Standards and transition period determined

- Regulatory minimums — "The minimum capital standards announced by the BCBS on September 12 were 4.5% for Core Tier I capital, 6% for Tier I capital, and 8% for overall capital adequacy."
- Capital buffers — "Banks will be required to secure a 2.5% capital preservation buffer (via common stock) by 2019. In addition, they will be required to amass a buffer of up to 2.5% during periods when the economy is overheating (lossabsorbing capital is acceptable)."
- Transition period — "The new capital adequacy regulations will be introduced in stages. In stage one, minimum capital adequacy ratios will be phased in (the Core Tier I ratio will be 3.5% in 2013 and 4.5% in 2015). The capital preservation buffer will be introduced in the second stage (0.625% in 2016,
2.5% in 2019)."
- Existing preferred securities — "Banks will lose the right to count capital that does not meet new stricter standards as Tier I capital in 10ppt increments from 2013 (with the full amount removed from Tier Ih capital by 2023)."
- Leverage ratio — "A monitoring period will run from 2011 to 2013, followed by a trial period until 2017. Full-scale introduction will come in 2018. The minimum leverage ratio (Tier I capital in the numerator) will be 3%."
- Liquidity coverage ratio — "The Liquidity Coverage Ratio (LCR) will be introduced in 2015 and the Net Stable Funding Ratio (NSFR) will be introduced in 2018. The minimum for both will be 100%."

Separate ways

- "We identify the magnitude of the shock to global GDP that would derail the capex and labor market recovery in the eurozone. A 1pp slowdown in global growth vs. our baseline scenario would induce a shallow capex recession in 1H 2011, with employment managing to hold up in slightly positive territory next year. Global GDP would need to be around 3pp weaker than expected to trigger a significant capex recession and a double-dip in the labor market, a scenario that we deem as quite unlikely."
- "As worries about decoupling within the eurozone are increasing, a crucial issue is whether the investment upswing will be widespread within the area. From a cyclical point of view, one of the drivers of investment is capacity utilization. In this regard, Germany seems ready to benefit from a genuine pick-up in investment spending, while for Italy, Spain and Greece the picture is less supportive. Hence, now that global demand is moderating, only the most competitive countries will be the ones where the investment recovery will continue to support economic growth."
- "A sustainable revival in French domestic demand is probably the “swing factor” to determine whether the current growth divergence across the area will be long-lasting. Our analysis suggests that the legacy from the financial crisis should not meaningfully alter the historical pattern that sees shallower recessions in France being followed by more sluggish recoveries than in Germany."
- "The easing in eurozone core inflation has come to a halt during the summer, but we are still convinced that another leg of core disinflation remains the most likely outcome. We also show that the recent spike in food commodity prices poses some upside risks to our food CPI projections in three-to-six month’s time."
- "We argue that a large divergence in the GDP performance across the area and pockets of weakness in the banking sector of some peripheral countries increase the chances that the ECB will have to raise the refi rate before fully exiting unlimited liquidity provisions, tightening collateral rules and discontinuing the govies purchase program."
- "Although UK inflation remains surprisingly sticky so far, the BoE’s projections in the August Inflation Report brought a downward revision in the growth outlook and envisage a steep downward trajectory for CPI. Against this backdrop, the BoE is very likely to remain on hold for longer than previously expected: we now see the first rate hike in 4Q 2011."
- FI: "Given our outlook for steady policy rates, 2Y yields in EMU, the US and the UK should trade around the current levels until end-1Q 2011. Subdued growth and low inflation should keep demand for long-term maturities healthy, especially for top rated issuers. The belly of the curve has performed quite well in 3Q, but the 2/5-year spread still offers value for yield hunters. Core-periphery spreads to stay volatile in 4Q."
- FX: "Resuming EMU worries may keep EUR-USD in an overall tight trading range throughout the autumn, but persisting global uncertainty will keep volatility high and prevent the formation of clear trends on major FX rates. Currency markets will remain a playground for big-wave surfers rather than for free-climbers in the next few quarters as well."

