A September rebound

- "Equity markets rebounded nicely in September, sending the S&P 500 and the S&P/TSX into positive territory for the year to date. However, there is still fog on the recovery track. First and foremost, there is no clear guidance on the extension or otherwise of the Bush tax cuts set to expire at the end of this year. Households remain in limbo as to whether their disposable income will take a hit in three months."
- "Uncertainty about tax policy is weighing on both consumer and business confidence. Volume retail sales have stalled in recent months and investment is decelerating. The ongoing softness of recent economic data has led to a period of downward earnings revisions for both S&P 500 and S&P/TSX. This is likely to last the rest of the year."
- "Fortunately the Federal Reserve has committed to provide more liquidity if needed. The prospect of new round of quantitative easing by the U.S. central bank will in our view guard against a double dip. We continue to see the U.S. economy accelerating in the first half of next year. Our asset mix is unchanged from last month. Equities remain market weight for the time being as we wait for the political dust to settle in the United States."
- "Unconventional action by the Bank of Japan and the Fed’s new commitment to provide more liquidity if needed show a new tolerance for competitive depreciation of national currencies. This significant development argues for relative strength in precious metals. We are upgrading our allocation of gold stocks to overweight. At the same time we are reducing our holdings of Industrials to market weight."

World: Monetary policy eases further

- "Global growth will moderate in 2011. Emerging Asia will remain the driver. With inflation on the whole still tame and, especially, with developed economies slowing, the major Asian central banks are probably not being reckless in giving monetary policy a further expansionary turn."
- "With the U.S. economy halfway back to its previous peak, cyclical forces are fading. A fog of uncertainty about next year’s tax rates is modifying the behaviour of households and businesses. The U.S. is entering a slow-growth trap, with real growth unlikely to exceed 2% annualized in the second half of 2010."
- "The Canadian recovery has reached maturity. Real GDP, employment and domestic demand have all passed their pre-recession peaks. On the other hand, U.S. growth is slowing just when Canada has moved from recovery to expansion and the first signs of cooling have appeared in domestic demand growth. We expect Canadian GDP growth to slow from 3%-plus in 2010 to its approximate cruising speed of 2% in 2011."

China’s 12th Five-Year Plan: Investable shift from growth quantity to growth quality

- More evolutionary than revolutionary "With the aftershocks of the Global Financial Crisis and “global imbalances” still reverberating through international markets, and with China having recently attained the status of the world’s second-largest economy, investors are looking toward October’s release of China’s 12th Five-Year Plan for key guideposts. Yet investors may need to temper expectations. With China well along in its market development, the days are gone when Beijing could exactly determine China’s economic path; and much of the new plan’s thrust should be a continuation of the economic rebalancing initiatives laid out in the 11th Five-Year Plan (2006–10) – a policy bias already well known to markets, and thus in many cases largely priced into listed equities."
- Investable themes – from growth quantity to growth quality "Still, we believe China is marking a path where the quality of growth – in terms of composition, efficiency, and environmental impact – now commands more attention at the margin than sheer quantity. This includes efforts to rebalance aggregate demand toward domestic consumption and service-sector activity from export manufacturing and investment. This implies reduced material- and energy-intensivity, to be effected in large part through higher factor costs – such as wages, energy/utility tariffs, land, and (potentially) capital costs. While these initiatives will generate relative winners, they may also imply downward pressure on margins generally, and a decline in China’s overall profits-to-GDP (which rose precipitously over the past decade). As in recent years, we expect to see continued emphasis on rural reform and Western-regional development – a policy bias that will continue affecting patterns of consumption, credit growth, and construction / investment activity, among others."
- The search for net-yet-fully priced plays "We distil these themes into a select list of ‘Top 25’ Five-Year Plan stocks (Figure 3, page 4). Key among these are names involved in 1) new energy vehicles, 2) clean power (including gas, wind, coal-to-liquid), 3) western-regional development and/or urbanization into lower-tier cities, 4) urban rail build-out, 5) medical system expansion, 6) private consumption and retail mall development, and 7) financial innovation. Yet, as noted, many of these themes are already well known to the market. In the effort to identify outstanding value, we filter our ‘Top 25’ for 1) historical PER discounts larger than the current MSCI China discount of 8%; 2) historical P/BV discounts of 30% or more; and/or 3) a PEG ratio (based on three-year 2010–12E CAGR) below MSCI China’s 0.6x PEG. By these standards, relative value among Five-Year Plan beneficiaries is found in Dongfeng Motor, ABC, Minsheng Bank, Sinoma, Guangshen Railway, Mindray, PetroChina, Longyuan Power, Dongfang Electric, Shenhua Energy, and China Coal Energy."

Italy: Public finances on track

- "After the solid performance in 1H 2010, we have revised slightly up our GDP growth call from 0.9% to 1.0% in 2010, and from 1.0% to 1.1% in 2011. However, our outlook envisaging a moderation of growth in the second half of this year remains safely in place."
- "Data on the labor market remain mixed and do not suggest that a genuine turning point has been reached yet. The unemployment rate seems close to peak, but recent dynamics of inactive people and labor force are less encouraging."
- "Even taking into account the statistical discontinuities introduced in June by the Bank of Italy, bank lending to households and non-financial corporations recorded a further improvement in recent months, confirming that the credit recovery is proceeding on the expected path."
- "After the remarkable surge in July, Italy’s CPI inflation edged down mildly in August to 1.6% yoy. The core inflation differential vs. the eurozone has widened over the past year. Producer prices accelerated further but surveys suggest that some moderation might lie ahead."
- "In the Focus section we analyze the details of the budgetary correction that had been unveiled in May and that was approved by the Parliament during the summer. The commitment on expenditure-cutting measures is encouraging, but implementation risks call for close monitoring ahead."

Fed has more flexibility after last week’s statement

- "Last week, NBER officially declared the end of the US recession in June 2009. Ironically, it was the same week in which the Fed said that it’s prepared to take additional action if needed (p.2, p.3 & p.4)."
- "This week’s focus is on the US ISM manufacturing index on Friday, on the euro zone CPI estimate on Thursday, and on the UK manufacturing PMI on Friday (p.2, p.3 & p.4)."
- "The Chart of the Week shows the Federal Reserve’s and Bank of Japan’s total assets outstanding as a percentage of nominal GDP. Last week’s FOMC statement showed that the Fed is ready to act if needed. The possibility that the Fed will purchase additional Treasuries in the coming months has therefore clearly increased. Indeed, it feels as if these ‘unconventional’ monetary policy measures are getting almost conventional given that the Fed already engaged in quantitative easing in 2008. The chart shows that the Fed acted aggressively as financial markets were in a deep shock that year. The chart also shows that while the BoJ has acted far less aggressive over the last few years, the total assets/nominal GDP ratio is still well-above that of the Fed. Over the last few months, the Fed slowly moved towards last week’s message that they are “prepared to provide additional accommodation”. Financial markets likely interpreted this as if additional quantitative easing will be coming (soon). Consequently, the USD depreciated last week to 1.35 against the euro. In addition, the downward trend of the USD on a trade-weighted basis that started in 2002 seems to be still intact. That said, although it remains uncertain whether the Fed (if they act) will be as aggressive as in 2008, additional QE could result in a further drop of the USD."

Non-commercial investors turn marginally long EUR

- "The latest IMM data cover the week from 14 to 21 September."
- "JPY longs remained in place after the BoJ intervention: The intervention from Bank of Japan that sent USD/JPY from 83 to almost 86 was not enough to square long JPY positions. IMM data show that speculative JPY net longs remained in place last week, reaching 20 percent of open interest. The market looks increasingly likely to re-test the central bank as USD/JPY is gaining downside momentum."
- "Non-commercial investors turn marginally long EUR: For the first time since December last year speculative investors are net long the euro. Net long positions have reached 3 percent of open interest, as improved risk sentiment - and increased concerns about the potential effect of QEII on the dollar – has sent EUR/USD higher to trade near 1.35. IMM data indicate that there is plenty of room for a further build-up in EUR longs, although we suspect that investors will be cautious adding too much EUR exposure as long as Euroland debt uncertainties remain high."
- "Commodity currencies still vulnerable to position squaring: September’s risk rally, which has seen the S&P500 index gain almost 10%, has coincided with a further build-up of long positions in the commodity currencies. Net longs are now at 69 percent in NZD, 50 percent in AUD, and 29 percent in CAD – indicating that these high beta currencies are becoming increasingly vulnerable to a potential position unwind. A trigger for this could be a sell-off on the stock market, which our equity analysts see a high risk of over the coming months."

