Spring Breezes Turn to Summer Doldrums

- "In much of the United States, the refreshing breezes of spring gave way some time ago to
stifling summer heat and humidity. So it is with the economy, as the twin boosts from early-cycle inventory accumulation and fiscal stimulus have begun to fade, taking growth with them. Real GDP growth decelerated to a 2.4% annual pace in the second quarter, from 3.7% in Q1 and 5.0% in Q4 2009. Revisions to 2007-2009 data took down growth by 0.2 percentage point on average."
- "Although the second-quarter GDP report featured a number of minor surprises, final demand continues to expand at the sluggish pace of the past year—only 1.3%. This is close to our 1.5% expectation for secondhalf GDP growth."
- "The inventory cycle continues to run its course, with signs from various surveys that it was starting to weigh on growth in July. We think the ISM manufacturing index fell to 54.5 in July (from 56.1), and a move to 50 by yearend would be fairly typical given the extent of the recent upswing."
- "This week we trimmed our expectations of fiscal outlays in 2011, based on what appears to be limited appetite for further stimulus. Folding in the impact of state and local budget cutbacks, we estimate the net impact of fiscal policy will swing from a 1.3-percentage point boost to GDP in early 2010 to a 1.7-point drag next year."
- "Monetary stimulus also does not appear to be forthcoming in the near term, though the
deterioration in economic data has clearly weighed on the confidence of at least a few Fed officials."

GoldmanSachs US Economics Analyst 20100730

A Half-Pint Recovery, One Year On

- "While the official business cycle dating authorities at the National Bureau of Economic Research have yet to render a judgment on the matter, the Great Recession ended approximately one year ago. That’s when real GDP and other measures of general economic activity stopped shrinking. How does Year 1 of the recovery measure up against prior cyclical experience?"
- "In the following charts, we compare the current recovery against recoveries following the two recent, mild, recessions (1990-1991, and 2001) and recoveries following two earlier severe recessions (1973-75 and 1981-82). This cyclically adjusts for the stylized fact that applies to most of business cycle history - “the harder the fall, the faster the rebound.”"
- "If such history were any guide, the current recovery should be as powerful, or
more so, than the recoveries following the severe recessions. But it’s only half as powerful measured in units of GDP – an unsatisfying result considering the sheer volume of stimulus thrown at the problem. Still, today’s recovery is beating the recoveries following the mild recessions - hence, we are clearly on a better path than the more pessimistic “U-shaped” or “L-shaped” forecasts."
- "Highlights include satisfying outperformance by business equipment and software purchases as well as exports; the rest of the economy’s sectors are disappointing by historical standards to greater or lesser degrees."

CreditSuisse US Economic Digest 20100730

Financial crises, deflation and the Japan analogy

- Both upside and downside surprises to inflation drive up the ERP "Historically, surprises to inflation have been associated with a high equity risk premium being priced by the market. This is true for both upside and downside surprises. Recent history suggests that risk aversion may be more sensitive to downside surprises in inflation when the level of inflation
and rates are themselves low."
- We analyze theoretical implications of deflation on sectors & styles "In a deflationary scenario we believe defensives would outperform cyclicals. Strong balance sheets would outperform weak balance sheets. Companies with large pension obligations, financials and companies with wage intensive cost structures would all underperform the market. Sectors used to deflation, such as technology, and companies exposed to areas of the world without deflation, would outperform."
- …and confirm that the conclusions held up in the case of Japan "In Japan, export oriented sectors outperformed domestically exposed sectors for more than 20 years. Financials underperformed the market, as did sectors with weak balance sheets."
- The aftermath of financial crises: Binary outcomes "We analyze the aftermath of financial crises in Sweden, Finland and Japan. The outcomes are binary. In the case of Sweden and Finland, earnings growth and ROE rebounded quickly, whereas they remained depressed in Japan. The outcome in terms of market prices was dramatically better in
Sweden and Finland. So far, the outcome in Europe looks more like the Swedish and Finnish cases. This supports our positive view on earnings and our 12-month price target of 300 for the Stoxx Europe 600."

GoldmanSachs Europe Portfolio Strategy 20100729

The Fed’s Options for Further Monetary Stimulus

- Hardening extended period commitment is an attractive option for the Fed: "A
commitment to keep rates unchanged until the end of 2011 could yield a 20 bp to 30 bp shift lower in yields without any further balance sheet commitment. 5s could richen another 10 bp on the curve."
- Neutral on Duration: "Increased discussion of a revival of QE offsets our view that Treasury yields are below what is justified by recent growth."
- Treasury Auctions Mixed, End With a Weak 7-yr: "The 2-yr, 5-yr and 7-yr auction
results were mixed this week, with the worst result coming in Thursday’s 7-yr."
- Attractive Carry Trade in Vol: "We recommend buying gamma on 5y tails and selling gamma on 30y tails in a box trade, for attractive carry."
- The Case for The Up-in-Coupon, Against the Insta-Refi: "We find the current environment to be the perfect storm for MBS up-in-coupon. We think the “freelunch” government induced refi program is anything but and unlikely to occur."
- Agency Debt: "A covered bond bill is making its way quickly through Congress and seems to have strong bi-partisan support. We summarize the salient points of the current bill."
- US Rate Strategy Model Portfolio: "The portfolio is up 1.3% month-to-date."
Citigroup US Rate MBS Strategy Weekly 20100730

