The economic outlook for the euro zone has worsened and the euro crisis has esca- lated. Our economists now anticipate that the ECB will lower the refi rate by 25bp (see link) and for the situation to worsen over the coming month. (see link)
The negative focus on Spain is unlikely to go away anytime soon and it seems appar- ent that the capital needs for the Spanish banks are significantly larger than assumed by the local authorities.
We expect Spanish government bonds to continue to underperform and the key ques- tion is how the ECB will react if ten-year yields climb above 7%. Restarting the secu- rities market programme (SMP) will, in our view, only create more sellers in the mar- kets because the programme has not been communicated properly and as investors have learned that they are subordinated to the ECB in the instance of debt restructur- ing. We do not think the ECB is ready for bold action yet, so sentiment is expected to worsen before it gets better.
We adjust our EUR and USD interest rate forecasts lower. On a three-month time horizon we assume rates will stay roughly flat in the US and European swap markets. However on a one-month horizon we see downside risks to rates. The forecasts are below the forwards markets on a three-month time horizon. We do not rule out new record lows in either German Bund yields or US Treasury yields. Furthermore, for shorter-dated German bonds we can imagine more negative yields than already seen. Denmark is expected to trade through Germany.
On a six to twelve-time horizon we anticipate a gradual rise in global rates and these forecasts are above the forward markets. This outlook is based on macroeconomic stabilisation over the summer and no EUR break up.
Potential triggers for more positive sentiment would be global central bank action and if progress is made in creating a common pan-European set-up for banking deposit insurance. Obviously it would also be positive if progress is made in creating euro bonds but that seems unlikely in the near future.
On the back of this outlook, the Danish central bank is now expected to deliver two more independent rate cuts of 10bp over the next couple of months, on top of the interest rate reduction of 0.25% in the lending rate that the ECB is expected to trigger automatically in June. This means that the certificates of deposit rate, currently 0.20%, is expected to hit 0.0% over the coming months. The lending rate, now at 0.6%, is expected to hit 0.15%.
Thus, Denmark - for the first time in history – will have a zero interest rate policy if the certificates of deposit rate is considered. We do not exclude the possibility that the certificates of deposit rate might end up being negative.
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