Have we underestimated Chinese consumption? - China Financial Markets
Quantitative Easing Helps Financial Institutions - Naked Capitalism
There is no solvency issue for a sovereign government - Billy Blog
What Bernanke doesn't understand about deflation - Steve Keen's Debtwatch

Ask Not Whether Governments Will Default, but How

- "This is the first issue of Sovereign Subjects, a new Morgan Stanley publication focusing on sovereign risk in advanced economies. In this first installment, we take a broad perspective on government balance sheets and raise several themes to which we will return in more depth in subsequent issues. We encourage clients to provide us with feedback on this new publication."
- "Debt/GDP ratios are too backward-looking and considerably underestimate the fiscal challenge faced by advanced economies’ governments. On the basis of current policies, most governments are deep in negative equity."
- "This means governments will impose a loss on some of their stakeholders, in our view. The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take."
- "So far during the Great Recession, sovereign (and bank) senior unsecured bond holders have been the only constituency fully protected from partaking in this loss."
- "It is overly optimistic to assume that this can continue forever. The conflict that opposes bond holders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well aligned with those of influential political constituencies."
- "There exists an alternative to outright default. ‘Financial oppression’ (imposing on creditors real rates of return that are either negative or artificially low) has been used repeatedly in history in similar circumstances."
- "Investors should be prepared to face financial oppression, a credible threat against which current yields provide little protection."

Morgan Stanley Sovereign Subjects 20100825

Conundrum Circa 2010

- Conundrum Circa 2010: "Long-term interest rates are implying almost perfect likelihood of significant balance sheet expansion by the Fed. A sell-off is likely if this view is not confirmed at Jackson Hole."
- Duration of Fed Purchases on Par: "Relative value of securities that the Federal Reserve targets appears to be of a second order concern."
- It is not too late to Hedge a Double Dip: "Buy 1y5y receiver 50bp/100bp spreads to hedge a modest one, 1y30y 75bp or 100bp low strike 50bp wide receiver spreads for a large double dip."
- The Year of Idiosyncratic MBS Prepays: "While ‘insta-refi’ fears linger, delinquent buyout fears taper. We consider government engineered refis a low probability event with undesirable side-effects. We continue to recommend MBS basis longs."
- Agency Debt: "With high negative convexity and tight yield spreads to bullets, investors should seek quality yields in the callable agency sector. 4nc1 and 5nc1 callable agencies provide a good balance between reduced negative convexity, reasonable OAS and yield."
- US Rate Strategy Model Portfolio: "The portfolio is up 1.2% month-to-date."


Investment Perspectives

- US Economics "Deleveraging the American Consumer: Faster than Expected"
- US Credit Strategy "Getting Some Credit"
- US Interest Rate Strategy "A New Leaf – Becoming More Tactical"
- Global Equity Strategy "The Rock, Part II – Don’t Ignore Yield"
- Europe Equity Strategy "Looking for Best Yield Opportunities"
- Equity Derivatives Strategy "Volatility Curves Help the Hunt for Yield"
- STEP Commentary "Behind the Spreadsheet: Adam Frisch"

Morgan Stanley Investment Perspectives 20100825

One is the loneliest number

- Macro viewpoint: One is the loneliest number "With two consecutive quarters with a one-handle, the US is dangerously close to a “growth recession.” Structural unemployment has increased but most of the rise in unemployment is cyclical."
- Fed watch: Ben buys time "As expected, Fed Chairman Bernanke departed from the usual script at Jackson Hole. He focused on explaining the logic behind policy rather than a specific road map. The speech buys time for the Fed to determine if the economy is weak enough to warrant action."
- Housing watch: Bringing down the house "Home sales collapsed to a new record low while inventory edged higher, widening the imbalance in the housing market. The looming shadow inventory likely will keep this gap wide."
- The week ahead: Anemic August payrolls "The overall mood of the data this week likely will be downbeat. We are only expecting +30k in private payrolls growth in August. Given the accuracy of forecasting payrolls, there is a risk that private payrolls print negative."

