Deflation risk overrated

- "The recent downtrend in core inflation has been troublesome, but we find empirical evidence to support the view that so long as the economy continues to recover, even at a sluggish pace, inflation could soon bottom and begin moving higher."
- "Our analysis finds that the relationship between economic slack and core inflation, which had weakened substantially in the 1990s, has strengthened again in recent years. However, it also appears to have changed, with “speed” effects now becoming a good deal more important than “gap” effects. That is, the positive effect on inflation of diminishing slack is apparently now more important than the negative effect of the high level of slack itself. That is, inflation will begin to rise again as unemployment trends lower."
- "This means the Fed’s “low for long” policy could well be abbreviated as soon as the pace of economic recovery begins to show clear signs of picking up sustainably."
DeutscheBank Global Economic Perspectives 20100714

Japan: Slight revisions to our growth forecasts for 2H 2010 and onwards

- Slight revisions to our growth forecasts for 2H 2010 and onwards
• Reflecting the recent weaker-than-expected job market data, we have slightly downgraded our forecast for private consumption • In the meantime, we have revised up our capex forecast as we anticipate corporate income growing at a somewhat faster pace
• We have downgraded our GDP deflator forecast as a delayed recovery in wages is likely to weigh on consumer prices
• Our annual real GDP growth rate forecasts are unchanged at 2.9% and 1.0% respectively for CY2010 and CY2011
- Improvement in consumer sentiment slows down
• Consumer sentiment index rose for the sixth consecutive month by 0.7pts mom to 43.5 in June; improvement pace has slowed down
• Consumer perception of “the value of property (asset) growth” also worsened
for the second consecutive month
• Industrial production was revised up 0.2pts to +0.1% mom in May. Manufacturing sector capital utilization also rose 0.8% mom to 72.5%
- Demand for funds remains weak
• The year-on-year growth in M2 in June slowed down for the first time in three months.
• The year-on-year decline in the balance of bank loans by city banks expanded further in June.
CreditSuisse Japan Economics Weekly 20100715


- Overview "A slight improvement for the eurozone’s peripheral"
- Germany: Fiscal consolidation measures "The general deficit will continue to widen in 2010 and will likely rise to circa 4.5% of GDP from 3.1% in 2009. The government announced, in early June, measures aimed at cutting the structural deficit by nearly EUR 28 billion between 2010 and 2014, lowering it from 2.2% to 1.0% of GDP during the period. The general deficit could thus drop back to 3% of GDP by 2012 and 2% in 2013. It remains low in comparison with other euro-zone countries and Germany will benefit from the economic upturn in 2010 to a greater extent than many other euro-zone countries."
- United States: Never again? Financial reform is passed "Congress has passed the financial reform act promoted by the Obama administration. The bill is designed to reduce systemic risk, better regulate financial players and products and provide better protection for consumers and investors. Regulators will have to iron out many of the details of the mechanisms approved by Congress. Practical implementation of the reform will make it more or less drastic, and will inevitably take time."

Germany: Moderate austerity measures

- Consolidation. "The German government has finalized its austerity package. It intends to reduce spending by a total of EUR 81.6bn or just over 3% of GDP – albeit spread over four years. Furthermore, the government raised mandatory social security contributions."
- Structure. "At just over EUR 30bn, a large part of the cuts are to the welfare budget. Business (incl. banks and the nuclear power industry) is to contribute close to EUR 20bn. Administrative spending should be reduced by EUR 13bn, while subsidy cuts total roughly EUR 10bn."
- Assessment. "The German austerity package is quite balanced. It should be enough to successively lower the current record-high deficit and over the medium term help the government to comply with the ambitious debt rule anchored in the Basic Law. On the other hand, it is moderate enough, above all in the critical coming year, not to stifle the recovery of
domestic demand (pages 4-6 & chart below)."
- Forecast. "Nevertheless, German economic growth will lose momentum. Next year, real GDP will expand by only 1.5% (2010: +2% unadjusted). That is, however, primarily attributable to the phasing-out of the inventory cycle as well as the fiscal stimulus program. The global economic slowdown will also be a burden."
- Criticism. "The Achilles Heel of the consolidation is the questionable implementation of some of the measures, like the bank levy, as well as the heightened economic risks and the possible liabilities stemming from domestic & international guarantees. In any case, the government could have been much more courageous in slashing subsidies."
Unicredit Friday Notes 20100716

