Recession? Probably not

- Macro viewpoint: Recession? Probably not "We explore a number of potential indicators of a future downturn by estimating a series of recession probability models. These catalog the ability of one or more indicators to accurately signal recessions in the past, and then ask what chance of a near-term recession they predict today. These simple and oft-used models can help to identify not only how strongly some indicators point toward a possible double dip, but also which suffer from limited accuracy or false positives."
- Fed watch: Fade the hawks … still "One recurring theme over the past year has been the outsized voice of the more hawkish FOMC members relative to their voting clout. This week was no exception, with three different members – but only one voter – expressing their displeasure with some aspect of current or prospective Fed policy. So, let us repeat a core message once again: fade the hawks on the FOMC."
- The week ahead: Core retail sales up; inflation subdued "Next week brings with it the inflation trifecta: import prices, producer prices, and consumer prices. Of those three measures we give the most weight to consumer prices and we are expecting goose-eggs on the headline and core measures. On Wednesday, retail sales data are released for June. While we expect a negative print on the headline, the core retail control measure, which provides us with a better sense of the trend in consumer spending, is expected to post a respectable 0.3% MoM gain."
Merrill Lynch US Economic Weekly 20100709

US Rate & MBS Strategy

- "Stay Short Duration: We expect 10yr yields to climb back towards 3.25%."
- "Strong TIPS Auction: The 10yr TIPS auction was exceptionally strong this week despite rising TIPS issuance and real yields near recent lows. This bodes well for post-auction performance of TIPS."
- "Long-Vol Should Rise Due to Legislation: Supply shock in long-dated vol stemming from legislation could total 20mm bp-vega, and be worth 20- 25bp/annum gradually over 5 years."
- "Go Up-In-Coupon in Agency MBS: With the Fed’s coupon swap program effectively done, high coupons look attractive based on carry, convexity, and supply shifts."
- "Agency Debt: Callable redemptions have been extremely high, and we expect this to continue with 83% of eligible callables to be redeemed in the base case."
- "US Rate Strategy Model Portfolio: The portfolio is currently up 0.5% month-todate."
Citigroup US Rate MBS Strategy Weekly 20100709

The risk of "wasting savings" is even greater than before the crisis

- "We use the term "waste of savings" for a situation where countries’ savings are not used to finance useful investments that could generate long-term growth."
- "In fact:
in Europe, before the crisis, savings financed productive investment and (unfortunately in certain cases) housing investment; in the wake of the crisis, they have financed fiscal deficits;
in Japan, savings continue to finance the fiscal deficit;
in the United States, the shortfall in savings (total and household) remains significant;
prior to the crisis, the excess savings in emerging and oil-exporting countries financed the US and also the UK external deficits, i.e. to a large extent the household borrowing requirement. Since the crisis, they have financed these countries’ fiscal deficits, and perhaps households in the United States once more."
- "The share of savings that finances productive investments in OECD countries is therefore even lower after the crisis than before."
Natixis Flash Economics 344 20100702

EM Recommendations

- "So far, the emerging markets have done very well in 2010. The benchmarks for both hard- (EMBI) and local- (GBI) currency bonds posted positive returns; EMBI and GBI posted returns of 5.56% and 18.83%, respectively, for the first six months of 2010. We are still positive about the asset class, although we do not expect the second half of the year to proceed at the same pace as the first half. We admit that the ongoing turmoil in relation to the debt problems of the euro zone constitutes a risk, particularly for the Eastern European countries. The public debt and budget deficits of the emerging-market countries are generally much lower. Therefore the emerging-market countries are not nearly as vulnerable as the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain). For the short term, however, there is a risk that Eastern Europe underperforms the other emergingmarket regions. Read more here. Provided that the cooperation between Greece and the EU/the IMF proceeds successfully, we see no reason to reduce exposure to emerging-market bonds. However, investors who overweight Central and Eastern Europe may consider reducing their exposure to the benefit of other emergingmarket regions. Investors should also take into consideration the mounting concern over global growth, the possibility of further intervention in the market (such as the 2 % tax in Brazil and Colombia’s sale of pesos), and the exit strategies from the very relaxed fiscal- and monetary policies pursued around the globe. This publication gives you an overview of our recommendations for local-currency bonds."
JyskeBank EM Recommendations 20100708

