Equity Strategy: A Mid-Year 2010 Perspective

- "The first half of the year reflected earnings strength and then slowing momentum. Better-than-expected 4Q09 results initially buoyed skeptical investors and the robust trends were further confirmed with 1Q10 earnings. But, typical slowing economic momentum following a reflexive bounce off of the anomalous early 2009 trough has generated a new sense of unease about the future which has been further complicated by government austerity and unanticipated FX swings. To some extent, the pattern was partially predictable, as investors had become trend followers rather than forecasters."
- "Powerful 1Q10 EPS growth was unsustainable, with margin pressures mounting. As noted in mid-April, the rapid acceleration in earnings growth projections reflected both increased executive confidence and a catch-up element. Upward EPS estimate revisions climbing above the 70% threshold was a clear indicator that the data was getting too virtuous and was unsustainable. The impressive margin rebound was due to incredible cost containment and a moderate revenue uptick, but maintaining such elevated profitability needs to be questioned."
- "Sentiment shifted from panic to complacency but now is back in panic mode. In early 2010, there was deep anxiety that the recovery rally from March 2009 had come too far given Greek debt fears, Chinese monetary policy tightening moves and perceived unfavorable policies out of Washington. By early February, the Panic/Euphoria Model had slipped back into panic territory. Yet, after 15%-20% appreciation in equity indices, this proprietary sentiment gauge advanced into complacency in April, leaving markets vulnerable to a pullback. In the past weeks, the model has collapsed back into panic, suggesting a high probability that the S&P 500 climbs in six months, supporting out 1,175 year-end 2010 target."
- "Uncertainty about 2011 trends is likely to cap any major summer rally efforts. While some may look for guidance out of the 2Q10 reporting season, which begins next month, it seems doubtful that issues including tax policies, government spending programs, housing trends, unemployment, trade disputes and currency trends will be settled that quickly. Ambiguity around capex is being resolved, but 2011 clarity is likely to be found later in the year rather than over the summer."
- "A late 3Q10/early 4Q10 market surge seems most likely driven by several catalysts. The start for a renewed rally appears probable in the September/October time period with the midterm elections, the bipartisan commission’s report on US deficit reduction and a better sense of how the Bush tax cuts expire all contributing to some increased clarity for 2011. In addition, there may be greater visibility regarding the impact of the European austerity initiatives relative to stronger economies such as Germany’s. Thus, the slowing economic momentum can be seen as settling in for more normal global growth rather than the traditional initial cyclical bounce."
Citigroup Equity Strategy 20100629


Europe's fiscal dystopia: the "New Austerity" road - Counterpunch
Employment report preview - Calculated Risk
Is monetary policy too expansionary or not expansionary enough? - FT Wolfexchange
RBS tells clients to prepare for 'monster' money-printing by the Fed - Telegraph
Parenteau: Marching to Austeria* and Other Neolib Fibs - Naked Capitalism
Wall Street's New Reality - Daily Beast
The risk of recession - Credit Writedowns
Study: Nearly One in Five Mortgage Defaults Are ‘Strategic’ - WSJ
How Far Underwater Do Borrowers Sink Before Walking Away? - WSJ
UK banks’ funding fun has just begun - FT Alphaville
Quantifying the ECB overdraft - FT Alphaville
Whoa. Look at the Yield on the 10-Year - Wall Street Journal
Owning the Banking System - New Deal 2.0
Three debts: A view from emerging Europe - Vox EU

Germans and fiscal deficits, monetisation of public debt, inflation

- "Remembering the traumatic experience of the 1920s and '30s, the great majority of Germans sincerely believe that it is absolutely essential to prevent:
• fiscal deficits, which can result in forced monetisation, and which divert savings to the detriment of companies;
• the monetisation of public debt (monetary creation), which inevitably leads to spiralling inflation;
• Inflation, which is destructive for society by despoiling savers."
- "One can therefore understand Germans' reservations regarding:
• the euro zone if there are no strict budgetary rules; without such rules, countries other than Germany could have excessive fiscal deficits that the ECB would in the end have to monetise; Germans' savings would be used to finance the fiscal deficits of the other countries;
• the monetisation of public debt by the ECB;
• the loss of competitiveness of the other countries which could, at fixed exchange rates, push up inflation in Germany."
- "The need to prevent the destruction of the euro zone (in particular due to sovereign defaults) and the need to accept different productive specialisations in the other countries therefore face resistance in Germany, because they force it to accept developments (monetisation of public debt, divergence of wage costs and trade balances) that it normally rejects."