Comeback kid

- "The Euro has staged a remarkable comeback over the last month, recovering from below 1.20 to the dollar to nearly 1.30. What has been driving it? Will it strengthen further, consolidate, or reverse trend? And should its appreciation be welcomed? There are several factors at work. The first is a paradoxical situation where, while the recovery is clearly more robust in the US than in the eurozone, the Fed sounds more dovish and seems to be toying with the idea of a renewed wave of quantitative easing, whereas the ECB sounds cautiously more optimistic and short term market rates have tentatively begun to edge up. Moreover, investors are
gradually gaining a measure of confidence from the policy actions of individual eurozone governments: nothing earth-shattering so far, but enough to raise hopes that policymakers have perhaps accepted the need to launch long-overdue fiscal and structural reforms. Spain is probably the best example. Most encouragingly, it seems that Asian investors, having done their homework over the last nine months, now feel more comfortable in assessing and taking on individual sovereign credit risk within the eurozone: demand at recent Spanish auctions is a case in point, and if this trend is sustained it would mean that risks of a systemic regional
debt crisis have substantially diminished. The make-or-break challenge ahead is the release of the stress tests, which begins in a week’s time. We should not get our hopes too high, as the very fact that we will initially get only the aggregate results for individual countries rather than individual banks tells us the first best is already off the table. Hopefully, however, the exercise will be handled professionally enough to avoid a major accident, in which case EUR/USD will remain stable in the coming months, to the satisfaction of both parties involved."
Unicredit Market Sense 20100716

Pan-European:Under or Over - UK:Sector Changes

- Pan-European — Under or Over
• Recovery — Global GDP is above previous peaks. European earnings are not. Industrials and Staples have the most robust forecasts, all above trend.
• Believer or sceptic? — The market is backing sectors delivering earnings, even if above trend and de-rating those that fail to deliver. International over domestic.
- UK — Sector Changes
• Recovery biased — Our economists’ forecasts remain for an economic recovery. This should underpin earnings expectations and makes valuations supportive.
• Sector weightings — We downgrade Pharma to Underweight from Overweight and move Industrials up to Overweight. Mobile and Construction up to Neutral.
Citigroup European Portfolio Strategist 20100715

The Japanese model cannot be exported to all countries

- "The Japanese economic and financial model has not been changed by the crisis:
high corporate profitability, despite the weakness of household demand,
achieved via a squeezing of wages;
• weakness of household demand and negative inflation (deflation) due to the fall in wages;
decent growth overall, thanks to exports and the related investments;
• low interest rates due to negative inflation, while savers accept these low interest rates, which therefore makes it easy to finance the high public debt caused by sluggish growth."
- "We can see this model trying to spread to many other countries in the wake of
the crisis. But it cannot be exported to all countries, as it requires:
significant export capacity, in particular to countries enjoying rapid growth (only Germany and Japan);
that the fall in wages and the distortion of income sharing be accepted;
• capacity to finance the economy with domestic savings;
• savers who accept very low returns on their capital."
- "Moreover, this model seems to be unfavourable for stock markets."
Natixis Flash Economics 357 20100713

UK impact from EMU break-up: Double dip or depression?

- "In our recent note, “EMU Break-up: Quantifying the Unthinkable, 7 July 2010”, we looked at the global impact of a break-up of the Eurozone. In this report we discuss the potential impact of such a scenario on the UK. Given the level of trade and financial linkages, a major adverse reaction is inevitable. Should complete break-up occur, the economic and financial impact will be far greater than seen in the recent recession. Output might fall by 8% relative to our base case within the first two years. Under this scenario, talk of depression could quickly reignite."
INGBank Financial Markets Research 20100715

Declining US Activity and European Fiscal Risk Premia

- "Weaker US growth, reasonably solid Euro-zone macro data and less political/fiscal disruptions than feared have been a feature of the past few weeks, and have motivated another forecast change to reflect more broad USD weakness than before. We now project EUR/$ at 1.35 and 1.38 in 6 and 12 months to reflect the fundamental outlook. However, it is too early to sound the ‘all clear’ on the Euro in the near term as political stress could intensify again. Many European governments are still facing low approval ratings and the post-holiday period may be critical. We therefore keep the 3-month forecast at 1.22. Projected Yen strength is linked to US rate differentials and a reduced likelihood of Japanese interventions in light of the new managed $/CNY float. Our new $/JPY forecasts stand at 85, 83 and 90. We also discuss the impact of Renminbi appreciation in more detail. Lastly, developments in Europe and Switzerland suggest EUR/CHF can continue to depreciate, despite the move already seen. Our new forecasts see a temporary move below 1.30."
GoldmanSachs Global Viewpoint 20100714

