In Ireland, Dangers Still Loom - Economix
Why Settling Trade In Yuan Matters - China Realtime Report
American Investors Absorb $4 Trillion in Treasuries - Oil Price
Will a Payroll Tax Cut Stimulate the Economy? - Economist's View
The IMF continue to demonstrate their failings - Billy Blog
Sovereign default – Unnecessary, Undesirable, and Unlikely - FT Alphaville
Back to the Future? - Steve Keen's Debtwatch
Obama to Link Tax Plan, Hiring - Wall Street Journal

Update on recession/deflation risk in the US and euro risk in Europe

- Rising risk of recession and deflation in the US
• "Fears of a double-dip recession and the risk of deflation have risen appreciably. While our own baseline forecast has not moved that far, the downside risks have clearly increased. We review the recent US economic news and what can be gleaned from movements in financial indicators, indexes of leading indicators, and recession probability models."
• "We find that recession probabilities have in some cases risen close to levels that have in the past been associated with ensuing economic downturns. While the evidence on this point is mixed, the risk is heightened by two policy factors: (1) a Fed that is running very low on available policy stimulus measures and (2) fiscal policy that is scheduled to turn substantially contractionary in the quarters ahead, with at best mixed signals from Washington on the prospects for relief on that score."
• "With inflation low, economic slack high and possibly rising, and longer-term inflation expectations showing some signs of wavering, the possibility of dipping into deflation grows larger. We judge the risk of deflation to be somewhat greater than that of a serious double-dip recession."
- Euro crisis: Mission not yet accomplished
• "Policy makers so far have treated the euro crisis as a liquidity crisis while market participants have tended to believe that at the heart of the euro crisis is the insolvency of one or more euro area states. Hence, measures taken so far have not been able to reduce tensions in EMU bond and money markets."
• "To reassure markets authorities need to develop a scheme that can deal with an insolvent state within EMU, if only as a contingency plan in case their assessment that adjustment will be successful proves wrong. The key for such a scheme is to allow a sovereign default in EMU at minimum cost for tax payers by building an efficient safety net for investors in EMU government debt."
• "Without such a scheme, failure of the deficit countries to adjust as promised could turn into a life-threatening event for EMU. But it will probably take a return of the euro crisis and a clear and present danger of a collapse of EMU to trigger the construction of such a scheme. We expect this to happen within the next one to two years."

DeutscheBank Global Economic Perspectives 20100901

The yen and Japanese equities in historical perspective

- The yen has risen roughly 4.2x in the last 40 years
Yen to get stuck in ¥70/$-¥80/$ range? — "Yen strengthening is not something that suddenly started yesterday. Since the fixed exchange rate system came to an end in 1971, the yen has risen 4.2x against the US dollar. We need to look at a risk scenario in which US long-term interest rates fall, the yen strengthens, and share prices remain depressed."
A strengthening yen is a long-term trend — "The yen’s nominal effective exchange rate rose 4.56x against the US dollar in the four decades or so from January 1970 to end-July 2010. In the space of the 39 years from August 1971, when the yen was at ¥360/$ (a fixed rate), the Japanese currency has risen 4.24x to ¥85/$."
Why the yen has risen long term — "Japan’s current account-to-GDP surplus has historically been high. In recent years, while the balance of trade surplus has been shrinking, net factor income (income from investments made abroad, etc.) has been rising. In 2009, the current account surplus was ¥13.2trn, with the income surplus coming in at ¥12.3trn."
Japan, overseas interest rate differentials narrowing — "The balance of overseas securities investments rose to ¥262trn at end-2009 from ¥131trn at end-1999, with the balance of overseas net assets rising over the same period to ¥266trn from ¥84trn. These increases in capital transactions are exacerbating the impact of Japanese and overseas interest rate differentials on the forex market."
US interest rates in long-term decline — "Over the long run, we believe the falling US nominal growth rate is causing long-term US interest rates to decline. The peak in the US nominal growth rate came in 1978 at 13.0% (real growth rate of 5.6%, CPI growth of 7.6%)."
Powerful downward pressure on interest rates in the near term, too — "We expect US core inflation to be weak for a while, due to the decline in rents. We also think tax increases are likely to be implemented as proposed. We thus conclude that rebounds for US long-term interest rates, the dollar versus the yen, and Japanese equities will depend on us seeing some positive metrics for the US economy."