Natixis Flash Economics 324 20100623

Towards a "Japanese" model in the euro zone?

- "There is currently a clear economic recovery in Asia, Latin America, the large Central European countries, Europe apart from the zone euro, Japan, India, oil-exporting countries and even in the United States, despite the deterioration in households’ financial situation, Canada and Australia. The euro zone is an exception, and we actually expect sluggish growth in domestic demand in the euro zone due to:
• the slowdown in wages,
• the rise in household savings,
• offshoring,
• the reduction in fiscal deficits;"
- "The euro zone could therefore evolve towards the "Japanese model": weak wage incomes and household demand, growth due to exports and associated investments."
- "This new model would be a major trend break for many countries, would be favourable only in countries that have kept a large industry and exports and would also raise the question whether the distortion of income sharing at the expense of wage earners can be accepted."
Natixis Flash Economics 323 20100623

Local regulation in global markets?

- "The last couple of weeks brought about some breathtaking developments. Who would have imagined a few months ago that center-left governments in Greece, Spain and Portugal would come up with draconian fiscal belt-tightening, while a center-right government in Germany implemented drastic regulatory tightening? Both factors have (potentially negative) implications for credit markets. However, while the deleveraging of sovereign balance sheets seems to be inevitable, an improved regulatory framework should address the formation of a bubble rather than preventing tools to hedge against a bubble."
Macro Outlook: "Financial markets play an essential role in the economy as intermediaries. However, asymmetric information, moral hazard and adverse selection make regulatory intervention indispensable for efficient functioning."
Micro Fundamentals: "Regulation has managed to become the main concern of investors due to poor political response to the capital markets shake-up in May. Tighter credit conditions could be one implication that negatively affects borrowers."
Debt-Equity-Linkage: "The new regulation measures will potentially impact the link
between debt and equity financial instruments, not only reducing liquidity in these markets but also disturbing the relative pricing of debt and equity instruments."
Credit Quality Trend: "Increasing the credit quality of banks is the ultimate goal of regulators to improve systemic stability. The easiest way would be to increase bank capital, but this has negative implications for the economy, as it would increase the cost of credit."
Market Technicals: "The sovereign debt crisis impacts primary markets. With the risk of a substantial repricing of credits in the cards, investors are not ready to add credit exposure."
Valuation & Timing: "Markets will behave less jumpy but spread widening pressure will persist."
Other Credit Markets: Credit Derivatives: "The actual usefulness of the German short-selling ban on CDS remains a mystery. EEMEA Credits: Accelerating inflation, surging housing prices and economic growth reaching almost 12% have increased pressure on Chinese authorities to undertake steps preventing a hard landing, with potentially negative implications for EEMEA credits. Regulation overkill in securitization illustrated by two new rules, i.e., CESR money market regulation, US-SEC Rule 17g-5."
Allocation: "Having missed the opportunity to cut our exposure to the more cyclical basic resources sector on time, we are also reluctant to implement this reversal during a panic phase. Nevertheless, amid mounting evidence of slower economic activity in China, we plan to reduce our exposure in the next few weeks. The rest of the portfolio remains unchanged as it already reflects our defensive stance."
Model Portfolio: "Our financials portfolio underperformed the benchmark by -67bp, while the non-financials portfolio underperformed by -32bp due to our exposure to basic resources."
Unicredit Euro Credit Pilot June2010