Income solutions via equity & credit

- The investment world has a problem: it needs income "European pension funds require a return on assets of roughly 6-8%, safety doesn’t pay much in a backdrop where growth is slower and rates are lower. In the UK pension funds went from 82% in equities in 1990s to 47% today. UK bonds picked up the slack and their weight has quadrupled. But the real yield in the UK and Europe is less than 2%. The solution: corporates are a good home for income - let the battle between Equity and Credit commence."
- An equity strategist’s view: the equity de-rating has gone too far "The real yield gap between government bonds and equities is at a 25-year high (favouring equities). The 12-month forward dividend yield of 4% is above its 30 year average of 3%. Dividends are the performance enhancer in a slow growth environment with range bound markets. We see upside in markets and are not worried about dividend cuts (chart 18)."
- A credit strategist’s view: the equity de-rating could continue "The de-rating of equities will continue given demographic issues and volatility. Credit provides an excellent “middle ground” for income seekers. In particular, BB/B offers income, stability, and upside potential as strategic M&A rise."
- Solutions: in equities, credit and across asset classes "Equities: dividends as a return enhancer for growth & big dividend payers (pg 18). Credit: Risk/Reward opportunities within BB/B bonds (pg 21) Cross Asset Baskets: where we prefer equity to bond and vice-versa (pg 27). Below is our list of a cross-asset preference for equities."

Richard Koo: fiscal stimulus remains essential

- Globalized economies, localized politics
- Extreme economic pessimism has diminished
- Even monetary authorities lack confidence in US economy
- Is recession really attributable to Obama reforms?
- US monetary authorities admit they cannot rule out balance sheet recession
- Two concerns of people who understand that US is in balance sheet recession
- US politics characterized by growing polarization and obstruction tactics
- Obama has proposed second round of fiscal stimulus
- Little chance of new measures becoming law immediately
- Banks in some parts of US are easing lending posture
- Significance of IMF’s support for fiscal stimulus
- Change in stance by IMF and UNCTAD may prevent double-dip recession
- DPJ leadership election debates laid foundation for fiscal stimulus in Japan
- Lessons of the failed social experiment called Incubator Bank of Japan
- Incubator Bank of Japan’s creation also tied to bashing of BOJ and Japanese banks
- Will cap on deposit insurance really be a plus for Japan’s economy?
- Limits to what banks can achieve in a balance sheet recession

Intervention and regulation

- Market Movers ahead 
• "In the US, the FOMC meeting is expected to largely maintain the status quo. The economy has not worsened enough for additional quantitative easing (QE)."
• "In Europe, PMIs and the German Ifo are poised to disappoint, suggesting growth is now easing."
• "In Asia, attention will be on possible further intervention from Japan. Japan could face criticism when global leaders gather for the UN meeting in New York."
• "We expect Norges Bank to keep interest rates unchanged at this week‟s meeting, but suspect the statement will be a bit more hawkish."
- Global update 
• "Japan intervened for the first time since 2004 and has so far been successful in stemming the appreciation of the yen." 
• "The Basel III proposal has eased fears that it forced banks to rush to raise capital and weigh on the global recovery." 
• "Encouraging data in the US and China ease fears of a double dip." 
• "However, data from Europe have been disappointing suggesting that growth is now slowing."
- Focus 
• "In the first Focus article, we look at leading indicators ability to predict G10 exchange rate movements. Our conclusion is that to some degree they can." 
• "In the second Focus article, we look closer at the sustainability of public finances in the US. Our conclusion is that fiscal tightening is needed but at this stage it is not urgent."

