Reasons to be bearish…

- Overview: "Bond yields now look low by almost any measure, fuelled by cheap funding, QE and strong seasonal support. However we think additional QE is now fully priced and that the technical backdrop is turning."
- US Rates Strategy: "10yr Treasury yields are 30bp below our view of fair value, but we are cautious due to strong momentum; we prefer to be long TIPS breakevens and short the 5yr Treasury butterfly, to position for higher yields."
- "We analyze the 10yr-30yr Treasury curve and conclude that despite its recent volatility it appears fair."
- Euro Rates Strategy: "We expect EMU spreads to continue to register high levels of volatility, with little scope for retracement in the weaker peripheral markets in the near-term. As we enter September, and perhaps a return to more liquid markets, we suggest 10s30s euro steepeners look appealing."
- Sterling Rates Strategy: "We recommend a 10s-30s GBP conditional flattener via payers. We also like boxing flatteners on the gilt curve with steepeners on the Bund curve or buying 30yr gilt asset-swaps versus Bunds."
- Global Inflation Strategy: "We recommend a long position in 5yr, 5yr forward TIPS break-evens as a view on the Fed. Euro break-evens have widened sharply; we are inclined to fade the move and see better value in TIPS."
- APAC Rates Strategy: "Base case scenario revisited in Japan after the recent sell-off."
- "Update to Semi-Government Borrowing Program in Australia."


Bullish bond market takes a break

- FI Strategizer: "Next week, the data calendar will be light on both sides of the Atlantic; better-than-expected NFP should thus remain the main driver of bond performance, leading to a further moderate rise in yields. Supply in the US and German data (likely to confirm the resilience of the German economy) should put additional moderate pressure on bonds."
- EU Portfolio Strategy: "We would return to a neutral duration, ready to lengthen the active duration again heading towards the FOMC meeting on 21 September. Cross-country wise, we cut back a little on Germany after the positive NFP and we increase France and Belgium. We also reduce Spain in favor of Portugal."
- MM: "The ECB announced the extension of full allotment until 18 Jan-11, meeting market expectations. It also announced three more 3M LTROs but with the rate linked to that of the 1W MROs, to stress that the exit from extraordinary liquidity measures is still in place."
- Trade Idea: "OT Apr37 has strongly richened vs. OT Jun20, and the two bonds now offer almost the same yield. One reason is that Portuguese supply on the 30Y has been very scarce in the last year. The flattening on the Portuguese curve seems overdone and we would sell the 30Y."
- Supply Corner: "In EMU, next week redemptions will be abundant (EUR 48bn), coming from core and from BTPei Sep10. Scheduled supply, mainly from core, is subdued. Portugal will sell 3Y & 10Y. The abundant liquidity creates a window of opportunity for unscheduled supply."
- Inflation: "The flash estimate for eurozone August HICP came in at 1.6% yoy. In the near-term, we expect inflation to stay subdued and our yearend target remains around 1.8%."
-FX Strategizer: "Trading on FX majors should remain exposed to daily or at best weekly volatility in the coming days. Even after better-thanexpected US labor data, swings in global risk aversion and the stock market performance will continue to set the tone."
- EUR: "The EMU growth potential will not be strong enough to completely offset the outstanding budget crisis. The EUR-USD strength should ease and the next key resistance level at 1.3125 won’t be broken easily."
- JPY: "Once the impact of the US labor data has abated, JPY bulls will challenge again the Japanese authorities. If inaction persists, USD-JPY could still fall towards 80, which could drag EUR-JPY to just above 101."
- GBP: "Global risk factors should continue to overshadow bleak data at home primarily for cable: risks of a new break towards 1.53 thus remain concrete, while EUR-GBP should remain capped above 0.8350."
- Pacific Rim: "The healthy performance of the Australian economy should not be enough to spur another rate hike at the RBA meeting on Tuesday. AUD-USD rally through August peaks above 0.92 should be taken with caution. NZD-USD might have difficulties breaking above 0.73."
- Nordics: "EUR-SEK and EUR-NOK were unable to crack key levels like 9.30 and 7.85, despite a more risk-prone scenario. Hence, a short-term bounce of these EUR cross rates may be cautiously explored"

Unicredit Curves & Crosses 20100903

Are Periphery Credits Cheap?