Get ready for the 12M LTRO expiry

- FI Strategizer: "Weak US data along with uncertainty ahead of the 12M LTRO expiry should create a favorable environment for Bunds and UST. Pressure on periphery should stay high in the coming days."
- EU Portfolio Strategy: "We stay long duration: the G-20 over this weekend and next week’s US data should not change much the positive mood for FI."
- 12M LTRO: "Next week, the 12M LTRO held in June last year will mature. The amount to be rolled over will send an important signal about the health of European banks, will affect excess liquidity in the Eurosystem and will be crucial for the dynamics of MM rates."
- German Q4 funding: "Due to a decline in its deficit, Germany cut bond supply by EUR 2bn in 3Q vs. what was previously planned, an overall modest amount. We expect a more sizeable cut (ca. EUR 10bn) in 4Q."
- UK Budget: "This week, the UK released its emergency budget, which contained strong measures to cut the deficit. As a result, this year Gilt supply may be 28% lower than last year."
- MM: "Bids at the 1W MRO reached EUR 151bn. Data released by the CB of Portugal showed that Portuguese banks bid EUR 35bn of liquidity in May at the ECB, almost twice as much as in April."
- Supply Corner: "Next week, there will be ca. EUR 20bn of redemptions and EUR 14bn in coupons (from Germany), while gross supply should be EUR 18/20bn. Net supply should be slightly negative (EUR 0/-2.6bn)."
-FX Strategizer: "Choppy trading on FX majors should continue also in the aftermath of the G-20 meeting. Resuming global risk aversion should remain the key driver ahead of a sluggish US employment report on Friday, favoring both the JPY and the CHF."
- EUR: "Although the euro held the line despite falling stock markets and widening yield spreads & CDS across the eurozone, EUR-USD should face more downward pressure due to the renewed clouded risk picture."
- JPY: "Market euphoria for Beijing’s decision to allow the yuan greater flexibility has faded, but the JPY should stay firm as risk aversion persists: we wouldn’t rule out EUR-JPY to slide again towards 108, also helped by a stronger BoJ Tankan report."
- CHF: "Jordan’s explicit remarks that the SNB has no need to intervene in the FX market were clearly taken as a “green light” for more intense EUR-CHF sales: the full break of also the 1.35 wall is approaching fast."
- GBP: "The UK Emergency Budget proved to be tough enough to boost sterling. Cable should definitively break through 1.50 and move towards 1.51, while EUR-GBP should fall below 0.82 if EMU woes persist."
- Pacific Rim & CAD: "While resuming risk aversion may weigh further on the three commodity units, political uncertainty may represent a unique source of volatility for the Aussie dollar, after Gillard became the new PM and debate on the mining tax abruptly returned to the spotlight."
- Nordics: "The SEK and NOK trends may diverge for the time being due to monetary policy at home. The Norges Bank sounded cautious on more intense tightening, while the Riksbank should hike rates next Thursday."
Unicredit Curves&Crosses 20100625

How fragile are debt holdings in EMU?

- "74% of Euro debt, issued by EMU residents, is held inside the Euro area and underlines that debt portfolio shifts are predominantly an intra-EMU story."
- "Intra-EMU non-resident debt holdings are a source of financial fragility for the periphery as rollover is likely to prove tough, especially in private sector debt."
- "Divestment risk from US and Japanese holders of € debt is interesting but ownership of the periphery is rather limited, tough illiquidity amplifies market impacts."
- "A dearth of data makes assessment of reserve manager shifts out of periphery paper hard to forecast, but this looks to be the trend. Caution on some core EGB names can rise but reserve managers are likely to increase exposure to the likes of Germany."
- "There little reason to think Bunds face a systematic risk of non-resident selling, unless the crisis envelops Germany to the point of much higher default risk."
RBS European Rates Strategy 20100625

Cult of the equity will disappear; Sub 2% US 10s

- Overview: "Get ready for the cliff-edge. Be maximum long duration of nominal government bonds in safe haven markets. This means US, UK, Germany, in that order, and perhaps others. Be long gold. Think the unthinkable. Get ready for sub 2% on 10-yr USTs; sub 2% on 10-yr bunds; and the UK not far behind, 2.5% 10-yr Gilts. We strongly believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe), and for the global economy (particularly in the US/Europe). We like the risk/reward. Surely risks associated with us being wrong are low (ie, rates just stay where they are, yields back up a little bit). But risks associated with us being right are >10% returns in 10-yr USTs at the same time that equities/commodities will collapse far beyond what even some equity bears anticipate."
- Euro Area: "The run-off of the 1y LTRO is unlikely to see marked impact on periphery short end or a material rise in EONIA, though the OIS curve can steepen. In addition to this subject, in this issue we looked at the Periphery vulnerability via external debt."
- UK: "We update funding numbers post-Budget. We still like Gilts against Europe as a trade & theme, but acknowledge the mere meeting of Budget expectations, coupled with quieter market with less events risks, implies a slower outperformance."
RBS European Rates Weekly 20100625

