Appeasing the Bond Gods - New York Times
Needed: a new economic paradigm - Finacial Times
McDonald’s’ renminbi bonds - FT Lex
Is China Turning Japanese? - Foreign Policy
Watching China whizz by - Economist
Fidelity: retirement fund withdrawals rise in downturn - Reuters
China Swallows Obama Stimulus Meant for U.S. Economy: Andy Xie - Bloomberg

The impact of structural challenges to growth in advanced economies

- "The current debate between the proponents of austerity measures and those who favour additional stimulus is largely irrelevant because most of the socio-economic problems faced by advanced industrial countries are structural rather than cyclical."
- "Increased global competition, de-industrialization and a loss of control over innovation have undermined the ability of advanced industrial economies to sustain "normal" or historical levels of economic growth."
- "We believe a combination of structural long-term debt, deteriorating demographics, a backlash against immigration, spending cuts and stagnating incomes will lead to political gridlock and instability in developed economies, further undermining efforts to deal with slow economic growth."
- "The current global economic and political situation increases the likelihood of protectionism and trade tensions."
- "Economic power and geopolitical power are inextricably linked. We believe the decline in the geopolitical clout of advanced countries will carry negative implications for economic growth. Conversely, economic growth in developing countries will benefit from theirexpanding sphere of influence."
- "Investors have to be mindful of the increasing disconnect between economic growth and market performance at the national level."
- "Investment conclusions: Emerging markets will continue to outperform developed markets; U.S. markets will outperform most other advanced economies; Indian markets will outperform Chinese markets; Latin American investments are favoured over African ones; Commodities will outperform, as will investments geared to global mega-trends."

NBC Global Investment Implications August 2010

The new “untouchables”

- Introducing our “musings on” series of reports "To move away from reactive writings on short-term issues, we’d like to introduce our new series of reports called “musings on”. In this series, we will write about long-term issues and try to think laterally. Some of our musings will have immediate market implications, but many, we suspect, may not. In our inaugural issue, we will contemplate on sectors that may face significant policy risks over the next few years as China undergoes structural reforms. We name them the new “untouchables” for effect and it doesn’t mean we won’t recommend them from time to time for other reasons."
- Untouchable No. 1 - monopolies "Many protected sectors are earning high ROEs and the government is going about changing that by capping salary growth, introducing private competition, limiting fee increases, and imposing additional taxes. Sectors vulnerable here include banks, energy and other resources, IPPs and telcos, by our assessment."
- Untouchable No. 2 – twin-high industries "I.e.,, high energy consuming and highly polluting industries e.g., steel, cement and metals. They benefited greatly from China’s investment-driven growth and have not paid their fair share of resources and environment costs. The government has rolled out a resources tax, cancelled tax rebates and concessionary tariffs, limited financing and shut down operations. It may also impose an environmental tax and a carbon tax, and raise environmental standards and charges."
- Untouchable No. 3 – property developers "Rightly or wrongly, many people in China are blaming developers for unaffordable houses and the government’s policies have turned increasingly hostile, e.g., cracking down on investment/speculative demand, expanding welfare housing programs, doubling land supply, collecting more taxes and restricting funding. Real estate taxes, property taxes and a capital gains tax may also be on the way."
- Untouchable No. 4 – public goods/services providers "The government has vowed to check their costs carefully to prevent excessive profits. This may undermine pricing power in a broad range of sectors, including fertilizer makers, drug makers, gas suppliers and distributors, IPPs, ports, airlines, airports and financial service providers."
- Untouchable No. 5 – the market "Untouchables No. 1-4 accounted for some 90% of market earnings in 2009."

Merrill Lynch China Musings on 20100813

Current Accounts and Demographics: The Road Ahead

- "Demographics are a major determinant of long-term current account trends."
- "Countries with a high proportion of ‘prime savers’ (those aged between 35 and 69) are more likely to run current account surpluses."
- "We show how demographic shifts have influenced global current account trends in the past 30 years, and what they imply for the next 20 years and beyond."
- "We have seen some rebalancing from the extremes in 2008 but the process is not yet complete."
- "Demographic shifts point to a cleaner split between emerging markets (mostly in surplus) and developed markets (mostly in deficit) in the future than is evident in the current, more complicated picture."
- "Emerging markets (EM) could continue to lend to developed markets (DM) on average."
- "Demographic forces may help keep global real rates low."
- "The development of EM capital markets may be important in offsetting demographic pressures for capital flows from the EM to the DM world."