Fed QE2? Fun for bonds, pain for the buck

- FI Strategizer: "After the last FOMC meeting, 10Y US and Bund yields are almost back to end-August levels. To justify lower yields from here, a worsening growth outlook (unlikely given next week's data), more stress in the EMU periphery, or additional hints on QE would be needed."
- EU Portfolio Strategy: "Hopes for QE2 provided strong support to EGBs this week. The EMU index is up +4.79% YTD and the excess return of our active portfolio is +20bp. It is difficult to find arguments in favor of a trend reversal: we stay moderately long duration."
- MM: "We expect investors to only partially roll over the EUR 93bn coming from expiring 6M and 12M LTROs. Excess liquidity and maturity of ECB operations will likely fall. Expect a moderate increase in MM rates."
- Italian 4Q funding: "We present a detailed analysis of Italian 4Q10 funding. Supply pressure should focus mainly on the short end and the 10Y, while it should be limited at the extra-long end."
- Trade Idea: "We suggest switching from OBL Apr15 into OBL Oct15 given the appealing benchmark roll. Furthermore, on the Spanish curve, the 15Y has cheapened to an interesting level vs. the 10Y and 30Y."
- FI Special: "We discuss how much haircut is discounted in current periphery spreads vs. Bunds."
- Supply Corner: "Next week, there are no redemptions in the EMU. Gross supply should be rather subdued, ca. EUR 9/12.5bn, mainly coming from Italy. The US will issue USD 100bn in Treasuries at the 2Y, 5Y and 7Y."
- Inflation: "The September flash estimate should show an acceleration from 1.6% to 1.8% yoy. The move should be totally energy-driven."
- FX Strategizer: "The FOMC statement, hinting at a possible restart of QE, instilled a negative bias in the US dollar, but selling pressure may be partly mitigated by local risk factors, FX trading should thus stay choppy."
- EUR: "Risks that our long-run target of 1.36 may be reached much sooner than expected are concrete if US data disappoints, but renewed EMU woes, involving primarily Ireland, may still slow the EUR-USD rise."
- JPY: "Risk of aggressive BoJ intervention if USD-JPY retests 83 should discourage heavy USD-JPY sales, even in case of a firm Tankan survey. EUR-JPY still capped above 113-115."
- CHF: "The USD-CHF drop below 0.98 should spill over to EUR-CHF and frustrate any recovery attempt even if EUR-USD remains firm. Selling both USD-CHF and EUR-CHF on a rally is still recommended."
- GBP: "Cable may still benefit from the weak USD towards a 1.5850 test. EUR-GBP should mostly remain capped above 0.85-0.86."
- Pacific Rim: "Commodity currencies should remain favored against the USD, but a partial correction is required before buying them back."
- Nordics: "More consolidation is expected for EUR-SEK between 9.15 and 9.25. EUR-NOK to offer selling opportunities above 7.93-7.95."
- TICS Monitor: "Long-term net inflows to the US amounted to USD 61bn. Last month's appetite for Treasuries & Agencies was reconfirmed."

Treading water before breaking the range

- "Lead indicators lost some momentum over the summer; the ISM has softened and the Euroland PMIs have started to come down from their highs. But arguably the equity market has moved to discount this ahead of the softening. Returns on equities have been on the weak side this year especially in the context of very strong earnings growth; the SXXP is up 5% year to date. We see a number of positives that should help support European equities in 2011:
1. We expect the US growth picture to improve modestly through 2011 and for concerns about a double dip to fade. Our US economists’ forecast 1.5% annualized GDP growth in 1Q2011 but by 4Q2011 they forecast growth of 3.0% annualized. The drivers of growth should also become more sustainable, US growth in 1H2010 was driven by inventories and fiscal policy whereas by end-2011 we expect more private sector demand. This more solid foundation for growth should ultimately stave off
fears of a double dip that have plagued markets for the last two years.
2. Loose monetary conditions: Our US team expects the funds rate to stay in a zero to 25 bp range through year-end 2011, as economic growth averages less than long-term potential rate and inflation continues to recede. They also expect the FOMC to resume unconventional policy easing – most likely by purchasing at least US$1 tn in Treasuries.
3. European economic growth remains robust. Despite the slight moderation in the survey data, the level of growth remains strong and there is evidence that the cycle is moving away from pure dependence on exports; in the last quarterly GDP breakdown, Germany and France saw a strong investment recovery.
4. Equities still provide attractive potential returns as the risk premium embedded in share prices remains high in our view. We expect some of this value to be realized through buybacks, increased dividends and/or M&A. Companies have strong balance sheets and plenty of firepower and increasingly those companies making strategic acquisitions are rewarded.
5. Earnings estimates have been revised up through 2010 and we also expect 2011 to be another strong year for earnings. Global growth on our economists’ forecasts remains high and companies still have catch-up growth to come through from the downturn, capacity utilization is still low in many sectors. We have updated our profit model and forecast 23% earnings growth in 2011 versus 16% for the bottom-up consensus.
- "Given this picture we upgrade – or probably fairer to say roll-on – our 12-month price target for the SXXP to 320 from 300. This would provide 23% price returns on European equities from the current level, 26%-27% including the dividend. We expect this to be driven by strong earnings growth rather than a rerating in the market, as is typical in this phase of a market recovery. It would still leave the market 20% off the highs in mid-2007."

Flow of funds for Q2/CY2010: continued expansion in the private sector’s financial surplus

- Flow of funds for Q2/CY2010: continued expansion in the private sector’s financial surplus
• "Amid the remaining uncertainty about the economic outlook, Japanese firms have continued to favour debt restructuring"
• "Importantly, their appetite for liquid financial assets, i.e. cash and deposits, has remained robust, constraining business fixed investment"
• "Foreign direct investments, such as direct and portfolio investment, have continued to increase and are now 11.5% of total financial assets, the highest level since 3Q08"
• "The financial surplus in the private sector, including households and depository financial institutions, amounted to 46.5 trillion yen (40 trillion yen in Q1/CY2010), well exceeding the government sector’s financial deficit of 34.7 trillion yen"
- Another drop in manufacturers’ capacity utilization
• "Capacity utilization rate among manufacturers dropped for the second consecutive month to the lowest level since last December"
- Demand for Funds Remains Weak
• "Bank lending continued to drop, falling 2.0%yoy in August, reflecting the weak demand for funds among the private corporate sector"

Dovish FOMC puts more downward pressure on the USD

- "The FOMC’s hint that more QE may be coming in November sent the USD into a renewed decline against all the traditionally more risky currencies, with the EUR, AUD and Scandis leading the way. It is hard to oppose this trend short term even though the USD is reaching very cheap levels. The USD made a new historic low against the CHF this week, but it seems likely that more risk positive currencies will perform better next week as a more positive risk tone emerged at the end of the week. The AUD is in focus as parity approaches, but there is better value in the NOK and SEK. GBP should also be a strong performer as EU related payments are expected to push EUR/GBP lower. The US ISM on Friday will be the main data focus, with some chance of a USD recovery both on a weak and a strong number."
- "The USD fell against all of its G10 counterparts after a more dovish Fed FOMC statement and decent global macro data boosted demand for high yielders and commodity currencies. Along with the NOK and AUD, the SEK and EUR were the best performers, logging gains of between 2% and 3.5% vs the greenback. Sterling strengthened vs the CAD and USD but dropped 2.3% vs the EUR. GBP has now dropped 3.3% since the start of the month and now trades at levels last seen right after the general election in May (0.8550). The BoJ declined to comment whether it intervened but a spike up to 85.30 in USD/JPY on Friday left little to the imagination. Chinese premier Wen met with US president Obama but resisted pressure on country’s slow progress on strengthening the yuan."
- "The FOMC kept policy unchanged but subtle shifts in the accompanying statement revealed greater concern over the present suboptimal level of inflation, giving the market fresh ammunition to believe that a new and potentially more far reaching asset purchase initiative is unavoidable. UK data were fairly thin on the ground, with lower house prices and falls in mortgage lending underlining the soft path in housing market activity. The public finances showed a marked £15.3bln rise in August borrowing as a result of higher interest payments. The MPC minutes revealed no change and showed member Sentance repeating his preference for an immediate rise in Bank rate."
- "Core bonds staged a turnaround from last week with the FOMC statement triggering a buying spree in the long end, resulting in flatter 2y/10y and 10y/30y yield curves. Failing to establish a foothold near one-moth highs, yields and swaps plunged on Wednesday on speculation of Fed easing down the road. Profit taking in risk assets and record spreads for Ireland and Portugal over bunds also stirred demand for G3 paper. 5y swaps closed below 2.10%, having traded as high as 2.29% on Monday. The 2y/10y swap curve flattened back below 180bp. The 3mth libor/Ois spread held steady at 23bp. Telefonica issued £400mln 2029 at 170bp and GdF sold £700mln of 2060 at 115bp over. Coventry Building Society and GE Capital also issued £400mln in 2022 and 2017 maturities."

The Decoupling Debate And Its Consequences

- "If decoupling just means a bigger growth differential between emerging and advanced economies, then decoupling is becoming more and more apparent: we expect Emerging Markets to generate 2.3 ppts of the world’s 3.7% GDP growth rate this year, and a bigger share next year."
- "More EM growth is coming from domestic spending, and this should reinforce concerns about inflationary risks. Although some EM inflationary pressures can be absorbed by rising imports, we think that some dangers may lurk here, partly because of the consequences of the 2010 global food price shock."
- "A number of EM central banks should be hiking rates over the next several months, but resistance to rate hikes among a number of EM central banks appears to be growing. One crucial reason for this is likely the fear of higher levels of unwelcome capital inflows."
- "So the dilemma is this: either you keep rates too low and raise the risk of asset bubbles; or you hike rates and suck in yield-seeking capital inflows. Either way, emerging currencies seem bound to strengthen over time, in spite of more aggressive fx intervention by many EM central banks in the short run. One consequence of this is likely to be more experimentation with controls on capital inflows."

Pension Solvency and the Long-End

- "Government bond yields fell sharply in August, contributing to a further easing of financial conditions. US 10-yr Treasuries reached our forecast of 2.5%, before bouncing higher. Valuations are now roughly ‘fair’, according to our Bond Sudoku model."
- "The prospect of further quantitative easing by the Fed, amid ongoing uncertainties over the trajectory for growth, argue against a quick reversal of the rally. But, based on our global macro projections, we think the cyclical trough for bond yields has already been seen. We forecast a steeper US 2s-10s curve than the forwards are discounting. We would position for a flattening of the 10s-30s Gilt curve against Germany. This ‘box’ spread has co-moved with the level of rates lately."
- "The rally over the past month was amplified by asset-liability management flows, particularly in continental Europe. We have commented on these dynamics in our weekly Bonds Snapshot publications. Here we present our updated Pension Solvency Indices, which help track changes in solvency positions through time and across regions."
- "Peripheral EMU markets have been volatile again, but the market has been much more discriminating than it was in May-June. Ireland is under pressure because of the contingent liabilities from banks. Portugal and Greece are suffering from growth concerns. But Italy and Spain are now participating in the rally. We have recommended long positions in 10-yr Italy vs. France, and in 30-yr Greek bonds, which already discount a substantial credit risk premium."

