Fed QE2? Fun for bonds, pain for the buck

- FI Strategizer: "After the last FOMC meeting, 10Y US and Bund yields are almost back to end-August levels. To justify lower yields from here, a worsening growth outlook (unlikely given next week's data), more stress in the EMU periphery, or additional hints on QE would be needed."
- EU Portfolio Strategy: "Hopes for QE2 provided strong support to EGBs this week. The EMU index is up +4.79% YTD and the excess return of our active portfolio is +20bp. It is difficult to find arguments in favor of a trend reversal: we stay moderately long duration."
- MM: "We expect investors to only partially roll over the EUR 93bn coming from expiring 6M and 12M LTROs. Excess liquidity and maturity of ECB operations will likely fall. Expect a moderate increase in MM rates."
- Italian 4Q funding: "We present a detailed analysis of Italian 4Q10 funding. Supply pressure should focus mainly on the short end and the 10Y, while it should be limited at the extra-long end."
- Trade Idea: "We suggest switching from OBL Apr15 into OBL Oct15 given the appealing benchmark roll. Furthermore, on the Spanish curve, the 15Y has cheapened to an interesting level vs. the 10Y and 30Y."
- FI Special: "We discuss how much haircut is discounted in current periphery spreads vs. Bunds."
- Supply Corner: "Next week, there are no redemptions in the EMU. Gross supply should be rather subdued, ca. EUR 9/12.5bn, mainly coming from Italy. The US will issue USD 100bn in Treasuries at the 2Y, 5Y and 7Y."
- Inflation: "The September flash estimate should show an acceleration from 1.6% to 1.8% yoy. The move should be totally energy-driven."
- FX Strategizer: "The FOMC statement, hinting at a possible restart of QE, instilled a negative bias in the US dollar, but selling pressure may be partly mitigated by local risk factors, FX trading should thus stay choppy."
- EUR: "Risks that our long-run target of 1.36 may be reached much sooner than expected are concrete if US data disappoints, but renewed EMU woes, involving primarily Ireland, may still slow the EUR-USD rise."
- JPY: "Risk of aggressive BoJ intervention if USD-JPY retests 83 should discourage heavy USD-JPY sales, even in case of a firm Tankan survey. EUR-JPY still capped above 113-115."
- CHF: "The USD-CHF drop below 0.98 should spill over to EUR-CHF and frustrate any recovery attempt even if EUR-USD remains firm. Selling both USD-CHF and EUR-CHF on a rally is still recommended."
- GBP: "Cable may still benefit from the weak USD towards a 1.5850 test. EUR-GBP should mostly remain capped above 0.85-0.86."
- Pacific Rim: "Commodity currencies should remain favored against the USD, but a partial correction is required before buying them back."
- Nordics: "More consolidation is expected for EUR-SEK between 9.15 and 9.25. EUR-NOK to offer selling opportunities above 7.93-7.95."
- TICS Monitor: "Long-term net inflows to the US amounted to USD 61bn. Last month's appetite for Treasuries & Agencies was reconfirmed."

Treading water before breaking the range

- "Lead indicators lost some momentum over the summer; the ISM has softened and the Euroland PMIs have started to come down from their highs. But arguably the equity market has moved to discount this ahead of the softening. Returns on equities have been on the weak side this year especially in the context of very strong earnings growth; the SXXP is up 5% year to date. We see a number of positives that should help support European equities in 2011:
1. We expect the US growth picture to improve modestly through 2011 and for concerns about a double dip to fade. Our US economists’ forecast 1.5% annualized GDP growth in 1Q2011 but by 4Q2011 they forecast growth of 3.0% annualized. The drivers of growth should also become more sustainable, US growth in 1H2010 was driven by inventories and fiscal policy whereas by end-2011 we expect more private sector demand. This more solid foundation for growth should ultimately stave off
fears of a double dip that have plagued markets for the last two years.
2. Loose monetary conditions: Our US team expects the funds rate to stay in a zero to 25 bp range through year-end 2011, as economic growth averages less than long-term potential rate and inflation continues to recede. They also expect the FOMC to resume unconventional policy easing – most likely by purchasing at least US$1 tn in Treasuries.
3. European economic growth remains robust. Despite the slight moderation in the survey data, the level of growth remains strong and there is evidence that the cycle is moving away from pure dependence on exports; in the last quarterly GDP breakdown, Germany and France saw a strong investment recovery.
4. Equities still provide attractive potential returns as the risk premium embedded in share prices remains high in our view. We expect some of this value to be realized through buybacks, increased dividends and/or M&A. Companies have strong balance sheets and plenty of firepower and increasingly those companies making strategic acquisitions are rewarded.
5. Earnings estimates have been revised up through 2010 and we also expect 2011 to be another strong year for earnings. Global growth on our economists’ forecasts remains high and companies still have catch-up growth to come through from the downturn, capacity utilization is still low in many sectors. We have updated our profit model and forecast 23% earnings growth in 2011 versus 16% for the bottom-up consensus.
- "Given this picture we upgrade – or probably fairer to say roll-on – our 12-month price target for the SXXP to 320 from 300. This would provide 23% price returns on European equities from the current level, 26%-27% including the dividend. We expect this to be driven by strong earnings growth rather than a rerating in the market, as is typical in this phase of a market recovery. It would still leave the market 20% off the highs in mid-2007."