Striking a balance

- "UK Chancellor of the Exchequer George Osborne’s first Budget did not disappoint the markets. The decline in the budget deficit over the course of the parliament was broadly as we had expected – a further 2% of GDP reduction, with the structural deficit falling to between 0% and 1% by the end of the forecast horizon."
- "The ratio of spending cuts to tax increases was roughly in line with the 80-20% rule of thumb outlined by the Conservatives ahead of the election. While half of the spending cuts announced this week have yet to be detailed (we must wait until the October Spending Review) the resolve of the Chancellor to make these cuts does not seem in doubt after this Budget. The rating agencies’ initial response has been positive, and we do not see a downgrade to the UK’s AAA sovereign rating following this Budget."
- "Market sentiment deteriorated once again this week, not because of the euro debt crisis per se, but because of a re-assessment of global growth prospects. This opens a downside risk to our already sub-consensus euro area GDP growth view. There was something of a warning in this week’s euro area business surveys. The rolling over of expectations balances probably heralds the peak in the economic sentiment cycle."
- "A key event this week will be the expiry of the first (and at EUR442bn the largest) of the ECB’s 12-month tenders. The rollover risk is low because of the coinciding full allotment tenders. The amount rolled-over will provide a good indication of the state of the banking sector (the lower the better)."
- "Also in this week’s Focus Europe we preview the German Presidential election and look at the worsening economic sentiment environment in France, imported inflation in the UK and euro area, and the latest events in Romania where the IMF’s 4th review has been delayed."
DeutscheBank Focus Europe 20100625


A pendulum swing toward austerity - New York Times
China, the yuan and euro - Credit Writedowns
The other liquidity strain -- in China - FT Alphaville
Spain's long, hot, refinancing summer - FT Alphaville
Jobless bill dies amid deficit fears - Wall Street Journal
Increasing hours worked versus increasing hiring - Macroblog
Iceland's campaign is a joke, until he's elected - New York Times
Obama's most costly error - The Money illusion
Chinese pay rises spur move to cheaper sites - Financial Times
Close but no cigar! - Pension Pulse
Date set for historic deal with Taiwan - China Daily
Fannie Mae to charge strategic defaulters, for everything - Housing Wire
The banks that cried wolf - Slate
The second bubble bursts - The Street
Is quantitative easing the last gasp bubble? - Minyanville
The best stimulus? Spend less, borrow less - Fortune
Chinese property: Another popping sound? - FT Beyondbrics
The ECB and good liquidity versus bad liquidity - Data Diary
Societe Generale: We are now walking on the deflationary quicksand - Fmx Connect
MIT researchers see natural gas as the choice for lower carbon emissions - NY Times

UK banks: Turning the corner

- "UK banks are benefiting from a combination of declining impairments, rising margins and strengthened capital bases. The domestic banks are trading on valuations at or below book value. In the past, UK banking has proved a profitable industry and could be expected to be so again, as long as economic recovery continues, even if future returns are well below those achieved in the past cycle. Compared with European banks, UK groups are also likely to have relatively limited exposure to southern European markets. We therefore expect the UK banks to continue to perform positively in a sector context. Against the market as a whole, banks are likely to continue to be geared towards perceptions of economic recovery. Downside in UK banks appears to require a double-dip scenario."
• "We are raising our rating on Lloyds to Buy and target price to 80p from 53p, and it is now our preferred domestic UK banking name. Lloyds is particularly geared to the theme of domestic margin expansion owing to the repricing of mortgage asset yields and short-term wholesale funding. In addition, we believe that balance sheet restructuring will eliminate the double leverage of the capital deployed in the life insurance business by 2012, allowing it to be more highly valued in the group valuation. We prefer Lloyds to RBS, on which we retain our Reduce recommendation, but raise our target price to 41p from 31p. Both groups are geared to credit trends and to wholesale funding rates. However, we believe that Lloyds is capable of achieving an attractive normalised RoE, whereas we are more cautious towards the achievable profitability at RBS."
• "We cut our Barclays recommendation to Neutral and reduce our target price to 300p from 425p. Although the group may report respectable profits by peer group standards, we believe the valuation is likely to remain capped by the business mix and associated regulatory risk."
• "Among the Far Eastern banks we continue to prefer Standard Chartered and retain our buy recommendation. We cut our HSBC recommendation to Neutral, and reduce our target price to 725p from 800p. The shares have outperformed the European bank sector in the recent correction. Although they retain defensive attractions, we see the main upside catalyst as increases in US interest rates, which would benefit deposit margins."
• "This note includes our projections for balance sheet trends, including asset quality, capital and liquidity, in addition to an analysis of current profitability drivers and our estimates for normalised earnings."
Nomura UK Banks 20100625

