Italy: Public finances on track

- "After the solid performance in 1H 2010, we have revised slightly up our GDP growth call from 0.9% to 1.0% in 2010, and from 1.0% to 1.1% in 2011. However, our outlook envisaging a moderation of growth in the second half of this year remains safely in place."
- "Data on the labor market remain mixed and do not suggest that a genuine turning point has been reached yet. The unemployment rate seems close to peak, but recent dynamics of inactive people and labor force are less encouraging."
- "Even taking into account the statistical discontinuities introduced in June by the Bank of Italy, bank lending to households and non-financial corporations recorded a further improvement in recent months, confirming that the credit recovery is proceeding on the expected path."
- "After the remarkable surge in July, Italy’s CPI inflation edged down mildly in August to 1.6% yoy. The core inflation differential vs. the eurozone has widened over the past year. Producer prices accelerated further but surveys suggest that some moderation might lie ahead."
- "In the Focus section we analyze the details of the budgetary correction that had been unveiled in May and that was approved by the Parliament during the summer. The commitment on expenditure-cutting measures is encouraging, but implementation risks call for close monitoring ahead."

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."

FX for surfing, FI for diving

- FI Strategizer: Stable policy rates and slowing growth momentum should prove beneficial for long-term yields, especially AAAs. The belly of the curve performed well in 3Q, but the 2/5-year spread still offers value for yield hunters. Spreads within the eurozone should stay volatile in 4Q.
- EU Portfolio Strategy: Over the next several quarters, we face a global fiscal policy tightening (reversed German reunification) which calls for a modest long duration, adding to the active deviation if 10Y Bunds rise by another 25bp. Country wise, we continue to favor BTPs within periphery. We also take a prudent stance on France.
- Money Market: Demand for liquidity at the ECB refinancing operations has stabilized in recent months, although at regional level we still observe high reliance on ECB funding. Full allotment should stay in place until 2Q11, contributing to smoothing the path of MM rates in EMU.
- Inflation: As we had pointed out last quarter, EMU BE proved a good opportunity in 3Q. Now we are back to more “average” and unattractive levels. In 4Q we expect inflation to remain subdued, recent ECB remarks on upside risks are the only factor that may provide further support.
- Supply Corner: 4Q will be the least liquid quarter of the year, with just EUR 82bn in redemptions and EUR 30bn in coupons. We expect gross supply in 4Q to be EUR 165-180bn, with risks skewed to the downside. Net supply should be EUR 80-95bn, up from EUR 25bn in 3Q.
- FX Strategizer: Global uncertainty is still on and investors will continue to frequently change their mind due to opposing and temporary short-term drivers. The FX market remains more interesting for big-wave surfers than for free-climbers.
- EUR: EUR-USD will reflect again global and local risk factors (US growth fears vs. EMU woes), staying mostly trendless throughout 2H11. More strength will occur in late 2011, when the ECB starts hiking rates.
- JPY: BoJ intervention managed to stem JPY appreciation, but USD-JPY reversal is unlikely to exceed 90-95 in the medium term. In turn, EUR-JPY should progressively pull back above 125 by the end of 2011.
- CHF: SNB sounded more dovish on growth and inflation, but this will not prevent EUR-CHF to slide again below 1.30 if risk aversion persists. The 2011 outlook still points to a consolidation back towards 1.35.
- GBP: Cable may suffer again and a rally above 1.60 can be penciled in only in late 2H11, when we now expect the BoE to start a rate hike cycle. EUR-GBP should again remain mostly stuck within the 0.80-0.85 band.
- Commodity Currencies: The recent rally of the three dollars should be reverted if risk aversion escalates. More AUD, NZD and CAD strength should occur in 2011 in case of a relaxation of the global picture.
- Nordics: More EUR-SEK and EUR-NOK weakness is in the pipeline, but more attacks & retreats can be expected along their appreciation path.
- FX Special: Risk aversion has clearly enhanced the role of safe-haven currencies, but our dedicated special demonstrates that the yen tends to outperform the CHF and the greenback in this role.

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."