Russia: Renewed privatization drive will bring benefits

- Government assets for sale — "The Russian government has announced its intention to sell government stakes in a number of Russian companies for around $30bn. The list of companies for sale is likely to include stakes in oil giant Rosneft, banks Sberbank and VTB, and other state-controlled companies, including Transneft and RusHydro. In addition, several fully state-owned companies may be partially privatized."
- More supply should bring benefits… eventually — "Although the Russian equity market is relatively liquid, trading is concentrated in a handful of shares, primarily commodity stocks and banks. Any action to increase the supply of companies outside the extractive industries is likely to be taken well by the market."
- Could also encourage “best behavior” from government — "Another prospective benefit of privatization would be to encourage greater disclosure by the government and a more investor-friendly approach in the run-up to major asset sales. Hopefully this would result in greater clarity on issues such as tax policy."
- However the sales, if they happen, will take time — "Recent comments from the
Finance Ministry and other government agencies indicate that the plans are still evolving, and that in any case completing the proposed sales could take years. This is likely to be particularly true for the fully government-owned companies being brought to market for the first time."
- Market likely to absorb new supply — "$30bn would represent about 15% of Russian equity free float. While not an insignificant amount, this is likely to be absorbed by the market over time. The pipeline of other planned IPOs over the next two years is around $8bn."
- More interesting government sales: less liquid stocks, consumer, infrastructure "Less liquid stocks such as Transneft are likely to benefit from privatization sales, as should consumer and infrastructure-related stocks."

Citigroup Russia Strategy 20100730

FX Strategy Weekly

- "Dollar weakness coloured G10 fx markets in July but a stabilisation in speculative positioning begs the question if the currency is due for some reprieve in August. The path to a USD bounce remains uneven at best, but as the tide of positive Q2 corporate earnings subsides
and scepticism surrounding EU peripheral spreads lingers, we wonder if safe haven flows could make a surprise return. Dovish statements by the BoE have so far been disregarded by GBP bulls but as the policy stakes are gradually raised, we think there is a possibility that GBP exposure is gradually reduced from technically overbought levels. The week ahead is dominated by the PMIs and US non-farm payrolls. Holiday disrupted trading conditions are likely to characterise daily flows. Demand for carry may keep the AUD underpinned even assuming for no change in RBA policy."
- "A strong week for the pound capped the month of July, with GBP taking weak consumer
confidence and housing data in its stride. GBP rallied vs its G10 peers with the exception of the JPY and CHF, netting gains of 2% vs the NZ$, 1.9% vs the USD (topping 1.57), and 0.6% vs the EUR. The NZ$ underperformed the G10 after the RBNZ raised interest rates to 3% but warned of a slower pace of policy tightening in the months ahead. The rally in EUR/USD ran out of steam at 1.3107 and a negative report by Moody’s on Spain caused profit taking to set in, dragging the cross back below 1.30 into Friday’s close."
- "US Q2 GDP was in line with forecast at 2.4% annualised. An upward revision for Q1 to 3.7% vs 2.7% previously on the back of stronger inventories highlighted scepticism surrounding the durability of the recovery. The core PCE index accelerated to 1.1% vs 0.7%.
In the UK, data confirmed the recent slowdown in housing market activity with prices dropping 0.5% m/m in July (Nationwide) and an easing in mortgage approvals to 47,600 from 49,500. The CBI reported a surge in reported retail sales to +33 in July from -5 in June,
marking the biggest gain in three years. The MPC testimony to the TSC brought no change in
policy perceptions and means next week should see the BoE keep BR and the APF unchanged."
- "Gilt yields and swaps shot up to one-month highs over the first part of the week but dovish
MPC commentary on growth and month-end extension buying drove yields back down with the breach of key support levels triggering additional support. 10y yields hit a 3.52% high but ended the week at 3.33%, after piercing support levels and 3.45% and 3.40%. 5y swaps initially firmed to 2.62% but three days of lower rates followed and led swaps to close at 2.41%. The 3mth Libor/Ois spread widened 2bp to 25bp, the highest since last September. The 2y/10y swap curve ended the week close to flat at 200bp after having widened at 204bp. The 10y swap spread rose 3bp to 5bp. A £6.0bln syndicated 2040 IL auction was sold at a yield of 1.02%"

LloydsTSB FX Strategy Weekly 20100730

Non-commercial investors reduce long JPY and CHF positions

- "The latest IMM data cover the week from 20 to 27 July."
- "Speculative investors have recently reduced net long JPY and CHF positions. The moves
occurred in a week with strong gains in the equity market where the safe-haven currencies
- "Net short GBP positions have been reduced while short EUR positions have been unchanged. Both are well below the panic levels observed earlier this year."
- "Net long non-commercial NZD, MXN an AUD positions remain at stretched levels and have been extended further. Risk of a ‘long squeeze’ remains."

