Physics Envy in Finance - Rick Bootstaber
Economising on Liquidity is Deflation’s Antidote - A Wealth of Labour
For China, it’s diversify, diversify, diversify - FT Alphaville
Summer spikes - Free Exchange
Tensions Rise in Greece as Austerity Measures Backfire - Spiegel Online
Aggregate Demand Forecasts Are Falling - Macro and Other Market Musings
What is Happening with Bond Prices? - J. Bradford Delong
What should we do about national debt, and when? - McClatchy

India and China: New Tigers of Asia, Part III

- "The huge surplus in the working-age populations in India and China has forced the world economy to recognize the countries’ roles in the global competitive dynamic. Both markets are increasingly integral to the business strategies of multinational companies and are viewed as structural drivers for global productivity. By 2020, we forecast India’s GDP will cross the US$6trn mark while China’s will surpass US$20trn, driven by the powerful combination of favorable demographics, structural reforms, and globalization. We expect the two economies to be the dominant growth stories for the next 20 years."
- "This report is the third part of our India and China: New Tigers of Asia series. Part I, published in July 2004, assessed the long-term outlook for the two economies during a period of rapid globalization. We highlighted how the rise of India and China is the most significant economic force in the world economy and that their growing presence will continue to change the rules that underpin the structure of global manufacturing and services output."
- "In Part II, published in June 2006, we focused on the challenges the two economies faced to maintain their growth trajectories beyond the then current boom. In that report, we highlighted that India had the potential to catch up to China’s economic growth rates over a 10-year period. Indeed, India is now not far from doing so."
- "In Part III, we focus on the long-term growth outlook in India. We believe that, over the next two years, India should start matching China’s economic growth, barring another global crisis, clearly reaping the rewards of very positive demographics and an increasingly dynamic economy."
- "We will continue to see both these economic powerhouses develop and reform as their respective models or stages of growth evolve as they create wealth and see their demographics change. The drive and dynamism both these economies provide to the world has and will become ever more important as they continue to develop and engage more intricately with the global economy."
- "This report provides some terrific insights into that evolution and the longer-term comparative factors driving the success of both economies. We now increasingly have a genuine double act from China and India in terms of dynamic economic growth engines willing and enthusiastic to engage with the global economy. This can only be beneficial for the continued growth and stability of the region and the world economy as a whole."

Morgan Stanley India and China New Tigers of Asia Part III 20100813

Physical oil market tightening even as economic recovery softens

- WTI timespreads point to a tightening physical oil market even as oil prices slide on concerns over the economic recovery "WTI timespreads have largely recovered from the liquidation of speculative long positions in May, with 1st-60th month WTI timespreads rising as much as $10/bbl to trade between -$8.00 and -$10/bbl since mid July. Further, WTI timespreads remain resilient, actually strengthening by $0.11/bbl as WTI prices fell from $80.25/bbl to $75.39/bbl this week."
- Discharge of floating storage suggests that the oil supply-demand balance is in deficit, even as onshore inventories continue to rise "Recent shipbroker reports suggest that floating storage drew by 40-45 million b/d in June and July, to its lowest level in over 18 months. Using the more conservative estimate of the June-July discharge suggests that the draw at sea has more than offset the build on shore, which the IEA estimates at 21 million barrels. Consequently, we believe that total world inventories including floating storage declined counter-seasonally in June and July, even as onshore inventories continued to build, with oil demand exceeding supply by 600 thousand b/d on a seasonally-adjusted basis."
- Increased downside risk from US and Chinese economic policy "We continue to expect the WTI forward curve to flatten in 2H10, lifting prompt WTI prices into the $85-$95/bbl range that long-dated WTI prices have traded in since October of last year. However, the anticipated tightening of Chinese economic policy is having an impact on Chinese oil demand, with notable weakness in the recent July data. Further, US fiscal policy looks set to shift from a boost to a drag on economic growth, which led our US economists to revise down their 2011 US GDP forecast recently to 1.9% from 2.5%. While we anticipate that Chinese economic policy will loosen in coming months, and the US Fed will likely return to quantitative easing, the downside risk from economic policy in the United States and China to our WTI crude oil price forecast has increased."

