Weekly Focus Fiscal cliff negotiations will go to the edge doc

Source: Reuters EcoWin, Danske Bank Markets Source: Reuters EcoWin, Danske Bank Markets 21 December 2012 Important disclosures and certifications are contained from page 21 of this repo

www.danskeresearch.com

Investment Research

Market movers ahead

• Market attention is likely to centre on the fiscal cliff negotiations, as the deadline is

moving closer President Barack Obama and House speaker John Boehner still have

five days after Christmas to strike a deal but it is possible that the US will go ‘over the

cliff’

these are released in the first week of the new year

Global update

German ifo figures that signalled improvement going forward

minister’s first priority will be to push Japan out of recession with additional fiscal

easing and increased pressure on the Bank of Japan for more aggressive QE

we expect the Riksbank to deliver another rate cut in April

course of 2013

Focus

• Nordic Outlook - December 2012, 20 December The Nordics are all true triple-A

characterised by strong fundamentals

The Swedish economy is set for lower growth and we expect unemployment to

increase due to weakness in exports

the housing market is beginning to give cause for concern Finland is on the verge of

recession and growth is not likely to pick up much in the near future

• We wish all our readers a Merry Christmas and a Happy New Year

Euro area leading indicators have

98 00 02 04 06 08 10 12

25 30 35 40 45 50 55 60 65

-75

-50

-25

0

25

50

75

100

<< ZEW expectations Ifo expectations (minus 50) >>

PMI manufacturing >>

00 02 04 06 08 10 12

-800 -600 -400 -200 0 200 400

-800 -600 -400 -200 0 200

400 1000 persons 1000 persons

MoM

Private payrolls, 3 mth avg.

Source: Reuters EcoWin, Danske Bank Markets Source: Reuters EcoWin, Danske Bank Markets

21 December 2012

Important disclosures and certifications are contained from page 21 of this report

Editors

Allan von Mehren +45 4512 8055 alvo@danskebank.dk Steen Bocian +45 45 12 85 31 steen.bocian@danskebank.dk

Weekly Focus

Fiscal cliff negotiations will go to the edge

Contents

Market movers ahead 2

Global Update 6

Scandi update 8

EMEA Update 9

Latest research from Danske Bank 10

Rates: The outlook for 2013 11

FX: More dollar and yen weakness in 2013 12

Credit: Happy (Holi)days 13

Financial views 14

Macroeconomic forecast 16

Financial forecast 17

Calendar – Key Data and Events in Week 52 18

Calendar – Key Data and Events in Week 1 19

Financial views

Major indices

21-Dec 3M 12M 10yr EUR swap 1.62 1.75 2.15 EUR/USD 132 134 132

21-Dec 6M 12-24M S&P500 1444 -5% to +5% 5%-10%

Read more on Page 17

Source: Danske Bank

Two releases will dominate the US calendar in the next two weeks – the ISM

manufacturing index and the December employment report

, both released after New Year The Markit PMI has been above the ISM in the last couple of months and the

flash PMI increased substantially in December It will be interesting to see if the ISM

index increases to reduce this gap We expect at least some improvement in the ISM

but we need some more data to make our final estimate The ISM report should also

bring some indications of how the fiscal cliff debate has affected business sentiment

change in payrolls and the unemployment rate

• Also of very high interest in the first week of 2013 is the release of the

The distortions from Hurricane Sandy seem to have faded and the jobless claims are now below their pre-Sandy level This

indicates that we should get another decent employment report with a relatively large

addition to payrolls

minutes from the December FOMC meeting

As the FOMC at the December meeting introduced numerical threshold values for inflation and unemployment to be used as an interest

rate tool, the minutes will be of special interest They should give some insight in how

the threshold values have been decided and what considerations different members of

the committee have made

Conference board consumer confidence

as the most interesting one We expect consumer confidence to fall from 73.7 to 70.0, thereby mirroring the drop in the

Michigan measure of consumer sentiment Consumer sentiment is likely to be

affected by the fiscal cliff negotiations, where the outcome might be an increase in

income taxes

fiscal cliff

on 31 December if no agreement is reached We will therefore follow the negotiations to see

if a solution is found before the deadline

retail sales are expected to have improved decently in November after a sharp October decline

