SEE Weekly Analyst: Tajana Striga Above expected kuna bond issue? [email protected] +385 1 6033 522 SEE yields mixed Fed left monetary policy unchanged with key interest rates unchanged in line with market expectations. However, statement released after meeting was more cautious than expected whereby Fed members acknowledge improved consumer and business sentiment, but stays dovish on inflation still below 2% long-term target. All in all, until newly elected US president Trump details his planned fiscal expansion, the markets currently expect only two rate hikes in 2017, while FOMC baseline remains three rate hikes. Despite that, SEE yields saw rather modest moves this week, with Slovenian and Croatian USD yields down 9bp and 6bp, respectively, and Serbian USD yields barely rose by 4bp. Euro yields stayed unchanged in Slovenia and rose 4bps in Croatia. Locally, investors’ focus is on the next week's bond auction in Croatia, including two issues in kuna with 5Y and 11Y maturities. Given the generous HRK17bn excess liquidity and potential ECB tapering later this year, we expect the MinFin to issue in excess of HRK5.5bn maturity and place HRK7-8n to strengthen cash reserves ahead of the upcoming USD bond maturity. Subdued banks’ credit activity and new European rules on sovereign debt risk requirements also bode well for demand as well as recent S&P (- and Fitch) rating outlook upgrade from negative to stable that led to some 15bp spread tightening since then. We see 5Y and 11Y yields just below 2% and 3%, respectively, with the former subject do downside risks as the future buying conduct of ECB may shift meaningfully towards the sub 5Y sector and the CNB may resume easing focused on the medium part of the yield curve. CHART OF THE WEEK: YIELD CHANGE, (average) wow, bp 10 Source: Bloomberg, Addiko research 5 0 -5 -10 EUR USD EUR USD USD SLO CRO SRB Kuna appreciated, EUR/RSD stabile Croatian MinFin issued HRK800m of 1Y T-bills, surpassing not only the plan (HRK600m) but also redemptions (HRK626m), resulting in HRK174m higher stock of short-term debt. Despite ample interbank excess liquidity of roughly 5% of GDP, 1Y yield barely fell to 0.59% amid bid-to-cover ratio of 1.2x. Meanwhile, the kuna rallied almost 500 pips this week on the back of stronger corporate FC sales (and possibly institutional sales ahead of kuna bond issue), and, fundamentally, external and fiscal risks mitigation, with high likelihood of the EDP suspension this spring. The latter would thus pave the way for rating upgrades, in line with the recent outlook upgrades by S&Ps and Fitch from negative to stable. If anything meaningfully, depreciation pressures stem from the expected sporadic worsening of goods trade balance on the back of stronger goods import caused by domestic demand recovery and potential political instability in the euro zone given the number of forthcoming elections. The EUR/RSD traded range bound this week, with the NBS selling EUR15m in order to curb the dinar depreciation. That said, there are number of reasons for the dinar to continue to move around 124 barriers. Namely, stronger macro picture and risk profile, lower internal and external imbalances, improvement in banks’ net foreign asset and general NBS’ intolerance of the weaker dinar in view of 33% of external debt in USD(un-hedged) and stronger USD. Downside risks stem from political instability in case of material changes in the parliamentary math, US reflation and stronger USD as well as stronger import demand. Meanwhile, the NBS continued withdrawing excess interbank liquidity through repo while short end dinar rates stayed largely unchanged and we expect for the similar performance to continue in the short-term given still supportive external environment and expected 'on-hold' NBS stance on their next meeting in mid-February. *SEE Weekly editorial deadline: 4pm Thursday SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION SEE Weekly Economic Highlights Slovenia • Private consumption growth at its strongest pace since 2008. December's retail trade surprised on the upside in flash estimate as it soared 14.6% mom (working-day-adjusted) and fully matched the strong November's 10.2% yoy increase. Before a full data set publication by the end of February, we currently see that general department store sales, car purchases and higher number of trading days boosted the headline sales figure during the all-important x-mass period. For the 4Q16, retail trade surged 10.0% yoy, tripling its growth pace relative to Q3 average. December trade data combined by further improvement in consumer confidence gauges (EC sentiment up 2.2pp on Q3 average) on our calculations bode well at least 3.5% yoy household consumption growth in 4Q16 (the highest since the spring 2008) after 2.6% yoy in Q3, driven by accelerating 2.5%-alike (yoy) employment growth, easier financial conditions, accelerating