds increase the risk in France
Macro data continue to show a stronger start to the year than expected, which forms the core of our view of increasing rates. While bond yields have recovered part of their recent loss, the drama has mainly been concentrated on US short-term interest rates, which have risen dramatically, and a Fed hike in March that is more or less a done deal (see page 3).
The European election year is on the starting blocks, with the Netherlands first out on March 15. We are on the lookout for political impacts on the financial markets and are finding plenty (see page 3).
The Swedish government, with the support of the Left Party, has put a stop to the proposed bank tax. This comes after devastating criticism about its structure from several referral authorities. However, this will be compensated by an increase in the resolution fee. Given that the fee is based on the balance sheet at year-end, we anticipate even greater effects in the short-term fixed income market during the last two weeks of the year (see page 5).
Macroeconomic view challenges Riksbank's staying power
There is currently an abundance of strong macroeconomic data. In our view, we are seeing the effects of the relaxed monetary policy of recent years feeding through to the economic system. A wave of upward revisions to GDP forecasts will be seen in the near future (Figure 1).
Swedish data is also coming in strongly; for example, the Swedish labour market appears to be increasingly tighter. The January inflation rate fell back compared with December, which was expected. Our view is that this does not change the trend toward increasing inflation during 2017. Despite this, the Riksbank is indicating that a reduction in the repo rate is more likely than an increase. Policy errors made during 2010 and 2011 are still in recent memory and are curbing the will for tighter monetary policy.
Repo rate path in focus for the Riksbank
We are approaching the first monetary policy decision of the year from the Riksbank - on February 15. The decision will be made in conditions that we have not seen for many years. Inflation is bordering on 2 percent, inflationary expectations (fairly good) are anchored around the inflation target, and the economic climate is pointing upward. We believe that the repo rate, the repo rate path and the QE programme will all remain unchanged. However, we think that the Executive Board will disagree about the repo rate path and a number of members will register dissenting opinions from the official line.
However the timing for a normalisation of the repo rate ends up, we are approaching the time when normalisation will start and the probability of it being brought forward in time is, in our opinion, significantly greater than it being put back. This makes it interesting to look at floating rate notes (FRN) and put them in relation to bonds with a fixed coupon yield.
Cyclical boost with or without the Trump effect
Expectations of a growth stimulus initiated by President Trump have been high since his unexpected election victory in November last year. Uncertainty about his policies are at least as great now as they were during the election campaign. However, there are reasons to believe that even without fiscal policy stimulus from the US, we are poised for a cyclical boost to global growth, led by that country. This will be driven by the earlier acceleration in global QE and the easier financial conditions associated with that. Inflation will likewise receive a boost. As a consequence, there is scope for further increases in long-term yields.
Snow and cold weather in Southern Europe are causing vegetable prices to soar. You might almost think that the Executive Board of the Riksbank had sent Jack Frost to the Mediterranean to boost Swedish inflation. We have rooted around the vegetable counters and spoken to industry experts to get an idea of the effect on the CPI.
Executive Board split regarding new measures
At first sight, there was nothing particularly remarkable about the Riksbank's final monetary policy decision for 2016. The repo rate is unchanged and the Riksbank will continue its bond purchases for another six months. However, if we consider that the Executive Board was totally split regarding the decision to make more bond purchases (two completely against and one in favour of half the amount), and that the possibility of more measures between the meetings is being removed, the tone is definitely more hawkish than expected.
We retain our view that the Riksbank has completed its monetary policy interventions. We believe the repo rate will be raised on the first occasion in H1 2018 and no further bond purchases will be decided. Concerning the repo rate, however, the risk scenario is tilted toward an increase toward the end of 2017.