Credit derivatives: under the bonnet

- A primer on CDS, indices and tranches
• CDS contracts, volumes and conventions
• Building credit curves and pricing CDS
• MTM and quotation conventions
• Exotic variants including recovery swaps, quantos, CLNs and FTDs
• Index tranche volumes and rationale
• Index tranche conventions
• Pricing, base correlation and risk analysis
Citigroup Credit Derivatives 20100625

Sovereign risk looms large

- Bank of England Financial Stability Report (FSR) highlights three key risks for the financial system:
• "Concerns about the commitment and ability of some European governments to strengthen their balance sheets, potentially leading to a ‘conflagration’."
• "The capacity of the UK banks to refinance or replace close to £800 billion of funding that matures by end of 2012"
• "The risk that banks are forced to adjust to the new regulatory requirements too quickly."
- "The common thread through the whole Report is the outlook for credit supply: the need for supportive lending is deemed to have increased, and the risks of another crunch have escalated."
- "The Bank judges that the resilience of the UK banks has continued to improve: leverage is down, the quality and quantity of capital and liquid assets are up. But problems remain, with pockets of vulnerability in the banking book and profitability likely to be constrained going forward."
RBS UK Economics 20100628

Economic outlook, Norway

- The slow recovery continues
• "The economic recovery continues, but the pace is surprisingly moderate in early 2010."
• "The expansionary economic policy and private consumption are still driving the recovery. This will also be the case for the next quarters combined with a contribution from exports."
• "We lower our growth forecast for 2010 to 1.9% from 2.4% due to the disappointing start to the year, while we maintain our forecast for 2011 at 2.6%."
- Consumers still important for the recovery
• "The increase in private consumption has fallen a bit in 2010, but private consumption still grows fairly well."
• "Still, wage growth is strong, inflation is low, and progress in the housing market not least means that this trend will continue over the next quarters."
- The manufacturing industry has started to pick up - but only moderately
• "After a period of stabilisation, industrial production has again begun to grow moderately."
• "The manufacturing industry is kept down - in spite of solid growth in private consumption and a recovery of the global economy - by a high cost level due to solid wage growth."
- Interest-rate hikes at a measured pace
• "We expect that Norges Bank will continue to raise interest rates - but at a measured pace."
• "The next hike is expected in October."
• "We expect interest rates to stand at 2.75% at the end of the first half of 2011."
• "The hikes will be at a measured pace due to a slightly disappointing development in the economy and increased uncertainty due to the debt problems in Southern Europe."
JyskeBank Economic Outlook Norway June2010

Growth and EPS in the euro zone

- "The rapid reduction in fiscal deficits will definitely reduce euro-zone growth below what is consensually expected. In order to quantify the effect of this reduction in growth on stock market indices, we estimate the link between GDP growth and EPS (earnings per share) for the euro zone. A 1 percentage point shortfall in growth reduces total EPS by 11.3%"
Natixis Special Report 20100625

The USD/CNY at 7?

- "The decision made by the People's Bank of China to adopt a basket of currencies again has been accompanied by a slight depreciation of the dollar against the RMB. We show that the targeting of the RMB against a currency basket will not automatically lead to an appreciation of the RMB. On the contrary, the Chinese yuan could very well depreciate against the dollar in the event of a sharp depreciation of the euro against the greenback!"
Natixis Special Report 20100624

Can the euro lose its international currency status?

- "There is actually reason to fear that the euro may lose its international currency status due to the appearance of sovereign risk on the public debts of a certain a number of countries and the deterioration in the quality of the ECB’s balance sheet. Given the amounts of euro-denominated assets held by non-residents, a sale of these assets would lead to a huge crisis."
- "For the time being there is no reduction in the share of the euro in official reserves, but the capital flows from non-residents into bonds and liquid assets in the euro zone have declined."
- "However, quite a large number of factors indicate that the euro will keep its international currency status:
· only French and German public debts are widely held outside Europe;
· non-residents hold a large amount of euro-zone equities, and European listed companies are very international;
· the quality of the Federal Reserve’s balance sheet is far worse than that of the ECB’s balance sheet, and the financial situation of US households is far worse than that of European households;
· the US external deficit is reappearing, which is likely to create mistrust towards the dollar;
· the euro zone will definitely adopt a new, far more substantial governance, i.e. supervision of budgets and macroeconomic situations."
Natixis Flash Economics 322 20100623