Merrill Lynch US Economic Weekly 20100827

The $300bn question

- "Commodity investments in July passed an important milestone when AUM surpassed $300bn for the first time as commodity inflows bounced back, up by $5bn compared with June’s $2.3bn and prices strengthened. Growth in index swaps was the main driver, more than offsetting a large outflow of funds from ETPs, especially from physically backed gold products. Over the past 10 years, commodity AUMs have risen by $290bn with investment inflows having amounted to $245bn, at an annual average rate of about $24bn."
- "Will those inflows continue? In our focus piece this month we examine two issues at the top of commodity investors’ list of concerns. First, the long-term demand growth outlook for commodities, and whether emerging market demand will be sufficient to offset slower growth ahead in industrialised markets. Second, we examine the recent close correlation of commodities with other risky assets, which has prompted debate about the value of commodities as a distinct asset class."
- "Trading strategy in commodities is more complicated than it was a few months ago when we still saw considerable upside potential across a wide range of markets. The bounce in a number of energy and industrial metals markets that we had been expecting finally arrived in July and early August, though it has proved short-lived. Also, with markets focusing on slowdown fears in the US and China we are reducing some risk by closing out long base metals positions and have instituted an outright short in US natural gas. However, we remain long crude oil, gold, corn and cotton."

Barclays Commodity Investor Aug2010

Why it is still right to fade the rally

- Overview: "We continue to view the bond market rally as being fundamentally overextended. Hence, we still believe it is right to look for opportunities to fade the rally."
- US Rates Strategy: "10-year treasury yields are pricing 0%-1% growth and a high probability of significant balance sheet expansion by the Fed, we believe."
- Euro Rates Strategy: "Although Ireland’s significant prefunding has reduced its vulnerability, this is unlikely to be sufficient to reverse short-term sentiment and counteract positioning. Medium term, peripherals find themselves between the dangers of too weak and too vigorous growth."
- Global Inflation Strategy: "The risk-reward of staying short the 5yr, 5yr forward TIPS break-even inflation (BE) rate has diminished. We look at the changing dynamics of the euro BE curve and suggest further 10s30s BE flattening is likely. In the UK, we like buying 10yr linker asset swaps boxed against 30s."
- JGB Rates Strategy: "We believe that upside and downside risks to our 10yr JGB forecasts are now balanced but the threat of global deflation will probably leave many investors feeling that it is still better to buy sooner rather than later."
- Australia Rates Strategy: "Continue to hold long duration positions in 10yr CGS or buy on dips. Sell semi-government (semis) in the long-end at a spread of 25bps or under to 10yr CGS or to buy non-guaranteed semis at a spread 50bps over CGS."
- US Treasury Issuance Outlook: "The supply of fixed income duration in the belly is estimated to be $600 billion less in 2010 compared to 2009. We estimate that the Treasury will issue slightly less than $2 trillion in 2011."
- September European Supply Outlook: "The euro net cash requirement (NCR) is marginally negative in September (-€4bn): €63bn of redemptions and €15bn of coupons outweigh €75bn of gross supply The NCR is the most supportive for Belgium (-€17bn).