GoldmanSachs Global Economics Paper 20100812

JPY intervention risk rising

- "The prospect of currency intervention to stem the appreciation of the yen has surfaced in the past week. In examining the market’s arguments, and comparing Japan’s situation with other major economies, we think the risk of intervention is real and rising."
- "Intervention is normally considered an option when markets can not be relied upon to adjust prices according to fundamentals. The main conundrum confronting the yen is that markets have favored the currency in both bad times and good.
• When the global recovery story was strong, the argument was that Japan stood to benefit from increased demand in Asia. This sounds logical except that, unlike other Asian stock markets, the Nikkei slides when the yen appreciates. The stronger yen not only hurts the operating profits at Japanese manufacturers, but are encouraging more companies to consider shifting production offshore.
• When risk aversion sets in, the yen becomes a safe haven currency. With 56% of Japan’s exports headed for Asia, does it make sense for the yen to appreciate while Asian currencies depreciate during this period? Probably not.
• A more plausible explanation for yen strength is the inability of the US economy to shake off post-crisis worries that it was headed towards a Japan-style deflation. Put simply, it is more reasonably a case of USD/JPY accompanying US bond yields lower. But the thing is, investors are seeking safety in US bonds, not Japanese bonds during periods of risk aversion."
- "In our view, markets should not be too quick to dismiss Japan’s complaint about the excessive strength in its yen. To be sure, in falling alongside US interest rates, a lower USD/JPY has dragged Japan’s equities lower. In reflecting US deflation risks, a stronger yen increases the odds of deepening Japan’s deflation woes. With China’s economy surpassing Japan this year, it does not make sense for the yen to bear the brunt of the currency adjustment on behalf of the yuan. In this regard, the yen has already delivered more than its fair share of appreciation since 2008."

DBS Asian Currency Research 20100818

BIS3: Some reprieve, with US banks OK on capital/liquidity

- BIS3: US Banks OK given softer standards, longer timeline "Proposed changes to BIS capital and liquidity standards have been a key source of uncertainty for Global Banks. Original proposals were vague but harsh, particularly as it related to liquidity requirements and timeline. BIS has now pushed back implementation dates for key items and softened some effects including deductions from Tier-1 Common, netting of derivatives, and liquidity requirements. We believe, US firms appear well armored in terms of capital/liquidity, with JPM strongest on relevant metrics. See tables on pg 3 for impact of key BIS3 capital/liquidity standards on US brokers/money center banks."
- JPM, GS, C well positioned for early capital deployment "Under our base case which assumes 2.5x Market Risk RWA (i.e. trading book) “inflation”, we believe the 4 big US dealers we cover appear sufficiently capitalized to meet BIS3, with JPM, GS, and C well positioned for early capital deployment in 2011, MS in 2012. Under BIS3 liquidity req. (Net Stable Funding ratio >100%), we est. C and JPM are already at or above 100% target while GS and MS are currently below it - though given NSF ratio isn’t mandated until 2018, they have ample time to reach target. Based on our analysis, C appears most liquid (105%), MS least (86%)."
- Scenario: Rising RWAs, Core Tier-1 target of 6,7,or 8% "Impact of RWA “inflation” on BIS3 CT-1 ratio (i.e. adjusted T-1 Common) hard to estimate as capital targets not set and US banks report RWA under BIS1. In our scenario analysis, we assume: Market Risk RWAs rise 2x-5x; counterparty credit risk RWAs rise 37.5%; a CT-1 target ratio of 6, 7, or 8%; no increased capital deployment; and roll forward RWA & earnings to 2012E. Results show JPM, C best positioned to withstand higher multiples of Market Risk RWA. Note though, C may face higher RWA “inflation” than peers (see below)."
- Stressed VaR to drive differences in RWA “inflation” "Comparing VaR across firms is treacherous given different methods of calculating it. However, comparing VaR reported at “peak” stress periods to Market Risk RWA, we can estimate how much of a firm’s RWA drives capital to support “normal risk” and how much reflects extra “cushion” for “tail risk”. Firms that currently fail to address “tail risk” face higher RWA “inflation”, we believe. Given VaR inconsistencies, we run 2 scenarios where we measure “tail risk” as a % of Market Risk (trading risk) and as % of combined Market and Credit Risk (cpty. credit risk). Based on our analysis, C appears weak on both metrics and could face higher RWA “inflation”. That said, given C’s excess CT-1, per our estimates, we believe it can withstand significant RWA “inflation” and still achieve min. CT-1 t argets. We also see potential for capital deployment at C, as early as 2011."