The implications of extended QE

- Overview: "A raised probability of further QE by the Fed extends the potential upside for US Treasuries slightly. We recommend unwinding short UST versus Bund trades but retain our outright short Bund recommendation."
- US Rates: "With an increased likelihood of further Fed balance sheet expansion we examine the likely structure of such a move and its potential impact."
- Euro Rates Strategy: "On a relative basis we are more worried about Portugal than Ireland. We suspect the market will find it much easier to believe in the risk/reward of being short Portugal than long. Italy remains our long of choice."
- Sterling Rates Strategy: "Speculation of further QE in the UK looks overdone. We suggest fading the recent strong performance of short-term sterling contracts and the belly of the gilt curve."
- Global Inflation Strategy: "TIPS break-evens are vulnerable if market expectations for QE are disappointed. 10yr euro real yields look historically attractive versus TIPS. Euro linker issuance for 2010 is around 80% complete."
- APAC Rates Strategy: "We continue to recommend flattening trades in Asia: 7s30s swap curve flatteners in JPY and 3s10s via futures in AUD."
- Flow Analysis: "Buyers of Europe remain more confident than buyers of the US, where net demand has been weak recently. In Europe, Italy, followed by Germany has seen the strongest net buying over the past month."
- Month-End Index Projections: "We expect a significant increase in the EGBI at the end of September. At a country level we see the largest weighted duration increases in France, followed by Italy and Germany."

TOPIX Core 30 outlook and key points

- "The TOPIX Core 30 briefly fell to 441 on 1 September before subsequently rebounding. Concerns about a further downturn spread when the index broke through the November 2009 low of 457, but ultimately it did not fall that much, indicating that investor pessimism may have peaked. With the wave count pointing to a consolidation phase ahead of the next rally, we think the index will lack direction until around Oct–Nov, when the next nearterm (four-month) cyclical bottom is due. However, we think there is greater potential for a rally now that forex intervention by the government and BOJ has brought yen appreciation to a halt. Whereas defensive stocks have outperformed since April, the charts have started to point to a turnaround for economy-sensitive and export-related stocks. As such, we think investors would do well to gear themselves for a change in market trends."
• "Defensive stocks in the ascendancy since April, but this may change: Defensive stocks have been in the ascendancy since April, but we are gradually starting to see signs of change. For example, Kansai Electric Power [9503] posted a new high for the year in September, bucking the downturn in the  market as a whole, but technical indicators such as the RSI (25-days) started to flash red, and performance relative to the TOPIX also showed signs of peaking out."
• "Charts already giving off positive signals for some economy-sensitive and export-related stocks: By contrast, some economy-sensitive and export-related stocks have started to show signs of bottoming. Indeed, some charts have already begun to give off positive signals. For example, Shin-Etsu Chemical [4063], Komatsu [6301], Nissan Motor [7201], Honda Motor [7267], Canon [7751], and Mitsui & Co [8031] have broken through the upper limit of the resistance band (cloud) on the daily Ichimoku Kinko Hyo equilibrium chart, and their MACD based on share prices relative to the TOPIX has moved into positive territory or moved upwards within negative territory. Companies such as Nippon Steel [5401], JFE Holdings [5411], Sony [6758], and Mitsubishi Corp [8058] appear likely to join this group in due course."
• "Other stocks for which charts are giving off positive signals: Meanwhile, the charts have started to give off positive signals for stocks other than those sensitive to the economy and exports, including Japan Tobacco [2914], Astellas Pharma [4503], Tokio Marine Holdings [8766], Mitsubishi Estate [8802], Nippon Telegraph and Telephone [9432], and NTT Docomo [9437]."
• "No need for excessive pessimism despite ongoing downside risks for some stocks: By contrast, we see ongoing downside risks for some stocks, including megabanks such as Mitsubishi UFJ Financial Group [8306], Seven & i Holdings [3382], Toshiba [6502], Toyota Motor [7203], and East Japan Railway [9020]. However, we see no need for excessive pessimism, as most are stocks that look to be trading in their bottom range over the longer term and/or stocks with limited downside risk, based on technical indicators."

Spanish Banks: Deleveraging and the misallocation of capital

- "We are cutting our rating on SAN to Neutral from Outperform and reducing our target price to €11.75 from €12.25. While SAN has emerged as one of the main winners in the current financial crisis, we are concerned that it is now so big that structural growth is likely to decline and it may face marginally declining returns. We note Brazilian profitability might be slowerthan-expected."
- "We continue to have a cautious view on the Spanish economy and the domestic banks. An overleveraged private sector and structurally high unemployment are likely to affect banking results. We think the banking system is facing a significant deleverage process and the adjustment in the real estate sector is not yet complete which will likely translate into higher credit losses. We think the structural profitability of the banking system has been permanently impaired and we do not expect the domestic banks to meet their cost of capital in the next two years at least. Money illusion relating to negative real interest rates is partly responsible for the lack of recognition of certain credit losses and for unusually high (and unsustainable, in our view) net interest income relating to the carry trade."
- "The Cajas sector has started restructuring but this might be a long process. We think the market is underestimating the execution risk and costs associated with the integration process. We believe some institutions might lose money and require extra equity over time."
- "SAN is one of the leading banking franchises in Europe, in our opinion, but we believe that any excess capital generated is likely to be directed to increase size through non-organic growth; this strategy may not necessarily create value for shareholders in the long term. We believe it would be more difficult for the shares to continue to outperform."
- "Stock Calls: We maintain our Underperform rating on all the pure domestic Spanish banks we cover and our Outperform rating on BBVA."

Why The Gold Price Rally Will Continue

- "Gold prices hit a new all time nominal high this week. We believe this rally has further to run. Indeed at the end of June we highlighted why gold prices would need to surpass USD1,455/oz to be considered extreme in real terms and hit USD2,000/oz to represent a bubble."
- "For the time being we believe the drivers of this rally are fundamental rather than speculative. However, we admit physically backed gold ETFs are playing an important role in the gold market."
- "However, we view interest rate and exchange rate trends as gold price bullish. Indeed history would suggest a collapse in the US dollar can not be dismissed out of hand. Moreover central banks have become a new source of gold demand while gold mining companies remain committed to closing their hedging programmes."

Moving closer to QEII

- Market Movers ahead
• "We expect the US ISM to decline to 54.5 after the surprise increase in August."
• "In Euroland, PIIGS will probably remain on the radar screen. On the data front, focus will be on inflation."
• "In Asia, the release of China’s two manufacturing PMIs and Japan’s Tankan will be in focus. We expect a confirmation that the Chinese economy is currently bottoming out and a gain in the Tankan index for Japan’s large manufacturers."
• "A lot of data out of Sweden including retail sales, PMIs and the NIER surveys."
• "In Norway particularly credit growth and retail sales should attract attention."
- Global Update
• "The FOMC statement struck a more dovish tone than expected. We now see a new round of quantitative easing as the most likely outcome."
• "In the Euro area, focus has centred on Ireland and worries about the costs associated with restructuring in the banking sector."
• "The global slowdown is now being felt in the manufacturing sector in core Euro area countries. German PMI and Ifo expectations posted declines."
• "Tensions between the US and China have intensified. The US is unhappy about the slow appreciation of the yuan."
• "In Japan, the prospects of new quantitative easing in the US has led to a stronger JPY. This puts pressure on both the BoJ and the Ministry of Finance."
- Focus
• "In this week’s focus article we take a closer look at Danish house prices. Prices are currently in line with the level predicted by our fundamental model. This is however all due to the historically low level of interest rates." 

A year of drifting… but better times beckon

- "For frontier market equities, 2010 has been a disappointing year. After rallying early in the year, the MSCI Frontier Markets (ex-GCC) index has steadily underperformed the emerging markets index and is flat for the year versus a gain of 6% for GEMs. This puts the frontier markets on track to underperform the larger emerging markets index for a fourth consecutive year."
- "Some success stories, but many markets have struggled. Sri Lanka, Bangladesh, Estonia, Argentina and Kenya have all benefitted from a combination of supportive political developments and a recovery from oversold conditions last year. Many Eastern European markets have lagged, as have Kazakhstan, Jordan and Lebanon."
- "The macro outlook continues to improve. Economic output in the frontier economies is recovering more quickly than expected, with average growth now expected to exceed 4% next year. Inflation has picked up modestly but remains close to historic lows, while current account deficits are back to sustainable levels in most countries."
- "Valuations: still reasonable if not cheap. Frontier market earnings have not rebounded as quickly as they have in emerging markets and thus the region’s discount to EM has closed somewhat. However at 12.3x trailing earnings and 1.7x book value, the index remains at a significant discount to both its own history and EM peers."
- "Low volumes, high correlations. Trading volumes have been muted, and frontier markets are not providing much diversification with the 40-week correlation to global markets now at an all-time high of 80%. We do not expect either trend to last however."
- "With the growth story largely intact, frontier markets look positioned to outperform. Our top markets are Nigeria, Argentina and some of the “value” Baltic/Balkan markets, especially Estonia and Bulgaria. We also like Kazakhstan and Kenya. Preferred frontier market stocks under coverage include: Galicia (Argentina), Halyk Bank (Kazakhstan), Hikma (Jordan), Kazmunaigas (Kazakhstan), Nova Kreditna Banka (Slovenia) and Solidere (Lebanon). Indirect plays on frontier markets that we like include Afren, Aggreko, CETV, Millicom and MTN Group."