Policymakers growing more confident on Asia's outlook

- "The past week’s economic news across Asia has been dominated by China’s announcement to allow greater exchange rate flexibility. Markets welcomed the announcement and stock markets and currencies initially rallied, although euphoria soon faded on realization that any appreciation will be limited and gradual through the year. The RMB appreciated for the week by about 0.5%, a small move in absolute terms, but relatively large given the de facto peg that had been in place since July 2008. And certainly large enough for China to successfully fend off criticism at the G20 meeting that concluded over the weekend in Toronto."
- "The week ended with a surprise interest rate hike in Taiwan (see highlights), a signal of the authorities’ growing confidence in the economic outlook. Adding to optimism was the announcement that Taiwan and China have concluded their historic trade agreement, ECFA, to remove barriers to cross-strait trade and investment ties. Korea’s government also significantly upgraded its growth outlook and signaled a more aggressive implementation of its exit strategy. Elsewhere in the region, CPI figures show that inflation remains under control, although it is gradually rising (outliers are India and Vietnam with relatively high inflation, and Japan with deflation) except in India and Vietnam). For further confirmation of the outlook, Markets this week will be awaiting important PMI data in China, and trade, production, and inflation data for June in Korea."
- "Australia provided a political surprise for the region, with Prime Minister Kevin Rudd resigning, as his popularity had fallen in recent months. The new PM, Ms. Julian Gillard, has signaled more flexibility in negotiating and formulating Australia’s new mining tax. For the region, the fallout of Australia’s integration with Asia will be watched, as Kevin Rudd had been known as a keen promoter."
BBVA Asia Weekly Watch 20100628

LatAm pushes forward on the back of domestic demand

- "Imports data from Argentina, Brazil and Chile confirm strong growth of domestic demand in the region. Lending continued to grow in Brazil in May (19% y/y). Also Colombian GDP (4.4% y/y, 1.3% q/q) beat expectations due to robust expansion of domestic demand. Argentina completed with a 66% acceptance rate the debt swaps with holdouts, beating expectations, while en Venezuela Cadivi increased access to formal exchange rate market in May by 59.2% y/y. Mexico's GDP fell -0.3% q/q (4.4% y/y), as a result of a drop in private consumption and public sector investment. Chile announced new local issue of sovereign long-term debt for value equivalent to 3 billion dollars."
- "Positive outlook for Latin American currencies, despite the uncertain international environment."
- "Uncertainty about European economies added to jitters about U.S. recovery, and fears surrounding appreciation of the Chinese Yuan; however, domestic factors in each economy prevailed and contributed to strengthening the region's currencies."
BBVA Latin Weekly Observatory 20100625

FX Strategy Weekly

- "The resilience of GBP and stale USD performance vs G10 currencies in a broader context of risk aversion is a new development and will bear close watching over the week ahead as we square up to heightened event risk from the US and the euro zone. Investor scepticism has been underlined by the 40% collapse in the Baltic Dry and a dreadful sequence of US housing data for May, drawing support for the JPY and CHF. A second disappointing US employment report in as many months threatens to further derail confidence and could add to the view that the Fed will eventually have to resume asset purchases. The ECB one-year tender expires on Thursday. The quarterly IMF Cofer statistics covering changes in Q1 FX reserve composition are due on Wednesday."
- "A solid weekly performance saw GBP rally against all G10 currencies bar the JPY as the correlation with risk turned lower. Bolstered by hawkish MPC minutes and the endorsement of the UK Budget by the credit ratings agencies lifted GBP/NOK to the top of the rankings with a 2.7% gain, followed by GBP/CAD (2.6%) and GBP/EUR (1.6%). China’s decision to de-peg the yuan from the USD resulted in USD/CNY hitting an all-time low at 6.7860, but the impact on the broader G10 was muted with JPY gains primarily attributed to the flight from risk. The CHF continues to attract solid demand since the June 17 SNB meeting, and progressed to below 1.35 vs the EUR. USD/CHF slipped below 1.10."
- "News that MPC member Sentance voted for a rate hike at the June meeting came as a shock and was the highlight of a week primarily dominated by the emergency Budget. Though the majority MPC view still points to low interest rates for longer, Mr Sentance’s dissent indicates that the policy debate could be become more fragmented if the recovery is sustained in the second half of the year. The regime of fiscal austerity imposed by the Chancellor leaves many question marks over the direction of the economy. The Budget foresees GDP growth of 1.2% this year and 2.3% in 2011, with CPI inflation on target. An additional £40bln of fiscal tightening means net borrowing is projected to fall from £155bln of GDP this year to £37bln by 2015."
- "A stellar performance for UK rates saw 5y swaps return to the lower end of the trading range and 10y yields slide to the lowest level since last October, cracking technical support at 3.44% and 3.40%. Key support runs at 3.35%. 3-mth Libor was unchanged at 0.73% for a 3rd week running, causing the 3mth Libor/5y swaps curve to flatten to 176bp, a twoweek low. The 3mth Libor/Ois spread ended the week marginally tighter at 23.5bp. The 2y/10y swaps curve flattened 6bp to 197bp. Failure to break 206bp leaves the curve vulnerable to a corrective flattening to 192bp. Following this week’s lull, gilt sales will resume next week with the auction of £800mln, 0.75%, 2047 IL paper."