GoldmanSachs Energy Weekly 20100816

Looking for clearer upside catalysts into year end

- Wheat has surged higher, but key commodities remain fragile "Commodity returns rose over the last month led by sharp gains in the agricultural complex owing to weather-related supply shocks in wheat. Additional key commodities also broke out to the upside of recent ranges in late July, driven primarily by a shift in policy tone in China, key financial uncertainties abating post European bank stress tests and the passage of US financial reform and generally positive corporate earnings, all of which boosted sentiment in risky markets. However, sentiment remains fragile and concerns about economic growth have dominated again in recent days, leading to some retracement across assets from multi-month peaks."
- Improved data will likely be required to sustain rising prices "Current soft economic data, combined with increasingly mixed signals from the commodity markets, is likely to continue to generate choppy commodity price action in the near term. In particular, although commodity demand indicators remain generally supportive, growth in Chinese implied oil demand fell sharply in July, observed oil inventories in the developed economies continue to build on a seasonally-adjusted basis and the decline in metals exchange inventories has slowed. While we expected some softness in 3Q2010, we believe that improvement in this data will likely be required before upward commodity price pressure can be sustained."
- We remain constructive on key commodities heading into year end "We maintain that high and rising emerging market demand levels against limited supply growth are likely to increasingly tighten balances, lending support to key commodities during 4Q2010. We expect upside to be greatest for crude oil, copper, zinc, platinum and gold. However, given market price action over the past month we are lowering our 12-mo returns forecasts for base metals to 15% from 25% and for agriculture to -10% from -1.0%. These revisions lead us to lower our 12-mo forecasted return for the S&P GSCI Enhanced Total Returns Index to 19% from 21.6%."

GoldmanSachs Commodity Watch 20100814

Mid-Quarter Update: Bond and Equity ‘Connect’

- Staying the Course — "Our Q3 trading range thesis is intact; the sharp pullback in GEMs in recent days should not turn into a rout. After some consolidation at or just below current levels – the seasonals are not good for August and September – we expect a breakout to new highs and strong gains for emerging markets in Q4."
- Good Quarter — "Emerging markets are having a good quarter. At one stage in early-August, MSCI GEMs were up by over 10%. EMEA and Latin America (both now up 9.8% in Q3) have led the way, while Asia (+4.8%) has lagged; GEMs (+6.8%) have outperformed AC World (+6.1%). Both emerging market currencies (+1.9%) and bonds (+6.6%) have delivered positive returns."
- Worrying about Bonds — "The latest symbol of the ‘wall of worry’ is the collapse of US bond yields to 2.6% (10-years). Since March 2010, nominal yields are down by 120bp but real yields have barely moved (-10bp) as inflation has fallen sharply."
- Bond/Equity ‘Disconnect’ — "At US yields below 6%, equities tend to fall when yields fall (correlation between US bonds and equities of +0.84 since the start of 2007). However, since early-July, US equities have rebounded as bond yields have fallen – a ‘disconnect’."
- Emerging Markets’ ‘Connect’ — "The bond/equity link in GEMs is the exact opposite. The correlation between equities and bond yields is -0.84, given that debt yields are typically the main driver of equity prices; equities like low yields, so there is no ‘disconnect’ in GEMs. This relationship should only break down if ‘double-dip’ fears cause a new bout of risk aversion, so pulling equities lower."
- Resolution — "Our global strategy team sees the bond/equity disconnect being resolved via lower bonds not lower equities. This outcome should not threaten emerging markets as long as yields do not rise too far."
- Regions/Countries — "We remain cautious near-term and look to add beta around end-Q3. We stay Overweight in the more defensive Asia and continue to prefer EMEA (Neutral) to Latin America (Underweight). We raise to Overweight Peru, Czech Republic and Egypt (from Underweight) and Poland (from Neutral). We cut Thailand and Turkey to Neutral and Malaysia and Mexico to Underweight."
- Sectors — "We upgrade Utilities to overweight, based mainly on attractive valuations, underperformance in the third quarter and the sector’s low beta status. We reduce slightly our Overweights in IT, Industrials and Materials. We make several changes to our Model Portfolio of stocks".
Citigroup Global Emerging Markets Strategy 20100816

Which macroeconomic equilibrium in the United States and the euro zone?