Ireland: great complexity

- "Ireland’s issues remain large and complex. Its economic, fiscal and financial sector problems are interconnected and considerable. Irish GDP is more than 10% below its peak in real terms and closer to 20% in nominal terms; this year, the Irish core government deficit is likely to be 12% of GDP, general government debt has risen by 60% of GDP since 2007; in addition, the balance sheet of its troubled banking sector is almost five times the size of annual GDP."
- "Although the recent widening in Irish government bond spreads appears to be related to issues in the financial sector, it is worth remembering that Ireland’s financial, fiscal and economic problems are interrelated."
- "The process of transferring troubled assets from banks’ balance sheets to the NAMA bad bank has revealed that the quality of those assets is far worse than expected – haircuts have been around 50% compared to expectations of much smaller discounts when the scheme was announced. And the government’s actual and contingent liabilities from the banking sector are considerable."
- "A large government deficit, combined with capital injections into the banks, means Irish government debt is likely to peak above 100% of GDP. If the government guaranteed NAMA bonds were also counted as government debt – they’re backed by assets, so it’s doubtful as to whether they should – then that number would be closer to 130% of GDP."
- "So markets are right to be concerned about Ireland. But there are several positive points that shouldn’t be disregarded. The process of deficit consolidation is well on track: the deficit has already started to fall. And the government’s strong political determination to reduce the deficit should once again be apparent in the budget later this year."
- "Ireland is also in an extremely strong financing position. This year’s funding needs have almost all been met. We estimate next year’s financing needs to be a manageable €30bn (18% of GDP). That’s especially the case as we think the Irish government holds over €20bn in cash, providing a considerable buffer if market conditions become problematic."
- "And perhaps more importantly, recovery is underway. Ireland is particularly sensitive to trade outside the euro area, so the euro’s recent decline, boosted by falling prices in Ireland, has led to a sharp improvement in competitiveness. That’s having an effect – industrial production is already back above its pre-recession peak."
- "Ireland’s problems are considerable, and will likely remain so for some time. But, so far, the government and the economy seem to be doing reasonably well at coping with and addressing them."

Fading Operational Leverage

- Sluggish Global Economic Recovery — "The global economic recovery continues to disappoint. Lead indicators are softer and economists are lowering expectations."
- Sharp Global Profits Recovery — "But the profits recovery has been sharp. Analysts have upgraded forecasts as many underestimated the rebound in revenues and the effects of operational leverage."
- High Margins — "We expect profit margins to be approaching peak levels over the next 2 years. Continued cost control suggests they are sustainable even as the economic backdrop is sluggish."
- Accretion Kicks In — "Operational leverage will fade as we progress through the cycle. But EPS accretion should kick in. We expect many companies to retire expensive equity with cheap credit."
- Stock Analysts Closer Than The Market — "We forecast global non-financial EPS growth of 12% in 2011 and 9% in 2012. While analysts’ estimates seem too high, they are closer to our forecasts than the market appears to be pricing in. We believe analysts need to cut expectations a little, the market needs to raise them."

Ireland – the sovereign implications of the banking crisis

- "A very costly bank restructuring process (amounting to 24-31% of GDP) and concerns about the impact of weak macroeconomic conditions on banks’ battered loan portfolios are unsettling the Irish bond markets. While the Irish treasury does not have immediate liquidity needs, the colossal fiscal effort which will be required to stabilise the public debt over the medium term leaves little fiscal space to deal with any further unexpected financial sector losses – this is a source of market instability."
- "In our view, the resolution of Anglo Irish Bank, by splitting it into a funding bank and an asset recovery bank, is essentially equivalent to a wind up of the bank in ‘slow motion’. Over the medium term, the remaining assets of Anglo Irish Bank will have to be sold, disposed of or liquidated to repay the bank’s liabilities. Further injections of public funds into Anglo Irish Bank cannot be discounted (so far, the government has pumped a total of €25bn into the bank)."
- "At this juncture, given the comfortable near-term liquidity position of the Irish treasury, we argue that the government does not need to draw on financial assistance from the EU-IMF – at least not yet. Yet should further unexpected financial sector losses materialise or macroeconomic conditions deteriorate beyond our baseline forecasts in the coming months, the government may need to seek outside help. On the IMF side, the “enhanced” Flexible Credit Line facility recently approved by their Executive Board could provide a suitable funding vehicle should this be required by the Irish government, in our view."