French final Q3 GDP figures are released on 28 December No surprise outcome

expected A Christmas speech by Merkel is broadcast on 25 December and a new year

speech on 31 December Next year we start out with final December PMIs, which are

expected to confirm signs of modest improvement German and euro area inflation

data will probably not be that exciting as ECB governor Mario Draghi shows little

concern about inflation and all data signal that he has no reason to be – at least for

now We might see a pick-up in German core inflation in the medium term though, as

money growth has gained substantial momentum Euro area M3 might send more

December after eight consecutive months of increasing unemployment

Money growth signals growth pick-up

96 98 00 02 04 06 08 10 12

-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0

-13 -9 -5 -1 3 7 11 15

M1 growth, 6 month lead

Euro area GDP

Source: Reuters EcoWin

Will ISM close the gap?

35 40 45 50 55 60

30 35 40 45 50 55

60

Index ISM

Markit Flash PMI Index

Source: Reuters EcoWin

Employment on the way up

00 02 04 06 08 10 12

-800 -600 -400 -200 0 200 400

-800 -600 -400 -200 0 200

400 1000 persons 1000 persons

MoM

Private payrolls, 3 mth avg.

Source: Reuters EcoWin

German unemployment increased

'000 persons

Jan Apr Jul Sep Dec Mar Jun Sep

-50 -40 -30 -20 -10 0 10 20

-50 -40 -30 -20 -10 0 10 20

Source: Reuters EcoWin

growth in manufacturing activity The flash estimate for HSBC manufacturing PMI

already released improved to 50.9 in December from a final reading of 50.5 in

November It should be remembered that the sample used for the December flash

estimate was collected very early in December and was relatively small and for that

reason we would not be surprised if the final estimate for the HSBC manufacturing

PMI is revised higher We expect the NBS manufacturing PMI

• Focus in Japan will be on the political developments after the landslide victory for

the Liberal Democratic Party (LDP) in connection with the Lower House election last

weekend The new prime minister and the new LDP-led government will be

inaugurated on 26 December and in the financial markets there will be particular

interest in who will get the economic portfolio in the new government Former prime

minister Taro Aso is rumoured to be Abe’s first choice as finance minister A flood of

economic data for November will also be released between Christmas and New Year

We expect

in December to improve 51.3 from 50.6 in November, broadly in line with the HSBC manufacturing

PMI

industrial production to decline -1.1% m/m in November after increasing 1.6 m/m in the previous month Production plans suggest that industrial production

will recover markedly in December, so the overall picture is that industrial production

has started to stabilise in late 2012 This should also be evident in the JMMA/Markitt

manufacturing PMI, which we expect to stabilise in December However, we expect

the labour market data for November to be weak as the contraction in GDP in Q3 and

Q4 increasingly weighs CPI inflation

Scandi

is also expected to ease from 0.0% y/y to -0.1%

y/y underscoring that Japan is still far from achieving its current inflation target

We do not think growth is currently high enough to stabilise the labour market and

therefore expect an increase of 1,000 to 166,500 The same day brings figures for the

Nationalbank’s foreign exchange reserves, which will be interesting to follow because

the bank is expected to intervene to the tune of DKK5-20bn before raising rates

unilaterally The data will thus give an indication of whether a rate increase is

imminent The previous day sees the release of manufacturing sentiment

November

, which we expect will fall from 2 in November to 0 in December, pulled down primarily by non-

oil exports and industrial production, both of which have fallen in the last two

releases

trade balance and retail sales

both have bearing on Q4 GDP and should serve to confirm negative growth (q/q) Plunging December consumer confidence

suggest that retail sales may be quite weak The chart shows higher perceived risk of

being unemployed (red line) against retail sales growth (blue) The key issue with

these figures is whether they indicate that growth will be in line with the Riksbank

forecast (-0.2 % q/q) or not We forecast a weaker number, hence expect some

support for that view

manufacturing and services PMI

•

are released German manufacturing PMI has stabilised, implying the very depressed Swedish ditto may