Banks: No stress... but no growth either

- Stress tests helpful but do not change the medium-term outlook "We remain Neutral on the Banks sector in Europe overall and continue to recommend a long position in our Global Retail Banks basket (GSSBBKGL). The upcoming Stress tests should increase clarity, especially for the nonlisted sector, and are also likely to move concern away from the large Spanish banks (which in our view are well financed). Furthermore discussions to soften regulation – pushing out the time to implement Basel III and softening the requirements – would also be supportive in our view."
- Expect slow loan growth in Europe "However, despite the crisis financials still make up 24% of the market cap in Europe; only fractionally below the long-term average of 25%. The large near-term uplift in expected earnings for banks is driven by provisioning rather than loan growth. Declining provisions is obviously helpful (and provides a high level of viability) but beyond this we see weak loan growth especially for banks with domestic exposure."
- Valuation case for Banks is not compelling "Banks trade at a P/E relative of 67% (2012E) compared with an historical average of 75% – a small discount to where it has typically traded. But given the risks to the sector, uncertainty regarding pending regulatory
reform and that Greek sovereign debt fears have not fallen away, the sector should arguably be on more of a discount. Furthermore, it is not yielding more than other low growth sectors such as telecoms or utilities."
- We are long Global Banks versus short Domestic Banks "We continue to prefer banks with global exposure. Our European Global Retail Banks basket (GSSBBKGL) has outperformed Domestic European Banks (GSSBBKDE) by 12% since March 2010 and would have done better if BBVA and Santander were not in the basket. Our Banks team argues that
the Stress tests should move the focus away from Spanish banks where funding appears secure."
GoldmanSachs Europe Portfolio Strategy 20100713

EMEA Weekly: We remain worried about ZAR and HUF

- Market movers ahead: Will the SARB cut again? "Rate decisions in Hungary and South Africa are the main events to watch next week. In Hungary we expect the Hungarian central bank to stay on hold keeping the key policy rate at 5.25% as the recent sell-off in forint and the increased uncertainty outlook for fiscal policy probably mean that easing cycle has come to an end. South African rate decision will undoubtedly prove interesting to follow as the uncertainty about the outcome is fairly high. While consensus expect the South African central bank (SARB) to stay on hold we see a chance of yet another 50bp rate cut. That would bring the key policy rate to 6.00% in South Africa. For the rate reduction argues recent dovish comments from the SARB governor Gill Marcus, inflation development but also recent data from the economy, which mostly surprised on the downside signalling that economic recovery is losing steam."
- FX Outlook: CZK back on the top spot "Last week our EMEA FX Scorecard overall send relatively bearish signals. The bearish signals are not quite as strong now, but nonetheless the Scorecard is still overall negative and we would therefore overall continue to expect some pressure on the EMEA currencies going forward in next 1-3 months. That said the signal is certainly not a “massive sell” signal and the Scorecard is in fact positive on three out of the seven currencies in the Scorecard – CZK, PLN and TRY. The Czech koruna is now back as the top scorer and CZK also remain the currency with the strong potential for strengthening over the longer term due to attractive valuation. Therefore we feel pretty confident in recommending investors to continue to be long the Czech currency both against its region peers and USD and EUR. This week we updated our FX forecasts. Read more in the July version of the Emerging Markets Briefer."
- Scorecard-based trade of the week Buy CZK/ZAR "Last week we recommended buying RON/ZAR based on our EMEA FX Scorecard. That trade is up a bit over the week. This week the rand is still the lowest scoring currency in the EMEA FX Scorecard, while the Czech koruna now is the highest scoring currency in the Scorecard. We therefore recommend buying CZK/ZAR going into next week."
DenDanske EMEA Weekly 20100716

Weekly Credit Update

- "Modest primary activity and indices trading sideways"
- "Scandi reporting season kicking off"
- "Financial bill approved in US"
DenDanske Weekly Credit Update 20100716