- "Sovereign risk completely dominated corporate credit in H1 10. Past crises strongly suggest it will remain the principal driver of periphery corporate credit until the uncertainty is laid to rest."
- "Sovereign crises tend to cause sharp increases in corporate default rates. The transmission mechanisms vary but some sovereign crises in EM countries have seen speculative default rates rise as high as 60%."
- "Decoupling unlikely – not all the contagion mechanisms in past EM crises would be repeated, but we believe there is plenty of uncertainty about the repercussions of a sovereign crisis in an EMU country to prevent most corporates decoupling from their sovereigns."
- "Banks are particularly susceptible – in theory and in practice. Non-financial spreads tend to be highly correlated with the sovereign, but may initially respond less than proportionately. But the deeper the crisis, the more likely that corporates will respond almost 1:1 with the sovereign."
- "Better value elsewhere – until European periphery sovereigns address solvency concerns more resolutely, we believe there is better value elsewhere than in periphery corporates."


Germany: Only modest decline in the current account surplus

- "The German economy is currently benefiting from extremely dynamic world trade. In Q2 real goods exports rose by more than 20% and Germany’s macroeconomic growth hit a new record of 2.2% compared with the pre-year quarter."
- "German export momentum is, however, likely to ease significantly in H2 2010 and above all in 2011, as the international inventory cycle as well as the catch-up effects from investments postponed in 2009 will slowly tail off and also the underlying cyclical performance in major client countries will probably recede."
- "In addition to the impact of this cyclical development the highly export-dependent German economy is also being hit by the adjust-ments in Europe’s crisis-ridden countries. The correction of the excesses in the real estate markets and the partially drastic consolidation programmes will severely dampen the import demand of these countries over the longer term."
- "The strain on the German current account is, however, likely to remain within bounds, as the importance of the problem countries for the German economy is relatively low, other major markets are stable, and any adverse effect s may be offset by demand from emerging markets, especially in Asia."
- "Nevertheless, in the medium term Germany’s large current account surplus needs to be reduced, as the origins of the crisis lay in undesirable structural developments on both sides, that is not only in current account deficits, but also in the reciprocal surpluses. All in all, we expect that the German current account surplus will first widen from 5.0% to 5 ½% of GDP this year, before narrowing slowly, however. In 2012 it could then stand at 4 ½%."

DeutscheBank Current Issues 20100906

Winning in a Weaker World

- "Weak developed economic growth is proving favorable for Asia and EM. Capital flows are strong. EM and APxJ are outperforming developed equity markets."
- "The key changes are to upgrade Malaysia to OW, downgrade Korea to Neutral from OW and sell business discretionary."
- "In this report we describe our base case for the balance of 2010:
1) Sub-trend DM economic growth and low core inflation
2) G3 interest rates on hold
3) Healthy EM and Asian growth (2010 6.9% and 2011 5.5%)
4) EM inflation near central bank target zone
5) China’s economic rebalancing is positive for sustainable growth but a risk to commodity investors and large SoEs.
6) Capital flows to EM continue as investors seek carry and growth
The result is that EM markets melt up."
- "Within APxJ, autos in Korea, semiconductors in Korea and Taiwan, and industrials in Korea and China offer cheap growth. These sectors had strong earnings momentum in the last three months. Consumer staples offer high growth but are expensive (see page 5)."
- "EM weighted and median 2011 EPS growth are 17%. This is 5% higher than the 2011 nominal GDP growth forecast of 12%. Material and financial sectors’ earnings are forecast to grow in excess of 20% while IT and telecom have the lowest growth forecasts at 10-11%. Brazil steel and Russian oil & gas contribute 20% of 2011 EPS growth. The median EPS growth for Taiwan tech is 19%."
- "The main risks to our view are a significant increase in EM inflation, sharp slowdown in global growth and no sell-off in commodities. For more on risks, please see 30."

JPMorgan Asia Pacific Equity Strategy 20100903

Non-commercial investors turn short CAD

- "The latest IMM data covers the week from 24 to 31 August."
- IMM data collected prior to positive US data: "Non-commercial investors reduced their exposure to risk-sensitive currencies according to the latest IMM report, which was, however, collected prior to recent positive US data. Short EUR positions were extended to 10.6% of open interest, and long positions reduced in the commodity currencies AUD, CAD and NZD. Wednesday’s stronger-than-expected ISM manufacturing report, which triggered a rebound in risky assets, is however likely to have seen a reversal of positioning flows – and extended further by Friday’s positive non-farm payrolls report."
- USD/JPY upside risks persist from stretched positioning: "A further easing of monetary policy in Japan was not enough to see speculative investors unwind their long JPY positions, nor was it enough to keep JPY from appreciating further. Given the Japanese election, our Asian economists see a high probability of further monetary steps to stem JPY appreciation pressures. Given the biased market positioning, these measures could trigger an accelerated move higher in both USD/JPY and EUR/JPY should more aggressive action, than the latest monetary easing, be taken."
- Speculative investors turn short CAD: "The unwinding of long CAD positions has continued and non-commercial investors are now marginally net short CAD for the first time since May 2009. With markets pricing only a 56% probability of a 25bp rate hike at Wednesday’s BoC meeting and speculative investors now short CAD, the upward potential in USD/CAD from a rate hike is likely to have increased."