show some upward correction Swedish services PMI also appears set for a small

upward correction The uncertainty here is whether the sagging labour market will

continue to weigh on this sector

Manufacturing PMIs is expected to improve further in December

07 08 09 10 11 12 40

45 50 55 60

-4 -2 0 2 4 6 8

60 80 100 120 140 160

180,000 persons ,000 persons

Source: Reuters EcoWin

Weaker retail sales ahead

Source: Macrobond

new year brings the

growth is likely to have remained at 4.5 %, where it has flattened out over the past couple of months This growth rate is still too high to

stabilise the household debt ratio, currently at about 170 % of DI and the main

restriction on additional monetary easing

PMI

Market movers ahead — Week 52

for December, which will give us a better picture of the state

of the Norwegian industry at the close of the year Having been very volatile over the

summer, the PMI has stabilised towards the end of 2012, tending towards a gradual

brightening of the outlook for Norwegian manufacturers In November the index

moved above the critical level of 50 (separating growth from contraction) for the first

time since May The underlying data were somewhat less encouraging, though, with a

fall in the new orders index and a rise in the inventories index This may mean that the

potential for a further increase in the PMI in December is limited On the other hand,

there are signs that global industrial indicators have stabilised or improved in

December, potentially reducing the negative contribution from export markets The

domestic market is still being driven by oil-related industries but activity levels, while

still high, were probably somewhat lower towards the end of the year We therefore

expect the PMI to be largely unchanged in December at 50.0

16:00 USD New home sales 1000 (m/m) Nov 374 (1.5%) 380 (3.3%) 386 (-0.3%)

0:30 JPY CPI - national ex fresh food y/y Nov -0.1% -0.1% 0.0%

0:50 JPY Industrial production, preliminary m/m|y/y Nov -1.1%| 1.6%|-4.5%

8:45 FRF GDP, final q/q|y/y 3rd quarter 0.2%| 0.2%|0.1% 0.2%|0.2%

Source: Bloomberg and Danske Bank Markets

Recovery in industry

Source: Reuters EcoWin

Market movers ahead — Week 1

20:10 DEM Merkel's New Year speech

20:00 USD Minutes from FOMC meeting

Fri 04-Jan 9:00 DKK Gross unemployment s.a K (%) Nov 166.500 (6.4%) 165.500 (6.3%)

Source: Bloomberg and Danske Bank Markets

Weekly Focus

Global Update

US: Merry Cliffmas

Despite progress in negotiations, the US Congress failed to pass legislation that averts the

significant fiscal tightening about to hit th e US economy on 1 January if nothing is

done President Obama and House speaker Boehner still have five days after the

Christmas holiday to strike a deal but the clock is ticking Thursday night Boehner

dropped a House vote on his so-called Plan B, which included tax hikes for those earning

more than USD1m per year, and the Congress has now left for Christmas holiday but will

return on December 26 There is still time for Obama and Boehner to reach a

comprehensive mega-deal, which includes a solution to the immediate fiscal cliff issue

for 2013, a framework for spending cuts over the coming decade and an increase of the

debt ceiling about to be hit in February/March next year However, a just as likely

scenario is that we get a mini-deal, which will bridge the fiscal cliff by extending the

Bush tax cuts for the majority of American households and indexing the AMT for

inflation, but which does not include raising the debt ceiling or a framework for the

longer-term budget This will ease the immediate fiscal blow to US households but will

leave political uncertainty high, as politicians will face another round of fierce

negotiations in February or March when the debt ceiling becomes binding

Turning to economic data received over the past week, it has generally been good The

housing market continues to show higher activity and rising prices In the manufacturing

sector the December flash PMI jumped to 54.2 from 52.8 and the details were good This

stands in stark contrast to the below-50 reading on the ISM for November Which of the

two surveys is right is too early to say but the jump in the Philly Fed survey for December

does suggest that the ISM is likely to move above 50 again in December

Europe: leading indicators signal improvement

The data released the past couple of weeks continue to surprise to the upside in the euro

area The euro area surprise index has moved above zero in line with the equivalent index

from the rest of the world This week it was the German Ifo figures that surprised to the

upside The Ifo expectations index jumped to 97.9 in December from 95.2 in November –

the highest level since May This level is slightly below the average value for this index