- Turning point will not be policy but a bottom for the US economy
No hopes for policy action — "The BoJ has decided to supply around ¥10trn in new funds to the market. This equivalent to no more than 0.7% of broadly defined liquidity (¥1,455trn). The fiscal response is also likely to be a drop in the ocean. We doubt there will be any big changes in the near term to the weak US economy, declines in long-term US interest rates, yen strength, and low share prices."
No prospect of bold forex intervention — "The Obama administration is aiming to significantly shrink the US fiscal deficit and at the same time is adopting a strategy of promoting exports to grow the economy. We think that President Obama, who with a support rate of around 45% and 50% of voters opposed to him is finding his popularity flagging, would actually welcome steady dollar weakening."
Overshoot — "We feel investors need to keep in mind a risk scenario in which the markets overshoot, with the yen surging into the ¥70/$-¥80/$ range, US long-term interest rates plummeting into the 1%-2% range, and the Nikkei tumbling to around 8,000. However, our base case is for rising US long-term interest rates, yen weakness, and rebounding Japanese equities over the longer run."
Advantages of lower interest rates — "We recommend investing in real estate, tourism, and telecom stocks, domestic-demand plays that benefit from deregulation. We think additional monetary easing and falling long-term interest rates will benefit companies such as Sumitomo Realty & Development, All Nippon Airways, Central Japan Railway, and SoftBank, which have relatively low shareholders’ equity ratios."
Asia-related names have been doing well — "In August, it was domestic-demand stocks that outperformed, with global cyclicals and exporters suffering big pullbacks. Even though export-related names were slack overall, the shares of Asia-related names such as Daihatsu Motor and Isuzu Motors were relatively strong."
Resource and energy names — "There is not infrequently an inverse correlation between the dollar’s real effective exchange rate and the real price of crude. For investors expecting a fall in the dollar, we think it would be desirable to increase holdings of resource and energy names such as Sumitomo Metal Mining and Mitsubishi Corp."


The World is Down, But Far From Out

- "Welcome to our first Global Economics Weekly after the August break. We return to discuss the state of the world economy, our forecasts and our views on markets for the remainder of the year and beyond. During August, we saw unequivocal evidence of a significant slowdown in the US economy and, together with the already clear evidence of some earlier slowing in China, this has reawakened familiar fears for financial market participants. That said, we pinpoint here some key factors that should limit the downside for equities and other ‘risky’ assets."
- "Although the US economy will probably struggle for a number of quarters, we still think that a full-blow recession is not the most likely outcome. Moreover, US financial conditions are more important than the US economy for the rest of the world, and so the US policy response to the US economy’s ongoing sub-trend performance is more important than the US economy itself. If the economy performs as we forecast, we would expect fresh steps from the Federal Reserve to ease financial conditions."
- "In China, we expect further evidence of softening GDP growth but, in contrast to the US, this slowdown has been deliberately induced by tightening financial conditions. The evidence in recent weeks suggests that Beijing is moving to reverse these steps now that they have brought inflationary pressures under control. We forecast renewed strength in Chinese GDP growth in 2011, led by domestic demand."
- "Against a background of reasonable valuations and rather high equity risk premia, we think that once markets realise that the US is not likely to enter a full-blown recession and that China is going to strengthen, equity markets and risky assets in general will rally."

GoldmanSachs Global Economics Weekly 20100901

I’ll remember April

- "Data raise concerns that US businesses are turning defensive"
- "Next week’s ISM surveys and payroll report will help clarify path of economy and policy"
- "Market-based measures of inflation expectations sliding in US, Europe"
- "Hopeful signs of domestic demand growth in Germany"

JPMorgan Global Data Watch 20100827

Thorn in the side

- "Today’s press conference signals no change in the ECB’s stance, as the central bank scales back liquidity support at a barely perceptible pace, just enough to signal the direction of an excruciatingly slow normalization process. Overall, the ECB feels confident that a sustainable recovery is underway, both in Europe and in the global economy, but harbors no illusions as to its strength. The ECB is not losing sleep over the risk of a double-dip recession, but rather over the persistent fragility in the financial sector, underscored by the recent resurgence in market tensions. With inflation—and inflation expectations—well under control, liquidity will remain ample and rates low for quite a while. Trichet noted the uncertainty on the US outlook, acknowledging that this time around the ECB puts no faith in a possible decoupling. But it is decoupling within the eurozone which is becoming the thorn in the ECB’s side. Trichet resorted to his favorite comparison with the US to brush off concerns that the widening gap in growth rates across eurozone states might undermine the recovery or complicate ECB policy. I remained unconvinced: differences in national growth and unemployment rates pose a risk to national budgets and financial sectors that are potentially destabilizing—as confirmed by the recent resurgence in market tensions. Moreover, having witnessed bitter debates on fiscal austerity and export-led growth strategies, I shudder to think what will happen if strong growth should boost German inflation while the periphery still struggles with stagnation. And we should not forget that the one-size monetary policy contributed to boosting credit, debt and imbalances in the now embattled periphery. Diversity within such a large economy as the eurozone is indeed a fact of life, as Trichet noted, but it is also a problem that needs to be addressed more seriously."