DenDanske IMM Positioning 20100906

Finally somewhat positive US macro-economic news

- "Following some weeks of disappointing US macro-economic data, last week’s figures took away short-term double-dip fears somewhat. Consequently, investor appetite for risk improved markedly: government bonds fell and equity markets rose sharply (p.2, p.3 & p.4)."
- "This week’s focus is on German industrial production figures on Wednesday, and on the BoE meeting on Thursday (p.2, p.3 & p.4)."
- "The Chart of the Week shows the ‘official’ unemployment rate and the U6 unemployment rate (i.e. which includes: total unemployed + discouraged and marginally attached workers + total employed part-time workers for economic reasons) in the United States. Last weeks figures showed that non-farm payrolls fell for a 2nd consecutive month by 54k in August. However, as the headline figures are affected by Census related layoffs, financial markets were especially interested in the change in private payrolls. Encouragingly, private non-farm payrolls rose by 67k in August after 107k in July. Nonetheless, this increase has to be seen in the context of a loss of about 8.5mn jobs in the January 2008-December 2009 period. The only 733k jobs that have been ‘created’ since January are clearly not enough to push down the unemployment rate significantly. True, the unemployment rate has come down from its peak of 10.1% in October 2009 to 9.6% in August, but the Chart of the Week shows that the unemployment rate is still very high from a historical perspective. And also the U6 unemployment rate is still ‘sky-high’. Labour market conditions are thus far from good and another deterioration of conditions may lead to a next round of QE. However, last week’s figures showed that no additional QE should be expected in the short-term."

NIBC Markets Roundup 20100906

German residential property: Back in fashion – with good reason?

- 40 million dwellings in Germany. "Germany’s population of just under 82 million people live in approximately 40 million dwellings. Nearly half of these are single and two-family homes. At slightly over 42%, the home ownership ratio is still below the European average. In itself, this ratio represents neither a call for politicians to approve new incentives nor an implicit invitation for investors to tap into the market."
- Prices are unchanged on average. "Unlike in many other European countries, residential markets in Germany did not go on rollercoaster rides in the last ten years. Prices had neither soared up until 2007 nor did they drop in the course of the recession."
- Average fails to reflect major regional differences. "However, price trends also differed substantially between the attractive regions with high in-migration and the economically weak regions with high out-migration. While house prices in the weakest regions fell by more than 30% in the last ten years, they rose by up to 20% in the best regions."
- Slight price increases to be expected in the next few years. "The low number of completions, Germany's quick economic recovery, low interest rates and the fact that many investors are looking for low-risk investment products have led to a small boom in some subsegments of the residential property market. Prices are on the rise for prime inner-city locations especially in the major conurbations. But bargains can be found outside these few major conurbations as well. There are numerous attractive medium-sized towns and cities such as wellestablished university towns. On average, house prices in Germany look set to rise by roughly 1.5% p.a. over the next two years."
- Beware of the risks. "The positive outlook should not, however, render investors blind to the specific investment risks: real estate is always an investment in a particular region or area, making it vulnerable to changes in regional economic structures and the related demographic changes."

DeutscheBank Current Issues 20100903

Latin America: different recovery cycles

- "While Peru maintains a high growth rate (above expectations), in Brazil the data for 2Q10 shows that the economy continues growing at a high pace, though lower than 1Q10. The Central Bank of Brazil kept its policy rate at 10.75%. There was a setback to confidence among manufacturers in Mexico as a result of worse news about the US, while consumer confidence remained stable. In Peru, consumers’ confidence dropped to neutral levels due to concerns about inflation. In Argentina and Mexico, tax revenues have been boosted by value added tax. Unemployment has increased in Colombia, signaling a weakening of the labor market, while in Chile it fell, supported by the strong growth of economic activity and employment."
- "Perceptions of global risk are having a negative effect on financial markets, but this depends on the degree of exposure to the global cycle and local factors."
- "There is a positive differential in the currencies of Brazil and Chile, relative stability in the case of Colombia, Peru and Argentina, and a negative differential in the Mexican peso. The prospects for higher growth in the region with respect to other parts of the world have led to stock markets performing relatively better."

