Market Economics | Interest Rate Strategy - BNP PARIBAS ...

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will be strong for those currencies that have seen solid foreign inflows beforehand. When discussing inflation-fighting credentials, the ECB stands out. Only last week, the ECB’s Trichet expressed his unease at EMU HICP moving above the ECB’s 2% ceiling. Instantly, the euro rushed higher. However, in the case of the EUR, the credibility of the ECB must also be viewed in the context of outstanding credit risks, leading to nonhomogenous monetary conditions within the eurozone. Table 7 alongside has been constructed with the help of the IMF. It shows debt levels and the interest rate-growth differentials of selected EMU countries. At the start of the currency union, rates were way too loose for peripheral countries. The rule of thumb suggests that nominal GDP and rates should be at approximately the same level. The rule should particularly apply in the long term. Table 7: Public Debt and Interest Rate–Growth Rate Differential (pp) Country Debt/GDP 2007 2009 2015 1/ Historical /2 Projected /1 France 63.8 77.4 94.8 0.8 0.5 Germany 65 72.5 81.5 2.6 1.5 Greece 95.6 114.7 158.6 -1.5 2.2 Ireland 24.9 64.5 94 -5.8 3.2 Italy 103.4 115.8 124.7 1.4 1.7 Portugal 63.6 77.1 98.4 -0.6 2.2 Spain 36.1 55.2 94.4 -2.4 2.6 Median 63.8 77.1 94.8 -0.6 2.2 Mean 64.6 82.5 106.6 -0.8 2 Source: IMF’s WEO database, BNP Paribas Interest rate-Growth rate Differential Chart 8: USD Liquidity vs. S&P 500, CRB However, before the crisis, peripheral countries enjoyed relative to their nominal GDP growth very low funding costs, which led to booming and consequently busting assets. The table shows that Ireland ran a negative interest rate-growth gap of 5.6%. But now, as assets have tanked, peripheral countries are exposed to liabilities no longer covered by asset values. The funding costs of these liabilities have soared and will stay high if you believe the IMF numbers, leading to the perverse situation that monetary conditions in the recessionary countries of Europe’s periphery have tightened while booming Germany faces superloose monetary conditions. This environment will put the inflation-fighting credentials of the ECB to the test. We recall the situation from August to early November, when the ECB channelled 3mths Euribor rates up by about 60bp. At the same time, intra-EMU credit spreads widened, leaving us confident with our EURUSD 1.34 year-end call for 2010. Now as inflation is moving up and the ECB rhetoric is becoming more hawkish, we are watching credit spreads with interest. As long as credit does not pop up, the euro will strengthen, supported by expectations of a hawkish central bank reaction to rising inflation. However, recessionary peripheral economies facing already-tight monetary conditions are unlikely to cope well with monetary tightening. Inflation and the reaction of central banks must always be viewed in the context of credit; this is particularly the case for EMU. Inflation will kill the ‘quasi-China trade’ Source: Reuters Ecowin Pro, BNP Paribas Third, the emergence of inflation might actually be good news for countries currently stuck in deflation or facing the threat of deflation (e.g. Japan and the US, respectively). On the other hand, inflation represents the biggest threat in countries where there has been domestically built up leverage. Above, we discussed the case of China, where inflation will either undermine the real value of household assets (in the case of deposit rates remaining below inflation) or the highly leveraged corporate sector faces rising funding costs (should the central bank take on the fight against inflation by increasing official lending rates). In our view, the inflation trade is the ‘anti quasi-China trade’ working against shares, commodities and last and not least the AUD. Inflation will bring the USD-funded carry trade to an abrupt halt, leading to a higher USD. Inflation will weaken the JPY Fourth, rising inflation globally will put the JPY under significant selling pressure. Japan has accumulated foreign currency hedged assets as hedging costs became virtually zero in a world where quantitative easing is a common policy tool. When inflation comes back and central banks tighten policy, the JPY will fall victim to the process. Hans Redeker 20 January 2011 Market Mover, Non-Objective Research Section 62 www.GlobalMarkets.bnpparibas.com