Ifo current conditions decreased to 107.1 from 108.1 Despite the decrease in the current

conditions this index has remained remarkably resilient in terms of the level Germany

avoided recession in Q3 and the leading indicators for Q4 indicate that growth has been

stalling and negative growth in Q4 cannot be ruled out The improvement in Ifo, PMI and

ZEW indicate improvement going forward, see also Flash Comment Germany: Ifo points

to further improvement, 19 December The improvement in the leading indicators has

weakened the case for an ECB rate cut in January, which we never bought into

US housing activity trending up

0.2 0.4 0.6 0.8 1.0 1.2 1.4

0 10 20 30 40 50 60 70

80

<< New home sales relevative

to 5yr moving average

NAHB

Source; Reuters EcoWin, Danske Bank

Economic surprise index is improving

in the euro area

Source: Macrobond, Danske Bank Markets

Leading indicators have bottomed

98 00 02 04 06 08 10 12

25 30 35 40 45 50 55 60 65

-75 -50 -25 0 25 50 75 100

China: government signals status quo on economic policy

In China the Central Economic Work Conference (CEWC) was held 15-16 December

CEWC is a joint meeting between the government and the leadership of China’s

Communist Party where the strategy for economic policy for 2013 is discussed The

overall message from CEWC is status quo for macroeconomic policy and more focus on

longer-term structural reforms Monetary policy will remain ‘prudent’, which is Chinese

terminology for neutral Fiscal policy will remain ‘pro-active’, which usually means a

moderately loose fiscal policy The statement from the meeting did not include specific

targets for GDP growth and inflation However, according to press reports, the target for

GDP growth will remain unchanged at 7.5% and the inflation target for 2013 will be cut

to 3.5% from 4% for 2012 The government will probably not announce the target

officially until the National People’s Congress in March 2013 It should be remembered

that these targets for growth and inflation should not be regarded as forecasts but rather as

critical levels where the government feels it will have to respond with policy adjustments

Japan: landslide LDP victory paves the way for more easing

The Liberal Democratic Party (LDP) won a landslide victory in connection with the

Lower House election and together with its usual coalition partner, New Komeito, LDP

will have a super-majority that allows the Lower House a possible majority in the Upper

way for Abenomics, 17 December Hence, LDP will be in a strong position to push

through its political agenda The new prime minister Shinzo Abe’s first priority will be to

push Japan out of recession and the new government is expected to announce additional

fiscal easing soon after the government has been inaugurated on 26 December The main

weakness with the Abe’s economic strategy is its apparent disregard for longer-term

structural economic reforms and consolidation of public finances If a planned increase in

sales taxes in 2014 is postponed, Japan’s rating could be downgraded by the rating

agencies

LDP has also been campaigning on more aggressive easing from Bank of Japan (BoJ) and

the new government will be in a strong position to influence BoJ through the appointment

of two new deputy board governors in March and a replacement for governor Masaaki

Shirakawa whose term expires in April LDP has also opened up for possibly changing

the BoJ law to force BoJ to ease more aggressively BoJ in connection with this week’s

monetary meeting expanded its asset purchase programme by JPY10trn to JPY76trn, see

Flash Comment Japan: BoJ could raise inflation target at next meeting, 20 December

The implication is that the pace of BoJ’s asset purchases will accelerate slightly to close

to 9% of GDP in Q1 13 from about 8% of GDP in Q4 12 For comparison, the Fed’s

planned purchases of government bonds and mortgages is expected to be close to 6.5% of

GDP in 2013 Hence, monetary policy is already being eased quite aggressively in Japan

In the statement BoJ also said it will discuss the inflation target at its next meeting on

20-21 January We now expect the inflation target to be raised from 1% to 2% in connection

with that meeting

Status quo in China

Monetary Fiscal GDP Inflation

Source: Danske Bank Markets

Asset purchases poised to accelerate slightly next year

2 4 6 8 10 12

0 2 4 6 8 10

Denmark – fall in confidence has not hit spending

Thursday’s consumer confidence figures showed a fall from -1.3 in November to -4.7 in