LloydsTSB FX Strategy Weekly 20100625

USD currencies still expected to gain vs. EUR currencies

- "The latest IMM data covers the week from 15 to 22 June."
- "Net long USD positions were reduced slightly for a second week as the USD rally has begun to lose steam. Still, non-commercial investors are net long the USD against all the EUR currencies (GBP, EUR and CHF), but net short the USD against all the other G10 USD currencies (MXN, CAD, AUD, NZD, and JPY)."
- "As EUR/USD failed to break above 1.25, after correcting higher from its 7 June 1.1877 low, non-commercial investors have added fresh EUR shorts – taking net short EUR positions to 32% of open interest. This should imply that the upside risk to EUR/USD from a position squeeze has increased again, although there is still room for the market to add further short EUR/USD positions before reaching the crowded positioning levels seen during May – where net shorts reached 40% of open interest."
- "Non-commercial investors turned net long NZD again after briefly having been net short during the past two weeks. However, open interest is currently quite low in NZD, which means that one should be careful not to read too much into the data."
- "Open interest has declined in most currencies, potentially indicating lower liquidity in the market going into the summer period – though other factors could easily be driving this. Thin summer trading could be expected to bring higher volatility on the market. However, in previous research (see FX Crossroads: Post vacation blues), we have highlighted the lack of empirical evidence supporting this hypothesis. While there are signs that liquidity does indeed decrease during July, implied volatility does not seem to pick up. In contrast, implied volatility tends to pick up in the autumn."
DenDanske IMM Positioning 20100628

Euro area: Fiscal tightening is unlikely to kill growth

- "The debt crisis has accelerated fiscal tightening in the euro area. If the tightening is accelerated too much, it will kill growth."
- "We have estimated the impact of the tightening that has already been put forward. This is projected to dampen euro area growth by 1.0 percentage points in 2011."
- "The debt crisis has also resulted in significant euro weakening. This counters the negative impact of the fiscal tightening as it improves euro area competitiveness."
- "Euro weakening is estimated to lift euro area growth in 2011 by 0.8 percentage points. The net effect of fiscal tightening and euro depreciation on growth is modest."
- "The most open economies should benefit the most from the euro weakening while the negative impact of the debt crisis has been most felt in southern Europe."
- "The negative impact from fiscal tightening is also countered by a positive growth contribution from interest rates, which due to the debt crisis are expected to stay low for longer."
- "The overall effect of the debt crisis might however be somewhat more negative as the crisis has increased uncertainty and resulted in tighter credit conditions, affecting weaker countries and institutions most."
DenDanske Research Euroland 20100628

The competitiveness of the periphery; the cash position of Spain

- "With fiscal consolidation and private-sector deleveraging across the Euro-zone underway, peripheral countries in particular will need to improve their export competitiveness and rebalance their economies towards external demand. While the weakening of the Euro so far this year should certainly help in this regard, the overall starting position for these countries is, at face value, not particularly favourable: by most standard measures, they have suffered a marked deterioration in price competitiveness over the past decade."
- "However, our analysis produces a more encouraging result: when we examine the
historical relationship between these measures of competitiveness and relative export performance, we find that their explanatory power for Euro-zone countries is rather limited. In particular, they seem to overstate the extent to which competitiveness has deteriorated in certain countries, partly because they fail to take into account the extent to which price and cost increases have been driven by quality improvements. For this reason, we think the competitiveness situation in the periphery may not be as dire as the indicators suggest, and that the price adjustments (i.e., internal devaluation) needed to generate export gains may not have to be as draconian as most envision."
- "Spain’s public finances remain under the spotlight. One reason is that in July Spain will need to finance its monthly cash deficit (some €10bn-€15bn) and refinance the redemption of €24.7bn in government paper. Our second focus assesses its financing prospects, and the type and order of magnitude of any possible funding squeeze—as well as the tools the government has at its disposal to resolve it adequately."
GoldmanSachs European Weekly Analyst 20100624