- "We try to characterise the macroeconomic equilibrium over the next few years in the United States and the euro zone. After the crisis, we are likely to see:
• a significant need for household deleveraging due to the persistent imbalances in their balance sheets, leading to sluggish household demand;
• a reduction in fiscal deficits;
• need for companies that want to reduce their debt leverage to increase their profitability via a squeezing of wage costs instead of via rapid growth in their turnover; accordingly, distortion of income sharing at the expense of wage earners, which will reinforce the weakness of household demand and boost company earnings. The resulting effects on stock markets will be ambiguous;
• the main source of growth is therefore likely to be exports and related investments;
• due to the weakness of domestic demand and the distortion of income sharing at the expense of wage earners, domestic inflation will remain very low, and monetary policy will hence remain expansionary. This points to low risk-free nominal interest rates;
• the international environment can be expected to move in the same direction for several years: high level of global savings, rise in commodity prices deferred for several years by the crisis, and low inflation given the labour reserves in emerging countries. Emerging countries will probably not become inflationary or stop generating excess savings before the end of the decade."
- "All in all, we expect an under-employment equilibrium (Keynesian unemployment equilibrium) in the United States and the euro zone for a few years, with fiscal policy becoming more restrictive and monetary policy remaining expansionary, resulting in the normal characteristics of such an equilibrium: unemployment, lack of inflation and low interest rates. The distortion of income sharing will shift the burden to wage earners, while corporate profitability will be robust despite tepid growth."

Natixis Flash Economics 396 20100809

The correlation between equities and bonds in the euro zone: How many regimes?

- "We study the factors determining the correlation between equities and bonds. At first sight, it is reasonable to think that:
• a rise (fall) in growth or a fall (rise) in risk aversion will lead to a rise (fall) in both share prices and long-term interest rates, implying a positive correlation between equities and interest rates;
• a rise (fall) in commodity prices - not linked to growth - will lead to a fall (rise) in share prices and to a rise (fall) in interest rates, meaning there would be a negative correlation between equities and long-term interest rates;
• a very expansionary (restrictive) monetary policy will lead to a fall (rise) in long-term interest rates and to a rise (fall) in share prices, and hence a negative correlation between equities and long-term interest rates."
- "We therefore have one regime (linked to growth and/or risk aversion) with normally a positive correlation between equities and long-term interest rates and two regimes (commodity prices, monetary policy) with normally a negative correlation between equities and long-term interest rates."
- "In the past we have seen:
• a regime of positive correlation between equities and interest rates (end-1998 to early 2004, end-2006 to 2010) linked to growth and risk aversion;
• a regime of negative correlation between equities and long-term interest rates (1996 to early 1998, end-2004 to the first half of 2006) linked to monetary policy."
- "Periods of sharp fluctuations in commodity prices (end-2007 - early 2008) have for the time being been too short to lead to an identifiable regime of negative correlation. However, such a regime must be included in the list of possibilities in the future."

Natixis Flash Economics 395 20100806

Real estate tightness counterbalances net loosening in commercial and industrial

- "Credit standards loosen for both large and small firms, but this is mostly the result of competition rather than robust loan demand"
- "Prime loan standards loosened, but overall residential loan demand remains weak"
- "Willingness to extend consumer installment loans is at the high end of the past decade"

BBVA US Banking Watch 20100817

Agency MBS: Outlook for Agency MBS Basis

- "Over the past two weeks, agency MBS had significantly underperformed Treasuries. The sharp underperformance of the MBS universe could be gauged from the fact that the dollar prices of FN 4.5s have appreciated by only 6+ ticks and those of FN 5.5s and 6.0s have declined by close to 22-24 ticks even as the 10-year Treasury Futures contract had appreciated by 2-08 and the 5-year Treasury Futures contract had appreciated by 0-31+ over the past two weeks (Figure 1).1 This sharp underperformance of agency MBS had occurred even as implied volatility of interest rate options (both Gamma and Vega) had declined by 3-7 bps over this time period, which is unlike prior episodes of mortgage spread widening when MBS spread widening was typically associated with a spike in implied volatilities."
- "As regular readers are well aware of, our strategy team has been recommending a long-term underweight on the MBS basis versus Treasuries for 2H’10, primarily because of our expectation of the Federal Reserve not reinvesting paydowns on its existing MBS holdings back in the MBS. This would represent a significant net supply of agency MBS to the rest of the market and spreads will have to widen for this excess supply to be absorbed by private investors. However, even we are somewhat surprised at the pace of spread widening over the past two weeks."
- "Below we present an assessment of some of the macro-factors that are likely to drive agency MBS spreads over the next several weeks and outline our short-term and long-term trade recommendations on MBS basis:
• Issue #1: Reinvestment of MBS paydowns received by the Fed in Treasuries
• Issue #2: Elevated prepay uncertainty due of the possibility of streamlined refinancing
• Issue #3: Low absolute yield levels and relatively cheap MBS valuations
• Issuer #3: Servicers"