December Although the indicator typically falls slightly in December, the decrease was

somewhat larger than expected Nevertheless, private consumption is moving in the right

direction: Thursday’s retail sales data for November showed an increase of 0.6% m/m and

the same picture emerges from Dankort debit card transactions, which trended upwards in

Q4 Finally, we released a new forecast for the Danish economy during the week We

now expect the economy to expand by 0.7% in 2013 and 1.6% in 2014 after contracting

by 0.5% this year This is not, however, expected to be enough to stabilise the Danish

labour market in the short term, so we will probably see a decrease in private sector

employment in 2013

Sweden – expect another cut from the Riksbank in April

The Riksbank cut the repo rate by 25bp to 1.0% as expected earlier this week The repo

path signals an unchanged rate from here and future hikes were again pushed out into the

future The Riksbank justified the cut by arguing that recent economic developments

(including inflation) had been weaker than expected and that this weighed more than

households’ high debt ratio this time

NIER’s December confidence survey rose slightly on the back of improving sentiment in

manufacturing and private services That said, confidence is still at levels suggesting Q4

GDP growth will be negative with possible spillover to Q1 13 A worrying sign is that

consumer confidence plunged in December, probably on the back of the acceleration

deterioration of the labour market, which suggests that private spending may be in for a

squeeze over the next couple of months This is also indicated in household spending

plans

As downside risks still dominate the economic outlook, we have revised our call on the

Riksbank We now see another 25bp rate in April Unless there is a very sharp

deterioration in economic activity over the next couple of weeks, a February cut seems

unlikely as the Riksbank still wants to move very gradually

Norway – nothing new from Norges Bank

As expected, Norges Bank left interest rates alone at the year’s last rate-setting meeting

Also, there were no new signals about future interest rates Indeed, deputy governor Jan

Qvigstad said that there was ‘no reason to amend the interest rate projections [from

October] and we are still assuming that the first rate increase will come in March, May,

June or September’ This was possibly somewhat less aggressive than many had expected

given the appreciation of the krone and the rate cut in Sweden The reason for the bank

standing by the interest rate path published in October is quite simply that economic

developments have been largely as expected since then The bank acknowledges that

growth in Europe may turn out weaker than it thought but a number of measures have

been agreed that could improve the situation One interpretation of this is that the point

estimate for growth in Europe is now somewhat lower but so is the downside risk The

absence of fresh signals from Norges Bank means that we still expect two hikes in

Norway in 2013 The biggest risk to our prediction is, of course, further appreciation of

-20 -15 -10 -5 0 5 10 15

20 Net bal. Net bal.

Source: Reuters EcoWin

Plunging consumer confidence

Source: Macrobond

Strong NOK results in low rate

Source: Reuters EcoWin

Fed , BoJ and BoE to help EMEA markets in 2013

2012 has been a surprisingly good year for the EMEA currencies and particularly the

Polish zloty and the Hungarian forint have seen fairly strong gains We think there are

overall two reasons for the fairly positive performance First of all, the euro crisis – even

though certainly not over – has eased somewhat and fears of a disintegration of the

European currency union have been reduced Second and equally if not more important,

the Federal Reserve has stepped up monetary easing, which has done quite a bit to

improve global risk appetite and that is certainly positive for the EMEA currencies

However, the positive performance of the EMEA currencies has effectively also meant a

tightening of monetary conditions in the region and this, combined with very weak

growth in most of the eurozone, has hurt EMEA growth over the past couple of months

Fairly strong currencies and weak growth have triggered interest rate cuts across the

region in 2012 and we expect more monetary easing in 2013 Growth looks set to recover

slowly and inflationary pressures are nowhere to be seen

Looking at 2013 we are fairly optimistic that most of the region’s currencies will do well

as the Bank of Japan and the Bank of England are likely to take the lead from the Federal

Reserve and step up monetary easing That should make carry trades attractive –

something that certainly will help the EMEA currencies

With currencies likely to remain fairly strong and to potentially get even stronger we

expect most EMEA central banks to continue to ease monetary policy That should

eventually help the recovery to get under way in the region but we certainly do not expect

a boom in 2013

Concluding, 2013 is likely to be a fairly good year for the EMEA currencies, rates should

continue to drop and we are likely to see a moderate recovery in growth across the region