The spectre of structural unemployment

- "The week has been dominated by discussions of European banking-sector stress tests and
the publication of the results on July 23. We now know that 91 banks will be in the spotlight, but we have little detail on the underlying test assumptions and, in particular, on the simulated shocks to sovereign bond portfolios. Today’s ECB press conference provided little further
information, despite a battery of stress-testrelated questions. On other matters, the ECB
appears to believe that money market tensions have, if anything, eased, and is not particularly concerned (rightly so, in our view) about the market-led liquidity withdrawal witnessed in July, or the rate implications thereof. The ECB also expressed a neutral view on the strength of
the recovery."
- "For the recovery to become sustainable, labour markets need to stabilise so that consumer confidence can be restored. This week we discuss the cyclical versus structural aspects of the unemployment picture. While it looks as if employment contraction has stabilised, the divergence in unemployment rates across European economies is now at historical highs. In some countries, short-term working-time arrangements have shifted the labour market
adjustment away from job cuts towards more flexible hours worked. Heterogeneous
macroeconomic exposures to harder-hit sectors such as construction and industry have also played a role. We find that there is a non-negligible risk that hard-hit countries such as Spain and Ireland are heading towards an increase in structural—as opposed to merely cyclical—unemployment. However, the Euro-zone as a whole seems to be shielded from an acute and persistent skills mismatch."
GoldmanSachs European Weekly Analyst 20100708

Reading Macro Themes from Equity Markets

- "As the second half of 2010 unfolds and we survey the uncertain macroeconomic outlook
ahead, it is especially important to listen closely to the macro messages from financial markets. The macro outlook that is implicitly priced by various asset markets is an
important input into our macro and market views, and helps us to better understand the
tactical macro landscape."
- "Fixed income and FX markets have traditionally been most comfortable with this type of macro conversation. But we have found that the equity market—although less straightforwardly macro—has a potentially rich set of information that can be mined for
its macro content. Over the last several years, aided by our Wavefront models, we have
developed a ‘vocabulary’ around the equity market and its pricing of macro risks."
- "We are also launching today the International Macro Equity Monitor (IMEM), a short weekly publication presenting metrics based on our suite of Wavefront models, which aims to explain the interplay between macroeconomic forces and equity market dynamics both at the industry level within the US equity market and globally across a wide range of country-level
- "Turning to the current state of affairs, as the Global Markets group has discussed recently,
the most salient and emerging feature of the macro landscape has been the turn in the global cycle, as accelerating growth has given way to a bit of a slowdown. Cyclical equities in the US and Europe have reflected this as equity market growth views have been downgraded sharply. Given this, it is striking that global growth views in the equity market are more resilient, and (outside of China) EM outperformance is a re-emerging theme."
GoldmanSachs Global Economics Weekly 20100707

Housing Falters after the Tax Credit Expires

- "The reduced supply of new homes for sale is one of the steps necessary to bring the market into balance."
- "With distressed sales likely counting for a larger proportion of home sales during the second half of this year, we will likely see some renewed pressure on home prices."
Wells Fargo Special Commentary 20100709

Global: Growth is bound to slow - but by how much?

- "Growth is bound to slow down in the second half of 2010, as the balance between tailwinds and headwinds turns less favourable."
- "The key question though is how much will growth slow. We still don’t expect growth to go below potential growth over the coming quarters, but a pick-up in employment soon and no new setbacks in financial markets are key assumptions behind this forecast."
- "Should current headwinds get stronger we will have to re-evaluate our outlook."
DenDanske Research 20100709