India: The four good reasons that explain the hike in the key benchmark interest rates

- "The Reserve Bank of India has just carried out its fifth consecutive interest rate hike since March 2010, continuing the withdrawal of a significant part of the stimulus implemented during the financial crisis. This very gradual monetary policy tightening seems logical in an environment where inflation is relatively high and where prices of financial assets are rising sharply. Furthermore, the interest rate hike does not endanger the domestic financing of the fiscal deficit (which is declining markedly) at reasonable borrowing costs. A likely appreciation of the rupee will probably not adversely affect India’s price-competitiveness for exports, which has improved against India’s trading partners during 2010. If the current macroeconomic environment (i.e. high nominal GDP growth, high inflation, negative real interest rates, lowering budget deficit and rupee stability) persists, more gradual monetary tightening in the months to come will be very likely."

US Mid-Terms: Still The Economy, Not The Tea Party

- "The Tea Party movement, the latest manifestation of a deeprooted tendency in the US, is now set to dominate coverage of the run-up to the 2 November Mid-Term elections."
- "But we doubt that its recent successes in the Republican primaries will have any significant impact on the outcome of the Mid-Terms where the economy will remain pivotal."
- "Overall, it remains our view that the Republicans are likely to secure a majority in the House of Representatives but will struggle to do likewise in the Senate."
- "Irrespective, we anticipate gridlock in Congress through to 2012, even though a Republican majority in one or both houses would be an incentive to reach compromises with the Democrats."
- "Most importantly to sentiment in the short to medium term, we look for agreement to be reached on extending all the Bush tax cuts for 12 months once the Mid-Terms are out of the way."
- "Beyond that, we expect little agreement on fiscal policy other than, possibly, more help at the margins for business."
- "We also expect bipartisan agreement on keeping the pressure on the Administration to take more punitive action against China’s alleged “currency manipulation”."
- "We do not expect possible Republican efforts to repeal healthcare reform to be successful."
- "Legislation to limit carbon emissions now looks unlikely; so the Administration may resort to regulatory measures."
- "Sarah Palin, the Tea Party’s de facto leader, appears to be positioning herself to run in the 2012 Republican presidential primaries. We do not dismiss her chances."

Currency interventions to stabilise exchange rates seem to be relatively ineffective

- "Based on the recent experience of many countries (e.g. Japan, Switzerland,
Brazil, South Korea), policies of currency intervention (use of foreign
exchange reserves) to stabilise exchange rates (in the cases studied, to
prevent an exchange rate appreciation) in a flexible exchange rate regime
seem to be relatively ineffective."
- "This is probably due to the fact that the expectation of an exchange rate
appreciation has, in the contemporary period, attracted to the country in
question a larger mass of capital than what the central bank is prepared to
accumulate in its reserves, in a situation of flexible exchange rates and
perfect capital mobility."
- "China is a case apart, firstly because there are capital controls and secondly
because the exchange rate is not flexible but fixed, administered by the
central bank, which may limit expectations of an appreciation."

In the 2010s, five years of anaemic nominal growth, followed by five years of stronger nominal growth in the United States and in the euro zone

- "The first five (roughly) years of the 2010s should be characterised, from our viewpoint, in the United States and in the euro zone:• by further household and corporate deleveraging, due to the adjustment of debt ratios to the lower level of wealth resulting from the crisis;• by the distortion of income sharing to the detriment of employees owing to companies’ determination not to depend on external financing to carry out their investments;• by persistently quite low commodity prices, because of the contraction in global demand for commodities stemming from the crisis."
- "One will therefore likely have in the first half of the decade, both muted real growth and low inflation and, by consequence, very weak nominal growth. When deleveraging is deemed sufficient, and income sharing levels off, real growth will accelerate. At the same time, strains will appear in commodity markets owing to robust growth in demand for commodities in emerging countries, and this will generate additional inflation. Nominal growth should therefore be more robust from 2015 onwards."
- "Investors with a long-term horizon thus have to factor in this highly probable trend break in both real growth and inflation in the middle of the 2010s. If nominal interest rates move in line with nominal growth, this trend break will normally be neutral for equities, but obviously unfavourable for bonds. In reality, due to nominal short-sightedness, it will also be negative for equities. If real growth increases at the same time as inflation, real estate (both residential and commercial) is a good protection against this trend break."

Rates firmly on hold everywhere

- Market movers ahead: Rate decision and PMI in focus "We have four rate decisions in the coming week - in Romania, Hungary, Poland and Russia – and the outcome is likely to be the same everywhere; unchanged rates and little variation in rhetoric from any of the central banks. PMI for September due for release next week across the EMEA region will provide an indication of how well EMEA economies are doing. Overall, we expect EMEA PMIs to follow the global trend and to decline somewhat in September, but in general remain above the critical 50 level, indicating continued expansion in EMEA economies. Still, PMIs in several countries will fall fairly close to 50."
- Fixed income outlook: Downside potential for Polish bond yields "Polish Minutes published this week showed some MPC members advocated a 50bp rate hike at the August meeting. Still, interest rates remained on hold in August (absent majority support to hike) and will continue unchanged at next week’s MPC meeting as well. Nevertheless, many market participants expect the Polish central bank to deliver its first rate hike soon although we do not believe it will do so until Q1 next year at the very earliest given the continued benign inflation outlook. Based on our “dovish” outlook for Polish monetary policy for both the next 3-4 months and 2-3 years, we see further downside potential for Polish bond yields."
- Scorecard-based trade of the week: buy ILS/ZAR "For the sixth consecutive week, the highest-scoring currency in our EMEA FX Scorecard is the Israeli shekel, and the lowest-scoring the South African rand. We therefore continue to recommend buying ILS/ZAR based on our EMEA FX Scorecard."

JPY intervention starts

- "Last week was historic for USD/JPY. On 14 September, the DPJ leadership election saw the previous DPJ Secretary General Ichiro Ozawa lose his challenge of Prime Minster Kan. Ozawa was regarded as a stronger advocate of yen-selling intervention than Kan and market participants lowered their expectations of intervention once Kan won. With US rates falling, USD/JPY fell below 83 in the New York session that day, declining to 82.88 in the Tokyo session on 15 September, finally prompting the first Japanese government intervention since March 2004. The move immediately sent USD/JPY to 85. Since 16 September, there has seemingly been no further intervention. USD/JPY at one point declined to 85.23 on 16 September as Japanese exporters sold USD, but otherwise it maintained an 85 high as market participants remain alert to intervention and US markets stayed relatively calm."
- "Should USD/JPY move to a low 85 we would expect a second round of intervention. If the MOF fails to indicate 85 as a defensive line, USD selling against JPY might accelerate, particularly as government officials have already specified 82 as a line worth defending. We believe USD/JPY has the scope to weaken to 86-87, but as exporters are likely to sell USD forward at these levels, we expect limited upside for USD/JPY. Judging by fragile US fundamentals, we lowered our USD/JPY forecasts on 6 September and now expect USD/JPY to trade at 82.5 at end-2010 and at 80 at end-March 2011, even after considering the effects of intervention. We recommend shorting USD/JPY if it rallies to 86-87."

In many European countries, the problem before the crisis was simple: The fact that growth outpaced potential growth did not lead to an increase in potential growth

- "We describe the problem that many European countries (France, Spain, Italy, Portugal, Ireland) are encountering these days, as follows:
• prior to the crisis, growth outpaced potential growth (due to the fact that demand was stimulated by indebtedness, the fall in unemployment, immigration);• but this did not lead to a rise in potential growth; the pre-crisis growth model was therefore unsustainable. This unsustainability can be presented as follows: as productivity gains remained too low, real pay rises were too low for demand to continue to increase quickly without the help of indebtedness (or later fiscal deficits);• potential growth did not increase because the growth model drawn on above all developed unsophisticated, not very productive sectors (construction, domestic services, etc.), which accounts for the fact that there was no acceleration in productivity and no increase in R&D spending. Policies to stimulate domestic demand normally lead to a development of services and construction (of non-traded goods) to the detriment of industry."

It would be very useful to know the value of the fiscal multiplier, but it is difficult to estimate

- "While all European Union countries are set to rapidly reduce their fiscal deficits, it would be very useful to know the value of the euro zone’s fiscal multiplier, in order to estimate the shortfall in growth resulting from the reduction in deficits. But at first sight it is difficult to estimate this multiplier. Empirical estimates vary a great deal (from 0.3 to around 1.6), which is fundamentally explained by the fact that the value of the fiscal multiplier essentially depends on many factors (behaviours):
• the degree of stickiness of nominal prices and wages; if prices and wages are perfectly flexible, the multiplier is zero;
• the degree of short-sightedness among economic agents: if they have long time horizons and if they are rational, the multiplier is zero ("Ricardian neutrality"); if they face a liquidity constraint, they spend all their income in each period and the multiplier is high;
• of course, the marginal propensities to save and import; if they are high, the fiscal multiplier is low;
• the reaction of interest rates and the exchange rate to the fiscal expansion; if there is a rise in interest rates and an appreciation of the exchange rate, the multiplier is obviously low."
- "When looking at these factors as a whole in the case of the euro zone, we conclude that the euro zone’s fiscal multiplier is very difficult to estimate:
• two criteria (significant price and wage stickiness, lack of reaction of interest rates and the exchange rate) lead to a high fiscal multiplier;
• two criteria (presence of Ricardian neutrality effects, high marginal propensity to import) lead to a low fiscal multiplier."

Towards significant growth variability in emerging and export-dependent countries?