Read our trade recommendations for EMEA markets in 2013 in FX Top Trades 2013, 5

December (page 13 and 14) and in EM Bond Snapshot, 18 December

Chief Analyst Lars Christensen +45 45 12 85 30

larch@danskebank.dk

Analyst Stanislava Pravdova +45 45 12 80 71 spra@danskebank.dk

Latest research from Danske Bank

20/12 Nordic Outlook - December 2012

Quarterly update on the Nordic economies

20/12 Flash Comment - Japan: BoJ could raise inflation target at next meeting

Bank of Japan at today's monetary meeting raised the ceiling for its asset purchases by

JPY10trn to JPY76trn It now looks increasingly likely that Bank of Japan will raise the

inflation target in January

19/12 Flash Comment: Germany - Ifo points to further improvement

The Ifo expectations is rebounding in December and points to further improvement in the

coming months

18/12 Flash Comment - Riksbank update

The forecast update from the Riksbank released today is a fairly standard style document

In short: temporary weakness in 2013 followed by a gradual return towards trend

Danske Bank's EMU poll: Only one in eight Danes would definitely vote Yes to euro

Only one in eight Danes would vote Yes to the euro if a referendum were held today, the

lowest since our EMU survey began in 1999

17/12 Yield Forecast Update - Curve steepening to continue

Monthly yield forecast update

17/12 Flash Comment - Japan: landslide LDP victory paves the way for Abenomics

The Liberal Democratic Party won a landslide victory in connection with the Lower

House election and LDP will be in a strong position to push through its political agenda

11 | 21 December 2012 www.danskeresearch.com

Rates: The outlook for 2013

Where to search for yield next year?

This year has seen very good performance in almost every fixed income market Core

markets, periphery, high yield and high grade have all performed very well With central

bank rates at zero and long bond yields very low, many investors will ponder where to

pick up the yield next year As always, it seems to be no easy task, but as always

opportunities will show up along the way Many of them we cannot see yet but we outline

below some of the themes that we will be looking for next year

# 1: Short end to stay anchored

Global central banks remain in easing mode and although there are signs of improvement

in both global and European economic data, the big central banks are not likely to raise

rates in the next couple of years Hence, short rates will remain fairly anchored This

implies that the environment for carry and roll down trades in the shorter end of the curve

will remain intact

# 2: No big sell-off in EUR core 10-year segment

We believe that the 10-year segment will continue to be range bound through most of

H1 13 The recovery is set to remain moderate and central banks will focus on the huge

negative output gap in the economy Currently, we are in the lower part of that range, but

if the economy improves, as we forecast, then we should move back to the higher end

However, we do not expect German or Danish 10-year government bond yields to move

above 2% anytime soon

# 3: Very long end to remain steep

Since June the very long end of the EUR swap curve has steepened This is driven by the

change of the discount curve for the L&P sector in several countries In Denmark, many

pension clients are now moving into market-based pensions We expect this flow to

continue adding steepening pressure on the long end of the curve next year Moreover, the

very aggressive balance sheet expansion from global central banks – most noteworthy the

Fed and BoJ – will eventually push long-term inflation and growth expectations higher, in

turn moving back-end forward rates higher

# 4: US to underperform Europe

The spread between USD and EUR rates is expected to widen next year, as the US

macroeconomic outlook is better than the European Furthermore, the Federal Reserve is

much more aggressive in its unconventional policy easing and credit is starting flow in

the US Next year the Federal Reserve will print 6-7% of GDP, while the ECB balance

sheet could actually shrink as the banks pay back the LTRO money

# 5: Spread compression to continue

The spread normalisation in the European periphery markets is expected to continue The

ECB OMT is deemed credible by the markets and Spain and Italy are likely to return to

positive growth late next year In the current low rate environment, we expect investors to

continue to move into lower credit and further out on the curve

Returns in the fixed income markets

Source: Macrobond financial

Global government bond returns

Source: Macrobond financial

European government bond returns

Source: Macrobond financial