BBVA Latin Weekly Observatory 20100903

Which rating agency is the most accurate in forecasting sovereign spreads in emerging markets?

- "Sovereign ratings contain vital information concerning the quality of economic fundamentals. We use the agencies’ vision of risk to determine their ability to forecast sovereign spreads in 28 emerging markets. A number of conclusions may be drawn from this:
• Ratings and risk aversion explain approximately 63% of sovereign spreads. S&P and Fitch are level pegging in terms of effectiveness, closely followed by Moody’s.
• The forecasting power of ratings on spreads coincides in 61% of the cases among our entire sample.
• S&P ratings are the best performers in terms of forecasting spreads in Argentina, Brazil, Colombia, the Dominican Republic and Pakistan, Fitch outperforms its peers concerning Russia and Malaysia, and Moody’s for Mexico."
- "The relevance of the ratings increases when we add co-movements to our models (84% of spreads explained). With contagion:
• The ranking of rating agencies is not disrupted.
• There is convergence in 82% of our sample.
• Fitch ratings are the best performers in determining spreads in Hungary, Poland and Russia. S&P is the most accurate for spreads in Argentina and Pakistan and Moody’s for spreads in Uruguay."

Natixis Flash Economics 419 20100827

Rates View for the 3rdQuarter of 2010

- Rates Macro
- Fed Policy, QE & OMO’s
- Inflation or Deflation?
- Treasury Supply / Demand
- Market Views & Trade Ideas
- MBS Refi Wildcard on Rates
- Japan Rates Review: Is the US a Repeat?
- US Economic Outlook
Nomura US Rates Team Sep2010

Unless ROE targets are reduced, the United States and the euro zone will be in trouble

- "Growth is set to be weaker than before the crisis in the United States and the euro zone, due to private sector deleveraging. If companies in these countries maintain their pre-crisis ROE (return on equity) targets, the only way they will be able to meet these targets is to distort income sharing at the expense of wage earners. Growth will be weakened even further by the sluggishness of household income and the problems they then will meet in terms of deleveraging. It is clearly this perverse dynamics we have witnessed in Japan and Germany since the late 1990s. However, these countries’ economies have been underpinned by exports, which is much less the case in the United States, France, Spain and Italy."

Natixis Flash Economics 418 20100826

Washington Watch: Fiscal Restraint Has a Price

- Federal, state and local budgets are under increased pressure to cut spending. "With the 2010 federal deficit at more than $1.4 trillion or 10% of GDP and federal debt expected to rise to greater than 70% of GDP by 2012, there is clear concern that governments will need to exercise fiscally responsible behavior. Indeed, federal, state and local governments may be forced at some point in time by capital markets to cut spending in order to stem the current imbalance and there are ramifications to various industries that benefit from fiscal largesse."
- Indirect and direct exposures to these potential spending cuts exist. "While direct recipients of directed government dollars are easy to identify, indirect exposure in industries away from infrastructure, defense and health care could lead to more sales compression than investors may be considering. For example, while most investors may think of any reduction in the food stamps program as having only a minimal impact on food retailers, cuts to welfare or social security would create issues for more retailers than is currently acknowledged."
- Health Care and Defense obviously rely on government expenditures. "While most investors are focused on the potential impact on industries such as Health Care and Defense, there are other industries that do not immediately come to mind as being impacted. President Obama demanded that all programs be on the table when he created the Commission on Deficit Reduction. Thus, education, highway funding, scientific research, welfare and many other programs are potentially on the chopping block, which would affect many end markets."
- Headlines may be focused on cuts that may not generate the largest impact. "The news media may focus on items like the attempt to trim $100 billion from the Department of Defense budget over the next five years. Yet there seems to be little consideration that these cuts are more about cutting inefficiencies as opposed to decreasing R&D and weapons procurement budgets, and some of this may already be discounted in defense stock prices."
- Specific companies have meaningful exposures even if the industry does not necessarily. "After polling CIRA’s analysts for US government exposure within their coverage universes, it is clear that some companies have meaningful exposures that are not in-line with the industry average. Companies like PLCM, DELL and XRX within Tech Hardware, CSC within Business IT Services, AMGN in Biotech and OFC jn REITs, have substantive government sales exposure."
- Least appreciated exposures may present even greater risk. "Investors often perceive danger inaccurately by hedging the companies with the exposure considered at risk, while leaving themselves open to hits where the exposures are not as obvious. Hence, some deeper analysis is needed to protect portfolios from any potential government budget axes."