Nomura Special Topics 20100813

Japanese equity valuations should rise as double-dip concerns fade

- Japanese equity prices excessively discount concerns about global economic outlook: "In our opinion, Japanese equities have excessively priced in concerns about the global economic outlook and a double dip for the Japanese economy. We think this provides an opportunity for investors, particularly value investors with a long-term horizon."
- Little risk of double dip for Japanese economy: "If the Japanese economy were to slide into recession, this would likely be caused by recession in the US or the world economy. We see little risk of the US economy moving into recession unless some kind of major shock occurs. Some argue that the concerted switch to fiscal tightening by major economies could provide a substantial shock. However, our calculations of the impact of policy stimulus withdrawal, as well as past examples of fiscal tightening, indicate that fiscal tightening is unlikely to be so severe as to trigger a recession."
- Japanese economy headed for self-sustained recovery: "We expect the Japanese economy to regain momentum after slowing up to 2011 Q1. We think this momentum will be driven by (1) a rebound in capex, (2) the positive implications of this for employment, incomes and consumption, and (3) firm exports on the back of sustained strong growth in emerging economies."
- Scope for upward adjustment in Japanese equities, which price in fall in FY11 profits: "We think that equity markets price in a scenario whereby the improvement in Japanese corporate earnings loses momentum in the lead-up to FY11, and profits decline in FY11. This suggests to us that market participants may be factoring in a recession for the Japanese economy. Our analysis suggests there is little risk of the Japanese economy sliding into recession. Once the excessive pessimism fades, we think Japanese equities will see an upward adjustment in their low valuations."
- Japanese economy-sensitive stocks at or near lows: "We believe Japanese economy-sensitive (high-beta) stocks are trading at or near lows. As long as there is no recurrence of the financial crisis, we see limited scope for further underperformance by high-beta stocks. Among high-beta stocks, we recommend overweighting sectors sensitive to emerging economies (trading companies, construction machinery). From 2011, we anticipate an almost simultaneous upward adjustment in “capex” and “consumer durables” sectors as well as “domestic demandsensitive” sectors. Meanwhile, valuations look high for "emerging economy growth" sectors (robots/pneumatic equipment, healthcare, cosmetics/toiletries) following strong share price performance in 2010 H1. In the near term, we think "emerging economy-sensitive" sectors could take over as the main driver of high-beta stocks."

Nomura Japan Investment Strategy 20100813

Asian markets unnerved by US spillovers

- Asian markets unnerved by US spillovers "Signs of a weakening US growth outlook dragged Asian markets down over the past the week. The deterioration in sentiment was exacerbated by indicators of slowing growth and domestic demand in China, even though the data were in line with expectations. Rising risk aversion has led to a steep strengthening of the Japanese yen, which benefits given its safe haven characteristics, with officials beginning to express concern about the impact on Japan’s recovery. The tentative nature of Japan’s recovery was underscored by a weaker-than-expected Q2 GDP outturn (0.1% q/q, s.a., versus consensus of 0.6%) on weak private consumption."
- Indicators continued to show a gradual slowdown in the region… "China’s monthly economic indicators for July provide further evidence of a soft landing for the economy in the second half of the year (see Highlights). Industrial production, housing prices, and credit growth all moderated. Exports remained resilient, resulting in a surprisingly large trade surplus. Elsewhere in the region, indicators were soft. In addition to a weaker Q2 GDP outturn, Japan’s machinery orders for July (-2.2% y/y) were well below expectations. June industrial production in India was also weaker than expected (7.1% y/y) raising questions about India’s 8.5% GDP growth target for the year. Meanwhile, Q2 GDP growth in Hong Kong came out in line with expectations, at 6.5% y/y (BBVA: 6.7%)."
- The Bank of Korea pauses on interest rate hikes… "While some market participants were expecting a second straight interest rate hike in Korea, the Bank of Korea left rates unchanged, although it signaled the likelihood of further rate hikes in the coming months to contain rising inflationary expectations."

BBVA Asia Weekly Watch 20100816