JPY intervention starts as we expected

- "MOF intervened unilaterally in the forex market today by selling JPY, likely triggered by the governments motivation to defend the 80 line. The decision was also likely motivated by the excessive nature of JPY appreciation in light of US stock market and interest rate trends, and by domestic political conditions following the DPJ leadership election. Although the intervention was unilateral, we think it was probably unsterilized (i.e., that the BOJ is unlikely to try to mop up the liquidity created). Judging by reports that MOF sold some ¥1.5tn of JPY today, we estimate that by the time their intervention is finished it could have sold ¥10–20tn."
- "Based on the impact of previous intervention and the current level of US interest rates, we estimate that USD/JPY could rebound to 85–87 in the near term. However, forex market trends are largely determined by USD weakness against all major currencies, which reflects the poor fundamentals of the US economy. Judging from past interventions, such JPY selling can only prop up the USD for one to two months, thereafter developments will once again depend on US fundamentals. We are therefore maintaining our forecast for USD/JPY at 82.5 by year-end 2010 and 80.0 by end-March 2011."

Impact of JPY intervention on the rest of Asia

- "Confirmation that the Japanese authorities have intervened in USD/JPY (the first intervention since March 2004) marginally weakens the short USD/Asia story, in our view. Asian central banks may view Japan’s intervention as an additional reason to resist local FX appreciation, despite increased global political pressure to move (namely on China and to some extent Korea ahead of the G20 summit of 11-12 November). However, we do not believe the Asia ex-Japan authorities can argue on the same fundamental basis as Japan given the large recent divergences in broad economic performance, exports, equity markets and FX valuation. In this respect, we think that the impact of JPY intervention could be important, but not decisively for Asian FX. This may, for example, support reducing our short USD/CNY trade (as it reduces our conviction in that trade from 75% to say 65%). However, we do not think that it markedly alters the core story (see FX Insights: China Visit Notes, 1 September 2010).1 Likewise, it reduces our conviction on our short EUR/KRW trade to perhaps <60% from 65% previously (See FX Insights: Recommend adding a short EUR/KRW trade, 6 September 2010)."

Why could the internationalization of RMB and its non convertibility make Hong Kong a RMB offshore center?

- "Chinese currency is wanted to be internationalized in long term horizon. However, it will remain unconvertible for a long time. The key solution in this context is to develop a RMB offshore center as intermediate step. The need of such a center could be also pragmatic in short and medium term. Hong Kong would be the natural candidate. Deeper RMB businesses will be developed quickly in Hong Kong in response to Chinese RMB internationalization promotion program."

Can the global economy grow only with very expansionary monetary and fiscal policies?

- "We fear that the nature of economic cycles has changed significantly. In the past, they were linked to the appearance of inflation and restrictive monetary policies at the end of the growth period. At present, it seems that growth exists only when all economic policies are very expansionary, and that the return to "normal" policies triggers a recession. Could the world experience growth only as a result of abnormally expansionary economic policies, with a high level of indebtedness and a subsequent increase in private savings?"

Keeping a Modest Overweight

- Long double-dip risk — "In August, markets responded negatively to the slide in the US data. Yet our economists continue to believe that double dip concerns are overstated. Near-term European peripheral liquidity fears also seem overdone."
- Keeping a modest overweight — "Investors show strong appetite for risk. However, risks remain from the sheer size of the pipeline, elevated sovereign spreads, and potential downward 3Q earnings revisions. With these in mind, stay only modestly overweight."
- Bonds over CDS — "Bonds are the cheapest they have been to CDS since January. While CDS spreads are priced to perfection, cash still has a lot of catching up to do. We favor index and single-name CDS hedges."
- BBBs yet again — "Resurfacing of M&A activity argues in favor of buying cheap lower-rated non-financials with healthy balance sheets, which could become attractive acquisition targets."
- TruPS — "Comerica and City National called their hybrids, justifying our preference for yieldy TruPS - especially those trading at a discount."
- Premium bonds — "Not only do they trade cheap to low-dollar bonds, but also could be taken out in favor of issuing low-coupon debt."