UK Housing: Another leg down

- "There has been further evidence published this week to suggest that the UK housing market is slowing. A number of house price indicators have fallen over recent months, while we have also seen evidence of weaker activity."
- "Real house prices have not fallen as much relative to their 2007 peak as they did in the early 1990s correction. In the initial adjustment they did fall more sharply, but subsequently gained ground to stand ‘only’ around 20% below their highs (they fell by a total of 35% during a period of over six years in the 1990s). However, we think there is further to go in the adjustment, and after remaining broadly static in 2010 we see a 5% nominal decline in 2011."
- "However, with net new lending at exceptionally low levels, our credit impulse analysis suggests that there may be resistance to house prices falling any further without an absolute decline in the level of mortgage debt. This partly explains our forecast for relatively modest price falls next year. While there is a limit to how far nominal house prices might decline, real house prices could well fall for some time thereafter."
- "Also in this week’s Focus Europe, we look back at the latest ECB decisions. As far as liquidity is concerned, there is an underlying keenness for exit in principle, but the ECB will be led by the markets. As far as monetary policy is concerned, rate hikes are not imminent. We see the first hike in mid-2011. In our Euroland Review and Outlook we also present a schedule of fiscal and other policy events through September and October with the potential to create volatility around euro sovereign debt markets. We examine a range of monetary conditions indicators for Poland and find none suggests a need for imminent rate hikes. In our inflation outlook we explore the two key and counter-veiling forces likely to impact on inflation forecasts—declining growth and rising food prices."

DeutscheBank Focus Europe 20100903

JPY: heading for BoJ intervention?

- JPY: heading for BoJ intervention? "Resilience in high yield and commodity currencies took us by surprise as demand for risk staged an early September comeback and US payrolls proved better than feared. However, with the outlook for the US not ceasing to cloud over (services ISM, new manufacturing orders) but Washington mulling tax breaks, demand for AUD and NOK will stay sensitive to incoming US data and broader appetite for risk. The week ahead features central bank meetings at the BoJ, Bank of Canada and RBA. BoJ intervention may prove the only effective ammunition to reverse demand for the JPY, but may be delayed until after September 14. The emergence of cracks in the UK do not spell good news for GBP and confirmation of softening industrial activity next week could see sterling extend one of the worst starts to a month since January. We look for the BoE to stand pat on BR and APF target. Our special note this week discusses the outlook for the JPY and CHF."
- "USD fell against most G10 currencies as risk appetite resurfaced in the lead up to Friday’s non-farm payroll numbers and major equity and commodity markets rallied strongly. GBP continued to lose ground and dropped against every G10 currency. Among the most watched currency pairs, after dropping initially during the week, EUR/USD rallied 1% to 1.2886. GBP/USD recovered to 1.5444 after slumping by 1.3% at one stage to 1.5327, finishing the week down 0.6%. JPY remained firm against USD (+0.9%), GBP and especially EUR against the backdrop of continuing speculation about possible policy intervention by the BoJ, possibly after the September 14 DPJ leadership challenge."
- "UK economic indicators showed significant slowing of activity. While, on the one hand, PMI surveys for manufacturing, services and construction showed a synchronised slowing of activity, on the other hand, the housing market saw the first back-to-back drops in average prices (down 0.9% m/m after falling 0.5% on Nationwide’s index). In the US, the uncertain economic picture got even harder to interpret. The ISM manufacturing index rose from the previous month (56.3 vs 55.5). The most significant release of the weak, Aug non-farm payrolls, came in better than consensus (-54k), but enthusiasm was tempered by a softer non-manufacturing ISM (51.5 vs 54.3 last) and decline in new orders."
- "All major bond markets fell as risk assets posted handsome gains. Benchmark 10-year government bond yields finished the week higher for the UK (+11bp), Germany (+22bp), Japan (12bp) and the US (18bp). The sharp rise may be a reversal from overbought conditions (prices) after yields hit new all-time lows in late August. The major swap curves ended steeper with the 2y/10y spread widening 10bp in the UK, 11bp in the US and 18bp in Germany. The GBP 3mth libor/OIS spread was unchanged at 23bp. The 2014 auction was covered 1.69 times (0.7bp tail). Thames Water issued £300mln of 2030 paper at 250bp over gilts. The FTSE rallied 5.3% to close over the 200d MA at 5,400."

LloydsTSB FX Strategy Weekly 20100903