Unicredit Market Sense 20100902

De-leveraging, deficits don’t spell ‘deflation’

- "Despite market risk aversion, we believe the Bernanke Fed has the power and will to forcibly resist deflation."
- "Even though de-leveraging among households continues, the pace of increase in saving ratios appears to be moderating, or even in some countries turning down."
- "The Fed's shifting stance is set to result in an easier global monetary policy – in Japan, we look for a more accommodative BoJ operational stance; unilateral FX intervention appears imminent."
- "In the euro area, the ECB is likely to continue with full allotments in its regular refinancings through until at least early 2011, though it appears to lack appetite to resume aggressive bond purchases."

Barclays Global Economics Weekly 20100827

August Recap – Weak, In Line With History

- New GEMs Product — "With this report, we introduce our new GEMs Monthly Recap product. This will provide a review of market performance, macro data and important events over the past month for the asset class overall, Asia, Latin America, EMEA and the largest seven countries within the GEMs index. By design, there is little forward-looking material in this report."
- Big Outperformance in Down Market — "Emerging markets outperformed in August, with GEMs down 2.2% vs AC World -3.7%. Asia led with a decline of only 1.7%, followed by Latin America (-2.5%), while EMEA lagged (-3.2%). The top three performing markets were Colombia, Thailand, and Chile; laggards were Morocco, Mexico and Czech Rep. The ‘big seven’ emerging markets all declined in August."
- Defensive over Cyclicals — "In August, Health Care and Consumer Staples were the main outperformers, rising by 1% and 0.9%, respectively. In contrast, Technology and Financials declined the most, by 5.3% and 3.1%. Energy stocks fell by 2.9%, on a decline in oil prices of 2.3% to $75/bbl, and Materials fell by 0.9%."
- Historically Low Yields — "Emerging market bond prices continued to rise last month; the EMBI+ blended yield fell to an historical low of 5.40% on August 23 but has since rebounded modestly to end the month at 5.61%. Our FX proxy shows an average fall of 0.5% of EM currencies (MSCI-weighted) versus the dollar."
- Strategy — "Our view remains that the MSCI GEMs index will stay within its current trading range over the rest of Q3, but will break out to a new high for the cycle in Q4, when the seasonals are favorable and current ‘double-dip’ fears may began to subside. We look to add beta into Q4; for now, we remain Overweight in defensive Asia and Underweight high-beta Latin America; we are Neutral in EMEA."


Japan: A slowing economy and inventory adjustments

- A slowing economy and inventory adjustments
• "Inventory levels have started to creep higher in the manufacturing sector on the slowdown in shipment as post-crisis inventory restocking and economic stimulus effects have been largely played out."
• "While they remain relatively low for manufacturers as a whole, we believe that there should be little need for drastic inventory and output cuts at the macroeconomic level even if the global economic recovery does continue to lose momentum."
• "That said, some sectors – such as information & communication electronics equipment, electronic parts & devices, and transport equipment – have started to accumulate substantial inventories. These sectors may face a need for relatively deep inventory adjustments if demand does indeed turn out to be weaker than previously anticipated over the coming months."
- Momentum of recovery in production continues to slow down
• "Industrial production was stronger than the consensus forecast (-0.2%mom). However, as an indication of the momentum of the recovery, production dropped by 0.7% when compared with three months ago, the first decrease in 15 months."
- BoJ introduced an additional fund-supplying operation
• "BoJ decided to add ¥10tn in six-month fixed-rate fund supplying operations"

CreditSuisse Japan Economics Weekly 20100902

How Steep Is The Japan Slowdown?