Why is the variability of growth in China too high?

- "Chinese growth is highly variable, with a quick succession of periods of sharp growth and periods of pronounced economic slowdown."
- "We believe this is explained by the excessively low weight of consumption, which is not very cyclical, compared with the (highly variable) cyclical demand components: investment (especially in construction), exports, etc."
- "The following would therefore be needed in China:
• a less brutal management of monetary policy (of lending conditions);• accelerating the government programme aimed at supporting wage earners and boosting consumption."
- "The worrying point is that - for the time being - Chinese growth becomes insufficient when credit no longer finances speculative investments."

FX: Risk on, risk off, risk on, risk off.../Rates and yields: strong rand pushes down South African yields

- FX: Risk on, risk off, risk on, risk off... "Emerging Markets FX markets have been relatively directionless the over the past week, with about half of the EM currencies that we cover appreciating against EUR and USD and the other half depreciating. The overall theme has no doubt been whether the G3 economies are heading for a double-dip or whether the global recovery will continue. Lacking a decisive answer to this key question, the EM FX markets have mostly drifted sideways."
- Rates and yields: strong rand pushes down South African yields "It has also been remarkably calm in the EM fixed income markets. The most interesting “story” has certainly been the decline in South African yields, which have been driven down by the continued strengthening of the rand. That said, we do not see much potential for South African yields to fall further."

Risk management in agriculture: Towards market solutions in the EU

- "Volatility in agriculture is expected to increase – production volatility, mostly driven by climate change as well as price volatility, due to higher production volatility, a tight supply/demand balance, volatile energy prices, and other factors."
- "The responsibility to manage risks is increasingly in farmers’ hands. The EU’s Common Agricultural Policy is undergoing major reform towards greater market orientation. Tighter budgets as well as environmental and trade consider-ations have led to the reduction of market interventions. The post-2013 CAP is currently being discussed along those lines."
- "Agricultural producers will need to rely more heavily on market-based tools. We investigated the main risk management tools available for EU farmers pre-dominantly in the light of their effectiveness to stabilise their income – also taking into account, wherever possible, their impact on the environment and their effect on food security. EU farmers will benefit from a growing variety of private risk management tools in the future. Most likely, they will increasingly use financial derivatives and insurance products."
- "The derivatives market is still limited in Europe but developing, and the potential is significant. Public support may encourage the use of derivatives to cope with price volatility by promoting training on these products, ensuring availability of information and ensuring judicious regulation: this will be essential so that commodity derivatives keep serving their purpose of price discovery and hedging."
- "The insurance market is also expected to develop, to cope with production risk and mitigate financial risk. The current insurance level in the EU is generally insufficient to smooth major income reductions in bad years."
- "For the sake of environmental sustainability, thus long-term food security, it is important to reward farmers for delivering public goods: biodiversity, water quality and availability, air quality, soil functionality, climate stability, etc. Key to shifting to a more sustainable agriculture (until other actions are taken to price these externalities), payments for the provision of public goods can also contribute to stabilising farmers’ income."
- "All in all, public policy could be most useful in increasing the risk management ability of farmers. Any extension of the public safety net will reduce the incentives for farmers and other agents along the food supply chain to manage their risks effectively through derivatives, private insurance or on-farm strategies like production diversification. Policies need to empower farmers to take their own risk management decisions and to have access to a diversity of instruments and strategies. More direct interventions are likely better kept as a means of last resort and restricted to measures which do not act at the expense of the rest of the world or of environmental sustainability."