Japan and the post-crisis world

- "As is by now well known, Japan is on the verge of losing its number two status in the ranking of the world’s largest economies. For the past decade, Japan has struggled to keep up with the pace of growth in other major developed economies, the BRICs and other emerging economies. China has increased its size to seven times that of Japan, and even some of the Euro economies have increased in size more than Japan in US$ terms (both exaggerated by the weakness of the Dollar). Unsurprisingly, therefore, financial market participants now tend to think about Japan and its markets against this backdrop."
- "However, recent developments paint a less gloomy picture. First, the cyclical recovery of the economy is on a par with that in the US and Europe—and possibly even better. Second, following another change in the Prime Minister, the conditions for Japan to make progress on its taxation system and its fiscal challenges now appear to be in place. Moreover, Japan is in the same continent as most of the key exciting economies of the next decade and beyond. Hence, Japan’s experience and historical success as an exporter should allow it to benefit from the continued emergence of China and India, and, within the context of the N-11 economies, Indonesia and perhaps some of the other Asian economies too."
- "We currently forecast that JGBs will underperform other major markets by the end of the year. We also expect a weaker Yen and a stronger performance of Japanese stocks (although we expect other global markets to outperform). It will be interesting to see how the outlook for Japan pans out in coming weeks and months. But it may be that Japan will not be as uninteresting’ as many overseas investors typically think.
GoldmanSachs Global Economics Weekly 20100623

Dipsy doodle

- Macro viewpoint: Dipsy doodle "Perhaps the biggest concern is in the housing market. In the past week, new home sales plunged 32.7% to a 300,000 annual pace in May. This is the weakest level of sales in the 47 year history of the series. Clearly, the housing market remains deeply depressed.
- Fed watch: Launching QE II? "The June FOMC statement did not contain any surprises. But reading between the lines, some investors are asking: does the Fed now expect a double-dip or deflation? We think not, but are somewhat concerned about its policy options should either occur.
- The week ahead: Waiting for nonfarm Friday "With the capital markets on pins and needles, next week’s bevy of economic data is particularly critical. The main event will be Friday’s employment report. We expect private nonfarm payrolls to advance 150,000 in June after a disappointing 41,000 increase in May. With the Census employment rolling off appreciably, headline nonfarm employment is expected to decline by 100,000, and the
unemployment rate is expected to tick up to 9.8% from 9.7%.
Merrill Lynch US Economic Weekly 20100625


What might history tell us about the Greek crisis? - China Financial Markets
China bank debt repackaging, loan growth raises risk of crises, Fitch says - Bloomberg
Ben Bernanke needs fresh monetary blitz as US recovery falters - Telegraph
The next Icelandic banking crisis - Reuters
Sanity in the offing? - Economist
Why isn't the Fed doing more? - Macro and Other Market Musings
World trade volumes dropped in April - Wall Street Journal
Local govt debt could trigger financial crisis - China Daily
Print away your troubles - Economist
Get me a job, Ben! - Slate
Repent at Leisure - Economist
The Renmbinbi runaround - New York Times
The banks keep stealing -- Why do we keep paying? - Business Insider

No Relief from the ‘Trilemma’

- "The PBoC surprised markets at the weekend by removing the currency peg to the US dollar. Not surprisingly, the lack of explicit detail in the PBoC’s communication left investors divided about how significant the appreciation is likely to be."
- "Our China economics team’s prescient call on a summer de-pegging before the G20 summit was for a modest appreciation this year and a continuation of the appreciation into 2011."
- "If this change in policy is a precursor to a more flexible exchange rate regime, then it is a welcome first step away from political frictions and towards a more balanced domestic economy in China, and a more balanced global economy as well."
- "In the short run, however, the predictability of the appreciation may actually increase the constraints on policymakers, in our view. The move to a more flexible exchange rate should, in theory, provide more independence to monetary policymakers."
- "However, the predictable nature of the current regime means that any policy tightening could exacerbate capital inflows and lead to even greater accumulation of reserves."
Morgan Stanley Global Monetary Analyst 20100623