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