Macro Investment Prospects

- Growing Signs of Slowdown in Advanced Economies "The global economic recovery would continue, although at a slower pace. Advanced countries’ economy has bounced back, driven by fiscal and monetary stimulus measures; businesses replenishing depleted inventories; and sharp recovery in exports. However, production growth is peaking out as companies slowed their buildup of inventories. Sharp recovery in the volume of global trade after a slump is losing strength: World trade had plunged in the wake of the collapse of Lehman Brothers September 2008, caused by a sudden shortage of the trade credit which finances transactions and a sharp reduction in inventories amid falling demand. Stimulus effect from tax cuts and government spending measures would also fade. Furthermore, amid persistent concerns about sovereign debt following the Greek fiscal deficit crisis, European and other advanced economies are adopting austerity measures. The U.S. government is likely to extend former President George W. Bush’s tax cuts for low-and middle-income families, while letting the break for high-income people to expire. Overall, the U.S. would effectively raise tax in fiscal 2011 beginning October this year, compared with fiscal 2010. Corporate profits in the U.S. and other major economies are bouncing back strongly. That is mainly because companies cut costs as they remain cautious about taking on new workers. The economic growth of advanced countries would decelerate after rising solidly early this year. Supply-demand gap of the U.S. and European economy remains large and won’t close easily, as indicated by persistently high unemployment rate, raising the risks of a continued disinflationary trend. Meanwhile, because of low potential growth, even if the Japanese economy grows only moderately, the supply-demand gap would close over time. Against the backdrop, Japan would get out of deflation in the middle of 2011 at the earliest. Under the circumstances, chances have risen that central banks of developed economies maintain their monetary easing for some time. Government bond yields of the U.S. and Japan have been declining. The continued downtrend in long-term interest rates is caused not only by fund inflows to the perceived safe haven of the government securities amid lingering European sovereign debt worries, but also by market expectations of a slowing economy, disinflation and prolonged monetary easing by central banks. Although concern about an economic slowdown remain, continued monetary stimulus, low government bond yields and rebounding corporate profits constitute an environment positive to the stock market. The euro has been bouncing back since June as risk aversion among investors following the Greek debt crisis receded. European bank stress test released July 23 showed most lenders have sufficient capital to withstand a recession and a sovereign-debt crisis, although the outcome was still insufficient to remove worries about the state of the European banking industry. That said, after getting through a crucial event, the market would restore calm at least for now. Meanwhile, the dollar has been weakening against major currencies as yield curb between long and short term U.S. Treasury securities has been flattening amid growing worries about an economic slowdown in the U.S."
- A Peak Out in Emerging Market Economic Growth "Emerging country economy is growing much faster overall than advanced economies. However, many central banks have shifted their monetary policy to tighten amid growing concerns about an economic overheating and accelerating inflation. Therefore, economic growth should have hit peak in the first half of this year and would gradually lose steam. Meanwhile, in most countries, excluding India, inflation isn’t rising as fast as had been feared months ago. Accordingly, concern receded that central banks may need to aggressively tighten monetary policy to curb inflation, which could touch off a sharp economic slowdown. In this respect, chances have risen that emerging economies achieve a soft landing."
- Threat of Deflation and Competitive Devaluation "Despite expected slowdown in the global economy, due to strong profit growth, businesses in advanced countries aren’t likely to further trim payrolls and cut back on capital investment. Meanwhile, emerging economies’ central banks would avert implementing a sharp monetary tightening. Therefore, chances of the global economy slipping into a double-dip recession is low. However, risks remain. One is deflation worries in advanced economies. Core consumer price indices excluding food and energy in the U.S. and Europe have slowed to around 1% year on year. If inflation head lower to slip into deflation, businesses and households would restrain spending, causing a further weakness in economic growth. Another risk is that countries may move toward letting their currencies to depreciate in an effort to give exporters competitive advantage and spur economic growth. Neither the dollar, euro and yen is much overvalued in terms of the real effective exchange rate. However, having limited room for carrying out further fiscal stimulus, the governments may engage in aggressive monetary easing and competitive currency devaluation, possibly leaving the currency market volatile and fueling tension over trade relations. That could spark a runup in commodity prices as credibility of major currencies as a whole decline and the attractiveness of hard assets increase."

Nomura Macro Investment Prospects Aug2010

Where can we see wealth effects linked to the crisis?

- "In theory, household spending (their savings rate and housing investment) is linked to their property and financial wealth; corporate investment is linked to companies’ market capitalisation."
- "We seek to ascertain where these wealth effects are most visible, and what they imply for the future."
- "With regard to households, we can see that wealth has a significant effect on spending in the United States, the United Kingdom, France, Italy and Spain, but not at all in Germany."
- "With regard to companies, we find in all countries (albeit less markedly in the United Kingdom) a significant effect of market capitalisation on productive investment."
- "Stock markets are rather sluggish and residential property prices are on the rise again in the United States, the United Kingdom, France and Italy - but slowly, and property wealth remains depressed."
- "Wealth effects will therefore continue to stifle demand, except in the case of German household demand."

Natixis Flash Economics 404 20100823

Will population ageing change the global economic equilibrium?