- "Japan’s economic performance was generally stronger than most analysts anticipated in the first quarter of 2010 as strong regional growth helped produce a robust export driven expansion, but growth slowed markedly in the second quarter, raising concerns about a double-dip recession. The second half of 2010 and 2011 looks to be an increasingly challenging time for the country’s economy and for the country’s policymakers. A GDP growth slowdown in China and the United States will combine with a stronger yen to temper the advance of Japan’s exports and production. At the same time, fiscal stimulus pumped into the economy in 2009 and 2010 that helped to bolster Japanese consumer spending will swiftly fade from view over the forecast horizon. This sets one of the world’s largest economies up for a stark deterioration in growth in 2011 at a time when the Japanese economy is still struggling with deflationary forces. The policy response in Japan is increasingly important, but also increasingly difficult given the high government debt levels and seemingly unending need for additional monetary and fiscal pump priming."

Wells Fargo Special Commentary 20100901

Learn to Love Work

- "The value of financial assets held in retirement systems and accounts is derived from the expected future income generated by labor and capital. Thus, a slowing growth rate of the labor force can make the value of assets – and the luxury of a retirement itself – less likely. In fact, theory suggests rates of return on capital fall faster than labor income when the available labor supply slows."
- "The CBO notes that a slower-growing working age population should lower potential asset returns, but this might be made up for by greater deficit spending which would generate higher real interest rates. Higher interest rates generated this way appear inconsistent with fully comparable rising returns for risk assets (while also implying a drop in market prices)."
- "Even at low interest rates, the growth of age-triggered entitlement spending implies a crowding out of private investment, lowering potential growth."
- "In the current context, an unsustainable long-term fiscal course might make desirable short-run countercyclical policies less possible."
- "While there is still substantial room for reform, policies that imply and support an ever larger share of life in retirement might even threaten broader financial stability. In the end, there is little recourse but “more work” for many, if not most, even if our political process fails to acknowledge this now."


Growth recession launches QE2

- "After salami-slicing our forecast in recent months, we are ready to make a deeper cut. We now expect a growth recession: we think the economy will manage to post positive headline GDP numbers, but this growth will not be fast enough to keep the unemployment rate from drifting higher. We expect below-trend GDP growth in each of the next four quarters, and with a gradual rise in the unemployment rate above 10%. With the weaker growth, we believe the Fed will launch QE2—a new asset buying program—in Q1 of next year. Our interest rate team expects this to push 10-year yields below 2% in the early part of the year."
- "Recent data show a steady deceleration in growth. After surging in the first few months of the year, the two most important monthly indicators—private payrolls and core retail sales—have stalled (Chart 1). At the same time the post-tax-credit housing hangover has been worse than expected, and even the business equipment recovery shows signs of faltering. Our sense is that the growth recession is already here and it is likely to linger through the first half of next year."
- "For 2010, our full-year GDP forecast has been sliced 0.1ppts to just 2.6%. For 2011, we have shaved growth 0.5ppts to just 1.8%."
- "The downward revision comes from weaker anticipated spending from both consumers and businesses. With business confidence weakening and the economy slowing, we took our 2011 capex forecast down to 7.0% from 12.0%."
- "And, given the protracted inventory overhang in residential real estate and weaker labor market, we assume a long, even more painful, U-shaped housing recovery."

Merrill Lynch Economic Commentary 20100901

September Outlook: Humpty Dumpty

- "Over the past couple of years, central bankers and politicians around the world have spent trillions of dollars in an effort to restore employment and economic growth. Some traction was made, although the past month has proved to be challenging and perhaps suggests an over-reliance by the global economies on stimulatory measures. Unfortunately, more is likely to required to put the world “back together again” as the risk of a double-dip recession becomes an ever growing possibility. Such a view comes in light of all the recent economic data readings across the US, Europe and Asia turning down at differing speeds. The result is that the Asian credit markets will be challenged for the rest of the year contending with the different speeds, together with an increase in M&A activity. While Asian credit is attractive on a relative value basis (vs. its global peers), the technicals that have supported it in recent months are finally showing signs of fatigue. Going in to September, our strategy across the credit spectrum consists of a shift into lower beta credits. Specifically, we recommend:
HG Corporates: We continue to see value among the AAA credits trickling down to the AA and A space, with limited opportunities in BBB credits.
HG Banks: We continue to think the Australian major banks will call their subordinated debt and therefore offer value. The Basel proposal, if adopted, would likely drive a contraction in Australian major bank subordinated CDS versus senior.
HY Corporates: While we do not see much upside in Chinese property and Indonesian issues on an outright basis, we continue to like selective defensive names as carry trades and see relative value opportunities.
Sovereigns: Indonesia and Philippines cash bonds remain subject to market technicals. Depending on global macro conditions, we could see Malaysia and Vietnam underperform."