Central banks – slow motion exit

- Central banks. "The global economy is losing momentum, while worldwide growth risks are on the rise. This benefits not only safe-haven investments like gold and government bonds but also money market rates, which will stay extremely low for an extended period. It will likely be late 2011 or early 2012 before major central banks start hiking rates, while the exit from the ultra-expansive liquidity policy is being pushed back."
- US. "Here, it is primarily the growth risks, i.e. the fear of a double-dip recession, that prompted the Fed to adopt a more cautious stance when it announced that it would reinvest all the proceeds from maturing and prepaid agency debt and MBS in longer-term Treasuries."
- Fed. "The US central bank has, therefore, not only abandoned its slight tightening bias but also opened the door again to additional quantitative easing measures. Things should not, however, go that far: Additional purchases of Treasury securities would lower the yield level only marginally. Moreover, the transmission channels of lower interest rates to the real economy are already clogged (pages 6-9)."
- EMU. "Here, it is still the ongoing sovereign debt crisis, the again surfacing concerns about the solidity of banks, and the strong real economic divergence that are making the central bank more cautious."
- ECB. "As a result, the European Central Bank will not be able to forge ahead, as planned, with its exit strategy, which would even not have to be completed before the first rate hike, not expected before the end of next year (pages 10-12)."

Credit Markets in 4D: Double-dip & debt-deflation?

- "To clarify one thing right at the start: neither a (global) double-dip recession nor a debtdeflation process is our base-case scenario. The most likely path is one of sluggish growth, a scenario that would be – at least in theory – preferable for credits. Nevertheless, there are plenty of signs that the tremendous recovery is coming to an end. Hence, with a slowdown of economic activity ahead, investors will ask themselves “where will the slowdown stop – above or below the zero line”? It is this discussion in a fragile environment that we are concerned about, as investors do not wait to discount an adverse scenario until it really unfolds. Moreover, developments over the last couple of years have shown that investors do not necessarily have to be the “follower” of economic developments, they can be the “leader”. An adverse economic development can be triggered by an erosion of confidence in financial markets. The problem is that – in particular in the European periphery – governments lack the financial flexibility to weather another storm. Investors should not forget that the major ingredients for a Great Depression-like scenario were “too much debt” and “deflation” – two factors that are also hanging like a Damocles Sword above us in the current scenario."
- Macro Outlook: "Reducing macroeconomic disequilibria in the eurozone implies the need for significant internal devaluation: Lessons from the Baltic countries, which are undergoing a similar problem, suggest huge challenges for the economies."
- Micro Fundamentals: "With government yields at record lows and piles of cash on corporate balance sheets, the question is whether a new M&A boom is imminent. We take a look at leverage of European corporate bond issuers to gain more insight."
- Debt-Equity-Linkage: "M&A activity and the loan market are two sides of the same coin. As M&A activity remains subdued so does loan origination."
- Credit Quality Trend: "The default rate forecast is driving spreads, but what is driving the forecast? Is it really highly sophisticated economic forecast models?"
- Market Technicals: "Loan origination volumes grew rapidly before the crisis and collapsed afterwards, partly due to the turmoil in the CLO market."
- Valuation & Timing: "Our fundamental concerns are more on a mid-term horizon. But on a short-term perspective, investors' focus on eurozone periphery sovereign debt, the 3Q earnings season and the outlook for 2011 could present catalysts for a more pronounced spread widening in the coming weeks."

- Other Credit Markets: Derivatives: "The rapid growth in credit derivatives over the last few years enlarged the spectrum of hedging possibilities also in EEMEA credits, albeit the market is still small and in most cases illiquid. Securitization: Update on European and US housing market. EEMEA Credits: Two-speed recovery also bears some deflationary risks."

- Allocation: "We leave our defensive credit portfolio allocation unchanged."

- Model Portfolio: "Our financials portfolio outperformed the benchmark by 9bp, while the non-financials portfolio outperformed by 6bp."

Still swings in mood next week

- FI Strategizer: "A clear trend for USTs is unlikely to emerge given the light calendar and a cautious investor stance ahead of the September 21 FOMC meeting. In the EMU, the Greek T-bill auction and news on Irish banks should be the main drivers putting pressure on periphery spreads."

- EU Portfolio Strategy: "Just as the double-dip discussion lost steam, another round of credibility erosion moved center stage, although a clear Bund yield rally did not emerge. We return to a modest long duration stance to benefit from renewed uncertainty."

- MM: "Excess liquidity has stabilized in the EMU as shown by the recent 1W and 1M auctions. Portuguese and Greek data show that borrowing at the ECB has not eased in August after the stress test results."

- Trade Idea (I): "The Portuguese curve has cheapened vs. swap at the 15Y and offers an interesting switch with Ireland. Our Z-score system also suggests switching from the BTP Apr15 into the SPGB Apr15."