retail credit, stronger consumer sentiment, despite temporary weakness in the overall wage growth dynamics. The sharp improvement in consumer confidence in January to its best level ever reflects ongoing public wage hikes (additional 4% wage and benefits hike this year after 6% in 2016), as well as better employment prospects. On Q4 GDP growth outlook, the expected surge in private consumption and stronger private (equipment) capex, notwithstanding fading boost from net exports, support our 0.7% qoq and 2.9% yoy forecast, implying the FY16 average GDP growth of 2.7%. • Rising inflationary pressures...? Next week we will see releases of inflation and merchandise trade data for January and December, respectively. For starters, CPI inflation is set to decline by -0.5% mom, with cheaper clothing prices (within usual post-holiday sales) and utility tariffs likely to offset resurgent oil and food prices. On a yoy level, CPI is seen soaring to 1.4% (highest level since the autumn 2013), largely reflecting the fact that the slump in energy prices at the start of 2016 drops out of the annual comparison. At the current level, Slovenian inflation is somewhat below the euro zone's, with some positive impact on competitiveness. Given the uncertain inflation outlook, we do not expect the ECB to change its monetary policy course until the core inflation rate rises lastingly.... as exports momentum stays intact. Meanwhile, we expect export growth to pick up to a 7%-alike (yoy) pace given the upside investment-driven surprises in the euro zone's activity in the eve of 2016. We can derive similar messages from better export order books as well as the increase in manufacturing capacity utilization to 84.7%. Merchandise import growth will also likely pick up on stronger import-driven domestic demand and higher commodity prices, leading to the overall slightly negative net trade contribution to Q4 growth. SEE Weekly Economic Highlights Croatia • Industrial output continues sprint in December... December’s seasonally adjusted industrial production sprinted 3.9% mom (prev. +2.7%), following already several months of decent monthly growth. Besides unusually higher number of working days, the strongest contribution came from non-durable goods (+6.5% mom), with all other segments outside the energy sector contributing positively as well (energy -1.6% mom). On the yoy level, industrial production soared 12.9% yoy, with 23.8% stronger energy generation in one of the coldest winters ever and very volatile refinery output, followed by 8.9% stronger non-durable goods being the main drivers. For the 4Q16, industrial production rose 7.2% yoy on average, thus well surpassing both 3.2% yoy increase in 3Q16 and 3.8% growth in 4Q15. Industrial production thus increased by 5.0% yoy for the FY16 on average. Meanwhile, manufacturing increased 7.1% yoy in 4Q16 mainly supported with stronger production of electrical equipment, fabricated metal products and pharmaceutical products. Such performance implies an 1pp-alike positive contribution to the GVA formation in final quarter of the last year. The latter alongside the expected 3.5%-alike increase in household consumption and slightly negative net trade contribution implies 3.5% GDP growth in 4Q16, shaping the FY16 GDP growth at 3.0% on our estimates. For more insights please chek our flash note on 4Q16 Industrial Production. • Retail sales growth is strongest in 9 years... December’s working-day-adjusted real retail trade (+5.8% yoy) posted the strongest growth in nine years, substantially above our already optimistic 4%-alike yoy forecast. Before detailed data release on 13th February, we see retail trade driven by strong holiday-related spending with higher number of trading days, PIT cuts, X- mass bonuses in public sector, 82.4% yoy (!!!) stronger car sales, solid 2%+ real net wage growth, resurgent consumer credit and steady 2%-alike employment gains. Moreover, we expect positive contribution from tourist spending during Advent and X-mass fairs in Zagreb. For the 4Q16, real retail trade rose 4.6% yoy on average, well above 3.2% yoy growth in the same quarter last year, suggesting 3.6% yoy increase in household consumption in the national accounts in Q4. The latter alongside strong industrial output growth (7.2% yoy), stronger private investments and upside surprises in external demand on strong euro zone activity implies a 3.5% GDP growth in 4Q16 for an average 3.0% GDP growth in 2016, on our estimates. For more insights please chek our flash note on 4Q16 Retail Trade. • Retail sales growth is strongest in 9 years... The broadest money M4 growth accelerated in December (+4.7% yoy, prev. 3.5% yoy) and thus exceeded HRK300bn for the first time ever. A brief look at M4 components reveals the expansion was driven by the most liquid M1 money supply where the growth accelerated to 18.1% yoy (prev.