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.
Central banks will continue setting the tone in 2017
The central banks and monetary policy have been in the driving seat of economic developments for a number of years and their activities will continue to set the tone during 2017. The Fed will continue its tighter monetary policy, although focus in the US will be on future fiscal policy. The fact that the ECB has signalled an extension of its QE programme indicates that it will continue to be a central player in the European bond markets.
Now that the ECB has stated that its bond purchases will continue throughout 2017, we are more convinced than previously that the Riksbank will continue its own bond purchases. This is insurance against the krona strengthening too quickly and too strongly. However, there are a few aspects which mean that we cannot completely rule out a lower repo rate. For more details, see page 4.
Continued steepening in sight
We saw huge interest rate movements in the aftermath of the US election, and this trend has continued. The Fed's re-pricing has been clear and the market is starting to approach two rate hikes in 2017. An increase in December is a dead certainty. The market is thus moving toward the Fed's own interest rate forecast. We see knock-on effects in the Swedish market and consider there to be scope for a steeper Swedish curve, which is supported by the increasingly strained labour market.
There continues to be a major, widespread shortage of dollars after the changed rules for US money market funds which took effect on October 14. The question is how far the Fed and other major central banks will allow this to go before they again start to utilise the facilities that are still available since the major financial crisis eight years ago.