Nomura Asia Credit Commentary 20100831

US: Fed up with QEII

- "Markets over interpreted the August FOMC statement - QEII is still not a done deal"
- "Whether we will get a new round of easing is a close call, but it will take time for the FOMC to agree."
- "We think it will take a continued weakening in the labour market, an ISM below 50 or a significant decline in inflation expectations to trigger the Fed"
- "Generally we attach a 40% probability of a new round of treasury purchases"

DenDanske Research 20100902

Will investors react positively or negatively to the improvement in company results?

- "The sharp rise in the results of listed companies stems above all from the distortion of income sharing at the expense of wage earners. Investors may have two types of reaction to this situation:
• positive reaction: the improvement in results attracts investors and the stock market rises;
• negative reaction: the (excessive) distortion of income sharing creates expectations among investors of sluggish household demand and lacklustre growth, which discourages them from investing in equities and drives down the stock market."
- "We are therefore dealing with a clash between the effect of the distortion of income sharing on profits and its effect on PERs. When looking at similar situations in the past (euro zone in the 1980s, Japan in the 1990s), we conclude that the first reaction is likely to prevail: stock market prices can be expected to move in line with the improvement in company results."
- "This is what was seen in the 1980s in the euro zone; in Japan, on the contrary, there has been a sharp decline in PERs since the late 1990s, but this observation is difficult to use given the extraordinarily high level of PERs in Japan in the late 1990s: it was 80 in 2000."

Natixis Flash Economics 413 20100825

The gross domestic product level must continue to be watched

- "Observers were pleased with the second-quarter growth figures for the euro zone following the good figures for the end of 2009 and the beginning of 2010 in the United States and Japan. However, after a recession, because of the recovery in global trade, the end to de-stocking and highly expansionary economic policies, it is not surprising that certain quarterly growth rates are very high. What must continue to be watched is the GDP level relative to the level that would have been reached without the crisis, the shortfall in the GDP level relative to either potential GDP or trend GDP, depending on the case, which determines unemployment, investment, inflation, wage increases, fiscal deficits, etc."
- "All the countries analysed (United States, United Kingdom, Japan, Germany, France, Spain and Italy) show a substantial shortfall in the GDP level in the second quarter of 2010. This ranges from four percentage points (Germany) to more than 10 percentage points (Spain relative to the previous trend)."

Natixis Flash Economics 412 20100825

Diversification of China’s foreign exchange reserves into euro and yen: Is this good news?

- "It seems that the Chinese authorities want to inform financial markets and governments that they intend to diversify China's foreign exchange reserves from the dollar into the euro and the yen. Seemingly this can already be seen from the trend in exchange rates since the spring of 2010."
- "If this development is confirmed, it raises two questions:
• why would China diversify its foreign exchange reserves into the euro and the yen? The economic prospects in the short and long term are not better in the euro zone and Japan than in the United States; but the trends in debts and external assets may have convinced the Chinese authorities that the dollar will depreciate in the long term. Furthermore, if China now pegs the RMB to a dollar/yen/euro basket, a stabilisation of the RMB's exchange rate against the basket will clearly lead to purchases of yens and euros, instead of purchases of dollars. There may therefore be both a financial explanation and an explanation linked to the exchange-rate regime;
• are the effects of this change in the composition of China’s foreign exchange reserves favourable or unfavourable for the United States, the euro zone, Japan and China? The developments will be symmetrical: in the United States (where there is a need for external financing), the fall in the purchases of dollars would cause a fall in the dollar and a rise in long-term interest rates, which may be significant if the US external deficit must be reduced; in Japan and the euro zone (where there is no external borrowing requirement), an appreciation of the exchange rate and a fall in long-term interest rates."
- "The question is therefore whether it is better for the United States, the euro zone and Japan to have a weak currency or low long-term interest rates."
- "As regards China, weakening the RMB against the euro and the yen and strengthening it against the dollar may be dangerous as long as China's foreign trade and the reference prices of goods and commodities are denominated in dollars."
- "We believe that this development is:
• unfavourable for the United States, given the weight of its external debt;
• unfavourable for the euro zone, given the sensitivity of foreign trade to the exchange rate;
• not unfavourable for Japan, as the fall in long-term interest rates applies to a huge long-term debt."
- "This depends on the weight of foreign trade, its sensitivity to the exchange rate; the weight of the external debt, the long-term debt (public and private) and the sensitivity of investment to interest rates."

Natixis Flash Economics 410 20100824