- "Population ageing (an increase in the proportion of elderly and pensioners in the population) normally leads to a fall in savings. In theory, this should lead to:
• in the short term, a situation of (ex ante) excess demand for goods and services, leading to inflationary pressures;
• in the long term, a rise in real interest rates that rebalances, ex post, savings and investment."
- "This situation would therefore be very different from that seen at present with excess savings, deflationary pressures and low interest rates."
- "The key question is when there will be a changeover from an equilibrium with excess savings to an equilibrium with a shortfall in savings: what is the pace of ageing? At what stage of ageing is there a decline in the savings rate?"
- "The example of Japan shows that the household and national savings rate falls when the share of the population aged over 60 in the total population increases, which will occur at a worldwide level from 2010-2012. The situation of global excess savings is therefore likely to gradually disappear, unless investment declines at the same time as savings, as in Japan."

Natixis Flash Economics 403 20100820

Worries are intensifying

- Market Movers ahead
• "Market focus is likely to remain on the US economy in the coming week. The minutes of the most recent FOMC policy meeting could reveal important information about the Federal Reserve’s decision to reinvest the proceeds of its MBS portfolio in Treasuries. There have been rumours that several FOMC members were in doubt about the decision. In addition, the ISM will give us an update on the pace of the slowdown in the US manufacturing industry. We expect the ISM to decline to 53.6 in August. The August employment report will finish off a hectic week on Friday. Early labour market indicators are pointing towards a weak report, with private employment set to grow a meagre 20,000."
• "In Europe, the key event of the week will be the ECB Governing Council meeting on Thursday. While policy rates are likely to remain unchanged, a key question is whether the ECB has become more worried about the effect of the increasingly disappointing US indicators on the European growth outlook. Another important question that might be addressed at the policy meeting is whether the ECB will extend the full liquidity allotment - we believe this is likely. In Sweden, we expect the Riksbank to hike policy rates by 25bp to 0.75%."
- Global Update
• "The flow of weak economic indicators out of the US continued in the past week. Home sales have plummeted following the expiry of the tax credit for homebuyers. This has raised concerns about the strength of the underlying trend in home sales. Also, durable goods orders have called the strength of business investment into doubt. However, the reduction of weekly jobless claims was a positive, with initial jobless claims retreating to 473,000."
• "The weakness in US indicators is likely to feed through to the European economy. In fact, new export orders in Europe’s manufacturing PMI weakened. The European economy, led by Germany, should nonetheless be able to continue delivering abovetrend growth in Q3. However, although it has remained strong so far, Germany’s Ifo manufacturing activity index is also pointing towards slowing growth."

Housing: An abnormally long journey back to normal

- We expect a sluggish U-shaped housing recovery "Housing data have been decidedly weak with home sales tumbling to record lows, housing starts spiraling lower and home prices slipping back. Part of the recent deterioration reflects the volatility induced by the homebuyer tax credit, but even more so, a slower-than-expected jobs recovery. The main factor determining the fate of the housing market will be the macro backdrop. If the economy falls back into recession, which we judge to be a 20% probability, the housing market will follow suit. Otherwise, we expect the volatile bottoming in the housing market to persist for some time, creating a long, painful, U-shaped recovery."
- Another five years until a “normal” housing market "We define a normal housing market to be one in which housing starts are trending at the historical average of 1.5 million homes a year. In our view, we are several years away from this state of normalcy. Housing supply has outpaced housing demand by about 2 million homes over the past few years and is on pace to add another 500,000 excess homes by the end of 2012. For this excess to clear, housing starts must remain at a depressed level, not returning to normal until 2015. This would make it the slowest housing recovery in post-war history."
- What to watch? Labor market and foreclosures "There are two primary interrelated factors that determine when the housing market will normalize: 1) the health of the labor market and 2) the pace of foreclosures. On the demand side, high unemployment and foreclosures will greatly reduce the pace by which new households are formed. Fewer new households will be created as young adults stay with their families longer or live with roommates amid high unemployment and concern about job security. In addition, the loss of homes due to foreclosure leads to doubling up and excess supply."
- Housing will not help, but should only hurt a little "The recession caused serious stress and imbalances in the housing market which will take considerable time to correct. Unlike in prior recoveries, this means that the housing market cannot be looked to for stimulating the recovery, but we do not see much of a drag left from housing construction. The bigger downside risk, in our view, comes from the trajectory of home prices. If foreclosures flood the market faster than we expect, home prices could take another serious leg down, tipping the economy back into recession. The interplay between the economy and the housing market should not be underestimated in our view."