- Trade Idea (II): "The 10/30Y spread in the UK trades close to all-time highs and has recently started to tighten. We expect the recent trend to gain momentum, also thanks to a slowing in inflation."

- Supply Corner: "There is no liquidity next week, while gross supply should be EUR 25/30bn, with almost an auction per day. 68% will come from core countries, the remaining will come from Italy and Spain. Keep an eye on Tuesday's Greek T-Bill auction (EUR 0.9bn of 26W T-bills)."

- FX Strategizer: "Safe-haven currencies (i.e., JPY, CHF & USD) should remain favored as long as global uncertainty persists. Next week's data are unlikely to cause direction-setting impulses, but large swings should prevail in the medium term too, preventing the formation of clear trends."

- EUR: "We do not expect heavy EUR-USD losses over the next couple of weeks, but we don’t rule out a retest of 1.25-1.20 in the coming months, if EMU worries escalate. A recovery up to 1.30-1.35 may occur only in late 2011, when the ECB starts its tightening process."

- JPY: "The JPY should stay strong and BoJ intervention, if any, may at best contain its rise. A weaker JPY may occur only from 2Q11 onwards, if risk appetite resumes, but USD-JPY is unlikely to rally above 90-95."

- CHF: "The SNB meeting on Thursday will be a crucial test, but we won’t be surprised if EUR-CHF slides to 1.27-1.25 before December. This will limit the room for a pullback in 2H11 that won’t exceed 1.30-1.35."

- GBP: "Cable should be dragged down towards 1.52-1.50 if risk aversion persists and we don’t see great upside potential towards 1.60 before the end of 2011. EUR-GBP should stay locked within the 0.80-0.85 band."

- Pacific Rim: "The three dollars shrugged off risk aversion, but we would handle their strength with care. A more sustained rally may resume in 2H11, when interest rate spreads may offer stronger support in the wake of a less uncertain global scenario and a weaker JPY."

- Nordics: "EUR-SEK and EUR-NOK will fall towards 9.15-9.10 and 7.65-7.60, respectively, but attacks and retreats will remain the theme. Book squaring may weigh on the SEK ahead of the September 19 elections."

The global economy is losing steam

- Setback. "Our picture of a W-shaped economic recovery after the Great Recession appears to be materializing. The expiration of the fiscal packages running into the billions and the reversal of the inventory cycle are now increasingly slowing the pace of global growth. Consideration is being given to new stimulus programs, first and foremost in the US."
- US. "The slowdown there started as far back as this spring and will, moreover, be more pronounced than originally anticipated. There is the growing fear that the economy will slide back into recession. We would not go that far, but we are making a downward revision to our growth expectations for 2010/11 (pages 4-7)."
- Fed. "It is not only the US administration that intends to stimulate again. The central bank has announced its intention to prevent a further shrinking of its balance sheet. Consequently, we do not expect the first rate hike until the beginning of 2012."
- EMU. "The European economy is holding up pretty well. This appears to confirm what ECB economists discovered as far back as 2009: The US cycle is feeding through to Europe less strongly and above all later than in former years. But here too, the slowdown is inevitable. The rapid pace of growth reported this spring cannot be maintained. For 2010/11, we expect GDP growth of 1.6% and 1.3%, respectively (pages 8-9)."
- ECB. "A slide back into recession is, however, improbable, with the result that the central bank could really lean back and continue its exit from the ultra-expansive monetary policy – were it not for the resurfacing concerns about the solidity of European banks and the rapid sovereign bond spread widening (cf. Weekly Comment, pages 2-3)."

Gold heading towards USD 1,600

- "The Fed's decision to reinvest the proceeds from maturing and prepaid agency debt and MBS in longer-term Treasuries and to continue rolling over its holdings of Treasury securities as they mature has eliminated the slight tightening bias of US monetary policy."

- "Thus far, it is not yet clear whether this will now also result in a lengthening of the Fed balance sheet. In the past, however, the gold market reacted extremely positively to a monetization of government debt."

- "In the second quarter of 2010, demand for gold measured in tons increased by 34% yoy. On a USD basis, a new record was even posted for the quarter. The reason for this is the surge in investor demand triggered by the Fed decision and the renewed widening of CDS spreads in Europe."

- "In the interim, a growing number of Chinese investors is also discovering the gold market. Although China has advanced in recent years to become the world’s largest gold producer, its annual production of most recently 330 tons is by no means sufficient to satisfy this demand."