Merrill Lynch Banks Multinational Universal 20100812

A little help from my FED

- Do you need any money? Extending Quantitative Easing “to help support the economic recovery”. "The Fed addressed market expectations of reinvesting principal paydowns in the Treasury market in today’s statement. Yesterday, we highlighted that the failure to do so could result in shrinkage of the portfolio of around 15%, an implicit tightening the Fed now acknowledges it does not intend to allow. Notably, the NY Fed clarified the location of those purchases in the 2 to 10 year curve - precisely where the strongest rally in the Treasury curve has occurred since the end of June. That suggests much of today’s action was anticipated though clearly not all as the belly of the curve (5 and 10 years) outperformed today declining in yield by around 8 and 7 basis points respectively."
- Yields – the magic 4%. "In the euro credit market, flows have historically been dictated more by spread-based investors. However, in recent years, there has been a growing participation from investors that focus on yield: retail investors, insurance companies, and institutional investors managing absolute return funds. To meet return targets, investors will need to extend in duration, buy lower-rated cyclicals, or dip into BBs. We highlight bonds in the European space which are yielding over 4%."
- BIS3: Some reprieve, with US banks OK on capital/liquidity. "BIS3: US Banks OK given softer standards, longer timeline. Proposed changes to BIS capital and liquidity standards have been a key source of uncertainty for Global Banks. Original proposals were vague but harsh, particularly as it related to liquidity requirements and timeline. BIS has now pushed back implementation dates for key items and softened some effects including deductions from Tier-1 Common, netting of derivatives, and liquidity requirements. We believe, US firms appear well armored in terms of capital/liquidity, with JPM strongest on relevant metrics. See tables on pg 3 for impact of key BIS3 capital/liquidity standards on US brokers/money center banks."
- FOMC: Shift back into neutral. "Fed announces reinvestment plan. In an effort to “help support the economic recovery,” the Federal Open Market Committee (FOMC) announced plans to maintain the current size of its balance sheet by reinvesting the principal payments from its mortgage portfolio into longer-term Treasuries. This action is best thought of a return to a neutral stance for policy, in which mortgage runoffs are not passively tightening policy — rather than the first step toward an inevitable restart of outright asset purchases. The outlook for growth and inflation would need to deteriorate materially for the Fed to move to actively expanding their balance sheet further, in our view."
- Productivity declines for the first time since 2008. "Hours jump as output slows. Nonfarm business sector productivity fell an annualized 0.9% in the second quarter as output advanced 2.6% while employee hours jumped 3.6%. Employee hours have now increased for three consecutive quarters and the second quarter increase in labor input is the largest since 2006. The recent surge in hours worked suggests that the backdrop for employment is improving as employers have exhausted the current staff. The median of analysts’ expectations was for a productivity gain of 0.1%. Productivity growth in the first quarter was revised from a preliminary increase of 2.8% to 3.9%. The upward revision is due to an increase in output as hours worked was unchanged. Over the past four quarters, productivity increased 3.9%. For the four quarters ended 2009Q2, productivity increased 2.5%."
- China: Trade surplus widened on slower imports in July. "Bottom Line: China’s trade growth is softening in 2H. China’s export growth softened to 38.1% YoY in July from 43.9% in June, mainly on a higher comparison base. The reading was stronger than expected, suggesting external demand had held up well. On the other hand, import growth declined sharply, on a rapid fall of YoY growth in import prices and sequential slowdown of the Chinese
economy. As a result, trade surplus widened significantly in July from June."

Merrill Lynch Situation Room 20100810

Brazil drills deep for petrodollars

- "Such has been the flow of good news about his country’s vast energy resources that President Lula da Silva of Brazil has already declared God to be “a Brazilian”. The discovery of what could be up to 100bn barrels of oil lying deep under the Atlantic promises to transform the nation’s economy and bring millions of people out of poverty. But when in July the president opened the taps on his country’s first commercial deep-sea oil production platform, the sheer scale of the challenge facing Brazil was starkly underlined by the offshore catastrophe further north in the Gulf of Mexico."

ABNAmro Energy Monthly August 2010

Dry bulk shipping costs hinting at double-dip recession?

- "The post-recession rally and subsequent collapse this year of the Baltic Dry Index, which measures the cost of transporting dry bulk goods by sea, is puzzling. A stronger performance by the index in Q2 seemed to support the views of those who believed that the emerging markets had escaped the financial crisis relatively unscathed, and would lead the rest of the world, including the advanced economies, into recovery. But the recent extraordinary crash in bulk carrier charges has left many wondering if a double dip recession is already upon us, and if it will be severe enough to drag down the economies of emerging markets too."

ABNAmro Metals Monthly August 2010

Will the resilience of the German labour market be long-lasting?

- "The German labour market’s resilience to the crisis has been exemplary, as the unemployment rate is at its lowest level since 1993 and continues to decline."
- "This performance shows the combined impact of several factors. Thus, out of the current three percentage point gap between the German unemployment rate (7.0%) and that of the euro zone (10.0%):
• 0.3 percentage point is explained by changes in the labour force in Germany, where demographic effects have had an favourable impact since the rise in the participation rate - which was spurred on by the Hartz reforms - ended;
• 1.2 percentage point is explained by the employment policy (0.3 percentage point by the reinforcement of support measures for job seekers and 0.9 by the easing of the terms for short-time work);
• apart from the success of short-time work, the German stimulus package has had a limited impact on employment (5,000 jobs created in construction);
• 0.8 percentage point is explained by the lack of destruction of jobs in construction, since there has not been any real estate bubble recently in Germany."
- "All in all, the "implicit" outperformance of German employment is "only" 0.7 percentage point of unemployment, in particular thanks to the jobs created in non-market services."
- "Demographic effects and the lack of a real estate bubble have made this performance long-lasting. However, it will subside as the employment policy runs out of steam, i.e. by around one percentage point over the next two years."

Natixis Flash Economics 397 20100811