Merrill Lynch Economic Commentary 20100824

US worries could become EMEA worries

- Market movers ahead: PMI and Polish Q2 GDP "The recovery in the Polish economy continues and we expect this to be confirmed by Q2 GDP that is due to be published next week. Hence, we expect Polish GDP to have grown by 3.3% y/y Q2 – up from 3.0% y/y in Q1 and slightly more optimistic than the consensus expectation of 3.2% y/y. Nonetheless, it is now clear that Q2 probably was the peak for economic growth in Europe and concerns about growth in the coming quarter have increased sharply. Therefore, the GDP numbers look even more backward-looking than normal – everybody in the market realises that the recovery continued in Q2, but investors are increasingly worried about future growth. PMI data for August due for release across the region will provide a little more information about how the EMEA economies are holding up. Overall we expect PMI to have dropped across the region, but we also expect the PMIs in general to stay above the critical 50 level indicating continued expansion in the EMEA economies. That said the risk is clearly on the downside.
- Fixed Income Outlook: Be careful with the long-end of the curve "As we have emphasised in EMEA Weekly in the past couple of weeks we are likely to see EMEA central banks turning more dovish going forward – either by cutting rates or by not hiking as early and as much as previously expected. The only notable exception is Hungary where the MNB could be forced to hike rates more than previously expected. The outlook for lower rates in most EMEA countries continues to be supported by our Monetary Policy Tracker (MPT) which now points to monetary easing in the Czech Republic, Romania, Turkey, Israel and South Africa over the coming nine to 12 months, while it continues to point toward monetary tightening in Hungary and Poland."
- FX Outlook: Nothing to buy… "It is rather depressing to look at our EMEA FX Scorecard this week, as five out of seven currencies in the Scorecard score negatively indicating a potential for further weakness in the EMEA currencies on a one- to three-month horizon. The best scoring currency for the second week in a row is the Israeli shekel, but the score on ILS is only slightly positive – so it is not exactly a strong buy signal. The fact is that this looks more like an ugly contest than a beauty contest – as the general outlook for the EMEA currencies in the short run appears to be rather bleak."
- Scorecard-based trade of the week: Buy ILS/ZAR "The shekel remains the highest scoring currency in our EMEA FX Scorecard, while the South African rand remains the most negative scoring currency in the Scorecard. Hence, for the second week in a row our Scorecard-based trade of the week is to buy ILS/ZAR. Over the past week the cross is down somewhat."

DenDanske EMEA Weekly 20100827

LatAm: strong exports

- LatAm: strong exports "The strength of raw material exports keeps the trade balances of Argentina, Brazil and Chile in the black. However, Brazil’s current account is deteriorating rapidly, and Mexico’s is still negative. Bank lending in Brazil slowed in June, in line with other economic activity indicators. Public spending keeps growing fast in Argentina and Peru, but is still being financed by increasing revenues. Employment figures also improved in Argentina, where the unemployment rate fell to 7.9%; however, unemployment is worsening in Venezuela, having increased to 8.7%. On the other hand, the Central Bank of Argentina announced the relaxation of the Monetary Program for the last 2 quarters and Peru’s currency strength leads the Central Bank to raise the bank reserves requirement and to S&P to ratify the solvency of public debt, changing the outlook to positive."
- Fears about the global economic cycle had asymmetrical effects in Latin America due to local factors. The outlook is still positive for the region’s assets "Brazil and Mexico experienced the largest exchange rate adjustments following the release of negative economic indicators in the USA, whilst the currencies of Chile, Peru and Colombia strengthened. The appetite for LATAM issues (stocks and private debt) remains high in the face of positive economic differentiation in most of the countries in the region."

BBVA Latin Weekly Observatory 20100827