- "Hence, China announced key gold market reforms at the beginning of August. Foreign companies are now permitted to offer their gold coins at the Shanghai Exchange, and more banks are permitted to import gold from abroad. The Chinese demand will now increasingly be felt on the global markets."

- "We are, therefore, raising our target price for 2011 from USD 1,250 to USD 1,400 per troy ounce. For 2012, we now expect USD 1,600 per troy ounce (in each case calendar year averages)."

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

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

Scary Movie Reloaded

- FI Strategizer: "Next week, the US data calendar will likely reinforce evidence of a softening economy. As the bad news should already be priced in, scope for another sizeable rally looks limited. If anything, after the strong rally, investors may look to take profits. With the economic outlook still weak, we would regard profit-taking as a buy opportunity."
- ECB: "The GDP projection will likely be upped significantly this year but left largely unchanged in 2011, and the picture of tame inflation is likely to be confirmed. On the liquidity front, we expect the ECB to announce more 3M LTROs and leave the full allotment in place at least until 1Q11."
- EU Portfolio Strategy: "Given the bond-friendly newsflow and the attractive carry and roll impulse within the EGB curve, we keep our active duration at +0.5 years. Cross-country, we reduce France and Germany in favor of Belgium and we cut Ireland to zero after the S&P downgrade."
- MM: "Moderate demand at recent ECB auctions suggests that tensions are limited to few players and countries. OIS forwards and Euribor futures rates have dropped dramatically in the last weeks but we do not see strong reasons for a retracement in the near term."
- Supply Corner: "Next week, there are no redemptions in the EMU. EUR 16/20bn of supply from Italy, France and Spain will be scattered along the curve. Italy will sell EUR 4/5bn of the new BTP 3.75 Mar21."
- Inflation: "We see August inflation slowing from 1.7% to 1.6%, with risks tilted to the downside. The move should be fully energy-driven."
- FX Strategizer: "Risk aversion is the name of the game again on FX majors: this should keep demand high for safe-haven units like the JPY, the CHF and, to a lesser extent, the USD."
- FX Special: "Direct actions by central banks in the currency markets are a key theme again in the wake of the sharp JPY and CHF rise. We examine rationales behind FX intervention in a dedicated focus."
- TICS: "Net long-term inflows into the US amounted to a still subdued USD 44bn in June, following USD 35bn in inflows in May. An in-depth analysis of US portfolio flows can be found in our monthly Monitor."
- EUR: "The EUR-USD picture has worsened in recent weeks, but for now this pair may only crumble like a cookie and not drop like a stone. An early test of our 3Q10 target of 1.24 thus seems unlikely next week."
- JPY & CHF: "The near-term outlook for both USD-JPY and EUR-CHF will strongly depend on the response of the BoJ and the SNB, which may prevent a rapid test of new lows towards 80 and 1.27, respectively."
- GBP: "The outlook for sterling has become less bright as well: cable may re-test 1.50 in the near future, while EUR-GBP should further struggle trendless between 0.81-0.83, favoring short strangle there."
- Pacific Rim & CAD: "Both the AUD and the NZD should struggle further between 0.87-0.91 and 0.68-0.72. The CAD may get some help from another USD fall or on signals that the BoC will hike rates again."
- Nordics: "A new 25bp rate hike to 0.75% by the Riksbank next Thursday should not be taken as a given, as markets consensus suggests: a no move, as we expect, may thus frustrate NOK-SEK bears much further."

Unicredit Curves & Crosses 20100827

Out of office: Gone to the beach!