- "Growth in domestic demand in OECD countries will in all likelihood be weak and steady, due to deleveraging, the increase in capital requirements, the rise in profitability, etc."
- "But, conversely, we can expect significant growth variability in emerging countries and in countries whose economies are export-oriented, due to:
• the high volatility in the Chinese economy, and therefore in economies linked to China;• the sharp fluctuations in the exchange rates of emerging and OECD countries, due to the instability of international capital flows and risk aversion;• the high variability of lending in emerging countries, linked to capital flows and changes in monetary policies."
- "In the future, we will probably see economies with slow and regular growth in OECD countries where domestic demand dominates (United States, United Kingdom, France, Spain, Italy), and economies with very erratic growth in emerging and OECD countries linked to global trade (Germany, Japan, etc.)."

Turkey: and another “yes” for GDP!

- "The prospects for Turkey are looking brighter and brighter. On Sunday, the overriding "yes" in the country’s constitutional referendum boosted Prime Minister Erdogan’s position after this vote and lessened the risk of political instability. Yesterday, GDP figures for the second quarter confirmed the favorable wind behind Turkey’s economy. While macroeconomic performance was expected to be excellent following the first quarter’s results (+11.7% YoY), growth outperformed even the most optimistic forecasts (+10.3% compared with a consensus of +9% YoY). Historically low interest rates, stimulus measures and stability in the banking sector have all been driving forces for such expansion, making Turkey one of the most dynamic emerging countries together with China. We are thus revising our growth forecast for 2010 upward to 7.5%, from our earlier 6.2%."

Since the Lehman bankruptcy, the stock market has not discriminated between companies and sectors, and has been steered by risk aversion

- "Since the Lehman bankruptcy, all stock market prices (companies and sectors; we will look at the situation of the CAC and the Eurostoxx) have moved in lockstep. Discrimination between companies and between sectors has been significantly reduced; the stock market as a whole has fluctuated in line with risk aversion, which has become the dominant explanatory factor of the share prices of all companies, whatever their specific situations (trends in results, turnover, etc.). This has obviously generated very significant valuation anomalies (dispersion of PERs), and a need to forecast risk aversion in order to forecast stock market prices."

Global Growth Remains Solid, Fed Edges Towards More Stimulus

- "We continue to look for sustained but uneven global growth, led in general by strong emerging market growth and with more modest recoveries in the US and Europe. But, after a slight bias to GDP forecast downgrades in the last two months, this month we make more GDP forecast upgrades than downgrades. We regard a "double-dip" as unlikely. Rather than negative growth, the greater likelihood is that recoveries in some key industrial countries will not be strong enough to quickly eliminate slack created by the recession."
- "As last month, we expect the Fed, ECB, BoJ, BoE and PBOC all to keep their key policy rates on hold to the middle of 2011 and indeed we expect the US Fed to keep rates on hold to end-2011 as well. The Fed is edging towards further stimulus. Barring material improvements in the outlook, we would anticipate action as early as the November meeting."
- "Chief Economist Essay (by Willem Buiter, see page 14). There is no such thing as completely safe sovereign debt. The cost-benefit analysis of sovereign default may favour default for the most highly indebted sovereigns, especially if they also have surpluses in their primary budgets. Default looks most likely for Greece, and Ireland may not be able to make whole both its sovereign debt holders and all unsecured creditors of its banks."
- "Citi rate strategists have become a little more bearish over the past two weeks. Citi strategists believe that corporate credit in core countries looks attractive in risk/reward terms, while Citi equity strategists argue that global equities can make healthy gains in 4Q10. For securitized products, Citi strategists remain positive, and recommend overweighting CMBS and Agency MBS while marketweighting consumer ABS. Citi FX strategists believe that SEK offers best fundamental value among G10 markets, while GBP looks stretched. For EM, our medium-term FX forecasts remain generally bullish versus forwards."

Relationship between spare crude oil supply capacity and prices

- "Crude oil prices continue to consolidate in a lateral range. We largely attribute their range-bound action to an uncertain economic outlook. Another factor militating against an upside breakout of their trading range is the existence of ample supply capacity globally. If the global economy weakens, crude oil prices would likely gain downside momentum. Conversely, if crude oil demand grows as projected by the IEA amid favorable economic conditions, upward pressure on crude oil prices would presumably begin to intensify. Spare crude oil supply capacity is currently equivalent to 6.4% of demand, a historically price-suppressive level. However, curtailment of petroleum resource development during the 2008–09 economic downturn bodes unfavorably for growth in production capacity through 2012. If demand grows in line with the IEA's forecast without any offsetting growth in production capacity, we estimate that spare supply capacity will fall to 4–5% of demand. Historically, when this ratio of spare supply capacity to demand has fallen below 5%, crude oil prices have risen steadily, fueled by concerns about supply constraints. Spare supply capacity bears close watching in terms of the outlook for crude oil prices."

Yen Intervention and Yuan Adjustment

- "Japan’s intervention in foreign exchange markets last week was a response to the slow pace of CNY appreciation and the yen’s rapid appreciation. Unlike the yuan, the yen is not an undervalued currency but it had appreciated faster than other Asian currencies this year."
- "China’s revealed preference for real appreciation via inflation rather than nominal exchange rate appreciation is paying off. Wages are rising rapidly and the current account surplus is falling as the real effective exchange rate rises. We forecast a current account surplus of only 2.7% of GDP next year."
- "The appropriate metric for assessing currency values is the real effective exchange rate. On that basis, most Asian currencies appear undervalued, but the CNY’s undervaluation is relatively modest in comparison with some of its neighbours. We consider two estimates of the deviation of the real exchange rate from equilibrium and the larger estimate is only 13.5%. That implies a 24% appreciation in CNY/USD over the next five years, which is consistent with our forecast. But that may overstate the necessary extent of CNY appreciation."

India: Small plays on the big capex idea

- Infra capex — next ramp-up point approaching "We believe the Indian investment cycle is likely to witness a significant structural inflection in the next few years, led by a significant improvement in the cashflows of private infrastructure operators. Despite some short-term delays, the story on both infra and corporate capex is expected to be strong in India. We think that 2012-13 will see a significant inflection in activity levels in the Indian infrastructure sector."
- Industrial capex turning around "On the corporate capex side, while the picture is becoming positive, companies with dependence on large and late-cycle industrial capex have not recovered fully.
Overall, strong demand, high capacity utilisation and a relatively stable macro environment present a positive environment for a revival in corporate capex."
- Looking for mid-cap beneficiaries "We have looked at mid-cap (US$200mn-US$1.5bn) companies which are fairly leveraged to and are likely to benefit significantly from a pick-up in capex activities. These are companies with strong competitive positions in relatively consolidated industries with large capacity expansions (without equity dilution)."
- Our top mid-cap picks "Voltas (18.4% earnings CAGR over FY10-12F, 40.6 % ROE, 15x FY12F P/E) is a well established, liquid stock with a world-class engineering project portfolio and a successful refrigeration business. Triveni Engineering’s (52% CAGR over FY10-12F, 20% ROE FY09, 14.6x FY12F P/E) tie-up with GE brings its market-leading turbine business into sharper focus and a spin-off could unlock value. Sterlite Technologies’ (14% CAGR over FY10-12F, 32% ROE, 10.7x FY12F P/E) strengths in optical fibre and power conductors fit right into telecom expansion and the significant growth in power capacity. Maharashtra Seamless (13% CAGR over FY10-12F, 16% ROE, 7.5x FY12F P/E) is the leading supplier of seamless pipes to the oil and power industries. We also present Nomura Nuggets (non-rated reviews) on GEI Industrial Systems, Elgi Equipments and Techno-Electricals."

The new geography of global innovation

- The new geography of global innovation "While the United States and Japan remain leaders in innovation, increased competition from growth markets, notably China, suggests a changing landscape. Research and development spending in Asia surpassed EU levels in 2005, and is likely to overtake US levels in the next five years, thanks primarily to striking growth in R&D investment in China. Measures of R&D intensity, or R&D investment as a share of GDP, allow for cross-country comparisons of commitment to R&D. R&D intensity has remained flat across G7 markets during the last decade at 2.1%. In China it has impressively doubled as a share of GDP since 1999, reaching 1.5%, which remains low by international standards. R&D investment is driven largely by the corporate sector, which finances more than two-thirds of total R&D spending in many countries. Companies in a range of industries, from pharmaceuticals to technology hardware, have exposure to new hubs of global innovation."
- Pipeline concerns and the role of human capital "The new geography of global innovation is critically dependent upon higher education in science and engineering (S&E) fields. Student interest in S&E is low in G7 countries, suggesting that these markets are likely to have difficulty replacing an aging cohort of native-born scientists and engineers. Reliance on foreign-born skilled labor is set to rise further as the world’s S&E skill base shifts toward Asia, notably China, where S&E fields represent 40% of all new university degrees awarded (more than two and a half times US levels)."
- New geography demands a policy response "Innovation-led productivity growth in the G7 will increasingly require public policies which attract and retain skilled foreign students and workers. In the short term, a more flexible and talent-friendly immigration regime can help developed economies and companies to benefit from the globalization of S&E skills. Longer-term investments in R&D and science education can further enable G7 countries to remain competitive by rebuilding student interest in S&E fields and by expanding the domestic supply of skilled S&E labor."