EURUSD Rally Eyes 1.3750-1.3950 • The EURUSD rally is poised to break out above 1.3500 sparking a larger medium-term rally toward 1.3745-1.3980 • Bullish weekly momentum appears strong enough to fuel a larger rise toward 1.40-1.41 over the next 3-5 weeks • However, a break above 1.40 would increase the odds of a multi-month EURUSD rally toward 1.4335-1.4455 • The US Dollar Index (DXY) has broken its December base favouring a deeper dive towards 76.25 The EURUSD rally has broken above 1.3500 this week hitting its highest level since late November. By overcoming 6 weeks of resistance between 1.3435 and 1.3500, the rise favours a medium-term extension towards the 1.3745/85 resistance including the 61.8% Fibonacci retracement point of November-January’s decline. The bullish tone of weekly momentum suggests the EURUSD rally may reach 1.40-1.41 in the next 3-4 weeks. Currently, weekly momentum (51% on the 8-week stochastic indicator) is strongly bullish, accelerating and just crossing the neutral zone (50%). This is similar to weekly momentum conditions in early July 2010 when EURUSD was in the midst of its 1.1875-1.3335 summer rally. On a comparative basis, this suggests the EURUSD rally has scope to climb another 5-6 cents towards 1.40-1.41 by the end of February. A further rise above 1.40, however, would be a very bullish longer-term development opening scope toward 1.4335-1.4455. It would suggest the June 2010 rise is continuing and will ultimately be comparable to the October 2008-November 2009 rise, targeting 1.4375 (the 76.4% retracement point of the November 2009-June 2010 decline) and the July 2008 downtrend near 1.4455. Such a rise could persist until mid-March to early April forming a major EURUSD top in the process. In the short term, EURUSD could see a pullback correcting some of its recent gains. Support near 1.3245-1.3200 should limit such losses and provide a EURUSD buying opportunity. As the mirror image of EURUSD, the US Dollar Index (DXY) is falling sharply off its November/January 81.44/31 double-top. This week’s break of 78.77 key support (December low) risks extending the sell-off to the 76.25 double-top objective. Such a decline would increase the probability of a longer-term DXY decline towards 75.50-74 akin to a EURUSD rise towards 1.43-1.45. Chart 1: EURUSD – Medium-term scope to 1.3745/85 and potentially 1.3950/80 EURUSD has cleared 1.4280 the 1.3500 level 1.4160 implying the Nov-Jan 1.40 decline is being retraced with 1.3500 medium-term scope 1.36 towards 1.3745/85 1.3335 over the next few weeks. Bullish weekly and monthly momentum could extend the rally 1.32 1.28 1.2965 1.2870 towards 1.3950/80 retracing 3/4ths of the Nov-Jan decline. Short-term pullbacks 1.24 1.20 1.2642 towards 1.3245 1.1875 support would provide a buying 1.16 opportunity. 31-May-10 28-Jul-10 24-Sep-10 23-Nov-10 20-Jan-11 Source: BNP Paribas Andrew Chaveriat 20 January 2011 Market Mover, Non-Objective Research Section 63 www.GlobalMarkets.bnpparibas.com
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Market Economics | Interest Rate St
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The obvious focal point is the Summ
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such shocks at the moment, such as
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US monetary conditions, because the
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Chart 9: Asia- Ifo Expected Inflati
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Page 23 and 24: households. Furthermore, the statis
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Page 27 and 28: Japan: New Cabinet and Policy Outlo
Page 29 and 30: Japan: Capex Outlook • Core machi
Page 31 and 32: US/EUR Spreads: Further Tightening
Page 33 and 34: US: Could the Short End Have a Puls
Page 35 and 36: Trades with higher hit ratio and Sh
Page 37 and 38: ange bound, as we expect, given tha
Page 39 and 40: EUR: Liquidity is No Stress • The
Page 41 and 42: EMU Debt Monitor: Trade Ideas • K
Page 43 and 44: EMU Debt Monitor: CDS Analysis Char
Page 45 and 46: EMU Debt Monitor: Redemptions • O
Page 47 and 48: EUR: Buy 3m5y Straddle vs 3m10y Str
Page 49 and 50: Global Inflation Watch Eurozone HIC
Page 51 and 52: Table 2: BNP Paribas' Inflation For
Page 53 and 54: Inflation: With Supply Comes Opport
Page 55 and 56: Pricing Date Repo Rate Sett. Date T
Page 57 and 58: Germany 10y: MT 61.8% (3.12) break
Page 59 and 60: Travelling Asia • Inflation has e
Page 61: Capitalism requires business cycles
Page 65 and 66: Currency Spot Trade Recommendations
Page 67 and 68: than an unrelenting rise in prices
Page 69 and 70: Economic Calendar: 21 - 28 January
Page 71 and 72: Key Data Preview 120 115 110 105 10
Page 73 and 74: Key Data Preview Chart 5: French Sa
Page 75 and 76: Key Data Preview 10 5 0 -5 -10 -15
Page 77 and 78: Key Data Preview 3 2 1 0 -1 Chart 1
Page 79 and 80: Economic Calendar: 31 Jan - 25 Feb
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Page 83 and 84: Economic Forecasts GDP Year 2010 20
Page 85 and 86: Market Coverage Market Economics Pa
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