- "The summer holiday season is upon us and many investors will recover from peripheryrelated stress on periphery beaches. Chances are good that during this summer investors can safely enjoy some relaxing days without being concerned about short-term risks too much. Major sources of potential headline risks – the stress test and the 2Q10 earnings season – are already behind us (or will end soon). While macroeconomic risk factors are on the horizon, we do not see catalysts in the short term that could trigger a change in the current more positive market perception. Nevertheless, many investors might still have the "summer lull 2008" in mind, which brought a major catalyst for a downturn – the Lehman default. Hence, we provide our priority list of "things that shouldn't happen in order not to spoil your summer holidays"."
- Macro Outlook: "While the bank stress test results led to some relief in the valuation of eurozone financials' risk, latest macroeconomic data suggest a deceleration of economic activity in the major economies may lead to more soberness in credit markets."
- Micro Fundamentals: "The European earnings season – consistent with the one in the US – currently fuels the positive momentum in equity markets as well as in credit spreads."
- Debt-Equity-Linkage: "Stock markets performed well during July, posting their strongest gains in a single month since July 2009. Credit markets rallied even stronger, to the tightest levels since May 2010. Hence it is worthwhile assessing where we stand in terms of valuations."
- Credit Quality Trend: "As authorities implement new rules for credit rating agencies (CRA) we assess their new role in light of changed regulation."
- Market Technicals: "Primary markets are already in summer lull mode."
- Valuation & Timing: "The end of the banking crisis. Sounds pathetic, but it isn't. While pressure from the slowdown will persist, what will be different is the role of the banks: Instead of being the major culprit during a crisis, they will rather become a victim during a crisis."
- Other Credit Markets: "Credit derivatives at the crossroads – an update on central clearing of CDS. Securitization: News on the new ECB haircuts for repo-collateral posted by banks in order to obtain liquidity. EEMEA Credits: Chinese banks back in the limelight."
- Allocation: "We upgrade the financials sector to MW from UW, while non-financials remain UW. Within the financials sector, we put bank and insurance senior on UW (from OW), LT2 on MW (from OW), and all other sub categories on OW (from UW), as we think that subs will outperform seniors."
- Model Portfolio: "Our financials portfolio outperformed the benchmark by 100bp, while the non-financials portfolio outperformed by 9bp."

Unicredit Euro Credit Pilot Aug2010

Emotional stress test for underweighted investors?u

- No new world: "Peak in ifo growth optimism urges caution. In past cycles over the last 20 years, the reward/risk ratio for equities has deteriorated at an upper turning point in the growth expectations. Overall, the leading indicators point to a slowdown in the growth dynamic looking to 2011."
- Reporting season: "Positive interim track record for Germany. In July, the German equity index reported positive earnings revisions for the index earnings estimates for 2010 and 2011. In the other large EMU countries, the negative revisions predominate."
- Outlook: "Bet on the expected direction of the leading indicators. Falling leading indicators mean a headwind for the equity market and argue for a sideways move in 2H10. The equity market is currently trading near the upper edge of the sideways movement."
- STOXX sectors: "Predominantly negative earnings revisions. Since the beginning of the 2Q10 earnings reporting, the earnings expectations were raised in only two sectors but reduced in 17 sectors."
- Hedge within the defensives: "Firmer EUR supports Telecom versus Food & Beverage. The relative performance of Telecom/Food & Beverage is closely correlated at the moment with the EUR development."

Unicredit Market Outlook 20100805

Weaker leading indicators will successively dominate in the course of 3Q

- Stress test: "The impact of the stress test on the ability of the interbank money market to function is a key indicator with respect to the mediumterm impact on the parameters for the equity market. The more strongly the stress in the banking system is ultimately linked with the problems of individual countries (government deficit, competitiveness), the less probable rapid relief is."
- EMU: "The causes of the tensions in EMU can only be eliminated via a protracted reform process. The possible renewed escalation of the tensions remains a material risk factor."
- Economy: "The recent rise in the Ifo expectations does not mark the beginning of a new positive trend. The positive share price effects from the reporting season will successively wane, and the strains from weaker leading indicators will increase."
- Financials: "Rally yes – sustained no. We think three risk groups will cut short the rally by the banks: credit risk, sovereign risk and regulatory risk."
- Defensives: "Growing appeal in 2H10. Leading indicators such as the money supply M1 are signaling the turning point in the relative earnings dynamic of cyclicals versus defensives."
- STOXX 600 allocation: "Chemicals, Oil & Gas, Telecom and Utilities remain overweighted. Alongside Construction & Materials, we are underweighting Basic Resources and Retail."

