Bancherul - BANCI / ENGLISH / Danske Bank: Lower yields ahead

Latest market developments:

Western governments have effected major rescue actions in recent weeks to ease the credit crisis and stabilise the markets. Signs are already emerging that the measures are having the desired effect, and we expect to see a significant improvement in the money and credit mar-kets in the coming months. Despite this, a recession in Europe and US now seems unavoidable, in our view. Together with the sharp fall in commodity prices, this will open the door to further central bank support for growth, and we expect additional rate cuts from all the major central banks, with the ECB tak-ing rates down to 3% in the course of H1 09.

Macro outlook: The financial crisis has tipped the US economy into recession. Despite some help from fal-ling energy prices, the outlook is for the economy to continue to deteriorate for the rest of the year and into early 2009, with a downturn in both consumption and investments. The intensification of the credit crisis, a still declining housing market and a weakening labour market mean that it will be quite some time before the economy begins to right itself. An emerging upswing is not expected until H2 09, and unem-ployment will not begin to correct until the start of 2010.

The Euroland economy has also entered recession. Falling global growth is hitting export and investment activity, and there are increasing problems in a number of housing markets. Consumption is also down in the wake of the steep price increases in the spring, rising unemployment and declining net wealth.

The outlook for growth will remain gloomy some way into 2009, though sliding commodity prices mean that in-flation in Euroland will retreat rapidly, and so there is a likelihood of the ECB inflation target of 2% being reached as early as the middle of next year.

Central banks and bond yields: The US Fed has resumed cutting interest rates. Given the gloomier out-look, we expect further cuts to 1.0% by the end of the year. Rates will remain unchanged throughout 2009. Swap rates look set to fall further in the coming three months due to the narrowing of credit spreads and the deterioration in the economic data. After this, yields are expected to gradually increase during 2009.

The ECB will cut three more times, bringing the key ECB rate down to 3.0% by spring next year. Due to this and as a result of improvements in the credit markets, swap rates will fall over the coming six months, and begin to rise again around summer 2009.

Yield curves: The US yield curve may steepen a little more in the short term, but as the Fed stops cutting and the economy begins to stabilise next year, the curve will flatten again. Lower yields in Euroland and easier monetary policy will mean a steeper yield curve in Euroland in the coming 3-6 months. In the longer term, the curve will flatten a little again.

Country spreads: Country spreads will be determined by central bank rates and monetary policy expecta-tions. In the short term, the Fed is expected to cut rates more than the ECB, meaning US bonds may per-form relatively better. In H1 09, the picture should reverse, with further ECB cuts and the Fed on hold.