Musical chairs

- "The M&A theme is back. When we wrote Musical chairs in November 2006, we felt that the corporate world was ready for a round of consolidation. This played out during the 2007 frenzy brought on by the rapid rise of the emerging-market economies. The world has changed much since then, but we believe conditions are ripe for another wave of M&A in Asia Pacific ex-Japan."
- "Despite widespread concerns over a 'balance sheet recession' in the US, the corporate sector is behaving very differently from households. Companies are re-leveraging given the ability to fund themselves at close to historically low rates."
- "When new order flows slow down, acquiring competitors to increase market share becomes more attractive than capex, given the still real risk of initiating new investment only to find that the demand has evaporated by the time a plant opens one or two years hence."
- "In this report, we highlight five stocks that we think are likely to be under scrutiny as potential acquisition targets: MobileOne (BUY), Biosensors (BUY), Korea Exchange Bank (BUY), Primary Health Care (BUY) and Wing Hang Bank (Rating suspended). We include fresh updates on the four rated stocks."
- "We include global data on M&A and corporate fund-raising."

Flow Rider

- Huge waves — "Flows are away from developed market equities towards bonds and EM equities. Mega caps have been caught in this underperformance rip tide."
- Awesome — "We estimate European mega caps have at least €375bn of firepower. While the UK mega caps have £200bn. How will it be used? M&A or buy backs?"
- Hang 10 — "M&A will continue the flow imbalance away from mega caps and towards large ex mega and mid cap. Long mega cap is short M&A."
- Radical — "Mega caps struggle under the weight of too many shares issued during the bull market of the late 90s. Be radical. Shrink the share count."
- Wipeout — "Over time those companies that have consistently shrunk the share count have outperformed those that have kept issuing shares."
- Gnarly, dude — "Get in front of the flows. Buy those companies that will retire their own equity and don’t own those who are buying someone else's."

If the US Sneezes...

- "Although our forecast for US growth has been more downbeat than the consensus for a long time—and remains so—our view on the rest of the world continues to be more optimistic. This kind of forecast appears to be in conflict with the popular notion that ‘if the US sneezes, the whole world catches a cold’. Nevertheless, we argue that it is plausible. All else equal, a significant US slowdown would slow growth to a degree in the rest of the world, and in some places more than others. But  espite the conventional wisdom, export channels are too small to transmit a US slowdown to a comparable degree. And while transmission through financial channels is arguably more capable of spreading a US slowdown, there are few signs currently of the kinds of pressures on financial conditions or stresses that would signal such an impact."
- "As a result, we continue to expect further divergence in growth and policy between the US and many others relative to what the market is pricing. And we have been recommending trades around that theme in recent months, particularly with respect to the emerging economies and the smaller G10. In particular, this gives us a bias towards widening rate differentials between the US and many others, further broad USD weakness and a preference for EM exposures in equities, both at the index level and within the major markets."
- "As our analysis here suggests, the principal risk is that a global shock acts to ‘connect’ the various economies more than we expect—either through financial markets, the banking system or some other new event. That is not what we expect, but it is this possibility, and not the fact of a US slowdown itself, that we think needs to be monitored."

The Death of the Equity Culture ?

- "The recovery in equity indexes that started in March 2009 has stalled as many indices have gone sideways since late May 2010. The overall year-to-date performance is close to zero."
- "This hesitating pattern is a clear reflection of the ongoing uncertainties pertaining to the economic growth. The doubledip risk is clearly visible in the sharp retrenchment registered by our proprietary News Index."
- "One can clearly see that the correlation between this index and the S&P 500 has strengthened since 2008. A quick look at the VIX chart below shows that this relationship is clearly regime-dependant: in times of heightened uncertainty on growth, the stock market is much more correlated to VIX than economic data releases."
- "This regime-dependant pattern is due to last and may explain why traditional valuation tools may not be pertinent for short term investors."
- "Speaking of double dip risk may suggest that we remain in a cyclical perspective. The crisis may yet have had some long run implications (for equilibrium valuation notably)."

Latin America: Scrubbing Up for Major Intervention

- "Ample global liquidity coupled with improved regional fundamentals, particularly higher commodity prices, should lead to further appreciation of LatAm exchange rates against the US dollar. We do not expect any depreciation in the major currencies (BRL, CLP, MXN and COP) against the USD in the next three months. In fact, we have changed our USD/BRL forecast for year-end 2010 to 1.72 from 1.80"
- "Global interest rates should remain at their current low levels for an extended period of time. This environment tends to support commodity prices, thus favoring terms of trade in Latin American countries. Increases in commodity prices amid reductions in risk aversion, which are part of the same phenomenon, have led to increased capital inflows into many Latin American countries."
- "The direct link between commodity prices and terms of trade lies in the large share of commodities in Latam exports. The weight of commodity exports in Latam countries ranges from 18% (in Mexico) to 95% (in Venezuela) of total exports, highlighting the great significance of those prices on exports dynamics."
- "Against this backdrop, we believe pressures for additional Central Bank intervention, in the form of dollar purchases in both spot and forward markets as well as capital controls, are likely to gain momentum."

Euro on the mend

- Overview: Euro on the mend "The euro is recovering against the dollar. The former mirrors the EMU which is a dynamic and well balanced economy. The latter suffers from the US economic slowdown. Nonetheless the EU single currency has still some weak points."
- US: Second quarter flow of funds accounts "Household debt once again declined markedly in the second quarter, whilst non-financial companies’ debt remained stable. The value of assets held by households declined, reflecting a correction in financial markets. Profits of non-financial companies grew further and reached their highest level since 2007. Public sector debt continued to rise at a rapid rate, driven by the federal component."
- Japan: Second quarter flow of funds accounts "In Q2 2010, strong overseas demand and very accommodative policies resulted in a widening of the financial deficits of the rest of the world and the government. The appreciation of the yen has led to an increase in overseas investment. In the coming quarters, the government’s financial balance is expected to improve gradually, while the financial surplus of the private sector might decline modestly."

Is Obama like Clinton or Bush?

- Macro viewpoint: Is Obama like Clinton or Bush? "Continued gridlock in Washington would be very bad for the economy. We expect a reluctant compromise on taxes at the last second."
- Fed watch: QE2: Pondering when and how "The Fed has adopted a clear easing bias, but there is no rush: the economy is weak but not drifting toward recession and Bernanke will want to get broad support from his committee before acting. The Fed has a number of options to further stimulate the economy. Now that they have acknowledged that inflation is “somewhat below” acceptable levels, one way to ease further would be to the “extended period” language to the inflation outlook. The Fed could also tie its asset purchase program to bond yields – buy whatever amount is needed to bring the 10-year yield down to a specific range."
- Housing watch: Builders still downbeat "New home sales remained close to record lows, the NAHB housing survey remained depressed and single-family permits fell, setting the stage for further declines in housing construction. The housing market will be a clear drag to GDP growth this quarter and next."
- The week ahead: New month; New ISM "We are not expecting any major revelations in next week's data flow and expect continued evidence of a weak economic landscape. The main event will be the release of the ISM manufacturing index on Friday. We are expecting the index to decline to 54.0, its lowest level since November 2009. We'll also receive the personal income and spending report."

What can be done when conventional economic policies are ineffective? The current example of the United States

- "The problems encountered by the US economy are structural:• excess indebtedness and loss of household solvency;• required adjustment in corporate balance sheets, leading to a distortion of income sharing at the expense of employees;• resulting deteriorations in the situation of the labour market and the real estate market."
- "In view of this situation, the Obama administration and the Federal Reserve are tempted to:
• abstain from reducing fiscal deficits;• make the monetary policy even more expansionary."
- "But these economic policies can no longer be efficiently used:
• fiscal deficits will have to be reduced under the pressure from public opinion, rating agencies and perhaps financial markets later. Moreover, the United States has an overall shortfall in savings;• there is no point in increasing liquidity further, as it is already overabundant and private economic agents are deleveraging."
- "So what economic policies remain?
• the dollar's exchange rate, which is abnormally strong because of the high level of risk aversion, cannot be controlled;• we could imagine the Federal Reserve or the Treasury taking over (writing off?) part of the debt of over-indebted households (with negative equity on their mortgage loans), financed by an increase in the taxation of companies’ non-invested profits, in order to reduce household defaults and accelerate the correction in their balance sheets. The distortion of income sharing in favour of companies in fact leads to higher profits than what is needed to finance investments. This would amount to an organised partial default on the US household debt."

Why do investors always buy when prices are at their highest?

- "We can see that investors (in a broad sense: institutional investors, banks, funds, non-residents) almost systematically buy assets in the United States and Europe when the prices of these assets are abnormally high, but not when they are abnormally low. This holds for currencies (especially the dollar), equities, bonds, etc."
- "It is well known that this is explained by herd behaviour, VaR and capital constraints, short-term horizons, competition between investors and monetary policies. However, this is extremely destabilising and, curiously, the crisis has not put an end to this behaviour."

Slowdown, but with a soft landing

- Short view: Weaker growth for longer "Commodities witnessed a pronounced sell-off in late August led by disappointing economic data. However, since then, prices of most products have risen despite little improvement in fundamentals. Volatility will probably remain high in H2, but heading into 2011 the prices of oil and base metals should gradually start to move higher as the business cycle matures and a soft landing on the back of the current mid-cycle slowdown is eventually confirmed."
- Energy: Soft patch ahead "Weakness is materialising in the oil market with both OECD and non-OECD demand softening. Due to lower GDP projections, we have taken down our forecasts for oil consumption in 2010 and introduce cautiously optimistic 2011 estimates. We now see stocks building for this year on average and postpone our call for a decline in world oil inventories to 2011. The OPEC October meeting will focus on quota compliance."
- Base metals: Still risk of a correction "Declines in global PMIs during the autumn should prove challenging for base metals. Notwithstanding, we continue to see the direction as being upwards and recommend buyers take advantage of almost inevitable price setbacks over the next couple of months to position for higher 2011 levels, especially for copper."
- Grains: Focus on tightness in corn "Wheat has showed continued strength but attention is shifting to corn, the market for which is growing increasingly tight. The projected output shortfalls for this year are unlikely to change the outlook for near-record harvests of most grains, but with demand simultaneously rising, stocks-to-use ratios are declining to less comfortable levels."
- Hedging: Consumers should await correction "We suggest consumers await setbacks in metals, crude oil and crack spreads for distillates before locking in 2011 prices for e.g. diesel."