Unicredit Market Outlook 20100730

A summer break with no breakthrough

- FI Strategizer: "Next week, US data confirming the slowdown in the economic recovery should be supportive for Treasuries. In the EMU, solid figures on German IP and orders should keep investors moderately optimistic, with Bunds suffering slightly. We do not expect major
surprises from the ECB meeting."
- EU Portfolio Strategy: "We would return to a minor long duration stance of +0.5 years. We keep our positive view on Italy and we increase moderately our exposure on Spain, closing further the gap with EFFAS weightings. We remain moderately overweight on France."
- Trade Idea: "Over the last week, Spain tightened sharply vs. Italy, especially at the front end and at the extra long end. We prefer Italy, due to its sounder macroeconomic fundamentals and we thus suggest switching from Spain into Italy at the 3Y maturity."
- MM: "This week, results of the 3M auction sent a reassuring signal, confirming that the EU banking system is sound. Next week, only the 1W MRO is scheduled, with EUR 190bn expiring. In line with this week, we expect demand to be slightly lower than the amount expiring, leading to another modest drop in liquidity."
- Supply Corner: "Next week, primary market activity will slow down. There will be no redemptions or coupons in the EMU, while gross supply should be a modest EUR 4bn, coming from Austria and Spain. Activity should focus on the short end, with little action on the extra long end."
- FX Strategizer: "The USD took the full impact of soft US news, but we do not expect the current market scenario to improve sharply. Investors are likely to scale back their risk exposure, which should provide USD, JPY and CHF some relief and put AUD, NZD and EUR under pressure."
- EUR: "The EMU growth prospects 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: "The latent downward pressure in USD-JPY and the modest upside potential for EUR-USD will limit any EUR-JPY rebound. EUR-JPY is thus unlikely to break through, while USD-JPY should stay in the 86/88 band."
- CHF: "As feared, the EUR-CHF recovery proved to be quite capped above 1.38: as risk aversion might spark more demand for safe-haven currencies, a full break of the 1.36 base may prompt a further sell-off."
- GBP: "Sterling should stay firm also in August with risks that our mediumterm target for cable at 1.60 may be hit rapidly. EUR-GBP should offer a more constrained picture, as a full break towards 0.80 might require time."
- Pacific Rim & CAD: "Commodity units are now less supported by tighter monetary policy at home. The AUD, NZD and CAD should hold the line vs. the USD, but their recent rally is likely to stay frozen in August."
- Nordics: "A more pronounced plunge of EUR-SEK and EUR-NOK below 9.40 and 7.95 appears quite ambitious at this stage. The two Nordic units should thus struggle in the “land of nowhere” in the coming weeks too."

Unicredit Curves & Crosses 20100730

Italy: Jobs, more work needs to be done

- "While industrial production increased at a strong pace in 2Q, the end of the car-scrapping scheme is likely to have weighed on overall GDP. In 2Q, we expect economic growth to have slowed to 0.2% qoq, which should be followed by still modest growth in the following quarters."
- "While the pace of increase in the number of inactive people keeps moderating and the growth rate of the labor force steadily increased, monthly employment figures and signals from business surveys show that a real turning point in the labor market has not yet occurred."
- "In May, bank lending continued to gain a stronger foothold, although the rate of growth remains modest. Still, it is encouraging that the increase in household lending was accompanied by a return on an upward trend of corporate lending, although the latter is still in negative territory."
- "Inflation kept easing in June, following the drop in gasoline prices. In July, we expect inflation to resume its upward trend. The Italy-EMU inflation gap has closed, mainly on the back of non-core components, while the differential on core prices remained relatively stable."
- "In the Focus section we analyze the impact of the recession on the labor market. While the unemployment rate has increased less than in the eurozone, reforms are needed to foster new hiring, and prevent that a dual labor market leads to a jobless recovery."
Unicredit Italy Monitor 20100726

Diverging labor market trends

- US. "It is primarily the weak labor market that is causing Americans to worry and fueling the fear of a double-dip recession. 8½ million people lost their job during the "Great Recession". And a growing population means a further 2½ million entered the labor market (cf. chart below)."
- Vicious circle. "The economic recovery created only a few new jobs, and above all few permanent jobs. Government and temporary-help agencies are responsible for most of the new jobs. And the further weakening of the dynamic in the economy as a whole means that the current development will continue to lag behind earlier labor market cycles for some time to come. This is slowing growth, which in turn is hurting hiring plans."
- Increase. "On top of that, there is the structural change that is making it increasingly difficult for those seeking employment. Jobs in the producing sector are disappearing forever. Job openings will be almost exclusively in the services sector. The prospects for inflexible and poorly-educated applicants are virtually non existent. There is the threat of permanently
higher long-term and core unemployment (pages 2-5)."
- Germany. "The perception is, in contrast, quite different in Germany. Some are even talking about the job miracle. In July, unemployment fell for the 13th consecutive month to the level prior to the Lehman collapse. Even during the crisis, unemployment was with 3¼ mn much lower than had been feared (5 mn) since management and labor agreed on shorter
working hours and the government promoted short-time work massively.
- Forecast. In the short term, the prospects remain favorable. Nevertheless, too many hopes should not be pinned on the creation of new, permanent jobs. In fact, employees will work longer hours again. And companies are focusing more on temporary staff in any case (page 14)."
Unicredit Friday Notes 20100730