DenDanske IMM Positioning 20100802

The dog days of summer

- Macro viewpoint: The dog days of summer "High levels of regulatory and economic uncertainty are an important headwind to the recovery. We expect these headwinds to ease over time."
- Fed watch: Bullard in a china shop "St. Louis Fed President Jim Bullard offered a trenchant critique of current Fed policy, and proposed a return to “quantitative easing” by the Fed. Wading through his self-described “geeky” paper, however, suggests more a series of probing questions than a sudden call for a policy reversal."
- The week ahead: All eyes on payrolls "The first week of each month is always important, but we view next week as especially important since we will get our first look at the third quarter. We expect to see signs of a slowing in sequential growth against an improving labor market backdrop. All eyes will be watching Friday’s employment report. We are expecting private payrolls to rise 125,000 in July, which is consistent with the “gradual” labor market recovery we heard repeatedly in this week’s Beige Book report from the

Merrill Lynch US Economic Weekly 20100730

Italy: Jobs, more work needs to be done

- "While industrial production increased at a strong pace in 2Q, the end of the car-scrapping scheme is likely to have weighed on overall GDP. In 2Q, we expect economic growth to have slowed to 0.2% qoq, which should be followed by still modest growth in the following quarters."
- "While the pace of increase in the number of inactive people keeps moderating and the growth rate of the labor force steadily increased, monthly employment figures and signals from business surveys show that a real turning point in the labor market has not yet occurred."
- "In May, bank lending continued to gain a stronger foothold, although the rate of growth remains modest. Still, it is encouraging that the increase in household lending was accompanied by a return on an upward trend of corporate lending, although the latter is still in negative territory."
- "Inflation kept easing in June, following the drop in gasoline prices. In July, we expect inflation to resume its upward trend. The Italy-EMU inflation gap has closed, mainly on the back of non-core components, while the differential on core prices remained relatively stable."
- "In the Focus section we analyze the impact of the recession on the labor market. While the unemployment rate has increased less than in the eurozone, reforms are needed to foster new hiring, and prevent that a dual labor market leads to a jobless recovery."
Unicredit Italy Monitor 20100726

Public savings, household savings and corporate savings: Where are the anomalies, what would international coordination of economic policies entail?

- "We look at the situation in major OECD countries. Some of them (Germany and Japan) are in an overall situation of excess savings even when there is a fiscal deficit: in Germany above all for households and also corporate savings; in Japan, corporate savings. Others (United States, United Kingdom, France, Spain, Italy) face an overall situation of a shortfall in
savings, but for very different reasons than prevailed before the crisis: shortfall in household savings with substantial corporate savings in the United States and in the United Kingdom; shortfall in corporate savings in France, in corporate and household savings in Spain and in Italy; since the crisis, moreover fiscal deficits have appeared, and household savings have
risen in certain countries (Spain)."
- "International coordination of economic policies would entail policies aimed at reducing savings in Germany and in Japan, as the Americans are calling for, while stimulating savings in the United States, the United Kingdom, France, Spain, and Italy. However, according to the composition of savings (households, companies, and central government) these policies are very different: modification in one direction or another of income sharing, change in financial incentives to save via tax and fiscal policy."

Natixis Flash Economics 372 20100721

Tighter monetary policies: are Asian central banks reading the bussiness cycle properly?

- "After India, Taiwan, Malaysia and Korea, it is now Thailand’s turn to raise its key interest rates by 25 bp mid July. There seems to be a widespread exit from accommodating monetary policies in nearly all emerging Asian countries."
- "But while monetary authorities (specifically, Korea and Thailand) indicate that monetary tightening should continue in a strong growth environment, we wonder about the benefit of further tightening."
- "While monetary tightening seems justified in India where inflation keeps on rising, it seems more debatable in other countries where growth is still fragile and any swift action to tighten monetary policy while the economic cycle is at inflection point could lead to future regrets."
Natixis Flash Economics 371 20100725

The destruction of bad debts

- "In the past, bad debts were destroyed via inflation: when (public or private) debt ratios were too high, the central bank would increase the money supply and this led to the appearance of inflation, resulted in negative real interest rates, and lowered debt ratios. Currently, central banks have monetised public (or private) debts, but this operation has not created any inflation because of the environment (unemployment, globalisation, distortion of
income sharing at the expense of wage earners)."
- "Monetisation has transferred (public or private) debts to the central bank’s balance sheet, and this reduces the quantity of debt private investors have to hold and, therefore, drives down risk premia, but does not destroy debts. Borrowers still have to ensure debt servicing, and this is a problem if debts are substantial since this entails allocating significant income to this purpose. To destroy bad debts, in this environment, central banks would have to destroy the ones they hold. This amounts to a default, but without any negative effect on the private holders of bad debts. It is, moreover, less serious to fleece in this manner the central bank than to fleece savers via inflation."
Natixis Flash Economics 370 20100721