Why the Federal Reserve’s recent and probably future policy is very dangerous

- "Since Lehman’s bankruptcy, the Federal Reserve has been implementing an ultra-expansionary monetary policy (nearly zero interest rates and liquidity growth), which will probably be stepped up because of the problems facing the US economy."
- "This policy in reality has virtually only drawbacks:
1) it has no positive effects on the US economy, since it does not lead to any upturn in credit or any rise in asset prices, in particular because of the ongoing deleveraging;
2) it leads to the appearance of excessive liquidity being held in banks’ balance sheets, and other economic agents that will subsequently be able to turn into purchases of assets and result in bubbles in asset prices;
3) it leads to growth in global short-term debt in dollars, hence:
• a distortion in exchange rates (appreciation in the yen and the Swiss franc, etc.);
• foreign exchange risk-taking (borrowers in dollars, lenders in other currencies);
• interest rate risk-taking (borrowers in the near term, lenders in the long term)."
- "In all likelihood, US monetary policy will remain very expansionary for a long time. To curtail the risks stemming from this situation, possible solutions include:
1) restricting international capital flows, but this would be difficult and might be inefficient;
2) regulating (curbing):
• foreign exchange risk-taking by banks (borrowing in foreign currencies, lending in local currency);
• interest rate (duration gap) risk-taking by banks (borrowing in the near term, lending in the long term)."

Who will do less badly? The United States or the euro zone?

- "The perception of the financial markets is oscillating: in very late 2009 and in early 2010, the consensus forecast an economic recovery in the United States, but not in the euro zone. Subsequently, investors turned despondent about the United States, before a slight upturn in confidence at the end of the summer 2010."- "What should one think in reality? Which zone, the United States or the euro zone, will post less deterioration in its economic performance after the crisis?"- "We have to compare:• productivity gains, and their probable trend (which depends on the investment drive, the utilisation of corporate savings, etc.);• industry’s capacity to benefit from the robust growth in emerging and oil-exporting countries;• the efficiency, the more or less reasonable nature of changes in income sharing;• changes in the breakdown of jobs between skilled jobs and lowskilled ones (with low wages);• the solvency of borrowers and the outlook for credit;• the need to improve public finances."- "We find that the euro zone is in a better situation than the United States for 4 criteria out of 6, and in an equivalent situation for the remaining 2."

The global economy has all the features of a deflationary economy. What can be done?

- "Some economists have mentioned the possibility of a rapid recovery in global growth, others emphasise the risk of inflation and excess liquidity, while others speak of a double dip."
- "And yet, it seems clear that the global economy shows all the features of a deflationary economy, i.e. excessive savings and hence sluggish demand; ineffectiveness of economic policies in kick-starting activity; unemployment and under-utilisation of capacity resulting in very low inflation; as a consequence abnormally high real interest rates, hence a fall in asset prices and deleveraging which exacerbate the fall in demand."

There is no solution in Japan without an increase in wages

- "The Japanese economy is caught in three traps:
• negative inflation, which increases real interest rates and keeps the country in deflation;
• fiscal deficits and the level of public debt, which has become huge;
• the appreciation of the yen, due to capital inflows and the trade balance surplus."
- "The usual remedies do not seem to be effective:
• increasing the deficit and the public debt further to boost the economy and offset the appreciation of the yen would be irresponsible;
• conversely, increasing VAT to reduce the fiscal deficit would eventually worsen deflation (as in 1997);
• foreign exchange interventions to weaken the yen may be ineffective, as in the past."
- "We believe that the only solution would be an increase in wages: it would lead to positive inflation and stimulate consumption and activity and would reduce the fiscal deficit, it would reduce the trade surplus and would weaken the yen; it would not have any negative effect on companies, which have excess savings and huge financial reserves due to the distortion of income sharing."

What happens if prices become stickier than wages?

- "Traditionally, it is believed that prices of goods and services are relatively flexible and nominal wages relatively sticky. The goods market therefore rapidly returns to equilibrium, while the labour market disequilibrium (unemployment) may persist. In this configuration, a fall in demand for goods (for instance a rise in the savings rate after a wealth loss) drives down prices and drives up the real wage, leading to a fall in output and employment but also a boost in household demand, drives down profits and therefore investment."
- "But in contemporary economies (we look at the situations in the United States and the euro zone) the labour market has become more competitive, whereas inflation is very inert, which must reflect the shortfall in competition in product and service markets. If wages have become more flexible than prices, the reaction of the economy is totally changed. A fall in demand drives down output and employment, but not prices; the nominal wage is curbed, leading to a fall in the real wage that amplifies the decline in household demand, but boosts profits. This is definitely the dynamics seen today, which is unfavourable if the propensity to spend profits is lower than the propensity to spend wages."

Alive and Well: The Equity Cult in Emerging Markets

- Equities v. Bonds — "A recent CIRA Global Strategy report described the collapse of the ‘cult of the equity’ in global markets and the rise of the ‘cult of the bond’ in recent years. The process of de-equitization is a key symbol of these trends. Deequitization means the shrinkage of equity markets, via cash-financed M&A and share buybacks, alongside limited IPO activity. Market cap falls."
- Alive and Well — "The exception to the de-equitization trend is the emerging markets. The weight of GEMs in MSCI ACWorld has risen from 3.8% in June 2002 to 13.1% at end-August. Price performance alone would have lifted this weight to 9%; the rest is explained by the relative pace of equitization/de-equitization in emerging versus developed markets over this period."
- The Evidence — "The ongoing equitization process in emerging markets is shown by: i) strong flows into GEM equity funds ($40bn in 2010, a year of virtually flat markets); ii) rising equity weights in GEM pension fund assets; iii) a structure of bond v. equity yields that does not encourage the retirement of equity; and iv) heavy IPO activity and secondary issuance."
- Q4 Rally — "The ongoing appetite for equities in emerging markets should help to fuel a strong fourth quarter in EM equities. The trading range in MSCI GEMs, in place for several months now, looks set to break at any moment. Ample liquidity, reduced fears of a US ‘double-dip’, favorable seasonals, a rally in the US market and attractive valuations should trigger a Q4 rally in emerging markets."

SMEs, keys to recovery

- "Hard hit by plummeting demand, threatened by globalization, facing unexpected financial difficulties and tackling a regulatory environment that has often been yet another obstacle, the more than three million small and medium-sized firms in Spain have suffered the worst of the crisis. A difficult time in addition to the customary competitive challenges facing SMEs, forcing entrepreneurs to redouble their efforts in order to navigate such rough waters. Because entrepreneurs make SMEs, their commitment and dedication, their view of the market, their management experience, their knowledge of the sector, their ability to take on risk. SMEs represent the entrepreneurial spirit in its purest state."
- "But the evidence shows that good entrepreneurs are not enough. The environment is also vital. A stable economy, with access to sources of both finances and skilled workers, good infrastructures and a suitable framework of labour, financial and accounting regulations are all essential to creating the right mix for SMEs to be born and grow. Society at large needs to realize and appreciate the crucial role played by SMEs in economic life and the development of shared wealth. Studies have confirmed that, proportionally, small firms create more jobs than large ones. Moreover, the new firms started up generate more competition and also make it easier for large firms to outsource, leading to synergies that enhance the progress and development of the economy in general and society."
- "Business people, public authorities and economic and social agents must sort out their capacities in order to optimize results. Entrepreneurs, committed to growing the business and striving to take on new challenges, and the rest, provide resources that help to overcome the intrinsic deficiencies of SMEs. In particular, their lower work factor productivity compared with large firms, in general resulting from the sector orientation, capital intensity or economies of scale, among other factors. Moreover, in a world where innovation and internationalization are decisive in economic progress, it’s important to recognize that SMEs play a fundamental role. In the case of innovation resulting from big investment in research and development, it’s evident that such heights are off limits to SMEs, but when we look at non-technological innovation, their role is key. This is a wide range of innovations that do not come out of the laboratory but result from contact with clients, suppliers and the market; particularly in a world where consumers develop a preference for variety, leading to many different demand niches that can be exploited with the agility and adaptive capacity of small firms."
- "On the other hand, SMEs must also be capable of taking on the challenge of globalization, although this may seem contradictory to their size, taking advantage of advances in information and communication technologies, establishing strategic alliances and cooperation networks that reduce the effects of economies of scale. Here economic policies (international promotion, providing efficient technological structures) also have a vital role to play."
- "SMEs were the first to notice the crisis but they will also be the first to bear out the recovery, once again contributing decisively to growth, to creating jobs and to supporting local and regional economies. Their success will be the success of all."

Tin sparkles

- "Tin’s impressive performance among the base metals is long overdue. By the end of August it was the star performer amongst base metals in 2010, with the price up 21% since the start of the year, to $21,475t, and 53% higher on year ago levels, with only nickel threatening its ascendency, at 16% and 21%, respectively. Although tin volumes traded on the LME are dwarfed by those of the other base metals (apart from molybdenum and cobalt), tin nevertheless remains a crucial industrial metal, particularly since the demise of lead in electronics’ soldering. The global tin market remains in a chronic supply shortfall that can ultimately be traced back to the tin price collapse some 25 years ago. Since that time, tin mineral exploration has been constrained, and compounded in the past five years by the lagged rebound in the tin price compared with the other base metals. Now tin faces what might be a prolonged period of price  strength due to a worsening supply shortfall that might persist for some years to come."