Not facing a double dip

- Reversal. "Sentiment has turned. While confidence had still dominated until recently, growth concerns are now spreading. The catalyst was poor US economic numbers combined with the expected retarding effects of the European-wide austerity policy measures. Some economists even expect the economy to slide back into recession."
- Assessment. "Just as we did not share the previous euphoria, we do not subscribe to the fears of the double-dip scenario. True, the leading indicators around the globe are heading south, while the impulses from the inventory cycle and the national fiscal spending programs are expiring and will soon become a drag. The pace of growth will therefore moderate, but
probably nothing more than that."
- US. "The worst recession since WW II in the aftermath of the Lehman collapse alone argues against a double-dip recession. Employment and fixed capital investment fell so low that a renewed, sustained contraction is scarcely possible. Furthermore, the administration is making the economy its top priority as it faces mid-term congressional elections in November.
GDP growth should not fall below an annual rate of 2%."
- Europe. "EMU-wide austerity measures will shave 0.6-0.7 of a percentage point off GDP growth in 2011. This, however, will be matched by the positive impulses from this year's EUR depreciation. Nevertheless, economic growth should moderate over the next few quarters to an annual rate of 1%-1¼%. The pendulum is swinging back even more pronounced in Germany. This is suggested by the new orders-to-stock ratio, one of the best global leading indicators. But as in the US, the downside risks in Europe cannot be ignored."
Unicredit Friday Notes 20100709

Brazilian presidential elections - What should we expect?

- "Brazil has come a very long way since the 2002 presidential elections that almost pushed the country into default. This year’s presidential elections will be contested by two candidates with broadly similar views of how to manage the economy, making the elections a relative non-event – at least from a short-term market point of view. If the next government succeeds in implementing a medium-term fiscal adjustment (a big “if”), there is no reason why Brazil won’t be able to achieve 6% growth. This might go some way in silencing some of the critics who believe that Brazil does not belong in the BRICs."
DeutscheBank Talking Point 20100709

Positioning risk on EUR/USD eases

- "The latest IMM data cover the week from 29 June to 6 July."
- "During the week covered by the latest IMM positioning data, USD has weakened more than 2% in effective terms, with EUR/USD breaking well above 1.26 in summer-thin trading and with USD/JPY dropping below 87. The broad-based USD weakening has coincided with speculative investors trimming their net long USD positions, primarily by paring short EUR positions. While speculative market participants remain short EUR, positioning is now less extreme than previously and directional risk from a position squeeze arguably less one-sided."
- "Speculative investors have continued to add to their long JPY positions. With net longs
approaching 30% of open interest, upside risks in USD/JPY are emanating from the significant JPY long positions."
- "The commodity currencies suffered during the time period covered by the IMM data as risk appetite was under pressure, causing speculative investors to scale back long positions in AUD and CAD. However, since then, market sentiment has improved and both AUD and CAD have received support from exceptionally strong employment reports. With money markets pricing in more future rate hikes from the RBA and the BoC, speculative investor interest in AUD and CAD looks bound to resume."
DenDanske IMM Positioning 20100712

Gas glut reaches Europe

- "A gas glut is heralding the dawn of a new era. This new era is marked by technological progress, greater convergence between global gas markets and the declining relevance of established pricing patterns in the continental European pipeline business. The areas concerned are the typical large-scale projects, the international supply relationships and the downstream trading and usage levels."
- "The free-market price of gas will become the new benchmark and will be the guide for the price of pipeline gas. We expect a pronounced buyers‟ market to develop in the European gas sector by 2013, with North America dictating the price trend. Following the end of the low-price phase from around 2014 onwards we do not expect to see a renaissance of the longstanding link with the oil price."
- "The gas glut is bringing opportunities for domestic customers to benefit from pricing changes and providing greater flexibility for industrial users. Traditional municipal utilities and regional energy suppliers are coming under pressure. By contrast, major opportunities are opening up for independent distributors, independent traders and newcomers. Power plant operators should review their procurement strategies. New challenges face gas producers and importers; they will not be in the same boat for much longer, as they will be competing against one another for tighter margins in future."
- "The security of supply in Europe is improving. The battle for unconventional gas deposits is in full swing. New pipelines and gas storage facilities currently appear to be less urgent. Nevertheless, there is a need to press ahead with the projects in the longer-term interest. Gas market liberalisation, the basis for the new competitive situation, must not under any circumstances be allowed to stagnate. The “Gas OPEC” is currently toothless, but its time will come. Europe should therefore invest in more open structures, globally diversified sources and new technologies – and also trust in the creative vigour of market participants."
DeutscheBank EU Monitor 20100708