Slowdown ahead

- Turning. "While global GDP growth accelerated up until recently, there is now mounting evidence pointing to a tangible slowdown. The OECD leading economic indicators, one of the most reliable and most forwardlooking yardsticks for the global economy, are already heading clearly south (cf. chart below). Their still high level does, however, argue against
a double-dip recession."
- US. "The slowdown is already evident in the hard numbers. Recent economic indicators were generally weaker than expected. In the second quarter, real GDP probably grew at an annual rate of only 2¼% (IV/09: +5.6%). For the first half of 2011, we expect only 2%."
- Fed. "The central bank is also becoming increasingly concerned about the economy, since the retarding effects of the inventory cycle and the expiring fiscal programs will soon be joined by the headwind from higher taxes. There is, therefore, a growing risk that the Fed will initiate its tightening cycle later than projected so far. It may possibly wait until summer next year."
- EMU. "In Europe, the spring quarter should have still been pretty good. That, however, is attributable solely to a technical reaction to the poor start to the year because of the cold winter weather and not to the recovery of final domestic demand. But GDP growth is set to slow down, although maybe not as pronounced or as early as projected given the recent upbeat readings of PMIs as well as the German Ifo climate index."
- ECB. "The retarding effects of the inventory cycle and fiscal policy measures are being joined by external strains. This is increasing the risk that the ECB will also have to postpone the first rate hike, especially if today's bank stress test results disappoint investors."
Unicredit Friday Notes 20100723

Stressed but not distressed

- "Eurozone GDP likely rose strongly in 2Q, by at least 0.6% qoq. The rebound mostly reflects an export-driven surge in IP, while construction activity bounced back after the cold winter. Private consumption remains the weak spot. GDP growth should slow substantially in 2H, probably to 1% annualized, but the risk of a double-dip recession is low."
- "While we await results of the stress test to be published on 23 July, we elaborate on recent dynamics of aggregated balance sheets of the eurozone banking system, highlighting some of the differences across national banking sectors. We show that the recent banking crisis has provided incentives to significantly improve the quality of banks’ balance sheets. However, the difficult heritage of the crisis in terms of credit losses and weak economic prospects will keep weighing on banks’ profitability in the coming two years. In this context, remnants of fears regarding the potential impact of the sovereign debt crisis could persist."
- "Since the beginning of the year, Greece has significantly squeezed primary and capital expenditure, exceeding the target for the general government deficit agreed with the EU/IMF. Against these resolute fiscal consolidation steps and persistent financial woes, it is not surprising that the domestic economy has been hit severely. Growth indicators suggest that the recession is indeed deepening, but the GDP contraction should not be more severe than projected by the IMF."
- "The June inflation slowdown should be short lived, and consumer prices will probably accelerate again in July. Energy remains the main source of volatility. Food prices, despite being up only 0.2% yoy, have entered a moderate upward trajectory that seems increasingly well established."
- "The recent upward trend in short-term rates doesn’t worry the ECB, given that the move is fully driven by a drop in excess liquidity as banks are bidding less funds than the ones expiring. We analyze two possible scenarios for interbank rates and the ECB strategy after the publication of the stress test results."
- "Growth momentum in the UK probably accelerated in 2Q, but this is likely to be a cyclical peak, as growth should decelerate in the second half of the year. The fiscal tightening will negatively affect GDP over the next few years, although it won’t derail the recovery. Against this backdrop, it is unlikely that the BoE will hike rates before the end of the year and we are postponing the start of the tightening cycle to 1Q 2011."
- FI: "The summer months are usually characterized by reduced activity and low traded volumes. Seasonality suggests that this is a good time to invest in FI but, with yields very low, statistical evidence should be taken with a pinch of salt. Also, stress test results will be a key driver affecting FI returns in the near term."
- FX: "Fears that the US recovery may prove more sluggish than expected offered the EUR-USD temporary relief, but the global risk picture remains cloudy and EMU woes have not disappeared. Hence, while EUR-USD may still hold the line during the rest of the summer, its medium-term prospects are still skewed to the downside, although room for a large drop has declined significantly."
Unicredit Euro Compass July2010