Battle of the QE2s

- Japan’s intervention: a sterile debate
"The MOF’s FX intervention gives the BOJ another shot at QE, which it should take."
- United States: Time to act
"Growing downside risks warrant the next phase of QE."
- Europe: Shell-shocked but not shell-bound
"Euro-area consumers seem to have resumed spending but a boom is not imminent."
- Japan: Policymaking for a new cabinet
"The new Kan cabinet faces challenges on a range of economic issues."
- China: A soft landing underway
"We lower our growth forecast to 10.2% for 2010 but hold to our 9.8% forecast for 2011."
- EEMEA: Minimal impact from Basel III
"Most EEMEA banking sectors already meet Basel III standards but challenges remain."
- ASEAN: Fiscal exit by stealth
"Fiscal 2010 results will likely exceed budget and in some cases may be contractionary."
- Turkey: No ‘new normal’ yet for Turkish GDP 
"The recovery increasingly looks like previous ones. We revise our 2010 forecast."
- South Africa: Pravin Gordhan and Susan Shabangu event
"We hosted a meeting with South Africa's Ministers of Finance and Mineral Resources."
- Mexico: Policy rate cuts unlikely
"Expectations of an interest rate cut have risen but we expect no change until Q1 2012."

Asian Banks: The Mid-Autumn Review

- India, China to Continue Robust GDP Growth into 2011 – "Our real GDP growth estimates for 2010 show stellar GDP growth for Singapore, mainly attributed to a rebound from a low base. However, on a sustained basis, China and India are expected to continue robust GDP growth well into 2011. Indonesia is also expected to maintain strong growth in the 6.1%-6.2% range."
- 2Q10 Loan and Deposit Growth Trends — "Loan growth at 2Q10 was moderate for Taiwan, Thailand, Singapore and Malaysia and strong for India, China, Indonesia and HK. Korea was the only market with low (~3%) loan growth YoY. Deposits growth was also strong (with the exceptions of HK, Thailand and Taiwan). However, loan growth surpassed deposit growth for all markets except Korea. Also, the loan / deposit ratio was <100% for all markets except Korea (116%)."
- Consumer Loans/GDP Lower Than Non-Consumer Loans / GDP — "Consumer loans as a % of nominal GDP lag the business loans / nominal GDP ratio for most markets (except Malaysia). Consumer loans as a % of GDP are lowest for Indonesia (8.4%), India (9.5%) and China (16.5%). However, a recent steep rise in household debt across Asia also hints at asset/property bubble formations."
- Policy Rate Trends Suggest Uptick — "With central banks pressing the brakes, monetary tightening across the region is expected to push up interest rates. So far, India (+100bps), Korea (+25bps), Taiwan (+12.5bps), Thailand (+25bps) and Malaysia (+75bps) have increased rates since Dec 2009. For the remainder of 2010, Citi’s macro team expects no hikes in China, Indonesia and Malaysia; 1 hike in TW (+12.5bps) and Korea (+25bps), 2 hikes in India (+50bps) and 3 hikes in Thailand (+75bps)."
- Credit Multiplier and Market Cap / GDP Studies – "India, Korea, Thailand and Singapore banks are close to the low end of their respective credit multiplier range (credit multiplier = loan growth / nominal GDP growth). HK and Malaysia are at the top ends of their similar range. However, low recent credit multipliers for some markets may also be attributed to a stellar 1H10 GDP rebound from a low base and hence may understate the actual credit multiplier. Banking sector size in equity value terms relative to local economy (i.e. banking sector market cap / GDP %) is low for India, Indonesia and Korea compared to others, highlighting possible scope for improvement in banking sector market caps over time."

Asian Banks: Re-Leveraging Asia, Big Deposit Franchises Shine

- Loan Growth Recovery – "Loan growth for most Asian countries has recovered strongly, with four markets on ~20% growth (IN, ID, CN, HK) and three markets on ~10% growth (MY, SG, TH). Loan growth has mostly outpaced deposit growth; negative real deposit rates have encouraged outflows from bank deposits."
- Tightening Liquidity – "LDRs have risen but are generally still low. But this masks potential liquidity pressures building up, as liquidity/reserve requirements are high in some countries (eg. IN, CN, ID). Excluding these reserves, the loans/lendable deposits ratio rises to 106% for IN, 92% in TH and 87% in ID. Continuation of rapid loan growth could see funding pressures first in IN, followed by TH and ID."
- Rising Household Debt – "Consumer loans have mostly outpaced the growth in overall lending across Asia. Low nominal rates and negative real rates are likely to drive asset prices further, leading to higher levels of household debt. MY and KR have the highest levels of household debt in the region; if adjusted for GDP/capita, MY’s level of household debt would be the highest in the region."
- Rate Normalization Continues – "We see the most rate hikes in the next 12-18mths in IN, ID, TH and KR; least hikes in HK, SG, CN, MY and TW. Banks/sectors with high levels of CASA deposits and low fixed rate lending benefit most. HK, CN, TW, TH and selective ID banks are structurally best positioned; MY and KR banks seem least sensitive to rate hikes."
- Big Deposit Franchises With Liquid Balance Sheets – "Key beneficiaries of strong credit growth and a rising rate environment are mostly low-LDR banks with big deposit franchises. We highlight: BCA, Mandiri in Indonesia; KTB, BBL, KBANK in Thailand; SBI, PNB, HDFCB, AXIS, ICICI in India. Big HK banks BOCHK, HSB are the most liquid regionally but HK has the least potential for rate hikes."
- Valuations Not Cheap Post Re-Rating – "Most Asian banks re-rated sharply in past 3 mths as prices in most markets (except CN, KR, SG) have climbed ~20% vs positive consensus EPS revisions only in MY and ID. Most Asian banking sectors are now over 13x forward PE; cheapest are KR and CN on less than 10x."
- Overweight CN, TH – "CN banks’ valuation gap vs the region has widened further; most concerns seem priced-in. TH banks still at a discount to ASEAN peers but with better growth, although there is potential policy risk to curb liquidity inflows. Overweight CN, TH. Neutral IN, KR, MY, HK. Underweight ID, TW, SG. Top buys: CCB, ABC, SCB, KTB, Stan. Top sells: BDMN, UOB, OCBC, Cathay, Fubon."
- Multi-strategy — "We recommend 1) Long investors to buy a customised basket of selected regional top picks, 2) Derivatives investors to buy single-stock calls."

Latvia and Hungary: Start October headache

- "We see a troublesome threesome in emerging Europe, hidden below the current decent risk conditions and bond inflows to emerging market funds. Hungary, Latvia and Romania each have risks connecting fiscal, politics and elections. We wrote about Romania last week in “Metastable Equilibria” and the rising risks of early elections and disintegration of the cabinet. Now we look at the other two countries in a little more depth. However, these three countries and their respective domestic fiscal nd political stories can feed back on one another, and we believe this could develop into a more generalised regional sovereign risk story. This could well become important at the start of October with the Latvian parliamentary elections on the 2nd and then the Hungarian local elections on the 3rd."
- "This theme is particularly relevant as we move though H2 and towards next year as these countries are reaching the end of their IMF credit lines (October 2010 for Hungary, April 2011 for Latvia and May 2011 for Romania). More than that these countries face potential difficulties funding in the market under adverse risk conditions, and IMF repayments could add further difficulties down the line (although all have a significant proportion of IMF/EU aid still in reserve, drawing down reserves is not a good sign) although that will not start for another year or two. On top of this, we expect the market re-focus on the issue of peripheral Europe and how it will fare through 2011, and so any risk in CEE is likely to be associated with a corresponding country in western Europe. In particular Hungary is obviously linked via its banking system to Germany. Romania is linked to Greece and the rest of the periphery in both banking and export terms, while Latvia has its classic linkage to Sweden."
- "The Hungarian government has turned its back on the IMF/EU lending package and appears to have “got away with it” so far. Risk sentiment towards EM countries in general is positive and bond inflows have remained moderately supportive. In addition, some in the market believe that the government is on the right path. However, the risk that other governments (or opposition parties) try to force a similar anti-Brussels/Washington consensus line is being closely watched by the EU and we believe any such behaviour will be stamped out quickly in a flurry of rhetoric and if necessary warnings of likely consequences."
- "As ever with such events, markets are likely to be slow to react, in part because results will not be known for some time and also in the case of Latvia because coalition talks may well take a month or more. The speed of market reaction may well be influenced strongly by the degree of risk tolerance of markets in three and a half weeks’ time."

Tax Policy Could Break U.S. Economic Stalemate

- "Changes in income tax rates in isolation have virtually never set the U.S. economy in an entirely different direction. Nonetheless, as the sharp turning points of 2008/2009 fade behind us, tax scenarios that could mean fiscal tightening of 2% of GDP or zero represent quite meaningful differences to the 2011 outlook."
- "Our base case U.S. economic view embeds tax increases close to 0.8 percent of GDP, similar to the Obama administration’s proposals and a bit less than we assumed earlier this year. Compared to our earlier views, a scenario of forestalling all tax increases now seems possible, if not probable, in our view."
- "While income tax increases for the highest earners would affect a small minority of tax payers, it would be a drag on a relatively large share of income and spending. According to the Congressional Budget Office, across all sources of income, the top 5% of income tax filers accounted for 44% of all
federal tax liabilities in 2007. It would also affect the employers of millions, if not the millions of small business (S-Corp and proprietors) employees directly."
- "The case for a stronger recovery in the U.S. is clearly centered on reviving business expectations amid a massive precautionary liquidity buildup in both the business and household sectors that could be put to more active use. Some certainty and consistency on tax rates could eliminate a barrier to action."