Flow of funds for Q2/CY2010: continued expansion in the private sector’s financial surplus

- Flow of funds for Q2/CY2010: continued expansion in the private sector’s financial surplus
• "Amid the remaining uncertainty about the economic outlook, Japanese firms have continued to favour debt restructuring"
• "Importantly, their appetite for liquid financial assets, i.e. cash and deposits, has remained robust, constraining business fixed investment"
• "Foreign direct investments, such as direct and portfolio investment, have continued to increase and are now 11.5% of total financial assets, the highest level since 3Q08"
• "The financial surplus in the private sector, including households and depository financial institutions, amounted to 46.5 trillion yen (40 trillion yen in Q1/CY2010), well exceeding the government sector’s financial deficit of 34.7 trillion yen"
- Another drop in manufacturers’ capacity utilization
• "Capacity utilization rate among manufacturers dropped for the second consecutive month to the lowest level since last December"
- Demand for Funds Remains Weak
• "Bank lending continued to drop, falling 2.0%yoy in August, reflecting the weak demand for funds among the private corporate sector"

Dovish FOMC puts more downward pressure on the USD

- "The FOMC’s hint that more QE may be coming in November sent the USD into a renewed decline against all the traditionally more risky currencies, with the EUR, AUD and Scandis leading the way. It is hard to oppose this trend short term even though the USD is reaching very cheap levels. The USD made a new historic low against the CHF this week, but it seems likely that more risk positive currencies will perform better next week as a more positive risk tone emerged at the end of the week. The AUD is in focus as parity approaches, but there is better value in the NOK and SEK. GBP should also be a strong performer as EU related payments are expected to push EUR/GBP lower. The US ISM on Friday will be the main data focus, with some chance of a USD recovery both on a weak and a strong number."
- "The USD fell against all of its G10 counterparts after a more dovish Fed FOMC statement and decent global macro data boosted demand for high yielders and commodity currencies. Along with the NOK and AUD, the SEK and EUR were the best performers, logging gains of between 2% and 3.5% vs the greenback. Sterling strengthened vs the CAD and USD but dropped 2.3% vs the EUR. GBP has now dropped 3.3% since the start of the month and now trades at levels last seen right after the general election in May (0.8550). The BoJ declined to comment whether it intervened but a spike up to 85.30 in USD/JPY on Friday left little to the imagination. Chinese premier Wen met with US president Obama but resisted pressure on country’s slow progress on strengthening the yuan."
- "The FOMC kept policy unchanged but subtle shifts in the accompanying statement revealed greater concern over the present suboptimal level of inflation, giving the market fresh ammunition to believe that a new and potentially more far reaching asset purchase initiative is unavoidable. UK data were fairly thin on the ground, with lower house prices and falls in mortgage lending underlining the soft path in housing market activity. The public finances showed a marked £15.3bln rise in August borrowing as a result of higher interest payments. The MPC minutes revealed no change and showed member Sentance repeating his preference for an immediate rise in Bank rate."
- "Core bonds staged a turnaround from last week with the FOMC statement triggering a buying spree in the long end, resulting in flatter 2y/10y and 10y/30y yield curves. Failing to establish a foothold near one-moth highs, yields and swaps plunged on Wednesday on speculation of Fed easing down the road. Profit taking in risk assets and record spreads for Ireland and Portugal over bunds also stirred demand for G3 paper. 5y swaps closed below 2.10%, having traded as high as 2.29% on Monday. The 2y/10y swap curve flattened back below 180bp. The 3mth libor/Ois spread held steady at 23bp. Telefonica issued £400mln 2029 at 170bp and GdF sold £700mln of 2060 at 115bp over. Coventry Building Society and GE Capital also issued £400mln in 2022 and 2017 maturities."